Archive

Tag Archives: Marcel Proust

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 September 22, 1997

1997-9-22 Why a Zero Deficit Means Failure titleI DON’T want to alarm anyone, but I think it important for us to realize that the United States of America is about to sail into unfamiliar waters. What is more, those waters are inaccurately charted.

Many years ago I had occasion to consult charts of the Aegean Sea, the island pocked body of water between Greece and Asia Minor. From 1522 to 1912 the principal southern islands were occupied by the Ottoman Turks, and from 1912 to 1947 by Italy. I used British revisions of charts originally prepared by the Italian Navy. Scores of tiny islands and mid sea rock formations had notations beside them: “Reported 2.6 mi.   north, 1949,” or “Reported 1.9 mi. south, 1948.”

The economic waters we are now entering are at least as badly charted. The years 1947, 1948, 1949, 1951, 1956, 1957, 1960, and 1969 are the only ones since the great Crash of 1929 in which we managed to balance the Federal budget. As we shall see, what happened in those eight years is the diametrical opposite of what is generally assumed, and our misconception is driving us in an unexpected and unhappy direction.

We need to understand this because we are approaching another balanced budget much faster than anyone thought possible. Indeed, the embarrassing fact is that tax revenues are so good in today’s relatively affluent society that the budget would balance itself in a couple of years if Congress just sat on its hands and watched[1].

The universal mantra has been that we must at any cost balance the budget by 2002. We came within two votes of .launching a Constitutional amendment to that effect. I suppose most people have forgotten the reasoning behind the mantra. Forgetfulness, of course, is what mantras, like the Big Lie, are for. No matter.

The various reasons that were given for balancing the budget a couple of years ago appear to have been reduced to one: President Clinton, House Speaker Newt Gingrich and all their economic advisers say that the balancing will lower the interest rate and hence save good citizens money as well as make for prosperity.

Yes, but I seem to remember that six months ago-on March 25, 1997, to be precise-the Federal Reserve Board kicked the Federal funds rate up a quarter of a point, and soon thereafter every other interest rate went up at least that much. What was the budget news then? There was certainly a noisy squabble going on, but was there anyone, inside the Beltway or out, who was proposing to increase the deficit? If no one was even thinking about such a thing, why did the interest rate go up?

We don’t have to reach back as far as March 25 for incongruities. In the midst of the budgeteers’ recent self-congratulations, the Bureau of Labor Statistics of the Department of Labor announced that the official unemployment rate had fallen to 4.8 per cent (it’s since crept up a tenth of a point or two). That prompted a flood of professional prophecies that the Federal Reserve Board would have to (the Board seems never to act of its own free will) raise the interest rate again to keep more people from getting jobs.

And shortly thereafter the International Monetary Fund, well-known for its conventional views, cautioned that “undue delay in tightening monetary policy could undermine the current expansion.”

Look at the crosscurrents we have drifted into:

  • News about an imminent budget balance, which is supposed to presage prosperity.
  • News about falling unemployment, which you might think would be an essential element of prosperit
  • Prophecies about necessarily rising interest rates, which must be bad if it’s good to balance the budget to get lower rates.

While we were being buffeted by these currents, Federal Reserve Chairman Alan Greenspan made his semiannual reports to Congress, partly televised on C-Span.

I always look forward to the televised versions of these reports, because they often include questions by Congressmen and answers by the Chairman. The Times and the Wall Street Journal usually provide little more than a summary of the Chairman’s prepared remarks. Constant readers may remember my excitement two years ago (“What Greenspan Really Told Congress,” NL, July 17-31, 1995), when I scooped the world with the news that Greenspan doesn’t believe in NAIRU (or a natural rate of unemployment), that he doesn’t think we must have high interest rates in order to sell our bonds, and that he does think the increasing inequality of incomes is the most serious economic problem now facing the United States.

No doubt chagrined by my scooping them, the rest of the media have not noticed my reportage (though I have a videotape of Greenspan’s words). Neither were they moved to fully report Greenspan’s latest testimony, although in the course of it he had a wary yet respectful exchange with Congressman Jesse L. Jackson Jr. of Illinois.

Jackson questioned the wisdom of relying on the official unemployment figures, since they count as unemployed only people who looked for work last week. A better number, Jackson suggested, would include those too discouraged to continue looking for work, those too turned off ever to have looked for lawful work, those working part time when they would rather work full time, and those slogging away at jobs for which they are overqualified. If all these people were counted, Jackson said, unemployment would be nearer 20 million than the officially reported 6 million or 7 million.

1997-9-22 Jesse L. Jackson Jr..jpgGreenspan replied that he did not know enough about the people Jackson mentioned to use them as a basis for policy, but he acknowledged that they exist. His acknowledgment is my scoop for this week. For I submit that an economy incapable of providing proper jobs for 15 or 20 per cent of its work force is not an adequate economy. It may be “prosperous,” but it does not come close to doing what an economy ought to do. So we have a fourth crosscurrent to reckon with as we approach the waters whose charts are questionable.

PRESIDENT CLINTON and Speaker Gingrich and practically the entire economics profession, as I have said, are united in steering us toward a balanced budget on the theory that this will reward us with lower interest rates. A look at the records, however, reveals that in every one of the eight post-Depression years with a balanced Federal budget the prime interest rate (to which most rates we pay are related) went up, not down. We must conclude, therefore, that either our leaders or the records (or both) have lost their bearings. Clinton, for instance, claims credit for reducing the Federal deficit and says it has resulted in lower interest rates. Granted, recent budgets have boasted a reduced deficit. The Republicans, not surprisingly, insist they brought about the reductions, but that’s not what is plainly wrong with the President’s story.

What’s wrong is that although the deficit has gone down in all five years of his watch, the interest rate went up in three of them -1994, 1995 and 1997-and the prime rate is now two full points higher than it was when Clinton took office.

In other words, five years of reinventing government-of “it’s the economy, stupid”; of the end of welfare as we know it; of the end of the era of big government-have brought forth, not a decrease, but an increase of 32 per cent in the prime interest rate. The emperor, his advisers and his loyal opposition may have plenty of new clothes; they just have them on inside out and backward. There is no empirical evidence whatever that a falling deficit causes or inspires or favors or even accompanies lower interest rates.

Nor is there evidence for a contrary causation: A high deficit has not automatically produced high interest rates. Consider the famous years 1981 through 1986, when Ronald Reagan was President and Paul A. Volcker was the Federal Reserve Board Chairman. The prime interest rate fell from 21.5 per cent to 7.5 per cent. Was this the result of a falling budget deficit? Hardly. The deficit more than tripled in those years, and the interest rate went down at an equally record breaking pace.

Conventional economics, incidentally, teaches that high deficits cause high inflation, and that high interest rates cure inflation. Consequently, true believers should expect that inflation soared in the Reagan- Volcker years. Again the records belie conventional expectations. In 1981 the annual change in the Consumer Price Index was 10.3 per cent. In 1986 it was only 1.9 per cent.

In short, the economic waters we are now entering are charted to correlate high deficits with high interest rates and low inflation. A realistic mapping, though, shows that low or nonexistent deficits are not associated with falling interest rates, while high interest rates are commonly associated with high inflation.

The discrepancies between the conventional view of the economy and its recent performance lead me to suggest the future may prove Proust was right in observing that our desires may be fulfilled on condition that they do not bring the happiness we expect of them. We may succeed in balancing the budget, but it is exceedingly unlikely that the interest rate will fall as far as our leaders and advisers expect. Even if the rate should drop a point or two, it is unlikely that business will correspondingly expand. If anything, a balanced budget will act as a constraint on business, in the same way that the drive for a balanced budget has constrained expenditures for maintaining our infrastructure, for improving the lot of the disadvantaged among us, and for nurturing progress in the arts and sciences.

Is there no limit to the deficit that we can sustain? Sure there is a limit. My father advised my wife and me always to stretch a little when buying a home for our family. That way we could, and did, steadily improve our standard of living. Naturally, we had to be able to pay the interest on our successive mortgages. It is the same with a capitalist nation. Capitalism is based on borrowing as much as it can from the future in order to build for the future.

A zero deficit is a confession of a failure of faith in the future, especially when 20 million citizens lack proper jobs.

The New Leader

[1] As it happened, over the four years following the publishing of this article the Clinton Administration balanced the Federal Budget four years running: http://www.factcheck.org/2008/02/the-budget-and-deficit-under-clinton/

%d bloggers like this: