123. Information Memorandum From Secretary of the Treasury Blumenthal to President Carter 1
- Inflation, Energy, and the Dollar
I want to summarize for you a series of recent developments that, taken together, heighten my concern about the inflation, energy, and dollar situations.
All the recent statistics are very troubling.
• Treasury and CEA now estimate that the CPI will rise 7.0–7.1% between the fourth quarter of 1977 and the fourth quarter of 1978. As recently as January, our published estimate was 6.1%.
• Early indications suggest that the GNP deflator will rise at an annual rate of 7.8% in the first quarter of 1978, as opposed to only 5.9% in the fourth quarter of 1977.
• In January, the CPI rose 0.8%, i.e. an annual rate of 9.6%. The February numbers will likely be equally discouraging.
• The wholesale prices of consumer foods increased by 2.9% in February, foreshadowing sharp retail food price increases.
As statistics like this accumulate in the next few weeks, they will fuel inflationary expectations throughout the private sector and will impart a new, upward thrust to the wage-price spiral.
Inflationary expectations may be further aggravated by the budgetary situation.
In January, we proposed a $60 billion deficit for FY 1979. We defended this figure as being smaller than the FY 1978 deficit. Since then, however, we have re-estimated the FY 1978 deficit at $53 and our proposed FY 1979 deficit at $59 (due in each case to spending shortfalls). This has put us in the very awkward position of arguing that the deficit should grow substantially between FY 1978 and FY 1979—even though by 1979, unemployment will have fallen further, capacity and labor [Page 372] markets will be tighter, and inflation will be higher. What’s worse, there are enormous pressures, at every program point, to enlarge the FY 1979 deficit beyond our January figure.
A few examples:
|Urban program||$1–3 billion|
|Farm legislation||$1–3 billion|
|Elimination of some tax reforms||$2–4 billion (at minimum)|
|Tuition Tax credit||$1–2 billion|
Unless we exercise a very firm hand, the FY 1979 deficit will almost certainly balloon—despite shortfalls and contingencies—to $63–65 billion, i.e. at least a $10 billion increase over FY 1978.
Against this inflationary background, financial markets will inevitably tighten, either spontaneously or through a more restrictive monetary policy by the Federal Reserve.
The Energy Conferees have recessed for another 10 days, with no action in sight on COET. For this bill, the end is always in sight, but never in hand.
There are gathering signs that OPEC will not long hold back from price-raising action. King Khalid’s letter to you is one straw in the wind.2 The Kuwaiti-led drive for a 5% price rise is an equally serious portent.
Given this environment, the foreign exchange markets remain nervous. The pressure has momentarily subsided on the German mark and Swiss franc but demand for the Japanese yen is especially strong. The dollar has depreciated against the yen by 4.4% so far this month, despite intervention by Japanese authorities totaling $4.1 billion. We are seeing signs that central banks as well as private firms are shifting financial reserves into yen; our information is incomplete and sensitive but the amounts appear to be quite substantial.
Private bankers are telling me that capital is continuing to flow out of the U.S., following an estimated fourth quarter 1977 net outflow of almost $10 billion.
I am very concerned about the impact on the market of next week’s release of the CPI and leading indicators for February. The leading in[Page 373]dicators may be down due to a decline in money supply and to weather and coal strike3 effects, following on the heels of a decline in January of 1.9%. It is unlikely that this and the inflation figures for February will be well received, especially after we just this week revised upward our estimate for the 1977 current account deficit to $20.2 billion.
These trends seem to me to dictate three conclusions:
1. Immediately after your trip, we should inform the Congress that, absent prompt passage of COET, circumstances will require imposition of an oil import fee. This would not be intended as a threat but as a step necessary to our economic and political security.
2. The anti-inflation program you announce after your trip must be tough and credible. I have asked the EPG to review the plan submitted this week with this in mind: we may propose additional options to you.
3. In light of the economic and political risks of accelerating inflation and continuing weakening of the dollar, we should review our economic goals and the fiscal policies designed to achieve them.
We still have time to master these related threats to our prosperity, but not much time. If we shy from taking difficult actions now, we may face almost impossible difficulties in the future.
- Source: Department of the Treasury, Office of the Secretary, Executive Secretariat, 1978 Files, 56–83–69. Secret. In a March 24 note to Hutcheson, Hessler wrote: “Mike Blumenthal asked whether the President might see this Monday [March 27], before his trip. It is an information memo, and Mike has no objection to it being staffed routinely—so long as the President gets to see it before his trip.” (Ibid.) Carter traveled to Venezuela, Brazil, Nigeria, and Liberia March 28–April 3.↩
- The text of Khalid’s March 12 letter to Carter is in telegram 1941 from Jidda, March 13; National Archives, RG 59, Central Foreign Policy File, D780112–0063.↩
- Coal miners were on strike from December 1977 until March 1978.↩