Freeze II: Back to the Drawing Board

"Oh, everybody thinks Phase III was a failure. Let's move on."

With more than a touch of bitter resignation, Treasury Secretary George Shultz last week thus delivered the epitaph for the Administration's five-month-old attempt to control inflation on the honor system, of which he was the chief ideologue. An hour later, in a nationwide TV speech, President Nixon did indeed move on--with the second freeze since August 1971. He imposed a halt on increases in prices--but not in paychecks--for up to 60 days.

That will be followed, the President promised, by a Phase IV with "tighter standards" and "more mandatory compliance procedures" than those of the discredited third phase.

America First. The freeze was better by far than Phase III, but many critics in Congress and in U.S. and foreign business would have preferred a more permanent program--which is now up to two months away. The interim program was hurriedly slapped together and seemed like a desperation move.

The President and his aides were drafting changes almost up to the moment that he announced it. Even if, as seems likely, it accomplishes a temporary slowdown in price increases, the danger remains that too much inflationary momentum has been built up for anything less than an extremely tough Phase IV to curb it. Reason: the President waited unconscionably long to take a new stand against high prices.

Since January, U.S. consumer prices have spiraled upward at an annual rate of 9.2%, their worst rise in more than two decades (TIME cover, June 18). The increases were even greater in the supermarket, where prices have been inflating at an annual rate of 25% or more --and worse was ahead.

Moreover, Nixon made a bid to gain vast new authority over the nation's exports. He asked Congress to let him regulate the overseas shipment of all "articles, commodities or products." He could then personally limit overseas sales of wheat and other grains, the rising demand for which Nixon blames for high food prices at home. The nation would honor prior commitments. But, said Nixon with some jingoism: "When we have shortages and sharply rising prices of food at home, I have made this basic decision: in allocating the products of America's farms between markets abroad and those in the United States, we must put the American consumer first."

TIME Correspondent John Berry learned that the Administration has even gone so far as to set targets for key feed commodity prices--all of them dramatically below those prevailing.

Samples: for soybeans delivered next November, the target price is $4 per bu., down from $6.43 the day that Nixon spoke; for wheat at Kansas City in July, $2 per bu., down from $2.78. Thus, the Administration plans a market intervention of enormous proportions.

Gyrating Grain. The threat of export controls caused prices on the nation's commodities markets, where speculators have recently bid up prices to heights undreamed of only a year ago, to gyrate widely. On Thursday, prices for major grains and soybeans were "down the limit"--they dropped as far as trading rules permitted in a single day. The panic seemed to substantiate Nixon's assessment of grain speculation as a root cause of food inflation.

Whether a U.S. President should be given the power to regulate the nation's export faucet indefinitely, however, is extremely doubtful. The use of such barriers to free trade invites retaliation from injured foreign nations and fans economic nationalism. Further, farm products constitute the U.S.'s second biggest export after machinery--$9.4 billion worth last year. To limit their sale would only worsen the nation's alarming balance of payments deficits.

Many of the critics of the Administration's recent do-little attitude toward inflation were pleased that Nixon had finally decided to act and predicted that Freeze II would make a difference. Otto Eckstein, a member of TIME'S Board of Economists, revised his estimate of one measure of inflation --called the G.N.P. deflator--downward ever so slightly (to an annual rate of 4.3%) because of the freeze and said that the move "has substantially reduced the risk to our prosperity." Walter Heller, another member of TIME'S board, agreed: "We've broken through that mushiness and moribundness, and now there's some flint and steel."

Yet almost nowhere did the President's second resort to anti-inflation shock treatment produce anything like the widespread sense of relief, even enthusiasm that followed the first. The cowering stock market sank even further into despair. The Dow Jones industrial average lost 27 points on the two trading days after Nixon's speech and closed the week at a dismal 889.

On world money markets, the undervalued dollar remained distinctly anemic; in Frankfurt it fell to an all-time low of 2.57 marks, down 9% in just the past month. Economist Paul Samuelson explained the lack of enthusiasm by complaining that Nixon's sudden lurches from one set of rules to another add up to "schizoid economics," and that "you use up" the effectiveness of extreme measures like freezes. Raymond Jallow, senior vice president of the United California Bank, worried that in the current near-capacity economy a freeze "will create a bubble of inflation" after it is over. AFL-CIO President George Meany damned the freeze as a "failure of policy" and pointed out that Nixon had frozen prices at a historic high point. Most important, the fear remained that the economy's case of Watergate woes is simply too serious to be remedied by yet another White House program. "It's strictly a holding operation," says Economist Sam Nakagama. "Nixon has pulled back into a defensive position until Watergate blows over." Says George Doup, president of the Indiana farm bureau: "You could see, even during the President's presentation, that his heart wasn't in it."

Inner Circle. Neither, to put it mildly, are the hearts of his top economic advisers. Free Marketeer Shultz had argued vehemently against anything more than minor changes in Phase III. In fact, Shultz and Herbert Stein, chairman of the Council of Economic Advisers, left for a bankers' meeting in Paris on June 5 with the understanding that Nixon had decided on a program far less drastic than the freeze. The next morning, Nixon sent a memo to his advisers through Chief of Staff Alexander Haig asking for new information on a variety of economic matters. Administration aides speculated that the President was persuaded to change course by Melvin Laird, who had just signed on as Nixon's domestic affairs chief and promptly advocated bold economic moves.

Neither Shultz nor Stein plans to become active in the Administration's public relations campaign to sell the program to the nation, and they may decide to quit before long. Shultz, a highly moral man, is also depressed over the Watergate morass. Likewise, former Treasury Secretary John Connally, who urged Nixon to act but apparently felt left out of the inner circle, will quit his vaguely defined Administration job.

The freeze will be run by a special group within the Cost of Living Council headed by its deputy director, James W. McLane, 34, a Harvard Business School graduate turned bureaucrat.

Stores will be required to keep a list of "freeze prices," which are the highest levels that retailers charged for at least 10% of sales on any given item or service between June 1 and June 8.

Exempted altogether from the freeze are wages, which the President correctly judged as being held to "responsible" increases of some 5% a year --without stiff controls. Rents, interest rates and dividends are also exempted.

Agriculture prices at the farm level were left uncontrolled, though they are anything but responsible. Any attempt to hold down a rising price would lower farmers' incentives to solve the nation's food problem by producing more.

However, unlike the first freeze, even raw agricultural goods are now price-controlled after their first sale by the farmer to the distributor or wholesaler.

Against Narcotics. McLane said that "seven or nine" industries will be specifically scrutinized in a "profits sweep," because they are suspected of having exceeded Phase Ill's price rules and may now face rollbacks. Two of the industries are chemicals and electrical machinery. Businessmen apparently also have decided that the freeze was for real. U.S. Steel, Bethlehem Steel, Uniroyal, B.F. Goodrich and Kennecott Copper canceled or postponed increases that had been put into effect or scheduled.

White House insiders say that the President really does not know yet what should be done about Phase IV. He is all but irrevocably committed to a program as tough as Phase II--and probably even tougher in the politically touchy areas of food and gasoline prices. Phase IV will also likely be expanded to include control on wages, profits and other areas.

Nixon remains basically opposed to strong controls, and promised to keep them from becoming a "narcotic." Yet, when the current freeze ends, he will have presided over one or another set of wage-price rules for about 40% of his term in office. The President allowed his Administration's most effective inflation-fighting team--Phase II's Price Commission--to be dismantled in January with hardly a word of thanks.

Though he bragged last week about the exemplary 3.4% inflation rate that was posted during Phase II, he will have a difficult time repeating the performance in the next phase--if, indeed, he has the will to try.

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