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By George P. Brockway, originally published August 23, 1999

1999-8-23-why-we-must-have-a-recession-titlePROBABLY at least once in every one of the 18 years I’ve been writing this column, I have made fun of an obiter dictum[1] of President Calvin Coolidge: “When many people are out of work, unemployment results.” I think it is still good for a laugh, although of course it is undeniably true, and so is my variant: When many people raise prices, inflation results.

I’ll go a step further: It is only when many people raise prices that we (including the Federal Reserve Board) know we have inflation. And I’ll take another small step for man but a momentous step for understanding the economy: Except in time of war or disaster, we have inflation only when the central bank (the Federal Reserve Board) brings it about.

Let’s heed Deep Throat‘s advice and follow the money.

If you (as an individual or a corporation) plan to start anew business, or to expand an old one, or to merely keep an old one going, the first thing you have to do is look for financing. As Iago said, put money in thy purse.

You can get money in lots of ways. You can borrow it from a bank or from a venture fund. You can sell shares or unneeded assets to a more venturesome fund or to a friend or on an exchange. You can use money you have on hand or your company has on hand. It does not make much difference how you finance your enterprise, but you have to do it, and it will cost you. Even money that you or the company may have on hand has an opportunity cost-that is, what you might have made if you had invested it in some other way.

In short, borrowing comes first and its price depends on the interest rate. Interest rates have to be set before the financing of any good or service is agreed to; financing precedes manufacturing; manufacturing precedes delivery to customers; delivery requires prices, which must be set to cover all the previous costs, plus, it is hoped, a profit. This is the way capitalist business runs, and there is no better way to run it.

To be sure, different companies follow different routines to achieve the same result. Many arrange a line of credit with a bank to prepare for the needs of a year or a season or a project. Special projects may be planned all at once. An automobile company may glimpse a chance for a new sports utility maxivan. All that exists at the beginning is a price range, a schedule of standard specifications, and a menu of desired special features. The engineering and design departments see what they can do; the sales department does market research; but the car is not built unless the finance department can be reasonably sure of necessary monetary support at a feasible interest rate.

That is not to say that finance is more important than (or even as important as) engineering or design or advertising or sales. It is simply to say that finance is primary. After all, the name of our system is finance capitalism.

I have been belaboring the obvious because it is essential for understanding one of the crucial problems of our time-the relation of the interest rate to the price level in a modem economy. The interest rate has an effect on prices, because it is a cost, and costs have to be covered by prices. The causation goes only from interest rate to prices, not vice versa. Prices may affect the sensibilities of the Federal Reserve’s governors, and they do in fact set the interest rate. Nevertheless, this is not a chicken-and-egg question.

A chicken makes an egg, and the egg makes a chicken, and that chicken makes an egg, and so on. Leaving aside the Reserve’s sensibilities, prices do not affect the interest rate, because the interest rate is set before prices are.

It is possible to assemble the statistics and plot curves showing the fluctuations of the interest rate and the price level. Depending on where you start, the peaks and valleys of one will necessarily follow those of the other with, as they say, a lag. If you then start with the other one, their roles will be reversed, and the lag will be different. There is absolutely no way of telling from the statistics or the graphs themselves which “really” comes first, the interest rate or the price level.

In this, the question is like that of the three-way colonial trade (guns and calico for slaves, slaves for cotton and rum; cotton and rum for guns and calico). These are not statistical problems; they are analytical problems. We know from our analysis that the interest rate affects prices, but there is no way for prices to affect the interest rate.

Well, I’ll take that, or a little of it, back. Banks and other lenders have to make ends meet, too; so their prices (the interest rates) have to be high enough to cover their labor, capital and rent costs. But the basic price of their product is set by the Federal Reserve Board. Their overheads merely account for the differences between the rates of your friendly neighborhood banker and those of the snobbish bank in the next town. The dictum stands: Interest rates affect prices, but the Reserve, not prices, affects interest rates.

The business press frequently writes that in certain situations (usually good news, like increasing employment and more prosperous businesses) the Reserve “will have to raise rates,” but there is no natural law or legal requirement that forces it to take the specified action. If the Reserve does raise rates, it is because of the governors’ own free will, guided by their own economic theory, which in this case happens to be fallacious.

PLEASE NOTE that it does not matter whether inflation is thought to be demand-pull or cost-push. A strong argument can be made that in a modem economy inflation, when it occurs, is practically always cost-push. For demand-pull inflation to work, supply has to be rigidly limited, and in a modem economy there is practically nothing that cannot be readily and indefinitely replicated within a reasonable span of time.

In other words, while the hallowed law of supply and demand was plausible enough in the isolated market towns of Adam Smith‘s day, it no longer is absolute —except in the narrow confines of Wall Street, where the supply of investment grade securities is strictly limited. Even international cartels controlling natural resources, such as the Organization of Petroleum Exporting Countries, are of bounded effectiveness because of the development of substitutes and the threat of military reprisal.

To be sure, the Federal Reserve worries publicly about the supply of labor, and that is certainly at least biologically limited, although relaxed immigration laws could provide short-run solutions and expanded education could extend the long run. Yet the experience of the last few years should have taught us that neither the wisest statesmen nor the most erudite economists have the faintest idea where or whether there actually is a natural rate of unemployment (that most barbarous notion), beyond which inflation must rage uncontrolled.

However all this may be, the fact remains that the interest rate must be agreed to by each enterprise before the enterprise is able to make a responsible attempt at setting its own prices. Thus the price level, an aggregation of all the prices in the economy, is systematically subsequent to the interest rate. Following the money, we see that when the interest rate goes up so does the price level.

No precise formula guides the process. Some entrepreneurs will hold their prices down and be satisfied with a lower profit. Some will manage to cut other costs technological, administrative, sales, advertising, and so on. In general, though, even a small interest hike will result in a noticeable hike in the price level.

In any case, the country is full of inflation hawks-and that includes many governors of the Federal Reserve Board -who are constantly on the lookout for the most obscure forecast of the inflation they fear. Recently they raised the rate, and they threaten to raise it further, despite their admission that there is no significant evidence of coming inflation. Instead, there is much talk of pre-emptive strikes, and of the importance of being ahead of the curve. Indeed, it is widely said that the Reserve must act now.

What happens in these circumstances? The price level inches up, and actual inflation shows itself. The hawks demand a further interest rate increase. The scene is like Zeno’s paradox of Achilles and the tortoise, except that the Achilles of the interest rate can’t catch up with the tortoise of inflation, because Achilles is carrying the tortoise and even pushing it out ahead of him.

Well, we’ve seen how the story ends. In fact, we’ve seen the ending nine times since World War II.  Raising the interest rate can only slow down inflation if the Reserve keeps raising it until the whole economy is put into reverse-until, that is, millions of men and women lose their jobs, hundreds of thousands of businesses go bankrupt, and public works languish.

We’re on our way. If we keep it up, we must have a recession. When former Federal Reserve Chairman Paul A. Volcker was asked if his policies might lead to recession, he replied, “Yes, and the sooner the better.” He showed how it was done. Why do we have to do it again?

The New Leader

[1] Ed:  Really?  “Obiter dictum”?  Really?

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By George P. Brockway, originally published August 9, 1999

1999-8-9-lessons-from-the-depression-titleTHE NEW Congressional committee created ostensibly to reach a nonpartisan solution to the Social Security “crisis” may not really be intended to do anything, except perhaps issue a report calling for further study of the problem. In fact, I think it is probably a device for changing the subject whenever some humorless member of Congress tries to make an “issue” out of Social Security. “We must wait until the committee reports,” will be the ready response. If I’m right, Social Security will be effectively eliminated from the front lines of the November general election campaign, and no one will have to take a possibly unpopular stand either for or against any of the myriad “reform” schemes lurking on the horizon.

My junior high school civics teacher would be saddened to hear of my lapse from her innocent teaching, but I, for one, am enthusiastically in favor of another do-nothing committee on Social Security. A little over a year ago the much larger National Commission on Retirement Policy, made up of presumed experts business leaders, academics, Congressmen- managed to split three ways on which reform should be endorsed; so nothing was done. That was fine, because all of them would have gotten Social Security mixed up with the stock market in one way or another. Since the stock market is still dangerous, our need for a do-nothing committee is still great.

Nevertheless, I have not forgotten all I learned in those dear, departed civics classes, where we were taught to analyze legislation under three headings: (1) the need for the law, (2) the constitutionality of the law, and (3) the proper taxation to pay for it. That continues to strike me as a good, systematic approach, and I hereby suggest that the committee spend its time looking at the existing Social Security Act accordingly. This will give it something to do that no prior committee has done and keep the matter bottled up until after the balloting. Let me demonstrate.

1. Why was the Social Security Act needed? Well, there was a jim-dandy depression on. There being no official or semi-official definition of “depression,” one has to be supplied: A depression is a massive, comprehensive and persisting breakdown of the economic system. The economy does not recover without major changes or a major shock or both.

In the 1930s, millions and millions of people were out of work; the municipal poorhouses and charity soup kitchens were overwhelmed; beggars were everywhere; bands of hobos hitched long journeys on freight trains, tracking the seasons or wandering aimlessly. In most towns, near the freight yards or in the gashouse district, there appeared “Hoovervilles” of shacks made from old cartons and discarded (or stolen) boards, furnished with broken furniture from the town dump. In many cities a portion of the local jail was used as a temporary shelter for the more respectable homeless. I myself spent a night as a guest of the Hudson, New York, jail in the course of a hitchhiking journey to search for a job that I didn’t find.

The Great Depression was not a pretty time. Millions suffered, despite having worked long and hard and faithfully. Their dependents, of course, suffered along with them. So did young people coming fresh to a labor market that had no place for them. The society had failed, not a particular individual or group or class. Thus the Social Security Act was needed to deal with at least one aspect of the collapse of the social system-namely its effects on the elderly, the disabled and the orphaned.

2. Was the act constitutional? That proved to be a tough question for a Congress dominated by Southern Dixiecrats and Northern Republicans, and for a Supreme Court possessed of states’ rights notions that had become obsolete at Appomattox Court House on April 9, 1865. It took six years of depression for Congress and the Supreme Court to follow the election returns and take the general welfare seriously. Follow they eventually did, and our second question was answered in the affirmative.

3. Is the taxation appropriate? That question is still with us. The dispute today concerns the adequacy of the present payroll tax. No one wants to increase the rate. Some want to increase the income by putting a portion of the money in the stock market; others argue that income will be more than sufficient as long as the economy remains robust. The real trouble, however, is in the method of taxation itself.

A payroll tax has nothing going for it. It is comparatively easy to evade, especially by those in domestic or casual work. It also discourages employment. If you have a job, that laudable fact triggers a tax on you or your employer or both. On the other hand, if you are a professional gambler, or if all you do for a living is clip coupons and play the market, you don’t pay any payroll tax.

To be sure, aid for the needy is a responsibility of the state; and all businesses-manufacturing, wholesale or retail –owe their existence to the state. In some cases the state licenses or charters or franchises them; and in every case the state protects the society that is the source both of their work force and their market. Consequently, it is reasonable for businesses to be taxed to help pay for the general welfare of the government that nourishes them.

But a payroll tax is a poor way to do it. It is an up-front cost that must be met with the first employee hired, that increases with each additional employee and each wage increase given, and that continues until the last hour of the last employee’s employment. In his book The Next Left, the late Michael Harrington argued that French President Francois Mitterrand‘s bold, popular and promising social policies resulted in economic stagnation because he financed them by levying payroll tax after payroll tax. Instead of expanding, French industries cut employment to the bone in a largely vain attempt to keep their prices competitive with those of neighboring countries. The failure of Mitterrand’s programs had nothing to do with the fact that he was a Socialist. Their effect would have been the same even if the programs had been private fringe benefits.1999-8-9-lessons-from-the-depression-tight-money

OUR Social Security system, although in many respects the most successful legacy of the New Deal, has twice the vices of an ordinary payroll tax, since both employee and employer are taxed. Wage negotiations are rendered more difficult because the employees’ present value of any wage is reduced by the 6.2 per cent Social Security tax plus the 1.45 per cent Medicare tax, while for employers labor costs are increased by the same 7.65 per cent (called, no doubt to spare their delicate sensibilities, a “contribution”).

In addition, the Social Security tax has the extraordinary effect of being a radically regressive tax on the nation’s workers, especially the working poor. It is, to begin with, a flat tax–even flatter (as far as it goes) than the various flat tax proposals of current Republican politicians. It has no exemptions or credits, and starts with the first penny a worker earns. It continues at 7.65 per cent on both employee and employer until the employee earns $72,600, whereupon only the Medicare portion remains. A Fortune 500 CEO who pulls down $10 million a year therefore pays a rate that is less than one ten-thousandth of the rate paid by the charwoman whose job it is to clean up after him.

Nor are these the only indefensible unfairnesses of the Social Security tax. More important in the long run is the fact that the tax has been used to eliminate the higher brackets of the personal and corporate income taxes, and hence exacerbates the widening gap between the rich and the poor in the United States.

The Social Security system is said to be a pay-as-you-go plan, but of course it isn’t. It is a pay-years-before you go plan. The Trust Fund that is being paid for now will not be used up before 2029, and probably much later, if ever. In next year’s budget, the total of employee taxes, employer contributions, and interest earned by the Trust Fund is $636.5 billion, while the entire cost of Social Security (beneficiaries, bureaucrats and all) is only $408.6 billion. The $227.9 billion Social Security surplus not only goes to make possible the budget balance everyone is so proud of, but also accounts for the entire budget surplus that Congress is squabbling about.

The trouble with Social Security; in short, is the method of meeting the costs. A payroll tax is adverse to national employment and investment, and is unreasonable in its incidence. Moreover, the present payroll tax may be incapable of paying the bills. It is anticipation of the last that has caused today’s uproar. But speculating on the stock exchange, whatever else may be said for or against it, is almost guaranteed to fail at the most critical moment. A booming stock market does not guarantee a booming economy, but a crashing market is sure to bring the economy down with it.

Again I can offer a personal reminiscence. My father put together a satisfactory nest egg by playing the boom market of the 1920s. When the ’30s began he believed President Herbert Hoover and did not “sell America short.” In August 1933 he died broke. As the HMO lobby’s ads say, “There must be a better way.” And there is: The Social Security Act addresses a national need and it should be funded by a national tax. The income tax does not inhibit employment and investment, because it falls only on persons and enterprises capable of sustaining employment and investment.

It is often argued that the income tax is too subject to the cold and shifting winds of politics to be the support for something as vital as Social Security. But the raucous history of the present debate has surely demonstrated that Social Security is in any event buffeted by the very same winds as the rest of our political life.

The New Leader

By George P. Brockway, originally published May 7, 1999

5-7-99-why-nairu-is-nonesense-title

MANY YEARS AGO, when I was a college undergraduate, there was some talk on campus about The Fountainhead[1], a massive novel by Ayn Rand. I was aware of it because one of my close friends told me a bit about it, and the older brother of a classmate had edited it, but I never read the book nor did I see the movie. Perhaps it was too huge for me (I was reading Ernest Hemingway‘s stories and Gertrude Stein‘s scribblings). Perhaps I was sufficiently law-abiding to be put off by the novel’s intensely self-centered architect hero[2], whose action at the end was the principal topic of what I heard (he destroyed an allegedly supremely beautiful building he had built because the owner wanted some changes).

I never read Atlas Shrugged either, or any of the other works by Ayn Rand, and I was not aware that she was a self- invented economist until I became one myself. Even then I was-and still am-put off by the name she gave to her philosophy (“objectivism“). But despite my ignorance of what she has written, I am prepared to claim that she has had a great and salutary effect on the present and possible prosperity of the United States of America. Maybe of the world.

One of Ayn Rand’s disciples was Alan Greenspan, who grew up to be Chairman of the Federal Reserve Board. So far as I know, Greenspan has never made a public reference to her, and so far as I am aware, only three of her doctrines may have slipped into the proceedings of the august body he heads. He has spoken some odd words on the movement of the price of gold as an indicator of the future course of the price level. His aversion to regulation of the rogue multitrillion-dollar derivatives market may be linked in his mind with the behavior of the hero of The Fountainhead. And almost alone among the public men of our time, he doesn’t believe in the barbarous theory of a natural rate of unemployment.

In any case, I suspect that her influence has been both more profound and more beneficial than her ideas. As a result of his association with her, Greenspan learned how to be at once the consummate insider and the consummate outsider.

Because he is a consummate insider, he got to where he is. Because he is a consummate outsider, he has not been overawed by the high-powered bankers and economists with whom he does business. Because he is not overawed by these worthies, we have not had a boost in the interest rate since March 1994, and in fact had three quarter-of-a -point cuts last summer and fall.

These 60-odd months without a rate increase constitute the longest, indeed the only, period of tranquility the Federal Reserve Board has allowed the American economy in the 30 years since the Reserve launched its all-out war against inflation-which propelled the Consumer Price Index from 36.7 in 1969 to 99.6 in 1984, a record-breaking and stupefying leap of 272 per cent in 14 years. It is for the present period of tranquility (and for its continuance, if he can bring it off) that Greenspan is renowned today and will be forever famous in the annals of economics and of political economy.

There is no doubt that if Greenspan had polled the economics profession and the banking profession he would have had them almost solidly against him. On July 19, 1995, Greenspan said in Congressional testimony, “I don’t believe that any particular unemployment rate-that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with-is something desirable in and of itself. I don’t believe that.”

Neither the New York Times nor the Wall Street Journal reported this testimony (but THE NEW LEADER did, and I have the videotape). As I said at the time, this was earthshaking testimony. It directly contradicted what then was the first or second most sacred economic law, namely the natural rate of unemployment, a.k.a. the nonaccelerating inflation rate of unemployment, a.k.a. NAIRU. It is possible, but not certain, that the ancient “law” of supply and demand had a tighter grip than NAIRU on the hearts and minds of economists and those who pretended to an interest in economics. Yet Greenspan contradicted this barbarous doctrine, and got away with it.

As it happened, the economy jogged along pretty well. The stock market boomed, because the Baby Boomers were worried about saving for retirement and didn’t know where else to put their money. As the market soared, more and more of them made nice killings and began to spend some of their capital gains. Retail sales, especially of automobiles and other big-ticket items, picked up. Unemployment began to fall, and so, to almost everyone’s surprise, did inflation.

After a while the media began looking for someone to give the credit to. President Clinton was willing, but no matter what he claimed, and no matter what photo ops were arranged, people kept saying that he was too preoccupied with impeachment to run the country. Perhaps they were right, and, obviously the Republicans were too preoccupied, for the same reason.

Greenspan was available, and an interview with him was almost as good copy as the stories quoting Casey Stengel used to be. He talked about the free market, so he became the leader of the free world.

Of course, I wasn’t there, but I have a clear picture of what happened next. At meeting after meeting, the Federal Reserve Board staffers brought in sheaves of disturbing figures showing that Wendy’s in Sandusky was having trouble holding dishwashers and hiring cashiers; that Kmart in New Jersey had constant openings for stock clerks; that Boeing in Seattle was looking for riveters. Everywhere, in other words, the unemployment rate was falling-falling steadily below the rate at which all the bankers in the country knew, and all the mainline economists in the country absolutely knew, that inflation definitely had to break out again. The financial press talked nervously of the importance of being ahead of the curve, and Greenspan himself spoke of making a pre-emptive strike against inflation.

Nevertheless, Greenspan has not acted. He tried jawboning the stock market-and quickly learned that his reputation as economic wise man of the Western World was in jeopardy because practically no one was in favor of repeating the 1987 market crash.

Lately he has made a series of speeches suggesting that an increase in the productivity index explains our “miraculous” combination of falling unemployment and falling inflation. Since the productivity index is a fraction (output divided by hours worked), its value rises when the denominator falls. Greater productivity, therefore, is hardly an explanation of increasing employment.

WELL, maybe Greenspan can pull it off, but it would help if he could make clear why NAIRU has not performed as advertised. Since the business and financial press has not been able to do that either, the professional belief in NAIRU has been muted but not stilled. The true believers are prepared to stay the course, because they have been given no reason not to.

We shall continue to live in fear that our tranquil days of steadily expanding prosperity will soon be over unless somebody sets them straight. So, it might as well be me, here and now.

It isn’t enough to remind the believers that not so long ago they insisted the telltale rate of unemployment was 7.0 per cent, then 6.5 per cent, then 6.0 per cent, then 5.5 per cent, then 5.0 per cent, then 4.5 per cent, and now it must be 4.0 per cent or lower. They shrug off this embarrassment with the complaint that the available statistics are imperfect or that, as Humphrey Bogart said when told there were no waters in Casablanca, they were misinformed.

It also is not enough to show them that every one of the nine recessions since World War II has been preceded by boosts in the interest rate. The boosts were said to be necessary to nip inflation in the bud. But in fact inflation accelerated more rapidly after the boosts than before them. Another fact: In all the years since World War II, no matter what the Federal Reserve Board has tried, the price level has fallen only once, and in that year (1955) the interest rate fell too. Again, of course, the statistics are imperfect. And without a coherent theory everything is anecdotal, the diehards argue, as the doctors did when Linus Pauling tried to tell them about Vitamin C.

Yet the reason NAIRU is nonsense is not far to seek. To begin with, the interest rate and the unemployment rate are both percentages, just as apples and oranges are both fruits. Interest is a direct cost or an opportunity cost on both sides of every economic transaction. Labor costs are similarly universal. But interest costs are closely uniform for comparable risks throughout the economy; labor costs vary widely from industry to industry, job to job, locality to locality, and (shamefully) from ethnic group to ethnic group as well as from gender to gender.

The two percentages are so radically different in composition that NAIRU theorists themselves never had a theory of their interaction. All they had were some empirical observations that occasionally made pretty graphs, like the Phillips curve. As with all empirical observations, though, theirs were liable to falsification by events.

The serious recessions of 1974-75 and 1980-82 were certainly falsification enough. But those events were disregarded, perhaps because practitioners of this dismal science tend to believe that dismal outcomes must be true, while relatively happy outcomes (like the present situation) must nurture some occult seeds of their own distraction.

Moreover, a 1 point fall in the unemployment rate causes little more than a 1 point rise in the national wage bill (which itself is only three-fifths of the costs of production), whereas a 1 point rise in the basic interest rate (now 4.75 per cent) eventually results in a drop of about 20 per cent in the purchasing power of money (which is, of course, equivalent to a 20 per cent rise of the price level, or a pretty stiff dose of inflation).

Far more important, the interest hike would produce a 16.7 per cent decline in the borrowing power of money, resulting, as we shall see, in a 33 per cent drop in the value of investments that must be made to keep the capitalist system going. If the interest rate is 5 per cent, $500 will get you a year’s use of $10,000. You can invest that $10,000 in an enterprise of your choice, and, unless you are unwise or unlucky, you will earn back your $500 interest plus a profit to boot and be ready to do more of the same.

But if the rate rises to 6 per cent, you will be able to borrow only $8,333 with your $500. Worse yet, the purchasing power of the $8,333 you borrow will have been reduced 20 per cent; so in the end you will have only $6,667 worth of goods to invest in, compared with the $10,000 worth you would have had before the interest hike.

Any way you look at it, the “punishment” of a 1 per cent increase in the interest rate does not fit the “crime” of a 1 per cent decrease in the unemployment rate.

Federal Reserve Bulletin please copy.

The New Leader

[1] Ed: Not likely as an undergraduate.  The author graduated college in 1936.  The Fountainhead was published in 1943

[2] Ed: Howard Roark is no more self-centered, say, than Donald Trump…

By George P. Brockway, originally published March 3, 1999

3-8-99-the-love-song-of-homo-economicius-title

T.S. ELIOT sang of “Songs[1] that follow like a tedious argument! Of insidious intent! To lead you to an overwhelming question …. ” Economics

sometimes seems like that-tedious as well as dismal. Economics is also very like the next line of The Love Song of J. Alfred Prufrock”: “Oh, do not ask, ‘What is it?”’

For the characteristic economics essay or book lays out-“Like a patient etherized upon a table”-an account of the economy, or some part of it, demonstrating how it works, or doesn’t work. Often the putative truths contained therein are unpleasant, like the iron law of wages in the 19th century or the natural rate of unemployment in the 20th. Nonprofessionals are frequently prompted to ask, not “What is it?” but the truly overwhelming question, “What should we do about it?” Professional economists have tended to brush that question aside. They are, they say, scientists, not humanists; and science concerns what is, not what ought to be.

But there is another reason for the posture of most economists, and that is the problem posed by the first sentence of the last chapter of John Maynard KeynesGeneral Theory of Employment, Interest and Money: “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 income.” One would have to be extraordinarily deficient in empathy for one’s fellow human beings not to recognize the justice and urgency of Keynes’ dictum. One would also have to be exceptionally ignorant of the ways of the world to imagine that the problem will simply solve itself. Indeed, anyone with empathy and knowledge must find it acutely uncomfortable to deny that confronting those “faults” is the special responsibility of economists.

Yet starting with Adam Smith in 1776, the history of modem economics has instead been the story of a search for an automatic polity, a mechanism that, whether it makes all well or not, at least makes everything inexorable. With Smith, of course, it was the invisible hand. With Jeremy Bentham it was the felicific calculus, supposed to operate like Newton’s laws of motion. With Jean-Baptiste Say it was production creating its own demand. With John Stuart Mill it was supply and demand. With Karl Marx it was dialectical materialism. With William S. Jevons, Leon Walras and Carl Menger it was marginal utility. Among our contemporaries, equilibrium is the chosen control-metaphorical with John Hicks, mathematical with Gerard Debreu and Paul Samuelson, quasi-psychological with Frank Hahn and Edmund S. Phelps.

All those I have named are honorable men, as I believe almost every economist to be. I am sure none would dispute the truth of Keynes’ pronouncement. Faced with the enormity of the problem, though, all, with the possible exception of Marx, have found in pseudoscience an excuse for denying the need or ability to do anything substantial, and hence for refusing their responsibility.

The first thing to note about the problem is that originally it was a double pronged affair, but by now the prongs have joined together. In the ancient world, the feudal world and the mercantilist world, you could have full employment along with unconscionable disparities of wealth and income. Perhaps even in Keynes’ day, over half a century ago, it was possible to consider the two great failures of the economy separately. Today, however, we shall not be able to solve unemployment without at the same time solving maldistribution.

An explanation for the intertwining of the two problems was suggested by Joseph A. Schumpeter in an observation of the sort he made so casually and so tellingly. “The capitalist achievement,” he wrote, “does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.” The modem economy, unfortunately, may not be quite so good to factory girls as Schumpeter suggests.

The reason lies with the opportunities the wealthy have to dispose of their income. In most cases, their money derives from mass production, but they do not spend much of it on the products of the assembly line. This is not merely a matter of taste. It would be flatly impossible to do so. You can buy a top-of-the-line Mercedes, the archetypal expensive, mass-produced commodity, for about $145,000. If you were a senior officer of a Fortune 500 corporation, or a partner in a major financial house, you could pay cash for a brand-new Mercedes the first of every month, junk it at the end of the month, and still have more money than you and your family could conveniently spend.

Traditionally the wealthy have invested their surplus, a practice generally considered to return it to the producing economy it came from. And, like Prufrock’s Yankee contemporary, Miniver Cheevy, they think they “have reasons” to believe they are doing something good. Theoretically, for example, their investment would make more silk stockings available at lower prices by increasing productivity. But in common with the romantic notions Cheevy holds so dear, the idea is largely spurious.

This is because, regardless of what distinguished economists say, the producing economy is, in general, overcapitalized. As things stand, it could very easily, without investment in another machine or machine tool, increase its output by 15 or 20 per cent. It has that capacity right now. More investment will not lead to greater productivity.

Increased demand would. But Chairman Greenspan still hopes to restrain the “exuberance” of the stock market-in which case its upper middle class “wealth effect” will disappear. And far from trying to stimulate consumption, credit card companies can’t wait to put fear of a new bankruptcy law into their lower-middleclass clients.

These actions reduce the nonwealthy to relying on what they earn by working, and what they earn necessarily falls short of being able to buy what industry produces: Schumpeter’s silk stockings (or their millennial equivalent) become less affordable. The shortfall is equal to the earnings and other withdrawals of the wealthy. Its correction must also come from that source.

LEFT TO THEIR own devices, how do the wealthy spend their money? After buying several Andy Warhols and subscribing to tables at a couple of dozen charity balls, it is all too easy to become frustrated by the attempt to consume one’s income and turn to speculation. So the money the wealthy take out of mass production industry stays out, and the money devoted to speculation becomes a flood.

A “moderate” session of the New York Stock Exchange today sees half again as many shares traded as were thrown on the market in the frenzy of the crash of October 1987. And still there is not enough to meet the demand. Besides the NASDAQ and the Amex and the mercantile exchanges and exchanges abroad (including way stations all over the new global village), there are $85 trillion worth of derivative “products” invented by clever bankers and brokers to facilitate betting on almost anything you can think of. In comparison, numbers running is child’s play.

Also in comparison, trying to make money by operating an enterprise that turns out actual goods and services is a mug’s game. As fortunes are made in speculation, the opportunity cost of productive enterprise rises. To keep those who have invested in industry from selling out, they have to be promised increased profits; and the fashionable way of doing that is for lean and mean companies to become leaner and meaner, thereby narrowing the already narrow market. Where once there was a spreading wage-price spiral, heading upward, the economy has slipped into a constricting lean-mean spiral, heading downward.

3-8-99-the-love-song-of-homo-economicius-ts-elliotThe wealthy are not the only ones contributing to this trend. The middle class is the beneficial owner, through what are called “institutions” (especially mutual funds and pension funds and insurance policies), of between one-third and one half of all the shares on the current exchanges. By being funded rather than treated as current expenses, these institutions soak up purchasing power and weaken aggregate demand. The funds’ speculating deprives the producing economy of efficient financing. The resulting shrinkage of the producing economy raises the rate of unemployment, accelerating the erosion of the middle class the institutions were created to protect, and exacerbating the polarization of society.

That is how we are approaching the turn of another century: The nonwealthy are unable to buy the products their industry can produce; industry consequently has fewer opportunities for expansion; the wealthy consequently have fewer opportunities for productive investment; the nonwealthy consequently have fewer job opportunities and more of them become unemployed (“naturally”).

It is easy to convince yourself that looking to the government to fix the situation is hopeless. President Franklin D. Roosevelt couldn’t get a cap on stay-at home incomes even in the midst of World War II, when millions of young men and women (and middle-aged ones, too) were risking their lives for their country. President Richard M. Nixon, despite being re-elected by the second largest percentage of the popular vote yet recorded, couldn’t enlist a Congressional majority for a negative income tax. The current tax law, whose top rate is less than half the top rate of 25 years ago, does not assess even the present top rate against capital gains. And who can imagine the Federal Reserve Board maintaining an interest rate that is either low or steady, let alone both?

Some (if not all) of these things should be done to mitigate the polarization of our society. If they can’t be done in the current political climate, what can economists be expected to do about it? Well, if economists can’t suggest answers, the least they can do is get out of the way. Certainly no solution will succeed if no one has the will to work for it, and certainly those most responsible are the people claiming professional status.

In the meantime, the outstanding “faults” of our economic society, albeit forged into one, are substantially identical with those of Keynes’ day. But the degradation, despair, and (in the words of the late Erik Erikson) negative identity are worse. Will human voices wake us before we drown?

 

The New Leader

[1] Ed. Well, I’ll be damned.  The author, uncharacteristically, has the quote wrong.  Eliot wrote of “streets”, not “songs” that follow like a tedious argument ….

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