Economics of National Defense: Fiscal Policy Hamstrings Defense Policy

Sept. 1, 1957
President Conant, of Harvard University, used to refer to a certain speech of his as his “Texan longhorn speech”—two sharp points and a lot of bull in between.

Now, Professor Leach has recalled certain tragic and costly experiences in recent history. My first point invokes the statement of the late, great, perceptive James Forrestal: “It is obvious that defense policy should be continuously coordinated with the state of our foreign relations.” What is not obvious, what is being tragically ignored today, is the prime Forrestal teaching, that defense policy requires continuous coordination, not merely with foreign relations, but with fiscal policy.

Forrestal fought his way through, at the expense of his own career, to the clarification of that concept a decade before. The technological revolution in weapons production landed us in the middle of what is anything from an eight- to fifteen-year cycle, from the consumption of drawing board paper to combat readiness of weapon systems in being. It’s just taken us the better part of eight years and $800 million to find out that we don’t know enough about a certain well-known missile to test it. But the money cycle can’t run eight years.

Speaking of the enemy, you know the old saying, “Would that my enemy had written a book.” Well, our enemy has. Karl Marx said “I stood Hegel on his head.” What has resulted from our forgetting that money policy should be coordinated with defense policy is that we have stood that relationship on its head, and defense policy is now being coordinated with money policy. And that’s not only worse than it sounds, it is much more unworkable than anyone trying it yet realizes, for this reason: Money policy by definition changes with every gust of economic wind. If the new Chevrolet, which may or may not come with fins, is a flop, money policy will change accordingly. If there is bad weather over the Fourth of July, money conditions will change. People who participate in the money market not only count—they read. Whether they have confidence or lack of confidence, in one day can offset economies in the defense establishment which it will take a decade or more to assess.

For example, the last refinancing of the Treasury. If it had been a success, which it wasn’t, the Treasury would have had in pocket $1.2 billion. But this financing, however ingenious from a mechanical standpoint, by the generosity of its offer, frightened the untrusting recipients of the new bonds so much that the Treasury has had to shell out $1.2 billion. I would like to know, and I suspect that both the Treasury and Defense Departments would like to know, whether the $2 billion taken out of the current situation in the Pentagon had been reckoned before the erosion of the $1.2 billion suffered through the failure of the last financing.

When the Treasury is obligated to pay four percent for money that is not long-term money, and when public utilities are unable to sell their bonds for over six percent, the taxpayer finds it cheaper, he finds it an economy, to bank his tax accruals with the United States Treasury by not paying his taxes and incurring a merely six percent interest obligation instead of going to the institutions, if the usury laws will permit, and paying more than six and a quarter percent. When that happens, the Treasury loses funds as surely and more swiftly than it can hope to recapture by whatever it does to the defense program.

In any event, my first point is that the defense program is an eight- to fifteen-year program at any given point. Money policy at any given point is a twenty-four-hour to a twenty-four- or thirty-six month affair. You obviously cannot subject the long-term cycle to control by the short-term cycle. President Eisenhower is being criticized, the administration is being criticized, for the defense steps that have been taken. I feel it appropriate to congratulate the President upon the appointment of Secretary Anderson to the Treasury, because it’s high time, it’s an appropriate time, it’s a desperate time, to bring to the Treasury a man who has had a close and a working and a policy experience of the defense establishment, since the time when the defense cycle has come to be a two or three times longer affair than the money cycle.

Now, for my second point. We are told that the reason for what has been done on the defense side of the budget is that the debt limit must be respected. The logic of this proposition follows from the fact that our $70 million budget is four-sevenths defense. Therefore, goes the reasoning, to control spending and stay within the debt limit, slice at the four-sevenths part on the spending side. I put it to you that the question about the budget is not whether we are going over the debt limit, and soon and fast; the question about it is not whether the spending level is going over $70 billion. The question is whether, for the inflation that we are involved in, and for the spending and the deficits that lie ahead of us in any case, we are going to get less defense or more defense.

I read in the paper that the Office of Defense Mobilization had pronounced zinc out of bounds for defense purposes. Well, of course it is. Let the price of zinc, however, do what the price of zinc has done and let the employment of people in the zinc business suffer what has happened to them and there will be, I promise you, indeed, as I report to you, spending for zinc, not on defense account but on political account, on home relief account. Wheat, zinc, the automobile business, employment—are all interrelated. The Treasury is on a Chinese laundryman’s basis with the economy. No tickee, no shirtee; no cash flow, no tax collections.

There are two ways in which a deficit grows. The first is by spending more than you collect. The second is by collecting less than you spend. The effect of the current decisions, coupled as they are and compelled as they are by the subordination of defense policy to monetary policy instead of their coordination, is going to spell failure to the speculative experiment which launched this policy.

Secretary Humphrey stated some months ago that the Treasury’s tax collections would rise $3 billion annually. The basis for this speculation was that defense spending was rising at that rate. Collections are going to fall, not solely as the result of the defense decisions which are being applied, but also because of the governing monetary decisions which have put up the price of money.

Let the bond market fall, let the stock market fall—or merely not rise—let employment fall, let overtime disappear, and the Treasury’s tax collections will fall. There is, in other words, a built-in valving system between defense spending and over-all collection—between, if you will, defense spending, or the defense component of the Treasury’s situation, and the nondefense components. Let the defense component valve out, cut off, deflate, or depress—given the shortness of the money cycle for merely six months—and the Treasury will run into as difficult a situation as if the defense establishment were being enabled to fund, to budget requirements, and to spend in the only way that I know—or, if I may say so, that anyone knows—to achieve defense economy. And that is, as Mr. Baruch has put it, “by continuous respect for requirements which accrue whether they are put into the budget or not.”

* * *

Mr. Childs: We have heard a great deal from officials in the government and elsewhere about the very greatly increased cost of modern weaponry, and we are told that this is contributing to the current inflation. I would like to ask Mr. Janeway to appraise briefly what contribution this spending has made to inflation.

Mr. Janeway: It has made a very substantial contribution to inflation, for the reason that it has put out into the country a tremendous and continuous and geographically diversified flow of purchasing power without correspondingly creating merchandise wanting to be taken off markets or slowing down prices. It has, in other words, contributed a net of purchasing power. But that is of the essence of all research and development and construction and capital investment, whether in the defense establishment or whether conducted by IBM or General Motors. So that if, for the sake of argument, there were to be entire disarmament and an even sharper squeeze on margins than there is today, and there were to be renewed pressure on corporations to get their costs down, they would be doing exactly the same thing. It’s not because of defense, it is because of the investment process at a time of high development of the technological arts and lengthening of the technological side of it.

Mr. Witkin: Is there not some qualitative difference between defense spending of this sort, where you are dependent to a great extent on government purchases from industry, and the type of consumer growth of technological products that would be ordinarily developed in times of disarmament and relative calm of the international situation

Mr. Janeway: I’m not too sure. I don’t believe that commercial airlines would be thinking of spanning the world, as they are doing, if they had to get up the ante themselves.

Mr. Witkin: Well, that’s one example. But what about the broad spectrum of industry

Mr. Janeway: To the extent that, for example, to use a relevant name, General Clay in his annual report to the stockholders of Continental Can is able to speak of a simple, little old can company, as if it were just another coupon, X of our products, Y of our revenues now come from what was merely a source of consumption for very thin drawing board paper ten years ago. The only defense that the corporation has is to create purchasing power for the MIT graduate—I don’t mean to give Cambridge a degree of monopoly—for the Ph.D. product of the Case School in Cleveland. And to the extent that a higher ratio of production that is not for direct consumption obtains all over the world and not simply in the defense arts, there is a built-in cushioning to activity.

Mr. Lindley: Is it not true at least in ’55 and I believe in ’56, that the real income per capita in the United States, after all taxes, was the highest in our history

Mr. Janeway: No, sir. In the event real income in ’57, final take-home pay for everyone, is quite capable of rising due to the consideration our moderator emphasizes, namely, a lower tax burden, even while the defense establishment is being burdened with higher costs through purchasing more, and more, and more overhead, and through paying for termination, because people are recapturing their past taxes and the country is increasingly on a pay-as-you-go basis with the Treasury. So the net tax burden is falling, and therefore the real disposable income to the taxpayer, corporate and individual, is rising.

Mr. Lindley: How can anyone seriously maintain that the federal budget, particularly defense expenditures, is an insupportable burden when, as I understand, the real income of the American people has continued to rise during this period and, as far as I can see now, will continue to rise

Mr. Janeway: It’s going to rise in spite of any, or perhaps because of any, ceiling imposed on defense spending, due to this built-in cushioning of the tax system. And also bear in mind that, if there is any interruption in employment anywhere other than in Southern California, if there is any interruption to overtime, then the pot of soup available for the Secretary of the Treasury to dip his ladle into is a smaller pot of soup.

Mr. Lindley: As an economist, do you have any percentage of the gross national product or of the national income, whichever figure you want to use, that you have regarded as a ceiling

Mr. Janeway: Absolutely not. In fact, what is being done now is going to raise the burden on the Treasury. It’s going to raise the burden on the Treasury because here we have a short-term debt. The debt limit is $275 billion. It takes not many months to get the entire debt up to the level of the current interest rate. Four percent of $275 billion is $11 billion, and you are going to be overspending on interest account by $4 billion, substantially over what is being rubbed into the defense establishment. And that’s before taking account of the fact that, as the short-term debt is progressively, month by month, upgraded to this four percent—a higher level—that will rise and there will be progressive erosion in these quarterly re-financings. Therefore, the Treasury will lose cash very much faster than it pays interest, and very much faster than lower ceilings can be pressed down on the military.

Eliot Janeway. A long-time student of economic and political trends on the American scene, Mr. Janeway is president of Janeway’s Publishing and Research Corporation in New York City. Prior to establishment of his firm, he was business editor of Time magazine and a special business trends consultant for Newsweek. A frequent writer on economic affairs, Mr. Janeway has contributed articles to the Christian Science Monitor, Iron Age, and the New York Times and has often spoken at forums concerned with the American economy and its impact upon the citizenry.