The economic legacy of the Vietnam war has been an enduring inflation.
Even today, after five years of high unemployment and idle productive capacity, prices still are rising faster than 4 percent a year, more than double the pace of the 14 years preceding the war.
The demands of the war fell on an American economy already operating at or beyond full employment levels. When these demands were not offset by quick tax increases or federal spending cuts, an overheated economy started a wage and price spiral that never has been fully tamed.
The forces loosed during the war years were so strong that even a recession and then wage and price controls imposed in August 1971 could not contain them.
For the first time in modern history, an upward spiral of prices and wages endured through a recession (and, incidentally, destroyed a broad consensus among economists about the causes of inflation).
The actual rate of inflation was not at all high by today's standards. The problem was its acceleration. In the early 1960s, prices were rising about 1 1/2 percent a year, as measured by the gross national product implicit price deflator. That crept up to 2.2 percent in 1965, the year when the big American military build-up occurred and the year when the economy began to get off the track.
The essential difficulty was that the war spending further stimulated an economy with virtually no slack in its labor or product markets. In addition, President Johnson was reluctant to seek a big tax increase that would have reduced private-sector demand to make room for the war outlays.
As the inflation pressures rose in late 1965, the Federal Reserve tightened its monetary policy, an action that brought an angry response from President Johnson. But after his initial outburst, the president kept quiet even though interest rates continued to rise in 1966.
Gardner Ackley, a University of Michigan professor who then was chairman of the Council of Economic Advisers, recalls being asked by the White House that spring why Johnson should not condemn tight money and high interest rates.
"I went back through my files and pulled out about 10 different places in which we had said, in so many words, 'If you don't have a tax increase, one of the things you're really going to get is tight money and high interest rates. That is the choice you have to make.' So I said, 'We told you so!' Never another word. But he did take it. He was very unhappy," Ackley says in an oral history, "The President and the Council of Economic Advisers," published last year.
At that point, Johnson was not prepared to propose a major tax increase even though Ackley, Budget Director Charles L. Schultze and others urged him to do so. The standard interpretation is that Johnson resisted because he did not want to jeopardize passage of the pending Great Society legislation.
Schultze -- who later was CEA chairman in the Carter administration and who now is at the Brookings Institution and the University of Maryland -- says he believes that other factors were involved as well. For one thing, in late 1965 and early 1966, Johnson was under more pressure from hawks who wanted "to bomb Hanoi back to the Stone Age" than he was from doves wanting a U.S. withdrawal, Schultze says.
"Johnson could have wrapped himself in the flag and gotten a war tax like Harry Truman did during Korea, for a war that wasn't all that popular," Schultze says. "But Johnson was still trying to limit the scope of the war. He was afraid he would lose control of the limited war."
Also, at the beginning of 1966, no one knew how long U.S. involvement in the war was going to last. Budget planning was done on a kind of month-to-month basis, with Secretary of Defense Robert S. McNamara unwilling to let the military include money for long-lead-time items that they might not need. As the year wore on, defense spending escalated. Instead of the $10 billion budgeted for the 1967 fiscal year that began July 1, 1966, on the assumption that the war would end in mid-1967, it jumped to $20 billion. (In today's dollars, that $20 billion is $60 billion. Taking into account both inflation and growth of the economy, it would be the equivalent of $100 billion now in terms of a comparable impact on total demand for goods and services.)
By early September of 1966, Johnson had accepted the clear need for a tax increase, partly to encourage the Federal Reserve to lower interest rates. Interestingly, he called primarily for temporary suspension of the investment tax credit and a $6 billion increase in Social Security payroll taxes, and he promised to cut nonessential government spending.
But the Fed's tight money had done its job: By late 1966, the economy had ceased to grow and wholesale prices were falling. Under those circumstances, and with the war's cost still unclear, Congress wasn't buying most of the package, although it suspended the investment tax credit.
As part of his fiscal 1968 budget in January 1967, Johnson renewed his call for a tax increase but asked instead for a temporary 6 percent surcharge on personal and corporate income taxes. Two months later, with the economy still looking weak and new orders for capital goods flat, the president asked Congress to reinstate the investment credit, while still asking for the tax surcharge.
By August, the economy was picking up again and the U.S. involvement in the war continued to escalate. With the prospective budget deficit growing along with renewed inflation pressure, Johnson asked not for a 6 percent, but a 10 percent, surcharge effective almost immediately.
Finally, after a long and rancorous debate that centered on congressional insistance on spending cuts -- and after Johnson had made his dramatic announcement that he would not be a candidate for reelection -- the surcharge was passed and signed in June. It was effective retroactively to Jan. 1 for corporations and to April 1 for individuals, and it was supposed to expire in mid-1969.
The Fed, meanwhile, had tightened its policy again but quickly relaxed it once the tax surcharge was in hand.
With all the benefits of hindsight, it is clear that the restraining actions on both the fiscal and monetary fronts were too little and too late to keep the economy from experiencing a major surge in inflation. Schultze says that, even had Congress acted promptly on the surcharge, while it would have helped, it would not have been enough.
The brief economic slowdown in late 1966 and early 1967 did reduce price pressures, particularly at the wholesale level, and the GNP deflator (a broader and somewhat different measure than the consumer price index), rose 3 percent in 1967, slightly less than the year before.
But there was just too much pressure on labor markets. The civilian unemployment rate, which had been at 5.2 percent or higher between 1958 and 1964, had fallen to 4 1/2 percent in 1965. Despite the slowdown, it averaged only 3.8 percent in 1966 and 1967. Then it dipped again, to 3.6 percent in 1968 and to 3 1/2 percent in 1969.
Estimates today vary about the level below which unemployment can not be pushed without causing inflation to take off. The estimates range from about 4 1/2 percent to 5 percent or more.
The extremely low rates of unemployment that actually occurred -- and the accompanying very high rates of utilization of productive capacity -- were simply not consistent with stable prices. Schultze says it was a classic example how a low, but not sharply falling, unemployment rate can be associated with an accelerating inflation. The deflator, which rose 3 percent in 1967, went up 4.4 percent in 1968 and 5.1 percent in 1969.
The CPI accelerated even more, from about a 1.3 percent rate in the early 1960s to 5 1/2 percent in 1969.
A climate of nearly stable prices, which had helped to foster a massive investment boom in long-lived capital projects, was replaced by an inflation sufficiently serious to persuade the incoming Nixon administration to seek extension of the tax surcharge at a 10 percent rate for the second half of 1969 and at a 5 percent rate for the first half of 1970.
The advent of the surcharge and some limited spending cuts had swung fiscal policy from being sharply stimulative in fiscal 1968 toward significant restraint. That, plus a new round of tight money from the Fed, pushed the economy into a mild recession.
As usual with any administration, President Nixon and his advisers weren't entirely candid about what they expected to happen. During the first two-thirds of 1969, there were few signs of a slowdown, and repeated doubts were expressed that one would occur.
When the unemployment rate jumped from 3 1/2 percent in August to 4 percent in October (a figure later revised to 3.7 percent), Murray L. Weidenbaum, then assistant secretary for economic policy at the Treasury and later President Reagan's first CEA chairman, told a Washington audience that he welcolmed the increase as evidence that the administration's policy was working. There were immediate expressions of outrage from Capitol Hill over such a callous, unfeeling concern for the unemployed, and quick recantations from the administration followed.
Nevertheless, the economy was slowed as a result of deliberate policy actions taken to reduce inflation. Similar steps were taken again in 1974 and 1980 and 1981, each time to curb rising prices. Each time the nation paid the price in lost income and jobs. The current distress in a number of industries, particularly agriculture, can be traced directly to the process of disinflation that is still going on.
During the 1970s, of course, there were other major inflationary surges related to the two oil and food price shocks. They would have boosted prices had Vietnam and its inflationary legacy never occurred.
However, the supply shocks, especially on the food side, were temporary. Without Vietnam and the wage-price spiral that it set off, the food and energy price increases might well have not gotten built into the nation's basic wage structure to the extent that they did. If stable prices are the norm, then a departure from that norm may be regarded by workers and their employers as no more than that.
Stable prices were not the norm when the food price pressure began to build at the end of 1972 and the first oil price shock followed in 1973 in the context of a worldwide economic boom. Instead, these pressures came just as the Nixon administration was getting ready to unwind the wage-price controls it had imposed in 1971.
The controls, while holding down prices and, to a lesser extent, wages, also in a new way sensitized everyone to inflation and how best to protect oneself from it. One lesson clearly was that, with a risk of controls, get your wage or price increase sooner rather than later. Later may not be allowed.
And with price controls essentially controls on profit margins -- that is, cost increases could be passed through in selling prices -- there probably was a reinforcement of the notion that cost pressures need not be resisted all that strongly, because they could be borne by the customers.
In other words, the American society had become conscious of inflation, it was expected and the trick was to figure out how best not to be left holding the bag. Real assets -- most of all, a family's personal residence -- became the best inflation hedges.
Again, without Vietnam, there may well have been no price controls, certainly not in 1971. On the other hand, the inflation in the United States also put new pressure on the fixed-exchange-rate regime of the international monetary system, which began to collapse in 1971 and was dissolved in early 1973.
Just in terms of the acceleration of inflation, the Vietnam episode did more damage than either of the supply shocks of the 1970s, Schultze says. The GNP deflator eventually accelerated from about a 1 1/2 percent rate of rise to close to 10 percent, an increase of 8 1/2 percentage points. Vietnam accounts for about 4 of those 8 1/2 percentage points; and the two supply shocks together, for the remainder, he says.
As distant as are all the debates about the need for a tax surcharge and spending cuts to offset the demands of the war on the federal budget and the economy, the legacy has not disappeared.