Tag Archives: Inflation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

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

By George P. Brockway, originally published May 5, 1997

1997-5-5 Why I Want to Shake Alan Greenspan titleIN CONGRESSIONAL testimony, Chairman Alan P. Greenspan of the Federal Reserve Board has talked, in his gnomic way, about the rich getting richer and the poor getting poorer. Responding to a Congressman’s question, he testified: “There has been a regrettable dispersion of incomes that goes back to the later ’60s …. What’s the major threat to our society? I’d list this as a crucial issue. If it divides the society, I do not think that is good for any democracy of which I am aware.”

Sometimes you want to shake the man. He has done a bit to open up the Federal Reserve Board to public scrutiny, but often it seems he can’t make a straightforward declarative statement. There is no “if” about this proposition. Of course the “dispersion of incomes” divides the society. It does so by definition. We’ve known that since Aristotle. Whether or not there may be some democracies of which he is not aware, the dispersion is certainly not good for a democracy that was conceived in liberty and dedicated to the proposition that all men are created equal.

Later in his testimony Mr. Greenspan expressed regret that the Federal Reserve Board lacked the power to contribute to the solution of the problem. Whether it truly lacks that power is surely debatable.

What is beyond debate is that the Federal Reserve Board can make the problem worse. For they in fact did so as recently as March 25, 1997.

By raising the interest rate, the Reserve slowed the economy down-deliberately. A slowdown means that fewer goods and services will be sold than would have been sold otherwise-not necessarily fewer than are sold today, but certainly fewer than might have been sold tomorrow.

Since fewer goods and services will be sold, fewer will be supplied, and fewer people will be employed in supplying them. Since fewer people will be employed, fewer people will have money with which to “demand” goods and services. And since fewer people will be employed, those lucky enough to have jobs will hesitate to ask for raises and so also will have less money with which to demand goods and services. The expectation is that inflation will be contained or pre-emptively struck, depending on the metaphor you’re using this week, and that the rest of us will be free to choose among moderately priced commodities.

Now, it is obvious to everyone except (perhaps) the Federal Reserve Board that if raising the interest rate does in fact contain or pre-empt inflation, it does so at the expense of the workers and the would be workers of America. In other words, most of the poor will be poorer.

And will anyone be richer? That, too, should be obvious. When the interest rate is raised, someone benefits. Who else can that be but people with money to lend, that is, people with more money than they need for daily expenses of living? We may call these people rich. And most of them will be richer.

Nor will the middle class escape unscathed. For convenience, let’s say the middle class consists of all people who are constantly making mortgage payments or payments on their automobile or payments on educational loans or payments on their furniture or on their credit cards. They’re like the government: They pay their bills, and their credit is good, but they don’t balance their budgets.

These people will be hurt, some more than others, by the increase in interest rates, and the rich will be made richer at their expense. Since March 25, 1997, everyone with an outstanding variable rate loan and anyone taking out a new loan to buy a house, a car, a refrigerator, a loveseat, or a college education has been paying more-in some cases thousands of dollars more-than would have been required before March 25. Anyone lending after that date is correspondingly enriched. (Yes, most of the lending is done by banks and such, but these institutions are owned by people who are not poor.)

The rich will be distanced farther from everyone, from the middle class as well as from the poor. The rich have done nothing to deserve their increased incomes. They have not denied themselves more pleasures to finance the activities of the rest of us, and they will not be required, or even requested, to do anything. Their increased interest income is an outright gift from their fellow citizens, from the nation’s businesses, and from the Federal, state and local governments and school districts.

Nor has the middle class done anything to deserve having part of their wealth and income taken away from them. However large or small the part may be, it is, as the politicians say, their money-and it’s being given, not to the government for the presumed good of all, nor to some charity of their choice, but to the rich merely because they are rich.

As for the poor, they have done nothing to deserve the refusal of raises they might have had, or the denial of jobs that might have been created, or the downsizing from jobs they once had. Bernard Shaw’s Undeserving Poor are surely still with us, and some of them are doubtless unemployable, but the malign consequences- the intended malign consequences- of the increase in the interest rate will be visited on the poor whether they are otherwise deserving or not.

Some say that a quarter-point increase in the interest rate can’t hurt anyone very much. If that is so, why do it? The intention is to hurt. The alleged need is to hurt enough to force people to buy less, to consume less, to enjoy less.

Anyhow, the question before us is not whether it hurts, but whether it increases what Mr. Greenspan calls the dispersion of incomes. The answer to that question is clear. Because of the quarter-point increase in the interest rate, the total annual incomes of the richest 5 per cent of the population will be increased by several billion dollars, and the total annual incomes of the other 95 per cent will be decreased by several billion dollars. Moreover, since the rich are so few, they will, on average, grow richer almost 20 times as fast as their average fellow citizen becomes poorer. The income gap will continue to widen as long as the new rate is in effect, and it will widen even further if, as expected, the Reserve increases the rate again and again during the coming months.

The Federal Reserve Board has singlehandedly effected all these increased dispersions in income. Why did they do it? Surely they are not altogether oblivious of what happens to real people and real societies in the real world.

Well, we know why they did it. They’ve told us plenty of times. They were fighting inflation. They were fighting inflation when they caused recessions in 1954, 1958, 1961, 1970, 1975, 1980, 1982, and 1991. They’ve been fighting inflation, although they now say inflation never was as high as reported. They’ve been fighting inflation, although they’ve never made clear exactly what inflation is.

EVIDENTLY inflation is not all prices going up together, because they never have all gone up together; and since ordinary business requires making contracts at fixed prices, they never could all go up together. Evidently inflation is not an increase in the price of energy (a.k.a. oil) or an increase in the price of food, because economists have now concluded that these prices are controlled by foreigners or the weather or both. Evidently inflation is not an increase in the multimillion-dollar salaries of executives, entertainers and professional athletes, because such incentives are said to be needed to bring out the best in lethargic souls.

Evidently inflation is not an increase in profits, because profits are what it’s all about. Evidently inflation is not an increase in the cost of borrowing money, because raising the interest rate is the sole weapon the central bank uses in its perennial fight against inflation.

So what is left? Judging from press reports, it would appear that the chief signs of inflation are a fall in the unemployment rate, a fall in the number of new applications for unemployment insurance benefits, faint signs that some wages may be rising almost as fast as productivity, and improvement in the sales of discount stores.

As Pogo might have said, conventional economics has met the enemy and they is us. Inflation is some prices going up faster than others. In the conventional lexicon, the only really bad prices are the incomes of the middle class and the poor.

There is little doubt that an increase in these prices would eventually result in increases in some manufactured products, in some of what used to be called dry goods, and in some services. After all, the middle class and the poor do most of the work of the world, and wages are certainly a cost of doing business and thus a factor in prices.

But interest is also a cost of doing business and a factor in prices.  Increases in the interest rate thus push up prices. If Mr. Greenspan only grappled on to that simple and obvious fact, and if he took seriously his concerns about a divided society, he might launch a policy of slowly reducing the interest rate, striving to use his great power to achieve a new soft landing for all of us in a larger, more generous, more inclusive, more united, and more rewarding economy.

Conventional economists would of course scream that high interest rates are necessary to enforce a “natural rate of unemployment,” and that the Treasury couldn’t sell its bonds if the rate were reduced to what was common only 40 or 50 years ago (before the dispersion of incomes began). But everyone who is active in the economy wants lower interest rates-the automobile business and its ancillaries, the building industry and its suppliers from producers of carpet tacks to manufacturers of major appliances, all sorts of retail concerns and their customers, managers of mutual funds and their investors, most bankers, and governmental entities at all levels as they struggle to balance their budgets.

Did I say “most bankers”? Of course I did. The usurious rates of the ’70s and ’80s taught them a lesson. To attract and hold deposits they had to compete with Treasury bills paying as much as 16.3 per cent, while the Federal Reserve set a rate of up to 19.1 per cent on interbank loans. Borrowers resisted the rates that banks had to charge and cut their borrowing to the bone. Hundreds of S&Ls were wiped out (see “Who Killed the Savings and Loans?” NL, September 3, 1990), and many regular banks failed.

Mr. Greenspan himself, in answer to a question once posed about the natural rate of unemployment, said, “I don’t believe that any particular unemployment rate-that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with is something desirable in and of itself. I don’t believe that.” Responding to a suggestion that interest rates had to be high to attract foreign bond buyers, he has also said, “I’m not aware that we’ve had very many difficulties selling the debt-the Federal debt at low interest rates.”

Conventional economists may sneer at Mr. Greenspan for voicing such unconventional ideas. A more valid complaint is that he doesn’t act on them.

The New Leader

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

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

By George P. Brockway, originally published January 17, 1995
1995-1-30 The Phantom Tax Cut title

TWO YEARS AGO, reporting on the Little Rock “economic summit” (remember that?), I wrote sadly: “It was a dismal performance. For it was the supply side all over again. To be sure, the words ‘supply side’ could be read on no one’s lips; no one traced a laughable curve on a cocktail napkin; and the ideas were restated less breathlessly than Jack Kemp does it, and with a profundity beyond the capabilities of the Great Communicator. But if you had your eyes closed, there were times you could easily have imagined you were listening in on a planning session of Ronald Reagan’s early advisers.”

I was nevertheless confident that common sense and common decency would prevail more often in the Clinton White House than during the Reagan and Bush years, and that this would “make the Clinton Presidency worthy of being remembered.” Cheering the reiterated plea for full funding of Head Start, I concluded that the low-tech (and hence demand stimulating) operation would quickly get significant amounts of money circulating, and therefore would “do more to stimulate the economy this year, and every year of the program’s existence, than the schemes to restore the investment tax credit, to rehabilitate IRAs, and to cut taxes for the middle class-all of which are bum Reaganesque ideas we have already tried and found wanting.”

Well, the Reaganesque ideas are back again and are likely to be re-enacted by supply-side Republicans and “New” Democrats – none of whom is as stylish as the Bourbons, but all of whom, as Talleyrand said of the Bourbons, “have learned nothing and forgotten nothing.” In the process, what is represented as a version of the GI Bill of Rights for retraining downsized workers will be corrupted by a doctrinaire eagerness to support proprietary education mills.

Since anyone who is curious can look up the sorry record of previous investment tax credits and IRAs, let’s talk a bit about the tax cut for the middle class, arguably a demand-side action. The media have already noticed it will not amount to much – the equivalent of another couple of pizzas a month for every family. Still, the sheer number of pizzas is mindboggling and may result in supply-side expansion in the bakery industry as well as demand-side pressure for more laxatives and anti-gas pharmaceuticals, which will, in turn, inspire the creation of more sick-making television commercials. Although I am not now and never have been a pizza man, I have no great objection to any of that.

Nor do I have a strong objection to the elastic, not to say formless, definitions we are being given of the middle class. After all, speaking sociologically, as I occasionally do (“The Golden Mean,” NL, November 2, 1987), in any stable society the middle class is the society, the ultra-rich being exclusive and the infra-poor excluded.

Speaking economically, though, I find it hard to believe the Republicans believe anyone earning $200,000 a year (that is, snugly in the top 1 per cent of the population) needs a handout for an extra pizza. And I am sure everyone making $8,850 a year (the full-time minimum wage) should have a handout for more than that.

The President’s tax cut proposal presumes $75,000 a year is the top of the middle class (still almost 95 per cent of the population) and is estimated to cost $60 billion over five years – or something less than two-tenths of 1 per cent of the gross domestic product. That’s not even pizzas; that’s peanuts. It is barely a third of the woefully inadequate Clinton “stimulus package” the Republicans filibustered to death a year and a half ago.

So what’s all the fuss about? The fuss is about the votes of the small percentage of the American electorate that is not too lazy to go to the polls. Specifically, about its fear and loathing of the way things are going in the country; its stouthearted determination not to try to understand why the prospects aren’t brighter; its puerile anger against imagined tormentors; and its desperation for a quick fix, especially one that is mean to somebody else. An electorate with such qualifications can be bought and sold and made dizzy by spin doctors – who are undoubtedly a growth industry, but beyond the normal purview of this column.

For this column, the question is, What difference does all the fuss make to the economy? And the answer is, Precious little, and most of that counterproductive.

The tax break for the middle class (whether Clinton’s, Minority Leader Gephardt‘s, or the Republican Contract‘s) will of course be paid for by the middle class. Who else is there? Indeed, the paying will undoubtedly come to more than the cutting, particularly for those in the bottom half of that protean middle class. There are two principal reasons for this.

First and most important (constant readers may be certain) is the Federal Reserve Board, which considers itself entitled to frustrate every program, especially every promising program, of the constitutionally elected Executive and Legislature. In the notorious black wit of former Chairman W M. Martin, the Reserve’s aim in life is “to take away the punch bowl just when the party gets going.” It is sure as shooting going to raise the rate again if the talk about a tax cut continues. A tax cut at least pretends to give people money to spend, and people with money to spend give the Federal Reserve Board goose bumps.

When the Board gets goose bumps, it raises the interest rate. It can’t be bothered with the fact that this increases both the cost of producing and the cost of consuming, and consequently is doubly inflationary. It’s all the Reserve can think to do, even though inducing inflation while pretending to fight it makes the Reserve look silly.

Something more than silliness is involved. If the prices of consumer loans are raised, borrowers have less money to buy things with. ‘But where does their money go? It goes to the banks, of course. For example, I have a little adjustable rate mortgage. As a result of the Board’s recent maneuvers, my interest charges this year will be about $700 greater than they were last year. That won’t break me; but if the Board keeps it up (and you can bet it will), my pizza-size tax cut will disappear – roughly 10 times over – into the shining coffers of my friendly banker.

As Deep Throat said, follow the money. The famous middle-class tax cut, assuming there is one, will mean the United States of America will have less money to spend (and I’ll get to that in a moment). Congress will dangle that money before our eyes; but when we try to get our hands on it, the Federal Reserve Board will whisk it away and give it to our bankers, along with some money we thought was safely ours.

Every time the Reserve raises the interest rate to “head off inflation,” it effects a massive transfer of wealth and income from mostly middle-class borrowers to mostly rich lenders. Never mind what Polonius advised about borrowing; he was a Renaissance courtier, and not an over wise one. Borrowing is what modern capitalism is all about. Today’s borrowers have done nothing to deserve having their money taken away from them, and today’s lenders have done nothing to deserve being given it. You can forget about your pizza; your banker will be eating cake.

So much for the first reason why the middle-class tax cut will cost the middle class money.

THE SECOND REASON is that most of the “savings” proposed to pay for the cuts are fake, illusory, smoke-and-mirrors. I suppose it is true that, as Vice President Gore said the other day, there is an Agricultural Department field office within a day’s horseback ride from every farm. That sounds worse than it is; it doesn’t take many 50-mile radius circles to cover most farm country.

Schemes like turning air traffic controllers over to a government or private corporation (and there are a lot of such schemes) amount to nothing more than getting the costs off the Federal budget. The costs won’t vanish; they will reappear in the form of local taxes or user fees to be paid directly or indirectly by the middle class. Either that, or the airlines’ insurance premiums will take off into the wild blue yonder, and will have to be covered by higher fares.

Then there are all the truly vicious notions to eliminate or underfund programs that are already underfunded, like housing (as though there weren’t a million or more homeless fellow citizens in the streets), and school lunches and food stamps (as though ill nourishment were not a fact of life in the United States), and Medicaid (as though we have solved our health problems by yakking them to death). Not to mention Head Start, which was so promising two years ago. Or ending welfare as we know it by sending kids to orphanages and putting their mothers to work at jobs that won’t get them out of poverty, but will violate mainstream economists’ theory of a natural rate of unemployment and so give the Federal Reserve Board another excuse to raise the interest rate to head off inflation.

“Saving” by dumping on welfare and relief programs is what will cost the middle class – and the rich, too-many times more than their tax cuts will be worth. Supply-side Republicans and New Democrats are sensible enough not to like our decayed inner cities and rural slums, and they are reasonable enough to be afraid of the sullen, desperate people who live there. They seem to think there is an underclass, and that it can be cowed with long mandatory prison sentences and the death penalty. They shouldn’t count on it.

But they should count on having their household expenses and local taxes increase to pay for more guns and locks and burglar alarms and insurance and police and judges and prisons, some of which will have to be in their backyard for lack of anyplace else to put them. This being the case, they would be wise to take a long, straight look in the mirror and ask themselves if they really are or want to be as self-righteous, callous and mean-minded as they are in danger of becoming.

 The New Leader

By George P. Brockway, originally published September 3, 1990

1990-9-3 Who Killed the Savings and Loans Title

THE WAY WE’RE going, we’re not getting close to the truth about what happened to the savings and loans. It’s much easier to be bemused by the amount of money lost in the disaster, to be shocked by the skulduggery involved, to be flabbergasted by the bad judgment of rich men, to be titillated by political charge and countercharge.

The $500 billion fiasco has been a long time in preparation. The first official action leading up to it was taken as early as March 1951, when the Federal Reserve Board got the Treasury to agree to a slight advance in interest rates. In his Memoirs, President Harry S. Truman criticizes the Reserve for failing to live up to its part of the agreement; but as William Greider points out in Secrets of the Temple, the issue became moot with President Dwight D. Eisenhower‘s election. Wall Street won out over Washington. The Reserve has, ever since, been undisturbed in following its gleam.

When the media go beyond personalities, they explain that the S&Ls failed because they borrowed short and lent long. That is, they accepted deposits that could be withdrawn at will (30 days’ notice was often reserved but seldom enforced), and they lent against mortgages running 30 years into the future.

The curious fact, however, is that the S&Ls were deliberately set up to act in this way from their beginnings in the Great Depression. They were designed to perform two functions: First, they would offer a safe depository for the small savings of the middle class; second, they would aggregate those savings and lend them to finance middle class home ownership. Because the functions were restricted, it was understood that expenses would likewise be restricted. S&Ls, it was reasoned, could therefore offer a little bit more than the going rate on the deposits and charge a little bit less than the going rate on the mortgages. And so it was.

The new S&Ls were successful for more than 30 years. They were substantially responsible for the United States’ achieving the highest rate of home ownership in the world (a rate considerably higher than the present one). They were also substantially responsible for a rebirth of personal savings following the Depression. My wife and I were able to buy a home and start saving at a far younger age than either our parents or our children.

For all those years that they were contributing to the wealth and happiness of the American people, the S&Ls were borrowing short and lending long. Obviously, something else caused the downfall.

Plenty of people are ready to tell you the problem was inflation. Inflation is always bad for lenders. If the price level is rising at a rate of 5 per cent a year, anyone lending $100 today will receive back only $95 in purchasing power a year from now. At the same time, naturally, inflation is good for borrowers, who borrow $100 today and pay back $95 in purchasing power next year.

But look at the performance of the S&Ls over the long run-specifically, over the life of a mortgage. In that run of 20 or 30 years a go-getting middleclass American will both a borrower and a lender be. He/she will borrow at the beginning and save toward the end. They will gain from inflation (if any) when they are young and lose to inflation as they approach middle age. From their point of view, there is much to be said for this balance. From the point of view of the lending bank, inflation is not without its compensations. Inflation of real estate prices has the advantage of improving the quality of the bank’s portfolio. Foreclosures will be fewer, and losses in each foreclosure will be lower. Taken by itself, inflation no more explains the S&L debacle than does the borrowing-short-lending-long story.

Now we reach the root of the matter: What devastated the S&Ls was a tremendous rise in the interest rate.

The first noticeable sign of things to come was a period of tight money in 1955-57, but no one expected the trouble we’ve seen. The Federal Funds rate in those years jumped from 1.78 percent to 3.11 per cent, and continued to rise. By 1965 the average S&L was earning only 0.5 per cent on its capital. Crises followed in 1966, ’69, ’74, and ’78. High T-bill rates and the new money-market mutual funds drained the S&Ls of deposits.

When on October 6, 1979, the new chairman of the Federal Reserve Board, Paul A. Volcker, announced that thereafter the Reserve would concentrate on the money supply and let the interest rate go as it pleased (it pleased to go up), the S&Ls’ fate was sealed. In March 1980, the grandiloquently styled Depository Institutions Deregulatory and Money Control Act confirmed the seal. Practically unrestricted competition, coupled with $100,000 deposit insurance, guaranteed that the Savings and Loans, trying to escape the consequences of high interest, would engage in a binge of blue-sky financing and outright thievery. The only surprise is that the binge lasted for a full decade before the general collapse.

But what could the Federal Reserve do? Doesn’t inflation cause the interest rate to rise? When all is said and done, isn’t the culprit the usual suspect-inflation? It’s too bad – $500 billion too bad – that the S&Ls got caught in the crossfire of the Federal Reserve’s war with inflation, but the war must go on, mustn’t it?

Given the size of the S&L disaster, I suggest that the Reserve ought to have a pretty convincing explanation of the necessity for its actions. Chairman Volcker used to tell us that the interest rate was none of his doing but was the doing of the impersonal market. To the best of my knowledge, his successor, Alan Greenspan, has not said him nay. Well, if the Federal Reserve does not control the interest rate, I don’t know what it does do – unless, as W.S. Gilbert sang of the House of Lords, it does nothing in particular and does it very well.

Of course, the Reserve claims to control the money supply. Its Federal Open Market Committee buys or sells government bonds (it could trade in other assets as well, but prefers not to). If it wants to contract the money supply, it sells government bonds until enough banks buy enough of them to reduce their cash reserves and hence their loan-issuing power. If it wants to expand the money supply (a stratagem that rarely crosses its mind) it buys government bonds and builds up the banks’ reserves.

There’s more to buying and selling than stamping your foot and saying that’s what you want to do. Your price must be right. If you want to sell, your price must be enticingly low. A low price for a bond (or any asset) yields a high rate of return. Not only are banks eager to buy high-interest Treasury bonds, they are also quick to adjust upward the rates they charge their customers, whose credit, after all, is less solid than that of the U.S. Government. In the same way, when the Open Market Committee buys bonds at a high price, it drives the interest rate down.

Because the money supply is not a precise figure (the Reserve publishes four different major and two minor ways of measuring it), the effects of this activity on the money supply are not precise. But it certainly does have determinate effects on the interest rate, and that certainly has definite effects on the cost of living.

ALL OF WHICH brings us back to 1951. In the preceding decade the Federal Reserve Board and the Treasury worked together to maintain the price of government bonds, and the prime rate for most of those years  – despite their including World War II and the first year of the Korean War remained steady (believe it or not) at 1.50 per cent. In 1951 the Reserve, worried about inflation, managed to break free of the agreement with the Treasury and thereafter devoted itself to controlling inflation by managing the money supply.

As it happens, 1951 is the midpoint between the founding of the Reserve in 1913 and 1989, the most recent full year for the Consumer Price Index. Several fat volumes would be required for an exhaustive economic history of each period, and a thorough analysis of the impact of those histories on the CPI would be beyond reasonable achievement. Yet some events are clearly more significant than others. For obvious reasons, wars are held to be especially inflationary, while depressions are deflationary. World Wars I and II and the start of the Korean War occurred in the first period, while the Korean War truce talks and the Vietnam War occurred in the second period. The recession of 1920 and the Great Depression occurred in the first period, while there have been five (or six, if you count what’s going on now) recessions in the second period. So we may say with some justice that the control of inflation should have been no harder in the more recent period particularly since the Federal Reserve Board had now proclaimed this to be its primary objective – than in the earlier one.

How, then, do the two periods compare? From 1913 to 1951, the Consumer Price Index (1982-84 = 100) rose from 9.9 to 26, an increase of 163 per cent. In the later period, from 1951 through 1989, the index rose from 26 to 124, an increase of 377 per cent. In other words, during the 38 years that the Federal Reserve

Board has been deliberately and ostentatiously fighting inflation, the inflation rate has gone up more than twice as fast as it did in the previous 38 years. On the record, the burden of proof is on the Federal Reserve Board to show that its policies, which have resulted in the destruction of the S&Ls, have been effective by any standard whatever.

As I have argued previously (“Bankers Have the Classic COLA,” NL, January 9, 1989), a high interest rate causes rather than cures inflation. This will always be true because the outstanding nonfinancial debt in the nation is greater than the GNP. At the present time, the former stands at about $9.75 trillion, and the latter is about $5.4 trillion. Thus each percentage point in the interest rate is paid for by an increase of $97 .5 billion in the general price level, while a one point increase in inflation costs only $54 billion. With interest rates currently running about six points above normal, this year’s net cost of the Federal Reserve Board’s inflationary policies will be $261 billion – or considerably more than the budget deficit everyone moans about.

In comparison, the cost of the S&L mess is small potatoes. Nevertheless, it must be added to the other costs the Federal Reserve Board is responsible for. Several Presidents and Congresses have undoubtedly acted stupidly in regard to the S&Ls, but the S&Ls would still be operating and prospering to the benefit of us all if it were not for the stubbornly misguided behavior of the Federal Reserve Board.

 The New Leader

By George P. Brockway, originally published November 27, 1989

1989-11-27 What Happened to Jimmy Carter Title

James Mac Gregor Burns, Pulitzer Prize-winning biographer, historian, and political scientist, recently published The Crosswinds of Freedom, the third and final volume of his history of The American Experiment. The book confirms Burns’s standing as one of the foremost observers of the modern American scene.  It also carries forward the foreboding analysis he initiated in The Deadlock of Democracy: that American law, by creating a stalemate in politics, makes an almost impossible demand on-and for-leadership.

Jimmy Carter of course figures in Crosswinds, and reading about him makes you want to cry.  He was (and is) a decent man who apparently thought decency was enough, who had a talent for offbeat public relations, and who also had a propensity for shooting himself in the foot.  The prime example was the Iran hostage affair.  As Burns points out, it was Carter who kept that in the news, and it helped defeat him.  On the other hand, if not for Iran, Ted Kennedy might have been able to grab the Democratic nomination.  The economic situation was probably enough to finish Carter, no matter what.  In that connection I offer a footnote to Burns’s magisterial book.

During the last two years of Carter’s presidency we had double-digit jumps in the Consumer Price Index.  It is not clear why this happened.  The usual explanation blames OPEC.  What is generally forgotten is that OPEC blamed the strong dollar for its price increases.  For almost three decades – long before the advent of Paul Volckerthe Federal Reserve Board and other First World central banks had been steadily pushing interest rates higher, thus overhauling their currencies and raising the cost of the goods the OPEC members (which generally had few resources aside from their oil) bought from us.  Before raising their prices, OPEC tried for several years to persuade us to change our policies; but the Reserve plowed ahead, increasing the federal-funds rate from 4.69 percent in March 1977 to 6.79 percent in March 1978 and 10.09 percent in March 1979.

Finally, on March 27, 1979, OPEC oil went up 9 percent, to $14.54 a barrel, and three months later there was another jump of 24 percent.  In December OPEC was unable to agree on a uniform price, but individual hikes were made across the board. By July 1, 1980, the barrel price ranged from $26.00 in Venezuela to $34.72 in Libya.  Thus, in a little over a year, the cost of oil had more than doubled.

Yet petroleum accounted for less than 3 percentage points of the inflation. Moreover, in every OPEC year (and, indeed, in every year on record), the nation’s interest bill has been substantially greater than the national oil bill (including domestic oil and North Seas oil as well as OPEC oil).  If OPEC is to blame for the inflation of 1979-81, the Federal Reserve Board is even more to blame.

A major cause of the rest of it was hoarding, which resembles speculation yet differs from it in that real things are involved. During this period the stock market was quiescent:  The price/earnings ratio was lower than it had been at any time since 1950, and less than half what it would be in 1987 or is today [1989]. But hoarding, probably prompted by memories of the gas lines following the 1974 OPEC embargo, was heavy.

And not merely in petroleum; it extended to all sorts of commodities.  Manufacturers, wholesalers, retailers, and private citizens tried frenziedly to protect themselves against expected shortages. As often happens in such situations, the expectations were immediately self-fulfilled.  Confident that shortages would allow them to raise prices, manufacturers eagerly offered high prices themselves for raw materials they needed.  Maintenance of market share became an almost obsessive objective of business management.

In the book business, for example, “defensive buying” became common.  Bookstores and book wholesalers increased their prepublication orders for promising titles so that they would have stock if a runaway best-seller developed.  Publishers consequently increased their print orders to cover the burgeoning advance sales.  It soon became difficult to get press time in printing plants, and publishers increased press runs for this reason, too.  Naturally, everyone also stockpiled paper, overwhelming the capacity of the mills.  For all I know, the demand for pulpwood boosted prices of chain saws and of the Band-Aides needed by inexperienced sawyers.

Unlike speculation, hoarding has physical limits.  After a while, there’s no place to put the stuff.  And after a while, the realization dawns that a possible shortage of oil and gasoline doesn’t necessarily translate into an actual shortage of historical romances.  Moreover, the shortage of oil and gasoline, once the tanks were topped off, disappeared.  There was plenty of oil and gasoline; you just needed more money to buy it.  Hoarding-or most of it-slowed down and stopped.  Business inventories declined $8.3 billion in 1980.  But prices didn’t come down.

All this time Jimmy Carter was not idle, for he prided himself on being what we’ve come to call a hands-on manager.  As early as July 17, 1979, he got resignations from his Cabinet members and accepted several, including that of Treasury Secretary W. Michael Blumenthal. To fill the Treasury slot, he chose G. William Miller, chairman of the Federal Reserve, and that opened the spot for Paul A. Volcker, who was nominated on the 25th amid cheers on Wall Street.  At his confirmation hearings on September 7, Volcker revealed the conventional wisdom to the House Budget Committee.  “The Federal Reserve,” he testified, “intends to continue its efforts to restrain the growth of money and credit, growth that in recent monhts has been excessive.”

True to Volcker’s promise, on September 18 the Reserve raised the discount rate from 10.5 to 11 percent; and then, less than three weeks later, from 11 to 12 percent.  An additional reserve requirement of 8 percent was imposed on the banks.  More important, a fateful shift to monetarism was announced.  The Reserve, Volcker said, would be “placing greater emphasis on day-to-day operations of the supply of bank reserves, and less emphasis on confining short-term fluctuations in the Federal funds rate.”  On February 15, 1980, the discount rate was set at 13 percent.

Despite this conventionally approved strategy, prices kept going up.  In January and February, the inflation rate was 1.4 percent a month, or about 17 percent a year.

Again President Carter took action.  On March 14, 1980, using his authority under the Credit Control Act of 1969, he empowered the Federal Reserve Board to impose restraints on consumer credit.  It immediately ordered lenders to hold their total credits to the amount outstanding on that day.  If they exceeded that amount, 15 percent of the increase would have to be deposited in a non-interest bearing account in a Federal Reserve Bank. The banks and credit-card companies, adopting various procedures, hastened to comply.

All that was good standard economics.  If inflation is caused by too much money, the obvious cure is to reduce the amount of money.  President Carter and Chairman Volcker were in complete agreement.

The new policy had an immediate effect that, surprisingly, surprised the president and the Chairman.  Not only did sales slow down, as expected, but profits did, too-as should have been expected.  The automotive industry cried hurt almost at once.  General Motors reported an 87 percent drop in profits, and Ford and Chrysler reported losses.  The housing industry saw trouble coming as well.  It even appeared that consumers were taking seriously their leaders’ pleas to cut down consumption:  Some credit-card companies found their cardholders responding to restrictions by borrowing less than now permitted.

Alarmed by these and other complaints, the Reserve relaxed the new regulations after two and a half weeks, cut the reserve requirements on May 22, lowered the discount rate on May 28, and abolished the credit controls on July 3, whereupon the president rescinded the Board’s authority to act.  It was all over in three and a half months, in plenty of time for the nominating conventions.  Everyone pretended to be pleased with the result, and in fact the inflation rate did fall, but not below the double-digit range.  Still, Carter had shown that he could “kick ass” (his phrase), so he won renomination.  His hope of reelection, though, was dashed.

As Jimmy Carter moved back to Plains, Georgia, he must have wondered why inflation remained high.  The OPEC turbulence had subsided.  Hoarding had largely stopped.  Cutting consumer purchasing power had brought on instant recession.

Conventional theory has taught us to look at the money supply, or the budget deficit, or the trade deficit in seeking an explanation for inflation, since it is supposed to follow when these are high and going up.  Well, M1, the measure of the money supply the Federal Reserve claimed to control, went from 16.8 percent of GNP at the start of Carter’s term down to 15.3 percent at the end.  Carter’s reputation as a spendthrift notwithstanding, the budget deficit, again as a percentage of GNP, was lower in every one of his years than in any one of Ronald Reagan’s.  As for international trade, the deficit on current account was four and a half times greater in Reagan’s first term than it was under Carter, and of course in the second term it pierced the stratosphere- where on a clear day it can still be seen.

Carter’s mistake- and the mistake of the American people-was the common one of simply accepting what someone says he or she is doing.  Everybody, including the Federal Reserve Board itself, believed its contention that it was fighting inflation by encouraging the interest rate to soar.  Meanwhile, in the last two years of Carter’s term the nation’s interest bill went up 51 percent, although the outstanding indebtedness increased only 23 percent.  In addition to the fall in M1 that we’ve noted, the board increased the federal-funds rate 68 percent and the New York discount rate 59 percent.  In 1951 (when the Reserve started its well-publicized wrestle with inflation) it took only 4.59 percent of GNP to pay all domestic nonfinancial interest charges.  The Reserve pushed the rate up, in good years and bad, until it stood at 15.04 percent at the end of Carter’s term. (It’s much higher now [in 1989].)

It is generally recognized that Volcker slowed inflation (he obviously didn’t stop it) by inducing a serious recession, (if not depression) in 1981-83. Putting aside the question of whether causing so much grief was a noble idea, we may ask how pushing the interest rate up caused the recession.  The answer, of course, is that it made goods too expensive for most consumers.  Standard economics, though it pretends the consumer is supreme in the marketplace, perversely believes that consumption is a bad thing.

Goods became unaffordable for two reasons.  On the supply side, interest is a cost of doing business; so the prices businesses charged had to cover all the usual costs, plus the cost of usurious interest.  On the demand side, interest is a cost of living; so the prices consumers could afford were reduced by the interest they had to pay.  Usurious interest pushes prices up and the ability to pay down.

Had the interest rate not risen, wages would probably have risen.  Unemployment would certainly have fallen.  More people could have bought more things.  More producers could have sold more things.  Prices might have gone up until could no longer afford to buy; but if so, that stage would not have been reached so quickly or so inexorably as with usurious interest.  And those who had money to lend would have been worse off, unless they were wise enough to invest their money in productive enterprise or spend it on consumption.

Would instant Utopia have been achieved?  Of course not.  The point is that the conventional policies of Jimmy Carter and Paul Volcker were good for lenders but bad for everyone else

The tests of a “sound” economy that people still chatter about-a stable money supply. A balanced budget, and a favorable trade balance-all were worse under Reagan than under Carter.  Inflation was worse under Carter-and defeated him-because the interest rate was higher.  Professor Burns rightly fears that we will not find leaders able to organize power to handle the usual social and international problems.  I fear that we are even less likely to find leaders capable of understanding and leading us out of the slough of conventional economics.

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


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