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By George P. Brockway, originally published February 24, 1997

1997-2-24 The 7-Up Solution Title

THE LAST TIME I saw Michael J. Boskin on the tube, he was Chairman of the President’s Council of Economic Advisers under George Bush, and he was arguing against extending jobless insurance as the 1991 recession dragged on. Doing this would, he explained, discourage the unemployed from rushing to grab new jobs-jobs that were, he neglected to point out, a lot worse and paid a lot less than those they’d lost.

Now Boskin is being presented as the fellow with a nonpolitical scientific story about the Consumer Price Index. In 1995 the Senate Finance Committee put him in charge of an independent commission appointed to look at the accuracy of the CPI as a measure of inflation; a few months ago the panel issued its report, and since then he has been very much with us. As I listen to him these days, I am reminded of Carl Jonas‘ comic novel The Sputnik Rapist, in which an old goat of an aging mountain man is sweet talking an Indian maiden, whispering in her ear about the great time they’re having. She replies, “Well, perhaps, but I think I’m being screwed.”

I’ve already given you my notion that the CPI is not, and never was meant to be, a COLA. It measures changes in the price level, and that is not the same as changes in the cost of living (see “What Does It Cost You To Live?” NL, June 3-17, 1996). I don’t propose to go into that again in detail, but I do have a couple of points to add.

Professor Boskin and other members of his commission all have a lot to say about how the CPI doesn’t adequately measure the improvement in products over time. Automobiles last longer than in the past, they point out, so no wonder a car costs more. Well, I don’t know about you, but I run my automobile longer than

I used to because the new ones cost too much. In fact, the last new car I bought was in 1982.

Besides, they contend, items that used to be extras are now standard equipment, and so should be reflected in the CPI; what is more, the equipment is better than it used to be. Perhaps it is, but I used to be able (it was a fight, but I could win it) to buy a car without a radio and a tape deck and CD player and quadrilateral sound and white sidewall tires.

Still, the Boskin commission thinks the CPI should be cut 0.6 percentage points for these reasons.

Another claim they make, exactly contrary to the previous one, is that lots of things-literature, for example-are cheaper than they used to be. Eight or 10 years ago, a best-selling novel was $12.95 in hardcover; now it might be $25, but you can get a paperback for $10.95, and so are better off. (paperbacks once were 25 cents, but let that pass.) Indeed, they say, you don’t have to spend even $10.95, you can go to the library for free.

I seem to remember that we could go to the library for free when we were children and the world was young; so the cost of reading shouldn’t be a factor in the CPI anyhow, even assuming that the CPI measures changes in the cost of living rather than changes in the price level. Speaking of-libraries, however, how do you factor in the fact that increased book and magazine prices, coupled with decreased budgets, have forced reductions in the number of books purchased and also in the hours libraries are open?

Anyway, the commission wants to trim 0.4 percentage points for cheaper substitutes.

Finally, they want to knock off 0.1 of a percentage point for the availability of less expensive places to shop, like warehouses. I don’t know of such a place in my neighborhood; and even if there were one, I can’t imagine how I’d get the stuff home or where I’d store it if I did get it home. I’d have to rent a larger place, which would surely cancel the savings from buying wholesale, not to mention the interest I’d have to pay on my investment in canned goods.

The grand total of all the deductions comes to 1.1 percentage points. While this doesn’t sound like much, it amounts to between three-tenths and a half of recent COLAS. Everything I’ve said, of course, is anecdotal, but so are the explanations we’ve been given about the presumed inaccuracy of the CPI.

There is another issue that is not anecdotal at all; it goes to the heart of the conservative passion for cutting the CPI. That is the effect of the CPI on the interest rate. It should be of particular concern to Chairman Alan Greenspan of the Federal Reserve Board. Although he was the first to make a public clamor about the CPI, he seems to be bashful or (maybe) blind to this issue.

Almost always when he’s talking about the interest rate, Mr. Greenspan is careful to make clear whether he’s referring to the money rate or the real rate. When in 1993 he gave up on his attempt to use M2 to forecast the future, moreover, he indicated that the real rate continued to be the object of Reserve policy. The real rate, of course, is the money rate (the rate banks actually charge and we actually pay) less the CPI.  Thus if the CPI is overstated by “at least” 1.1 per cent, the Federal Funds rate (the key rate the Reserve sets) is also overstated by at least 1.1 percentage points, as are all other rates.

This should give Mr. Greenspan and the Republican-New Democratic cabal furiously to think. Right now the outstanding debt of nonfinancial sectors of the economy is about $14 trillion. That $14 trillion includes everything from what you owe on your bank credit card through Treasury 30-year bonds. If the CPI is 1.1 per cent too high, the annual interest paid on that $14 trillion is 1.1 percentage points too high-or $154 billion, almost 50 per cent more than the current budget deficit.

Or look at it this way: During the past 10 years, while Alan Greenspan has been keeping the Federal Reserve’s eye trained on the “real” rate of interest, we-you, me, all the businesses of the land, and the city, state, and Federal governments-have paid over $1 trillion too much in interest. We will again pay $1 trillion too much in interest between 1997 and the mystic year of 2002.

Now, the most that any of the Boskin commission expects to gain by cutting the Social Security COLA, modifying the brackets of the income tax, and holding down government and service pensions and disability entitlements seems to be about $200 billion over the next six years. If the commission would just take Mr. Greenspan aside and explain to him how the CPI is overestimated, he could save five times what the commission wants to dock the elderly and disabled.

Not only that: Since he claims to have been aware for a long time of errors in the CPI, he could have made proportionate savings for us at any time in the last decade without bothering the elderly and disabled. The Federal Reserve Board is an independent agency with large staffs of well-paid economists, not only in Washington but also in the 12 district banks. It doesn’t have to base its policies on numbers crunched by the underfunded Bureau of Labor Statistics of the Department of Labor, which computes the CPI, or by the Boskin panel either.

If the Fed were to take a responsible approach to the CPI question, it would sooner or later (depending on how fast they can do simple arithmetic in their heads) come up with a solution that would render irrelevant the Boskin commission’s report and all the debate and talk shows and editorials it has inspired.

BEFORE GETTING DOWN to this solution, let’s make a minor adjustment in nomenclature. I used to talk about the “Bankers’ COLA,” but a friend has complained that the term made unfair fun of bankers; they, after all, are not the only ones to benefit from it. So suppose we now call it the “Fed’s COLA,” because it is the Federal Reserve Board that decides how big the interest rate’s cost-of-living adjustment is.

The simple arithmetic is this: The Federal Reserve Board decides on an estimate of the current rate of change in the CPI, and then adds that estimate-the Fed’s COLA-to the “real” interest rate (which is determined altogether separately) to set the “money” rate. Multiply the outstanding indebtedness of the nonfinancial sectors of the economy by the Fed’s COLA, and you get its cost to the economy.

Next, multiply the Gross Domestic Product by the same rate of change in the CPI (whatever it is). This will give you the cost of inflation to the economy, for that is what the Consumer Price Index is supposed to point to.

Lastly, compare these two costs. In today’s economy it will turn out, no matter what the rate of change in the CPI is, no matter how or by whom calculated or by whom approved, that the Fed’s COLA costs the economy almost twice what inflation costs. The plain and simple reason, as Tom Swift used to say in a marvelous old series of books for 10-yearolds, is that the outstanding indebtedness of the nonfinancial sectors of the economy is, and has been for many years, almost twice the Gross Domestic Product. So when you multiply them both by the same number, no matter what it is, you get figures that are different by nearly a factor of two.

It doesn’t take Tom Swift to see that if there were no change in the CPI, there would be no Fed’s COLA. Conventional economics, which is perhaps not so smart as Tom Swift, concludes that the thing to do is to get inflation down to zero, whereupon the interest rate could be lowered because the Fed’s COLA would be reduced to zero, too. In order to get inflation down to zero, though, the Federal Reserve Board (which is nothing if not conventional) raises interest rates to control inflation putting us right back where we started from.

Since interest rates are set before things are made, and hence before prices are set, one might rationally expect that the proper procedure would be to get rid of the Fed’s COLA, which (if the estimate of the CPI change is correct) would get rid of inflation as a consequence. And if we got rid of inflation, we could get rid of all the other COLAS. And nobody would be hurt, as people are being hurt today. For a variety of reasons, this could not happen overnight. I’ll name two: First, monetary policy seems to take about two years to have a substantial effect. Second, most existing indebtedness has many years to run. But it shouldn’t take Tom Swift to convince us that we ought not to do the wrong thing just because doing the right thing takes time.

The New Leader

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By George P. Brockway, originally published September 6, 1996

1996-9-6 Caught in a Boom Market Title

ON OCTOBER 15, 1929, less than two weeks before the worst crash in the history of any stock market anywhere, one of America’s most renowned economists, Professor Irving Fisher of Yale, announced that stock prices would be “a good deal higher … within a few months.”

Fisher’s prophecy is as good today as it was on the eve of the Depression. All it took to make the market go up then was an influx of money, and that is all it takes now. Per contra, without an influx of money nobody, not even the wisest professors in the land, can induce the market to levitate.

The stock exchanges are, after all, among the few remaining places where the law of supply and demand still runs according to script. Brokers, bankers and publicists who operate in the shadow of the exchanges come to feel the law obtains always and everywhere, imposing market discipline as it goes. But as anyone who has noticed the programmed gyrations of prices in malls and supermarkets knows, this is not the case.

For the law to work, supply must be limited. It no longer is limited in most transactions of daily life. When a bookstore runs out of a bestseller today, it can have fresh stock tomorrow. If you want a new automobile, there are, as my Vermont father-in-law once remarked, plenty of people ready to sell you one.

Supply used to be limited in isolated provincial markets of the sort familiar to Adam Smith, and it is still limited in the narrow confines of Wall Street. Only the issues of a certain number of companies, and only a certain number of shares of each, are admitted for trading on the exchanges. When millions of people with money in their fists start demanding to purchase some of the finite supply, the old law comes into play and prices go up. We have a bull market.

The 1920s upsurge was generated by what may be called exuberant greed. The Great War had liberated and greatly enlarged the middle class. Wall Street promised more liberation. Today greed is certainly just as crucial, but the mood is noticeably different, more desperate than exuberant. For a moment, it seemed like morning in America, but the Baby Boomer generation has grown up and begun to worry about its retirement years, because suddenly they bode to be less golden than those of its parents.

The problem is, at least initially, demographic. Generation X (or whatever it may ultimately be named) is substantially less numerous than its parents’ generation. It is said, therefore, that the Social Security and Medicare trust funds will be depleted, and that the burgeoning costs of these “entitlements” will fall on a smaller number of taxpayers. Much as they love their folks, the young are expected to revolt. Boomers are advised to start looking out for themselves.

Where to look is the question. Many financial advisers answer that, over the years, the stock market has out-performed all other kinds of investment – Treasury bonds, foreign currencies, real estate, collectibles, gold, pork bellies, the lot. The difficulty that few citizens are qualified to play the market seems solved by the existence of 7,000 or more mutual funds whose comparative performances are widely rated. It is unlikely there are 7,000 fund managers more qualified today than Irving Fisher was in his day, but let that pass: The 7,000 funds now manage close to $3 trillion.

Unfortunately, this astronomical sum must be multiplied many times if it is to do the job expected of it. The Boomer objective, after all, is a decent retirement income. Not to be too ambitious, let us say something around $35,000 a year, which is somewhat more than the present median family income. This will certainly not be enough if Medicare is privatized any further, or if the Social Security COLA is eliminated. Nor will it be enough if inflation continues at its current “optimal” rate of 2.5 per cent, since over 10 years this will raise the price level 31 per cent. We can’t, however, allow for every contingency, or we would give up at once.

So let’s assume $35,000 a year, and let’s assume further that Social Security will somehow be good for $10,000, leaving our typical Boomer with $25,000 a year to coax from Individual Retirement Accounts (IRAs), 401(k) schemes and other available fliers. Right now the average stock’s dividend is running at not much more than 2 per cent. At this rate, to rake in $25,000 a year in dividends, our Boomer’s portfolio would have to be worth roughly a million and a quarter.

Although I am no Irving Fisher, nor was meant to be, I think I shall not go far wrong in prophesying that the market will continue climbing, because the desperate Boomers are going to have to put their retirement money somewhere; and regardless of what Bob Dole’s new supply-side friends say, the country isn’t full of enterprises crying for new capital. As long as the Boomers’ annual contributions to IRAs and 40 1(k)s go into the market faster than other people take their money out, the weary bull is bound to keep scrabbling upward, at least for a while.

BUT ALL good things come to an end, and we have already received intimations of the mortality of this one. There are, to begin with, the worries about our corporations’ abilities to compete in the new global village, plus the uneasy suspicion that the information superhighway may turn out to be a curiosity, like the English Chunnel[1]. The principal sign of danger, however, is the 2 per cent dividend rate previously mentioned. Stocks paying only 2 per cent are an acceptable gamble as long as capital gains keep piling up. When they start falling (or turn negative), the stodgy 6 or 7 per cent yield of the Treasury long bond looks like an increasingly desirable port in what could develop into an unpleasant storm.

In 1983, when the present bull market began, the dividend yield of the Standard & Poor’s 500 was more than 6 per cent. When (post hoc and probably propter hoc) the dividend rate fell below 3 per cent, we had the “corrective crash” of 1987. Four years later, the rate had worked its way back to 4 per cent. Now, ominously, it is the lowest it has ever been.

It is by no means certain that even a 2 per cent dividend rate can last. The economy is strong enough to frighten the Federal Reserve Board, and all that, but the rate of profit has been maintained to a considerable extent by downsizing, and the thing about that is it frequently means exactly what it says. For when a company cuts staff, it cuts output, too-unless it has previously been unlucky or unbelievably inefficient or surprised by overwhelming technological change.

The trick is to cut jobs and wages faster than output. If a firm can manage that, its “productivity” will rise, though its production will probably fall. The lower cost per item produced may delight its economist and please its cost accountant; nonetheless, its total profits are likely to fall with its total output. Indeed, a company can be the most “productive” outfit in an industry (as Nissan’s and Toyota’s American automobile plants were rated last year), yet operate at a loss (as the Nissan and Toyota factories did).

For the nation all the time, and for the stock market in the medium and long run, what counts is production, not productivity. Production-goods and services created-can be used and enjoyed, and if so, can yield profits. Productivity which is merely an index number, a ratio of output to hours worked, nothing tangible – is not good to eat and pays no dividends.

The way things stand, if dividends fall much lower, capital gains will dry up as cautious money leaves stocks for bonds; the bull market will 1996-9-6 Caught in a Boom Market Nissanapproach its end. At some point before the end, or soon after, fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect. The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate.  Therefore, for the Boomer generation to enjoy a reasonably comfortable retire there will no doubt be calls for the Federal Reserve Board to intervene, and the Board will be tempted to comply. Besides wringing its hands, it will have two choices: to raise the interest rate, or to lower it. It will be leery of raising it, because someone on its staff may remember that in 1929 and 1930 the Reserve’s tight money policy was blamed for triggering the Crash and then turning it into the Depression.

In any event, raising the interest rate would lower the price of bonds; and almost immediately the price of every income-earning asset, including common shares, would follow. In other words, the stock market would fall, or at the minimum be impeded in its climb. In addition, the costs, and hence the prices, of ordinary businesses would sooner or later increase, and their sales and profits would fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect.

The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate.

Therefore, for the Boomer generation to enjoy a reasonably comfortable retirement, as every generation should, it can no longer consult its narrow self-interest. Instead, it must look forward to, and participate in, and help organize, a great surge in the gross domestic product. This can be accomplished in only one way in a free society. It is not enough for goods to be manufactured and services to be made available. To contribute to private profits and common wealth, commodities must be sold, and someone must be both willing and able to buy them. Otherwise, sensible producers will cut output and make up for the resulting drop in profits by laying off employees.

Mass industry requires mass consumption. But that will require a more generous and hopeful and responsible attitude toward the distribution of income than has been seen, in this country for many long years.

The New Leader

[1] Ed – so much for prognostication, neither turned out to be “merely a curiosity.”

By George P. Brockway, originally published June 3, 1996

1996-6-3 What Does it Cost You to Live Title

THE ENTRY in this space for April 5, 1982, was titled Let’s Put Indexing on the Index. The occasion was a Reagan Administration announcement of a shift in the Consumer Price Index (CPI). Fewer citizens than previously, it had been discovered, were buying houses.

There was a reason for that. The going interest rate for mortgages had reached 15.84 per cent. You may be sure there were “points” and lawyers’ fees and title insurance and surveyors’ fees and such to pay, too. As a result, the real estate market was sluggish, despite the fact that the children of the Boomer Generation were coming on line. With fewer houses sold, fewer mortgages were undertaken. Although the interest rate was out of sight, consumers had less interest to pay because not as many of them could afford it.

So the Bureau of Labor Statistics reduced mortgage interest as a factor in the CPI. This shrank the index as a whole and President Ronald Reagan got credit for controlling inflation, which President Jimmy Carter had not been able to do. Now a similar scheme is being suggested.

Federal Reserve Board Chairman Alan Greenspan, who seems to have been the scheme’s most prominent publicist, has a new and original end in view: He wants to turn the CPI into something it never was intended to be, in order to solve a problem no one thought existed.1996-6-3 What Does it Cost You to Live Greenspan

From its beginning in 1919 the CPI, issued monthly by the Bureau of Labor Statistics, has shown the changes in what urban consumers shell out for the goods and services they buy – commonly referred to as a “market basket.” (Farmers get much of what they consume “free.”) As with any index, the items in the basket are weighted to reflect how frequently they appear on the typical shopping list. It was the “weight” of mortgage interest, for instance, that was scaled down in 1982.

Alone, an index number means nothing. You must have at least two numbers that are put together in the same way for a comparison to be possible. The CPI is a series of numbers. Similar series are created by those trying to compare the price levels of different countries and periods.

The CPI is used by historians as well as economists. And it is not discriminating. It does not try to measure the cost of what consumers ought to spend their money on; rather, it tells us what urban consumers do spend their money on. Over the long run, it needs periodic adjustments to accurately reflect the basket’s cost. In the short run, it is a measure of inflation and deflation.

Fear of inflation has been the economic neurosis of our time. Especially after World War II, it became common for contracts to contain Cost of Living Adjustments, or COLAS. The purpose was to ensure that no party to a contract either profited or lost from shifts in the price level.  In 1972 and ’73 the idea was adopted for Social Security benefits. In 1986 the tax brackets in the Federal Income Tax were “indexed” to the CPI, so that taxpayers would not find themselves creeping into higher brackets even though their “real” incomes had not changed. Now COLAS appear in many kinds of contracts, public and private. Bankers also have long charged borrowers an inflation premium that is a COLA in everything but name.

What has been happening since Greenspan said last year that the CPI “overstates inflation” and should be corrected would be ludicrous if it were not liable to cause havoc in millions of lives. It seems that either the Reserve Board Chairman or someone with access to him happened to notice one day that the CPI doesn’t measure the cost of living. As we have seen, it never pretended to. Moreover, if Chairman Greenspan had time to stop and think, he would not only realize that the CPI is what is wanted in the sort of situation described above[1], but that the cost of living in a literal sense has nothing to do with it.

In sad fact, it is probable the whole mess was caused by the childish attraction almost everyone in the government and the media seems to feel for acronyms. One imagines a publicity flack being given the job of announcing a contract that provided for “an adjustment of compensation to offset, nullify, and render nugatory substantial shifts, if any, in the price level.” After much fretting and black coffee, the flack, inspired, rushes in to the director of public relations, whose door is always open. “Look, chief,” she or he cries, “let’s drop all this garbage. Let’s call it a ‘cost of living adjustment.’ Then for short we can call it a ‘cola.’ Get it?” The chief says, “Not bad.” Then he or she shows how he or she got to be chief. “We’ll run it in caps,” he or she adds softly, taking out a pad and a Mont Blanc pen and printing the word in big capitals: “C 0 L A.” The rest is history.

Possessed of the misapprehension that when people spoke of COLAS they truly meant what it cost to keep a person alive, Chairman Greenspan, though scarcely a close student of the physiological form of the problem, saw that many of the factors in the CPI were not essential costs of living. One hypothetical example seems to appeal to most of those who have taken up the idea. Think of beef, they say; everyone knows its price has gone up, but no one has to eat it, even in England.  Chicken is not only cheaper, it’s better for you (less cholesterol, unless you persist in frying it); so chicken should be in the CPI basket instead of beef. That way, the cost of living would be less.

The reasoning would be impeccable if the CPI were supposed to measure the cost of living. Indeed, in that event the argument could be carried a step or two further. Bread (whole wheat or oatmeal, of course) is cheaper than chicken. Cake, as Marie Antoinette discovered, is not cheaper than bread, but rice (unhulled, of course) is. No doubt there are even cheaper ways of keeping body and soul together, but I’m not anxious to know about them. I can already hear King Lear: “0, reason not the need! Our basest beggars are in the poorest thing superfluous. Allow not nature more than nature needs: Man’s life is cheap as beast’s.”

Not even Speaker Gingrich is likely to argue openly that the cost of biological existence is all that should concern us. Nor does Chairman Greenspan, who has noted that the CPI may be overstated in part because it overlooks shoppers who switch to bargain brands and discount stores, really believe the index should tell us citizens what to eat and, afortiori, how to clothe and shelter ourselves. For my part, I do not think that there shall be no more cakes and ale, and I doubt that either the Chairman or the Speaker thinks so. The cost of living, as Lear implies, may well require a standard, but index numbers are compared with each other, not an exogenous standard.

THAT BRINGS us back to the purpose of COLAS. They are not, and never have been, intended to lift Social Security benefits up to the poverty level. They couldn’t do that at any acceptable cost if we wanted them to. In the case of union contracts, they would not be worth bothering about if poverty were the best they could guarantee. No, the COLAS were and are meant to offset the effects of inflation.

Needless to say, the CPI is not a perfect yardstick. In particular, there are serious difficulties with the way the housing component is calculated that result, as Dimitri Papadimitriou and L. Randall Wray of the Jerome Levy Economics Institute have shown, in an accelerating upward bias of the index. On the other hand, when senior citizens cozy up to the fireplace on cool evenings, they are apt to exchange anecdotes about how everything costs a great deal more than it used to.

Having said all that, let me say further that I am opposed to indexing in principle, for it is always and everywhere inflationary. In every case where, as in the Weimar Republic, a runaway inflation has occurred, indexing has been at the bottom of it.

But, as I’ve written before, Bankers Have the Classic COLA” (NL, January 9, 1989), and as long as they have it, the rest of us are entitled to all the CPI-driven benefits we can get. With the support of economic theorists, bankers (and lenders generally) divide the interest they charge into two parts: “real interest,” which is what they would charge in a stable economy, and their COLA, or “inflation premium,” which is generally said to be the same as the year-to-year change of the CPI. At first glance this seems as reasonable as any other COLA, but it doesn’t work out that way, because the total indebtedness of the nonfinancial sectors of the economy (you, me, the corner store, and the government) is almost double the GDP.

In other words the total Bankers’ COLA, while supposedly designed to protect lenders from inflation, is about double what inflation costs the whole economy (lenders and borrowers and everyone). The arithmetic is apparently too simple for most economists to understand: In 1995, the rate of change of the CPI was 2.5 per cent; the total indebtedness was $13,804.2 billion; so the Bankers’ COLA was .025 x$13,804.2 billion, or $345.1 billion. At the same time, the GDP was $7,297.2 billion, which, when multiplied by .025, gives $182.4 billion as due to inflation. Take away the Bankers’ COLA of $345.1 billion, and the economy is in deflation, not inflation.

I am, you may be sure, aware that the 1995 CPI applies only to indebtedness incurred in 1995, which is only about a twelfth of the total. The other eleven twelfths include mortgages and Treasury bonds stretching back to 1965, though almost all debts are of more recent vintage (the average length of current public debt is less than six years). The key point is that in only one of those 30 years (1986) was the change in the CPI lower than in 1995. In short, taking 2.5 percent as the Bankers’ COLA rate for all debts outstanding in 1995 gives lenders a generous benefit of a serious doubt, particularly since it is not unknown for individual bankers to figure more than the CPI as the inflation premium.

In sum, if there were no Bankers’ COLA, there would now be no inflation, hence no occasion for all the other COLAS, hence no need for Chairman Greenspan to raise the interest rate to “fight inflation,” nor for Speaker Gingrich to weary himself dreaming up arcane tricks to play on the elderly.

Furthermore, although I am not scared silly by the present deficit, I am terrified by and ashamed of the budgeteers’ mindless and compassionless trashing of American culture and civilization. Therefore

I want to point out that if the Board Greenspan chairs devoted itself to getting rid of the Bankers’ COLA, it could lower the interest rate and put us on a fast track to a balanced budget and a more humane and more prosperous America.

The New Leader

[1] Ed – the author is not here to ask but this is the link we believe he is making here

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

1989-1-9 Bankers Have The Classic Cola Title

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

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

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

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

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

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

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

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

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

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

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

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

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

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

1989-1-9 Bankers Have The Classic Cola Factory

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

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

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

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

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

The New Leader

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

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