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By George P. Brockway, originally published July/August 2000

2000-7-8-a-new-new-theory-titleTWO YEARS AGO, the hope was expressed here that the Federal Reserve Board was on the verge of learning how a modem capitalist economy-call it “the New Economy” if you wish-actually works, or could work (“A Fortunate Experiment,” NL, August 10-24, 1998). But it has become clear that the Reserve was merely adopting another new theory of how a quasi-mercantilist economy functions at least the fifth in Chairman Alan Greenspan‘s incumbency.

The previous new theory of the old economy went like this: Exuberant stock markets are giving rise to a “wealth effect,” whereby wildly successful speculators are using their inflated capital gains as collateral for loans to buy second (or first) homes and automobiles and a variety of other items, some necessary and some simply nice to have. As a result, the economy is in danger of “overheating.”

Now here comes what they call in Silicon Valley the new new thing: The secret cause of our trouble is that our productivity is growing too fast (the year before last it was supposed to be growing too slowly); consequently, the wealth effect is higher than ever. Indeed, it is so great that people’s income from borrowing on their capital gains exceeds their income from working at productive jobs. This situation is said to be unbalanced and unsustainable. We are borrowing on the future,” “living beyond our means,” and violating other 18th century copybook maxims.

Yet that is exactly the virtue of modern capitalism. It is how the company I worked for could expand to give me a better job, how my wife and I could buy a decent home in which to raise our children, how the city could build schools to educate them, and not least, how World War II could be won.

It is also argued that the wealth effect will cause too much money to chase after too few goods, a.k.a. inflation. A moderately rational person might consider encouraging the production of more goods wiser in such circumstances than reducing the amount of available money. The answer to this suggestion is that to produce more goods we would have to hire more people; and since we pride ourselves on having practically full employment (so why not say it’s really full?), we can’t hire more people without starting a wage-price spiral. To be sure, we have some 20 million fellow citizens who are either unemployed, underemployed, uninterested in employment at the going wage, or turned off.

Because of (not in spite of) the Federal Reserve Board’s threat to resume increasing the Federal funds rate, the United States economy is on the launching pad for an interest-price spiral (not a wage-price spiral) that could start spinning tightly upward before the 2000 election and then, before the election of 2004, could collapse in the ninth recession since the end of World War II.

In It Can’t Happen Here Sinclair Lewis’ hero opined that we Americans might one day have fascism but would call it antifascism. True to this heritage, the Federal Reserve Board has adopted an inflationary policy but tells us (and itself) that it is fighting an inflation invisible to ordinary folk like us because it is around the curve.

PERHAPS not altogether coincidentally, the Reserve acted in the same way almost a third of a century ago, in 1969, the last year we had a budget surplus before the current one. It was also the final year of what is now the economy’s second longest expansion. During the following 14 years we had four recessions, the highest unemployment rates since the Great Depression, a series of sensational bankruptcies, and a record breaking 271.4 per cent surge in the Consumer Price Index. The Reserve was serious about inflation the whole time.

Of course, there was a war on in Vietnam then and (as at present) trouble with the Organization of Petroleum Exporting Countries, but raising the interest rate did not stop the war and in truth started the trouble with OPEC. Meanwhile, the costs of living and doing business went higher, and the budget surplus was wiped out.

Money has power-several powers, in fact, as we shall see. The most familiar is its purchasing power. The Federal Reserve Board, in its diurnal struggle with inflation, has long concentrated on restraining money’s buying power. It does this by increasing the interest rate in order to reduce the number of consumers able to buy interest-sensitive commodities (especially cars and houses). This, in turn, reduces the number of workers employed in supplying those commodities, keeping them from buying other commodities they want or need. All of that is supposed to prevent the economy from overheating.

When we return from a shopping (or web-surfing) expedition and say the dollar doesn’t go as far as it used to, we mean its purchasing power is reduced. That is the same as a rise in the general price level, which is the same-as inflation.

THERE ARE two other probable, but presumably unintended, consequences of the Reserve’s actions. The first is a recession. To rephrase “Engine Charlie” Wilson, what is bad for General Motors is bad for the economy. We can’t slow down on the building trades and the automobile industry and their many auxiliaries (steel, lumber, oil, glass, rubber, major appliances, and on and on) without slowing down the whole show. Second, although the Reserve may have only restraint of purchasing power in mind, raising the interest rate simultaneously reduces the borrowing and investing power of money.

A fall in the investing power of money is, of course, the same as a decline in the amount of investing that is done-in other words, stagnation. Assuming that a projected investment is attractive and that the credit of the company wanting to make it is sound, the interest rate determines the limit of investing the company can finance with a given sum.

The range of impacts on investing power is vast, as four historical examples will show. Before the 1951 “Accord” that “freed” the Federal Reserve Board from its World War II commitment to help the Treasury maintain the market prices (and, of course, the interest rates) of government securities (not an unreasonable chore for a central bank in time of war or peace), the prime rate was 1.5 per cent. In December 1980 and January 1981 the prime topped off at 21.5 percent. In June 1999, at the start of the Reserve’s present program, it stood at 7.75 percent. Now it has reached 9.5 per cent (not so long ago, anything over 6 per cent was illegal usury). A corporation that could afford an annual interest expense of $150,000 and borrow at prime, could therefore have borrowed and invested $10 million in the first example, but only $697,674 in the second example, $1,935,484 a year ago, and $1,598,947 today.

Moreover, the effects of a rise (or fall) in the interest rate multiply throughout the economy. When the prime hit 21.5 per cent around Christmastime 1980 and our company’s investment was limited to $697,674, the purchasing power of every dollar of that amount likewise fell 12 per cent. So the firm could actually purchase only $613,953 worth of goods and services for its investment.

The Reserve’s present program (ironically assisted by OPEC) will increase the cost of doing business and will soon prompt or excuse enough price increases to embolden the many inflation hawks on its Board of Governors to push harder for really pre-emptive strikes, whereupon further price increases will begin appearing on the visible part of the curve, and the interest-price spiral will be well launched.

The increasing prices will harden the inflation hawks’ belief that they “must” (as the business press puts it) raise the interest rate to hold prices down. But a capitalist economy is based on borrowing, and the causation runs from the cost of borrowing (the interest rate) to price, rather than the other way[1]. Every firm, before it starts work on a new project, or orders a new production run of an old one, must know its costs to set prices.

The cost of borrowing is established by the Federal Reserve Board when it determines the Federal funds rate. To be sure, that rate is the one banks charge each other for very short-term loans (usually overnight) to allow the borrowing bank to meet an emergency or to take advantage of an exceptional opportunity, but it also sets the floor under the cost of all borrowing.

Today the nation’s business enterprises routinely quote many millions of prices, change some, and establish thousands of new ones. Scores of millions of consumers agree to some of the prices, and sales are made; a few haggle for lower ones, with occasional success. All of these prices are based in part on what the Reserve did at its last meeting. But there is no way on earth that what the Reserve did at its last meeting could have been based on the prices sellers and buyers actually agree to afterward.

This is not a chickenandegg question. Actual prices are based on actual costs, never the other way around. Businesses do not set the floor under interest rates, the Federal Reserve does[2].

In sum, as the Federal Reserve Board continues to raise the interest rate, it will cause stagnation (a decline in investment), stimulate inflation (a rise in the price level), and achieve its perverse intentions (a decrease in demand and an increase in unemployment). It will prick the stock exchanges’ irrational bubbles with consequences that will confirm the wisdom of Marcel Proust, somewhere in whose expansive universe is the observation that our wishes may be fulfilled, on the condition that we not find in them the satisfactions we expected.

IT IS POSSIBLE that the Reserve is already too far in to back out, for to cut rates now would announce to all the Fed watchers that the threat of inflation was past. The bull market would roar ahead, speculators confident that the Reserve would protect them. (Economists call this phenomenon by the odd name of “moral hazard.”)

Yet at the very least stagnation would be avoided if the Reserve did the unimaginable and lowered rates. At the best, new ways might be found to expand the economy and to reverse the fatal trend toward continually widening the chasm between the haves and the have-nots of our society.

Given the Reserve’s blind tradition of “staying the course,” the summer’s growing inflation and stagnation may continue and prove enough to defeat Vice President Gore (as former Reserve Chairman

Paul A. Volcker‘s recession defeated Jimmy Carter 20 years ago). Similarly, 2004’s recession[3] may prove enough to defeat then-President Bush (as Chairman Greenspan’s recession defeated his father eight years ago).

The New Leader

[1] Ed:  my emPHAsis

[2] Ibid

[3] Ed:  Well, it happened in 2007

By George P. Brockway, originally published January 11, 1999

1-11-1999 Interest Rates I have Known titleFRIENDS have been congratulating me on bringing the Federal Reserve Board around to my way of thinking about the interest rate. It is, to be sure, true that over the years I have scolded Chairman Alan Greenspan many more times than once about his interest rate policy, and that I scolded his predecessor, Paul A. Volcker, even more harshly (because his notions were indeed worse). Well, I am still at it: I don’t think the Federal Reserve Board has gone far enough.

Greenspan himself had the Federal Funds rate lower than it is at present from November 1991 through November 1994, and he kept it hovering around 3 per cent from mid-1992 through early 1994. Somehow it seems impossible for most people, especially financial reporters and bankers’ advertising agents, to remember what happened that long ago. Every day we read in the business pages that truck and minivan sales are responding vigorously to the current “low” interest rates, and that the real estate market is strong thanks to “low” mortgage rates. Commercials running on television have been touting mortgages at 6.5 per cent as “the lowest they’ve ever been!”

My own memory goes back somewhat farther. In 1940, like millions of our fellow citizens, my wife and I had an FHA mortgage at 4 per cent. In 1947, we refinanced it with a GI mortgage that started at 4 per cent and ultimately dropped to 3.5 per cent. At that time, anything above 6 per cent was condemned as usury by state law.

In 1947, too, I became a junior officer of a small firm and quickly learned the importance of a low interest rate to any company whose business is at all seasonal (you borrow money in one half of the year and pay it back in the next). The prime rate (what the majority of banks charge their most reliable customers) was then 1.5 per cent (it is now 7.75 per cent).

Two years later the prime was up to 1.75 per cent. I remember especially the concern with which our legal counsel telephoned us a few months later to tell us that he had just seen on the ticker that the prime had jumped to 2 per cent. He strongly recommended that we raise prices and go slow with some of the projects we were working on.

The point I’m trying to make is that, contrary to what you read in the newspapers or hear on the radio or TV, interest rates in this country are high by historical standards. They are higher than they have been in most of the years since the end of World War II, higher than in most of the years since the creation of the Federal Reserve Board in 1913, higher than of the Constitution.

In fact, they are so high that it will take a good long time to get them down to where they ought to be. How long is a good long time? Well, Milton Friedman says his empirical work convinces him that it takes at least two years for monetary policy to have a substantial effect in the world of action. Given the $15 trillion of mortgages, bonds and other long term indebtedness now outstanding, and given the number of leases and other long-term contracts with settled prices, I expect it will take nearer five years, and perhaps 10, to squeeze an appreciable amount of the inflation out of the system.

AS I HAVE SAID many times before, our capitalist system runs on borrowing, and borrowing is paid for by interest. Interest is a direct or indirect cost of every business and every farm in the land. The direct cost is what you pay to whoever lends you money. The indirect cost (technically termed “opportunity cost”) is what you pay yourself for using your own money in your own business, instead of taking the opportunity of lending it to another firm and making an effortless profit from the interest you would receive. Your business has to earn its opportunity cost, or it is not worth doing, except for fun; and it has to earn the direct cost, or it goes bankrupt. I’m all for having fun running a business (or a farm, though that seems more like hard labor to me)-after all, it is how you spend most of your waking hours-but you have to pay for it directly or indirectly or both.

Direct and indirect interest costs are therefore factors in the prices you charge. They are not the only factors, but they are unavoidable factors. You can’t escape them. If the interest rate falls, competition is likely to persuade you to lower your prices. If the interest rate goes up, the prices you charge have to go up too, or your profits go down.

In all this, you are not alone. That’s the way our economy works, and it works better than any other yet invented. But, to paraphrase President Calvin Coolidge, as I like to do, when many people raise prices, inflation results.

Last year, and for at least the past half century, the total indebtedness of the nonfinancial sectors of the economy ran fairly close to double the Gross Domestic Product. On this basis, a shift of one percentage point in the interest rate should cause a shift of almost two percentage points in the price level. Like most economic calculations, this one is far from precise. There are too many gaps and lags and crosscurrents and arguable assumptions and downright errors in the statistics.

We don’t need precision in this case, however. We merely need a direction, because the desired end is an interest rate barely high enough to cover transaction costs (which will, I hasten to say, include loan officers and clearinghouses and deposit insurance and much of the other paraphernalia of modern banking). The record here is so clear that it does not overstate the matter to say that a rise of one percentage point in the interest rate will cause a rise of at least one percentage point in the price level, and that a fall of one percentage point in the interest rate will cause a roughly corresponding fall in the price level. (Constant readers will recognize that the foregoing is a restatement of what appeared in this space 10 years ago as “Brockway’s Law No.2: Raising the interest rate doesn’t cure inflation; it causes it.”)

WELL, as you have no doubt guessed, I am in favor of the Federal Reserve Board continuing the policy of nibbling away at the interest rate started last summer. It might be risky to do this too fast, but it should be done steadily, and there is a recent example that should give the Board confidence. The Reserve brought the Federal Funds rate down from 9.21 per cent in 1989 to 3.02 per cent in 1993. That is a fall of about 67 per cent in four years. Such a fall, starting today, would give us in 2003 a Federal Funds rate of 1.5 per cent-just about what it should be.

Also in the years from 1989 to 1993, the annual change in the Consumer Price Index fell from 4.6 per cent to 2.7 per cent, a fall of about 60 per cent. This may be little more than a coincidence, rather than a consequence of the fall in the Federal Funds rate, but at least it’s a happy one and does not contradict our theory that the interest rate and the inflation rate tend to go up and down together, with the former causing the latter.

There are certainly occasional cases where a short supply, natural or man-devised, of a quasi-essential resource allows the ancient “law” of supply and demand to drive a particular price up, whereupon a one-time shock runs through the economy. In ordinary commerce today, though, price is the independent variable, usually set by the seller, while supply and demand are dependent upon it.

If the foregoing analysis is correct, the role of the Federal Reserve Board should be largely restricted to regulating banking (or some of it), to running a clearinghouse, and to maintaining a truly low and steady pattern of interest rates in order to stabilize the price level. Most of the other great desiderata of a good economy must necessarily be left to Congress and the President, provided they can get their minds off sex.

The New Leader

By George P. Brockway, originally published March 13, 1992

1992-3-9 The Key to Consumption Title

 

 

 

 

 

 

 

 

LAST TIME I reported why our present economic muddle should be called a “contained depression.” The term is the coinage of S Jay Levy and David A. Levy of the Jerome Levy Economics Institute of Bard College. It distinguishes our present situation from the five or six recessions we’ve had since World War I, and also from the Great Depression of the 1930s.

The earliest recessions were temporary gluts of unsold consumer goods-relatively easy to slip into and correspondingly easy to recover from. Hence President Bush‘s long mad posture of “What? Me worry? Hence the frigid, almost insolent objections of Chairman Michael J. Boskin of the Council of Economic Advisers to extensions of jobless benefits. Hence the plaintive repetitions of Chairman Alan Greenspan of the Federal Reserve Board that the present recession will be short and shallow, and that recovery will start about six months from the date on which he happens to be speaking.

As the thing drags on, I’m reminded of the Elaine May- Mike Nichols skit in which a patient complains that she has been sick for a couple of weeks with what was diagnosed as 24-hour flu. “Well,” responds the doctor after carefully thinking the matter through, “this may be something of longer duration.”

Indeed it may. What we are now trapped in is not a consumption goods glut but a capital goods glut. We have too many factories, too many warehouses, too many office buildings, too many shopping malls, too many retail chains, too many too expensive apartments, too many too expensive vacation resorts, and especially too many banks and insurance companies and pension funds with too much of the foregoing as collateral for loans.

This sort of glut is not easily worked off in the modern world. Regardless of what the Cassandras say, we’re marvelously productive. If you want more steel, we certainly can turn it out for you. Or more automobiles, refrigerators, escalators, computers. Or more houses and highways. Or more cough medicines and handkerchiefs. Or more magazines and books. Or, when the President’s four new pair wear out, more sweat socks.

We are not oversupplied with any of these things – well, not with many of them. Our inventories are mean and lean and all that, but there’s no danger of serious shortages of anything for very long. What we are oversupplied with is the capacity to make more of almost anything. We have factories and machinery and office equipment and distribution systems and office managers and workers and know-how aplenty. No problem with any of that, except that we have too much and, like the sorcerer’s apprentice, the manic capacity to make more.

An inventory glut can be handled by shutting down the factories for a few weeks or months. But what can be done with a capital goods glut? There are two principal solutions: (1) We can let the unneeded capacity stand idle until it rusts out, or enough currently used capacity wears out, to bring our capacity to produce down to the level of our capacity to consume. Or (2) We can bring our capacity to consume up to the level of our capacity to produce.

The first solution, in its more benign form, is what Joseph Schumpeter called creative destruction. Schumpeter saw the economy driven by a succession of new industries, whose birth and growth led to the destruction of large existing industries. The most familiar example is the automobile industry, with its subsidiary industries of steel, glass and so on, and its ancillary industries of highway construction, petroleum and parking facilities. The new industry gradually overwhelmed industries built on the power of horses.

That did not happen all at once. As late as the 1920s, many cities still had horse-drawn fire engines whose pumps were powered by dramatic coal-fired steam engines. As late as the outbreak of World War II, the Boston Globe discovered to its surprised delight that it had not gotten around to completely dismantling its capability to deliver newspapers by horse-drawn wagon. A few carriage makers were able to convert to the production of automobile bodies. Many livery stables became garages. But manufacturers of buggy whips provided a metaphor for progress and quietly went out of business.

As Schumpeter pointed out, the new industries were bigger and in most ways better than the ones they destroyed. Or as folk wisdom has it, you can’t make an omelet without cracking eggs. The trouble now is that there’s no great new omelet industry on the horizon. The computer industry, which many expected to save us, is itself stumbling[1].

In fact, our situation is dauntingly similar to that of 1930. The unneeded or unwanted capacity is not limited to a single doomed industry. It is universal. Its destruction – if it occurred-would not be creative. It would be merelv destruction: wasted money, wasted resources, blighted hopes. And perhaps most important of all: wasted time. Once again Bessie in Clifford Odets’ Awake and Sing! would be speaking a bitter truth: “On the calendar it’s a different place, but here without a dollar you don’t look the world in the eye. Talk from now to next year – this is life in America.”

It would take a long time for the bright new assets to rust out or the good old assets to wear out. It would take a long time for banks and insurance companies and pension funds to become solid again. It would not be a pleasant time. For millions of citizens it would be a hopeless time, made more bleak by the deterioration of their surroundings both social and physical.

It took World War II, with its enormous stimulation of governmental and then personal demand, to pull us out of the Great Depression. The New Deal had moved painfully slowly, hamstrung by a coalition of Northern Republicans and Southern Democrats, and hampered by its own emotional commitment to classical economics. (A “responsible” effort to reduce the minuscule deficit in 1937 caused an instant recession.) Yet the New Deal was open, eager, hopeful, vigorous, experimental, caring. New Dealers didn’t have to make speeches about how they cared; they showed it. In their place we have Boskin, Brady and Darman and their trickle-down schemes.

So much for the first solution to our troubles. It is no solution at all.

The second solution (bringing our capacity to consume up to the level of our capacity to produce) would seem, on its face, to be easy as pie. Consuming is what we’re supposed to do best. Shopping malls are where we shine. But all the wise men kept telling us not to consume-until Bush bought those socks. Unfortunately, now that they are telling us consuming has become patriotic, we either haven’t any spare money or are afraid we soon won’t have any spare money.

The problem is, the wrong people have what spending money there is. Worse than that, practically nobody in public life says it is the wrong people who have money to spend – except Senator Tom Harkin, and look what happened to him in the Democratic Presidential primaries.

Somehow it has become conventional to believe that the distribution of wealth or income is not the issue. Or that redistribution is not practicable. Or that it wouldn’t make any difference, anyhow.

LET ME INTERPOSE a little story. The other evening I was a dinner guest at the home of some liberal friends. There were eight of us around the table, and none of us was afraid of what the President calls “the ‘L’ word.” We are liberals, possibly even knee-jerk liberals, and proud of it. After all, some injustices are so flagrant, and some events so sudden, that decent people must respond to them semi-automatically. A liberal response is surely more honorable than a reactionary withdrawal.

Anyway, there we were, and we got talking about the very subject of this article. You will not be surprised to learn that I argued in favor of restoring steep progressivity to the income tax. And I was not surprised to be told that Robin Hood was a seductive medieval myth, that taking from the rich and giving to the poor would simply make everyone poor because the rich are so few and the poor are so many, and that soaking the rich would not much improve revenues because tax avoidance would then increase.

We have all heard that line of talk before, very likely first meeting up with it at our father’s knee, if not at our mother’s. The line may actually have been true back then (though I doubt it), but it’s certainly not true today. The average of all family incomes in the United States is somewhere between $70,000 and $80,000.  It’s difficult to be more precise, because it’s hard to agree on exactly what a family is. In any case, it’s obvious that the Robin Hood myth is not impossible today.

I don’t suppose that anyone advocates perfect equality. (Even Engels called equality “a one-sided French idea which was justified as a stage of development in its own time and place but which now should be overcome.”) Nevertheless, it is important to understand that the present distribution of income is not an aspect of the universe that we, like Margaret Fuller, had better accept. It is not the unalterable consequence of some mathematical or psychological or perhaps theological law.

A second point must be made: Any attempt to change the distribution of income will certainly give some people, including those whom Shaw’s Mr. Doolittle called the undeserving poor, some money for nothing. I’ll let you compile your own list of why something for nothing is bad-psychologically, socially, ethically-and I’ll even grant the validity of most of your reasons. But then I’ll ask you to compile a list of the Astors and Morgans and Fords and so on who got something for nothing. A wit on the New York Times a couple of years ago noted that most of the richest people in America got their money the good old fashioned way-they inherited it. Something for nothing is, Nelson Rockefeller might have said, in the mainstream of Republican thinking.

Once we have mastered the message of the two preceding paragraphs, we have earned the right to consider ways of building demand worthy of our productive capacity. We all know the most obvious ways: First, massive public works, massive support for education, comprehensive national health care insurance.

Second, an almost vertically progressive inheritance tax, a steeply progressive income tax, probably a negative income tax at the bottom, and possibly an income limitation tax at the top.

We don’t have to do it all at once. But unless we get started soon, it will be a long time before happy days are here again.

 The New Leader

[1] Ed:  OK, so even this author gets it wrong from time to time….

By George P. Brockway, originally published January 13, 1992

1992-1-13 Mister Bush Meet Mister Hoover Title

 

 

 

 

 

 

 

 

 

 

Mister Herbert Hoover
Says that now’s the time to buy;
So let’s have another cup o’ coffee
And let’s have another piece o’pie

.

THE ABOVE text for today’s lesson was composed (words and music) by that universal philosopher of the American way of life, Irving Berlin. The song was the high point (or perhaps more accurately, the sardonic point) of Face the Music, a Broadway hit of 1932- just 15 presidential terms ago.

It all came back to me as I gazed in wonder at the TV coverage of President Bush‘s Thanksgiving demonstration of the propensity to consume, during which he showed how to buy four pair of sweat socks for $8.00.  I suppose the President’s handlers meant the sweat socks worn by some working stiffs inside metal-toed boots and by all preppies while jogging or playing racquet ball-to remind us that the President is a regular guy as well as a consumer doing his part to get the economy going again. But it reminded those who didn’t laugh at the spectacle that Mr. George Bush’s economic policies have a lot in common with Mr. Herbert Hoovers. That is to say, he has practically no policies at all.

Not only are President Hoover’s and President Bush’s policies similar, but so are their depressions (and ours). For what we are now mired in is something quite different from the half dozen or so recessions we have gone through since World War II.

Economists persist in calling our present experience a recession, and they are puzzled by its failure to perform like the others. Even the fact that business is bad puzzles them, because the “indicators” they take seriously have not been ominous. Their biggest worry has been that inventories might get out of hand. “The current downturn is expected to be short and shallow,” wrote the Council of Economic Advisers a year ago.

“Most firms have kept inventories low relative to sales, reducing the need for a sharp cut in production to work off excess inventories. Such inventory corrections accounted for much of the decline in output in earlier postwar recessions.”

The smallest mom-and-pop novelty store today boasts a computer at the cash register that scans bar codes, not simply to generate sales slips but also to indicate when and how much to reorder. At the other end of the spectrum, most manufacturers have long since learned how to order “just in time. Inventories have been lean and clean for several years now; yet the downturn came, and it refuses to go away.

S. Jay Levy and David A. Levy, respectively chairman and vice chairman of the Jerome Levy Economics Institute of Bard College, have a simple yet comprehensive explanation: This downturn is not a recession at all, it is a depression.  To be sure, it is a new sort of depression. They call it a “contained depression. Because Mr. Bush’s depression is “contained,” it is not likely to be so deep as Mr. Hoover’s, but it may well last as long, or even longer.

To the Levy’s, a depression is not, as it is in ordinary speech, merely a very severe recession. They agree with the majority of other economists that a recession is essentially an inventory glut, which comes about in a quasi-natural fashion in the modern economy. In the ancient and medieval worlds, most nonagricultural goods were made to order. If you wanted a pair of boots, you didn’t go to a store

And buy them off a shelf, the way Oliver North picked up revolutions. You went to a cordwainer, who would run up a pair to fit your last. In such a system there might be a glut of agricultural produce (though there seldom was), but manufactured goods were never oversupplied.

In addition, of course, few economies of scale were available; production was slow, expensive and weak. In the modern world, where most production is for sale, not for use, economies of scale are everywhere, and output is exponentially increased, as Adam Smith showed with the manufacture of pins.

But time is necessarily introduced between the start of production of goods for sale and the purchase and use of those goods by the eventual consumer. In that time, many things can go wrong (and some can go surprisingly well), because the future is unknowable.

Among the things that can go wrong is an inventory glut. This starts slowly, as optimistic producers expand output to take advantage of economies of scale. Stepped-up orders gradually push manufacturers to capacity, heighten competition for time on the machines, and result in ever larger orders (see “What Happened to Jimmy Carter,” NL, November 27, 1989, for the way  this “defensive buying” works). The increases in plant utilization naturally require increases in employment. Newly employed workers have new money to spend and encourage greater production.

At this point, manufacturers are likely to seize the opportunity to raise prices, thus depressing demand. Banks will see inflation and raise the interest rate, thus intensifying the inflation, further depressing demand, and perhaps throwing he cycle into reverse. Even without inflation an inventory glut will develop, for our irrational income distribution and usurious interest rates guarantee that workers cannot earn enough to buy what they produce.

Manufacturers participate in the buildup in self-defense as well as in search of profit. Those that don’t participate find themselves squeezed out by their more aggressive competitors. In any case, the buildup is necessarily blind and eventually overleaps itself, whereupon it recedes by stumbling down the up staircase.

According to the Levy’s, a depression, like a recession, is cyclical, and proceeds in a similar manner. It is a capital goods glut, however, rather than an inventory glut. Since capital goods typically are expensive and take a long time to produce, more money is tied up in them, and the tie up lasts longer. The Levy’s argue that what we have now is a depression. Factories, warehouses, office buildings, stores, motels, apartment buildings – all are overbuilt. The banks and insurance companies and pension funds that financed the construction are in trouble – unless they have already failed.

NOW, FASHIONABLE commentators say our problem is that we no longer compete successfully in the world market, partly because our interest rates are too high (they still are), and partly because, all of a sudden, our educational system has fallen apart. Michael Boskin, chairman of the President’s Council of Economic Advisers, testified the other day that we spend more on elementary and secondary education than any other industrialized country, except maybe Switzerland, and that our kids still perform toward the bottom. That sounds enough like the state of our medical services to be true; but if true, it is clear that we will not be able to correct the situation in the present century. In the unlikely case that Mr. Bush’s scheme of making schools compete for students were to be immediately successful, it would take 12 years for the full effects to be realized and then there would still be the problem of the colleges and graduate schools.

1992-1-13 Mister Bush Meet Mister Hoover Herbert Hoover

I’m not opposed to doing something about education (though I am opposed to Mr. Bush’s scheme), but it won’t make us internationally competitive overnight. As I have said before (“The Productivity Scam,” NL, May 28, 1984), I don’t take seriously the underlying notion of productivity. More to the point, the United States of America is not the only nation that is smothered in overcapacity. Every industrialized and partially industrialized country in the world is, too. Plants everywhere are standing idle because plants everywhere are capable of choking us to death with steel, automobiles, TVs, cameras, toaster ovens, and sweat socks. Indeed, they are already choking us with them.

This worldwide overcapacity means that there is no quick solution to our depression. Nevertheless, our depression will, as the Levy’s put it, be contained. In the United States, banks fail and will fail, but there will be no runs on them, as there were in the Great Depression, because the Federal Deposit Insurance Corporation exists. Businesses as remarkable as Pan Am will fail, but there will be no panic selling of assets, because big government will, budget agreement or no, prevent a free fall.

In Mr. Hoover’s day, the government accounted for less than 3 per cent of GNP; in Mr. Bush’s, it accounts for almost 25 per cent. Mr. Bush thinks his 25 per cent too much (as Mr. Hoover thought his 3 per cent), but it is our true safety net. With that high percentage of GNP assured, plus its multiplier effect on the rest of the economy, we will not drop to the lowest depths.

On the other hand, we may be truly depressed for years or decades to come. The glut of capital goods that caused the Great Depression was not absorbed until World War II. There is no reason to expect our present glut to be more tractable. The American oversupply is probably greater now than it was then, and the worldwide oversupply is certainly greater.

Yet I detect a glimmer of hope. Today the richest 1percent of American families have as much income as the poorest 40 per cent. That’s outrageous. But in 1929, on the eve of the Great Depression, the richest 0.1 per cent had as much as the bottom 41 percent. We are, in a manner of speaking, 10 times better off now. The way to put the oversupply of capital goods to use is to draw the bottom two-fifths of us into full participation in the economy. That will not be easy, especially since we have, for the past 15 years, been going hell-bent in the opposite direction. The tentative appeals to “fairness” that the Congressional Democrats made in the budget debate are only a faint promise of a beginning, as are some proposals now coming before the Joint Committee on Taxation. Yet all are opposed by Mr. Bush and his men.

In another column I’ll try to suggest some specific things to do about our predicament. In the meantime, be sure you have plenty of sweat socks.

 The New Leader

By George P. Brockway, originally published February 11, 1991

1991-2-11 Don't Bet On The Banks Title

I CAN’T THINK of a single good reason why the rest of the financial sector, led by the commercial banks, should not eventually follow the S&Ls to the woodshed. In a few cases the usual arguments about “the others” being more experienced or diversified may carry some weight, but in general their problems and those of the S&Ls have similar causes and will have similar consequences.

There is more than a trace of poetic justice here; the commercial banks lobbied hard for the deregulation that did in the S&Ls, and the same deregulation has returned to plague its champion.

Only 11 years ago, the states had usury laws that set the maximum interest rates for different loans. There were, of course, exceptions of various degrees of complexity, but the important point is that there were limits to what could be charged. The Federal Reserve Board set limits in the other direction, the most discussed being Regulation Q. To give the S&L’s a chance to survive, and to offset their being restricted essentially to home financing, Regulation Q allowed them to pay savings accounts a fraction of a point more than the commercial banks.

That system was a casualty of the Federal Reserve Board’s sensational and long-running battle with inflation (see “Who Killed the Savings and Loans?” NL, September 3, 1990). It took almost 30 years for the system to start to break down, and the collapse is not yet complete.

The reason for the long Untergang is the inherent stickiness of finance. In any 12months the nonfinancial sectors (public and private) make new borrowings equal to less than one-twelfth of their total indebtedness. The other eleven-twelfths includes 30-year mortgages still paying 4 per cent interest, 20-year Treasuries paying 15.75 per cent, credit card freaks paying 19.9 per cent, and all sorts of things in between.

With this big backlog (currently about $8.3 trillion), even very large shifts in the interest rate on new loans have only a lethargic effect on the nation’s overall interest rate. The overall rate was 9.55 per cent in 1979-when former Reserve Chairman Paul A. Volcker took well publicized command of the inflation battle-and reached 10.61 per cent a year later. As a result of Volcker’s policies, however, the average prime rate on new loans jumped from 12.67 per cent in 1979 to 15.27 per cent in 1980 and topped out at 21.5 per cent that December and the following January. Since what is comparatively slow going up is also comparatively slow coming down, the average interest rate is higher today than it was in 1980, although the prime is less than half its 1980 peak.

The stickiness of finance enabled the S&Ls and the commercial banks to withstand the surge of interest rates as long as they did. It is probable that the bankers (of all kinds) do not yet know what hit them; certainly the Federal Reserve Board (called the nation’s central bank by its present chairman, Alan Greenspan) does not know. So I’ll give them a hint. If they pay high interest to attract funds, they must charge high interest to cover their costs. And if businesses must pay high interest, they must charge high prices for their goods. At this point, the bubble gets very thin. Consumers do not have money to pay high prices, particularly if many have lost their jobs.

You can charge whatever amuses you for a book or a loaf of bread or a new broom to sweep things clean. Only the book or bread or broom business will be affected. But when you charge too much for the use of money (and it is the Federal Reserve Board that ultimately sets the rate), all businesses, all banks and insurance companies and “institutions,” and all men, women and children are affected.

The S&Ls were driven to the wall first, but the death march of the commercial banks is gathering momentum. Both S&Ls and commercial banks cheered when the state usury laws were suspended, and rushed to expand their real estate business. They are now suffering from a surfeit of residential condos, motor inns, office buildings, and shopping malls. The commercial banks greedily participated in the Great Recycling of OPEC’S profits and as a result will have to face up to their losses in the Third World. Many S&Ls and commercial banks have stuck themselves with junk bonds. How many will survive the recession?

Well, the Bush Administration proposes to help them by getting rid of two of the few remaining New Deal banking reforms. The most important of these keeps commercial banking separate from investment banking, insurance and especially ordinary business. The other restriction keeps commercial banks from branching out beyond a state’s borders.

In the cheery days of President Ronald Reagan, these regulations were anathema simply because they were regulations, and because, as some sports-minded journalist noticed, not one American bank ranked among the top 10 in the world. Even more shameful, most of the giant banks were Japanese. Once again it seemed that they knew something we didn’t know.

In the drearier economic days of President George Bush, less is said about the Japanese banks, for they have fallen on harder times. The index of leading stocks on the Japanese exchange fell 38.7 per cent in 1990, and the Japanese banks (this is one of the secrets of their size) have long positions in those stocks. They have long positions, too, in a rapidly falling real estate market, which they can speculate in (unlike American banks) as well as lend money on.

A few years ago, proposals to permit interstate Banking and to allow banks to own brokerage houses and insurance companies (and vice versa) would have caused a considerable hullabaloo. The large banks were in favor of changing everything; they wanted to get on that top 10 board with the Japanese. Likewise the big stock brokerage houses and insurance companies and all-in-one companies such as Sears, Roebuck. Smaller operators (except those who wanted to sell out for capital gains) preferred the existing conditions-although some would not have objected to dabbling in additional financial services, provided that other financial servers couldn’t dabble back.

Today, the Bush banking moves are not stirring much controversy. A professor of finance suggested recently in the New York Times that this is because they don’t go far enough, that there is nothing to shout about. But commercial banks are in trouble, and since the trouble is no longer confined to Texas and Oklahoma, there is little reason to expect greener pastures in other states. Nor is the solution to be found in putting them together with the problem plagued brokerage houses, insurance companies, pension funds, investment banks-and Sears, Roebuck. A couple of dozen such financial smorgasbords would likely result in a couple of dozen concentrated headaches, if not hemorrhages.

To be sure, the Administration promises to supervise the banks closely to prevent their making more bad loans. Does that mean they are not supervised closely now? Yes, it does. You see, supervision costs money, and you’ve heard about the deficit. Increased costs will have to be matched by increased taxes-in this case, Federal insurance fees. Higher insurance fees will mean lower interest on deposits, and that means money-market funds and Treasury bills will attract cash away from the banks. To keep their deposits, banks will have to pay higher interest, and to do that they’ll have to make more loans at high rates. Sound borrowers won’t pay high rates; so the banks will have to hunt for riskier deals (see “Big Is Ugly,” NL, September3, 1984). And that’s what got them where they are.

In short, interest rates aren’t innocent.  If you refuse to control them, you destabilize the financial sector-and the whole economy. If you manipulate them in a fallacious attempt to contain inflation, you bring on recession (See “Bankers Have the Classic COLA,” NL, January 9, 1989). And that’s what the Federal Reserve has done.

A GOOD DEAL of the trouble lies in the fact that few bankers understand how the capitalist system differs from the mercantilist system. In Legal Foundations of Capitalism (one of the neglected great books),

John R. Commons explains the shift from property as use-value to property as exchange value. This did not start in the United States until the first Minnesota Rate Case a century ago, and most bankers are still out of date. They remain mainly interested in fixed assets that can be attached, not in going concerns that generate cash flow and profits. Hence their fatal fascination with real estate and the idiotic recycling that transformed OPEC profits into loans that are in effect gifts of American money to rulers of Third World nations.

Willard Butcher, when he was chairman of Chase Manhattan, once delivered himself of a perfect example of bankerly thinking: “Is Mexico worth $85 billion?” he asked rhetorically. “Of course it is. It has oil, gold, silver, copper. … “All these assets are physical. You can touch them, and you can attach them. But they aren’t worth much if they can’t be sold at a profitable price, and when usurious interest rates are charged profitable prices are impossible.

On an arguably more modest level, I came up against this sort of thinking at another bank while I was in the publishing business. The bank examined our balance sheet and advised us that our inventory was too low. Did we have an unusually large number of titles out of stock? I asked. No, on that point our record was exceptionally good. Did we allow titles to go out of print too quickly? No, rather the contrary. Were we slow to fill orders? No, again. Our record here was the best the bank knew of. Did our practice of printing in relatively small quantities (this was before the Japanese made “just in time” inventory control famous) result in significantly higher unit costs? No, yet again.

You’d have to say that we were managing our inventory as well as anyone in publishing. Nevertheless, the bank insisted it was too low. The unspoken (or unrecognized) reason was that our low inventory meant we did not have much for the bank to attach if we got in trouble. It never crossed the bank’s mind that too much money tied up in inventory might get us in trouble, and that if we couldn’t sell the inventory profitably, the bank certainly would be unable to do so.

Commercial bankers aren’t the only people still living in a precapitalist world. Our financial system as a whole (S&Ls, banks, insurance companies, pension funds, “institutions” and supervisors) continues to be essentially mercantilist. Its ideal profit, like Bush’s, is a capital gain. In this understanding it is joined by mainstream economics, which analyzes business as a disconnected series of market-clearing ventures, not as a going concern. Until these two powerful sectors of our society are brought into the modern world, stagnation, punctuated by bankruptcies, is likely to be our lot.

 The New Leader

By George P. Brockway, originally published January 14, 1991

1991-1-14 Our Austerity Recession Title

FINANCIAL EXPERTS are saying that the present recession was caused by consumers failing to consume. The supply side supplied, but the demand side didn’t demand. I’ll go along with that; but I’m dismayed that the supply-siders seem to have learned nothing from the experience.

1991-1-14 Our Austerity Recession Phil Gramm

I have just finished a decennial purging of what I whimsically refer to as my files; they were crowding me off my desk, much as the Federal deficit is said to crowd entrepreneurs out of the credit market. As the clippings and offprints fluttered into my wastebasket, I was struck by the volume and vehemence of those complaining that we Americans consumed too much or didn’t save enough (take your pick).

For 20 or 30 years now, all the respectable bankers (once upon a time every banker was respectable), all the respectable journalists, all the respectable economists have been moaning about how we Americans have been on a consumption binge. (If you want the facts of the matter, ask the Economic Policy Institute, 1730 Rhode Island Avenue, NW, Washington, DC 20036, for a detailed refutation by Robert A. Blecker.)  Ronald Reagan’s Right-wing revolution was supposed to exalt the supply side over the demand side. There were tax cuts for the rich and tax increases for the poor, because the poor would only waste their money by buying things they needed or maybe wanted, while the rich would invest theirs in Wall Street and make capital gains. Austere elements of the far Left joined in the chorus (of course, for ostensibly different reasons). Consumerism got a bad press wherever you turned. Sometimes it seemed that Ralph Nader was more subversive than the Chamber of Commerce believed him to be.

Among the worthies represented in the clippings I threw out were at least four Nobel laureates, one former chairman of the Federal Reserve Board, three former chairmen of the Council of Economic Advisers, six former Secretaries of the Treasury, one former Secretary of Commerce (who seems to have started a new anti-consumption committee every other week), a past chairman of the Committee for Economic  Development, nine officers or staffers of the Brookings Institution, almost everyone who has ever set foot inside the American Enterprise Institute, innumerable other professors and journalists and TV pundits, not to mention Presidents and Senators and Representatives and unsuccessful candidates for those offices. The idea has had its spokesmen in the International Monetary Fund and the World Bank (where it is known as austerity), as well as in Britain, France, Italy, Germany, Norway, Japan, and Kenya. It has not suffered from lack of publicity.

The present failure of consumers to consume is just what these doctors ordered. Some of the doctors-those who still believe in the efficacy of purging and bloodletting – are no doubt pleased with the resulting recession. A few are puzzled and silent. But most are as noisy as ever.

Many of the respectable economists, I shudder to say, were bashing consumption in the name of Keynes. They seem not to have noticed that he concluded Chapter 6 of The General Theory with these words: “the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

Classical economists had long held that consumption was a drag on investment. Back in 1803, Jean-Baptiste Say wrote in words that could be applauded today by Newt Gingrich, “It is the aim of good government to stimulate production, of bad government to encourage consumption.” The reasoning was simple. What is spent on consumption can’t be invested in production. Obviously. Keynes also agreed with the proposition-with one proviso: There has to be full employment. Not 4, 5 or 6 per cent unemployed, but really, truly, full employment. In that case, and in that case only, with the economy running flat out, nothing more can be produced; so whatever labor goes for one thing can’t at the same time go for something else. But with millions of men and women unemployed, it is always possible to increase production by giving them jobs.

What I don’t understand is how the notion that consumption is bad got started. If consumption is bad, then production must be, too. I’m used to writing jeremiads that nobody takes seriously (someday they’ll be sorry), but why should tens or hundreds of thousands of people be expected to band together to make automobiles if nobody is supposed to buy and drive them?

The consumption thing (to use a Presidential locution) is another of those fallacies of composition economists keep perpetrating. An individual who saves his money (even hiding it under the hearth) is more likely to die rich than someone who flings roses riotously with the throng. But if everyone in the land sits home, wasting not and wanting not, the economy runs down, and no one has anything to consume, or to save, either.

The consumption thing is vastly more threatening because the government is doing its best to participate. Look at what Gramm-Rudman-Hollings has done to us. As a result of the budget deal of a couple of months ago, the Federal government is committed to spending 30 or 40 billion dollars less next year than it had planned (conservatively) to spend, and the cuts will be greater in succeeding years. A considerable part of the “savings” will be at the expense of the states and municipalities, all of which are already short of funds because of the recession, and all of which are traumatized by childish and self-defeating taxpayers’ strikes. In order to balance their budgets, the states will have to cut down on their services – and that is simply another way of saying they will have to fire people. School class sizes will rise, and bridges will fall.

Taken as a whole, the government part of the consumption thing means that, one way or another, at least a million people will lose their jobs. Some of the affected will no doubt be those dreadful goldbricking bureaucrats we keep hearing about, but most will be employees of private business – a.k.a. free enterprise – for the government is the private economy’s greatest single market for goods and services. The billions of dollars the private economy will lose because of Gramm-Rudman-Hollings will make the recession both deeper and harder to climb out of.

FACED WITH this dismal prospect, a rational Congress would repeal Gramm-Rudman-Hollings, a rational President would sign the repealer, and together they would embark on a massive public works program. Everyone knows there is plenty to be done and plenty of people to do it. But everyone knows nothing of the sort will happen because of the deficit.

1991-1-14 Our Austerity Recession Warren RudmanSuppose our reaction to Pearl Harbor had been similar. In 1941 the Federal government was running a deficit equal to 4.3 percent of GNP. It jumped to 14.4 per cent in 1942 and to 31.1 per cent in 1943. Thereafter it fell, but remained above 7. 5 percent as late as 1946, and averaged 18 per cent over the six war-time years.

In contrast, consider the current deficit and its steadily rising estimates. Last February the Economic Report of the President presented figures predicting a deficit of 1.1 per cent of GNP, while according to the latest estimate of the Congressional Budget Office, the deficit will be at least 5.4 per cent of GNP.

Had we taken deficits in this range as cause for inaction in 1941, we would have run up the white flag no later than December 11, when Germany declared war on us. And we would have  spent the succeeding 39 years studying Japanese and German industrial management from the ground up.

It is no answer to say that there was a war on. Indeed there was, and we came out of it with total Federal indebtedness equal to 127.3 per cent of GNP – more than double today’s comparable figure. Yet when the War was over we set about rehabilitating Europe and ultimately did so with the Marshall Plan, at a cost to us, in 1990 dollars, in excess of $250 billion (see “Don’t Cash Your Peace Dividend,” NL, March 19, 1990).

Did we ruin ourselves by this profligacy? Hardly. It was not until 1975 – almost 30 years later – that the unemployment rate became as high as it is today. Aside from the flash inflation caused by precipitate lifting of price controls (over Harry Truman’s veto), it was not until 1974 that the Consumer Price Index rose at its present rate. Furthermore, after-tax profits as a percentage of GNP were higher than today’s in every postwar year except three Nixon-Ford years (1974, 1975and 1976) before Jimmy Carter appointed Paul A. Volcker chairman of the Federal Reserve Board in 1979.

Since then our mirror has cracked from side to side, and the curse of inaction has come upon us. That is what the record of unemployment, of inflation and of after-tax profits shows. It won’t do to point a finger at OPEC (see What Happened to Jimmy Carter,” NL, November 27, 1989). Some blame falls upon us for what we did because of OPEC that is, nothing much (and as I write we threaten to go to war in its defense). But the major blame falls upon us for casually and stupidly embracing the fallacy that a nation can save itself into a healthful economy.

If we could disabuse ourselves of this fallacy, the current recession would not last long, and the subsequent prosperity would show up the alleged prosperity of the past decade for the pallid fraud that it was. Unfortunately, those who urged the fallacy upon us continue to push it; we continue to follow them; and as a result the recession will be deeper and longer than necessary.

 The New Leader

By George P. Brockway, originally published October 1, 1990

1990-10-1 What Color is Your Recession Title

EVERYBODY SEEMS to have a theory about the when or what or how of a recession. The official or customary theory (I’m not sure what office decrees the custom) is that you have a recession if you have two back-to-back quarters of falling real GNP. Some journalists, apparently trying to avoid monotony, say you need to have six months of falling real GNP-which is a little bit harder to do. Federal Reserve Board Chairman Alan Greenspan has a different approach. A business downturn has to feed on itself for him to call it a recession.

1990-10-1 What Color is Your Recession Greenspan

Before Greenspan will sit up and pay attention, inventories have to rise, causing orders for more goods to fall, causing workers who might make more goods to be fired, causing stores that might have sold goods to those ex-workers to lose business, causing them to cancel orders from their suppliers, causing more factory closings, and so on and on and on. The trouble with this is that if such a self-cannibalistic process should get started, Greenspan is not likely to be able to do much about it. The Federal Reserve Board was not conspicuously effective when it realized (some months after the event) that the Great Depression was upon us. Anyway, Milton Friedman, the monetary guru, says it takes two years for monetary policies to take effect.

In short, most economists feel they have done their job if they just say No to recession. But whether what we are now going through is a recession or not, it seems like one to honest proprietors of S&Ls (there used to be many), to automobile dealers, to building contractors, to all the earnest Willy Lomans desperately trying to meet their Christmas-line quotas, and to all their regular customers trying desperately to emulate the Japanese and place their orders “just in time.”

My poet friend has what she calls the Taxicab Theory. As late as the middle of August, she says, you could not get a cab in New York even if there wasn’t a cloud in the sky. It took a half hour or more to sweat out the line at the Vanderbilt Avenue side of Grand Central. Now, she points out, you can get a cab anywhere, rain or shine, night or day. She concludes that if people don’t have money for taxis, we are in a recession. “If you don’t believe me,” she says, “you can ask the cabbies. They’ll tell you.”

No doubt there are other recession theories. What difference do the different theories make?  Suppose all those who are saying we’re in a recession, whatever their degree of technical sophistication, are right. So what? To be able to refer to “The Recession of1990-91” will no doubt be convenient for future historians, but how does it butter our parsnips today?

The answer, of course, is that if somehow someone could convince the Federal Reserve Board that we are in a recession, they might bring themselves to do something about it. And (this is what Samuel Johnson would call the triumph of hope over experience) they might even do the right thing. That’s why Chairman

Greenspan’s definition of a recession is so ominous. If, as he says, a recession is a disaster feeding on itself, there is not much that the monetary authorities can do; and if we are not in a recession, there is no need to do anything. His formulation is an ideal excuse for inaction.

Rather, it is an excuse for no change of action, for what former Chairman Paul A. Volcker liked to call “staying the course.” He was probably brought up (like me) on Iron Men and Wooden Ships and Howard Pyle’s Book of the American Spirit; so he couldn’t help it if others of our generation had visions of him as David Farragut standing in the rigging, shouting, “Damn the torpedoes! Captain Drayton, go ahead!” or as Ulysses S. Grant, lounging on a rough bench during the Wilderness campaign, calmly proposing to “fight it out on this line if it takes all summer.”

The “two quarters” approach to recession is only slightly less lethargic than Greenspan’s. According to this view, the last recession ended in 1982. It follows that we have had prosperity ever since-in fact, we are told, the longest sustained prosperity in our history. Thus the definition of recession is also important because when you say what you mean by recession, you ipso facto reveal what you mean by prosperity. The meaning of bad times implies the meaning of good times. How good are the good times we have been enjoying from the end of 1982 to the present? Let me count the ways. The national debt has increased from $1.137 trillion in 1982 to $3.319 trillion today. The annual trade deficit has gone from $7 billion in 1982 to $136.5 billion today (with two higher years in between). The nation’s atomic plants have so deteriorated that it will cost $200 billion to repair them. Likewise, at a similar cost, the interstate highway system. The United States of America, the world’s largest creditor nation at the start of the period, is now the world’s largest debtor nation.

To be sure, we have been staying the course in order to conquer inflation. So what has happened? The Consumer Index has risen 34.7 per cent. Perhaps you are politically inclined and want to compare these eight Reagan-Bush years with the eight Kennedy-Johnson years. During the latter (which included the Vietnam War), the CPI went up only 22.7 per cent.

The foregoing is not the worst that can be said of our allegedly prosperous era. The worst is what was done to people directly.

In the years since 1982, the number of our unemployed fellow citizens has never fallen below 6.5 million and has generally been much higher. The number of those too discouraged or demoralized to look for work has hovered around 1 million. The number of those working part time has not fallen below 35 million. The number of men, women and children living in poverty has not fallen below 31.5 million. The number of the homeless can only be guessed at. Our infant mortality rate has become the worst of any industrialized nation. We have the most expensive and the least satisfactory medical care system. And the gap between the rich and the poor has steadily widened, reaching its widest in the figures just released by the Census Bureau.

I submit that the economy sketchily described above is not prosperous. Nor is it “fundamentally sound,” although that meaningless phrase will be trotted out if anything more goes wrong. Certainly the current state of affairs is not so wonderful that it justifies “staying the course.” Every sane citizen must want America to do better. Therefore the customary definition of recession and the Greenspan definition are both mischievously misleading.

We want to be alerted to any weakness in our society, and we want especially to be alerted to faltering in our striving to build and maintain a fair and free economy. We don’t have an economy simply to put chickens in our pots and automobiles in our garages. Communism in the Western world has collapsed because its objectives narrowed to just such trivia. When capitalism judges itself on the basis of its GNP, it risks succumbing to the same fate.

We have economics so that we all can be free and responsible providers of our own sustenance, thinkers of our own thoughts, and definers of our own relationships with our fellows. By “all” I mean all. We have come a long way, and obviously we have a long way to go.

HOW CAN WE measure our progress more precisely? We now have two statistical series that will serve at least for the time being. The first gives us the number and percentage of families living in poverty.

To no one’s surprise, the proper way of determining poverty is in dispute. On one side are those who say that the reported numbers of the poor are too high because the definition of poverty is limited to cash income only and excludes the value of public housing, food stamps, Medicaid, and so on.

On the other side are those who say that the reported numbers are too low because the definition of poverty is based on an estimate of the cost of necessary food, which is assumed to be one-third of the minimum budget. It is argued the estimate of the cost of necessary food is too low, and that other essential expenditures come to more than double the cost of food.

We may eventually reach that happy day when we have reduced the number of poor to the point where it is vital to settle this dispute. In the meantime our performance is so disgraceful that almost any definition of poverty will serve to mark our progress (or lack thereof) from year to year. Whether the number is 31 million or 16 million or 40 million, it is shameful and should spur decent people to action.

The other relevant statistical series shows the share of the national income that goes to the different quintiles or deciles of the population. Again there are disputes over details, and again the trend is a good-enough measure for now. Surprisingly, many people (among them Friedrich Engels) have fretted that perfect equality is either impossible or bad or both, but they really need not worry.

The two statistical series-the number or percentage of fellow citizens living in poverty, and the distribution of the national income-are both socially revealing and economically crucial. A free economy not only produces goods, it consumes them. If significant numbers of the citizens are unable-for whatever reason-to produce goods, the economy is weakened. If significant numbers are unable-for whatever reason-to consume what is or might be produced, the economy is weakened. The supply side must be balanced by the demand side, or the whole thing grinds to a halt.

The grinding to a halt is very like Greenspan’s self-cannibalism. It is not quite so bloodthirsty, but it is no less deadly. Real GNP may be increasing from quarter to quarter, yet increasing numbers of men, women and children are excluded. It may take decades or centuries, but the resulting stagnation and rot could destroy the society (see The Evils of Economic Man,” NL, July 9- 23).

We are not fated to destroy ourselves. To avoid destruction, however, we must first understand what can go wrong what is going wrong. The current popular tests of recession hinder-they do not help-our understanding.

 The New Leader

By George P. Brockway, originally published April 30, 1990

1990-4-30 Bunk About Junk Title

A RECENT EDITORIAL in the New York Times opened with these words: “Michael Milken is a convicted felon. But he is also a financial genius who transformed high-risk bonds junk bonds into a lifeline of credit for hundreds of emerging companies. Snubbed by the banks, these businesses would otherwise have shriveled …There is no condoning Mr. Milken’s criminality. But if overzealous government regulators overreact by dismantling his junk-bond legacy, they will wind up crushing the most dynamic parts of the economy.”

1990-4-30 Bunk About Junk Michael Milken

This reminded me of a story about Henry J. Raymond, the Times’ founding editor and a member of Congress. One day he was prowling the House floor, trying to arrange a pair on an important upcoming vote, so he could return to New York on business. Old Thad Stevens (one of my heroes) asked, “Why doesn’t the gentleman pair with himself? He’s been on both sides of the question already.” Raymond’s successors seem to be straining to be on both sides of the junk-bond question.

For my part, I’m ready to grant that Milken is (or was) a crackerjack salesman and a mighty cute operator. But a financial genius he was not. Certainly he was not the first investment banker (what an impressive-sounding job description!) to sell carloads of not-of-investment-grade securities (see “Junk Bonds and Watered Stock,” NL, March 24, 1986). Nor is the New York Times the first journal to discover virtue in such super salesmanship. Nor, I daresay, is this the first time the Times itself has made such a discovery. Junk bonds are a slight variation on a very old theme, played at least as early as the Mississippi Bubble and the South Sea Bubble, both of which burst in 1720.

I’m also ready to grant that a lot of emerging companies have been snubbed by banks, yet I rather wonder why. Having paid casual attention to some banks’ advertising campaigns, I was under the impression that nothing was more likely to make a banker’s day than an opportunity to lend a helping hand to a bright but inexperienced young woman with a new idea for a flower shop, or to a similarly energetic young man eager to play a part in the great drama of American business. If the banks weren’t seizing these opportunities, what were they doing with the money they persuaded us to deposit with them?

Well, one thing they did was make Milken’s junk-bond business possible. They were no big buyers of junk bonds themselves (although the savings and loans snapped up about a tenth of those issued). Instead, they supplied bridge loans. When Robert Campeau made his deals to buy the Allied and Federated department store chains, he did not put up much cash. He counted on selling junk bonds, and he knew that would take a little while, especially since it was important to wait for the moment when the market was right. The banks loaned him the money to bridge that gap. After the bonds were sold, the banks would be paid off, handsomely.

The trouble was, it turned out that the junk couldn’t be sold, at least not at the necessary price; so the banks involved couldn’t be paid off. They were stuck with nonperforming loans, and Campeau’s stores took refuge in bankruptcy. There are recurring rumors that one of the banks is on the verge of bankruptcy, too. Junk bonds aren’t doing a job the banks are falling down on; the banks are in fact doing the job indirectly by making all those bridge loans. The banks are essential players in the junk-bond game.

Not surprisingly, the Federal Reserve Board (which is responsible for the availability of credit) doesn’t see a problem here, anyhow. The Board has just reported: “There is little evidence that a ‘credit crunch’ is developing; the majority of businesses say they have not seen any change in credit terms and have had no trouble getting credit.  Where credit tightening by banks and thrift institutions has been noted, however, it has mainly affected newer small businesses and the real estate industry.” A medical researcher would scorn that diagnosis as anecdotal. It doesn’t mean much to say a “majority” of businesses have no trouble with credit; 49 per cent could be having a lot of trouble.

Whatever the situation, we can be sure that the “newer small businesses” turned away by the commercial banks are also unable to find an investment banker ready to float junk bonds for them. The junk bond market being thin and precarious, a $3 million issue is about the smallest anyone will undertake. This assumes a company with upwards of $15 million or $20 million in annual sales. It is not the sort of stuff that made Milken notorious, but it is considerably more than can be expected from most newer small businesses.

A new small business has always had a tough time and always will, for the reason suggested by John Maynard Keynes. “If human nature felt no temptation to take a chance,” he wrote, “no satisfaction (profit apart) in constructing a railway, a mine, or a farm, there might not be much investment merely as a result of cold calculation.” Every new enterprise faces a high probability of failure.

Real estate, though, is a key industry. New Building Permits Issued is one of the “leading indicators” of the economy. No prosperity lasts long if real estate does not prosper. Moreover, we have great need of it. Not only do we have uncounted millions of homeless and ill housed; we are unable, in this supposedly family-oriented society, to provide enough affordable housing for young couples, employed and upwardly mobile though both partners may be.

Still, as everyone knows, real estate loans are prominent among the troubles of savings and loans and of commercial banks like the one pushed to the brink by the Campeau fiasco. Why do the loans go bad? Not because the housing is not wanted or not needed, and only partly because prices are too high. It is the high carrying charges that are to blame. Real estate loans go bad for the same reason junk bonds go bad. The interest rates are usurious. The usury affects real estate developers (another impressive job description) and contractors as well as potential buyers, and commercial construction as well as residential. High interest rates are a main factor of high real estate prices – and of high furniture and food and clothing prices, too.

Interest charges paid by the nonfinancial sectors of the economy are now in excess of 20 per cent annually. They were only 4.9 per cent of the GNP in 1950, rising to 7.2 per cent in 1960, to 10.1 per cent in 1970, and to 15.0 percent in 1980. These great leaps forward, culminating in today’s 20 per cent, didn’t just happen. They were carefully fine-tuned by the Federal Reserve Board.

Why did the Board members do it? They have certainly told us enough times. They’ve been fighting inflation. Unfortunately, the fight has not been remarkably successful. You can see that from the fact that the Consumer Price Index, which stood at 24.1 in 1950, reached 126.1 by last December-an increase of 523 per cent in the 40 years in question. (As I’ve remarked before, this figure seems to me too low; the food, clothing, shelter, transportation, education, medicine and entertainment I buy have all increased much more than that. But let that pass.)

1990-4-30 Bunk About Junk ChartHIGH INTEREST becomes a self-fulfilling prophecy. What is prophesied is the probable failure of the borrowers. The probability is a risk the lenders must protect themselves from. They protect themselves by charging even higher interest. That, naturally, increases the risk of failure.

Abstractly there is no end to the escalation of interest rates, for there is no end to the escalation of risk. Indeed, in a sort of Malthusian progression, risk increases geometrically while rates increase arithmetically. Actually, of course, the escalation does have an end, because potential borrowers are driven off. That may be prudence, but foreclosing production (or consumption) does not make for prosperity.

It all comes back to the nation’s monetary policy – its rates and rules and regulations. Deregulation, combined with tightened credit, results in escalation of rates. Escalation of rates discourages production and encourages speculation. Junk bonds are just one of the forms speculation takes. Junk bonds are the creation of the nation and of the Federal Reserve Board (which is, absurdly, an independent power), not of the genius of a super salesperson.

There is another issue here. The Times thinks that junk bonds are good because they force companies to become more efficient (and hence more “competitive”) in order to payoff the high interest charges. If this tale isn’t false, I wish somebody would cite a few shining examples.

There are certainly examples on the other side, Allied and Federated department stores being first among them. Both chains were long established. I know, because in the days of my youth I spent many gold-bricking hours waiting in their sample rooms to see buyers. They were also successful. They’re not successful now.

Furthermore, the usual test of efficiency is a fat bottom line, and the quickest way to fatten the bottom line is to fire some people and put a leash on the rest. But as John Kenneth Galbraith argued years ago in The Affluent Society, an economy that makes life unpleasant for people is something we don’t need. If the virtue of junk bonds is that they are a sort of handicap inspiring efficiency, why not try a different handicap by giving all the working stiffs a raise? It used to be said that management’s first test was meeting the payroll. Why wouldn’t meeting a bigger payroll be a better test than paying higher interest?

 The New Leader

By George P. Brockway, originally published June 12, 1989

1989-6-12 The Reserve's Silly New Equation Title

IN HIS EXCELLENT and comprehensive book about the Federal Reserve Board, Secrets of the Temple, William Greider properly fastens on the first word of his title, the Board being at least the third most secretive arm of the United States government. The rationale for the secrecy is that billions of dollars can be made by uncovering what, if anything, the Reserve is going to do next . Greider suspects, as I do, that the secrecy is useful mainly for instilling awe in us poor mortals.

1989-6-12 The Reserve's Silly New Equation Greenspan

Whatever the case, in contrast with its usual practice, the Reserve has recently gone to considerable trouble to call attention to a new equation that is supposed to predict inflation levels two years or so in advance. We are told that Chairman Alan Greenspan set a team of three economists to work on the problem when he took over in the spring of 1987, and that there is now light at the end of the tunnel. Remembering a New Yorker cartoon of a couple of years ago, I expect the apparent light will turn out to be New Jersey.

As constant readers know, I am, like Adam Smith, skeptical of all alleged mathematical solution to basic economic problems. Happily, the present formula is very elementary mathematics; something that kids probably do today in kindergarten, and that you used to toss off in fifth or sixth grade. So don’t panic.

First, a bit of background. Culminating a century of deep thinking by deep economists, Irving Fisher of Yale promulgated , 80-odd years ago, an equation sometimes said to be the essence of monetarism. Milton Friedman, in The New Palgrave (a four -volume economics encyclopedia I wish I could afford), assures us that monetarism is something else, and he’s entitled to his opinion; but it is Fisher’s formula the Reserve starts with.

 

Friedman also tells us, “There is no unique way to express either the nominal or the real quantity of money.” Nevertheless, some number is chosen and fed into an equation that says the quantity of money, multiplied by the velocity of its circulation, is equal to the general price level, multiplied by the goods produced. The equation, written all in capitals, looks formidable (MV = PQ) but expresses a simple, even a simplistic idea.

 

The money supply (M) is not the only term beset with difficulties. It turns out that the velocity (V) cannot be determined except by means of this equation. Fanciers of the theory contend that over the past many years V has been reasonably constant; MV is practically a single term.

 

The right-hand side of the equation presents different difficulties. Q stands for the total of the goods and services produced – that is, the “real” (stated in things), as opposed to the “nominal” (stated in money), gross national product. I have from time to time averred that the GNP, whether real or nominal, is less than it is cracked up to be, yet for the moment let’s accept it at its face value. We are immediately struck by the fact that its face value is expressed in money. Moreover, it cannot be expressed otherwise, for money is the sole relevant unit of measurement that applies to apples and oranges and tons of steel and all the rest. The paradoxical truth is that the “real” GNP can only be quantified “nominally.”

 

What, then, is the price level (P)? It is the sort of index I often grumble about, derived by combining the prices of a great variety of goods and services, each one weighted to allow its supposedly proper importance in the economy. But the prices of goods and services are already and necessarily included in the GNP. Many have therefore dropped P from the equation, effectively reducing it to M=Q. Translating it back into English, we learn that the total money spent for goods and services equals the total prices charged for those goods and services. Not much to learn from two centuries of study.

 

This is the reed the Federal Reserve leans on. It starts again with MV = PQ. Dividing both sides of the equation by Q. it gets P= MV/Q. Mainly because M2 yields a relatively constant value for V, which the Reserve wants, M2 is selected as the quantity of money. (M2 consists-you don’t have to pay attention here-of  currency, traveler’s checks, checking deposits, savings and ordinary time deposits, money market funds, and overnight Eurodollar deposits, but excludes time deposits of $100,000 or more.)

 

Next, the Reserve pretties up the equation with some asterisks or stars, like this: P* = M2 x V*/Q*. P* (or “P-star,” as insiders say) stands for the price level a couple of years down the road. V*is the determined constant, now with a suspiciously precise value of 1.6527. Q* is the future “real” GNP, assuming a steady growth of 2.5 per cent a year.

 

That last assumption is of course the secret of the game. The inflation-fighting Reserve wants the fraction to the right of the equal sign to be as small as possible, since it is equal to P*, or the future price level. As you remember from the fifth grade, you can reduce the value of a fraction either by reducing the numerator (1/3 is less than 2/3) or by increasing the denominator (1/3 is also less than 1/2). So taking the Reserve’s equation at face value, we could hold the price level (P*) down either by decreasing the money supply (M2) or by increasing production (Q*).

 

Faced with such an alternative, anyone who had not altogether taken leave of his (or her) senses would opt for increasing production, because after all that makes possible our standard of living. The Reserve, I’m sorry to say, opts for decreasing the money supply. It would unfair to imply that the Reserve doesn’t have a reason for its unnatural decision; the trouble is, the “reason” is erroneous. The Reserve, in fact, is not unlike one of my favorite characters in all literature, “The King of Korea I [who] was gay and harmonious: / he had one idea I and that was erroneous.”

 

The Reserve’s one idea is to control the money supply. For reasons that have taken me the better part of a book (to be published by Cornelia and Michael Bessie for Harper&Row about a year from now -advt.) to elucidate, the Reserve can very readily reduce the money supply -but it can’t be sure of increasing it. By “money supply” I don’t mean the gabble-gabble of items that make up M2; I mean the money actually at work in the economy. And in the capitalist economy everyone agrees we have, that is credit, the flip side of which is debit, or borrowing.

 

The textbooks say, I know, that bankers create money by lending it, yet actually they produce nothing except some useful services. Although bankers are often hyperactive in thinking up new financial “products” (index trading, etc.), they are passive partners in the work of the world. The active partners in the creation of money, and the uses it can be put to, are the borrowers. If no entrepreneur plans to produce a better mousetrap, if no consumers long for anything beyond their means, if no speculator schemes for a big killing, the banker sits idle. He can refuse to support plans, longings and schemes, but the first and essential step in creating money is taken by borrowers.

 

THE FEDERAL RESERVE –  the banker par excellence – can make it hard for ordinary banks to lend money, and hence hard for productive people to borrow money. Even if it makes borrowing easy, however, it can’t make people borrow. In other words, it can surely reduce the money supply, but can’t be sure of increasing it.

 

On the other hand, the Reserve can affect the interest rate, and that makes a difference the new equation does not take into account. By raising or lowering the Federal funds rate (the interest banks pay on temporary loans from each other, or from the Reserve itself) or the discount rate (the interest Federal Reserve banks charge commercial banks for short-term loans), the Reserve directly raises or lowers the interest banks have to pay, and consequently the interest they have to set. Naturally, too, by making it difficult for people and businesses to borrow money, the Reserve can indirectly raise the interest they have to pay.

 

Given that interest is a cost of doing business and a cost of living, raising the rate (whether directly or indirectly) ups those costs, thus certainly inhibiting or reducing output (Q*). But we remember that reducing Q* increases the value of the Reserve’s equation by increasing P* (the price level). So we find the Federal

 

Reserve deliberately reducing our standard of living and at the same time raising the price level. True to its one idea, the Reserve next solemnly goes about further reducing M2 (which might be the money supply if ours were a mercantilist system instead of a capitalist system).  In the process, it manages both to restrict the national output and to keep the inflation fires burning.

 

That is indeed the record the Federal Reserve Board has compiled since 1951, when it succeeded in abrogating its wartime agreement with the Treasury that kept the prime rate down to 1.5 per cent from 1939 to 1947. The abrogation was necessary, the Reserve argued, so it could be free to control the money supply (then said to be M1), as it dearly wanted to do.

 

Let’s go to the computer tape. Since the fateful year of 1951, the price level has increased 436.9 per cent. (That’s what the Bureau of Labor Statistics says; if food, shelter, clothing, and transportation have anything to do with the cost of living, I’ll say it has gone up a lot more than that.) More to the point, look at the figures that are left out of the Reserve’s equation: (l)interest paid as a percentage of GNP: up from 4.59 per cent in 1951 to 19.19 per cent in 1987; (2)pretax profits: down from 11.82 per cent of GNP to 6.92 per cent; (3) after tax profits (despite the best efforts of Ronald Reagan): down from 5.19 per cent of GNP to 3.94 per cent; (4)unemployment: up from 3.2 per cent to 6.1 percent; (5)Federal budget: from a surplus of 6.1 per cent of GNP to a deficit of 3.35 per cent; (6)foreign trade balance on current account, from positive $884 million to negative $153,964 million.

 

That is one sorry record. Monetarists say it is the consequence of failing to restrain M2 even further; but they know in their hearts that if the Reserve had in fact restrained it any further, the interest rate would have gone God knows how high, and we would have spent the subsequent years in a rapidly deepening depression that would have made 1932 seem idyllic.

 

How long must we allow ourselves to be deluded by silly equations?

 

The New Leader

 

Originally published July 1, 1985

INTHE PREFACE to their best seller Free to Choose, Milton and Rose Friedman write, “We are still free as a people to choose whether we shall continue speeding down the ‘road to serfdom,’ as Friedrich Hayek entitled his profound and influential book …. ” Since Hayek’s book was published 40 years ago, it would seem that we have been “speeding” down that road at a remarkably sedate pace. I must confess that praise like the Friedmans’ put me off reading The Road to Serfdom until now.

That was a mistake. Hayek is well worth reading, both for what he says and for what he doesn’t say. Looking first at the latter, we find that he is far from advocating the sort of libertarian – that is, practically nonexistent state the Friedmans envisage. The Friedmans share with Marx a longing for the state to wither away, but Hayek is having none of that; he merely wants the state to act responsibly.

He is, for example, willing to consider “restricting the allowed methods of production, so long as these restrictions affect all potential producers equally and are not used as an indirect way of controlling prices and quantities …. ” He also believes that “To prohibit the use of certain poisonous substances or to require special precautions in their use, to limit working hours or to require certain sanitary arrangements, is fully compatible with the preservation of competition.” Hayek would thus not be sympathetic with the notion, advanced by both neoliberals and neoconservatives, that factories should be allowed to pollute as they please, so long as they pay a fee for the privilege.

Nor would he approve of the merger movement and the consequent concentration of power in sprawling conglomerates. He disputes, without naming him, his fellow countryman Joseph A. Schumpeter (who is at present being touted by neoconservatives as a foil to Keynes), rejecting “the myth … that … competition is spontaneously eliminated by technological changes.” In addition, Hayek quotes with favor from the New Deal report of the Temporary National Economic Committee: “‘The superior efficiency of large establishments has not been demonstrated … monopoly is frequently the product of factors other than the lower costs of greater size. It is attained by collusive agreement and promoted by public policies. When these agreements are invalidated and when these policies are reversed, competitive conditions can be restored.'”

In another place Hayek says, “It is only because the control of the means of production is divided among many people acting independently that nobody has complete power over us.” He is against monopoly as well as against the “monster state,” and in his last chapter, he writes (anticipating E.F. Schumacher), “It is no accident that on the whole there was more beauty and decency to be found in the life of the small peoples.”

Though Hayek’s main thesis is objection to a comprehensively planned economy, he recognizes that “the case for the state’s helping to organize a comprehensive system of social insurance is very strong.” He holds, too, that the state should be concerned in “the extremely important problem of combating general fluctuations of economic activity and the recurrent waves of large-scale unemployment which accompany them.” And strong as he is in his insistence on private property, he thinks that the case for inheritance may not be supported with “the same necessity.”

I have quoted Hayek extensively because his reputation is that of an extreme, devil-may-care, laissez-faire conservative. His book was actually greeted with qualified praise by Keynes, as Robert Heilbroner tells us in The Worldly Philosophers; but endorsements like the Friedmans’ have established his reactionary” image.” Much of Hayek’s later work, however (e.g., his attack on John Kenneth Galbraith; see” Rereading Galbraith,” NL, June 13,1983), does exhibit a hardening conservatism.

This is not, I think, an instance of the notorious syndrome whereby flaming youths turn into reactionary elders (“When old age came over them / With all its aches and qualms, / King Solomon wrote the Proverbs / And King David wrote the Psalms”[1]). Rather, it is an instance of a common, albeit little noticed, progression whereby a great leader becomes misled by his followers. The change is not always in a conservative direction. Marx became more violent and conspiratorial at least in part because his most vocal supporters were conspiratorial. John Dewey, whose Human Nature and Conduct showed strong elements of philosophical idealism, became famous for the contrary theory of instrumentalism that appealed to his admirers.

I have also seen such changes occur at less rarefied levels. One of the most delightful books I ever published was Little Britches (I was never good at titles) by Ralph Moody. It was the first of several memoirs of family life. No one reading the series would guess Little Britches was begun as a polemic against the Social Security system. But Ralph’s readers – starting with those in an extension writing course in Berkeley-praised him for the warmth of his characterizations, and he became more interested in people and less in abstract theory.

THERE ARE other interesting themes in The Road to Serfdom.  One of these appears in his analysis of the failure of the Social Democrats to stop Hitler. We have heard much of the trahison[2] of the Communists; but Hayek argues that the socialist emphasis on comprehensive planning predisposed the German electorate in favor of grandiose schemes like Hitler’s. If he is right, this fact should give pause to our Atari Democrats, who want to set up a committee to decide which industries we should foster and which we should abandon and in general to plan how to use our resources. As Robert Lekachman has pointed out, such committees are more likely to be run by big business than by idealistic planners.

The Social Democrats were further weakened, Hayek says, by a split that appeared in the labor movement. For various reasons, certain unions and certain categories of workers were able to achieve remarkable economic gains, while others were left far behind. The laggers were understandably disillusioned about the Social Democrats and became ready to acquiesce in, if not support, the National Socialist program.

“To them,” Hayek writes, “and not without some justification, the more prosperous sections of the labor movement seemed to belong to the exploiting rather than to the exploited class.”

This is a problem that American labor leaders have yet to solve. The split in our labor movement was opened, as I suggested last year (“Voodoo on the Primary Trail,” NL, April 30, 1984) by the Vietnam War. But it has been astutely widened by apologists for big business and by the just- folks demeanor of President Reagan, and deepened by the misguided anti-labor Presidential campaign of Gary Hart.

It is said, by the way, that Hart appealed especially to the so-called Yuppies- young, upwardly mobile professionals. I venture to think that Hayek’s analysis of what happened in Germany is closer to what is happening here. He writes that “no single economic factor has contributed more to help [the Nazis] than the envy of the unsuccessful professional man, the university-trained engineer or lawyer, and of the ‘white-collar proletariat’ in general for the … members of the strongest trade unions whose income was many times theirs.” I suggest that the “white-collar proletariat,” hitherto most visible in countries like India, will become a growing and destabilizing factor in our public life as computerization and conglomeration steadily reduce the need for “middle management.”

Another theme of current interest in Hayek’s book is his concern over the tendency of legislatures to turn hard questions over to independent public authorities. I suppose he would therefore welcome a good deal of the current deregulation, but he would appear not to have been a knee-jerk deregulator. Hayek’s concern is also a central topic in Theodore J. Lowi‘s widely read The End of Liberalism. Both men describe the irresponsibility that results from the delegation of undefined powers. Hayek emphasizes the dictatorial arrogance that ensues; Lowi notes (as does Lekachman in the comment cited above) that ill defined regulatory commissions tend to be co-opted by the industries they regulate. A different example of irresponsible delegation is the willingness of Congress to give the President power to commit military forces to action, and indeed to launch a nuclear strike, without carefully defining limits to that power.

In the same way, control over our money, and hence over our economy as a whole, has been surrendered to the Federal Reserve Board. I regret to have to admit that three Democratic Presidents played crucial roles in the surrender: Woodrow Wilson, who admitted he knew nothing about banking, signed the Federal Reserve Act. Harry Truman allowed his Secretary of the Treasury to dissolve the agreement with the Federal Reserve that had held the prime interest rate down to 1.5 per cent during the War. Jimmy Carter appointed Paul Volcker chairman of the Fed.

How all this came about is told in fascinating and chilling detail by F.W. Maisel in a little book entitled Great American Ripoff (Condido Press, Box27551,San Diego 92128). Maisel may upset the sensitive by his espousal of a conspiracy theory of American banking; nevertheless, it’s hard to fault his facts, and I’m not even prepared to say he’s wrong about the conspiracy.

Should you feel that the bankers running the Federal Reserve, far from being conspirators, are idealistic public servants who have, in Hayek’s phrase, “devoted their lives to a single task,” there is still reason to be wary of them, for “From the saintly and single-minded idealist to the fanatic is often but a step.” Single-minded conservatives please copy.

The New Leader


[1] A poem by James Ball Naylor http://www.jamesballnaylor.com/

[2] French for “betrayal” or “treason.”

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