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By George P. Brockway, originally published November 2, 1998

1998-11-2 Learning From Russia title

THIS IS OUR learning year. At least it is a year of learning opportunities. Whether we’re capable of actually learning remains to be seen.

In January the debacle of Southeast Asia taught us, as I pointed out at the time in this space, that “In the special branch of ethics that is economics, any system built on the backs of the downtrodden will be forever unstable.” A couple of months ago I observed that Japan “is as successful a supply-side economy as the modern world has seen, and as such its difficulties should be a warning to the United States.” Today the object lesson is Russia, and what it teaches is that a sound government is the sine qua non of a sound economy.

Please note that sound government comes before sound economy. To the extent that the Soviet Union was Marxist, things were the other way around before Communism’s collapse seven years ago. They are still the wrong way around in Russia’s brave new world of privatization, plunging rubles and other economic shock treatments.

In a footnote in Capital, Karl Marx wrote, “The middle ages could not live on Catholicism, nor the ancient world on politics. On the contrary, it is the mode in which they gained a livelihood that explains why here politics, and there Catholicism, played the chief part.”

That bothered his collaborator, Friedrich Engels. “Without making oneself ridiculous,” he wrote to Joseph Bloch, “it would be a difficult thing to explain in terms of economics the existence of every small state in Germany, past and present, or the origin of the High German consonant shifts.” Nevertheless, Engels did not doubt that the “economic situation is the basis” of everything even though “the various elements of the superstructure … also exercise their influence ….”

The form of government Lenin instituted, said to be a “dictatorship of the proletariat,” was certainly some kind of dictatorship. lts civil law concerned orders and commands, but not customs and contracts. So Mikhail S. Gorbachev and Boris N. Yeltsin found no legal system in place to regulate the revolution to a market economy.

It should be noticed that the high-powered “reform” economic advisers from Harvard and MIT and the International Monetary Fund were not dismayed by the lack of a free-market legal system. They were all convinced that the vice of the Western world is excessive regulation, and that the former Soviet Union and its former Warsaw Pact allies would benefit from the shock treatment of being thrust to sink or swim in the turbulent waters of the new global economy. Although this might cause some suffering and even some inefficiency (which in standard economics is evidently more blameworthy than suffering), they contended that it would be better to get rid of the bad old ways at one fell swoop than to creep along incrementally. Once the market was freed and assets were privatized, the reformers promised, everything would efficiently fall into place.

Of course, that is not what happened. In some respects Russia may be the American West all over again, but there are significant differences. Our “privatization” was better managed as a result of long experience with land settlement, and blatant corruption was at least reined in by posses of settlers eager and able to take the law in their own hands. Furthermore, our pioneers could maintain themselves by subsistence farming and small-scale mining; in Russia there is little to fall back on when large-scale privatization misfires. Most important, our banking and taxation systems grew with the country, whereas in Russia they are struggling to be transmogrified from Soviet systems utterly unsuited for their present purposes.

Suppose for a moment that you live in Minsk and have gotten your hands on a factory that produces something used in Pinsk. Ten years ago a commissar periodically instructed you to send x amount of the stuff to Pinsk and gave good grades for fulfilling the quotas. The people in Pinsk accepted whatever they received.

Since the orders were large enough to keep the factory busy-that’s one reason you went after the shares when it was privatized-you pursue them. “Sure,” the Pinsk people say. “What do we have to do now that we’re free?” You explain that you will have a lawyer draw up a contract. It takes some time, because the lawyer never did such a document before and has trouble literally digging up a water soaked 1912 textbook. Finally, you send the contract to the Pinsk peopIe, who naturally have to get a lawyer to read it. Meanwhile, they say: “By the way, we went to some lectures on free enterprise, where we heard there are factories in Omsk and Tomsk, not to mention some in Krakow, Kinshasa, Kyoto, and Kalamazoo, that can make what we want. We were told you should be competing with them for our business.”

Well, you can see this is going to be a drawn-out affair and you may get nothing for your trouble. Moreover, you find that your bank and the Pinsk bank have no satisfactory clearinghouse arrangements (they’re working on them). Assuming you get the order, your payment will be slow and uncertain.

In the meantime, it turns out that you already have staggering taxes to pay. A trip to the tax office enlightens you: The local bureaucrats have not been paid for months. But you are confidentially told the taxes can be taken care of with a few dollars or marks (and cautious winks tell you where to get hold of some) in the proper hands, plus several samples of what you manufacture. You resist with all your patriotic heart. Then you learn that the local big-time operators (known as “moguls”), whose Mercedes and dachas you have envied, have embraced this system (and it is, after all, not unlike what you were taught to expect of capitalism). You go along.

The Harvard and IMF economists are possessed of the notion that the ruble keeps falling in value because neither the national budget nor the foreign trade account is balanced. (The same was true of the United States for decades, and our dollar remained embarrassingly strong, but let that pass.) The economists’ models convinced them that Russia required an austere tightening of the public belt that could be accomplished by downsizing the government, including the tax offices. As might have been expected, tax collections shrank further, just as they did in Nigeria and other emerging markets of the global village.

The problem with the ruble is that only suckers now have much need of them. Almost everyone else takes care of taxes under the table-or simply disregards them altogether.

Money is a funny thing. If no one has to pay taxes, it‘s not of much use for other purposes. There is no gold or anything else “behind” it, and it can hardly serve any practical purpose, even as wall decoration. The Federal Reserve bills I have in my pocket say on their face in small capitals, “This note is legal tender for all debts, public and private.” That means I can settle all debts I now owe by offering Federal Reserve notes to my creditors, including the government. It does not mean that anyone has to sell me something I want because I offer to pay in dollars.

Storekeepers could demand cigarettes or Confederate currency or a bag of barley seeds (the money of account in some prehistoric societies), or they might just say no. It’s a free country. But if they have bills and taxes to pay-why else would anyone maintain a store? -they will need dollars.

For my part, I need a good many dollars to settle things with the various tax collectors (Federal, state and local). And I don’t have much trouble getting rid of whatever dollars I have left, since the country is full of people willing to sell me things because they need dollars to pay taxes, and there are plenty of bureaucrats ready to see that they do. We’re all happy to work to earn dollars. We know that we will be able to use them to buy what we want as long as-but only as long as taxes are as certain as death.

Russia recently announced that it would print rubles to help meet the government’s payroll and bills. Commentators in the American media have expressed horror at this use of the printing press. But the question is not how rubles are manufactured, it is whether enough taxes are levied and collected to ensure that there is a great demand for rubles by both individuals and businesses. As I’ve remarked before, the notes issued during our Revolution were “not worth a Continental” because the Continental Congress had no power to collect taxes.

THE LESSON of our story is as promised at the beginning: A sound government is the sine qua non of a sound economy. Russia’s troubles are not primarily economic. Seven years ago its economic “fundamentals” were strong enough to scare us silly, as some of us are scared silly by China today. Its population was large and better educated than China’s. Its natural resources were greater. Its infrastructure was more highly developed. Russia had gone about as far as it could go peacefully, but it has a long way to go before its legal system can support a free economy.

As we review our own political campaigns of the past couple of decades, we must doubt whether we have learned the lesson. Recent slogans have included “Balance the budget by 2002,” “It’s the economy, stupid,” “Read my lips. No new taxes,” “It’s your money,” “Abolish the IRS.”

Our new slogan, greeted with cheers on both sides of the Congressional aisle, is “The era of big government is over.” Marx would have been delighted with it. The state, you will remember, was supposed to wither away.

We have recently shown our allegiance to this slogan in at least four major ways. First, we led the way for NAFTA and GATT, both of which subordinate national sovereignty, human rights, and labor and environmental protection to commerce. Second, we extended most favored nation status to China on the fanciful ground that association with our business representatives would teach the Chinese not to torture or execute an untold number of political prisoners every year. Third, we are preparing to use our long-sought budget surplus, not to repair our torn social fabric, but to cut taxes, mainly for the well to-do. Fourth, it is not improbable that majorities in both houses of Congress could be whipped up in favor of abolishing or privatizing the Internal Revenue Service.

Big government has a special and indispensable role in a free market economy. As the late Hyman Minsky pointed out, although we had three full-fledged depressions in the first third of this century (1907, 1921 and 1929), we have had none in the last two thirds, mainly because of two institutions bequeathed to

us by the New Deal and World War II: (1) The New Deal gave us bank regulations and deposit insurance that have forestalled bank runs, and (2) World War II gave us our “big government”-24 per cent of GDP as opposed to the prewar 3 per cent-that provides a solid foundation of demand on which the supply side of the private economy can build with confidence, regardless of what happens in the rest of the world.

Will we ever learn?

The New Leader

By George P. Brockway, originally published August 10, 1998

1998-8-10 A Fortunate Experiment titleONE OF THE mysteries of life in the United States today is why we are not in the midst of a raging inflation, a depressing recession, or both. The answer, though, is staring us in the face.

For the past 30 years, hard-nosed devotion to the theory of a natural rate of unemployment (a frequent target in this space) has been a prerequisite for appointment to the economics faculties of our major colleges and universities. Hence the doctrine has not only been taught at those institutions, it has been accepted respectfully in editorial rooms and enthusiastically in board rooms across the land.

The theory, of course, claims that if too few people are unemployed, inflation will accelerate rapidly, and the only way to slow it down is to raise and keep raising the interest rate. Chairman Alan Greenspan of the Federal Reserve says he does not altogether agree with the theory. He keeps talking, however, about raising the interest rate on some unspecified occasion in the future.

Yet today unemployment is lower than it has been for decades, while inflation (especially if you figure it as the Boskin Commission did a couple of years ago) has been practically invisible for at least four years. Moreover, during the same period the interest rate has been relatively stable. If mainstream economic theory were sound, the world would not move in this way.

Nevertheless, the world does move in this way and, I make bold to predict, will continue to do so until the Baby Boomers start retiring in substantial numbers, at which point the present stock market boom will come to an end. I hasten to explain that I agree with Mr. Greenspan that the market is overenthusiastic, overpriced and in danger of collapsing. But I also think that as long as the Baby Boomers keep pouring their savings into it, and as long as the interest rate does not go up, the market will continue to rise in a classic example of the “law” of supply and demand.

The situation is beautifully ironic. The market is all the bad and dangerous things Mr. Greenspan says, and he could stop them by jumping the interest rate-as the Reserve did in 1978 (not to mention 1929). But the Federal Reserve Board does not dare to act. Every three months the Reserve Board meets and the bankers anguish over their belief that inflation must be around the comer. Their terror, though, is that if they raise the interest rate to stop the inflation no one else can see, they will be remembered for having precipitated one of the great economic crashes of all time[1].

So the booming stock market that concerns Mr. Greenspan has incidentally forced the Reserve into an unnoticed experiment that lays bare the fallacies of conventional interest rate policy. If the economics profession can bring itself to pay attention to what is happening in this accidental experiment, we may be spared further exposure to the barbarous theory of a natural rate of unemployment.

Even without the experiment, the Reserve should have learned a few of the effects of raising the interest rate-at least five bad effects and one claimed to be good. The first thing it does is cause a drop in investment. By investment I don’t mean speculating in mutual stock funds and derivatives; I mean helping to finance the organization, continuation or expansion of companies that will produce goods and services to be sold in the marketplace and enjoyed by everyone. In the capitalist system, almost all investment depends directly or indirectly on credit, that is to say, borrowing.

Let’s look at the record. In the early 1960s, when the Federal funds rate averaged about 2.7 per cent, annual investment ran over 21 per cent of the gross domestic product. Today the Federal funds rate is at 5.5 per cent, and investment is only 16 per cent of GDP in an economy that, according to Mr. Greenspan’s recent Congressional testimony, is one of the best he has seen.

Second, an increase in the interest rate favors established and big businesses over small and start-up businesses. Since the latter provide most of the new jobs, any impediment to new business is an additional handicap for the poor, as well as for middle-class would-be entrepreneurs. Indeed, the percentage of American families living below the poverty line is higher in this economy that is one of the best Mr. Greenspan has seen than it was 25 years ago.

The third thing raising the interest rate does is raise the unemployment rate. According to conventional theory this cruel absurdity is a good thing and the way things are supposed to be. Howsoever that may be, the unemployment rate today is 4.5 per cent, or lower than it has been since 1969. In the quarter century before 1969, though, there were no fewer than 12 years with a lower rate of unemployment than the 4.5 per cent of this economy that is one of the best Mr. Greenspan has seen.

Fourth, raising the interest rate raises Federal, state, local, and school taxes, as the recent hoo-ha over the deficit has taught us all.

Fifth, raising the interest rate is a principal way for the rich to become richer. Mr. Greenspan has more than once cited the widening gap between the rich and the poor as dangerous to our democracy. He has protested that it is a problem for Congress, not for him. But every interest payment is a transfer to the haves from the have-nots. To be sure, not everyone who borrows is down and out. Still, as a general rule, people who lend money are richer than those who borrow[2].

The shift from 4 per cent (or lower) FHA and VA mortgages of 50 years ago to today’s “low” rate of 7 or 7.5 per cent has been a gift of billions (if not trillions) of dollars to mortgagees and a corresponding drain on mortgagers. No wonder the rate of home ownership has fallen in this economy that is one of the best Mr. Greenspan has seen.

Now, I am not saying that the interest rate is solely responsible for the rich becoming richer and the poor poorer, and I am emphatically not against borrowing and lending and the charging of interest. I am saying that interest always has the immediate effect of taking from the poor and giving to the rich; that therefore the rich are richer and the poor poorer; that increasing the interest rate increases this effect; that the present rate does not improve matters (except in relation to the rates Mr. Greenspan’s predecessors gloried in); and that an unnecessary uncertainty is introduced into the economy by Mr. Greenspan’s unwillingness to specify conditions that would prompt him to raise the rates further.

THAT’S the bad news-or some of it-about raising the interest rate. The good news-or what’s supposed to be good-is that raising the interest rate stops inflation. Well, no one can say it quite does that, because since World War II the Consumer Price Index has gone up in every year except 1955 (and that year the prime interest rate was lower than in any subsequent year) [3].

But there have been 10 surges of the economy since World War II, and except for the present surge, every one of them was seen by economists as threatening to spiral into inflation and snubbed down by the Federal Reserve Board. In short, its raising the interest rate reduced the investment rate, increased the bankruptcy rate of businesses, increased the poverty rate, increased the cost of living, raised taxes, made the rich richer, caused nine recessions-and thus slowed the rate of inflation.

Those consequences were not unpredictable. They are inherent in the nature of money, something conventional economics has archaic ideas about. Money has no price (there is no point in paying a dollar for a dollar bill). What money has is power-purchasing power and borrowing power. The piece of greenbacked paper you have in your pocket has no practical use as paper. It is an IOU of the state, was issued by the government in payment for some goods or services, and will be accepted by the government in payment of some tax or fee. It is accepted in private transactions because there are always, somewhere in the economy, citizens who need government IOUs to pay taxes or government fees.

You may borrow the use of someone else’s money by paying a fee (interest), which is a cost to you and has the effect of diminishing the amount you can borrow. The relation of money to the fee for its use is similar to the relation of the price of a government bond (also an IOU) to the rate of interest. In both cases, the higher the interest rate, the lower the purchasing power (the effect on borrowing power, essential for investment, is even more severe).

When one speaks of low purchasing power, it is the same as speaking of a high general price level. By upping the interest rate, the Federal Reserve Board reduces everyone’s purchasing power and thus increases the general price level.

Raising the interest rate does not cure inflation; it causes it. (This, you may remember, is Brockway’s Law Number Two, first proclaimed here in the issue of January 9, 1989.) Raising the interest rate gives the appearance of stopping inflation because, on the supply side, it increases the costs of operating a business, discourages expansion and leads to downsizing, which, in turn, reduces wages and thereby contracts the demand side. In other words, raising the interest rate tends to bring about a recession.

That is the way all threats of inflation have been contained since World War II -with a single exception, the present one. This time the Federal Reserve Board has refrained from raising the interest rate, as its governors would normally be inclined to.

The current stock market boom has accidentally forced upon us an economic experiment of world shaking possibilities. We are finding that holding the interest rate steady does not cause inflation, even when the unemployment rate steadily falls[4]. All the dismal prophecies of a natural rate of unemployment have proved false. Also proved false is the immoral claim that a decent minimum wage causes unemployment.

With such empirical results in hand, we may be emboldened to take the next step and discover that lowering the interest rate can lower the price level, increase productive enterprise, and start the long task of healing the suppurating wound in our society that gapes between the rich and the poor.

Do we dare?

The New Leader

[1] Ed –  this experiment has been repeated during the Obama administration when the Fed under Bernanke and now Yellen kept interest rates low whilst talking on end about raising them

[2] Ed – on this fifth factor, despite low interest rates in the Obama years the separation continues.  Just speculatin’, but the current economy is fully “globalized” and has no Glass-Steagall.

[3] Ed – current tables add only one other year, 2009, the deepest year of the Great Recession

[4] Ed – as has happened during the Obama Administration

By George P. Brockway, originally published May 4, 1998

1998-5-4 Learning From Japan titleTHE ECONOMICS profession and the military are similar in many ways, but they differ in one important respect. Generals are notorious for planning and training for the last war, while economists, who do not believe in history, have only one basic prescription for whatever problem may befall.

I don’t mean economists deny that Caesar crossed the Rubicon, or that Columbus sailed the ocean blue, or that Paul Revere went for a ride. What they deny is that economics was any different in those years from what it is today or will be tomorrow. They recognize, to be sure, that people in prior eras had different ideas concerning the economy, but they regard these ideas as wrong or irrelevant and not worth bothering about. They note that the laws of physics and chemistry and other such proper sciences are understood to have worked in the days of Aristotle whether he knew it or not, and assert that the same is true for the laws of economics- which, they claim, were not properly formulated until a half century ago, or after the death of John Maynard Keynes.

As a consequence, Japan is now having a rough time. We are likely to have a rough time, too, if we don’t watch out.

At the end of the Good War, General MacArthur explained to the chastened Japanese that it was not polite to steal things from other countries, and that in the future they would have to make or buy whatever they wanted. Economists pointed out to them that in order to buy things from foreign countries they would have to sell things to foreigners. So they set to work to export textiles (the United States had sent warships under Commodore Matthew Perry in search of silk back in 1854), but soon decided to put what they had learned in the Good War to good use.

One important lesson they had learned was how to organize themselves. Everyone was prepared to make sacrifices. Since their land was not rich in resources (it especially lacked oil), they did not waste time and energy on producing items for local consumption and pleasure. Even their captains of industry led relatively modest lives-far more modest than those of their conquerors. As the country gradually recovered, everyone continued to live unpretentiously, and to save famously. Japanese saving became proverbial, the envy of Wall Street and MIT economists.

In fewer than 20 years they supplanted the West Germans as the wonder workers of the postwar world. Japanese radios and television sets took over the American market. Then came a great stroke of luck. The OPEC inflation and oil embargo of the 1970s hit the United States just as the Japanese were trying their compact and subcompact cars on the American market. Ford and General Motors and Chrysler relied on earlier market research indicating a strong American preference for long, heavy, powerful, chrome-encrusted gas-guzzlers. Recent experience has shown the market research was basically not far wrong[1], but the tiny Japanese cars were immediate hits, and their agile manufacturers have not lost their share of the American market.

For another 20 years Japan’s foreign trade balance grew, and still the country maintained its-parsimonious domestic life. To some extent the parsimony was cultural, but in any event, it was enforced.

We are so imbued with Ben Franklin’s ethics of a penny saved equaling a penny earned that we may mistakenly imagine Japan is the second coming of Tocqueville’s America. Indeed, it is not. Bribery of government officials and extortion by government officials are commonplace. Ordinary business is lubricated by expense accounts that put American extravagances to shame. Furthermore, the class distinctions are so strong that there is little protest when the cost of living (not to be confused with the rate of inflation) puts many conveniences and amenities beyond the reach of ordinary citizens. Japanese cameras are notoriously more expensive in Tokyo than in New York[2].

Those who read this column in the issue of June 14, 1982 (16 years ago, I ask you to remark), learned then that Japan was far from the ideal society being described by the Western business press. In particular, the “lifetime employment” the press continues to talk about covers only workers in the largest companies (less than 30 per cent of the total employment in the automobile business) and “runs only to age 55, whereupon the worker is either demoted, farmed out to a supplier of the giant firm, or turned loose with a couple of years’ severance pay. In each case he faces old age without a pension.” Although women were 36 per cent of the Japanese work force, they had none of the foregoing perks.

I went on to explain that “the Japanese economy is hierarchical in an idiosyncratic way.” Operations that in the U.S. would be performed by divisions of a company are performed in Japan by satellite companies that are technically independent but actually at the mercy of the giant firms. As a result, the employees of the satellite firms are paid low wages and are subject to sudden layoff and dismissal.

The vaunted “productivity” of Japanese automobile companies came from dividing the value of the finished cars by the number of employees of the major companies, excluding those of the parts suppliers[3]. “In spite of all of Japan’s ‘sunrise’ industries in steel and shipbuilding and textiles and electronics and optics as well as in automobiles, the Japanese GNP per capita is still well below ours.”

I also noted: “As Gus Tyler has shown (in ‘The Politics of Productivity,’ NL, March 22,1982), the notion that the Japanese are ‘catching up’ is a statistical flim-flam.”

In short, some Japanese may live abstemiously because of their upbringing; some may live abstemiously because they have to; and some may live abstemiously because consumption is discouraged in other ways. Jean-Baptiste Say, who wrote, “It is the aim of good government to encourage production and of bad government to encourage consumption,” would have loved modern Japan.

The trouble with good government as defined by Say is that you soon have more money than you know what to do with. The citizens have their little nest eggs, and the big businesses have their big profits, and the government has an enormous “favorable” balance of trade. Modern economists nod their heads approvingly because exports are a positive factor in the Gross National Product, while imports are a negative factor. Nevertheless, this is not an unmixed blessing.

Japan became (and remains) very rich by almost any definition; yet despite its riches, the economy began to go sour with the worldwide recession that set in after the Gulf War. In fact, Japan’s success in exporting all over the world led to its present weakness. Building its economy completely on the world market, Japan necessarily faltered when the world market faltered.

At this point, a feature of the Japanese economy that has captured the admiration of American observers came into play. Japanese banks, which are not restricted and regulated the way American banking is, naturally became the depository of industry’s enormous profits. Lists of the 10 or 20 largest financial institutions in the world were therefore dominated by Japanese banks. American bankers were (and are) envious of how intertwined giant industries and giant banks were. Banks owned and speculated in common stocks and real estate, and thus owned industrial corporations. The latter owned bank stocks and speculated in them. From time to time the central bank joined in the fun.

As world trade languished, and as Japanese forays in foreign investment from Radio City in New York to the Pebble Beach Golf Course[4] in California proved disappointing, bankers and indeed the whole of the Japanese economy devoted all available wit and energy and money to speculating in domestic securities and real estate. The stock market shot up faster and farther than Wall Street has ever managed, and the newspapers were filled with stories of lots 10 feet square in central Tokyo selling for a million dollars. Memberships in fashionable golf clubs also were said to cost a million dollars. Besides playing the markets for their own account, bankers lent vast sums to other high rollers. Speculation spilled over to Korea and bubbled around the Pacific rim.

THE HOME BUBBLES burst first, years before the current debacle in Southeast Asia. Japan’s economy has been essentially flat for most of the present decade.

Economists know what to do in such situations: increase saving, control consumption, raise the interest rate, cut taxes, balance the budget, and deregulate. As we have seen, however, Japan was already very much the sort of state advocated by Jean-Baptiste Say.

At the same time there were puzzling differences in details. Unemployment remained well under 3 per cent, yet inflation was close to zero (a situation similar to the one in the United States that is currently bewildering the Federal Reserve Board). The interest rate was below 2 per cent-as it had been in America in the decade ending in 1951-yet there was so much money around that raising the rate proved to be difficult. The regulations that the U.S. most objected to were those that made imports difficult and hence restrained consumption.

Well, it’s a long story and includes political plots and subplots and dark tales of gangsters (for some reason not known as the Japanese Mafia), but here I merely want to mention one detail. Evidently to appease sternly anti consumption economists, Japan introduced a national sales tax a couple of years ago. The latest “reform” package included extensive corporate and personal income tax cuts, but the sales tax was left intact.

There is, I think, very little chance that Japan will recover from its extended stagnation without a fundamental change of policy. Japan had a brilliant postwar run from destruction and demoralization to the second largest economy in the world. As we observed at the beginning, modern economics has a one-track mind, and Japan followed it. The economic advice that enabled the country to achieve riches is now hampering the recovery. It is as successful a supply-side economy as the modern world has seen, and as such its difficulties should be a warning to the United States.

A one-sided economy is unjust and, in the end, is inefficient. Adam Smith was a true citizen of the Enlightenment. He wrote, “Consumption is the sole end and purpose of all production, and the interest of the producer ought to be attended to only as far as it may be necessary for promoting that of the consumer.”

Keynes had a broader understanding of the needs and purposes of modern life. He wrote, “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” Japan came close to correcting the first fault, and we are nearer to it than we have been in modern times. But Japan has overlooked the second fault and is checkmated, and we are increasingly in danger of the same fate.

The New Leader

[1] Ed:  An example of what Steve Jobs, among others, hated about “market research” in that it echoed what people already knew about cars not what was possible about cars…

[2] Ed: “Yodobashi Camera is two blocks south of the Kamiyachō station on the Hibiya subway line.  Yodobashi Camera means BIG savings!”

[3] Ed:  Note that this is exactly paralleled in the US practice of using outsourcing to reduce headcount vs revenue thus presenting productivity gain by not counting the now, outsourced, jobs.

[4] Ed:  A great place to shoot 79 by playing the last 5 holes in one under par…

By George P. Brockway, originally published March 23, 1998

1998-3-23 Moynihan's Social Security Hocus Pocus titleON MARCH 16 Senator Daniel Patrick Moynihan delivered a speech titled “Social Security Saved!” at Harvard’s John Kennedy School of Government. Said to be the Senate’s authority on the subject, he has addressed it many times over the years.

This time he referred to “the magic of compound interest” and presented some figures that surely seem magical at first glance. At second glance, they seem more than magical.

The Senator would cut the Social Security tax rate 1 percentage point and cut the employers’ tax (officially called “contribution”) likewise in order to “get the system back on a pay-as-you-go basis.” That is a worthy objective; unfortunately, the Senator does not say anything more about it.

According to the Moynihan plan, workers would be given a choice: They could take their 1 per cent cut and spend it on riotous living, or they could take both their own tax cut and their employers’ and put them in “voluntary personal savings accounts.” This is where the compound interest comes in, and it comes in with a roar. A table accompanying the text of the Senator’s speech shows that a worker who earns the “average wage” of $30,000 and stashes an amount equal to 2 per cent of it away every year for 45 years in a voluntary savings account compounding at 3 per cent, will wind up with a nest egg of $275,000 at retirement. And that will be on top of his or her Social Security benefits.

It sounds great, but anyone can do better. The present Social Security tax (employee plus employer) is 12.4 per cent. Suppose the whole caboodle were put in the magical voluntary savings account and compounded at 3 per cent. Then the nest egg would be $1,685,000. If the interest were compounded at 5 per cent (a rate sufficiently close to credibility for the Senator to include it in his table), in 45 years the $30,000-a-year average worker would be worth $2,790,000. At age 65 or thereabouts, he or she could retire and, leaving this lordly sum in the magical account, live on the annual interest of $139,500[1].

With astute quasi-legal advice of the sort advertised in many journals, the principal, or most of it, could be sheltered from the inheritance tax and passed along to the worker’s heirs or assigns, who could live comfortably without working at all. Indeed, since on these assumptions even the $12,000-a-year minimum-wage worker would have $1,085,000, we can safely say that after at most another generation, no one would ever have to work again. It might take somewhat longer in Bangladesh.

Now, I am enough of a Yankee to believe that honest labor never hurt anyone and is good for the soul; so I find this outcome appalling, and I would be sorry I brought it up if it didn’t reduce Senator Moynihan’s scheme to the absurd. Why does the scheme wind up in absurdity? Do you remember how, when lRAs were first peddled, banks advertised that they would make us all millionaires? There was and is nothing wrong with the mathematics. Bankers have books of tables that contain such calculations, and I assume the Senator has consulted one.

The trouble here, however, is that there are not enough ways to invest the bags full of money that would theoretically accumulate. The bags of money will therefore not exist, no matter what the mathematics says. They will not be sitting in bank vaults, waiting for a good deal to turn up, or available for some jolly use. They will not exist, tout court. They will never have existed.

If the Senator’s average worker deposits $600 a year every year for 45 years in the bank of his or her choice, and the bank can’t find people willing and able to pay interest for the use of it, the worker will reach retirement with $27,000, which ain’t hay, but is a long way from the $275,000-or $350,000 at 4 percent, or $450,000 at 5 per cent-the Moynihan table promises. Compound interest is truly magical, but the magic won’t work if there is no interest to compound.

We have now reached a point in the argument where John Maynard Keynes parts from Classical and Neoclassical economics. All three agree that saving equals investment. The conventional schools hold that saving creates investment, and they nag us about it every chance they get. In contrast, Keynes observed that entrepreneurs borrow and invest, not for the fun of it (though it may be fun), but to make money by producing things people are willing and able to buy. Accordingly, he wrote, “The propensity to consume will … take the place of the propensity or disposition to save.”

In any case, three current events teach us that there is now no use for the tremendous savings the Senator’s scheme would generate. (I) Major corporations daily announce plans to buy back sizable blocks of their own stock, thus confessing that they don’t know how to put all the money they already have to work producing goods and services. (2) Corporations of every size and shape raise and spend vast sums of money to buy and sell each other. The rash of mergers and takeovers may keep Wall Street busy scratching but ordinarily is intended to result in a contraction, rather than an expansion, of productive activity. (3) The stock market boom, again, mostly concerns Wall Street. The earnings of the companies on the Dow or the Standard and Poor’s 500 are now less than 1.5 percent of their stocks’ market value. Profits, while growing, cannot grow as fast as the market. Many actively traded stocks on the NASDAQ have never earned a profit at all.

As I have remarked before, the law of supply and demand works if, and only if, supply is restricted. The supply of stocks is indeed limited; consequently, as long as-but only as long as-Baby Boomers worried about looming retirement keep pouring their savings into the market, the market will keep rising. That is why Wall Street is eager for the commissions to be earned (“the old-fashioned way”) from handling the Senator’s voluntary personal savings accounts.

The economic sterility of capital gains, it needs to be recalled in the present context, is that they increase the price but not the productiveness of capital assets. The risk with capital gains is that when large numbers of people try to cash in their gains all at once, the market can crash very far and fast. Some day – at the latest when Boomers start cashing in their gains in order to live on them – the music will stop, and many people will find themselves without a chair to sit on.

In the meantime, conservatives hail Senator Moynihan’s scheme and urge him on. James K. Glassman of the American Enterprise Institute proposes, in the Washington Post, cutting “another few points off the payroll tax” as a step toward the happy hunting ground of complete privatization.

Complete privatization is of course what we had before we had Social Security, and it was not pretty[2]. The inadequacy of the unregulated free market was taught to all who had eyes to see in the months following October 29,1929. It was not until August 14,1935, when the Great Depression was almost six years old, that the heart-rending inadequacy of private charity was ground into the public consciousness. Then the New Deal was finally able to break through the barriers to the general welfare that had been thrown up by Republicans, Dixiecrats and a states’-rights-minded Supreme Court.

THE RESULTING Social Security Act was-thanks to the long years of wrangling and compromising-pretty much like the proverbial horse designed by a committee. It was not, and is not, ideally suited to any of its several functions. Nevertheless, it was, and remains, one of the most useful and successful and necessary public laws of the century. It was enacted because there are, in fact, limits-actual limits that we have tested more than once-to the assuredly great capabilities of private enterprise and private charity.

Despite this record, conservatives are likely to push for complete privatization of Social Security benefits. They are not likely to want to eliminate the system, though, and especially not the tax that supports it. Since Social Security accounts for almost a quarter of what makes ours a big government (which conservatives pretend to be scared by), and since the Social Security tax, including the employers'”contribution,” is indubitably a tax (which in principle conservatives object to), it may seem surprising that they wouldn’t want to abolish the whole shebang.

The reason for this inconsistency is simple. The various flat tax schemes that Congressional Republicans are busy devising have for them the charm of being resolutely regressive. Anatole France observed that rich men, as well as poor, could sleep under the bridges of Paris. Flat-taxers boast that they will give poor men the honor of being taxed at the same rate as the rich. Yet regressive as the flat tax is, it is nowhere near as regressive as the Social Security tax.

The two systems are similar in that each taxes only earned income. Malcolm Forbes probably pays himself and his office boy a fair salary. The two of them pay Social Security taxes at the same rate, and they would both be flat-taxed at the same rate, but they wouldn’t pay any tax on their incomes from the fortunes they inherited, no matter how large or small. David Rockefeller and I, being retired, now pay no Social Security tax (except as employers of servants, if any) and would pay no flat tax at all.

But the Social Security tax is more regressive than the flat tax on two counts: (I) The Social Security tax is levied on the first dollar you earn, while the flat tax proposals, like the present income tax, exempt the first few thousand dollars you get your hands on. (2) The Social Security tax does not tax at all earnings over $68,400, while the flat tax goes to the last dollar. (Moynihan proposes to increase the “cap” to $97,500 by 2003, still leaving the top 13 per cent of wages untaxed.) In short, the Social Security tax is a flat tax that is extra hard on the poor and extra easy on the rich.

At least since the Social Security system was “reformed” in 1983 by Senator Moynihan and others, it has been running a surplus that has been used to bring the “unified budget” closer to a balance. Even in this alleged near-balance year for the budget and near-crisis year for Social Security, the near-balance depends on an actual Social Security surplus of about $40 billion.

For reasons I advanced in this space last September 22, I contend that “A zero deficit means failure,” and for reasons I have advanced here many times, I contend that the Social Security Trust Fund is a serious error. Putting these two mistakes together, we have compounded them, for we have been using the proceeds of a most regressive tax to avoid increasing the income tax, which is moderately progressive, to achieve an unnecessary and wasteful balance.

Senator Moynihan’s scheme continues these injustices, as well as his erroneous attack on the Consumer Price Index. Reactionaries will rejoice.

The New Leader

[1] Ed:  I have tried and tried using the financial functions in Excel, and have asked others to do so.  We cannot replicate these numbers.  We’d be happy to see how they are calculated.

[2] Editor’s emphasis

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