The Day of the Bear

THE ECONOMY (See Cover) The night of Blue Monday, 1962, was the grimmest evening on the New Frontier since the failure of the Bay of Pigs invasion. Measured by the Dow-Jones industrial average, the stock market was down 35 points in the deepest one-day plunge since the black year of 1929. Panicky drops had followed on European stock exchanges, and who could say just where and when it would stop? President Kennedy told staffers to prepare an agenda for a meeting next morning with his chief economic advisers.

The President met in the green-carpeted Cabinet Room with what New Frontiersmen call the "quadriad" of Administration economic thinkers: Treasury Secretary Douglas Dillon, Federal Reserve Chairman William McChesney Martin, Budget Director David E. Bell and Walter W. Heller, chairman of the President's three-man Council of Economic Advisers. Also present were officials from the Commerce Department and the Securities and Exchange Commission. What should be done? One possibility, quickly rejected, was to lower the margin requirement (the percentage of cash that a buyer has to put up to buy stocks) from the present 70%. The consensus was that any such move might be interpreted bearishly.

Also considered, and rejected at the forceful urging of Dillon, was an emergency tax cut to pep up the economy. Dillon argued that the economy does not really need any special pepping up, and a special tax cut for morale reasons would interfere with the plans for basic tax revision later on. Still another possibility was to speed up federal spending for public works and defense orders. But it was decided that such a step-up would not have swift enough effect to shore up the stock market. In short, the sense of the meeting was that for the moment the best thing to do was nothing.

It was sort of symbolic of the Kennedy Administration that Commerce Secretary Luther Hodges, the Administration's titular spokesman for business, was not present at the White House session. He had previously scheduled a press conference at the Commerce Department, and the White House feared that canceling it might be interpreted as an alarming sign. At the press conference, Hodges was asked what he thought should be done about the stock market. He replied that he "would favor an announcement by the Administration as quickly as possible that we ought to have, or that we are going to have, a tax overhaul." Shortly afterward, one of the officials who had attended the White House meeting got back to his office and found a wire-service report on Hodges' statement. Said he derisively: "Guess what I've just picked off the wires?" Near week's end, Minnesota's Democratic Senator Hubert Humphrey vociferously joined Hodges out on the tax-cut limb.

Ominous Word. The only overt effort the Administration made to buck up the stock market was a brief statement to reporters by Secretary Dillon. Calm-voiced and grey-suited, Republican Dillon was the very image of confidence. "I see no reason for panicky selling," he said. "The general economy is very sound." But to many, his reassurance recalled some of 1929's reassuring statements. That word "sound" was a favorite adjective in the autumn of 1929. There was President Herbert Hoover's statement that the "fundamental business of the country" was on a "sound and prosperous basis." And there was the joint statement by representatives of 35 brokerages declaring that the market was "fundamentally sound."

Far more persuasive reassurance came later in the day from the stock market itself: a dramatic turnaround that carried the Dow-Jones industrial average from a low of 563.24 around noon back to 603.96, for a hefty 27-point gain above the Monday closing.

When the market perked, gloom began to disappear from the New Frontier. It was, after all, the President's 45th birthday, and among the presents was $5,000,000 turned over to him under the terms of the trust fund set up for him by his father. Trucks drove up to the White House with floral tributes to the President. Among them was a rocking chair covered all over with yellow chrysanthemums and white carnations, a present from Frank Sinatra. The White House ordered it sent to Children's Hospital, where the kids had a lot of fun with it. The White House could even grin gamely at a newly minted Wall Street joke about Joseph P. Kennedy's awakening after Blue Monday and saying: "To think I voted for that s.o.b!"*

"An Overcommitted Life." But for all the more hopeful signs, the Administration's economic watchmen knew full well that during the days and weeks ahead they would have to stare more intently than ever at the economic indicators. The chief watchman, the man whose task it is to interpret the U.S. economy for the President, is Walter Wolfgang Heller, 46, sometime head of the University of Minnesota's economics department. Kennedy has come to be very fond of Heller, likes his undogmatic approach to economic policy and his dry, professorial wit. Heller jokingly says that his post cannot be very important because the yearly budget for the Council of Economic Advisers is "midway between that of the Battle Monuments Commission and the Indians Claims Commission." When the Billie Sol Estes scandal brought into public prominence the name Walter E. Heller & Co. (no kin), a Chicago finance company that had lent a lot of money on Estes' bogus mortgages, Heller said that to avoid confusion he was changing his handle from Walter W. to W. Wolfgang Heller.

Heller has become one of the most influential members of the Kennedy team, although opinions other than his enter into the making of Administration eco nomic policies. Treasury Secretary Dillon sometimes opposes Heller--and wins--on major questions. For example: Heller wanted to include an income tax cut among the Administration's antirecession measures shortly after Kennedy took office, but Dillon balked, and Kennedy backed him up. And Heller has learned that in Government the counsels of economics have to be alloyed with politics. "An economic adviser," he says, "has to expect to take his lumps in terms of political reality."

On Memorial Day. in the lull after the stock market storm. Heller spent the day in his office, ate his lunch--hamburger--at his desk. When he went home that evening, he took a briefcase of papers, worked on them until 2:30 a.m. "Pressure has just been a part of my life," says Heller. "Professionally I've led, perhaps, an overcommitted life. I enjoy it, but people sometimes ask me, 'Do you have ulcers yet?' "

Heller can say of himself, and of the state of the U.S. economy as he sees it: "No ulcers yet." On Monday, while the stock market was plummeting wildly, he delivered before the Women's Democratic Club in Washington a prepared speech in which he said that after disappointing signs of sluggishness in January and February, the upturns in the March and April indicators--especially the surges in auto sales and housing starts--had "put the economy back into high gear." After the Monday slide, Heller saw no reason to revise that judgment. The recovery, he says confidently, "will continue into the first half of 1963." It might keep up longer, but "we don't go beyond that because the crystal ball becomes clouded."

The stock market decline, said Heller, was not reflecting imminent trouble in the economy. "Given the great potential of this economy," he said, "and given the determination of the Kennedy Administration to pursue policies that not only realize but expand that potential, I would say that the basic outlook for the economy flatly contradicts the disturbing developments of the stock market."

Heller's assessment that the economy looks robust gets sturdy backing from many non-Government economists and industrialists across the U.S. Says Beryl W. Sprinkel, top economist of Chicago's Harris Trust & Savings Bank: "I haven't changed my ideas about the economy. It looks strong, and I expect the expansion to continue into 1963." Henry Ford II looked at the road ahead and saw a "bright business picture," not just for autos but for the economy in general. As for the stock market drop, Ford leaned to one of the week's more esoteric explanations : European investors started it by "taking their short-term money out."

Administration's Answer. The week's most poignant summary of the disparity between the shaky stock market and the sturdy economy was voiced by an elderly woman in a Chicago brokerage office who had lost three-quarters of her savings when she panicked and sold out during the plunge. "I don't understand," she said. "There's nothing wrong with our business here. Everything is O.K. in this country. Nothing's changed in two days. Workers are still working. Business is still going. The only thing is, some of us are broke."

If the economy is so healthy, why did the stock market drop so far so fast? The Administration's answer was that the decline in the stock market was not forecasting a recession ahead. Rather, it was belated recognition of the halt in postwar inflation. The U.S. Government's wholesale price index stopped climbing in early 1958. It has held steady ever since, but among buyers of stocks the idea persisted that inflation was still at work. According to Heller and other Administration spokesmen, the awakening came in April when the President forced the steel industry to cancel its announced increase in steel prices. That battle, says Heller, brought home to stock buyers the Administration's unmistakable determination to maintain price stability. "I think part of what's happening in the market," explains Heller, "is that the conviction that inflation is not a way of life in this country is beginning to permeate the economy." Secretary Dillon echoed the theme: "The belief that inflation was just around the corner has been dispelled. That is the basic reason behind the decline in stock prices over the past few months."

Undeserved Repute. In the mythology of Wall Street, the stock market is a clairvoyant forecaster of economic trends. But Heller argues that the correlation between the ups and downs of the stock market and the ups and downs of the economy is far from reliable. Non-Government economists tend to agree that the stock market's reputation as an economic barometer is largely undeserved. "I would never look at the stock market to tell me what the economy is going to do," says J. Howard Craven, chief economist of California's Bank of America.

But what of the possibility that the market decline, by wiping out assets and impairing confidence, might shrink consumer spending and business expansion plans enough to damage the economy? Heller admits that the market drop is "a minus rather than a plus" for the economy. But he thinks that unless it carries deeper, it will not make any severe dent in the economy. He asked outside economists for estimates of how much the downturn so far might clip off the gross national product this year. The highest estimate came to $4 billion, considerably less than 1% of the G.N.P.

But the nerve-rending possibility remains that the stocks will start sliding again after a pause, and fall far enough to drag the economy downward. Heller will be watching the market closely during the weeks ahead, and if it breaks below the turnabout Tuesday low, the Administration may well step in with a quick tax cut, and perhaps spending speedups too.

The Activist. In analyzing the stock market decline, Administration spokesmen failed to mention one factor that seemed important to many outsiders: business men's lack of confidence in the Kennedy Administration. The harshness of Kennedy's attack on steel staggered many businessmen--and stockholders. But the Administration could reasonably argue that the distrust was unjustified. In economic policy, the Administration has taken positions that many businessmen can applaud. Confronted with the gold outflow and the need to increase U.S. exports, the New Frontier has firmly committed itself to price stability. Rejecting labor leaders' arguments that higher wages are needed to increase consumer demand and spur economic growth, the Administration agrees with business that the economy's essential requirement for faster growth is expanded capital investment. To speed up capital investment, the Administration has sent Congress a proposal to grant business firms a special tax credit on expenditures for equipment. And the Treasury is currently working on revised depreciation schedules, to be released in July or thereabouts, that will permit business firms to write off the cost of equipment over a shorter span of years.

Yet the wariness that many businessmen feel toward the Administration--and toward Heller--does have some basis in reality. Like some other New Frontiersmen, Heller sometimes arouses suspicions that he is overly solicitous toward the economy, too much inclined to activism. His activist tendency traces back to the circumstances in which he decided to become an economist. The time was the early years of the Great Depression. "The Depression," says Heller, "attracted some of the best young minds into economics. Those of us who were growing up then saw the economy flat on its back. To explain why, and to try to do something about it, seemed a high calling."

Smothered Freedom. Heller became a do-something-about-it economist. Says the University of Chicago's Economist James H. Lorie, a conservative who greatly respects Heller: "Broadly, the economists fall into two groups. There are those who feel they know what a wage settlement should be, what a price level should be, what controls the Government should exercise over the economy. There are those, on the other hand, who feel we do not know well enough the intricate workings of the economy to be able to intervene and achieve a precise result, who feel that the forces of the economy should be left in free play, letting the market place make the necessary decisions and corrections. Mr. Heller belongs to the first group." A California banker puts it more bluntly: "Heller is a competent economist, but his thinking isn't oriented toward free enterprise. I object to his basic attitude that everytime something lags, Uncle Sam should step in."

There are times when the Government has to "do something" about the economy. There may even be times, as in 1933, when it is probably better to take slipshod or ill-considered economic action than to do nothing at all. But the do-something approach to economic policy shows some of the same defects as the do-something approach to parenthood: fussy economic policymakers, like fussy parents, can smother freedom with well-intentioned directives and solicitous hoverings. Children and economies, if let alone, may get into more mischief than their overmanaged counterparts. But they are likely to be healthier too.

Too Strong. The defects of the New Frontier's activist economics showed up in the Administration's grotesque efforts to deal with two of the U.S.'s most pervasive economic problems--the monopolistic powers of Big Labor and the messiness of the federal income tax structure.

Fortified by Government-granted privileges, notably exemption from antitrust laws, U.S. labor unions, once too weak, have become too strong--strong enough to demand and get wage increases that are not economically justified. Big Labor can now insist on periodic wage increases regardless of whether prices and profits are rising or falling. One result is that the benefits of increasing productivity (output per man-hour) tend to get gobbled up by wage increases rather than being distributed among higher profit margins, increased investment and lower prices, as well as higher wages.

During the 1950s, wage increases persistently outran productivity increases, and the result was price upcreep that dulled the capacity of the U.S. to compete in world trade, and thereby helped bring on the balance-of-payments problem of recent years. Price upcreep has halted for the time being, but the power of labor unions still impedes solutions to the big economic challenges that confront the Kennedy Administration: speeding up economic growth (which requires expanded investment) and increasing U.S. exports (which requires competitive pricing).

Kennedy Administration economic thinkers are aware that the power of Big Labor is a drag on the economy and an obstacle to achievement of New Frontier economic goals. One imaginable remedy would be to trim that power a bit, then step aside and let the free market operate, with wage settlements determined by collective bargaining within the framework of current market conditions. Otherwise, the only course left, short of direct meddling in wage negotiations, is the Eisenhower approach of frequent homilies on the need for "restraint."

The Kennedy Administration took the activist approach of informal wage fixing. First, Heller's Council of Economic Advisers laid down a rule that wage increases should be guided by expected gains in productivity. One trouble with this formulation is that while productivity is a clear enough concept (TIME, April 27), it turns muddy when applied to particular wage settlements; productivity is hard to measure with precision, and it varies from one year to another and from one industry to another.

After setting its "guidelines," the Administration undertook to persuade labor to follow along. With Labor Secretary Arthur Goldberg hovering over them, the United Steelworkers agreed last March to accept a relatively modest settlement amounting to about 10-c- an hour--roughly in line with an assumed 2 1/2% productivity gain. But when the steel industry, led by the U.S. Steel Corp.'s Chairman Roger Blough, tried to raise steel prices, the President reacted with fury, bullied the industry into canceling the announced increases.*

Kennedy insists that steel was a special case, brought about by Big Steel's own folly. So does Heller. Says he: "There's just not going to be another steel case." But businessmen remain unconvinced. Warns a Chicago economist: "Once you dip your finger into this economic stream, you have to put your whole hand in, and pretty soon you find you're wading up to the waist. President Kennedy presumed that he knew what steel prices should be. Before he's finished, he's going to have to say what auto wages should be, what railroad wages should be. One intervention begets another."

Distorted Decisions. Like the Administration's venture into price fixing, its tax proposals have stirred up a great deal of unintended bitterness.

The U.S.'s income tax structure needs drastic reform, and the Administration deserves credit for its announced intention of reforming it. The rates rise too steeply and reach all the way to a confiscatory 91%. These rates are undermined by tunnels of preferential deductions and special-case exceptions. Besides being inequitable, the structure is a drag on national efficiency. An appreciable fraction of the energies of prosperous men is directed toward reducing personal income tax liability, and enormous numbers of business decisions are distorted by consideration of tax angles.

Heller has been a longtime advocate of basic income tax reform--lowering the rates and blocking up many of the escape tunnels. President Kennedy has promised to put before Congress a "major program of tax reform" aimed at "simplification of our tax structure, the equal treatment of equally situated persons, and the strengthening of incentives for individual effort and for productive investment." But that still lies in the future. What the Administration has actually put forward so far in the way of tax revision is discouragingly scabby. Bent on inspiring capital investment, the Administration proposed an 8% tax credit on expenditures for capital equipment. This approach is in itself an example of a tendency to overmanage the economy. The Administration could have helped business morale a lot more just by trimming corporation tax rates a few points. Far from showing gratitude for the tax-credit proposal, businessmen have grumbled that the bill is overly complex and unfair in its distribution of benefits. A U.S. Chamber of Commerce spokesman rapped it as a windfall for firms that had planned to acquire capital equipment anyway.

After the Smashup. In pursuing two admirable ends that businessmen might easily approve--price stability and increased investment--the Administration has thus managed to bring hostility and suspicion upon itself and to impair the confidence of the business community. That impairment was symbolized when the stock market plunge more than wiped out the Dow-Jones average's entire gain from the late "Kennedy bull market."

"If I were in Washington," says the University of Chicago's Lorie, "I would ponder the fact that the really steep decline of the stock market started at the time of the Kennedy-Blough battle. I would ponder that, because to a great extent our growth, our prosperity and our hopes of moving the country forward depend on the confidence of businessmen, large and small, and their expectations for the future. If those expectations are damaged, that could be much more serious than the stock market decline."

President Kennedy may come to see that confidence is the most valuable boon a President can confer upon the economy--far more valuable than the best-intentioned tinkerings. Failure to provide it could sabotage his economic programs, torpedo his campaign promise to "get this country moving again." And as a man who likes to read history books, Kennedy can hardly help recalling 1929 and its aftermath. The smashup of 1929, leading to the Great Depression, crushingly ended the rarely interrupted Republican dominance that began with Abraham Lincoln. For a proud Democratic President, it would be hard to imagine a fate more hideous than to become the Democratic version of Herbert Hoover.

*Old Joe, of course, would have said nothing of the sort, since he has a rather affectionate attitude toward bear markets. In 1929 he got out in time and sold short heavily, thereby making a killing. As for the great postwar bull market, Old Joe missed it: wanting to protect his millions from the danger of another 1929, he invested in real estate instead, made even more money than he ever made in the market. *Kennedy got valuable help from Inland Steel Co.'s Chairman Joseph Block, who at a critical moment bowed to Administration urgings and announced that Inland would not go along with the price increase announced by U.S. Steel. That broke the industry's ranks, forced steel companies that had raised prices to surrender. During a recent Block visit to the White House, the President asked him whether he thought U.S. Steel was "too big." After all, said Kennedy, U.S. Steel "set prices for the entire industry." Said Block: "I would remind you, sir, that quite recently a company 10% of the size of U.S. Steel set prices for the entire industry."

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