Can History Save Us From A Depression?


The correct solution back in the late twenties, rather than the one we chose through the Smoot-Hawley Tariff Act—which made us poorer—was to share these growth ideas with the rest of the world. I’m not talking about sharing through the distribution of goods, by sending foreign aid out of the United States. I’m talking about sending ideas out. We are now getting a second run at this global leadership. Now, I hope, we’re going to be able to meet the challenge.

You mention the Mellon tax cuts of the twenties, which are one of the inspirations, certainly, for the whole supply-side revival in economics. Those tax cuts, and the boom that followed, actually increased government revenues to the point where there were regular surpluses. In that period the national debt declined by some 30 percent. Why didn’t the Reagan tax cuts of our era achieve the same ends?

A couple of things. One is that there was no social safety-net system in the 1920s. So when the crash occurred, Andrew Mellow said, well, you liquidate capital; you liquidate labor; you just liquidate things until you get back to a new equilibrium. But that meant that the poorest people in the country were crushed in the process. You can’t do that today—and shouldn’t. The second thing is that in the 1920s we were on a gold standard. That meant that monetary policy was acting at an optimum rate.


Now we have a floating currency, where monetary errors can be made and have been. We had a monetary deflation that brought the price of gold down very sharply from when Reagan was elected—from $620 to less than $300 in the summer of 1982. So we wound up with a recession, and this process brought the big deficits. Supply-siders were warning in the early 1980s that unless the Federal Reserve System was prevented from tightening monetary policy in 1981 and 1982, as it did, we would wind up with colossal budget deficits.

Recession in the kind of welfare state we have arranged is enormously expensive. The safety net is a good thing, but it costs. So supply-siders have been arguing from the beginning of the Reagan administration that at all costs recession must be avoided.

So, in your view, the budget deficits are a consequence not of tax cuts but of a restrictive monetary policy that triggered a recession in 1982. In any event, for years now, we have been running the highest deficits in our history, and we have a two-trillion-dollar national debt. Many suggest that the crash of October 1987 was in response to this. Is that right? How serious are the budget deficits? How serious is the national debt?

Again, the greatest threat to our deficits and our national debt is recession. The two-trillion-dollar national debt is not something that supply-siders are frightened by, because we have seen the tremendous addition, over the last several years, to the asset side of the ledger. The value of past savings, the value of financial assets to the United States, has risen by a phenomenal amount. It should make it relatively easy to finance the deficit, as long as we get it under control at some point. Now getting it under control at some point means not having any more recessions for a while. Not engineering them, certainly.

Doesn’t history offer some comfort in terms of the debt and the budget deficits? They’ve increased tremendously in nominal terms, but as a proportion of gross national product or—as you just pointed out—as a proportion of assets, they’re roughly what they were twenty-five years ago.

And they are much lower than they were at the end of World War II. At that time the publicly held national debt in the United States was something on the order of 120 percent of GNP. In other words, the whole country would have to work for fifteen months in order to pay off the national debt completely. At the present moment the publicly held national debt is something less than 50 percent of GNP, which means we would have to work six months to pay off the creditors.

What about the trade deficit?

We’ve become the world’s greatest debtor because of the enormous capital inflows that have come into the United States as a result of supply-side growth policies. When we were beginning to sell the idea of encouraging the wealth of nations by getting tax rates down to an optimum level, we pointed out that if we did this first in the United States, we would quickly have to get the rest of the world to replicate our policies. Otherwise, capital would flow to the United States. And capital can flow to the United States net only if we run a trade deficit. A trade deficit is the flip side of a capital inflow.

If Japanese investors see that profit opportunities are greater in the United States than they are in Japan, they will sell us more goods than they’re buying from us so that the differential can be used to buy financial assets. In other words, they can’t buy stocks or bonds or hotels on Central Park South unless they sell us more goods than they’re buying from us. So the capital inflow is huge today because we’re a magnet for capitalism worldwide.

Why did this happen?

Because the United States, under President Reagan, had to grope its way out of the world of the 1970s—the world of stagflation—by cutting taxes. With the tax reform of 1986, the United States will have a top tax rate of 28 percent. This makes us, as The Wallstreet Journal put it, the biggest tax haven in the world. And it is the capital flowing in that produces these enormous trade deficits.