February 17, 2005, 8:50 a.m.
The Triumph of Economic Technology
Three 20th century advances that changed the world.

technology n, 1. the practical application of knowledge especially in a particular area

When the word “technology” pops up in conversation people usually envision computers, cell phones, artificial body parts, and mechanical devices that improve our standards of living either through productivity advances or by solving problems that were perceived to be impossible to solve. In the lead-up to, and start of, the 21st century, spending on technology solved the Y2K problem. But technology investment to avoid the implications of a Y2K crash was so extensive that companies subsequently postponed normal technology investments. The unexpected slowdown in demand for computer technology led to the bursting of the so-called “tech bubble.” The same technology that gave us the bull market of the late 1990s triggered a major crash in technology stocks and contributed to the first U.S. recession of the 21st century.

In a broader sense, technological advances have not been limited to the private sector. New principles derived from extensive economic research have provided the basis for radical economic policies that have allowed the U.S. to reassert its global economic leadership. In the course of this process, the tools used to guide economies have changed. The good news is that economic technology has led to rising standards of living through increased incentives to work, save, and invest, as well as lower interest rates, low inflation, and rising free trade.

Since 1971, there have been three important advances in “economic technology” that have allowed the U.S. to maintain leadership in economic policy: the removal of the gold standard, a dramatic change in monetary policy, and pro-growth tax-rate reductions. Taken together, they represent the continuing triumph of economic technology.

In 1968, President Johnson declared that the U.S. would no longer maintain the gold link among central bank transactions. In 1971 President Nixon removed the U.S. financial system from a gold standard and the related constraints of a fixed-exchange-rate monetary system. This dollar-gold link was broken.

Prior to these decisions, the U.S. was constrained in the use of fiscal policy because any perception that the U.S. budget deficit was expanding or that the Federal Reserve was printing too much money could lower the value of the dollar. But once the U.S. broke the dollar-gold link there were no longer concerns about foreign governments forcing the U.S. to deplete its gold holdings and, in turn, trigger a run on the dollar. In the modern world of floating exchange rates, the only claim that foreign holders of U.S. government securities have on the U.S. government is the payment of dollars at the maturity of those securities.

The second great advance in economic technology took place in 1981 when the Federal Reserve began to implement a new methodology in managing monetary policy. During the ’60s and ’70s, monetary policy was guided by a quantity rule, which required the Fed to control the growth in the money supply within arbitrary growth bands. One problem in attempting to control the money supply in this way is that any shift in the demand for money has an unintended effect on efforts to control the quantity or supply of money. When shifts in demand for money occur when the Fed is attempting to control the supply of money there can be wide swings in interest rates. These swings cause distortions in borrowing and lending relationships in the private sector. The economy suffers as a result.

The Federal Reserve’s change to a price rule in the conduct of monetary policy brought stability to financial markets (although not initially) and ushered in a 24-year bull market in bonds. This policy can also be credited with nurturing a bull market in stocks that spanned two decades and has taken the Dow Jones Industrial Average from 1,000 to over 10,000. The adoption of a price rule — i.e., the targeting of interest rates to control inflation — is now commonplace among industrial countries in the conduct of monetary policy.

Prior to the 1980 election, candidate Reagan, who was behind Jimmy Carter in the polls, announced his support for a program of major tax-rate reductions to stimulate the economy. This would turn out to be the third great advance for economic technology in the 20th century. Reagan’s theory contradicted the accepted wisdom that a society, intent on expanding social programs, required ever-higher tax rates on the wealthy and on high-income wage earners to finance social programs. However, Reagan’s endorsement of a broad tax-rate reduction swung voters behind him. As president he followed through with two major tax-rate reductions.

Since Reagan’s shift to an incentive-based tax system, the benefits of lower tax rates have been reflected in over 70 countries that followed President Reagan’s lead and reduced tax rates. Today, the countries of the “New” Europe — those who have converted from communism to capitalism — are leading proponents of tax-rate reductions to promote economic growth.

As the 21st century began, President George W. Bush endorsed the dynamic effects of reduced tax rates on personal income. He also initiated two major tax-rate reduction programs that were passed by Congress as a solution to the recession triggered by the technology slowdown. The second tax-rate reduction, effected in mid-2003, can be given credit for turning the worst bear market in stocks of our lifetime into a new bull market that continues today.

President Bush’s second term is likely to be characterized by further changes in fiscal policy that will lower taxes for most Americans and provide additional fiscal-policy stimulus to keep the U.S. economy on a growth track. One risk to a continued strong economy and bull market is the possibility that the majority of liberal politicians, along with some traditionally conservative politicians, fail to recognize the need for deficit spending when the economy is not operating at full capacity.

Still, without the advances in economic technology during the last 35 years, we wouldn’t be world leaders. The U.S. took the lead in the development and implementation of economic technology and changed the lion’s share of world economies for the better.

— Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and chief investment officer for Victoria Capital Management, Inc.

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