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Art Laffer: As Close to Economic Nirvana as Could Be Imagined

The formula to ensure prosperity is simple: Add a low-rate, broad-based flat tax to spending restraint, free trade, and sound money, and there you have it.

The Great Depression was born out of xenophobic protectionism, embodied in the 1930 passage of the Smoot-Hawley Tariff, plus 1932’s massive increases in tax rates on our country’s most productive members. The economy collapsed as never before.

Gold being then, as it still is, the first refuge of the cautious, became a safe haven. There were runs on banks as depositors demanded gold in exchange for deposits or currency. The value of gold as measured in goods and services soared, meaning that there was a tremendous fall in the price level. Money back then was gold.

President Roosevelt was swept into office in March of 1933. Instead of reversing Hoover’s tariff and tax increases, Roosevelt made gold the scapegoat. In his first month in office, he legislated the so-called Bank Holiday Act, which prohibited banks from buying or selling foreign currencies or specie — especially gold; eliminated all gold clauses in contracts, public or private; and finally made holding gold by Americans illegal.

Gold ceased to be currency in the United States. This was the first step in ridding the monetary system of gold.

In late 1933, to make matters worse, Roosevelt followed his gold confiscation by devaluing the dollar against foreign currencies by some 60% and raising the official price of gold to $35 an ounce from $20.67. This was an enormous wealth tax on former gold holders. The depression settled in, lasting until 1945.

The anomaly was that while gold was removed from the U.S. economy, it still remained the official settlement medium internationally.

In the immediate postwar era, an incredibly well designed international monetary system was locked into place as a result of the Bretton-Woods accord. The dollar was fixed in price to gold by the U.S. at $35 per ounce, and other currencies were fixed in price by their separate monetary authorities to the dollar. There were no agency problems and redundancy problems, and the International Monetary Fund smoothly meshed international monetary settlements the world over.

Prices were stable, growth extraordinary, and peace broke out. This period was as close to economic Nirvana as could be imagined.

The task of fixing the dollar price of gold required the United States to buy as much gold as it took to keep the price high enough. This was easy — the United States could print as much money as it needed in order to buy gold.

We also had to sell gold out of reserves when gold prices began to rise. This side of the transaction was far more difficult because it required domestic monetary discipline. By 1971, the lure of easy money and bad economics proved too much for an undisciplined America.

Dramatic action-packed policies were President Nixon’s trademark, manifested, in part, by the United States going off gold. George Shultz, who over a half century hired me six separate times, was greatly persuaded by Milton Friedman that free markets mandated flexible exchange rates and abolishing the government price-fixing of gold.

John Connally, who was as impressive a pol as I’ve ever met, told us “If you want it square, I’ll sell it square, and if you want it round, I’ll sell it round.” Within the White House, no one else mattered.

At the time, I remember only two insiders who argued against going off gold — myself and Paul Volcker. My personal relationship, as well as my unwavering respect for George Shultz, was never impacted by our rare disagreements (he was my boss and he always listened).

However, in January of 1974, in the Wall Street Journal, I wrote an article entitled, “The Bitter Fruits of Devaluation,” which forecasted double-digit inflation as a consequence of the Camp David/Smithsonian Accord and going off gold.

In private George was uncharacteristically critical of my paper, but a couple of years later confessed that he was “the least surprised person” in the capital when we hit double-digit inflation.

As far as Paul Volcker was concerned, I had thought my alliance with him in 1971 on gold would have solidified a bond. No such luck. The only thing Paul Volcker liked more than a gold standard was super-high tax rates on the rich. Oh well, I liked him anyway, even if his feelings for me weren’t reciprocated.

After a decade of economic and financial trauma, President Reagan, along with Paul Volcker, temporarily brought 20 years of sanity back to America. Since the 2000's we seem to have lost it once again, and this time worse than ever.


Mr. Laffer, an economist, was awarded the Medal of Freedom by President Trump in June 2019. Image: Detail of the White House photo.

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Posted: August 14, 2021 Saturday 01:39 PM