How the U.S. Government Got Fat Jude Wanniski August 7, 2000

Yesterday’s “Memo on the Margin” about “Dick Cheney, Socialist,” really should have been an SSU lecture, as it offers a fairly clear picture on how seemingly small errors by the Federal Reserve in managing the paper unit of account, the dollar, can cause great mis-allocations of capital. It will enable you to understand why the price of a gallon of gasoline dropped so low two years ago and why it climbed so high this year. Only a supply-side analytical framework could provide that insight. If you have not read it, you should make a point of doing so even before you proceed with today’s lesson. I’ve reached back to an editorial I wrote for The Wall Street Journal almost 25 years ago, on December 11, 1975, when “Supply-Side Economics” was in short pants. (Actually, I decided to coin the phrase in 1975 to describe the classical economics of production that had been revived by Robert Mundell and Arthur Laffer, whose ideas we covered in three previous lectures this summer session.)

Remember, it was not long after President Richard Nixon was persuaded to break the dollar’s link to gold in 1971 and the dollar/gold price in six months doubled to $70 per ounce that Mundell predicted there soon would be a dramatic rise in the price of oil... and then all other commodities. In the years 1972-73, the gold price doubled again, to $140. Mundell’s only error was that other commodity prices soared even before oil did. This was because there are myriad producers of all other commodities, like copper and zinc, and a relatively few producers of oil, who continued selling more and more oil at prices below $3 a barrel until they decided the dollars they were getting had fallen in their purchasing power of all real goods. They then decided they would quadruple the price of oil. Because almost all the economists except Mundell and Laffer thought it a good idea to float the dollar, they had to explain the quadrupling of the oil price in terms of supply and demand. The Political Establishment quickly came to the conclusion that the world was RUNNING OUT OF OIL AND GAS!!!

Oh my goodness. If that were true, then we would soon FREEZE IN THE DARK. A coalition quickly formed from left-to-center-to-right. Clearly this was a problem with which the free market could not cope, so Republicans lined up behind the idea that the federal government had to SUBSIDIZE ENERGY ALTERNATIVES. This would be “conservative” only if private enterprise would do the actual work of turning coal into oil. Liberals, who loved the idea of having the government supervise this Common Cause, also liked the idea because it was environmentally nicer to turn smelly coal into clean gas. It would cost a fortune to do all this, more than the $12 a barrel the Arabs were charging, but sober centrists got behind the idea on the grounds that national security was at stake. This rationale could explain the rush by corporations that owned lots of coal, including Exxon, joining forces with banks like Chase Manhattan, to promote a new “Manhattan Project” that might be a tad expensive, but would SAVE MANKIND. How interesting that President Gerald R. Ford would choose his hand-picked Vice President, New York Governor Nelson Rockefeller, to head the “synthetic fuels” project. Rocky’s father, of course, had founded Exxon, which owned all that coal, and his brother David ran Chase Manhattan, Exxon’s banker. This is the way the world works. These were fun times for the WSJournal editorial page, where I worked under editor Robert L. Bartley, who still is at that same post. The editorial, headlined simply “BURP!” was one I especially enjoyed writing.

The Wall Street Journal
December 11, 1975
BURP!

The cover of the current issue of Newsweek is suitable for framing and would make a nice Christmas present for every member of Congress. Under a headline that reads, simply, BIG GOVERNMENT, sits an illustrated Uncle Sam weighing several hundred pounds, bloated and ready to burst.

How does he get so fat? Even though he knows he should slim down, Sam cannot resist eating tempting morsels. This week it’s a $6 billion loan-guarantee program of the Energy Resources Development Administration (ERDA) to develop synthetic fuels. The bureaucrats say “synfuel.” When this bold new program hit the Senate floor Tuesday, it was gobbled up by an 80-to-10 vote. No hearings. Almost no debate. About the only opposition came from the liberal Democrats, not because another $6 billion is fattening, but because it doesn’t suit their environmental tastes.

Why should the federal government be getting into the business of developing synthetic fuels? Well, er, there’s an energy crisis, isn’t there? Can’t we invent our way out of it? Like the Manhattan Project? Turn our scientists loose and have them find ways to turn coal into gas or coal into oil or squeeze the petroleum out of shale. Private enterprise, not Uncle Sam, really does the job. The government only puts up the cash, indirectly, by guaranteeing loans that banks would otherwise deem too risky. Jobs will be created, won’t they? And because Uncle Sam doesn’t do any of the actual work, it doesn’t make the government bigger, does it?

It is this kind of rationalization that tempts even the congressional conservatives, who would decry the scheme if it meant setting up a Federal Synfuel Corporation. But there is no significant difference in handling the scheme one way or the other. ERDA bureaucrats, not the marketplace, will decide which synfuel projects get the priorities. ERDA bureaucrats, not the marketplace, will decide which companies get the loan guarantees. ERDA bureaucrats, after heavy lobbying from the politicians, will decide which regions of the nation will be favored with demonstration projects.

To their credit, the great majority of the petroleum companies oppose this scheme because they know how damaging it will be to the national economy. Instead of applying their financial and technical resources to research projects that seem to be the most economically promising, the industry will be wagged by Washington. To remain competitive, companies will be forced to focus their efforts on politically pet projects, engaging in energy grantsmanship in the same way that city and state officials fought for federal matching funds in “solving” the urban crisis. Cities abandoned their own priorities, for which no free money was available, and adopted the federal priorities. The $6 billion ERDA scheme is conceptually the same as an urban renewal scheme, and might as well be called Energy Renewal.

The fact that the $6 billion would not be a direct expenditure of tax money, and would not show up as an item in the federal budget, is only fiscal gimmickry. The economic effect is the same as if the government squeezed $6 billion in taxes out of the private economy where it would be spent economically, and shoveled it into projects that are, by definition, uneconomic.

There is business support for the ERDA scheme, mostly from the natural gas producing and pipeline companies, which have become uneconomic because of previous meals Uncle Sam has made of them through price controls. They apparently figure they might as well blend uneconomically low-priced gas with uneconomically high-cost gasified coal and somehow come out even. Thus, the solution to problems caused by government interference is more government interference.

Although they might hate to admit it, those conservatives who so easily swallowed the ERDA bill helped move Uncle Sam toward nationalization of the energy industry. The synfuel project will inevitably become more costly, wasteful, corrupt and politicized and as a “solution” to these problems Uncle Sam will be asked to step in and do the job right. That’s how he gets so fat.

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Postscript: Thank Goodness for our democratic system and the American people. A few months after this editorial was written, the 1976 presidential campaign got underway. The Democrats put up several contestants for their presidential nomination, all of whom promised to nationalize the oil industry!!! Or at least punish it for having caused the Energy Crisis!!! Except one, a peanut farmer from Georgia named Jimmy Carter, who said he would actually lift price controls on oil. President Ford announced that he would continue the price controls!! I then wrote a lead editorial about Ford’s blunder, “A Major Presidential Mistake,” that practically invited Ronald Reagan into the race. Ford narrowly defeated Reagan and tried to pacify the conservatives by kicking Rockefeller off the ticket, replacing him with a Senator from Kansas named Dole. Carter went on to victory, but one of his first acts as President was to announce that he would not lift price controls on oil after all. Ronald Reagan had to come back in 1980, defeat Carter, and lift price controls as one of his first acts as President.