Tag Archives: deficits

By George P. Brockway, originally published April 4, 1988

1988-4-4 On the Matter of Consumption Title



THREE AND A HALF years ago, in THE NEW LEADER of November 26, 1984, to be exact, I made a prophecy that is remarkable among my prophecies in that it has come true. I said we would “start hearing a lot more about the value-added tax-how it is widely used in Europe, how invisible it is in comparison with the sales tax, how comparatively easy it is to collect, how it taxes consumption rather than production …. What we get won’t be called a value-added tax, but what’s in a name?”

Well, the name that seems to have been settled on is consumption tax, and the chorus in support of it is tuning up with a vengeance. For some reason no one bothers to explain, the stock market crash of last October 19 is thought to have provided a suitable occasion for taxing consumption. Everyone from Pierre DuPont to Peter Peterson has solemnly warned us that Wall Street won’t be satisfied with anything else. (If you asked me, I’d say Wall Street has a problem satisfying the rest of us. Who laid the egg, anyhow?)

As a distinguished example of consumption- tax thinking, I cite Robert M. Solow of the Massachusetts Institute of Technology, who gave the following advice to the next President in a recent issue of the New York Times: “If there is no recession, the first order of business is to make a start on reducing the deficit…. And [the President] should do it by increasing taxes on consumption, not investment …. Because a consumption tax means spending will fall, he must do something to offset that like lower interest rates.”

Now, Solow is not a fool; I don’t think you get to be an MIT professor by being a simpleton. Nevertheless, and putting aside a question of fact (hasn’t a “start on reducing the deficit” already been made?), I ask you to look closely at his two-step policy recommendation. First step: He would tax consumption. In other words, he would reduce the standard of living of the middle class (the poor will presumably not be taxed, at least not much, on necessities, which is what they mostly consume; and the rich won’t be much bothered). Second step: He would lower the interest rate. If the middle class stops consuming there will be a depression, so he would keep them consuming by making it easy for them to borrow. (When liberals propose lowering the interest rate, Wall Street insists that only the impersonal unregulated market can do it, but let that pass.)

Let us suppose Solow’s scheme works. What will the next President have accomplished? (1) The deficit will have been reduced, at best, by the amount of the consumption tax. (2) Since nothing will have been done to stimulate the economy, it will, at best, continue to languish in its present “prosperity.” (3)

Some indebtedness will have been shifted from the nation as a whole to the middle class as individuals. (4)The money borrowed by the middle class will have been lent them by the rich, whose extra dollars will have been left untaxed to better enable them to make this “investment.”

Solow’s scheme is, as the mathematicians say, elegant in its simplicity. But I don’t think it will work, at least not if its purpose is anything other than a transfer of wealth from the middle class to the already wealthy. The scheme would bring about such a transfer; there’s no doubt of that. There would also be some leakage, as the economists say. Because the middle class’ spending money will in effect be taxed twice (once by the consumption tax, then by the interest paid on the borrowed money), spending will be reduced after all, and the proceeds of the consumption tax will be correspondingly reduced. Depending on the new interest rate, the reduction in spending could be very large-large enough to bring on another recession (if you’re timid about saying “depression”).

Now I ask: We already did this, didn’t we? Do we have to go through it all again? We did it in 1981, and we got the depression (I’m not afraid to use the word) of 1982, not to mention the deficit everyone talks about. Those whose attention span is very short may have forgotten about the Laffer Curve, which purported

to show that you could increase tax collections by reducing the rates, and the Kemp- Roth tax bill, which promised to increase investment by cutting taxes, especially of the rich. Those were the heady days of the supply-side theory, but investment didn’t respond as promised. What actually happened was that tax collections fell far below expectations, creating the mega deficit that was covered by bonds paying usurious interest rates, purchased by the rich with their tax-cut windfalls. In effect the rich were given the bonds, just as Solow’s scheme would give the rich the promissory notes of the middle class. It is deja vu.

 Indeed, it is, if Yogi Berra will pardon me, deja vu all over again: The Great Depression was also preceded by tax cuts for the rich. I do not think this is mere coincidence, or mere post hoc, ergo propter hoc. For I am persuaded that there is a fatality about economics that in the end chokes any society making too great a distinction between the rewards of the favored and of the disfavored. It is a commonplace of legal theory that a law must not only be just but also be seen to be just. It is the other way around with economics, where it is more important for a policy to be fair than for it to be accepted as fair. This is particularly true when it comes to policies determining the distribution of a society’s rewards.

As near as we can tell, the Roman mob was appeased, if not altogether satisfied, by bread and circuses; but in the imperial city alone, upwards of 150,000 lived on the dole, while uncounted thousands waited upon the whims of the favored few. Labor power is the ultimate power-and Rome threw it away. In 1928, a year we look back on as a period of idyllic prosperity, almost 60 per cent of American families lived in poverty; then calculated at less than $2,000 a year. Now we have an underclass, and we have a large class of the underemployed. This costs us, and may finally destroy us; yet it would seem that substantial majorities of American voters have been satisfied with current policies. The policies are seen to be fair, but their actual unfairness may be our undoing.

The rich have always had a problem knowing what to do with their money. In times past it could always be invested in land and in improvements thereon. The improvements, whether in the shape of stately homes or scientific agriculture, were craft industries. Each staircase or mantelpiece designed by Grinling Gibbons and carved by him or his apprentices was the subject of an adhoc contract between him and the lord of the manor. There certainly was demand for his work, and this certainly affected how much he could charge; he did not produce for a market, however, nor was he himself an important outlet for what was produced on the estates where he worked.

The problem of today’s rich is different. In the first place, they have not become rich by investing in land-speculating in land, maybe, but accumulating rents, no. In the second place, their riches are vastly greater than the sums necessary to recreate a Chatsworth or a Montacute, should their fancy happen to take that turn. In the third and most important place, industry today is built on mass production: Giant corporations serve giant markets.

The giant markets are crucial; without them the giant corporations cannot exist. Giant markets are masses of people willing and able to buy. Such masses need to include the employees of the giant corporations, and the employees are able to buy only to the extent that they are well paid. Henry Ford talked as if he understood this, but even his shockingly high wages were not enough to raise his employees out of the ranks of the working poor. In any case, his has remained a minority view among American businessmen. The majority view, in recent years embraced by the electorate at large, is that consumption should be curtailed and investment should be encouraged.

IRONICALLY, consumption has nevertheless expanded as the banks have discovered profits to be made in personal loans at usurious interest rates. There are limits, though, and they have been reached in many an industry. Automobile companies struggle to maintain their share of the market, because the market is limited, and because the industry’s present capacity is much greater than the market. Steel mills, all over the world, are closed down or running at a fraction of capacity. Agriculture produces more than could be consumed even if somehow the idiocies that permit widespread starvation could be overcome.

The inevitable consequence of limited markets is limited opportunities for productive investment. Hence, as we’ve remarked here before, the rich have more money than they know what to do with, and so do the massive pension and charitable funds. Besides, the glittering gains from speculating in a churning stock market are enormous. In the eventual crash the too-much money of some of the rich and of some of the funds disappears; on October 19 perhaps as much as a trillion dollars disappeared forever. The Reagan revolution created a deficit to give this money to people who couldn’t use it.

The appalling fact is that practically everyone seems to want a repeat performance. It would appear that the first eight months of 1987, when the Dow went from under 2,000 to over 2,700, was the happiest period in millions of tawdry lives. Every day the “financial” news was a joy. Individuals with a few shares of a mutual fund and college presidents with great fortunes in their care were equally delighted. Economists, who gave the stock market a prominent place in their models, looked upward. Brokers stood tall. Arbitragers stood taller. Tens of millions more, although not directly involved, shared in the euphoria.

Despite the shock of October 19, these people seem determined to do it again. More stridently than ever the claim is being made that the stock market is both the heart blood and the brains not only of the national economy but of the whole free world; that our liberty as well as our prosperity depends on its ineffable wisdom; that any attempt to control it would, in the tasteless cliché, throw out the baby with the bath water.

Worse, we hear again the cry to tax consumption, with the deliberate purpose of destroying the mass market modem industry depends upon-which would foreclose rational investment opportunities and bring on a new fever of speculation. Some of this can be explained as simple greed. But beyond that there is a pathological psychology whose etiology I can’t even imagine.

The New Leader

By George P. Brockway, originally published June 1, 1987

1987-6-1 Vale, Volker Title

1987-6-1 Vale, Volker Greenspan

A COUPLE OF years ago, Mayor Edward I. Koch was asked who was responsible for pulling New York City back from the brink of bankruptcy. In one of his formerly frequent bright moments, he replied. “Well, I suppose someone has to get the credit, and it might as well be me.”

It is worth remembering that New York had been pushed to the brink by Walter B. Wriston’ s Citibank, David Rockefeller’s Chase, Donald T. Regan’s Merrill Lynch, and the rest, because in their self-advertised wisdom they thought it safer to lend our money to Argentina, Brazil and Mexico. Well, I suppose someone should get the credit for the mess our banks and the debtor nations are in, and it might as well be them.

But they don’t deserve all the credit. They should share it with Paul A. Volcker, for they couldn’t have raised the interest rate to usurious heights without his help. That may not be a nice thing to say about a man who is now retiring from government after many years of undoubtedly self-sacrificing service. Unhappily; I have some even less nice things to say. I say them not only in sorrow but also in anger, because people have been hurt-have had their lives ruined-by the lordly mistakes of this big man, and because his smaller successor as chairman of the Federal Reserve Board, Alan Greenspan, is apparently ready to keep making most of the same mistakes (besides, when the wind is north-northwest, declaring his devotion to Ayn Rand and longing for the gold standard).

Let’s briefly examine the Volcker record in five areas- (1) inflation, (2) general welfare, (3) economic output, (4) foreign trade, and (5) the deficit and then look more closely at his underlying theory. Volcker is admittedly not single-handedly responsible for the bad things-or the good things, if any-that can be pointed to in each case. He had a lot of help from Ronald Reagan, from legions of people who were sure they were doing what the President would have wanted had he been paying attention, and -yes- from you and me. Nevertheless, even if Paul VoIcker wasn’t, as the commentators liked to say, the second most powerful man in the world, he is, as they also say, a legend in his own time. It’s really what he stands for that I will [be] talking about.

1. Inflation. There is no doubt that VoIcker’s present fame is based on his claim to have been the tamer of the inflation dragon. He took office at the Fed in October 1979 and immediately began his attack. What really happened? From that December through December 1986, the Consumer Price Index (CPI) rose 51.06 per cent in constant dollars. In comparison, the increase from 1972 through 1979 was considerably greater, 73.50 per cent, but from 1964 through 1972 it was considerably less, 34.88 per cent. And if we go back to the bad old days of Harry S. Truman, we find that the increase from 1948 (following the jump when wartime controls were suddenly ended) through 1952 was only 10.26 per cent. On the record, VoIcker, the great inflation tamer, turns out not to have been all that great.

2. General Welfare. VoIcker never made a secret of the fact that his program was going to hurt. That may have been, as Ring Lardner would have said, one of its charms. Again using constant dollars, we find that from 1964 through 1972 the median family income increased 25.46 per cent; from 1972 through 1979 it increased 1.56 per cent; but in the VoIcker years, from 1979 through 1985 (the latest Economic Report of the President doesn’t have 1986 figures for this), the median income fell 4.56 per cent. Given that more families had multiple wage earners in 1985 than earlier, the drop in family income was even steeper.

The fate of the poor was much more dramatic. The number of our fellow Americans living in poverty actually declined 32.13 per cent from 1964 through 1972; it held unchanged from 1972 through 1979; but it jumped 26.81 per cent in the Volcker years.

On October 19, 1979, shortly after taking office, Volcker proclaimed, “The standard of living of the average American has to decline.” He made it happen.

3. Economic Output. Volcker’s rationale for hurting people was that inflation would thus be controlled, and the rationale for controlling inflation was that prosperity depended on it. As we have seen, inflation was only slightly restrained; perhaps it will be said that is why the recovery has been so lackluster.

The GNP rose (in constant dollars) 32.19 per cent from 1960 through 1972; 22.38 percent from 1972 through 1979; and only 12.30 per cent in the Volcker years. Since the working-age population increased 8.19 per cent in the last period, and more people produce and consume more goods, the Volcker recovery has been overpraised.

4. Foreign Trade. Everyone knows that our recent performance in foreign trade has been abysmal. If the monthly deficit on current accounts falls a point or two, it is hailed as a triumph. Everyone knows, too, that the strong dollar of recent years has made it difficult for American industry to compete either at home or abroad. What few remember, however, is that the strong dollar was a deliberate objective of Volcker’s policy, announced as early as October 17, 1979. It was supposed to stabilize international trade, and it sure made it fun to travel in Europe and to buy Volvos and Mazdas and madras shirts in the U.S. All this naturally contributed to the trade deficit and put Americans out of work. It also made it easier to sell American bonds-not goods but bonds-abroad. Volcker wanted the strong dollar because it made it easier to finance the American deficit-again a way to achieve a questionable result by imposing unquestionable hardship on millions of people.

5. The Deficit. The deficit question is a phony, and so is the problem of financing it; and I don’t mean merely that it wouldn’t have seemed important if it hadn’t been for the Kemp- Roth tax cuts. Volcker certainly isn’t to blame for those. He is to blame, though, for crying wolf over the deficit.

There are a few ways a national debt is like a personal debt, and one of them is that the amount of debt a nation can bear is a function of its income. Poor people and poor countries have trouble with small debts; rich people and rich countries can carry big debts. The United States’ debt is always thought enormous by knee-jerk conservatives; this was one of Reagan’s arguments against Jimmy Carter. In 1979 the Federal debt held by the public (some of it, of course, is held by government agencies, mainly Social Security) was 26.33 per cent of GNP. That was one of the lowest ratios in years, but Reagan promised to wipe it out and Volcker strengthened the dollar to help him. By 1986 the debt had risen to 41.94 per cent of GNP. This is a lot hairier than the 1979 animal, but even so it’s not a real wolf.

For something like a real wolf, we can go back to 1946, the last year of World War II, when the Federal debt held by the public was 113.62 per cent of GNP. If there is validity to the notion that a high debt/GNP ratio induces or requires a high interest rate, the 1946 rate should have been wild. Yet in that year, three-month Treasury bills paid all of three-eighths of 1 per cent, and the prime was 1.5 per cent.

Now consider this: During the Volcker years the Federal debt held by the public increased by $1,102 billion, and the interest paid on that debt amounted to $844 billion. Suppose the 1946 rate had been paid instead of the Volcker rate. The interest bill would have been reduced by about $812 billion, while the debt itself would have increased only $290 billion. At the same time, the debt/GNP ratio would have fallen to 2.46 per cent-hardly anything to get excited about (except as probably too low), and certainly below the urgent need for foreigners to invest in our bonds.

It comes down to this: Volcker allowed interest rates to soar, partly to reduce the average American’s standard of living, and partly to encourage foreign investment in government bonds. He was successful on both counts. But if the rates had been lower, the deficit would have been minuscule, and the foreign investors wouldn’t have been needed. High interest rates simply gave a lot of money to rich foreigners-and to rich Americans, too.

I HAVE ALREADY said that Volcker’s attack on the inflation dragon was not outstanding. I now make the heretical claim that his maneuvers with the interest rates indeed caused inflation to be greater than it might have been.

First, let me make a minor observation. The inflation rate is not a figure you read off an instrument, like barometric pressure. It is a statistical construction, and one of its factors is the interest rate.  Consequently, interest rates and inflation rates have a tendency to go up and down together. This is an arbitrary and possibly small effect, and one that could be eliminated by slight pressure on a computer key; nonetheless, it stands as a real fact in the real world.

Second, let me make the much more important observation that speculation is vastly stimulated by volatile interest rates. Volcker says that if the strong dollar weren’t available to bring in foreign money, Federal borrowing would crowd producers out of the money market. But speculation can always crowd out production, and that is what Volcker’s policy has encouraged.

There is a still more serious effect than either of these. If you are running a business and your friendly banker says he wants 20 per cent to renew your 10 per cent loan, your first defense is to increase your prices. Moreover, the loan isn’t the only thing that bothers you, because what economists call the “opportunity cost” of the money you and others have invested in your business increases as well. That is, whoever invests in your business passes up the opportunity to make easy money by being a lender rather than a borrower; so you have to raise prices to take care of that, too, and keep your colleagues from wanting to sell out.

A significant aspect of these increases is that they are percentages. What’s more, similar percentage increases are being made by everyone who supplies you with raw materials or rents you office space or provides shipping services for you. Every company below you in the production chain is adding a percentage to its prices, and you add your percentage on top of their inflated prices, and the companies above you in the chain do the same. The result is that, as Adam Smith observed in a little-noticed passage, prices are increased geometrically, whereas a wage increases pushes up prices only arithmetically.

The immediate impact of an increase in interest rates, therefore, is an increase in inflation. Of course, the intended decrease in the level of business follows sooner or later (it took Volcker almost three years to get things down to where he wanted them). Sooner or later, people can’t afford the new prices. Businesses can’t sell as much as they used to. Workers get laid off. Unions get afraid to strike. Wages are held down, and so price increases can be relaxed. This is what Volcker frankly worked for. But true to Adam Smith, we see that when wages go down (empirically, when any cost-including interest-goes down), prices fall only arithmetically; and if interest rates remain high, the net pressure on prices will continue to be upward.

Even a very severe depression (and Volcker made us one) will at best slow inflation; it will not stop it as long as interest rates remain high.

Volcker’s announced policy was to control the money supply (Ml) and let the interest rate take care of itself.

1987-6-1 Vale, Volker Table

His theory was that a controlled money supply would raise the interest rate, and that a drop in the inflation rate would take place. He was never able to keep M1 growth within the guidelines advocated by Milton Friedman. It’s just as well.

As the table above shows, in 1981 a minor fall in Ml growth (one of only two such occurrences in Volcker’s career) was accompanied, not by a rise, but by the second largest fall in the prime rate, and followed by the largest fall in the CPI. On the other hand, in 1985 the biggest jump in Ml was accompanied by a substantial fall in the prime and followed by the most dramatic fall in the CPI. In general, the figures in the table can be made to support Volcker’s theory only by appeals to “lags” and “anticipations” and other statistical gyrations of the sort J .B. Rhine used to “prove” extrasensory perception. For true believers in the Volcker magic, when 1980’s slight tightening of the money supply was followed by a slightly lower inflation rate, that “proved” the theory. But when 1984’s greater tightening was followed by an increased inflation rate, that “proved” businessmen had expected the tightening and had moved to offset it. Either way, Volcker’s theory was a winner. But such pseudo-logic can equally “prove” the opposite.

In short, there is no way on earth to construct a valid correlation of changes in the money supply, interest rates and inflation rates that will support Volcker’s theory of what he was doing. And there is no way on earth to deny that what he did reduced the standard of living of average Americans and forced millions more into poverty. The theory that I (and Adam Smith) have advanced (for a somewhat fuller exposition, see my note in the Winter 1986-87 Journal of Post Keynesian Economics) goes at least part way in showing why Volcker’s theory was wrong.

A case can be made for many Volcker virtues, especially in impeding somewhat the rush to deregulate banking. But the false legend of big Paul Volcker and the dragon is one that shouldn’t be told to children-or to grown-ups, either.

The New Leader

Originally published November 14, 1983







A FRIEND has taken exception to my proposal to limit or forbid the importation of foreign manufactures that threaten to destroy important domestic industries because of low prices based on the exploitation of local labor (“The Way to Protect,”November 14, 1983 NL, September 19). He says his freedom would be unacceptably abridged if he couldn’t buy a Japanese automobile, because he thinks they are better made than ours. He doesn’t deny that Americans are thrown out of work when our industries are shipped abroad, but he is confident that their distress is only temporary and perhaps not altogether undeserved. Besides, he objects to the word “exploitation” as old-fashioned rabble-rousing.

Two questions are mixed together here. The first I find difficult to take seriously. It is nowhere writ – not in the Bill of Rights, not in the Magna Carta, not in the Sermon on the Mount, not in the Code of Hammurabi – that my friend has a right to buy a Subaru, no matter how well it may be made. For various pragmatic or prudential reasons, the government will not interfere with his use of money except reluctantly and after due reflection; yet many uses are now routinely denied him, and there is no use that cannot, in principle, be denied. Money is, after all, a social, not an individual, creation. The issue is not whether denial is legitimate, but whether denial in this particular case is reasonable.

The other question is one of fact. In setting forth my proposal, I specified two steps that would have to be taken before barring a given import: “First, we decide that certain of our important industries are threatened in our home market by severe competition from foreign industries. Second, we determine whether that threat is made possible by wages or conditions that we would consider “exploitative.”

Now, whether these conditions apply to Subaru or not can readily be determined. I repeat: It is a question of fact, not of theory. For the purposes of our argument, my friend conceded that the conditions do apply, and that thousands of Americans in Detroit are thrown out of work because of Japanese labor policies. He nevertheless maintained that in the long run not too much suffering would be caused by the collapse of the American automobile industry; and that if suffering is caused the way to alleviate it is directly through the dole, not by forbidding the importation of Subarus.

I’m afraid that no doubt exists about the suffering, and it is by no means confined to the automobile industry. As I have previously said, as long as the American standard of living is higher than the Oriental standard of living, there is nothing whatsoever that cannot be manufactured more cheaply there than here. This goes for high-tech industries even more than for smokestack industries, because the technology of the former is in fact simpler and the capital requirements less extensive.

Nor is there any doubt that very little of the suffering we have so far seen will be alleviated by the so-called recovery. What’s going on now does not fit into the late Joseph A. Schumpeter‘s theory of new industries – ” railroad construction in its earlier stages, electrical power production before the First World War, steam and steel, the motor car, colonial ventures” – Ieading the upswing of fresh business cycles. The only new industry now on the horizon is high-tech, which, as noted, is high-tailing it for the Orient, and is not a big employer anyhow. For this reason, all the vague talk of retraining the millions of our unemployed fellow citizens is cruel nonsense. Retraining for what?

My friend is a compassionate man and is willing to consider the problem. Like Mr. Micawber, he expects something to turn up, but in the meantime he is willing to institute the dole (he is not a Reaganite) and to pay for it with a progressive income tax.

I am not one to say that it could not be done. Indeed, I say that it should be done. It is little enough. A dole at the poverty level might seem a bonanza for a part-time textile worker; it is a disaster for a veteran automobile worker who has saved a little money, started a family, bought a house, and nurtured the American dream. If, as some tell us, he was overpaid, then the dream was a fraud.

That is one side of the problem: the unconscionable cost to American workers of my friend’s assumed right to buy a Subaru or a Hong Kong sports shirt. The other side is the cost to my friend in taxes. Being in thrall to classical economics, he wants to balance the budget. At present rates, the Federal income tax raises about $285 billion, leaving a deficit of about $200 billion. A poverty-level dole would cost another $100 billion; a halfway decent dole would be double that. Thus to do what my friend wants to do would require income taxes one and a half times (if he doesn’t balance the budget) to two and a half times (if he does balance) those now in force. A flat tax at that rate of increase, let alone a truly progressive tax, would be a lot to pay for a Subaru. And millions of our fellow citizens would be condemned to aimless, hopeless lives.

Against this dreary scenario, my friend raises the specter of the Smoot-Hawley Tariff, sponsored by reactionary Republicans in 1930 and ever after blamed by junior high school civics texts for the Great Depression, the rise of fascism, World War II, the Cold War, and innumerable minor irritations. The analysis doesn’t rise even to the level of post hoc ergo propter hoc[1], for the Great Depression was already well under way when Smoot-Hawley was passed, while fascism had been in power in Italy for eight years, and was rapidly growing in Germany.

An interesting thing about Smoot-Hawley is that its original impetus came from distress on the farms. Although by the time the bill was passed, duties were raised on almost everything under the sun, the presenting complaint in President Hoovers call for a special session of Congress was largely agricultural. Today there is again distress on the farms, but its cause is different. This time no one is underselling us in our domestic market, or in our international market. The trouble, instead, is that the Poles and others who want our wheat haven’t anything to pay us with. (Except, my friend says, golf carts: Would you have believed that almost all carts on American golf courses were made in Poland?) The Poles have coal for sale, but so have we-and so do the Germans, the French, the Belgians, the British; (One of the “reindustrializing” schemes that has been advocated and, for all I know, implemented involves rebuilding the port of Norfolk to facilitate the export of coal to God knows whom.)

Since the Poles can’t pay us for our wheat, we had to fall back on our ingenuity. The solution was simplicity itself: We lent them the money. Partly we lent it as a nation through the Export-Import Bank, and partly we had it lent for us by our friendly bankers. Of course,

Chase and Citibank and the rest didn’t exactly use our money; they used the Arabs’ money, deposited with them because of the high interest rates the Federal Reserve Board encouraged, allegedly to fight inflation. Just as bankers become unwitting partners of debtors to whom they lend too much money, however, we as a nation have become the unwitting partners of the banks that now have shaky foreign loans far in excess of their assets[2].

THE UPSHOT of all this is that we the people of the United States will in effect pay our farmers for the wheat that is in effect given to the Poles. I have nothing against the Poles, but it occurs to me to wonder why it is better to give our wheat to them than to poor fellow citizens, whom we expect to feed themselves on a supplement of less than a dollar a day. Charity should no doubt be world-wide, yet it should certainly begin at home.

The result of the banks’ loans to Brazil et al. in many ways is worse. The Brazilians invested the money (which, you will remember, couldn’t be lent to New York City because it was a “bad risk”) in building up their industry, particularly steel. Thanks to their low wages, they are now driving American steel out of the world market and to a considerable extent out of the domestic American market. To repay the loans, though, Brazil has to export still more steel and import less of whatever it imports. It must adopt what the bankers and the International Monetary Fund (IMF) aseptically refer to as austerity measures. This means reducing Brazil’s standard of living, and consequently paying its steel workers even less than at present.

If the bankers’ scheme succeeds, by no means a certainty, additional American steel workers will lose their jobs. Should the scheme fail, the banks will come crying to Uncle Sam to bail them out (they’re already lobbying for an increase in our contribution to the IMF), and we will in reality have given Brazil the steel mills that are destroying our industry and putting our fellow citizens out of work.

A very high percentage of foreign trade follows the patterns I have outlined, distorting economies everywhere to the principal benefit of bankers. There are, naturally, many things we want or need to import; oil (because we are too witless to cope with our energy requirements), tungsten, chrome, bauxite, coffee, and there are many things we can, without special government assistance, export to pay for them. But the necessity, or even the desirability, of foreign trade has been grossly oversold.

Trade is one of the modes of civilization (that is what makes economics a humanistic-and ethical-discipline). Trade also adds to wealth – the wealth of individuals, of nations, of the world. It does this by increasing and rationalizing employment, for wealth is the product of work. When trade expands employment for both partners, the prosperity of both is advanced, and David Ricardo’s Law of Comparative Advantage (see “How Our Sun May Rise Again,” NL, July 12-26, 1982) can be said to apply. Conversely, when trade brings about unemployment for one of the partners, its advantage disappears. Trade will always result in some unemployment in a competitive situation, and the unemployment will be compounded where the competition is based on gross wage differentials. If Japanese citizens were to buy up the output of Korea’s nascent automobile industry in preference to Subarus and Toyotas, Japanese wealth would be decreased, and you may be sure that the Japanese government has imposed effective restrictions.

Microeconomically – that is, company by company-foreign trade can be very attractive. Once a company is successful in its home market – factories built and paid for, experience gained – it takes little extra effort to open an export business, and economies of scale will make that business extraordinarily profitable at the margin, especially when stimulated by tax incentives. The profitability of multinational conglomerates is enhanced by their ability to manufacture where wage scales are the lowest (and declare their profits where taxes are the lowest).

When we shift from microeconomics to macroeconomics – from firm to nation – we find (as we frequently do in such shifts) that we have committed the fallacy of composition. What is good for each firm individually is not necessarily good for the nation. In the circumstances we have been discussing, some (not all) American exports are being paid for by us in the shape of high interest rates that inordinately benefit a few, and we will doubtless bear the further cost of rescuing banks in danger of failing. On the other side, some (not all) American imports are being paid for by individual citizens in the shape of shattered prospects and grinding poverty.

These outcomes are not divinely ordained. They are the result of policies deliberately, albeit perhaps blindly, adopted. If this be rabble-rousing, as I told my friend, make the most of it.

[1] A logical mistake which assumes that when things happen in a sequence that means that the second event was dependent on or caused by the first.

[2] Reading this in 2012, post the late 2000’s mortgage fiasco, I can change this sentence by replacing “shaky foreign loans” to “shaky mortgages” and not have missed a beat.

Originally published November 29, 1982

EVER SINCE the elevation of Paul Volcker to its chairmanship three years ago, I have been one of those nattering about the Federal Reserve Board and the interest rate. Our steady cry has been that the Fed’s policy of trying (vainly) to control the money supply would first send the interest rate through the roof and then bring on a depression. Well, they’ve done it, and they’re not altogether pleased with the result. So now they are pawing at the start of the other course and are straining to bring down the interest rate and bring on prosperity. You might expect me to be happy, but I’m not.

My considered opinion, in which I’m not alone, is that they’re too late. A moment’s reflection will convince you that this opinion has extraordinary implications. If you say that something is too late, you are saying that chronological time is a factor [see footnote[1]]; and if you say that time is a factor, you are saying that you are dealing with history, not with science. So let’s face it: Economics is historical and ethical; it is not an exercise in algebra or analytic geometry. If economics were merely algebraic, and if a high interest rate depressed business (it does), then it would be a simple matter to lower the interest rate and stimulate business. In spite of what commentators say, though, there are no such tradeoffs.

It doesn’t work out that way in real life. It won’t work out that way in our life for at least two reasons: (1) Fourteen million of us (including those who have been out so long they’ve given up looking) are now unemployed, and (2) our industrial plant is running at less than 70 per cent of capacity.

Last month in this space I called attention to our World War II triumph of putting 15 million men and women in uniform and, at the same time, creating 7 million civilian jobs. But I remind you that it took an all-out effort. It took Mr. Win-the-War; Mr. New Deal had been unable, despite almost nine years of devoted endeavor by thousands of good men and women, to do more than make a dent in the mess created by the Harding – Coolidge – Hoover “prosperity. (The quotation marks call attention to the fact that at the height of that alleged prosperity almost 60 per cent of American families had annual incomes below the poverty level, then calculated at $2,000.)

I remind you, too, that President Hoover was not quite so feckless as his reputation allows. Not quite. To be sure, he did not believe in the dole. But he did come to believe in public works. Under the Federal Employment Stabilization Act of 1931, he drew up a six-year schedule of Federal projects to stimulate business. In a foretaste of the New Federalism, he urged the states and municipalities to expand their public works. And in the Reconstruction Finance Corporation (RFC) he anticipated the sort of industrial stimulation now advocated by those Robert Lekachman calls Atari Democrats. In relation to the GNP as it was then, and as it is now, the RFC was bigger than anything recently proposed. Yet things got steadily worse.

The lesson of the experience is that although it is easy to throw people out of work, getting them jobs again is a massive problem. John Maynard Keynes painstakingly explained all this 45 years ago, but many so-called Keynesians have persisted in thinking quick solutions are possible.

The underutilization of existing industrial plant should, of course, have warned the supply-siders (are there any left?) that investment was not the immediate difficulty. Why should I invest in a new or expanded plant when I don’t have enough business to keep my present one occupied? The size of this stumbling block is indicated by the fact that, with nearly a third of the nation’s plant idle, the economy would have to increase by almost 50 per cent simply to do what it is currently capable of doing.

Two years ago interest rates were a manageable factor. If they had even been held down to the usurious rates they have now descended to, the situation, while serious, would not have become as serious as it is. Now it’s too late. The recent fall in rates certainly has had some effect on the statements of profitable firms, and it will no doubt save some marginal businesses from bankruptcy; but it is probable that most still-profitable firms have already, by draconian measures, so reduced their reliance on borrowed money that the effect of the lower rates will be minimal. (The main use for borrowed money today is in takeovers like the Bendix fiasco.)

Consider a company that, before the advent of Volcker’ s form of monetarism, had been accustomed to borrowing $10 million of short-term money. When the prime went to 20 per cent (and higher), its interest costs soared to an unacceptable 2 million. Management did what had to be done: raised prices, abandoned plans for expansion, cut production and inventory, reduced marketing expenses, cracked down on slow accounts, perhaps shifted from FIFO to LIFO accounting, dragged its feet on pay raises-and laid off or fired  as many people as it had stomach for.

As a result, the company reduced its need for short-term money from $10 million to $2 million, and in the meantime the prime (partly because other companies drastically reduced their borrowing as well) went from more than 20 per cent to less than 12 per cent. Thus the firm’s interest costs fell from $2 million to $240,000 – and it survived. A further fall in interest rates from 12 per cent to 10 per cent reduces the firm’s costs merely another $40,000, a welcome development but nothing to get excited about – certainly not in the way Wall Street has been excited.

Our little scenario has applications right across the economy; and if you try to put yourself in the shoes of the managers of a company that has been through it, you will understand that they feel pretty smug about surviving and are not at all eager to put themselves in jeopardy again, at least not right away, not with the present people in charge of the banking system. The scenario also explains what must otherwise seem a case of levitation: why so many British companies are improving their earnings in the face of the ravaging of their economy. Since Messrs. Volcker, Ronald Reagan and Donald Regan have learned their lessons at the knee of Prime Minister Margaret Thatcher, we can expect similar occurrences here.

KEYNES laid all this out in The General Theory of Employment, Interest, and Money. The great message of that great book was that full employment is the only rational meaning of prosperity, and that it doesn’t just happen. The economists under whom Keynes had studied thought that a recession would lead to lower wages, which would make hiring people more profitable to entrepreneurs, which would bring about full employment again. Insofar as Volcker, Reagan and Regan think about people at all, they still think that that’s how it works. But it didn’t work that way in the Great Depression, and it doesn’t work that way now.

As Keynes showed, “the economic system in which we live … seems capable of remaining in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse.” It is, in short, perfectly possible for the economy to crawl indefinitely with (to choose some figures at random) more than 10 per cent of the labor force unemployed and more than 30 per cent of the industrial capacity unused. It is possible, too, that the modest proposals the Atari Democrats have advanced might in time knock as much as a third out of those figures and achieve a modest jog-trot at the lower level. That would be better, but it’s not great, and it is probably the best that can be done by indirect methods in the foreseeable future.

By indirect methods I mean schemes to diddle the taxes in order to promote savings or investment or international trade or sunrise industries or the like. I especially mean schemes to control inflation by keeping the economy cool. By direct methods I would mean those designed to do something for people. I don’t mind if you call me a populist. I hold that our greatest national sins are the unconscionable spreads we allow in incomes and in wealth. We have deliberately’ first under Richard Nixon and at present under Reagan, increased those spreads by the maxitax on earned income, the maxitax on unearned income, the reduction of the capital gains tax, and the emasculation of gift and inheritance taxes. And we now have before us the disgraceful spectacle of a private committee of so-called investment bankers (who make their fortunes arranging wasteful takeovers) spending heavy dollars to propagandize a cut in Social Security benefits and an increase in Social Security taxes.

Until we reverse these trends, the rich will stay as rich as they are, while the poor will grow poorer. If that is not bad enough on its face, no stimulation of the economy could come from consumption. The rich are already consuming as much as they want, and the poor are consuming as much as they can afford. We have surely seen that supply-side stimulation was, as David Stockman admitted, a Trojan Horse to make the rich richer. Even if the motives had been as pure as the driven snow (whose are?), the supply-side ploy was, as a bush-league politician said, voodoo economics.

Simply reversing the errors of the years from Nixon through Reagan, however, will not bring prosperity. Algebraic tradeoffs will at most keep things from getting worse. Nor will the job be done by the tentative public works programs that are being timidly proposed. No, to put 14 million of our fellow citizens to work will require perhaps $100 billion. If we don’t spend $l00 billion to pay our fellow citizens for doing useful work, we’ll have to spend upwards of $30 billion to maintain them in miserable inactivity. Can we find the $70 billion extra we need to do the job? Well, it’s proportionately much less than we accomplished in World War II. So the question is not Can we? but Will we?

The New Leader

[1] [Editor’s note:  even Einstein knew that time = money…..  :)]

Originally published September 6, 1982

THE NEW tax law[1] is, by and large, a wonder. Wall Street evidently was excited by the revenue-raising aspects of it, but that euphoria is not likely to last. We’ll still have the highest unemployment and bankruptcy rates since the Great Depression, and we’ll still have the largest deficits in history. The market will churn; some people will take a whirlpool bath, and more important, most of the new money that the Fed is expected to relax into the economy will go into that churning market rather than into production or consumption. It takes a lot of money to float a record 455.1-million-share week like the one we had August 16-20.

Nevertheless, the new tax law is a wonder, and Senator Robert Dole of Kansas is a wonder man. Among other things, as chairman of the Senate Finance Committee he demonstrated that lobbies can be licked. The double reverse he pulled on the restaurateurs was a beauty. They thought they had him stopped in his attempt to withhold taxes on waiters’ tips. But he had in his pocket the three-martini-lunch measure that got laughed to death when President Carter proposed it. In the nature of things, there are more people eating on expense accounts than there are waiters serving them. The waiters lost, and Bob Dole must have had a good chuckle.

Other and more significant loopholes were narrowed. I would not have given a wooden nickel for the chance to withhold taxes on interest and dividends, especially with Walter Wriston of Citibank bleeding over the astronomical sums he claims it will cost his little depositors. Nor could I have imagined the registration of Treasury and municipal bonds, impeding what is certainly a significant amount of hanky-panky. Nor would I have expected that high rollers would be required to call attention to their questionable tax shelters.

These are substantial reforms, and they’re expected to capture $21 billion of the $87 billion the IRS estimates the government was cheated out of in 1981 on legally acquired income. Joseph Pechman of the Brookings Institution and some others think the figure too high, but if you add in the cheating on state and local taxes, it will do well enough. Put it in perspective: Demagogues in high places love to make up anecdotes about welfare cheats, yet income tax cheating last year was more than 10 times [editor’s emphasis] the entire cost of the Aid to Families with Dependent Children program-the entire cost, including all the alleged graft and bungling.

Even with the new law, there will remain $66 billion of cheating, and we’re going to hear a lot of talk about how much more effective it would be to simplify the tax law and just have a low, easy-to-understand, flat-rate tax. There are already several such schemes on the table.

Now, $66 billion is real money, and we should really try to collect it. But we don’t have a country just for the fun of collecting taxes; so we shouldn’t design our tax policy with only ease of collection in mind. I fear that is all some of the “reformers” do have in mind. They seem to argue that the way to reduce tax cheating is to reduce taxes. This is a realistic view-as realistic as the notion that the way to get rid of mob-controlled gambling is to legalize gambling. (You can tell that one to Atlantic City.)

I can, nevertheless, see much virtue in simplification. I don’t know of a’ single deduction or exemption I’d not be happy to see go, but I’m a reasonable fellow and ready to compromise. If you’re unwilling to give up the “charity” deduction altogether, I’ll settle for one based on cash only. If you want to hold on to interest expense, I’ll agree if it’s only for a mortgage on one owner-occupied dwelling. As long as your federalism (new or old) makes for wildly various state and local taxing, I’ll go along with deduction of taxes paid. If you push me very hard, I’ll grudgingly assent to some slightly special treatment of long-term capital gains-provided you agree to define “long term” as at least 10 years. Although I’m a little tender on the subject of interest on municipal bonds (I have some laid away for my old age), I can imagine satisfactory solutions here, too. In short, if there’s a tide in favor of simplifying the income tax, let’s take it at the flood.

It by no means follows that a flat rate is a desirable simplification. It’s all very well to dramatize the subject by saying that if there were no deductions or exemptions or tax shelters, the government’s needs would be covered by a flat rate of 16 per cent or whatever. Yet progressive tax rates are not hard to figure out, even without a pocket calculator. That’s not the kind of simplification we need. We can-and should-have progressive rates even after simplifying all the rest, and the progression should be steep, not at all like the 28 per cent maximum proposed by Senator Bill Bradley of New Jersey.

There are two reasons for this, one broadly social, the other narrowly economic. The broad reason-which really should be conclusive-is among the many important issues examined in detail in a powerful new book by Wallace C. Peterson,  Our Overloaded Economy[2] (See Robert Lekachman’s review, “Challenging Corporate Efficiency,” NL, June 14 [pdf link below]). Peterson demonstrates the mischief caused in a democracy by such irrational spreads in income and wealth as we now tolerate.

The narrower reason turns on the indirect inflationary effect of high salaries. The direct effect is of course minimal. The economy is so large that it doesn’t matter much whether the president of Mobil gets $1.5 million a year or twice that or half that. The indirect effect is enormous and pervasive. The second level of Mobil executives cannot be expected to make do with salaries too far below their chief’s, and the third level has to be not too far below them, and so on down to the level of the working stiffs, whose union observes all those dollars up the line and quite reasonably demands a penny or two for its members. Thus to the extent that pay scales are a factor in productivity, and that productivity is a factor in inflation, the top pay scales are a factor – not the only one, but highly significant – in inflation.

If, as some say, take-home pay is what matters (this is what linguists might call the deep structure of the Laffer Curve), you would think that lower taxes would result in lower wage demands. The present law requires the president of Mobil to pay a tax of almost $750,000 on his $1.5 million salary. Under Dollar Bill Bradley’s scheme, the tax on $1.5 million would be something below $420,OOO-a windfall of $330,000. What would the president of Mobil then do? Would he work harder and make Montgomery Ward (conglomerated into Mobil at a loss) finally profitable and thus deserve even a higher salary? Since he probably works right now just as hard as he knows how, would he pocket the $330,000 with a grin on his face? Or would he insist on giving himself a pay cut to $1,041,658 (thus leaving his take-home pay at $750,000 and saving his stockholders and perhaps their customers-almost half a million?

Well, I don’t even know the man’s name so I can’t tell what he’d do, and it may not be fair to single him out for all this attention. His $1.5 million is by no means the highest salary in the country. Last year, according to Mark Green (Winning Back America), there were at least 35 executives who took down a million or more, and even a dozen who made off with $2 million. The CEO of Cabot Corporation (not a household name in most households) led all the rest in the book of gold with $3.3 million for one year’s work. How this happy few would react when brought face to face with a tax cut, I have no idea.

BUT I DO know what happened in the United States of America in a similar situation – when the maxitax of 50 per cent on earned income went into effect. Prior to that time, the tax went as high as 70 per cent, and I knew some people who paid it. The maxitax gave them a pretty plus. You might have expected – possibly some people really did expect – a nationwide reduction of executive salaries to hold their after-tax level more or less constant. What actually occurred was just the opposite – a great leap forward in executive salaries. When the tax was as high as 70 per cent, there possibly didn’t seem too much point to an extra hundred thousand; after the maxitax, a hundred got you fifty. That was more like it. In fact, it was better than the proportion of her earnings a working welfare mother was allowed to keep.

Before the maxitax, it was suspected that the higher a man got, the more time he spent wheeling and dealing, setting up capital gains situations through stock options and mergers, and devising new and more imaginative perks. With the “reform,” you might have expected a renewed and intense devotion to business, resulting in the kind of increases in industry and productivity that only good, old-fashioned American hard work and no-nonsense management can produce.

Again you would have been wrong. The sole industry stimulated by the maxitax was that of lawyers and accountants searching for tax shelters. After all, more executives had more to shelter. And perks expanded. Company limousines clogged the streets; company airplanes clogged the runways; and exhausted executives dried out (or not) in company suites at Sun Belt resorts. I myself have, over the years, had lunch four times at Lutece and twice at Four Seasons. It wouldn’t be hard to get used to.

On the basis of the record, it is easy to guess what would happen if Senator Bradley’s 28 per cent maxitax-or worse, Senator Jesse Helms flat 10 per cent tax were in effect. It is well to remember that the truly indecent American fortunes were gathered in when there was no income tax at all. A future danger in tax reform is that some men who think of themselves as liberals, and who are touted (or attacked) by the media as liberals are taken in by the supposed realism of a low flat tax. Liberals may need more realism; but whatever America needs, it is not more encouragement of the greed that no doubt lurks in all of us.

The New Leader

1982-6-14 Challenging Corporate Efficiency

[1] rescinded some of the effects of the Kemp-Roth Act passed the year before… as created in order to reduce the budget gap by generating revenue through closure of tax loopholes and introduction of tougher enforcement of tax rules, as opposed to changing marginal income tax rates

[2] The original text reads “OurOverburdenedEconomy” but Amazon says “Our Overloaded Economy”

Originally published April 19, 1982

Dear Editor


I feel tempted to say a word about one part of George P. Brockway’s Why Deficits Matter” (NL, March 8). Brockway draws a distinction between speculation and productive investment that is entirely misleading.

Of course, there is a difference between a purchase of a share of stock on narrow margin and a purchase of the same stock out of savings. The first is speculation, the second you might call investment, depending on the stock. The economic effect, however, is the same. The market does not distinguish where the buyer of a security got his money from. In fact, it has no way of knowing. In either case, the seller of the stock can do three things with the money he gets-consume it, hoard it, or put it into some other investment. Few sellers of stock consume their principal. Not much idle money is held at today’s interest rates. The chances are overwhelming that the seller of the stock, whoever he is, will put his money into another investment.

If that “new investment involves the creation of brick and mortar, it is directly productive. If it just leads to the purchase of an existing security, the same set of choices confronts each successive seller. Eventually, the money will find an outlet in directly productive new investment, unless it is consumed or hoarded. In the process, stronger demand for securities reduces interest rates and stock yields, reduces the cost of capital to investors, and in that way also stimulates investment.

In conclusion, I want to note that while I fully agree with the statement in the title that deficits do matter, I find the entire article so one-sided that in limiting my comments to the point I have made I do not mean to imply agreement with any of the rest of it.

Washington, D. C.                HENRY C. WALLICH

Member of the Board of Governors

Federal Reserve System


George P. Brockway replies:

To comment on Governor Wallich’s interesting letter I must try to summarize points I made in “Why Speculation Will Undo Reaganomics” (NL, September 7, 1981). There I proposed definitions of gambling, speculating and productive investing that, I believe, disclose the different economic effects of the three kinds of activity.

In brief, gambling is a zero-sum game that produces nothing but the players’ pleasure or despair. Speculating is not a zero-sum game: Over very long spans of time all who participate can gain, though some will no doubt gain more than others, but speculating is like gambling in that it only rearranges wealth that already exists. Productive investing is like speculating in that it is not a zero-sum game, but it differs in that goods and services are produced. It should be emphasized that all three activities are risky; consequently risk is not a useful criterion for distinguishing among them, though it is the one ordinarily used.

Governor Wallich’s view, which is the standard one, is that such distinctions are idle because ultimately the results of speculating go into consumption, hoarding, or “bricks and mortar.” This, I should contend, is one of those instances in which Keynes’ remark (“In the long run we are all dead“) is appropriate. Holland’s tulip mania increased in virulence from 1615-37-…It took nine years for the South Sea Bubble to burst. The Great Bull Market lasted six or eight years. Some of these speculative frenzies might, in Governor Wallich’s terms, be classified as hoarding or consumption; but they were not productive investments. They absorbed, and ultimately destroyed, vast sums that could have gone into productive investments.

More important than all this is the role of the stock and commodities markets. Governor Wallich says that “Eventually, the money will find an outlet in directly productive new investment unless it is consumed or hoarded.” The imagined event has to be a long time coming. Fewer than 1 per cent of the transactions on the stock and commodities exchanges have anything to do with productive new investment. Professional traders can and do spend their whole lives buying and selling without ever touching a productive new investment. Insurance companies and endowment funds tend to shy away from productive new investments. Investment bankers (so called) are now mainly concerned with mergers and takeovers. A very large nonproductive tail keeps the productive dog off balance.

I’m afraid it simply is not so that “stronger demand for securities reduces interest rates … and … stimulates investment.” This may be what the theory calls for, but it is flatly refuted by the present situation, when both exchange transactions and interest rates are at all-time highs. The “stronger demand” is a speculative demand, and it attracts money away from productive investment.

To cite an example, U.S. Steel abandoned plans to update its mills and borrowed $3 billion to acquire Marathon Oil. It would be fantasy to suppose that the happy Marathon stockholders, having unloaded at the top of the market, have not been encouraged to bid up the shares of other companies thought susceptible to takeover. There is nothing productive about this. Moreover, the $3 billion U.S. Steel borrowed has surely helped to keep the interest rates high. It is the same with margin accounts, which soak up available funds and thus help keep both securities prices and interest rates higher than they would otherwise be.

I agree with Governor Wallich that “The market does not distinguish where the buyer of a security got his money from.” For this reason (among others), I would not try to prevent speculation. But I would shut down margin accounts (as has been done before). I would see what could be done to discourage borrowing to finance mergers. And I would not encourage a hundred speculative transactions (as the low capital gains tax does) in the bumbling hope of stimulating one new productive investment.

As to the fact that the rest of my article on deficits was one sided, I admit the soft impeachment. If you have a reasoned conviction, I’d think it irresponsible to pretend to what is called a “balanced view.”

Originally published March 8, 1982

MY HEAD is spinning-which is not surprising, for I have been reading a circular argument. If you read much economics, you encounter a good many circular arguments. This one is a dandy.

I refer you to the “Annual Report of the Council of Economic Advisers.” It is said to be a document of 357 pages, but all I know of it is what was printed in the New York Times, which is enough. In the section headlined “Why Deficits Matter” we find the following:

“Financing a budget deficit may draw on private saving and foreign capital inflows that otherwise would be available to the private sector …. Weak and marginal borrowers may be ‘rationed’ out of the market by higher interest rates unless saving flows are adequate…. During a recession-as now exists-the borrowing requirements of business and consumers tend to be relatively small. At such a time a given deficit can be financed with less pressure on interest rates than during a period of growth…. Much of the Administration’s tax program is designed to increase the private saving of the nation. As a consequence, both public and private borrowing will be accommodated more easily.”

What (if anything) is being said here? Restating the argument, it goes like this: First, the Administration’s tax cuts are a net addition to an already existing deficit. Second, government borrowing will have to go up to cover the raised deficit. Third, there will be no trouble with the increased borrowing, provided the recession continues (or deepens)-and the people who receive the tax cuts lend the money back to the government.

In short, at the end of the circular maneuver-assuming it works as it is intended to-the recession will be just what it was, and sizable transfer payments will have been made to people judged not to need them. In fact, they have been chosen to get the money precisely because they don’t need it. Also (incidentally) the deficit will be increased, and interest at 14 per cent or so will have to be paid on that. It adds up to real money, and it’s crazy, no matter how you look at it.

Let’s imagine (as I’ve remarked before, economists have to have good imaginations) that we had a Republican administration that knew something about finance. It would occur to such an imaginary administration that it would be simpler to keep the tax money it has, instead of returning part of it to rich people in the hope that they will lend it back to the government. Not only simpler but, of course, cheaper. Not only cheaper but, of course, less disruptive of the economy. Not only less disruptive of the economy but, of course, more equitable.

I don’t know what I’d do if I were a supply-side economist (my imagination isn’t lively enough for that). The supply-sider’s game plan is to put money into the hands of producers, who will invest it in new plant, which will eventually improve our productivity and make possible a higher standard of living for us all. He’d have to be blind not to see that, in general, producers are richer than other people. Thus to get money to them, he cuts taxes for the rich rather than for the poor or even for the middle class. He’s playing for the trickle down. Fair enough.

He recognizes that when taxes are cut faster than expenditures, the Federal deficit (not to mention the state and local deficits) rises. The Laffer Curve doesn’t say there won’t be an initial deficit rise; it merely promises, as President Hoover did, that prosperity is around the corner. So Jack Kemp isn’t worried about the deficit; he’s going for the long ball.

Nevertheless, the deficits have to be monetized or funded. Monetizing the debt means just printing money to pay the bills, and supply-siders are afraid to do that. The deficits therefore have to be funded. That is, bonds have to be issued to cover them. But one doesn’t simply issue bonds, one sells them. To.whom? Why, naturally, to the rich. No one else has the money to buy them. Unfortunately, the money the rich use to buy the bonds is the money they were supposed to invest on the supply side.

Try as he will, the supply-sider can’t get money into the hands of producers. This is not because of the conspicuous consumption of the rich or the notorious perversity of Wall Street. Even when everyone is doing his best to cooperate, the scheme can’t work. The supply-sider’s tax cuts go to the rich, all right; but the recipients have to lend the money right back to the government to cover the deficits. No more money becomes available for productive investment than there was before the game started.

Actually, even less is available, because the pressure of the deficits pushes up interest rates. This doesn’t have to happen, yet it will happen as long as the Federal Reserve Board clings to its monetarist doctrine of restricting the money supply (if it could only figure out what money is). You may be sure that the Fed will depress both the supply side and the demand side if it can. The resulting high interest rates will increase the cost of government borrowing and add to the deficits in what is now a pretty tight upward spiral. But that’s not the end.

High interest rates inhibit investment. Businesses that used to borrow money to expand in the good old-fashioned capitalist way can’t afford to pay 15-20 per cent for their money and have to cut back in order to survive.

Hence the supply-side tax cuts, with the best will in the world, will reduce the amount of money available for investment. You will note that I say” available,” because I don’t for a minute believe much of that tax windfall would go into productive investment even if it could. Almost all of it is earmarked for speculation. No goods will be produced as a result of it, nor any services rendered. But the rich will be richer.

TO SHOW what I mean about speculation, let me call your attention to some figures the Times printed a couple of weeks ago about Merrill Lynch, Treasury Secretary Regan‘s old firm and, breeding apart, the very model of a modern “investment” house. It turns out that by far the biggest part of Merrill Lynch’s income comes from interest its clients pay on margin accounts. Margin accounts are nothing if they are not speculations, and interest on them is 45.4 per cent of Merrill Lynch’s income. Next we have commissions, which amount to 22.8 per cent of their income, and the transactions the commissions were earned on were also speculations, buying and selling securities, without a penny of all those billions going into new productive enterprise.

Then comes “investment banking,” 8.6 per cent of income. That sounds more like it. Well, it sounds more like it until you hear what the small print says. Then you learn that “investment banking” includes “municipal and corporate underwriting and merger and acquisition advice.” Of this, the only part (and we don’t know how large it is) that might concern productive investment is the corporate underwriting, but even that is unlikely, coming in close conjunction, as it does, with “merger and acquisition advice.” Was Merrill Lynch involved in the $3 billion US Steel borrowed to buy Marathon Oil, or the $4 billion DuPont borrowed to buy Conoco? I don’t know, but I do know that transactions like that are speculations, not productive investments. No more oil is refined- no more anything is produced- as a result of them.

Yet this is the sort of thing-and the only sort of thing-that is encouraged by the supply-side tax breaks. Don’t get me wrong. I’m in favor of producers; after all, I’m sort of one myself. The late Professor John William Miller used to say that an entrepreneur is an economic surd: there’s no accounting for him, but you don’t have any economic activity at all unless some willful character says that, come hell or high water, there’s going to be this here-now business. Such types should be encouraged. I’m willing to believe that at least some supply-siders want to encourage them. But I’m here to declare that Reaganomics is going to encourage only those whose principal activity is clipping coupons.

Let me, as the fellow said, make myself perfectly clear. I’m not arguing against a deficit or against tax cuts, or for them. All I’m saying is that unless the government is running a surplus, there is no way for tax cuts to be a direct stimulus to productive investment [editor’s bolding]. Tax cuts can be an indirect stimulus: By giving some people more money to buy things, they can eventuate in producers producing more. But that is the demand side, not the supply side.

To be sure, Reaganomics has its demand side: the military buildup. Because of its specialized nature, this is not the most efficient stimulus the economy could have; it produces comparatively few jobs for a buck. Moreover, it cannot continue to stimulate the economy even as much as it does unless the arms race speeds up. (That may rate as a suitably dismal thought.)

If you really want to stimulate the demand side (which you really ought to want to do), you will give tax breaks to people who will spend their windfalls, not “save” them. In short, you will start cutting taxes at the bottom (Social Security taxes, for example) and work tentatively upward. This is the precise contrary of Reaganomics, but it makes precise sense.

The New Leader

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