Don’t Bet On The Banks

By George P. Brockway, originally published February 11, 1991

I CAN’T THINK of a single good reason why the rest of the financial sector, led by the commercial banks, should not eventually follow the S&Ls to the woodshed. In a few cases the usual arguments about “the others” being more experienced or diversified may carry some weight, but in general their problems and those of the S&Ls have similar causes and will have similar consequences.

There is more than a trace of poetic justice here; the commercial banks lobbied hard for the deregulation that did in the S&Ls, and the same deregulation has returned to plague its champion.

Only 11 years ago, the states had usury laws that set the maximum interest rates for different loans. There were, of course, exceptions of various degrees of complexity, but the important point is that there were limits to what could be charged. The Federal Reserve Board set limits in the other direction, the most discussed being Regulation Q. To give the S&L’s a chance to survive, and to offset their being restricted essentially to home financing, Regulation Q allowed them to pay savings accounts a fraction of a point more than the commercial banks.

That system was a casualty of the Federal Reserve Board’s sensational and long-running battle with inflation (see “Who Killed the Savings and Loans?” NL, September 3, 1990). It took almost 30 years for the system to start to break down, and the collapse is not yet complete.

The reason for the long Untergang is the inherent stickiness of finance. In any 12months the nonfinancial sectors (public and private) make new borrowings equal to less than one-twelfth of their total indebtedness. The other eleven-twelfths includes 30-year mortgages still paying 4 per cent interest, 20-year Treasuries paying 15.75 per cent, credit card freaks paying 19.9 per cent, and all sorts of things in between.

With this big backlog (currently about $8.3 trillion), even very large shifts in the interest rate on new loans have only a lethargic effect on the nation’s overall interest rate. The overall rate was 9.55 per cent in 1979-when former Reserve Chairman Paul A. Volcker took well publicized command of the inflation battle-and reached 10.61 per cent a year later. As a result of Volcker’s policies, however, the average prime rate on new loans jumped from 12.67 per cent in 1979 to 15.27 per cent in 1980 and topped out at 21.5 per cent that December and the following January. Since what is comparatively slow going up is also comparatively slow coming down, the average interest rate is higher today than it was in 1980, although the prime is less than half its 1980 peak.

The stickiness of finance enabled the S&Ls and the commercial banks to withstand the surge of interest rates as long as they did. It is probable that the bankers (of all kinds) do not yet know what hit them; certainly the Federal Reserve Board (called the nation’s central bank by its present chairman, Alan Greenspan) does not know. So I’ll give them a hint. If they pay high interest to attract funds, they must charge high interest to cover their costs. And if businesses must pay high interest, they must charge high prices for their goods. At this point, the bubble gets very thin. Consumers do not have money to pay high prices, particularly if many have lost their jobs.

You can charge whatever amuses you for a book or a loaf of bread or a new broom to sweep things clean. Only the book or bread or broom business will be affected. But when you charge too much for the use of money (and it is the Federal Reserve Board that ultimately sets the rate), all businesses, all banks and insurance companies and “institutions,” and all men, women and children are affected.

The S&Ls were driven to the wall first, but the death march of the commercial banks is gathering momentum. Both S&Ls and commercial banks cheered when the state usury laws were suspended, and rushed to expand their real estate business. They are now suffering from a surfeit of residential condos, motor inns, office buildings, and shopping malls. The commercial banks greedily participated in the Great Recycling of OPEC’S profits and as a result will have to face up to their losses in the Third World. Many S&Ls and commercial banks have stuck themselves with junk bonds. How many will survive the recession?

Well, the Bush Administration proposes to help them by getting rid of two of the few remaining New Deal banking reforms. The most important of these keeps commercial banking separate from investment banking, insurance and especially ordinary business. The other restriction keeps commercial banks from branching out beyond a state’s borders.

In the cheery days of President Ronald Reagan, these regulations were anathema simply because they were regulations, and because, as some sports-minded journalist noticed, not one American bank ranked among the top 10 in the world. Even more shameful, most of the giant banks were Japanese. Once again it seemed that they knew something we didn’t know.

In the drearier economic days of President George Bush, less is said about the Japanese banks, for they have fallen on harder times. The index of leading stocks on the Japanese exchange fell 38.7 per cent in 1990, and the Japanese banks (this is one of the secrets of their size) have long positions in those stocks. They have long positions, too, in a rapidly falling real estate market, which they can speculate in (unlike American banks) as well as lend money on.

A few years ago, proposals to permit interstate Banking and to allow banks to own brokerage houses and insurance companies (and vice versa) would have caused a considerable hullabaloo. The large banks were in favor of changing everything; they wanted to get on that top 10 board with the Japanese. Likewise the big stock brokerage houses and insurance companies and all-in-one companies such as Sears, Roebuck. Smaller operators (except those who wanted to sell out for capital gains) preferred the existing conditions-although some would not have objected to dabbling in additional financial services, provided that other financial servers couldn’t dabble back.

Today, the Bush banking moves are not stirring much controversy. A professor of finance suggested recently in the New York Times that this is because they don’t go far enough, that there is nothing to shout about. But commercial banks are in trouble, and since the trouble is no longer confined to Texas and Oklahoma, there is little reason to expect greener pastures in other states. Nor is the solution to be found in putting them together with the problem plagued brokerage houses, insurance companies, pension funds, investment banks-and Sears, Roebuck. A couple of dozen such financial smorgasbords would likely result in a couple of dozen concentrated headaches, if not hemorrhages.

To be sure, the Administration promises to supervise the banks closely to prevent their making more bad loans. Does that mean they are not supervised closely now? Yes, it does. You see, supervision costs money, and you’ve heard about the deficit. Increased costs will have to be matched by increased taxes-in this case, Federal insurance fees. Higher insurance fees will mean lower interest on deposits, and that means money-market funds and Treasury bills will attract cash away from the banks. To keep their deposits, banks will have to pay higher interest, and to do that they’ll have to make more loans at high rates. Sound borrowers won’t pay high rates; so the banks will have to hunt for riskier deals (see “Big Is Ugly,” NL, September3, 1984). And that’s what got them where they are.

In short, interest rates aren’t innocent.  If you refuse to control them, you destabilize the financial sector-and the whole economy. If you manipulate them in a fallacious attempt to contain inflation, you bring on recession (See “Bankers Have the Classic COLA,” NL, January 9, 1989). And that’s what the Federal Reserve has done.

A GOOD DEAL of the trouble lies in the fact that few bankers understand how the capitalist system differs from the mercantilist system. In Legal Foundations of Capitalism (one of the neglected great books),

John R. Commons explains the shift from property as use-value to property as exchange value. This did not start in the United States until the first Minnesota Rate Case a century ago, and most bankers are still out of date. They remain mainly interested in fixed assets that can be attached, not in going concerns that generate cash flow and profits. Hence their fatal fascination with real estate and the idiotic recycling that transformed OPEC profits into loans that are in effect gifts of American money to rulers of Third World nations.

Willard Butcher, when he was chairman of Chase Manhattan, once delivered himself of a perfect example of bankerly thinking: “Is Mexico worth $85 billion?” he asked rhetorically. “Of course it is. It has oil, gold, silver, copper. … “All these assets are physical. You can touch them, and you can attach them. But they aren’t worth much if they can’t be sold at a profitable price, and when usurious interest rates are charged profitable prices are impossible.

On an arguably more modest level, I came up against this sort of thinking at another bank while I was in the publishing business. The bank examined our balance sheet and advised us that our inventory was too low. Did we have an unusually large number of titles out of stock? I asked. No, on that point our record was exceptionally good. Did we allow titles to go out of print too quickly? No, rather the contrary. Were we slow to fill orders? No, again. Our record here was the best the bank knew of. Did our practice of printing in relatively small quantities (this was before the Japanese made “just in time” inventory control famous) result in significantly higher unit costs? No, yet again.

You’d have to say that we were managing our inventory as well as anyone in publishing. Nevertheless, the bank insisted it was too low. The unspoken (or unrecognized) reason was that our low inventory meant we did not have much for the bank to attach if we got in trouble. It never crossed the bank’s mind that too much money tied up in inventory might get us in trouble, and that if we couldn’t sell the inventory profitably, the bank certainly would be unable to do so.

Commercial bankers aren’t the only people still living in a precapitalist world. Our financial system as a whole (S&Ls, banks, insurance companies, pension funds, “institutions” and supervisors) continues to be essentially mercantilist. Its ideal profit, like Bush’s, is a capital gain. In this understanding it is joined by mainstream economics, which analyzes business as a disconnected series of market-clearing ventures, not as a going concern. Until these two powerful sectors of our society are brought into the modern world, stagnation, punctuated by bankruptcies, is likely to be our lot.

 The New Leader

Our Austerity Recession

By George P. Brockway, originally published January 14, 1991

FINANCIAL EXPERTS are saying that the present recession was caused by consumers failing to consume. The supply side supplied, but the demand side didn’t demand. I’ll go along with that; but I’m dismayed that the supply-siders seem to have learned nothing from the experience.

I have just finished a decennial purging of what I whimsically refer to as my files; they were crowding me off my desk, much as the Federal deficit is said to crowd entrepreneurs out of the credit market. As the clippings and offprints fluttered into my wastebasket, I was struck by the volume and vehemence of those complaining that we Americans consumed too much or didn’t save enough (take your pick).

For 20 or 30 years now, all the respectable bankers (once upon a time every banker was respectable), all the respectable journalists, all the respectable economists have been moaning about how we Americans have been on a consumption binge. (If you want the facts of the matter, ask the Economic Policy Institute, 1730 Rhode Island Avenue, NW, Washington, DC 20036, for a detailed refutation by Robert A. Blecker.)  Ronald Reagan’s Right-wing revolution was supposed to exalt the supply side over the demand side. There were tax cuts for the rich and tax increases for the poor, because the poor would only waste their money by buying things they needed or maybe wanted, while the rich would invest theirs in Wall Street and make capital gains. Austere elements of the far Left joined in the chorus (of course, for ostensibly different reasons). Consumerism got a bad press wherever you turned. Sometimes it seemed that Ralph Nader was more subversive than the Chamber of Commerce believed him to be.

Among the worthies represented in the clippings I threw out were at least four Nobel laureates, one former chairman of the Federal Reserve Board, three former chairmen of the Council of Economic Advisers, six former Secretaries of the Treasury, one former Secretary of Commerce (who seems to have started a new anti-consumption committee every other week), a past chairman of the Committee for Economic  Development, nine officers or staffers of the Brookings Institution, almost everyone who has ever set foot inside the American Enterprise Institute, innumerable other professors and journalists and TV pundits, not to mention Presidents and Senators and Representatives and unsuccessful candidates for those offices. The idea has had its spokesmen in the International Monetary Fund and the World Bank (where it is known as austerity), as well as in Britain, France, Italy, Germany, Norway, Japan, and Kenya. It has not suffered from lack of publicity.

The present failure of consumers to consume is just what these doctors ordered. Some of the doctors-those who still believe in the efficacy of purging and bloodletting – are no doubt pleased with the resulting recession. A few are puzzled and silent. But most are as noisy as ever.

Many of the respectable economists, I shudder to say, were bashing consumption in the name of Keynes. They seem not to have noticed that he concluded Chapter 6 of The General Theory with these words: “the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

Classical economists had long held that consumption was a drag on investment. Back in 1803, Jean-Baptiste Say wrote in words that could be applauded today by Newt Gingrich, “It is the aim of good government to stimulate production, of bad government to encourage consumption.” The reasoning was simple. What is spent on consumption can’t be invested in production. Obviously. Keynes also agreed with the proposition-with one proviso: There has to be full employment. Not 4, 5 or 6 per cent unemployed, but really, truly, full employment. In that case, and in that case only, with the economy running flat out, nothing more can be produced; so whatever labor goes for one thing can’t at the same time go for something else. But with millions of men and women unemployed, it is always possible to increase production by giving them jobs.

What I don’t understand is how the notion that consumption is bad got started. If consumption is bad, then production must be, too. I’m used to writing jeremiads that nobody takes seriously (someday they’ll be sorry), but why should tens or hundreds of thousands of people be expected to band together to make automobiles if nobody is supposed to buy and drive them?

The consumption thing (to use a Presidential locution) is another of those fallacies of composition economists keep perpetrating. An individual who saves his money (even hiding it under the hearth) is more likely to die rich than someone who flings roses riotously with the throng. But if everyone in the land sits home, wasting not and wanting not, the economy runs down, and no one has anything to consume, or to save, either.

The consumption thing is vastly more threatening because the government is doing its best to participate. Look at what Gramm-Rudman-Hollings has done to us. As a result of the budget deal of a couple of months ago, the Federal government is committed to spending 30 or 40 billion dollars less next year than it had planned (conservatively) to spend, and the cuts will be greater in succeeding years. A considerable part of the “savings” will be at the expense of the states and municipalities, all of which are already short of funds because of the recession, and all of which are traumatized by childish and self-defeating taxpayers’ strikes. In order to balance their budgets, the states will have to cut down on their services – and that is simply another way of saying they will have to fire people. School class sizes will rise, and bridges will fall.

Taken as a whole, the government part of the consumption thing means that, one way or another, at least a million people will lose their jobs. Some of the affected will no doubt be those dreadful goldbricking bureaucrats we keep hearing about, but most will be employees of private business – a.k.a. free enterprise – for the government is the private economy’s greatest single market for goods and services. The billions of dollars the private economy will lose because of Gramm-Rudman-Hollings will make the recession both deeper and harder to climb out of.

FACED WITH this dismal prospect, a rational Congress would repeal Gramm-Rudman-Hollings, a rational President would sign the repealer, and together they would embark on a massive public works program. Everyone knows there is plenty to be done and plenty of people to do it. But everyone knows nothing of the sort will happen because of the deficit.

Suppose our reaction to Pearl Harbor had been similar. In 1941 the Federal government was running a deficit equal to 4.3 percent of GNP. It jumped to 14.4 per cent in 1942 and to 31.1 per cent in 1943. Thereafter it fell, but remained above 7. 5 percent as late as 1946, and averaged 18 per cent over the six war-time years.

In contrast, consider the current deficit and its steadily rising estimates. Last February the Economic Report of the President presented figures predicting a deficit of 1.1 per cent of GNP, while according to the latest estimate of the Congressional Budget Office, the deficit will be at least 5.4 per cent of GNP.

Had we taken deficits in this range as cause for inaction in 1941, we would have run up the white flag no later than December 11, when Germany declared war on us. And we would have  spent the succeeding 39 years studying Japanese and German industrial management from the ground up.

It is no answer to say that there was a war on. Indeed there was, and we came out of it with total Federal indebtedness equal to 127.3 per cent of GNP – more than double today’s comparable figure. Yet when the War was over we set about rehabilitating Europe and ultimately did so with the Marshall Plan, at a cost to us, in 1990 dollars, in excess of $250 billion (see “Don’t Cash Your Peace Dividend,” NL, March 19, 1990).

Did we ruin ourselves by this profligacy? Hardly. It was not until 1975 – almost 30 years later – that the unemployment rate became as high as it is today. Aside from the flash inflation caused by precipitate lifting of price controls (over Harry Truman’s veto), it was not until 1974 that the Consumer Price Index rose at its present rate. Furthermore, after-tax profits as a percentage of GNP were higher than today’s in every postwar year except three Nixon-Ford years (1974, 1975and 1976) before Jimmy Carter appointed Paul A. Volcker chairman of the Federal Reserve Board in 1979.

Since then our mirror has cracked from side to side, and the curse of inaction has come upon us. That is what the record of unemployment, of inflation and of after-tax profits shows. It won’t do to point a finger at OPEC (see “What Happened to Jimmy Carter,” NL, November 27, 1989). Some blame falls upon us for what we did because of OPEC that is, nothing much (and as I write we threaten to go to war in its defense). But the major blame falls upon us for casually and stupidly embracing the fallacy that a nation can save itself into a healthful economy.

If we could disabuse ourselves of this fallacy, the current recession would not last long, and the subsequent prosperity would show up the alleged prosperity of the past decade for the pallid fraud that it was. Unfortunately, those who urged the fallacy upon us continue to push it; we continue to follow them; and as a result the recession will be deeper and longer than necessary.

 The New Leader

A Road Eastern Europe Could Take

By George P. Brockway, originally published November 12, 1990

THE COUNTRIES of Eastern Europe have a unique opportunity to combine the virtues of capitalism and socialism. If they do not seize the opportunity-and Poland, for one, seems to be kicking it away-they will be in danger of combining the vices of both systems.

Capitalism’s virtues are the freedom and responsibility that come with being your own master. Its vice is class conflict. Only a small minority has so far enjoyed the capitalist virtues to the fullest, while a different and much larger minority suffers poverty and unemployment and hopelessness.

Socialism’s virtues are the ideal of classlessness and the practical abolition of unemployment. Its vice is totalitarianism-and too often has prevailed.

No nation has yet succeeded in combining the virtues and avoiding the vices. Perhaps it cannot be done, at least not on a large scale, or not for very long. Yet there is no doubt that some societies are vastly better places to live in than others, and that vast changes for the better are achievable in every society. It is sad when the road not taken is a better road.

Something like the imprinting of goslings seems to be happening in the nations of Eastern Europe. The collapse of the Communist order has occurred at a time when the most visible examples of capitalism are limping badly. The fledgling democracies (or some of them) seem determined to copy as well as follow the limpers.

The United States, Great Britain and Germany have shockingly high unemployment rates, and Japan’s is growing. In all these countries, the gap between the rich and the poor has always been great and has recently been widening. In all these countries, high or rising interest rates are regarded with complacency.

In all these countries, the general will is so corrupt that the growth of unemployment actually is greeted with cheers and a rising stock market. In all these countries, a hyper volatile stock market is considered an indicator of prosperity.

Nevertheless, those traits of the world’s most successful capitalist countries are regarded with envy by many of the new governments in Eastern Europe. Unemployment (previously unknown) is embraced as a necessity for free enterprise. Higher prices are somehow thought necessary to combat inflation (no doubt on the same theory that recommends higher interest rates to us), and lower wages are decreed (although in the future they will presumably be set by the free market).

Forward-looking Hungary has been trying for several years to get a stock market going and is ashamed that an average day’s trading is still only 40,000 shares. How can arbitragers and brokers and takeover experts get along on such slim pickings? Poland hopes to do better and has dispatched a commission to see how we run our admirable exchanges.

Such misdirections are bad enough, yet it seems likely that worse is in store. The newly liberated countries are being set up to recapitulate the disasters of Africa and Latin America. The setting up turns on a confusion of thought and may be only stupid, not deliberate. The disasters, though, will be real enough.

The confusion is of capital and money. They are both necessary, but they are not the same. With capital you can make things. With money you can buy things, including capital. You cannot make things with money, nor can you buy things with capital, except on an insignificant scale. These distinctions, although elementary, apparently are easy to forget; otherwise the privatization of Eastern Europe would be a cinch.

As matters stand, enthusiasts for privatization want to consult investment bankers (if they’re not bankers themselves), print up a lot of stock certificates, hire a hall or a curbside for a stock market, plug in their computers, and let her rip. There are complications, however. Consider the Polish tractor industry.

The Poles make a pretty good tractor, but today they’re overflowing the factory yards. The factories used to be subsidized, and so were the farmers who bought them and the city folk who bought farm produce. Now none of them will be subsidized (this is the free market hope). A few city folk seem to have some money and are delighted to buy fresh produce off the tailgates of a few farmers’ trucks. The TV news programs report that a Harvard professor is pleased with this example of free enterprise. But it is pretty small potatoes and evidently does not build much of a demand for tractors.

So there’s this tractor industry with the ability to make a product it can’t sell. Who will buy the operation? You might take a flyer on it if you could pick it up for, say, a quarter of what it cost to build. It might eventually payout, especially if somehow the Polish economy recovered from its self-imposed austerity. Then you could float a stock issue, which might respond to the cries in the stock market hall and make you very rich indeed.

But we have not asked where you got the money to buy the business. Of course, you will have borrowed it. The new Bank for European Reconstruction and Development is being established for that very purpose-to underwrite privatization. Unfortunately the bank will have only about $12 billion to lend, and perhaps 30 or 40 times that will be needed. So commercial banks and investment banks around the world will be encouraged to participate, as they were encouraged to participate in the Great Recycling of OPEC’S winnings. The new financing will probably be structured more like a leveraged buyout, in that bonds will mostly be sold to “institutions” – pension plans, mutual funds, and so on. Needless to say, these junk bonds will be given a more high-sounding name.

High sounding or not, junk is junk, as we’re beginning to understand. A subsidized tractor factory that loses money is not likely to become profitable when the subsidy is withdrawn and is replaced by interest charges of 14 per cent or more. In short, the privatization of Eastern Europe bids fair to wind up in something like a combination of the recycling of OPEC’S profits and the junk-bonding of American business. The newly liberated countries will find themselves burdened by unmanageable debt, while our institutions are burdened by uncollectible loans. The citizens of Eastern Europe, who so bravely and joyfully threw off the chains of communism, will be cruelly deceived.

None of that is necessary. It will probably come about because the whole world seems to have confused finance with industry, or, as aforesaid, money with capital. Everyone assumes that what Poland and the rest need to do to become viable capitalist nations is sell their industry to entrepreneurs. What they actually need to do – and have the opportunity of doing – is transfer the ownership of capital, which is what they used to call “the means of production,“ to the workers, thus making them entrepreneurs[1].

Take that tractor factory. It is currently owned by the State – that is, by the people who work there and all the other people of Poland. The same is true of the farms that used to buy the tractors and the grocery stores that used to buy the farm produce and every other productive organization in the country. To privatize their industries, all the Poles have to do is transfer the ownership from the people collectively to the people who work in each separate business. No money has to change hands; the capital exists. The new Reconstruction and Development Bank’s money can be used to finance modernization of the infrastructure.

POLAND – and the rest of Eastern Europe – could become a land of producers’ cooperatives. It could combine the best features of capitalism and socialism (see “The Labor Theory of Right,” NL February 11-25, 1985, and “Faint Praise for Profit Sharing,” NL March 25, 1985).  Its capitalists and laborers would not be at each other’s throats, because they’d be the same people. Its industries would not stagnate for lack of incentive. And all this could-can-be done at no cost.

Contrast the situation in Eastern Europe with that of our unions trying to buyout United Air Lines. First, the unions have to offer an outrageous price for the company’s stock to save it from investment bankers who want to break up the company. Second, they have to issue junk bonds at usurious interest to pay for the stock. Third, they have to hire an executive for $9 million, not because he knows anything about running an airline, but because he has the confidence of the junk bond bankers.

No doubt you can easily think up dozens of objections to the employee-ownership scheme; and if you’ll stay after class I’ll try to answer them. In the meantime, let me suggest that most of your objections will be similar to one raised recently by Barry Bosworth of the Brookings Institution. He points out that those who work for poorly run businesses would not get a fair shake, to which I reply that the bankers’ alternative would give them no shake at all.

Others may object that the Polish tractor business, say, is hampered by obsolete machinery and a swollen payroll. What is to be done? The classic bankers’ solution would be to abandon the whole thing and start over, with a leaner work force and a meaner mountain of debt. The money would come partly from the new bank and partly from Ford or Honda or Mercedes. The new plant would be able to compete internationally. That is, it would cut into the sale of American or Japanese or German tractors, and naturally into American or Japanese or German employment.

As for the Poles, many or most of the tractor workers would be out of a job that’s the principal reason for the new plant. Those remaining would find that their pay had to be held down so the plant could handle its debt service and still compete internationally. The debt service would of course go abroad, and so would the profits, if any. As in Africa and Latin America, there would be no winners from this creative destruction, with the possible exception of some foreign bankers.

If Eastern Europe copies the mistakes of its Western models, the best it can hope for is that the suffering imposed on the present generation will be followed by a better life for the next generation. This, you will recall, was the promise of communism, too. Such promises are rarely fulfilled. A more likely fate is that of Africa and Latin America (and of the creditor countries as well)-being doomed to decades of what is politely called austerity because of the Great Recycling.

The road less traveled by might still be taken. As Jake said to Lady Brett, isn’t it pretty to think so?

 The New Leader

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[1] Not a new thought to the author.  35 years earlier, while awaiting a return home after the end of WW II he wrote An Economic Bill of Rights

What Color is Your Recession?

By George P. Brockway, originally published October 1, 1990

EVERYBODY SEEMS to have a theory about the when or what or how of a recession. The official or customary theory (I’m not sure what office decrees the custom) is that you have a recession if you have two back-to-back quarters of falling real GNP. Some journalists, apparently trying to avoid monotony, say you need to have six months of falling real GNP-which is a little bit harder to do. Federal Reserve Board Chairman Alan Greenspan has a different approach. A business downturn has to feed on itself for him to call it a recession.

Before Greenspan will sit up and pay attention, inventories have to rise, causing orders for more goods to fall, causing workers who might make more goods to be fired, causing stores that might have sold goods to those ex-workers to lose business, causing them to cancel orders from their suppliers, causing more factory closings, and so on and on and on. The trouble with this is that if such a self-cannibalistic process should get started, Greenspan is not likely to be able to do much about it. The Federal Reserve Board was not conspicuously effective when it realized (some months after the event) that the Great Depression was upon us. Anyway, Milton Friedman, the monetary guru, says it takes two years for monetary policies to take effect.

In short, most economists feel they have done their job if they just say No to recession. But whether what we are now going through is a recession or not, it seems like one to honest proprietors of S&Ls (there used to be many), to automobile dealers, to building contractors, to all the earnest Willy Lomans desperately trying to meet their Christmas-line quotas, and to all their regular customers trying desperately to emulate the Japanese and place their orders “just in time.”

My poet friend has what she calls the Taxicab Theory. As late as the middle of August, she says, you could not get a cab in New York even if there wasn’t a cloud in the sky. It took a half hour or more to sweat out the line at the Vanderbilt Avenue side of Grand Central. Now, she points out, you can get a cab anywhere, rain or shine, night or day. She concludes that if people don’t have money for taxis, we are in a recession. “If you don’t believe me,” she says, “you can ask the cabbies. They’ll tell you.”

No doubt there are other recession theories. What difference do the different theories make?  Suppose all those who are saying we’re in a recession, whatever their degree of technical sophistication, are right. So what? To be able to refer to “The Recession of1990-91” will no doubt be convenient for future historians, but how does it butter our parsnips today?

The answer, of course, is that if somehow someone could convince the Federal Reserve Board that we are in a recession, they might bring themselves to do something about it. And (this is what Samuel Johnson would call the triumph of hope over experience) they might even do the right thing. That’s why Chairman

Greenspan’s definition of a recession is so ominous. If, as he says, a recession is a disaster feeding on itself, there is not much that the monetary authorities can do; and if we are not in a recession, there is no need to do anything. His formulation is an ideal excuse for inaction.

Rather, it is an excuse for no change of action, for what former Chairman Paul A. Volcker liked to call “staying the course.” He was probably brought up (like me) on Iron Men and Wooden Ships and Howard Pyle’s Book of the American Spirit; so he couldn’t help it if others of our generation had visions of him as David Farragut standing in the rigging, shouting, “Damn the torpedoes! Captain Drayton, go ahead!” or as Ulysses S. Grant, lounging on a rough bench during the Wilderness campaign, calmly proposing to “fight it out on this line if it takes all summer.”

The “two quarters” approach to recession is only slightly less lethargic than Greenspan’s. According to this view, the last recession ended in 1982. It follows that we have had prosperity ever since-in fact, we are told, the longest sustained prosperity in our history. Thus the definition of recession is also important because when you say what you mean by recession, you ipso facto reveal what you mean by prosperity. The meaning of bad times implies the meaning of good times. How good are the good times we have been enjoying from the end of 1982 to the present? Let me count the ways. The national debt has increased from $1.137 trillion in 1982 to $3.319 trillion today. The annual trade deficit has gone from $7 billion in 1982 to $136.5 billion today (with two higher years in between). The nation’s atomic plants have so deteriorated that it will cost $200 billion to repair them. Likewise, at a similar cost, the interstate highway system. The United States of America, the world’s largest creditor nation at the start of the period, is now the world’s largest debtor nation.

To be sure, we have been staying the course in order to conquer inflation. So what has happened? The Consumer Index has risen 34.7 per cent. Perhaps you are politically inclined and want to compare these eight Reagan-Bush years with the eight Kennedy-Johnson years. During the latter (which included the Vietnam War), the CPI went up only 22.7 per cent.

The foregoing is not the worst that can be said of our allegedly prosperous era. The worst is what was done to people directly.

In the years since 1982, the number of our unemployed fellow citizens has never fallen below 6.5 million and has generally been much higher. The number of those too discouraged or demoralized to look for work has hovered around 1 million. The number of those working part time has not fallen below 35 million. The number of men, women and children living in poverty has not fallen below 31.5 million. The number of the homeless can only be guessed at. Our infant mortality rate has become the worst of any industrialized nation. We have the most expensive and the least satisfactory medical care system. And the gap between the rich and the poor has steadily widened, reaching its widest in the figures just released by the Census Bureau.

I submit that the economy sketchily described above is not prosperous. Nor is it “fundamentally sound,” although that meaningless phrase will be trotted out if anything more goes wrong. Certainly the current state of affairs is not so wonderful that it justifies “staying the course.” Every sane citizen must want America to do better. Therefore the customary definition of recession and the Greenspan definition are both mischievously misleading.

We want to be alerted to any weakness in our society, and we want especially to be alerted to faltering in our striving to build and maintain a fair and free economy. We don’t have an economy simply to put chickens in our pots and automobiles in our garages. Communism in the Western world has collapsed because its objectives narrowed to just such trivia. When capitalism judges itself on the basis of its GNP, it risks succumbing to the same fate.

We have economics so that we all can be free and responsible providers of our own sustenance, thinkers of our own thoughts, and definers of our own relationships with our fellows. By “all” I mean all. We have come a long way, and obviously we have a long way to go.

HOW CAN WE measure our progress more precisely? We now have two statistical series that will serve at least for the time being. The first gives us the number and percentage of families living in poverty.

To no one’s surprise, the proper way of determining poverty is in dispute. On one side are those who say that the reported numbers of the poor are too high because the definition of poverty is limited to cash income only and excludes the value of public housing, food stamps, Medicaid, and so on.

On the other side are those who say that the reported numbers are too low because the definition of poverty is based on an estimate of the cost of necessary food, which is assumed to be one-third of the minimum budget. It is argued the estimate of the cost of necessary food is too low, and that other essential expenditures come to more than double the cost of food.

We may eventually reach that happy day when we have reduced the number of poor to the point where it is vital to settle this dispute. In the meantime our performance is so disgraceful that almost any definition of poverty will serve to mark our progress (or lack thereof) from year to year. Whether the number is 31 million or 16 million or 40 million, it is shameful and should spur decent people to action.

The other relevant statistical series shows the share of the national income that goes to the different quintiles or deciles of the population. Again there are disputes over details, and again the trend is a good-enough measure for now. Surprisingly, many people (among them Friedrich Engels) have fretted that perfect equality is either impossible or bad or both, but they really need not worry.

The two statistical series-the number or percentage of fellow citizens living in poverty, and the distribution of the national income-are both socially revealing and economically crucial. A free economy not only produces goods, it consumes them. If significant numbers of the citizens are unable-for whatever reason-to produce goods, the economy is weakened. If significant numbers are unable-for whatever reason-to consume what is or might be produced, the economy is weakened. The supply side must be balanced by the demand side, or the whole thing grinds to a halt.

The grinding to a halt is very like Greenspan’s self-cannibalism. It is not quite so bloodthirsty, but it is no less deadly. Real GNP may be increasing from quarter to quarter, yet increasing numbers of men, women and children are excluded. It may take decades or centuries, but the resulting stagnation and rot could destroy the society (see “The Evils of Economic Man,” NL, July 9- 23).

We are not fated to destroy ourselves. To avoid destruction, however, we must first understand what can go wrong what is going wrong. The current popular tests of recession hinder-they do not help-our understanding.

 The New Leader

Who Killed the Savings and Loans?

By George P. Brockway, originally published September 3, 1990

THE WAY WE’RE going, we’re not getting close to the truth about what happened to the savings and loans. It’s much easier to be bemused by the amount of money lost in the disaster, to be shocked by the skulduggery involved, to be flabbergasted by the bad judgment of rich men, to be titillated by political charge and countercharge.

The $500 billion fiasco has been a long time in preparation. The first official action leading up to it was taken as early as March 1951, when the Federal Reserve Board got the Treasury to agree to a slight advance in interest rates. In his Memoirs, President Harry S. Truman criticizes the Reserve for failing to live up to its part of the agreement; but as William Greider points out in Secrets of the Temple, the issue became moot with President Dwight D. Eisenhower‘s election. Wall Street won out over Washington. The Reserve has, ever since, been undisturbed in following its gleam.

When the media go beyond personalities, they explain that the S&Ls failed because they borrowed short and lent long. That is, they accepted deposits that could be withdrawn at will (30 days’ notice was often reserved but seldom enforced), and they lent against mortgages running 30 years into the future.

The curious fact, however, is that the S&Ls were deliberately set up to act in this way from their beginnings in the Great Depression. They were designed to perform two functions: First, they would offer a safe depository for the small savings of the middle class; second, they would aggregate those savings and lend them to finance middle class home ownership. Because the functions were restricted, it was understood that expenses would likewise be restricted. S&Ls, it was reasoned, could therefore offer a little bit more than the going rate on the deposits and charge a little bit less than the going rate on the mortgages. And so it was.

The new S&Ls were successful for more than 30 years. They were substantially responsible for the United States’ achieving the highest rate of home ownership in the world (a rate considerably higher than the present one). They were also substantially responsible for a rebirth of personal savings following the Depression. My wife and I were able to buy a home and start saving at a far younger age than either our parents or our children.

For all those years that they were contributing to the wealth and happiness of the American people, the S&Ls were borrowing short and lending long. Obviously, something else caused the downfall.

Plenty of people are ready to tell you the problem was inflation. Inflation is always bad for lenders. If the price level is rising at a rate of 5 per cent a year, anyone lending $100 today will receive back only $95 in purchasing power a year from now. At the same time, naturally, inflation is good for borrowers, who borrow $100 today and pay back $95 in purchasing power next year.

But look at the performance of the S&Ls over the long run-specifically, over the life of a mortgage. In that run of 20 or 30 years a go-getting middleclass American will both a borrower and a lender be. He/she will borrow at the beginning and save toward the end. They will gain from inflation (if any) when they are young and lose to inflation as they approach middle age. From their point of view, there is much to be said for this balance. From the point of view of the lending bank, inflation is not without its compensations. Inflation of real estate prices has the advantage of improving the quality of the bank’s portfolio. Foreclosures will be fewer, and losses in each foreclosure will be lower. Taken by itself, inflation no more explains the S&L debacle than does the borrowing-short-lending-long story.

Now we reach the root of the matter: What devastated the S&Ls was a tremendous rise in the interest rate.

The first noticeable sign of things to come was a period of tight money in 1955-57, but no one expected the trouble we’ve seen. The Federal Funds rate in those years jumped from 1.78 percent to 3.11 per cent, and continued to rise. By 1965 the average S&L was earning only 0.5 per cent on its capital. Crises followed in 1966, ’69, ’74, and ’78. High T-bill rates and the new money-market mutual funds drained the S&Ls of deposits.

When on October 6, 1979, the new chairman of the Federal Reserve Board, Paul A. Volcker, announced that thereafter the Reserve would concentrate on the money supply and let the interest rate go as it pleased (it pleased to go up), the S&Ls’ fate was sealed. In March 1980, the grandiloquently styled Depository Institutions Deregulatory and Money Control Act confirmed the seal. Practically unrestricted competition, coupled with $100,000 deposit insurance, guaranteed that the Savings and Loans, trying to escape the consequences of high interest, would engage in a binge of blue-sky financing and outright thievery. The only surprise is that the binge lasted for a full decade before the general collapse.

But what could the Federal Reserve do? Doesn’t inflation cause the interest rate to rise? When all is said and done, isn’t the culprit the usual suspect-inflation? It’s too bad – $500 billion too bad – that the S&Ls got caught in the crossfire of the Federal Reserve’s war with inflation, but the war must go on, mustn’t it?

Given the size of the S&L disaster, I suggest that the Reserve ought to have a pretty convincing explanation of the necessity for its actions. Chairman Volcker used to tell us that the interest rate was none of his doing but was the doing of the impersonal market. To the best of my knowledge, his successor, Alan Greenspan, has not said him nay. Well, if the Federal Reserve does not control the interest rate, I don’t know what it does do – unless, as W.S. Gilbert sang of the House of Lords, it does nothing in particular and does it very well.

Of course, the Reserve claims to control the money supply. Its Federal Open Market Committee buys or sells government bonds (it could trade in other assets as well, but prefers not to). If it wants to contract the money supply, it sells government bonds until enough banks buy enough of them to reduce their cash reserves and hence their loan-issuing power. If it wants to expand the money supply (a stratagem that rarely crosses its mind) it buys government bonds and builds up the banks’ reserves.

There’s more to buying and selling than stamping your foot and saying that’s what you want to do. Your price must be right. If you want to sell, your price must be enticingly low. A low price for a bond (or any asset) yields a high rate of return. Not only are banks eager to buy high-interest Treasury bonds, they are also quick to adjust upward the rates they charge their customers, whose credit, after all, is less solid than that of the U.S. Government. In the same way, when the Open Market Committee buys bonds at a high price, it drives the interest rate down.

Because the money supply is not a precise figure (the Reserve publishes four different major and two minor ways of measuring it), the effects of this activity on the money supply are not precise. But it certainly does have determinate effects on the interest rate, and that certainly has definite effects on the cost of living.

ALL OF WHICH brings us back to 1951. In the preceding decade the Federal Reserve Board and the Treasury worked together to maintain the price of government bonds, and the prime rate for most of those years  – despite their including World War II and the first year of the Korean War remained steady (believe it or not) at 1.50 per cent. In 1951 the Reserve, worried about inflation, managed to break free of the agreement with the Treasury and thereafter devoted itself to controlling inflation by managing the money supply.

As it happens, 1951 is the midpoint between the founding of the Reserve in 1913 and 1989, the most recent full year for the Consumer Price Index. Several fat volumes would be required for an exhaustive economic history of each period, and a thorough analysis of the impact of those histories on the CPI would be beyond reasonable achievement. Yet some events are clearly more significant than others. For obvious reasons, wars are held to be especially inflationary, while depressions are deflationary. World Wars I and II and the start of the Korean War occurred in the first period, while the Korean War truce talks and the Vietnam War occurred in the second period. The recession of 1920 and the Great Depression occurred in the first period, while there have been five (or six, if you count what’s going on now) recessions in the second period. So we may say with some justice that the control of inflation should have been no harder in the more recent period particularly since the Federal Reserve Board had now proclaimed this to be its primary objective – than in the earlier one.

How, then, do the two periods compare? From 1913 to 1951, the Consumer Price Index (1982-84 = 100) rose from 9.9 to 26, an increase of 163 per cent. In the later period, from 1951 through 1989, the index rose from 26 to 124, an increase of 377 per cent. In other words, during the 38 years that the Federal Reserve

Board has been deliberately and ostentatiously fighting inflation, the inflation rate has gone up more than twice as fast as it did in the previous 38 years. On the record, the burden of proof is on the Federal Reserve Board to show that its policies, which have resulted in the destruction of the S&Ls, have been effective by any standard whatever.

As I have argued previously (“Bankers Have the Classic COLA,” NL, January 9, 1989), a high interest rate causes rather than cures inflation. This will always be true because the outstanding nonfinancial debt in the nation is greater than the GNP. At the present time, the former stands at about $9.75 trillion, and the latter is about $5.4 trillion. Thus each percentage point in the interest rate is paid for by an increase of $97 .5 billion in the general price level, while a one point increase in inflation costs only $54 billion. With interest rates currently running about six points above normal, this year’s net cost of the Federal Reserve Board’s inflationary policies will be $261 billion – or considerably more than the budget deficit everyone moans about.

In comparison, the cost of the S&L mess is small potatoes. Nevertheless, it must be added to the other costs the Federal Reserve Board is responsible for. Several Presidents and Congresses have undoubtedly acted stupidly in regard to the S&Ls, but the S&Ls would still be operating and prospering to the benefit of us all if it were not for the stubbornly misguided behavior of the Federal Reserve Board.

 The New Leader

The Evils of Economic Man

By George P. Brockway, originally published July 9, 1990

NINETEEN NINETY bids fair to go in the books as the year of ironies. Everywhere economists are being asked the way out of the present Slough of Despond – and everywhere economists are sure only of the way in.

The Soviet Union and its former satellites are in trouble. Both industry and agriculture are failing. Crime and corruption are rampant. Store shelves are empty. Prices are soaring. Unemployment is rising. The solution (so everyone says) is to become like us.

But we are in trouble, too. Six million Americans are unemployed, another million are too discouraged to seek work, and 23 million are working only part time. We’re just beginning to find out how many of us are homeless. More than 31 million have no health protection. There are 15 nations whose citizens have a longer life expectancy than we do in this country.

Among the industrialized nations of the world, the U.S. ranks low in literacy and lower in comprehension of mathematics and science. We have finally acknowledged that the Head Start program enormously improves the effectiveness of our schools, but we provide it for merely a small number of our children.

Our banking system is in disarray. The part of it that was created to encourage home ownership and personal saving has been destroyed by doctrinaire “deregulation,” and it is now estimated that it will cost over $500 billion to clean up the mess and payoff the depositors. Commercial banks are choking on nonperforming real estate and foreign loans. Investment banks are being bankrupted by their own greed.

Our atomic plants are in disrepair; some must be closed down as dangerous. Repairing them will cost upwards of $200 billion. Our highway system, most of it more than 30 years old, is also crumbling and will cost hundreds of billions to restore. Meanwhile, we seem to be unable to find a few billion to try to pay for the damage that we caused directly in Panama and indirectly in Nicaragua.

Our troubles (so everyone says) are caused by our deficits, which (so everyone says) are caused by our lack of saving. The solution (so everyone says) is to become like Japan.

But Japan is in trouble, too. Perhaps a trillion dollars has been lost in its stock market so far this year. Despite the best efforts of the Bank of Japan, the yen is erratic against the dollar. The inflation rate is only a fraction of ours, but it is rising. Speculation in real estate has made home ownership impossible for all except the very rich.

The Japanese standard of living has never equaled ours and is only coming closer as ours falters. The secure and happy life of the Japanese worker has always been a fable propagated by the American business press. (See “How Our Sun May Rise Again,” NL, July 12-26, 1982.) The position of Japanese women is at a level we reached a century ago. Japanese invest in American real estate, like Radio City, because it is so much more profitable than Tokyo real estate; and in general Japanese investors are finding fewer and fewer opportunities at home. The solution (so everyone says) is to cut down on regulation and become more like us.

Then there are the two Germanys, whose situation is nicely described in Cynthia Propper Seton‘s A Fine Romance ( one of my favorite novels, which I’m rereading for the fifth time}:”Proust discovered that all our desires are fulfilled on condition that they do not bring the happiness we expected from them.” The West Germans will get all that eastern land (except for Sudetenland and the Prussian part of Poland) on condition they clean it up and modernize it and re-educate its citizens. The East Germans will again become important people in the world on condition they realize they’re less equal than their Western cousins.

Now that the Cold War is melting away, it is possible to see that these ironies have a similar, if not a common, source. We can for convenience call it the idea of Economic Man, who is selfishness incarnate and perhaps the one creature, real or imaginary, who can safely be referred to as “he.” No self respecting woman would want to be mistaken for him, but it is on the basis of his absolutely greedy behavior that economists deduce the laws they solemnly tell us about.

He is an essential organizing idea of contemporary economics, just as mass and energy are organizing ideas of physics. Adam Smith thought Economic Man’s selfishness would be automatically curbed by competing selfishness, while Karl Marx thought it would be inexorably curbed by dialectical materialism (not his phrase), which is another way of saying class selfishness.

Contemporary economics holds that any curbing of Economic Man is inefficient. Even Keynes, after painting an unappealing portrait of him, wrote, “For at least another hundred years we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into the daylight.”

Sixty of Keynes’ hundred years have gone by, but he imposed two conditions we have not met: no important wars (we have fought three: World War II, Korea, and Vietnam) and no important increase in population (ours has doubled, and the world’s has multiplied two and a half times). So Keynes would be justified in putting the end of the tunnel at least another hundred years down the road.

Although it will be none of my business, I expect it will be a lot farther away than that. If “avarice and usury and precaution” are to be desanctified, we must create gods to put before them. Economic Man will not be easy to displace.

Until we learn how to displace him, we face a long, slow, erratic decline. By “we” I mean not only the countries mentioned above but also the rest of the world – all of us.

REGARDLESS of what a society considers good, there is, at least in theory, some point above which an individual’s income can provide more of that good than a person has civilized use for. Conversely, there is some point below which an individual’s income provides little or none of the good.

Economic polarization has malign consequences across the distribution scale. The poor are unable to buy the products that industry could produce; industry consequently has fewer opportunities for further expansion; the rich consequently have fewer opportunities for investment; workers consequently have fewer job opportunities. If the rich are frustrated in their attempts to consume their incomes, they turn to speculation. The amount of money that flows into speculative markets – preeminently the securities markets – is increased; so prices in these markets escalate.

Escalating security prices force corporations of the producing economy to increase their “normal” or planned profit in order to attract the capital necessary simply to continue in business. Planned profit is in conflict with wages; so wages must be further restrained or employment reduced or “rationalized,” thus increasing polarization and narrowing the market for industry’s products – a phenomenon Professor Robert Averitt calls “The Paradox of Cost Reduction.” Such a situation cannot correct itself. On the contrary, the amplitude of the difference between the rich and the poor tends to increase, and the numbers of the rich and the poor tend to increase, too.

Until we make fundamental reforms, especially in income distribution, we can expect a series of crises and minicrises. The next one may come about as a result of Third World debt, or consumer debt, or trouble in the insurance business, or another market crash, or junk bonds, or (ironically) the end of the arms race, or something quite unforeseen. Whatever, with each crisis unemployment and inflation will inch upward.  Not that long ago it was widely believed that if either unemployment or inflation stayed long above 5 per cent, there would be condign punishment of the politicians in power. Now 5 per cent for either rate is a cause for unabashed self congratulation.

The slow deterioration of a society can go on for a very longtime. The Pharaonic World, the Roman World, the Medieval World, the Mandarin World, all stagnated for centuries. The modem world (it will be our successors who name it) can do the same. And it will do the same as long as we continue to worship Economic Man.

 The New Leader