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By George P. Brockway, originally published August 7, 1989

1989-8-7 Exxon And Squatter Economics Title

DEAN ACHESON once remarked wearily that if anyone, at any time, found him agreeing with any Indian on any subject whatever, that person should have him certified immediately. His judgment was no doubt colored by his experiences with V.K. Krishna Menon, who wanted all North Korean POWs shipped home whether they wished to go or not.

My feelings about standard economics are similar, perhaps because one summer, in a youthful fit of self-improvement, I spent many hours reading Frank Taussig’s introductory textbook when I could have been sleeping in the sun. My recollection is that Taussig, who was a big man in his day, started off by talking about Robinson Crusoe. I have since come to doubt that Robinson had anything to do with economics at all. So far as I know or Professor Taussig said, he never bought or sold anything, or used money.

One by one the classic laws have lost their savor for me. David Ricardo‘s Law of Comparative Advantage was an early loser, and I wrote three columns[1] about it six or so years ago. The notion that producers are profit maximizers and consumers are utility maximizers attracted my attention last year, and the Law of Diminishing Returns a couple of months ago. I’ve even dropped a hint or two concerning the Law of Supply and Demand, and might supply a column about it, if I detected any demand.

I’m ashamed to say that in one of my early columns I made a slip and endorsed the proposition that free competition in a free market makes for the most efficient allocation of scarce resources. As Abraham Lincoln[2] replied when requested to apologize for saying that Simon Cameron would not steal a red-hot stove, I now take that back.

The issue is in the news because of the great Valdez oil spill. Some excitable people want to punish Exxon, but they have been patiently told it would be inefficient to do so. Encouraged by the sound of their own voices, the naysayers add that it would be inefficient to impose further restrictions on the exploitation of Alaskan oil, and also that an increase in the gasoline tax would distort the allocation of resources. They urge, too, a relaxation of the already relaxed standards of gasoline efficiency (that word again) for new automobiles. Red-blooded Americans, if given their druthers, would prefer very big cars that can go very fast; therefore they should be allowed to put their money where their preference is, and the speed laws should be lifted while we’re at it.

The more beguiling advocates of free market theory admit that sooner or later oil will run out. They are confident, however, that the spur of possible profits will drive some mad scientist to invent a way of using crab grass or zucchini for fuel (as some tried to use dandelions for rubber in World War II), thus rehabilitating suburban agriculture and saving the automobile. In the meantime, they argue, as oil gets scarcer and the price rises higher, those willing to give up coarser pleasures are entitled to enjoy the daintier pleasure of burning gasoline in fast cars, fast boats and fast snowmobiles. Their willingness shows that is the efficient thing to do.

Let’s examine the proposition, not from the point of view of ecology or even of national security (where it’s a clear loser), but from the point of view of logic. Is economics really about the allocation of resources at all? To answer that question, we have to be able to say what a resource is. How about this: A resource is something that is useful or necessary to make something else, a component of an economic commodity.

(At this point there is a side issue we ought to deal with. The Education President tells us that a trained labor force is an essential resource in our struggle with Japan and Germany for the hearts and moneys of the world. But a labor force is not a thing; it is human beings, and human beings are ends in themselves. Trade is for human beings; human beings are not for trade. They are not a resource or a means to anything else. To treat human beings as means is the ultimate sin. I know that George Bush is a kind and gentle man who does not always mean exactly what he says. But if we are to read his lips, he should watch his tongue.)

So resources are things, objects. Natural resources are things untouched by human hands, lying around ready to be picked up or dug up or fished up, and used. Economic resources are also scarce. There is no point in talking about them if they are not scarce. Taussig (if my memory serves after all these years) gave air as an example of a noneconomic resource, the reasons being that there was a lot of it, and that no one could figure out how to bottle it and sell it. We’ve made progress, however. If you’re in the hospital and they decide to pep you up with oxygen, you’ll find $100 a day added to your bill. And Los Angeles knows that breatheable air would be impossibly expensive.

But of course not all scarce natural objects, even those that could be readily packaged, such as bluebird nests, are natural resources. Leon Walras, the patron saint of marginal utility analysis, credits his father Auguste with the notion that an economic good has to be useful as well as scarce. This does not seem a remarkably difficult advance in thought. It does not really advance us very far, either.

Maybe you are not clever enough to think up uses for bluebird nests, and maybe no one is; that does not mean a use will never be discovered or invented. Think of petroleum. If you had asked Adam Smith about it, he would have shrugged his Scotch shoulders. It was a sticky, stinky substance where it appeared, as in the notorious fields near Cumae, rendering useless the land that harbored it. Or you might have asked Karl Marx about uranium. He would never have heard of it, for one thing. What kind of resource is something you never heard of.  On the other hand, ancient man mined and traded obsidian, which, apart from the art and tools the ancients made of it, is now of no interest to a Harvard Business School graduate.

From these random samples we can infer that the usefulness of objects is not something inherent in them. As it happens, there is no dispute on this point. W. Stanley Jevons, who shares with Walras the distinction of having invented marginal utility, put it this way: “The price of a commodity is the only test we have of the utility of the commodity to the purchaser.” A half century earlier Jean- Baptiste Say had characteristically introduced an intermediate and indeterminable abstraction: “Price is the measure of the value of things, and their value is the measure of their utility.”

In our day, Gerard Debreu, a Nobelist and probably the world’s foremost mathematical economist, is in agreement with Jevons and Say. “The fact that the price of a commodity is positive, null, or negative,” he writes, “is not an intrinsic property of that commodity; it depends on the technology, the tastes, the resources … of the economy.”

(Please forgive another side issue. Noting the word “resources” before Debreu’s ellipses, I confess myself puzzled, since in a subsequent passage he says, “The total resources of an economy are the a priori given quantities of commodities that are made available to (or by) its agents.” It would appear that the price of a commodity depends, at least in part, on resources, and that resources are commodities-a line of argument that looks suspiciously circular to me.)

ONE WAY or another, then, we come to the conclusion that it is not so easy to say what economic resources are. They are useful, yes, but neither petroleum nor uranium nor a bluebird nest is, in and of itself, useful. Indeed, if you don’t know how to use them petroleum is nasty and uranium is dangerous. But our economy does know how to use them, up to a point. So they are resources for us. They are resources for us because of the way our economy is organized.

The organization of our economy is, as the marginal analysts say, a price system. (Like Oscar Wilde’s cynic, we economists know the price of everything and the value of nothing.) Every price is dependent on every other price in a delicately beautiful equilibrium. It is this balanced price system that allocates resources. If tomorrow morning some bright fellow comes up with a use for bluebird nests, the supply of and demand for them (the story goes) will set the price for them. Not only that, but as the demand for bluebird nests develops, the demand for some other things must decline. But other resources (including, sad to say, human resources) are shifted into the bluebird nest industry, restoring the equilibrium. Everything is properly allocated again.

Bluebird nests are now a resource, not simply because they are rare and a use has been found for them, but because they fit into the price system. That is crucial. The market does not so much allocate resources as tell us what resources are.

What, then, becomes of efficiency? It disappears. It is not separately discoverable, for resources are resources because the market says so, and their allocation is efficient only because the market says so. The market is not a better way of allocating resources; it is the only way. This is what the theory says.

Having said this much, it has uttered nonsense. If you really want to learn about resources and their allocation, you should go, not to Wall Street, but to someplace like World Watch Institute, which publishes an annual report called State of the World that explains the consequences of what we are doing and tells how we could do better.

Nonsense is always dangerous. The horror story that “The Market Knows” damages the ecosystem.  It also destroys economics itself, reducing the whole exercise to a defense of the status quo. True believers in the market apparently do not understand this, for they are very liberal (if you know what I mean) with advice about the sorts of issues we mentioned earlier – finding a way to make Exxon pay, restricting further exploitation of Alaskan oil, and so on. Yet these matters, as they now stand, are part of the present system. Changes in favor of the oil industry are no less an interference with the market than are changes in favor of the world and them that dwell therein.

Once any sort of change is admissible, every sort can be argued up or down. In the 1850s, Stephen A. Douglas proposed squatter sovereignty (allowing the territories to vote on slavery), which appeared to be impartial but actually favored the South. In their renowned debates, Lincoln forced Douglas to admit that slavery could be voted down as well as up. That won Douglas the Senate seat, but cost him the Presidency two years later. It would be lovely if we could come to understand the vacuity of squatter economics.

The New Leader


[2] Readers should see the upcoming link about “stealing a red-hot stove.”  The author attributes the quote to Lincoln but it was, according to Wikipedia, Thaddeus Stevens talking TO Lincoln.

By George P. Brockway, originally published June 12, 1989

1989-6-12 The Reserve's Silly New Equation Title

IN HIS EXCELLENT and comprehensive book about the Federal Reserve Board, Secrets of the Temple, William Greider properly fastens on the first word of his title, the Board being at least the third most secretive arm of the United States government. The rationale for the secrecy is that billions of dollars can be made by uncovering what, if anything, the Reserve is going to do next . Greider suspects, as I do, that the secrecy is useful mainly for instilling awe in us poor mortals.

1989-6-12 The Reserve's Silly New Equation Greenspan

Whatever the case, in contrast with its usual practice, the Reserve has recently gone to considerable trouble to call attention to a new equation that is supposed to predict inflation levels two years or so in advance. We are told that Chairman Alan Greenspan set a team of three economists to work on the problem when he took over in the spring of 1987, and that there is now light at the end of the tunnel. Remembering a New Yorker cartoon of a couple of years ago, I expect the apparent light will turn out to be New Jersey.

As constant readers know, I am, like Adam Smith, skeptical of all alleged mathematical solution to basic economic problems. Happily, the present formula is very elementary mathematics; something that kids probably do today in kindergarten, and that you used to toss off in fifth or sixth grade. So don’t panic.

First, a bit of background. Culminating a century of deep thinking by deep economists, Irving Fisher of Yale promulgated , 80-odd years ago, an equation sometimes said to be the essence of monetarism. Milton Friedman, in The New Palgrave (a four -volume economics encyclopedia I wish I could afford), assures us that monetarism is something else, and he’s entitled to his opinion; but it is Fisher’s formula the Reserve starts with.

 

Friedman also tells us, “There is no unique way to express either the nominal or the real quantity of money.” Nevertheless, some number is chosen and fed into an equation that says the quantity of money, multiplied by the velocity of its circulation, is equal to the general price level, multiplied by the goods produced. The equation, written all in capitals, looks formidable (MV = PQ) but expresses a simple, even a simplistic idea.

 

The money supply (M) is not the only term beset with difficulties. It turns out that the velocity (V) cannot be determined except by means of this equation. Fanciers of the theory contend that over the past many years V has been reasonably constant; MV is practically a single term.

 

The right-hand side of the equation presents different difficulties. Q stands for the total of the goods and services produced – that is, the “real” (stated in things), as opposed to the “nominal” (stated in money), gross national product. I have from time to time averred that the GNP, whether real or nominal, is less than it is cracked up to be, yet for the moment let’s accept it at its face value. We are immediately struck by the fact that its face value is expressed in money. Moreover, it cannot be expressed otherwise, for money is the sole relevant unit of measurement that applies to apples and oranges and tons of steel and all the rest. The paradoxical truth is that the “real” GNP can only be quantified “nominally.”

 

What, then, is the price level (P)? It is the sort of index I often grumble about, derived by combining the prices of a great variety of goods and services, each one weighted to allow its supposedly proper importance in the economy. But the prices of goods and services are already and necessarily included in the GNP. Many have therefore dropped P from the equation, effectively reducing it to M=Q. Translating it back into English, we learn that the total money spent for goods and services equals the total prices charged for those goods and services. Not much to learn from two centuries of study.

 

This is the reed the Federal Reserve leans on. It starts again with MV = PQ. Dividing both sides of the equation by Q. it gets P= MV/Q. Mainly because M2 yields a relatively constant value for V, which the Reserve wants, M2 is selected as the quantity of money. (M2 consists-you don’t have to pay attention here-of  currency, traveler’s checks, checking deposits, savings and ordinary time deposits, money market funds, and overnight Eurodollar deposits, but excludes time deposits of $100,000 or more.)

 

Next, the Reserve pretties up the equation with some asterisks or stars, like this: P* = M2 x V*/Q*. P* (or “P-star,” as insiders say) stands for the price level a couple of years down the road. V*is the determined constant, now with a suspiciously precise value of 1.6527. Q* is the future “real” GNP, assuming a steady growth of 2.5 per cent a year.

 

That last assumption is of course the secret of the game. The inflation-fighting Reserve wants the fraction to the right of the equal sign to be as small as possible, since it is equal to P*, or the future price level. As you remember from the fifth grade, you can reduce the value of a fraction either by reducing the numerator (1/3 is less than 2/3) or by increasing the denominator (1/3 is also less than 1/2). So taking the Reserve’s equation at face value, we could hold the price level (P*) down either by decreasing the money supply (M2) or by increasing production (Q*).

 

Faced with such an alternative, anyone who had not altogether taken leave of his (or her) senses would opt for increasing production, because after all that makes possible our standard of living. The Reserve, I’m sorry to say, opts for decreasing the money supply. It would unfair to imply that the Reserve doesn’t have a reason for its unnatural decision; the trouble is, the “reason” is erroneous. The Reserve, in fact, is not unlike one of my favorite characters in all literature, “The King of Korea I [who] was gay and harmonious: / he had one idea I and that was erroneous.”

 

The Reserve’s one idea is to control the money supply. For reasons that have taken me the better part of a book (to be published by Cornelia and Michael Bessie for Harper&Row about a year from now -advt.) to elucidate, the Reserve can very readily reduce the money supply -but it can’t be sure of increasing it. By “money supply” I don’t mean the gabble-gabble of items that make up M2; I mean the money actually at work in the economy. And in the capitalist economy everyone agrees we have, that is credit, the flip side of which is debit, or borrowing.

 

The textbooks say, I know, that bankers create money by lending it, yet actually they produce nothing except some useful services. Although bankers are often hyperactive in thinking up new financial “products” (index trading, etc.), they are passive partners in the work of the world. The active partners in the creation of money, and the uses it can be put to, are the borrowers. If no entrepreneur plans to produce a better mousetrap, if no consumers long for anything beyond their means, if no speculator schemes for a big killing, the banker sits idle. He can refuse to support plans, longings and schemes, but the first and essential step in creating money is taken by borrowers.

 

THE FEDERAL RESERVE –  the banker par excellence – can make it hard for ordinary banks to lend money, and hence hard for productive people to borrow money. Even if it makes borrowing easy, however, it can’t make people borrow. In other words, it can surely reduce the money supply, but can’t be sure of increasing it.

 

On the other hand, the Reserve can affect the interest rate, and that makes a difference the new equation does not take into account. By raising or lowering the Federal funds rate (the interest banks pay on temporary loans from each other, or from the Reserve itself) or the discount rate (the interest Federal Reserve banks charge commercial banks for short-term loans), the Reserve directly raises or lowers the interest banks have to pay, and consequently the interest they have to set. Naturally, too, by making it difficult for people and businesses to borrow money, the Reserve can indirectly raise the interest they have to pay.

 

Given that interest is a cost of doing business and a cost of living, raising the rate (whether directly or indirectly) ups those costs, thus certainly inhibiting or reducing output (Q*). But we remember that reducing Q* increases the value of the Reserve’s equation by increasing P* (the price level). So we find the Federal

 

Reserve deliberately reducing our standard of living and at the same time raising the price level. True to its one idea, the Reserve next solemnly goes about further reducing M2 (which might be the money supply if ours were a mercantilist system instead of a capitalist system).  In the process, it manages both to restrict the national output and to keep the inflation fires burning.

 

That is indeed the record the Federal Reserve Board has compiled since 1951, when it succeeded in abrogating its wartime agreement with the Treasury that kept the prime rate down to 1.5 per cent from 1939 to 1947. The abrogation was necessary, the Reserve argued, so it could be free to control the money supply (then said to be M1), as it dearly wanted to do.

 

Let’s go to the computer tape. Since the fateful year of 1951, the price level has increased 436.9 per cent. (That’s what the Bureau of Labor Statistics says; if food, shelter, clothing, and transportation have anything to do with the cost of living, I’ll say it has gone up a lot more than that.) More to the point, look at the figures that are left out of the Reserve’s equation: (l)interest paid as a percentage of GNP: up from 4.59 per cent in 1951 to 19.19 per cent in 1987; (2)pretax profits: down from 11.82 per cent of GNP to 6.92 per cent; (3) after tax profits (despite the best efforts of Ronald Reagan): down from 5.19 per cent of GNP to 3.94 per cent; (4)unemployment: up from 3.2 per cent to 6.1 percent; (5)Federal budget: from a surplus of 6.1 per cent of GNP to a deficit of 3.35 per cent; (6)foreign trade balance on current account, from positive $884 million to negative $153,964 million.

 

That is one sorry record. Monetarists say it is the consequence of failing to restrain M2 even further; but they know in their hearts that if the Reserve had in fact restrained it any further, the interest rate would have gone God knows how high, and we would have spent the subsequent years in a rapidly deepening depression that would have made 1932 seem idyllic.

 

How long must we allow ourselves to be deluded by silly equations?

 

The New Leader

 

By George P. Brockway, originally published April 3, 1989

1989-4-3 Minimum Wage vs. Maximum Confusion Title

THE FIGHT in Congress over a minimum-wage bill was recognized by both sides to be largely symbolic. It was nevertheless worth making. The press and TV characteristically presented what little they reported of the debate as a clash of personalities. But fundamental issues were at stake, and one must hope the debate has gone at least a little way toward educating the public (and the Congress) on the way the economy actually works.

First, a bit of background: The minimum wage is now $3.35 an hour. It has not been changed for eight years, even though the Consumer Price Index has gone up 32.3 per cent in that time. If you work full time, $3.35 an hour comes to $134 a week or $6,968 a year, which is well below the poverty level. But of course the assumption of full-time work is what economists call a heroic assumption (meaning that it doesn’t hurt the economists who make it any more than heroic medical procedures hurt doctors).  In fact, 25.3 per cent of the people employed in America work part time roughly half of them because they can’t get better jobs and half because they prefer it that way. It’s a fair guess that almost all of the minimum-wage workers are in the part-time group.

At present about 4 million workers earn the minimum wage or less. (Economics is full of miracles: In mathematics there’s nothing less than the minimum, but in economics there’s a great nether region below the minimum because commerce that doesn’t cross state lines is not covered by Federal law.) There are in addition just over 6.5 million people officially classified unemployed, and just under 1 million more who do not count because they are too discouraged to look for work. That adds up to 11.5 million Americans who work or are willing to work yet still are a long way below the poverty level.

The bills recently passed by both the House of Representatives and the Senate provide for the minimum to go to $3.85 in October of this year, then to $4.25 in 1990, and to $4.55 in 1991 (by which time inflation will have wiped out most, if not all, of the increase). In an attempt to attract Republican votes, the bills include a subminimum training wage: 85 per cent of the minimum for a first-time employee’s initial 60 days.  This provision would phase out in 1992. Though the bills have substantial support in both houses, particularly among Democrats, President George Bush has threatened to veto anything that goes beyond $4.25 an hour. Thirty-five Republican Senators have promised to sustain a veto. That should pretty much do it.

The threatened veto is, naturally, presented as a kinder, gentler act. The conservative argument is that companies pay the minimum wage (or less) because they cannot afford to pay more. Since they are at the limit of their resources, a pay increase would force them to fire those paid the present minimum and to turn away inexperienced teenagers, blacks and women looking for entry level jobs. The net result, conservatives say, would be an increase in unemployment.

Anyone who bothers to look at the record, however, will find that employment has risen in seven of the eight years when the minimum wage has been raised; and the one year employment fell (1975) was a time of severe recession when the drop was expected for other reasons. Moreover, the 11 states that now have a statewide minimum wage higher than the Federal standard also have the lowest unemployment.

You will have noticed that the argument shifts back and forth between the fate of the economy as a whole and that of individual workers and individual businesses – in other words, between macroeconomics and microeconomics. Several times over the years I have called attention to the fallacy of composition, which often pops up when such shifts are made, and I’ve suggested that economists must love it because they do so much dancing. In brief, the fallacy assumes that what is true of members of a logical class is thereby true of the class itself. Sometimes this leads to the laughable, as when Engine Charlie Wilson averred, “What’s good for General Motors is good for the country.”

In the present instance, conservatives argue that what may be bad for some workers must be bad for all. Liberals, on the other hand, argue that the possible microeconomic effect of some job loss will be more than offset by the macroeconomic effect of better jobs in the economy as a whole, resulting in increased spending that will stimulate business into hiring more workers.

Over a quarter of the low-income workers would have to be fired for the total wages to fall. It’s a judgment call, and the call pretty much separates the optimists from the pessimists, and the liberals from the conservatives. I’m such a liberal optimist, I doubt that as many as 10 per cent would be fired. In that case the macroeconomic stimulus would be considerable, making it likely the 10 per cent would be rehired almost at once, thus intensifying the stimulus and making inroads on those millions of unemployed.

If you too are an optimist, I ask you to consider a special implication of what we have been saying. The happier world we have projected depends on an act of Congress combined with a President’s willingness to sign his name. There is no economic law that will achieve our goal. Rather the contrary. Standard economics pits businesses in such implacable competition with each other that even good-hearted employers are unable to pay more than the minimum, while workers compete so fiercely for jobs that even the stout-hearted can’t hold out for more. (That, by the way, is the Iron Law of Wages, which prompted Thomas Carlyle to coin the name for this column.) Thus wages tend inexorably to zero, and profits do as well. So, to be sure, do prices; but since no one will have any money, I’ve never understood what difference that makes. Individual companies can’t stop this fall; it takes governmental action. Hence the minimum wage.

Shifting back to microeconomics, we are likely to find in boardrooms across the land another objection to raising the minimum wage. It cuts into profits, the gut feelings is, and cripples enterprise. This feeling is known as the wage-fund theory: it argues that the gross receipts of any enterprise form a fund from which wages, other costs and profits are paid. Therefore, as David Ricardo insisted, “There can be no rise in the value of labor without a fall of profits.” Karl Marx, an admirer of Ricardo, found the wage-fund theory handy in explaining the implacable opposition of labor and capital. Here, as in so many cases, we find the far Right in bed with the far Left.

But taking a peek at the real world, Joseph Schumpeter remarked the empirical fact that wages and profits tend to go up together. Really good times are at least pretty good times for everybody. Profits are high, wages are high, unemployment is low, and so, for that matter, is inflation. None of this could happen if the wage-fund theory were valid. It is not valid because wages are a cost of doing business, while profits are not.

Profit (or loss) is what is left over after all receivables have been collected and all bills paid. The costs of wages, interest, rent, and supplies can all be contracted for in advance; but profit is systematically residual. What’s to come is still unsure.

1989-4-3 Minimum Wage vs. Maximum Confusion boots

I’m talking about actual profit-the kind you pay taxes on. Business people talk also about “normal” profit – what they think an enterprise ought to earn to be worth the bother. There is obviously no such thing as normal loss. Normal profit is a planning concept. It is an estimate, even an expectation, but not an actuality. It is on the basis of this estimate that go/ no-go decisions are made, prices are set, and production runs are scheduled. Although in the real world some businesses are vastly more profitable than others, and more or less profitable from year to year, normal profits, making allowance for risk, are uniform, as are short-term interest rates. High-risk enterprises must promise high normal profits, yet in the real world the low-risk enterprises generally show the highest profits.

THERE IS clearly not much point in running an enterprise if it can’t earn the going interest rate and a bit more. You could lend your money to someone else and earn bank interest or better with no trouble at all. So the interest rate is what economists call an opportunity cost of normal profit: they are roughly equal. Consequently we have three related concepts: normal or hoped- for profit, the interest rate, and actual profit or loss. Since only the first two come out of the wage fund, only they are in conflict with wages.

A common error, from David Ricardo to Alan Greenspan, is to confuse interest and actual profits. Mathematical economists, too, have trouble with this phenomenon, because they are prone to work with normal profits rather than actual profits. Actual profits are earned in historical time, but mathematics knows only the present tense.

What Ricardo should have said was, “There can be no rise in the value of labor without a fall in the interest rate.” Wages and actual profits can and do go up and down together. They go up together when the interest rate is low, and they go down together when the interest rate is high.

As Henry Ford understood, it is in the rnicroeconornic interest of each business that all businesses pay good wages. For this macroeconomic phenomenon to happen reliably, it takes a law. It takes more than a minimum-wage law, but it takes at least that. It is not unlikely that pushing up the minimum wage would eventually push up the wages and salaries above it. That is why we have said (see “Reality and Welfare Reform,” NL, November 28, 1988) that doing something about the poor is inflationary unless a major effort is made to correct the massive maldistribution of income and wealth in this country.

That will not be easy, especially since we seem bemused by personalities, and since a previously wimpy personality will veto any attempt of personable Congressional leaders to move in the right direction. There is something more to the problem than David Rockefeller‘s objections to Michael Milken’s junky performance.

The New Leader

By George P. Brockway, originally published March 6, 1989

1989-3-6 How We Can Control The Interest Rate Title

IN THREE recent contributions to this space[1] I have argued that the conventional theories of inflation are wrong-that it is not caused by full or almost-full employment, and that it is not cured by raising the interest rate. I have gone further: I have maintained that raising the interest rate (which I call the Bankers’ COLA) is precisely what produces inflation in the first place. A legitimate question now is: What do I propose we do?

Let it be admitted – nay, insisted – at the outset that there aren’t any easy answers. No matter how ingenious the laws we enact, we can be certain that ingenious ways of avoiding them will be discovered. Legal avoidance happens with even the most uncomplicated statutes. There is a book out on how to defend against a drunk-driving charge by a trial lawyer who has had thousands of such cases and never lost a one. The unremitting search for loopholes in the income tax laws is sporadically countered by searches for ways to close them. It will be the same with whatever we propose. Perfection is impossible, because perfection cannot act.

To control the interest rate – to eliminate the Bankers’ COLA – one must be able to control the money supply. The Federal Reserve Board tries to do that now (for reasons different from those I’ve advanced) by fiddling with the reserve requirements it imposes on the banks and with the interest it charges them for temporary loans. Using these levers, the Fed can control the supply pretty well; but the interest rate – the cost of money – depends also on demand, and there is one demand for money that the Fed has so far refused to do much more than talk about. Seven and a half years ago (“Why Speculation Will Undo Reaganomics,” NL, September 7, 1981), I wrote in these pages: “Unless one is ready to run the printing presses flat out, the only way to get money into productive hands is to see to it that little or none of it falls into speculative hands.”

Although there is probably no way of keeping speculators from getting their hands on money if they want to, it would be quite easy to keep them from wanting to. All one has to do (as Felix Rohatyn and others have suggested in order to inhibit leveraged buyouts) is tax capital gains at 100 per cent on property held less than a year or two, then at 95 per cent on property held less than two or three years, and so on until the rate got down to the level of ordinary income.  (This, it will be noticed, is exactly contrary to the proposal of our new President, but he has never been quite clear in his mind what was and what was not Voodoo Economics.)

The foregoing, however, earth shaking as it is, would not be enough. For the archetypical speculators of our day are not beefy gents in flashy suits on the order of Betcha-million Gates or even aristocratic gentlemen with narrow ties on the order of J.P. Morgan or even indescribables like Ivan Boesky. No, the big-time wheeler-dealers are “institutions,” and institutions are churches and colleges and foundations and pension funds and insurance companies and mutual funds. We might almost say with Pogo that we’ve met the enemy and they is us, for most of us are beneficial owners of pieces of one or more of the nameless, faceless institutions the market gossips gossip about.

These institutions, our surrogates, write the computer programs that run the market, and they do it for capital gains. Unless that candy is taken away from them, it will do little good to take it away from the old-time speculators who still exist. Consequently, we’ll have to take a deep breath and tax the capital gains even of charitable institutions. (I said it wasn’t going to be easy.) The demand of nonproducing speculators for money would thus be greatly reduced, if not altogether stopped, and the Reserve Board, by increasing the money supply, could lower the interest rate for everyone else and take a step toward eliminating the Bankers’ COLA.

But it would be only a step. The bankers would resist, and their line of argument would be practically identical with the one they used in freeing themselves from most of the New Deal regulation. They were, in fact, remarkably successful in getting Democrats to make their arguments for them, as William Greider documents at excellent length in Secrets of the Temple. For example, Wisconsin’s recently retired Senator William Proxmire “delivered a short lecture on inflation and interest rates. At 15 per cent inflation, an investor lending $1 million at 10 per cent ‘loses’ $50,000 a year. ‘You cannot count on the lender being a complete idiot,’ Proxmire said. Sooner or later, he will stop lending at the low interest rate and invest the money himself in commodities or real estate.”

Our capital gains tax would cancel the commodities option and could be made to cancel the real estate option, but suppose the Senator’s million-dollar lender is smart and doesn’t lend at all, thus saving that $50,000 “loss.” He would be like the unfaithful servant in the parable, for at the end of a year he would have only his million dollars, while his neighbor, who wasn’t so smart and lent his million at 10 per cent interest, would have $1,100,000. What happened to the $50,000 loss Senator Proxmire talked about? If there was anything more to it than fancy rhetoric, the 15 per cent inflation affected both investors. The one who refused to lend wound up with $850,000 worth of purchasing power, while his neighbor wound up with $950,000. A negative “real” interest rate, in apparent defiance of the laws of mathematics, proves to be greater than zero. Perhaps we can count on the lender not being a complete idiot.

Of course, the millionaires have other choices. They could take their money and invest it directly in productive enterprise, or they could live it up. The former option is what we had hoped they would do, anyhow; that’s why all the editorial writers in the land have been urging them to save. As for the latter option, they might find consuming a million a little difficult, but it would be fun to try, and the economic result would at least be some priming of the pump. Someone has to consume what the economy produces.

The fact remains, though, that both millionaires have taken a loss in purchasing power, and that deliberate, cold-blooded national policy has forced the loss upon them. That’s not nice, and it’s nothing we can be proud of. So what can we do? Well, all that the Fed and other true believers in traditional economics have proposed (and put into practice) is raising the interest rate, usually by restricting the money supply. That’s how former Reserve Board Chairman Paul A. Volcker got the prime interest rate up to 21.5 per cent in December 1980, while the Consumer Price Index was up only 13.5 per cent, leaving Senator Proxmire’s investor with “real” interest of 8 per cent, which should have made him happy. The funny thing was, it didn’t make others eager to become like him. The real interest rate was greater than the prime itself had ever been (with one exception) before 1978; nevertheless, the national savings rate fell, and in spite of the subsequent Reaganomic tax cuts for the wealthy, the savings rate continued to fall. Moderately reflective true believers should have had their beliefs shaken just a bit.

Moderately compassionate believers should have been severely shaken by what else happened. The number of people unemployed went from 6.1 million in 1979 to 10.7 million in 1983. In the same years, 9.2 million more people were impoverished, and the median family income (in constant dollars) fell $2,305. That was not so nice either, and it was brought about by deliberate, coldblooded national policy.

Nor was that the whole story. The Federal deficit soared, our foreign trade was savaged, and Latin America was saddled with loans at un-payable interest rates. And all this was done to keep the real interest rate from falling below zero.

IFTHAT WERE merely a trade-off – suffering a lot of grief and getting back a little stability – it would be bad enough, for what was exchanged was the livelihood and prospects of millions of fellow citizens for the” reality” of usurious interest rates. The economy was deliberately depressed to “save” it from the possibility – the mere possibility – of being depressed later. But the savings rate continued to fall, corporate investment continued to fall, and industry after industry was allowed to fall before the Germans and Japanese, the Koreans and the Taiwanese.

At this point Wall Street-wise types will explain that Volcker was concerned about more than Senator Proxmire’s millionaire; he was concerned about the Japanese. He needed their money to pay for the deficit, which was all of $40.2 billion in 1979 (or about a third of the Gramm-Rudman target President Bush is going to be unable to meet). If Volcker had not given the Japanese what they wanted, they wouldn’t have bought our bonds, and Proxmire’ s millionaire would have sent his money abroad. The argument, in short, is that any attempt to reduce the interest rate will cause a flight from the dollar, and that the flight cannot be stopped because the financial world is international, its denizens are multinational, and they communicate electronically, instantaneously and secretly.

That is almost true. Yet multinational corporations are taxed. Granted, some of them may not be above diddling their books a bit, and very likely the diddling is difficult to detect; but taxes are collected, and where taxes are collected money can be controlled. The fact that financial operatives set up shop in the Cayman Islands to escape inconvenient regulation indicates that a flight from the dollar has to be an actual flight; a pretended flight won’t do.

We could perhaps stop the flight if we wanted to, but it would be much easier to let the money go. It is merely marks on paper; the factories and even the computers remain. The time to do the stopping is when the money wants to come back. Under present law, the Treasury Department is responsible for control of foreign exchange. It could require those who want to bring money into the country to go to the Treasury to buy dollars and to satisfy any taxes and regulations they had been fleeing from. The flight would no longer be so attractive, or serve any purpose.

Would that be the end of the problem? Of course not. Still, the proper direction of policy is, I think, clear. To control inflation, the interest rate has got to be brought down – way down. To do this, money has to be withdrawn from speculation and made available to productive enterprise. Faced with inconvenient regulation, finance will flee the dollar. The flight can be controlled by controlling foreign exchange. Such control will certainly affect foreign trade; but only doctrinaire true believers in laissez faire will blanch at that, and doctrinaire laissez faire is what got us into the mess we’re in.

The New Leader

 

By George P. Brockway, originally published February 6, 1989

1989-2-6 The Truth About InflationTitle

1989-2-6 The Truth About Inflation Dollar Sign

THERE ARE supposed to be two kinds of inflation, cost-push and demand-pull.  A benevolent

Providence is supposed to have provided them with the same cure: raising the interest rate or – if you prefer to do things indirectly – restricting the money supply. Last time out (“Bankers Have the Classic COLA,”NL, January 9), we looked at the panacea macro-economically and came up with the heretical conclusion that it caused inflation, rather than cured it. This should have occasioned no surprise, since medicine is a lot older than economics, and it was not until about a hundred years ago that your odds were better if you consulted a doctor than if you didn’t. Neoclassical economics has about caught up with Paracelsus.

The interest-rate panacea is, nevertheless, so solidly fixed in everyone’s pharmacopoeia that we’d better look at it micro-economically to try to discover its supposed merits. I should confess, at the outset, though, that having once met a payroll, as they used to say, I can’t imagine how raising the interest rate is expected to inhibit or prevent businesses from raising prices in response to the increased cost.

Every business must have money, and it therefore has to consider the cost of money, which is interest, whether it is a borrower or not. If it needs to borrow, interest is obviously a cost of doing business. If it is cash rich and doesn’t need to borrow, interest is an opportunity cost. By investing in its own business, it passes up the opportunity of lending its money to someone else and thereby earning the going rate of interest without working; so unless its own business can earn at least that much, it’s not worth continuing.

Interest is thus an inescapable element in doing business, and hardly a trivial one. Moreover, raising the rate not only affects every business, it does so geometrically. An increase in the interest rate is continuously compounded; the push is to an upward slope that becomes steadily steeper. Consequently, if the problem is cost-push inflation, upping the rate makes it worse.

In contrast, an increase in the price of oil is a one-time affair: It pushes most costs (not all, but most) up to a higher plateau, because oil is essential for the contemporary economy. At any given moment – now, for example – a certain quantity of it is used in myriad ways. At another moment – tomorrow, for example – the price may be doubled, thus doubling the economy’s outlay for oil and of course the percentage of total costs devoted to it. Producers, faced with the new cost, will raise their prices. They could maintain their profits if they just covered the increased cost of oil. In all probability, however, they will have been brought up to set their prices as a percentage markup on costs, and workers will have been brought up to expect their wages to be a certain percentage of costs.

Whether or not the new prices are enough to restore the balance among the factors of industry, they pretty quick-1yr each a new level and settle down there. Some industries and companies and workers may make out better than others, especially in the short run, yet by and large business soon goes on about as before. Prices are somewhat higher, to the detriment of people living on fixed incomes and of people who have lent money-and to the benefit of people who have borrowed money. But there is no reason for prices to rise above the new plateau unless the interest rate is tampered with.

When the Organization of Petroleum Exporting Countries (OPEC) made its successful moves, the Federal Reserve Board characteristically reacted in precisely the wrong way. OPEC raised costs for almost all businesses, and they now needed more money to continue. The Reserve Board perversely tightened the money supply, hiking the interest rate. I suppose they thought that by hurting business they would reduce the need for oil and OPEC would then be forced to lower the price. If so, they forgot that we had, as Art Buchwald wrote, encouraged the sheiks to send their sons to Harvard Business School rather than to Bowling Green State to learn basketball. At any rate, OPEC’S response was the standard one of a modem business faced with falling demand. Instead of cutting the price (as a neoclassical economist would have done), they cut production (as a modern businessman would do).

To be sure, the Reserve Board did manage to induce a recession, and that did, after eight years of trying, eventually result in an oil glut and lower oil prices. Just as in Vietnam some of our more thoughtful military leaders occasionally destroyed a village in order to save it, the Reserve Board caused massive unemployment, widespread bankruptcies, a growing Federal deficit, disaster in Latin America and the Third World, and a loss of much of our overseas business – all in the effort to control the price of oil. It was not a rational trade-off; and micro-economically the fact remains that raising the cost of any of the factors of production, of which interest is one, is not the way to inhibit cost-push inflation.

Demand-pull inflation is described by the popular cliché of too much money chasing too few goods. What is in the back of everyone’s mind is either an auction where millions of dollars are unexpectedly bid for a painting, or the hyperinflation that occurred in Weimar Germany, or the bread riots of pre-Revolutionary France. Briefly let us note that modern business is nothing like an auction, that hyperinflation occurs only when a nation has un-payable debts denominated in a foreign currency, and that the failure of the bread supply caused, not general inflation, but a deflation of all other prices as desperate people sold whatever they could at distress prices in order to pay for bread.

Putting to one side the probability that there is no such thing as demand pull inflation, we may doubt whether raising the interest rate will prevent too much money from chasing too few goods. A high interest rate no doubt chills the ardor of borrowers and thus may be thought to hold down the amount of money in circulation. Not all borrowers, however, are chilled equally. Speculators find high rates stimulating. Of course, money that goes into speculating doesn’t go into consuming; it chases paper, not goods; as far as consumption (or production, for that matter) is concerned, it might as well not exist.

Consumers, for reasons thought important by Professor Franco Modigliani and others, are said to try to maintain their accustomed or desired standard of living. They will shoulder heavy debts at usurious rates to do so. Hence their readiness to assume mortgages at more than double the maximum legal interest rate of a few years ago; hence the cavalier expansion of credit-card borrowing; and hence the failure of high interest rates to impede the chase for goods. In fact, because high interest rates have proved acceptable to consumers, the consumer loan business, once left to frowned-upon outsiders, has become attractive to banks-with the paradoxical probability that high rates have resulted in more money chasing goods, not less.

The famed bottom line, on the other hand, forces a more circumspect demeanor on businesses; few of them find it profitable to expand when the cost of financing is well up in the double-digit range. Many find it impossible to go on (right now, in this supposedly prosperous time, corporations are going bankrupt at a greater rate than at any time since the Great Depression). So high interest rates, while having only a minor effect on demand, have a major effect on supply. Whether or not there is more money in the chase, there are fewer goods in the running. To put it more generally, there are fewer goods than there might have been otherwise.

OUR HALF-CENTURY-LONG preoccupation with inflation is a sign of a profound confusion of American-even of global mind and will. Since World War II, inflation has been regarded as a pandemic disease, and a panacea has been sought. But social ills are specific, not universal, and corrective policies must be similarly specific.

If inflation were all prices going up together, a few people would be befuddled, but no one would be hurt much. As early as David Hume it was recognized that moderately rising prices stimulate the vital juices of entrepreneurs. As recently as the current “prosperity” it has been evident that business can readily accommodate itself to pretty steep inflation if it is fairly steady.

The trouble is that even moderately rising prices can be devastating to people living on fixed incomes, because they have no way of protecting themselves. This is a specific ill (there are others). Specific treatments are available, and some of them have been successfully applied. In 1966 Medicare began to protect the aged from one of the most crushing burdens of old age, and at the same time to provide millions with health care that otherwise would have been denied them. Since 1972 the Social Security COLAS have done much to prevent many of the retired from falling into poverty.

Some now say that the aged have it too good. This is a dubious proposition, but it is not to the point. The point is that the mentioned policies have had an effect. A specific ill was perceived, a specific treatment was devised, specific cures were effected, the cures may be judged, and specific improvements in them can be made. In contrast, the conventional theory of inflation that regards it as a pandemic ailment can propose only the panacea of a growing underclass of the chronically unemployed, and a narrowing overclass of those who have been able to make the Bankers’ COLA work for them.

Because interest payments are made pursuant to contract and continue years, often decades, into the future, the heavy hand of the Bankers’ COLA will be upon us, no matter what we do, for years to come. In the meantime our urgent task is to free ourselves, our politicians and our bankers from thralldom to the most dismal view of this dismal science.

The New Leader

By George P. Brockway, originally published January 9, 1989[1]

1989-1-9 Bankers Have The Classic Cola Title

IN “The Fear of Full Employment” (NL, October 31, ’88) we examined some of the fallacies behind the almost universally held doctrine that full employment makes for high inflation. This time we’ll look at another almost universally held doctrine, namely that raising the interest rate is the cure for whatever inflation exists. An astonishing thing about the latter doctrine is that no one bothers to say why it should work. The New York Times, which never mentions the prime interest rate without pedantically explaining that it is the rate banks charge their most credit-worthy borrowers, regularly reports without question that if the Consumer Price Index (CPI) starts to rise, the Federal Reserve Board will have to raise the interest rate.

Economists divide what they call the nominal or “money” interest rate (which is what you pay) into two parts: “real” interest (what they think you’d pay if the economy were in equilibrium) and an allowance for inflation. The allowance for inflation is what in other sectors of the economy is called a Cost of Living Adjustment, or COLA. People with money to spare are said to be enticed into lending by the prospect of getting back their money at a stated time with stated interest. What they want back is not the money, but the money’s purchasing power; and in inflationary times the only way to get back the same purchasing power is to get back more money. Hence the Bankers’ COLA.

Of course, bankers don’t call it a COLA. They have, in fact, been unremitting in propagandizing the notion that COLAS are bad and greedy and inflationary and likely to cause the downfall of the Republic. The COLAS bankers talk about are those that appear (or used to) in labor contracts, where they are manifestly an increased cost of doing business for companies with such contracts, and those that appear in Social Security and other pension payments, where they are manifestly an increased cost of running the government. (Another COLA, seldom mentioned, is the indexing of the income tax.) Since increased costs of doing business increase prices, and increased costs of running the government increase taxes (or the deficit), it is argued with some reason that COLAS are inflationary.

The propaganda against them (coupled with high unemployment and underemployment) has pretty well knocked cost-of-living clauses out of labor contracts. The Social Security COLAS are somewhat more secure because there are more worried senior citizens than alert union members. Even so, the steady cacophony from Peter Peterson and other investment bankers (when they take time off from promoting leveraged buyouts, which they evidently don’t think inflationary) has put the American Association of Retired Persons on the defensive. The Bankers’ COLA, however, is accepted as a natural law and discussed matter-of-factly in the textbooks, while the others are deplored as the work of greedy special interests out to line their own pockets at the expense of the nation and its God-fearing citizens.

One way of stating the Banker’s COLA is that it is the difference between the interest rate now and that of some earlier, less inflationary time. The prime rate at the moment is 10.5 per cent, and may have gone higher by the time this appears. In the 4O-oddyears since the end of WorId War II, there is one stretch, from 1959 through 1965, when the CPI and the prime were both substantially stable. In those seven years the CPI varied from 0.8 per cent to 1.7 per cent, and the prime from 4.48 per cent to 4.82 per cent. (Readers with a political turn of mind will note that the Presidents in this period were a Republican and two Democrats- Dwight D. Eisenhower, John F. Kennedy and Lyndon B. Johnson.). The Bankers’ COLA was evidently no more than 1.7 in those years, and the “real” interest rate was somewhere between 3.5 per cent and 4.5 per cent.

Let’s accept the higher figure, even though it is substantially higher than, for example, the rate in the years when the foundations of the modern economy were laid. Subtracting 4.5 per cent “real” interest from the current prime, we determine that the current Bankers’ COLA is, conservatively, 6 per cent.

But only about a tenth of outstanding loans were written in the past year, and many go back 25-30 years. Over the past 10 years the CPI has increased an average of 6.01 per cent a year. That is remarkably (and coincidentally) close to our estimate of the current Bankers’ COLA.  The average gets higher as we go back 15 and 20 years, and falls slightly if we go back 25 years. Consequently if the Bankers’ COLA has been doing what it’s supposed to do, we are not overstating the case in saying that today it is running at about 6 per cent.

Now, the present outstanding debt of domestic  non-financial sectors is about $8,300 billion. This figure includes everything from the Federal debt to the charge you got hit with when you didn’t pay your bank’s credit card on time; excluded are the debts banks owe each other and, for some reason, charges on your nonbank credit card. The cost of the Bankers’ COLA for this year therefore comes to about $498 billion (6 per cent of $8,300 billion).

As the late Senator Everett McKinley Dirksen would have said, we’re talking about real money. Let’s try to put it in perspective. At the moment the CPI is said to be about 4.5 per cent (less, you will have noticed, than the Bankers’ COLA, because bankers expect inflation to get worse). Since the GNP is currently about $4,500 billion, inflation is currently costing us 4.5 per cent of that, or $202.5 billion. The Bankers’ COLA is thus costing us almost two and a half times as much as the inflation it is claimed to offset.

So we come to Brockway’s Law No. 1: Given the fact that outstanding indebtedness is greater than GNP (as is always the case, in good years and bad), the Bankers’ COLA costs more than the total cost of inflation, at whatever rate.

Another comparison: The Bankers’ COLA costs close to three times as much as the Federal deficit the bankers moan about. (If there were no Bankers’ COLA, we’d be running a surplus, not a deficit.)

Also: The Bankers’ COLA costs many times more than all the other COLAS put together, and about 50 times – repeat 50 times – more than the Social Security COLA that so exercises investment banker Peter Peterson. (If there were no Bankers’ COLA, none of the other COLAS would exist, because the cost of living would not be going up.)

Also: The Bankers’ COLA costs more than giving every working man and woman in the land, from part-time office boy to CEO, a 10 per cent raise. (So much for the fear of full employment.)

SINCE THE Bankers’ COLA costs the economy more than inflation does, without it there would in effect be no inflation. Other things being equal, there would actually be deflation. And of course very great changes would follow if so large a factor as the Bankers’ COLA were eliminated. Reducing the interest rate to its “real” level would quickly and powerfully stimulate investment in productive enterprise, with a consequent growth in employment. It would trigger a one-time surge in the stock and bond markets, followed by a gradual tapering off of speculation.

1989-1-9 Bankers Have The Classic Cola Factory

As matters stand now, the Bankers’ COLA is an incubus of terrible weight depressing the economy. That this is so is revealed by the statistics whose subject is people rather than things. The standard of living of the median family is falling, even with two earners per family much more common than formerly. The number of people living in poverty is growing, and within that group the number of those who work full time yet are poverty stricken is growing still faster. The rate of unemployment – even counting part-timers as fully employed, and not counting at all those too discouraged to keep looking for work – would have been shocking a few years ago. These are signs of recession, of bad times.

The interest cost is the only one that has a general effect on the economy. We used to hear a lot about the wage price spiral, but a wage increase in the automobile industry (for many years the pundits’ whipping boy) works its way through the economy slowly and uncertainly. Initially it affects only the price of automobiles, and it never brings about a uniform wage scale. Wages of grocery clerks remain low, and all wages in Mississippi remain low. A boost in the prime rate of a prominent bank, on the other hand, immediately affects the rates charged by every bank in the country; and while it is possible for borrowers to shop around a bit for a loan, they find that rates vary within a very narrow range.

More important, interest costs affect all prices, because all businesses must have money, even if they don’t have to borrow it, and the cost of money is interest.

Vastly more important, the Bankers’ COLA is a forecast, a prediction, a prophecy. The figures we have been working with are from the past, but bankers – including, especially, those who make up the Federal Reserve Board – set rates that will have to be paid decades into the future. Well into the 21st century, for instance, we will be paying up to 15.75 per cent interest on a trillion dollars’ worth of Treasury bonds sold in the wonder-working days of former Fed Chairman Paul A. Volcker.

So we come to Brockway’s Law No. 2: Raising the interest rate doesn’t cure inflation; it causes it.

The New Leader

[1] Editor’s Note:  For those who are too young or forget the Coca Cola company came out with the “New Coke” in 1985, and it bombed.  Under-duress they kept the New Coke on the market, for a while, and re-issued the product people wanted to buy as Coca-Cola Classic, or the “Classic Cola.” http://en.wikipedia.org/wiki/Coca_Cola_Classic. Thus the gentle wit of the title of this article.

By George P. Brockway, originally published October 31, 1988

1988-10-31 The Fear of Full Employment title

The other day a friend sent me a clipping from the morning paper. My friend is a poet, whom I occasionally charge with deliberate obfuscation, and she was, she said, getting some of her own back. “What gives?” she asked, showing she can use ordinary speech when she wants to. “Who’s obfuscating now?”

The clipping she sent me read as follows: “Economists have become more pessimistic in recent days because the most recent batch of economic statistics, including yesterday’s strong employment report, suggests that the economy may be picking up steam and may overheat.” This was, of course, a run-of-the-mill news note of the sort we have all read many times, and I wondered why it was bothering my friend. I gave her a ring. “Surely your Webster or OED has all the words,” I remarked cuttingly, and only a couple of them have more than three syllables.”

“Yes,” she replied, “and many of my poems are made up of even shorter words. What I’d like to know is, what kinds of idiots are made pessimistic by an economy’s picking up steam? If it’s in danger of overheating, why not put more water in the boiler? I know you economists are even more devoted to metaphors than we poets are, but I thought you were all enamored of the one about a rising tide lifting all boats.”

“Don’t look at me,” I objected. “I’m not one of ‘you economists’. The pessimists of your clipping know that if business gets really good the Federal Reserve Board will get nervous about inflation and raise the interest rate, and that lowers the capitalized value of all stocks and bonds.”

“You mean, if I invest my royalties in a hundred-dollar bond that pays five dollars a year, and if the interest rate goes up to 10 percent, then my bond will be worth only fifty dollars?”

“I don’t know how a poet gets a hundred dollars in royalties,” I said, “but you’re absolutely right.”

“Eureka!” she cried. “I’ve outdone Archimedes! There’s no way the stock market can go up.”

“Keep your shirt on,” I advised.

But she paid no attention. “If business is bad,” she said, “poor earnings will send stock prices down. And if business is good, higher interest rates will send the market down. Why hasn’t anyone discovered this before? If you sell short, you can’t lose. Please give me the name of a good discount broker. I sincerely want to be rich.”

It’s a shame that my friend is merely one of the unacknowledged legislators of the world. We could use some of her guileful questioning in high places, and particularly in regard to the received doctrine that high employment makes for high inflation. Practically all economists, businessmen, bankers, politicians, and journalists are united in endorsement of this doctrine. Their unanimity is very curious – first, because few, if any, other economics propositions command such universal assent; second, because it is among the most unequivocally dismal notions in all this dismal science; and third, because there is no evidence whatever to support it. I don’t mean that no evidence is offered; I mean that the evidence offered is false or irrelevant or both.

If the proposition weren’t so dismal, it wouldn’t be worth troubling about. But look at what it means: It assumes that inflation is the worst economic misfortune that could befall us, and it asserts that in order to avoid – or simply to control – inflation, we must prevent several million people from having jobs. Even if all these millions were fully qualified and fully motivated, given the inexorable working of the system, they would still be unemployable.

Let’s think about that for a minute. It is the practically unanimous opinion of everyone who talks about the subject that our system, of which we are told to be so proud, must condemn upwards of seven million people to lives of undeserved squalor, uselessness, and hopelessness. Of course, that adds up to fifteen or twenty million men, women, and children when you count their dependents.

If I believed that our system were inevitably, necessarily, and indeed systematically that cruel, I’d be on the barricades in a minute – and I like to think I would be joined by you and by most of those who thoughtlessly repeat the dismal doctrine. My God, they’re talking about fellow human beings!

I don’t believe our system has to be that cruel. It is that cruel, but it doesn’t have to be. We’re given to understand that right now, with inflation running at about 3-5 percent and unemployment at about 6-5 percent, things are perhaps actually a little better than can be expected. Certainly our leaders consider them so good that they seem able to congratulate themselves without embarrassment.

Well, consulting Economic Report of the President[1] I find that since World War II there have been thirty-four years in which unemployment was at a lower rate, twenty-one years with lower inflation, and no fewer than twenty years where both inflation and unemployment were lower. Not only that, but in the year of lowest unemployment, inflation was lower than in all except four of the forty-odd years in question. In the year of highest inflation, unemployment was higher than in seven of the years. These figures certainly do not support the doctrine.

That may be said to be the small picture. A bigger picture is presented by the runaway inflations of our time that are regularly flashed on the screen to scare us into doing something drastic about inflation now, before we all have to get wheelbarrows to carry our worthless money to market to buy a loaf of black bread.

Besides the Weimar Republic runaway, the prime examples are Hungary after World War II and Brazil recently. If the doctrine were sound, those countries would have had full employment and overheated economies to start their runaways. Exactly the contrary, though, was the case. Each one suffered from appalling unemployment, and Brazil still does, without in any way impeding or controlling the inflation. These examples do not support the doctrine, either.

To complete the empirical record, we may note that today, of all industrialized nations, Japan has the second lowest unemployment and the lowest inflation. In short, there is no relevant evidence reliably connecting high inflation and full employment. We have not, after all, ever had full employment except in wartime, when inflation of civilian prices is to be expected because civilian production is necessarily curtailed. On the other hand, we have many times had inflation in peacetime, and we have perversely tried to control it by raising the interest rate in order to curtail production.

My poet friend asked me why, if the unemployed had jobs, they couldn’t produce goods at least equal in value to their wages. I couldn’t think why. “Then there wouldn’t be more money chasing fewer goods, would there?” she asked. “So why isn’t full employment the cure for inflation?”

Well, why isn’t it?

The New Leader


[1] The basis for this post is the re-print in the book “Economics Can Be Bad For Your Health” and the author updated the data to use the 1994 Economic Report.  The original was written in 1988. The points still hold.

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