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By George P. Brockway, originally published November 27, 1989

1989-11-27 What Happened to Jimmy Carter Title

James Mac Gregor Burns, Pulitzer Prize-winning biographer, historian, and political scientist, recently published The Crosswinds of Freedom, the third and final volume of his history of The American Experiment. The book confirms Burns’s standing as one of the foremost observers of the modern American scene.  It also carries forward the foreboding analysis he initiated in The Deadlock of Democracy: that American law, by creating a stalemate in politics, makes an almost impossible demand on-and for-leadership.

Jimmy Carter of course figures in Crosswinds, and reading about him makes you want to cry.  He was (and is) a decent man who apparently thought decency was enough, who had a talent for offbeat public relations, and who also had a propensity for shooting himself in the foot.  The prime example was the Iran hostage affair.  As Burns points out, it was Carter who kept that in the news, and it helped defeat him.  On the other hand, if not for Iran, Ted Kennedy might have been able to grab the Democratic nomination.  The economic situation was probably enough to finish Carter, no matter what.  In that connection I offer a footnote to Burns’s magisterial book.

During the last two years of Carter’s presidency we had double-digit jumps in the Consumer Price Index.  It is not clear why this happened.  The usual explanation blames OPEC.  What is generally forgotten is that OPEC blamed the strong dollar for its price increases.  For almost three decades – long before the advent of Paul Volckerthe Federal Reserve Board and other First World central banks had been steadily pushing interest rates higher, thus overhauling their currencies and raising the cost of the goods the OPEC members (which generally had few resources aside from their oil) bought from us.  Before raising their prices, OPEC tried for several years to persuade us to change our policies; but the Reserve plowed ahead, increasing the federal-funds rate from 4.69 percent in March 1977 to 6.79 percent in March 1978 and 10.09 percent in March 1979.

Finally, on March 27, 1979, OPEC oil went up 9 percent, to $14.54 a barrel, and three months later there was another jump of 24 percent.  In December OPEC was unable to agree on a uniform price, but individual hikes were made across the board. By July 1, 1980, the barrel price ranged from $26.00 in Venezuela to $34.72 in Libya.  Thus, in a little over a year, the cost of oil had more than doubled.

Yet petroleum accounted for less than 3 percentage points of the inflation. Moreover, in every OPEC year (and, indeed, in every year on record), the nation’s interest bill has been substantially greater than the national oil bill (including domestic oil and North Seas oil as well as OPEC oil).  If OPEC is to blame for the inflation of 1979-81, the Federal Reserve Board is even more to blame.

A major cause of the rest of it was hoarding, which resembles speculation yet differs from it in that real things are involved. During this period the stock market was quiescent:  The price/earnings ratio was lower than it had been at any time since 1950, and less than half what it would be in 1987 or is today [1989]. But hoarding, probably prompted by memories of the gas lines following the 1974 OPEC embargo, was heavy.

And not merely in petroleum; it extended to all sorts of commodities.  Manufacturers, wholesalers, retailers, and private citizens tried frenziedly to protect themselves against expected shortages. As often happens in such situations, the expectations were immediately self-fulfilled.  Confident that shortages would allow them to raise prices, manufacturers eagerly offered high prices themselves for raw materials they needed.  Maintenance of market share became an almost obsessive objective of business management.

In the book business, for example, “defensive buying” became common.  Bookstores and book wholesalers increased their prepublication orders for promising titles so that they would have stock if a runaway best-seller developed.  Publishers consequently increased their print orders to cover the burgeoning advance sales.  It soon became difficult to get press time in printing plants, and publishers increased press runs for this reason, too.  Naturally, everyone also stockpiled paper, overwhelming the capacity of the mills.  For all I know, the demand for pulpwood boosted prices of chain saws and of the Band-Aides needed by inexperienced sawyers.

Unlike speculation, hoarding has physical limits.  After a while, there’s no place to put the stuff.  And after a while, the realization dawns that a possible shortage of oil and gasoline doesn’t necessarily translate into an actual shortage of historical romances.  Moreover, the shortage of oil and gasoline, once the tanks were topped off, disappeared.  There was plenty of oil and gasoline; you just needed more money to buy it.  Hoarding-or most of it-slowed down and stopped.  Business inventories declined $8.3 billion in 1980.  But prices didn’t come down.

All this time Jimmy Carter was not idle, for he prided himself on being what we’ve come to call a hands-on manager.  As early as July 17, 1979, he got resignations from his Cabinet members and accepted several, including that of Treasury Secretary W. Michael Blumenthal. To fill the Treasury slot, he chose G. William Miller, chairman of the Federal Reserve, and that opened the spot for Paul A. Volcker, who was nominated on the 25th amid cheers on Wall Street.  At his confirmation hearings on September 7, Volcker revealed the conventional wisdom to the House Budget Committee.  “The Federal Reserve,” he testified, “intends to continue its efforts to restrain the growth of money and credit, growth that in recent monhts has been excessive.”

True to Volcker’s promise, on September 18 the Reserve raised the discount rate from 10.5 to 11 percent; and then, less than three weeks later, from 11 to 12 percent.  An additional reserve requirement of 8 percent was imposed on the banks.  More important, a fateful shift to monetarism was announced.  The Reserve, Volcker said, would be “placing greater emphasis on day-to-day operations of the supply of bank reserves, and less emphasis on confining short-term fluctuations in the Federal funds rate.”  On February 15, 1980, the discount rate was set at 13 percent.

Despite this conventionally approved strategy, prices kept going up.  In January and February, the inflation rate was 1.4 percent a month, or about 17 percent a year.

Again President Carter took action.  On March 14, 1980, using his authority under the Credit Control Act of 1969, he empowered the Federal Reserve Board to impose restraints on consumer credit.  It immediately ordered lenders to hold their total credits to the amount outstanding on that day.  If they exceeded that amount, 15 percent of the increase would have to be deposited in a non-interest bearing account in a Federal Reserve Bank. The banks and credit-card companies, adopting various procedures, hastened to comply.

All that was good standard economics.  If inflation is caused by too much money, the obvious cure is to reduce the amount of money.  President Carter and Chairman Volcker were in complete agreement.

The new policy had an immediate effect that, surprisingly, surprised the president and the Chairman.  Not only did sales slow down, as expected, but profits did, too-as should have been expected.  The automotive industry cried hurt almost at once.  General Motors reported an 87 percent drop in profits, and Ford and Chrysler reported losses.  The housing industry saw trouble coming as well.  It even appeared that consumers were taking seriously their leaders’ pleas to cut down consumption:  Some credit-card companies found their cardholders responding to restrictions by borrowing less than now permitted.

Alarmed by these and other complaints, the Reserve relaxed the new regulations after two and a half weeks, cut the reserve requirements on May 22, lowered the discount rate on May 28, and abolished the credit controls on July 3, whereupon the president rescinded the Board’s authority to act.  It was all over in three and a half months, in plenty of time for the nominating conventions.  Everyone pretended to be pleased with the result, and in fact the inflation rate did fall, but not below the double-digit range.  Still, Carter had shown that he could “kick ass” (his phrase), so he won renomination.  His hope of reelection, though, was dashed.

As Jimmy Carter moved back to Plains, Georgia, he must have wondered why inflation remained high.  The OPEC turbulence had subsided.  Hoarding had largely stopped.  Cutting consumer purchasing power had brought on instant recession.

Conventional theory has taught us to look at the money supply, or the budget deficit, or the trade deficit in seeking an explanation for inflation, since it is supposed to follow when these are high and going up.  Well, M1, the measure of the money supply the Federal Reserve claimed to control, went from 16.8 percent of GNP at the start of Carter’s term down to 15.3 percent at the end.  Carter’s reputation as a spendthrift notwithstanding, the budget deficit, again as a percentage of GNP, was lower in every one of his years than in any one of Ronald Reagan’s.  As for international trade, the deficit on current account was four and a half times greater in Reagan’s first term than it was under Carter, and of course in the second term it pierced the stratosphere- where on a clear day it can still be seen.

Carter’s mistake- and the mistake of the American people-was the common one of simply accepting what someone says he or she is doing.  Everybody, including the Federal Reserve Board itself, believed its contention that it was fighting inflation by encouraging the interest rate to soar.  Meanwhile, in the last two years of Carter’s term the nation’s interest bill went up 51 percent, although the outstanding indebtedness increased only 23 percent.  In addition to the fall in M1 that we’ve noted, the board increased the federal-funds rate 68 percent and the New York discount rate 59 percent.  In 1951 (when the Reserve started its well-publicized wrestle with inflation) it took only 4.59 percent of GNP to pay all domestic nonfinancial interest charges.  The Reserve pushed the rate up, in good years and bad, until it stood at 15.04 percent at the end of Carter’s term. (It’s much higher now [in 1989].)

It is generally recognized that Volcker slowed inflation (he obviously didn’t stop it) by inducing a serious recession, (if not depression) in 1981-83. Putting aside the question of whether causing so much grief was a noble idea, we may ask how pushing the interest rate up caused the recession.  The answer, of course, is that it made goods too expensive for most consumers.  Standard economics, though it pretends the consumer is supreme in the marketplace, perversely believes that consumption is a bad thing.

Goods became unaffordable for two reasons.  On the supply side, interest is a cost of doing business; so the prices businesses charged had to cover all the usual costs, plus the cost of usurious interest.  On the demand side, interest is a cost of living; so the prices consumers could afford were reduced by the interest they had to pay.  Usurious interest pushes prices up and the ability to pay down.

Had the interest rate not risen, wages would probably have risen.  Unemployment would certainly have fallen.  More people could have bought more things.  More producers could have sold more things.  Prices might have gone up until could no longer afford to buy; but if so, that stage would not have been reached so quickly or so inexorably as with usurious interest.  And those who had money to lend would have been worse off, unless they were wise enough to invest their money in productive enterprise or spend it on consumption.

Would instant Utopia have been achieved?  Of course not.  The point is that the conventional policies of Jimmy Carter and Paul Volcker were good for lenders but bad for everyone else

The tests of a “sound” economy that people still chatter about-a stable money supply. A balanced budget, and a favorable trade balance-all were worse under Reagan than under Carter.  Inflation was worse under Carter-and defeated him-because the interest rate was higher.  Professor Burns rightly fears that we will not find leaders able to organize power to handle the usual social and international problems.  I fear that we are even less likely to find leaders capable of understanding and leading us out of the slough of conventional economics.

The New Leader

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By George P. Brockway, originally published October 30, 1989

1989-10-30 Polution - Going Once, Going Twice.... Title

WE ARE SUPPOSED to cheer the Bush Administration’s clean air bill, which is intended to cut sulfur dioxide emissions  in half by the year 2000 and to do various other things. Well, I do cheer. Anything at all is better than what we’ve had for the past decade.

But there is a catch here-as there seems to be to every kinder, gentler proposal. Pollution control is going to be turned over to the economists, led by Michael J. Boskin, chairman of the Council of Economic Advisors; and the economists are going to push for as silly an idea as any the profession has spawned in this century. Unfortunately, this idea of theirs is not simply silly; it is, in a word, uncivilized. They should be ashamed.

The scheme is to establish a market for licenses to pollute-or, as I have sometimes heard it delicately put, for effluent rights.

This scam has been around for several years (you might even have read about it in this space as early as December 28, 1981). The major premise is that enforcing antipollution laws is expensive. The minor premise is that the free market can do everything. The conclusion is that rights to pollute should be auctioned off to the highest bidder (an auction being erroneously viewed as the ideal market), then the government could use the money to clean up the messes the polluters bought the rights to make. Not  only that, but the rights could be transferable- sort of like taxi medallions and the hope is that they would be traded on one of the exchanges, even that a futures market could be developed. And not only that, but environmental groups could bid for the rights and thus render them more expensive for polluters. If it weren’t a restraint on trade, environmental groups might go ahead and buy some of the rights and keep them off the market, thereby actually stopping the corresponding pollution. The mind boggles.

Anyone who has had the slightest connection with government can foresee dozens of practical difficulties with the scheme, especially if local governments are involved. I’ll take up a couple of them later. For the moment, let’s look warily at the theory.

The first thing about the free market is not just that it can’t do everything; it can’t, by itself, do anything. It can’t even set itself up and maintain itself. As Leon Walras, patron saint of General Equilibrium Analysis (a.k.a. the theory that The Market Knows) wrote when his followers weren’t looking, “[Production in free competition, after being engaged in a great number of small enterprises, tends to distribute itself among a number less great of medium enterprises, then among a small number of great enterprises, to end finally, first in a monopoly at cost price, then in a monopoly at the price of maximum gain.(Walras’ emphases.)

Yet antitrust laws are so difficult to write and so expensive to enforce that Milton Friedman, our contemporary conservative guru, throws the whole thing over. We act as if we had perfect competition, he says; therefore we do. On the same reasoning, we act as if pollution weren’t worth taking much trouble about; therefore it isn’t.

Once you start thinking this way, there is not much left for government to do; and if the voters get excited about pollution or whatever, you can pacify them by holding an auction. It would seem, for example, that the current fuss over the best way to approach the drug crisis is misdirected. It would be more economical to auction off the right to sell crack on the streets, possibly restricting the bidding for certain prestigious posts (like Official Lafayette Park Purveyor of Props for Presidential TV Shows) to pushers who promise to shave and wear a jacket and tie, even in summer.

Closer to pollution rights would be adulteration rights. The Pure Food and Drug Laws are expensive and difficult to enforce, too, and require lots of enterprise- stultifying paperwork. Why not auction off adulteration rights? We might have separate auctions for the right to mix sawdust with flour, for the right to let a processing plant get a teeny bit filthy, and for the right to use handy carcinogens without telling anybody, and without being sued if found out. This last auction would have to be carefully handled to avoid adverse publicity for the winners, which might have a depressing effect on their sales, and hence on the GNP.

To be sure, carcinogens are life-threatening. But so are air and water pollution. And so, for a different sort of example, is jogging in New York’s Central Park at night. As I suggested here eight years ago, why not admit that taxes would have to go up if Central Park were made safe? The economical solution would be to auction off mugging rights. Wilding rights might go for a little less per participant because of economies of scale. Also, we’ll be better able to compete internationally if we teach these youngsters how the free-market system works-or anyway how economists think it works.

On the other hand, the knock-down price (no pun intended, of course) for the right to commit mayhem and murder might be a bit higher. One would not want to set the price too high, because there wouldn’t be any bidders, and there would be no money to pay for the homicide squads needed to catch cheaters who didn’t pay for the rights. Some of these costs, though, could be defrayed if cops wore little logos advertising their shoes and underwear, like tennis professionals.

The economists are too convinced of their own cleverness to notice, but at this point prospective polluters would see a fault in the scheme and might hesitate before putting in their bids. One of them, a veteran of the antiwar demonstrations of the’ 60s, might persuade the others as follows: “Suppose they held an auction for pollution rights and nobody came. Then there would be no money to enforce antipollution laws or to clean up the messes. There would not even be any laws, because the Environmental Protection Agency wouldn’t have enough money to write the appropriate regulations. Without any laws or enforcement, who cares about pollution rights? They’re free. Only a sucker would pay for them.”

All kidding aside, it is clear that the economists’ scheme is self-contradictory. It promises to get rid of bureaucratic interference with the free-market system. Visions of balanced budgets dance before the professors’ eyes, and of the fantastic growth in “productivity” that would result from not wasting time and money on nonessentials (“externalities,” economists call them) like clean air or pure water. Yet these visions cannot be realized unless the Environmental Protection Agency, or some surrogate, stands ready to lower the boom on polluters who refuse to play by the new rules. No one is going to pay to avoid what does not exist.

Furthermore, without continued enforcement after the auctions you can bet that crafty polluters here or there would buy certain rights and then exceed them. The malefactors would have a leg up on their competitors and might well win awards for competing internationally. In short, the economists’ scheme would cost as much as ordinary control but would be far less effective. (I’ll admit it would give brokers another “product” or two to trade on the exchanges.)

AS I MENTIONED earlier, there are some practical difficulties, particularly if, instead of nationwide auctions, local options are recognized. (After all, who knows the environment better than those who live in it?) Suppose you have a steel mill on the shores of Lake Superior and you want to pollute the lake. Fine. We’ll have an auction. What are we offered? Since no one else needs the rights, how about a dollar?

I’m not forgetting the busybody (and probably elitist) environmental groups. They’re spread pretty thin, however (an awful lot of their budgets goes to sending me junk mail), and can’t all enter every auction. They take turns. The steel mill, meanwhile, provides most of the employment for our Lake Superior town, and the mill’s conglomerate owner threatens to shut it down. So the town enters the bidding, swamps the environmentalists, and wins, whereupon it gives the pollution rights to the steel mill for free. Everyone is happy, except for the environmentalists and the fish and the people who drink lake water instead of beer.

In most towns or regions there may be more than one polluter seeking the rights, and naturally they will compete vigorously for them. It’s the American way. Once upon a time I lived in New Jersey, where there are God knows how many separate municipalities, and almost all of them hire scavenger services. In each county there are several competing scavengers. At any rate, they all submit bids for every municipality’s business.

Much to everyone’s surprise, the same fellow is low man in the same towns year after year, while other players always win in their usual towns. (Economists think they know about this, too. The scavengers’ “experience” enables them to avoid the “Winner’s Curse,” which is the result of bidding too low.) Occasionally a feud breaks out, and a few truly surprised towns find themselves opening sealed envelopes containing very low bids. The feuds don’t last long.

It doesn’t take much imagination to visualize something similar with pollution rights, especially since the oil industry (one of the most stylish polluters) is familiar with a practice that looks to suspicious souls like collusive bidding. Offshore oil leases are expensive and risky, moreover, prompting oil companies to form syndicates to spread the risk. Syndicates would also appear to narrow the bidding.

What I’m afraid it all comes down to is that today’s economists don’t understand government. They don’t believe in government. Although they would quickly and nervously deny it, they are like Karl Marx in thinking that the state should wither away because all questions are economic questions. They get irritated when people object to cheap imports that take away their livelihood, or when unions strike to prevent wage cuts, or when attempts are made to use taxes to distribute income a little more equitably.

It further has to be said that economists do not take the general welfare seriously. They certainly don’t take the environment seriously. They don’t really believe in the greenhouse effect, or acid rain, or the consequences of PCBs in drinking water, or the possibility of another, closer Chernobyl. They can’t possibly understand these matters and make their fatuous proposals about auctioning off the right to pollute.

 The New Leader

By George P. Brockway, originally published September 18, 1989

1989-9-18 Something Seems Unbalanced Title

I  HAVE WAITED in vain for editorial comment on one of the most astounding public pronouncements of recent times, prompted by the news that Michael R. Milken had made $550 million selling junk bonds in 1987. I quote in full: “Such an extraordinary income inevitably raises questions as to whether there isn’t something unbalanced in the way our financial system is working.”

Indeed it does. My sentiments exactly. Well, not exactly, because I don’t think the news raised questions. It answered them, affirmatively and emphatically.

The astounding thing about the pronouncement, however, was its pronouncer: David Rockefeller. What could possibly have given him reason to suspect that there is something unbalanced in the way our financial system is working? Has it ever occurred to him to wonder whether his extraordinary inheritance raises such questions?

This column, I should hasten to note, is not going to be about David Rockefeller (even though I admit to a personal grudge against him). But before going to other matters, I would point out that he was one of the leaders in pressing impossible loans on eager Latin American republics, that he denied loans to New York City to do so, that he has not taken a lead in repairing the disasters his misjudgment (speaking mildly) has created, and that, to boot, he pressured Jimmy Carter into his misadventures (again speaking mildly) with the late Shah of Iran.

What interests me now is the general question of the distribution of income and wealth in this country, and in the world. This is a problem that is with us always. A couple of recent learned journal articles illuminate different aspects of it.

The Winter 1988 issue of The Journal of Economic Perspectives has an article by Professors Samuel Bowles, David M. Gordon and Thomas E. Weiskopf, who tell us that “Conservatives have been waging an economic revolution since the late Carter years,” and ask, “Have they succeeded?” The professors have many strings to their bow, but the following one in particular caught my ear: “The net effect of the low levels of capacity utilization and the high real interest rates which prevailed over the 1979-1987 period was to dampen investment even in spite of the beneficial effects that slack labor markets and the high demand for the dollar had on the power of capital to strike favorable deals with workers, citizens’ and the rest of the world.”

Our authors support their mildly class-conscious conclusion with an ingenious display of statistical analysis that is obligatory in contemporary professional economics. But it seems to me to stand very well on its own.

Ironically, the conservative program was (and is) class-conscious, too. The conservative aim was to get government and labor off business’ back. It took more than firing the air-traffic controllers to weaken labor; it took the threat and actuality of unemployment. But unemployment means slackened demand, which means constricted sales, which means constricted profits. It also means reduced tax collections and increased welfare costs. Entrepreneurial capital shot itself in the foot.

The authors try to be, so to say, conservative in the inferences they draw. They allow it will be a while yet before we know the outcome of the Reagan-Volcker revolution. Since I have no academic reputation to protect, I shall rush in and announce that the conservative revolution is and always will be a failure, except in the spirit of the old Peter Arno cartoon with the caption, “Let’s all go down to the Trans- Lux and hiss  Roosevelt.”

1989-9-18 Something Seems Unbalanced David Rockefeller

It is easy enough to get labor off your back, but you are liable to rip your shirt in the process. Likewise it is easy to get government off your back, but business’ back would atrophy without the exercise of filling the orders of big government. Big business needs big markets and big government. The conservative program is self-contradictory.

The trouble is that millions of people are hurt by the attempt to make the program work. A measure of how much the economy has suffered is provided by an article in the Spring 1989 issue of the Journal of Post Keynesian Economics, where Professors John F. Walker and Harold G. Vatter ask, “Why has the United States operated below potential since World War II?” We are told at every hand that we never had it so good, that the present “recovery” is the longest on record, and so on. Yet unemployment has been high for decades, utilization of our industrial plant has been low for decades, and our cities and infrastructure are decaying. Why have we get-up-and-go Americans done so poorly?

The villain, again, is the conservative theory, but this time there is no need to suggest a mean elitist or anti-labor spirit on the part of conservatives. They’re wrong, regardless of their intentions. Walker and Vatter consider the conservative theory that prosperity depends on investment and contrast it with a theorem independently developed by Roy Harrod and Evesy Domar some 40 years ago. The standard conservative theory has dominated American economic policy, even  in Democratic years, ever since the end of World War II. In accordance with it we have steadily cut taxes, especially corporation taxes, and have enacted many sorts of incentives to investment.  Nevertheless, investment has fallen in relation to GNP.

The reason for the fall is that investment has two effects. The first, which conservatives rely on, is that it creates jobs. The second, which the Harrod-Domar theorem emphasizes, is that it makes goods. Now, you’d think that the making of goods would itself be good. The catch is, the new industry can make goods faster than the new workers can consume them. Moreover, we already have the capacity to make more goods than we use-not more than we might use, but more than we can afford to buy.  Since we can’t afford to buy them, business can’t afford to make them; consequently investment languishes, regardless of incentives, and so does employment.

Keynes‘ observation that an economy can save itself into recession does not merely apply to one phase of the business cycle; it describes a general condition of modern industrial production in a market economy. The constant danger is that the demand side will be inadequate to consume what the supply side can produce.

In our current pallid recovery, with bankers becoming alarmed at the slightest improvement in business, big government has taken up some of the slack. It could have taken up more, and should have done so, and will have to do so in the future. But unless we want to go all the way toward some form of socialism (here I’m speaking in my own voice and not that of the articles referred to), we’re going to have to make a serious effort to redistribute income and wealth.

IT IS OFTEN said that the gap between the rich and the poor is not really significant because taking from the rich and giving to the poor would not give the poor a great deal more than they have now.  This may once have been true, but it is far from the truth today. In 1987 the total of personal incomes in the United States was $3,780 billion. If this sum had been equally divided among the 65.1 million American families, every family would have had an income of $58,065. Actually in that year only 16 per cent of families had incomes that large (and 11 per cent of families were below the poverty level).

The knee- jerk response to the idea of any leveling of income is that it would so sap the incentive of the wealthy that they would quit working, depriving the nation of the leadership of its best minds, and generally reducing the GNP.  Nobody really believes this. Common knowledge is against it, and there are no statistics to support it. Taxes have been raised from time to time, but no one has ever tried to prove that production has fallen as a result. Indeed, Walker and Vatter show that we have, in general, been most prosperous in periods of highest taxation.

Very few of the really important movers and shakers of the world have been primarily moved by lust for money. Lust for power or popularity, perhaps; lust for money, no. A financial incentive is certainly prominent in the case of wheelers and dealers of the first rank (not to mention scoundrels), but a wise society does not devote much effort to encouraging such people. It is enough to tolerate them. There are plenty of trustworthy and competent people ready to step into the jobs of those who call it quits.

In any case, the incentive argument proves too much. If people really responded primarily to money, think of the great leap forward that would follow from raising everyone’s realistically attainable income to $58,065! Eighty four per cent of the people would have their incentive stimulated; only 16 per cent of the people would have theirs sapped (most only marginally), and a considerable portion of that 16 per cent did not work for their money, anyhow. Like Rockefeller, they got it in the good old-fashioned way: They inherited it.

Hardly anyone proposes absolute equality of income, or anything closely approaching it. But it would not be difficult to suggest reasonable guidelines enforceable by steeply progressive income and inheritance taxes. We can say, at one end, that everyone’s self-respect depends on making a contribution to society-that is, on having a paying job. At the other end, we can say that no one is essential and deserving of unlimited income. Our aim should be to bring the ends steadily closer together.

New York’s Democratic Senator Daniel P. Moynihan suspects, and he is in a position to know, that conservatives deliberately let the budget deficit grow in order to make politically difficult or impossible the expansion of social welfare, ecological and other programs designed to do good and to improve the quality of life. In this conservatives prove themselves not only mean-spirited but foolish. The quality of life they deny includes their own.

 The New Leader

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

 

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