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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

By George P. Brockway, originally published January 29, 1996

1996-1-29 The Assumed Employment Virus Title

I SEE BY THE PAPERS that big corporations are downsizing their economics departments. IBM and GE have eliminated theirs altogether. Others are keeping a few people on for special projects, but still are outsourcing from one think tank or another when they want to know about the economy.

There is poetic justice in this, for economists have not been bashful about claiming credit (if that is the right word) for developing the theory of productivity. That allows the sensitive readers of the Wall Street Journal to call their brokers and take a position in the stock of any company announcing its intention to fire 10,000 or more employees, particularly those with 20 years of service or better.

I do not mean to gloat. Some of my best friends are economists; moreover, intellectual life in America is thin enough without sending more PhDs down to swell the ranks of telemarketers anxious to interact with me during my happy hour about a new exercise machine or a new insurance policy. No, I don’t mean to gloat, but I do intend to seize the day to fret a bit about the state of the profession.

I became concerned about the profession when I sent my brother a copy of my first book. He thanked me in due course, and congratulated me, but he didn’t pretend he had read it, nor did he promise to read it. “After all,” he wrote, “I doubt that I’ve ever in my life read an economics book straight through. You can hardly expect me to break that record now, even for my kid brother.” So far as I know, he never did.

My brother was not a dope. He was far from adopting what James Truslow Adams a half century ago called “the mucker pose.” He held both the baccalaureate and a doctorate from Harvard. He traveled widely and read widely. All his life he was involved in community affairs. But he couldn’t be bothered with economics. When I pressed him for an explanation, he said, “You people claim to be scientists, but you disagree with each other about everything. No two of you speak the same language. Some of you seem not speak any language.”

Although my brother was not a dope, I’m inclined to think that in this case he was almost precisely wrong. Economics is not a science, and the discipline’s practitioners tend to agree too much. Especially about the wrong questions.

One of the puzzles of contemporary economics is the number and variety of theories – including those most prominent in the universities today – that trace their origin to sensationally different journal articles, yet all end up advocating laissez-faire or something remarkably close to it. The puzzle is of course the greater because, not so long ago, the Great Depression and World War II seemed to have laid laissez-faire permanently to rest.

General Equilibrium Analysis, Monetarism, the Neoclassical Synthesis, and Rational Expectations are among the schools affected. In computer jargon, one might say that a virus has attacked them all, disrupting programs, infiltrating compositions, corrupting data bases.

We didn’t use to think of mathematics or logic in such highly charged terms. We were well aware that an error at any point in an exercise would render all that followed suspect; but our exercises used to be more insulated from each other, so that our assumptions were more frequently considered.

Be that as it may, I believe it can be demonstrated that something like a virus has indeed infected most contemporary models of the economy. We may give the virus a name: the Assumed Employment Virus.  For it is an assumption or presumption that the economy is operating either actually or effectively under conditions of full employment.

The Assumed Employment Virus appeared almost contemporaneously with The Wealth of Nations in 1776, but no one noticed for a century and a half. It was not until the Great Depression that providing employment was recognized as an economic problem. Adam Smith, for example, devotes a few pages to the comparative wages of different “employments” and to the “price of labor” generally. Yet the only unemployment he takes notice of is the seasonal one of bricklayers and masons. He pays some attention to the “Poor Laws” (which for 400 years were a staple of British fretfulness, the way “welfare as we know it” continues to occupy us), but seems not to have considered the possibility of, and need for, regular employment for the poor.

The “classics,” or most economists from Smith to the middle of the 20th century (except Karl Marx), presumed that all laborers could get jobs, no matter how bad the times, if they merely lowered their wage demands to what entrepreneurs offered. It was not suggested that in bad times (or at any time) entrepreneurs should pay a living wage at the expense of the going rate of profits. Bob Cratchit was a fortunate man, even though he couldn’t afford adequate medical attention for Tiny Tim. In modern jargon, entrepreneurs were forced by market discipline to cut wages. Laborers were free to accept jobs that would allow them to starve to death. As Phil Gramm and Dick Armey taught undergraduates only the other day in Texas, those who lacked jobs were unemployed because they didn’t want to work. There was no such thing as involuntary unemployment.

It remained for John Maynard Keynes to demonstrate why involuntary unemployment is a fact of laissez-faire life. He observed “that men are disposed … to increase their consumption as their income increases, but not by as much as the increase in their income.” If the resulting weakness in demand is not countered by investment (sooner or later by government investment), production will be decreased, and workers will become unemployed – involuntarily.

Laissez-faire theorists have tried to refute Keynes’ demonstration by presenting arguments that unemployment cannot be reduced to zero. The Monetarist Milton Friedman came up with the first of these -the Natural Rate of Unemployment (whatever is natural is ipso facto involuntary), now usually referred to as the Non-Accelerating-Inflation Rate of Unemployment, or NAIRU. It has also been called the Normal Rate, the Warranted Rate, and (in a triumphal oxymoron) the Full Employment Rate.

There is a sort of reason behind even that last name. All of the involuntary unemployment arguments maintain either that unemployment cannot be reduced below the mentioned rate, or that if it is temporarily reduced (and it can only be reduced temporarily), it will be followed by some unacceptable consequence, usually inflation without limit. If at some point policy forbids, for whatever reason, further reductions in unemployment, why not call that point Full Employment?

The Rational Expectationists, whose leader was recently crowned with a Nobel Memorial Prize, make the problem easy for themselves. It is, they say, rational to expect the economy to behave as the classics would have it; so involuntary unemployment doesn’t exist, and laissez-faire does.

In effect, then, for most contemporary economists both voluntary and involuntary unemployment amount to full employment. Distinguishing among the three terms would saddle scholars with two extra variables that could enormously complicate their equations. The obvious course is to simplify by using one term for three. It is with this simplification that the Assumed Employment Virus enters today’s models.

ONCE THE VIRUS is in the models, two things happen. First, since full employment is now an unequivocal term in an equation, the equation can be solved for it. Full employment is no longer a mere possibility or desideratum or dream but an eventuality, if not a determinate actuality – just as in General Equilibrium Analysis the “proof” of the possibility of an equilibrium quickly entails proof that an equilibrium exists, and that it is optimal. Second, since full employment is at last one of the prime objectives of any modern economic policy, any model containing the virus has apparently proved the achievability of the objective, and it can therefore be assumed. Whatever still remains for the economy to do can be done with comparative ease. In other words, take it easy: laissez-faire.

As might be expected, the Assumed Employment Virus, having successfully infected models of the economy as a whole, has had equal success in confusing more restricted models. Thus the proofs of Keynes and Michal Kalecki that saving equals investment have been used, and are still used, to justify the constant cries for decreased consumption and increased saving. (The proofs merely mean that whatever is invested has been saved; they do not mean that whatever is saved is invested.)

More to our present point, in the absence of truly full employment, too much saving can actually be, as Keynes was at pains to emphasize, a bar to investment as well as to consumption. Because what is saved cannot be consumed, saving reduces demand; and when demand is reduced, prudent entrepreneurs are not emboldened to invest in new production to satisfy it. Consequently, the recurrent schemes to encourage saving are generally either unproductive or counterproductive. In the 1993-94 debates over NAFTA and GATT,   Ricardo’s Law of Comparative Advantage was similarly cited regularly without acknowledgment or recognition of its dependence on the assumption of full employment.

It is obvious enough that a nation is neither enriched nor strengthened if substantial numbers of its citizens lose their jobs and are kept unemployed while the nation imports some product these citizens once made or could now make. This manifest truth is, however, rendered irrelevant by the Assumed Employment Virus.

Those who have been downsized into joblessness (including the economists we mentioned at the start) are likewise victims of the Virus. The standard productivity index is derived by dividing the Gross Domestic Product (GDP) for a period by the number of hours worked during that period. The index is a common fraction, so it will naturally rise if the denominator (“hours worked”) is reduced; hence the rush to downsize everything from the Federal government to the local supermarket.

“Productivity” may thereby be improved, but production (which is not an index number but actual goods and services produced for actual people to use and enjoy) falters. The victims of downsizing, being now unemployed, necessarily reduce their consumption, that is, the demands they make upon the economy. Entrepreneurs, faced by this reduction in demand, reduce production, which of course leads to a reduction of the GDP.

It would be different if full employment were the actuality rather than a deluded assumption caused by a “virus” in economists’ models. As long as there are unemployed workers, though, the first mission of macroeconomic policy should be to increase “hours worked”-that is, employment. This is not to say that we need a return of the Luddites. It is to say that we need economists dedicated to devising policies that will make full employment a hard reality instead of an easy assumption.

The New Leader

By George P. Brockway, originally published July 17, 1995

1995-7-17 What Greenspan Really Told Congress titleTODAY’S LESSON will be in two parts. The first will be an exhibition of a complaint; the second an exhibition of a gleam of hope for better times in this nation and this world and even this dismal science.

The complaint concerns the press, particularly the business press, which is so busy collecting meaningless quotes from pseudo-prominent bankers and brokers that it fails to notice the story it is presumably covering. For example, on July 19 Chairman Alan Greenspan of the Federal Reserve Board, who is as entitled as his predecessor to be called “the second most powerful man in America,” appeared before a subcommittee of the House of Representatives in accordance with the provisions of the Full Employment Act of 1978, otherwise known as Humphrey-Hawkins.

Now, Humphrey-Hawkins has not had a good press. In his excellently useful Presidential Economics, Herbert Stein says that its “goals are so unrealistic and inconsistent that they are not taken seriously by anyone.” Still, it is the law of the land, so Greenspan duly appeared on the Hill, surrounded by advisers and armed with a prepared statement plus supporting documents. At least some of the Washington press corps came to pick up the handouts and perhaps lend an ear to part of the subsequent testimony. It was a routine assignment.

The shape of a Greenspan news story is now well established. The question always is, will-he-won’t-he raise (or lower) the interest rate? The Chairman always answers it, to the delight of his audience, in his personal version of Casey-Stengelese. Thereupon the reporter interviews a clutch of brokers’ economists for their differing interpretations of what he said, and offers the thoughts of a smaller clutch of Congress people or government officials.1995-7-17 What Greenspan Really Told Congress Joseph Kennedy

And so it was with the New York Times account of the latest Humphrey-Hawkins affair. Three brokers’ economists were interviewed – one from Minneapolis (thus showing that the Times is a national newspaper), one from New York, and Allen Sinai. Sinai is from New York, too, but he is quoted in almost every story and I assume must be considered universal. Of the Congress people, the Times made do with a mildly querulous comment by subcommittee member Joseph Kennedy II (D.-Mass.) and a reverential tribute to the Reserve and its leader

By House Banking Committee Chairman Jim Leach (R.-Iowa). All in all, the 28-inch Times story (counting picture and headlines) did not do much more than, as the saying goes, keep the advertising columns separated (a problem we rarely have at THE NEW LEADER).

As it happened, however, Chairman Greenspan interspersed among his answers to questions from the Congressional panel several profound, profoundly astonishing and profoundly hopeful observations. The Times missed them all, and so did the Wall Street Journal. That’s the complaint I promised.

But fortunately for you and posterity, I was channel-surfing[1] the next day and came upon CNBC, which was using clips of the Humphrey-Hawkins hearings to keep sections of its Money Wheel separated. The first clip I heard stopped me short.

“I don’t believe,” Greenspan was saying, “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.”

Well, you may be sure that I stopped surfing and anchored myself to CNBC. At considerable trouble and expense I also now have the whole thing on videotape. If you want a good journeyman definition of the barbarous notion of a natural rate of unemployment, you can do worse than settle on “a particular unemployment rate that is something desirable in and of itself.” In his December 29, 1967 speech that named the cruel notion, Milton Friedman put it as follows: “At any moment of time, there is some level of unemployment which has the property that it is consistent with equilibrium in the structure of real wage rates.”

During the 28 years since Friedman made his speech, one or another of several theories of a natural rate of unemployment has swept through the economics profession. Some of the theories depend on productivity rankings; some on a distinction between nominal wages and real wages; some on both; some on neither. But all agree that the rate of unemployment is so linked to the price level that as one goes up, the other goes down. The linkage is not explained; it goes without saying. Everyone presumes that a fall in unemployment will “force” the Federal Reserve Board to damp the “inevitable” inflation by raising the interest rate. In fact, this presumption explains most of the gyrations of the interest rate during Greenspan’s tenure. (For a detailed refutation of the linkage, see the September issue of the Journal of Economic Issues self-advt.)

Now we have heard Chairman Greenspan repudiate the natural rate nonsense. If the second most powerful man in America can do that, there is hope for the rest of us.

From December 29, 1967, to date, economic thought in the United States has been stopped dead because the fundamental economic problem was solved. To be sure, it was solved the way Ko-ko explained the solution of his problem to the Mikado: “Your Majesty says, ‘Kill a gentleman,’ and a gentleman is told off to be killed. Consequently that gentleman is as good as dead-practically, he is dead and if he is dead, why not say so?”

In the same way, Paul Krugman, self-proclaimed spokesman for mainstream economics, writes: “Most of the 5 million or so unemployed are either unskilled or part of the inevitable ‘frictional’ unemployment.” In other words, there are no employable unemployed; hence there is no unemployment problem. Furthermore, says Krugman, “adding 2 million jobs, if we could do it, would drive the U.S. unemployment rate down to about 3 per cent. But that isn’t possible, or at any rate not for very long. At that low unemployment rate, inflation would begin to accelerate rapidly.”

Having grossly underestimated the number of unemployed and having arrogantly dismissed as useless their fellow human beings who make up that number, mainstream economists have embraced the theory of the natural rate of unemployment and simply declared joblessness a non-problem. This has left them free to spend the past quarter century pondering such weighty concerns as “Games with Incomplete Information” (the lead article in the current American Economic Review). Perhaps Greenspan can guide us to a fairer land.

INDEED, the Chairman took another step in that direction as the Humphrey-Hawkins hearings wore on. He was asked if it would be possible to lower interest rates and still have our bonds attractive to German and Japanese investors. Greenspan’s reply was short and to the point: “I’m not aware that we have had very many difficulties selling the debt – the Federal debt – at low interest rates.”

It was very brave of Greenspan to make that statement. Not only does it give the lie to his six-foot- four predecessor – who claimed the budget deficit forced high interest rates that crowded entrepreneurs out of the credit market – it undercuts his own words regarding the deficit. He is for balancing the budget (but no constitutional amendment) because, he said, “there is no doubt, in my judgment, that the net result of moving to budget balance will be a more efficient and more productive U.S. economy.” In forming that judgment he can scarcely have considered what is going on in Washington today or what will happen throughout the nation thanks to these “revolutionary” goings-on.

Nor can he have considered his own power over the deficit. The interest bill on the national debt is at present roughly equal to the budget deficit. A fraction of the debt is rolled over every year. If the new loans were issued in accordance with the “patterns of rates” followed by the Reserve and Treasury during World War II, the reduction in the interest bill alone would practically eliminate the deficit by the mystic year 2002 -and not a single welfare family would have to camp on the public sidewalk while the mother begged for a nonexistent job.

I don’t suppose you are willing to bet anything like that will happen. (It would be a good “derivative” to have the other side of.) You’re right, but it is not some esoteric economic law or some superhuman market that will prevent the happening. The reason, rather, is that we the people of the United States of America care more about money, and individuals with money, than we do about our fellow citizens and ourselves.  We should at least recognize that we are in the deficit mess (if it is a mess) not because too few people are unemployed, but because for the past 40-odd years relatively high interest rates have transferred money from the many who do the work of the world (including the government) to a comparatively few bankers,  rentiers and speculators.

The transfer has not escaped Greenspan’s attention. In response to a question from Congressman Kennedy he said, “Evidence suggests in recent years that income is being dispersed rather than concentrated [that is, the rich are becoming richer, the poor poorer, etc.]. … 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.”

Unfortunately, Greenspan did not see that there was anything the Federal Reserve Board could do to change the situation. He did not mention anything anyone else could do either, beyond the new obligatory red herring of higher education for competing in the coming world economy.

Nevertheless Greenspan had a vital three-part message: First and most important, there is no such thing as a natural rate of unemployment, therefore there is work aplenty for economists eager to grapple with real problems of the real world. Second, Federal Reserve policies based on the alleged crowding-out concept can now be forgotten. Third, we should embrace policies that unite us, because policies that divide us may well prove ruinous.

Greenspan’s message permits the gleam I mentioned at the beginning. Put into practice, it would make a better nation, a better world and a better economics. It’s a pity the Times, the Wall Street Journal and the rest missed it.

The New Leader

[1] Ed. – many who knew the author well are reeling, shocked, that he knew how to spell “channel-surfing” much less had a concept of what it was… God forbid he did it!  Oh!  How delicate the façade!

By George P. Brockway, originally published September 12, 1994

1994-9-12 Practicing 'Escalito' on the Economy titleWHEN ALAN BLINDER, the new vice-chairman of the Federal Reserve Board, happened to suggest last month that the rate of unemployment was a legitimate concern of public policy, the financial press typically tried to discover a personality clash between him and Chairman Alan Greenspan. Blinder insisted that there was no personality or policy clash. That’s a pity, because Greenspan’s policy has only weak and tangled connections with either experience or theory.

Over a year ago (see “The Reserve Takes Flight Once Again,” NL, August 9-23, 1993) he abandoned his prevailing theory and promised a new one. Since then what we have been given are at least four unoriginal theories that seem to lack any special relationship – except that they are all current notions of the Federal Reserve Board, and that each is to be implemented by fiddling with the interest rate. Maximizing four unrelated programs by a single action might be thought an improbable long shot, if anyone took them seriously.

The oldest of the four is the monetarist scheme of setting a target for the growth of the money supply. Milton Friedman held that the target should be 3 to 5 per cent, and that it did not matter how you measured the supply so long as you were consistent. Greenspan denigrated the concept last year, but went ahead anyhow and set a target for M2 between 1 and 5 per cent. Since M2 is currently growing at the low rate of 0.6 per cent, disciples of Friedman should be worrying about deflation rather than inflation.

The second program calls for a “neutral” rate of interest, which is apparently a rate that will neither heat up the economy nor cool it off. Sometimes the objective is said to be a soft landing. In other times and other metaphors, this was called “fine-tuning.” It has for many years been ridiculed, especially when suspected of being advocated by liberals.

During the summer a TV interviewer tried to get Wayne Angell – until recently a governor of the Reserve, and now an officer of a brokerage house – to say how the Board would know what to do in order to be “monetary neutral.” Were there “indicators” that reliably pointed to increasing or decreasing the rates? “No,” Angell answered. “It’s something you can’t precisely do. It’s a matter of the ‘best guess’ opinion.” He added that it would be a clever idea for the Reserve to overshoot the mark and then bring the rate back down. “That way,” he enthused, “the bond market would really take off!”

For a while after the interview there was talk of investigating the possibility that Angell was leaking information from a crony at the Reserve. My fear is that he was delivering one of the Board’s famous messages, and that the nonsense he divulged will be next month’s official policy. Is what’s good for the bond market necessarily good for America?

The third program we hear a lot about concerns the “real” interest rate – determining what the rate would be if there were no inflation, and allowing banks to compensate accordingly. This, it appears, is a particular pet of Chairman Greenspan’s. As I have said before, adding an inflation premium to the “real” rate amounts to giving lenders a Banker’s COLA that is ipso facto inflationary and already costs the economy upwards of $500 billion a year.

The claim is that bankers must have this COLA or they won’t lend, and the economy will stall for lack of investment. But the supposed shortage of funds to invest is nonsense. The securities markets are awash in money. Why else do they have to invent $41 trillion in “derivatives” in order to have enough stuff to sell to meet the demand?

The fourth and most obvious scheme is analogous to the bombing strategy pursued a quarter century ago under the code name Rolling Thunder, whereby, as Tom Lehrer put it, we “practiced escalation on the Vietnamese.” That is to say, we would bomb a little bit; if they didn’t give up, we would bomb a little bit more; if they still wouldn’t give up, we would go after them again, and again, and again, escalating the attacks so they could see we were serious.

In the same way, the Federal Reserve Board is now engaged in bombing the economy bit by bit in order to send the message that it is serious about inflation. Considering that the message has to be repeated until everyone gets it, I think it a shame that the information highway is not yet in operation. Couldn’t the idea be passed around by e-mail[1]?

In any case, these disparate programs are to be brought to coincidental fruition through the buying and selling of Treasury securities by the Federal Open Market Committee. That is not a coherent policy; it is a four-ring circus of guessing games.

Besides the performances in the main tent, Greenspan has two sideshows. The first, learned years ago from Ayn Rand, is based on the extraordinary notion that speculators in gold are infallible judges of the imminence of inflation. So he keeps his eye out for any increase in the price of gold.

The second, which is brand new, relies on the fact that years with low inflation tend to post high productivity gains, and vice versa. There are said to be some glitches here, and two staff economists have been detailed to fix them. My bet is that they won’t be able to fix them in a way that will give their boss another excuse to raise interest rates, because while years of low inflation are years of high productivity, they are also years of low interest rates.

In 1964, for example, productivity gained 4.3 per cent (its highest record since World War II), while the Consumer Price Index advanced only 1.3 per cent (one of its lowest), and the Federal funds rate was 3.5 per cent (also among the lowest). Ten years later, productivity fell 2.1 per cent (its worst performance), the CPI hit 11.0per cent (its third worst), and the Federal funds rate was 10.5 per cent (its fifth worst). A high interest rate is evidently a guarantee of decreased productivity. As I’ve said before, I don’t subscribe to standard productivity theory, but I do think it only fair that those who live by it should die by it.

Raising the interest rate has an inflationary effect because interest is a universal and inescapable cost of doing business. It is also a universal and inescapable cost of living. It is an explicit cost when you borrow money to run your business or buy your new car; it is an implicit or “opportunity” cost when you use money you have instead of lending it to someone else and earning interest yourself.

People think of the inflation of the ’70s and early’ 80s as having been caused by OPEC price-fixing, but interest then (and always) was a far greater cost to the economy than oil. The Federal Reserve Board, foreseeing inflation (then as now), rushed to head it off (then as now) and raised interest rates. As a consequence, instead of an oil-driven inflation, we got an oil-and-interest-driven inflation, and the prime rate reached 21.5 per cent before it all ended in a recession that the Reserve deliberately sought.

Interest rates must be raised again and again, because with every hike, prices rise to cover costs. The Federal Reserve Board then has actual rather than feared inflation to deal with, and so up go the rates once more. The only end to this game is recession. Just as in Vietnam we destroyed a village in order to save it, so the Federal Reserve is willing to destroy the price system in order to save it.

THE PRICE SYSTEM is far from monolithic. If it were, all prices commodities, wages, interest, taxes, the lot-would go up in lockstep, and no one would be much hurt. The part of the system that the Reserve worries about is a numerically small part of the economy-essentially banks, securities exchanges, and the investors (mostly functionless investors) who exploit them. This part of the economy produces no wealth itself but makes fortunes arranging and rearranging the wealth produced by others. We may call it the Speculating Economy. It is the price system of the Speculating Economy that the Reserve acts to protect.

Now, it is no secret that the cost of labor is several times the cost of interest. Therefore when wages (including multimillion-dollar executive salaries) go up, we might have a wage-price spiral instead of an interest-price leapfrog. But no wage-price spiral has ever spun into recession (except, as in Weimar Germany, when prices and wages are indexed and the nation has massive debts denominated in foreign currencies), whereas every interest-price leapfrog, if not abandoned by the monetary authority, ends in recession.

It is common knowledge, and freely reported by the press, that the Reserve practiced escalatio on the economy this past spring and summer. It really wanted to hurt the housing market, because it wanted to hurt the construction industry, because it wanted employment reduced and wage scales constrained, because it wanted to send a message that it was serious about inflation.

If you are not profoundly shocked by that last sentence, please read it again. It shows the depths of savagery below which we have fallen. I say “below” because even savages tend to share with their fellows in lean times; and those who seek to unload their troubles on a scapegoat usually try to choose one arguably blameworthy. Our behavior is not so civilized. In lean times we become mean, and we boast of it.

Since we are all members one of another, since what we do unto others we do to ourselves, the most important of the costs of production is labor. More people are primarily involved in labor than in any other cost, and more people are arbitrarily excluded.

The arbitrary exclusion is an official act of the Federal Reserve Board, an arm of the United States government, which raises the interest rate with the express intent of restricting the employment of labor and preventing increases in the wage scale. This intent has been formed and announced despite the fact that millions of our fellow citizens are living lives of desperation that is not always quiet. The message they receive is that the society has small concern and less respect for them.

The members of the Federal Reserve Board who have raised the interest rate, and the economists and speculators who have applauded their action, may protest that they intended no such message. But the message certainly has been received, and it certainly is as clear as the message that the Federal Reserve Board is serious about inflation.

It is a mark of strength of the American tradition that in relation to their numbers so few of the rejected have lost respect for themselves, developed what the late Erik Erikson described as a negative identity, and lashed out against the society that rejects them. Some at the bottom, though, are already lashing out. They impose such severe moral, emotional and fiscal costs on society (and on themselves) that one must wonder whether the policy of rejection may not be as imprudent as it is unjust.

The New Leader

[1] Ed:  On the one hand, knowing the author, I’m quite surprised he was aware of the term in 1994.  On the other, if he were writing more recently he’d suggest we tweet the info.  Plus ça change….

By George P. Brockway, originally published May 9, 1994

1994-5-9 Unemployment Japanese Style Title

1994-5-9 Unemployment Japanese Style Reuters

I REPRODUCE above in its entirety a news article that appeared on page D4 of the Business Day section of the New York Times for Friday, April 29, 1994. Don’t feel badly if you can’t recall seeing the story in tile paper. It was easy to miss. It ran in the gutter at the very foot of the page and was surrounded at its top and left by an article from a stringer headlined “Denver Airport Date Firm” (on Sunday the date turned out for the nth time not to be firm). If you were the editor of what you proudly and properly referred to as a newspaper of record, and you had a story you wanted to kill yet had to print in order to complete the record, you would handle it in just this way.

I leave to others the task of speculating why the Japanese unemployment story was in fact buried; why, given its explosively dramatic contrast with American and European unemployment records, it was not run as the lead on the first page of the Business Day section, if not on the front page of the entire paper; why the bare numbers were not accompanied by a backgrounder explaining how the Japanese manage such a low unemployment rate even in the midst of a recession; why nothing about the story has appeared among the concerns of the editorial page or the Op- Ed page; why the Times economics columnists have found nothing to remark on in a report that renders suspect the barbaric but fashionable theory of a natural rate of  unemployment, a smattering of whose arcane details they dazzle us with now and then.

Although I will not speculate, I am interested in that last point. For as I have said often enough, I follow Keynes (and indeed everyone at all capable of empathy with a fellow human being) in holding that an outstanding fault of the economic society in which we live is its failure to provide full employment. The theory of a natural rate of unemployment, subscribed to by almost every conventional economist in the United States, argues that this outstanding fault cannot be corrected without igniting an inflation that would destroy the economy.

The news from Tokyo tells us that the current unemployment rate in Japan, while the highest in six years, is nevertheless lower than the lowest unemployment rate the United States has posted since World War II. I do not have at hand Japanese figures earlier than 1967, but after that date Japan’s unemployment has never been higher than 2.9 per cent and U.S. unemployment has never been lower than 3.4 per cent. The American low was registered during the Vietnam War. Our present rate (achieved during a sluggish peacetime recovery that has scared the Federal Reserve Board silly with nightmares of future inflation) is almost three times the present Japanese rate (achieved during a persistent recession).

These facts strongly suggest that the so-called natural rate need not be accepted as immutable. What the Japanese have done is surely within our capabilities; and given the freedom, not to say volatility, of American life, a 2.6 percent rate would be as near full employment as never was.

The natural rate theory has from the beginning allowed that the rate is not really natural but depends on “market characteristics” that are, as Milton Friedman has said, “man-made and policy-made.” What man and policy make they presumably can unmake. The chief market characteristic complained of by natural rate theorists is a minimum wage law. Emboldened by my recent adventure in investigative reporting (see “Ending Welfare As We Know It,” NL, March 14-28), I phoned six Japanese agencies (four of them official) and one American labor union to find out whether Japan has a minimum wage law. No one knew offhand, but the consulate called me back a couple of hours later to report that indeed Japan has such a law. It is a national law, and it specifies minimum wages for different trades and different localities. I doubt that natural rate theorists, who are firm believers in market discipline, would think it an improvement on the American law.

Let us therefore consider the reaction of conventional theory to a 2.6 per cent unemployment rate. Without doubt the prescription would be for a high-very high-interest rate to contain inflation. Has that been prescribed in Japan? Indeed it has not, nor has such a regimen been followed. Rather the contrary, the interest earned by a 1O-year government bond in Japan is now 4 per cent; with us, the corresponding rate is, as I write, 7.10 per cent and will go higher before you read this, if the present majority of the Federal Reserve’s Open Market Committee has its way.

Well, then, since Japan has comparatively low unemployment and comparatively low interest, it must, according to conventional theory, have comparatively high inflation. But Japan’s price index changed 0.0 per cent in April and, at least from 1967, has never climbed as fast as ours.

IT IS OF COURSE possible that other elements contribute to the differences between Japan and the United States. I can name three that may: import policy, productivity and saving.

We all know about Japanese import policy. It is difficult, devious, protectionist, and successful. Twelve years ago I wrote the first of several columns arguing for a protectionist policy for the United States (“America’s Setting Sun,” NL, June 14, 1982). I don’t propose to repeat myself now, except to remark that Japanese protectionism has obviously not prevented the success of Japanese policies directed toward low unemployment, and may well have been a factor in their success.

Productivity is another question I have addressed several times (first in “Productivity: The New Shell Game,” NL, February 8, 1982). In the present context all that need be said is that American productivity is now, and as far as I have been able to discover has always been, greater than Japanese. In fact, among the leading industrial nations, only British productivity has generally been outranked by the Japanese.

On the other hand, Japan’s GNP has, until the last couple of years, grown faster than ours.  Conventional economic theory, though, is possessed of the altogether unintelligible notion that productivity is more desirable than production. It may work out that way in a mathematical model, but it certainly doesn’t on the dinner table[1].

I have also written about saving and shall do so again, but the problem with respect to Japan is special. In the first place, a 1990 study by Fred Block in the Journal of Post Keynesian Economics demonstrated that the figures usually published overstate Japanese saving and understate American. In the second place, as Block showed, an extraordinary amount of Japanese saving, however defined, goes into speculation rather than production. The real estate (land and improvements) of Japan, a nation whose area is no greater than that of Montana, is, at today’s prices, more valuable than the real estate of our 48 contiguous states (a not inconsiderable amount of which is owned by Japanese). The Japanese stock exchange is notoriously volatile, with daily spikes (or spike holes) of 5 per cent or more not uncommon. Keynes thought Americans were addicted to gambling, but the Japanese seem to have it worse.

1994-5-9 Unemployment Japanese Style Unemployment Office

All of their speculation absorbs enormous amounts of money, but it does nothing for the economy. The money is saved in the sense that although it was earned in the producing economy, it is withheld from use in the producing economy. The withholding is achieved by underpaying large classes of workers, especially women, and by underfunding social services. Because of its hierarchical distribution of wealth and its systematic maldistribution of income, Japan cannot consume all it produces and must sell overseas; thus when foreign markets falter, Japan suffers recession.

In short, neither Japanese import policy, nor Japanese productivity, nor Japanese saving can account for Japan’s low unemployment coupled with low inflation. So is there nothing we can learn from the Japanese record? There are, I think, a couple of things. In the circumstances, the actual virtues (as opposed to the theoretical vices) of some sort of protectionism are very hard to deny, as are the virtues of a steadily low interest rate.

Regarding the latter point, we are told that we cannot afford a low rate because it would stimulate a flight of capital to the Bahamas or the Caymans or perhaps some more exotic land farther overseas. I don’t know about that. Even in the early ’80s, when the prime rate here hit 21.5 per cent, and the Japanese rate was as low as it is now, only a small proportion of the yen flew here. Why did most of it stay home? For the good and simple reason (as Tom Swift used to say) that with a low interest rate Japanese industry could be happily profitable, while the “strong” American dollar caused by high American interest made it easy to penetrate our unprotected market.

A high interest rate (and our recent supposedly low rate was exceedingly high by Japanese standards, as well as by our own pre-1960 standards) is a market characteristic that makes for a high “natural” rate of unemployment. A low rate, contrariwise. The news was barely fit to print. Still, we’d be wise to pay attention to it.

The New Leader

[1] Ed.:  I can’t help but wonder what the author would have thought of Clayton Christensen’s concerns with corporate focus on margins instead of profits as in the Innovator’s Dilemma, and his more recent thoughts on The Capitalist’s Dilemma.

By George P. Brockway, originally published March 14, 1994

1994-3-14 Ending Welfare As We Know It Title

1994-3-14 Ending Welfare As We Know It Moynihan

POLITICAL COMMENTATORS are practically unanimous in telling us that Candidate Bill Clinton’s most popular sound bite in his 1992 campaign was a pledge to “end welfare as we know it.” I don’t recall it that way. Welfare is certainly a part of the economy, stupid; but I doubt that many voters even know what “AFDC” stands for, let alone how it works. My suspicion is that the average middle-class citizen’s interest in the question is nothing more than a mean spirited irritation at anyone (especially anyone who is not a big-time operator) getting something for nothing.

There are three things that especially interest me about the present welfare problem, and I’m going to tell you about all three of them.

First, as near as I can determine, we ended welfare as we know it (or thought we ended what we thought we knew) in 1988, and I wrote about it in this space (“Reality and Welfare Reform,” NL, November 28, 1988). The Family Support Act of that year has a curious legislative history, and an even more curious media history. Senator Daniel Patrick Moynihan guided it to a 93-3 vote in the

Senate on June 16. (A “less stringent” version of the bill had passed the House by 230 to 194 the previous December.) The New York Times ran the story in the lead column on the front page the next day-and almost immediately dropped it. If you search business papers and magazines of that time, you will find little or no reference to the event. I can’t tell you about TV coverage because I’m not a close student of the medium.

I can, however, guess why the course of the bill through the Senate-House conference, the final passage by both houses, and its signature by President Reagan on October 7 attracted little attention. A tip-off is Reagan’s Budget Message of January 9, 1989, which includes funding for the Family Support Act but still reduces “welfare” by $800 million. A further tip-off is the fact that in the following two years 40 states froze or cut Aid to Families with Dependent Children, 11 cut emergency programs for the homeless, nine cut ordinary programs for the homeless, and 24 froze or cut programs for the elderly, blind or disabled. All this happened without causing any public uproar. No one gave a damn one way or the other.

I mention all this because, so far as I can make out, President Clinton’s end to welfare as we know it is the same as Senator Moynihan’s Family Support Act of 1988. Both make a fuss about tracking down “deadbeat dads”; both make a fuss about training welfare mothers for private sector jobs; and both propose to shove people off welfare and into workfare in two years, more or less. It therefore seemed to me it might be helpful to know how the 1988 Act has worked.

Well, I’m not paid to be an investigative reporter, but I tried. A full half hour on hold at the Department of Health and Human Services didn’t even console me with Muzak. Two letters to Senator Moynihan have gone unanswered. An appeal to his press secretary produced a sheaf of papers about the provisions of the 1988 Act, but nothing about its implementation or results. The Budget of the United States Government for Fiscal Year 1994 shows that in 1992 only about two-thirds of a $1 billion appropriation for payments to states with AFDC work programs was spent, and that the estimated outlays in 1993 and 1994 are about three fourths and five-sixths of the respective appropriations. Six years ago Senator Moynihan estimated that his plan would cost $3.34 billion over five years; so it would seem not to have been underfunded, at least on its own terms, but who knows whether it has done any good? Someone ought to answer that question before we end welfare as we know it all over again.

Which brings me to my second point of interest. There exists a fully worked out plan that actually would end welfare as we know it, that would practically administer itself, that would begin to heal the suppurating wound in our society between the haves and the have-nots, and that would start to restore the self-respect of fellow citizens who have become entangled and degraded in our safety nets. Not only does the plan exist, it was for one shining moment a major plank in the platform of a leading candidate for the Presidency of the United States.

The plan is the creation of Leonard Greene, an inventor who bubbles with three new ideas while he’s chatting with you. He’s president of Safe Flight Instrument Corporation, founder of the Institute for Socio-Economic Studies, leader in a fistful of social welfare activities, and author of a book I’m proud to have published titled Free Enterprise Without Poverty. Greene devised his plan in answer to a problem he ran into in his business.

In the course of his civic work he had met and hired a bright and eager young black. The young man was a fast learner and seemed to have a rosy future, when one day, without warning or explanation, he quit. Greene sought him out at home and discovered that his wages, together with his mother’s Social Security and some AFDC payments for younger siblings, would make them too rich for their public housing and Medicaid and AFDC money, but would be far from enough to make up for what they would lose. “Welfare as we know it” would make it smart for him to leave home or not to work. Greene found it easy to collect scores of similar cases.

Greene’s reaction was to figure out how the law could be changed. His solution was beautiful in its simplicity, its comprehensiveness, its practicality, and its fairness. First, each person would take all his or her existing entitlements or transfer payments and put them in one pot. Those that were “in kind” (food stamps,Medicaid, public housing, and so on) would each be assigned a standard cash value that would be added to the cash received from Social Security and other transfer payments.

Second, every citizen, from Ross Perot to the bag lady on the comer, would receive what Greene gave the unfortunate name of a “Demogrant,” which is a sort of guaranteed income similar to what Milton Friedman calls a negative income tax. In most cases this would be a bookkeeping transaction; no money would actually change hands.

Third, all of the foregoing would be added together and taxed at progressive rates, starting, of course, very much higher than the rates do today. In general, none of the poor not now subject to Federal Income Tax would be taxed under Greene’s plan. But Greene’s excellent young man could accept a good job, paying the applicable income tax, without compromising his family’s public housing.

Most important, the hurdles now erected between underclass poverty and full membership in the commonwealth would be removed. The course would still be far from the level playing field demanded by the Wall Street Journal for speculators; but it would at least be a smooth upward path, and reasonably diligent young people could hope to do reasonably well on it.

I REMEMBER (more clearly than I remember talk about welfare reform) that hope was a steady theme in Clinton’s campaign message. As long as the inhabitants of the inner cities and the rural slums are without hope, we have no hope of solving the problems they make for society as a whole as well as for themselves. Conrad had it right: “Woe unto him who has not learned while young to love, to hope, and to put his trust in life.” The same woe threatens a nation.

Obviously, there would be complications in the Greene plan, especially as old plans were phased out and the new one was phased in. Yet work would not be discouraged, families would not be broken up, and everyone would be on the same scale as everyone else. Needless to say, the plan would not be without costs. Greene would cover them with a value added tax-but that’s another question.

As I’ve said, the plan once seemed a political possibility. Leonard Greene had George McGovern‘s ear. They were so close that Greene flew McGovern in his private plane to file for entry in the New Hampshire primary of 1972. McGovern carried the Greene plan into the primaries, where he had trouble getting it across.

The press made fun of “Demogrants,” which sounded like the grunting of Democratic candidates. Hubert Humphrey, I’m sorry to say, charged that the negative income tax was a gift to the rich. By the time of the California primary the Greene plan had come to seem a handicap. McGovern renounced it and never mentioned it again.

On reflection, I have concluded that the plan was too sensible, too simple, too practical. We Americans pride ourselves on our down-to-earth pragmatism, just as the French pride themselves on their rationality and the Indians on their spirituality. We are the most theory-driven people on earth, however, constantly prattling about market discipline and other such nonsense. And there is what the literary critics call a dark side to the issue: Everyone knows that blacks are disproportionately represented among recipients of the present welfare benefits. For a shamefully large number of us, welfare as we know it can be improved only by slashing it to ribbons.

Finally, there is the third thing I mentioned at the beginning. This is the notion that welfare recipients are to be given two years of job training and then pushed out into the labor market, where they will help us compete in the new global village.

Six years ago, when the Family Support Act was passed, I thought that was a nutty idea, and I still do. It is impracticable and it is vindictive. Moreover, it conflicts with the theory of a natural rate of unemployment (see Are You Naturally Unemployed?” NL, August lO-24, 1992). Although accepted by every mainstream economist in the land, the theory is a nutty idea too. If you believe in it, you must believe it would be a disastrous mistake to get everyone off welfare and into regular employment, because the natural rate of unemployment would be violated and inflation would rage without limit.

Indeed, the trouble is that if President Clinton actually begins to end welfare as we know it, the Federal Reserve Board will be theory-bound to raise the interest rate high enough to restart the recession and move those welfare mothers back among the naturally unemployed. I would like to see this conflict brought out into the open.

The New Leader

By George P. Brockway, originally published September 23, 1993

1993-9-23 The Reserve Takes Flight Again title

On July 20, Federal Reserve Board Chairman Alan Greenspan announced a fundamental change in the way the august body he heads looks upon the economy. This is not merely a tactical shift, as from easy money to tight money – although the Board’s volatility on the tactical level is bad enough – but a basic rethinking of how the economy works and what the Board should therefore do. It is the second such revision in Greenspan’s six and a half years as chairman, and the fourth in something under 14 years. So many radical rethinkings in so few years suggest an unseemly flightiness in an institution whose primary excuse for existence is to provide financial stability beyond the turmoil of partisan politics.

Let’s look at the record. On October 6, 1979, Paul A. Volcker, the then new chairman, revealed that thereafter the Reserve would “be placing greater emphasis on day-to-day operations of the supply of bank reserves, and less emphasis on confining short-term fluctuation in the Federal rate” (the rate at which banks borrow reserves from each other overnight or for a day or two). Monetarism had taken charge.

For the next six or seven years we heard a great deal about M1 and its velocity. (In case you’ve forgotten, M1 is cash and traveler’s checks and checking deposits; M2 is all that plus most savings accounts, money market funds, and other odds and ends.) Milton Friedman, the leading monetarist, wanted M1 to grow annually between 3 and 5 per cent. Expansion beyond 5 per cent, he claimed, would cause inflation – instantaneously if the expansion was anticipated, or with a lag of a year if it was not. Not only that, but the inflation would accelerate without limit. By 1986, expansion beyond 5 per cent was surely anticipated by all rational economic agents, because it had not been below 5 per cent for 10 years. Yet in 1986, when M1 jumped 16.8 per cent (and M2 jumped 9.4 per cent), the Consumer Price Index (CPI) rose only 1.9 per cent – its smallest rise in 22 years. Monetarism clearly missed the call, and missed badly.

The Federal Reserve Board was left without a theory – that is, without a coherent idea of what it was doing or why. For the rest of Volcker’s term, the nation was forced to rely on seat-of-the-pants judgments of officials whose cerebral judgments had proved sensationally wrongheaded.

In the spring of 1987, Alan Greenspan succeeded to the chairmanship and at once set three economists to work on an equation intended to use M2 to prophesy the price level two or more years ahead. Also, true to the teachings of Ayn Rand, he cut expansion of M1 and M2 back below the 5 per cent target. And what did the CPI do? It surged ahead 4.4 per cent in both 1987 and 1988.

Nevertheless, on June 13, 1989, the Reserve went to extraordinary lengths to publicize what two years of labor by those three economists had produced. If you yearn to know more about P-star (as their equation was called by insiders), I refer you to “The Reserve’s Silly New Equation” (NL, June 12-26, 1989), in whose last sentence I wailed, “How long must we allow ourselves to be deluded by silly equations?” Well, the Reserve seems at last to have abandoned this equation, or the theory behind it, which, Greenspan said last month, “has been downgraded as a reliable indicator.”

Of course, the money supply never was a reliable indicator, for the simple reason that no one can say what it is. The Federal Reserve owlishly publishes aggregates it calls M1, M2, M3, and L. L is about six times M1. Friedman once said the number used did not matter, so long as one stayed with it. Since the tracks of the different aggregates have been substantially different, it would appear to have made some difference.

You would think that by this time we might all agree to stop fretting over the money supply. Yet the Reserve, perhaps for ritualistic reasons, has adopted a new target for M2 growth (1-5 percent), even though it acknowledges that hitting (or missing) the target won’t indicate anything special.

The downgrading of M2 does not mean the Chairman is without any indicator. He has mentioned only one aspect of his new one (and that I will discuss presently), but he has used it with results that can hardly be called encouraging. In his July 20 testimony before Congress, he forecast a second quarter growth rate of 2.5-3.0 per cent. Nine days later, the official number proved to be 1.6 per cent.

I think I can promise you that the new indicator will continue to get things wrong. According to Greenspan, “one important guidepost” of the new indicator win be the so-called “real” interest rate: the actual rate minus the rate of inflation. When, as now, the Federal funds rate is about 3 per cent and the CPI rate is about 3.5 per cent, the “real” Federal funds rate is negative 0.5 per cent. Anyone lending $1,000 at 3 per cent gets back $1,030 at the end of a year, but his purchasing power will have shrunk to $993.95. So why should he lend? Because if he buries his money like the slothful servant in the Parable of the Talents, he will still have his $1,000 but his purchasing power will shrink to $965.

Greenspan thinks that’s unfair and hints about raising the Federal rate one-half a percentage point or more to make things even. Naturally, if he raises the Federal rate, he effectively raises others, including those that are far from negative.

What Greenspan is threatening is a Cost of Living Adjustment (cola) for bankers. It is well understood by bankers and economists that colas on workers’ wages are inflationary and should be resisted. How are bankers’ cola different? In a word, they aren’t, and they cost the economy (that is, you and me) about $500 billion a year (see “Bankers Have the Classic COLA,” NL, January 9, 1989).

Although bankers do most of the talking about the interest rate, their role in lending is comparatively passive. If no one wants to produce a better mousetrap or buy a better automobile or take a flyer in the stock market, bankers must sit on their cash. Putting consumers and speculators aside for the moment, consider a company with plans for a better mousetrap, requiring investment in a factory, equipping it with machinery, buying supplies, hiring workers. The company figures all that to cost $10 million. For convenience, let’s say it can borrow at prime, currently 6 per cent, for an annual interest expense of $600,000. It feels it can just about swing it.

Now suppose Greenspan gives bankers a one-half percentage point cola. At 6.5 per cent, the interest expense is up to $650,000 – an increase of 8.3 per cent in cost, and a decrease of 8.3 per cent in the amount of money the mousetrap company can afford to borrow.

The company then has three options: (1) Abandon or scale down the expansion and the jobs it would have created. (2) Raise prices to cover the added cost. (3) Make do with lower profits, which would make future borrowing still more expensive. These options are faced every day by every company, large or small. Even rich companies that do not need to borrow must consider the opportunity cost of using their own money instead of lending it out.

If investment is as important as everyone says it is, and if stable prices are as important as the Reserve says they are, Greenspan’s half point adjustment would be bad for every company and for the whole economy in one of the ways I’ve noted, and quite possibly in all three ways. Not only that, but the bond market would fall, as it necessarily does when interest rates rise. The stock market would surely follow later, for the same reason – and, considering its present fragile highs, could very well crash.

The interest rate, not the money supply, is what the Federal Reserve Board can control directly and assuredly. It sets the Federal funds rate and the discount rate, and it controls them by buying or selling Treasury bonds on the open market. In order to buy, it offers a high price, which is the same as a low interest rate. The banks that sell bonds thus increase their cash reserves, putting additional downward pressure on the interest rate.

If all this activity increases borrowing, as it is likely to do, it will increase the money supply, because money is negotiable debt. But who cares? It is the interest rate that matters to the economy, and it is through stabilizing the rate at a low level (about half what it is today) that the Reserve could (if it would) do its bit to stabilize the economy.

Milton Friedman has long contended that the Federal Reserve Board has used its great powers so erratically in the past that it should be put under strict statutory regulation. He may be right. But he would regulate the growth of the money supply within a narrow range, even though he doesn’t know what the money supply is, and the Board has shown it doesn’t know how to control it, whatever it is.

That there is a determinate money supply, and that its size determines the price level, is an old mercantilist idea. It was valid enough when money was something rare and tangible and not readily reproducible, like gold or silver. The capitalist system turns on borrowing, however, and borrowing depends on the interest rate, and the lower the rate the greater the economy. How long must we allow ourselves to be deluded by archaic ideas?

The New Leader

By George P. Brockway, originally published June 14, 1993

1993-6-14 In Pursuit of a Fiscal Fantasy title

PRESIDENT CLINTON’S $31 billion “stimulus package” was defeated by a filibuster that was organized, not on the reasonable ground that the package was woefully inadequate, but on the fanciful ground that by increasing the deficit it would hurt the recovery now supposed to be under way. I want to talk about the alleged recovery, but first let’s pay our respects to the deficit.

Suppose we had an adequate stimulus – something on the order of $200 billion, rather than the proposed $31 billion. That kind of money could knock 5 points off the official unemployment figure, bringing it down to an arguably tolerable level of 2-per cent, and could start to do a job as well on those who are working part time or are too discouraged to look for work.

But could we afford it? Of course we could. The late Arthur Okun, a universally respected economist and the chairman of the President’s Council of Economic Advisors under LBJ, maintained that a 1 per cent rise in unemployment causes a 3 per cent fall in real national product. If Okun’s Law works backward and becomes a multiplier (not guaranteed), the 5 per cent fall in unemployment we’re after should result in a 15 per cent rise in output. That would be about $850 billion and should, in turn, yield about $210 billion in taxes at present rates – not to mention the gains for state and local governments, or the savings in reduced welfare outlays. So our massive stimulus could produce a modest reduction in the deficit. As Mr. Micawber would say, result happiness.

The result would still be far from misery even if Okun’s Law didn’t quite work backward, and even if the government proved incompetent in all the ways the naysayers say it is. If we had to borrow the entire $200 billion, the deficit would be increased by the interest, or by $13 billion–and if the Federal Reserve Board should miraculously decide to be on the same team as the rest of us, the interest could be as low as $6 billion.

Are you worried silly about the $16,750 that rabble-rousers say is your share of the national debt? Grow up. I have a $75,000 mortgage that I’ll not pay off if I live till I’m 105. The bank isn’t worried. My estate will pay it off, of course, and whoever buys the house will mortgage it again and will no doubt later refinance the mortgage to pay for some improvements or repairs. And so on. It’s a well-built house and should last (and be mortgageable) for another hundred years or more. All that’s necessary is for the successive owners to be able to pay the interest. The same is true of the United States of America and its national debt.

What is the alternative? It is proposed that we get government out of the way or off business’ back or whatever metaphor appeals to you, and let the present “recovery” rip. The good old free enterprise system, we are told, the very system our economists are teaching with such smashing success to Russia and Eastern Europe, would soon show that a man knows what to do with his money a lot better than some bureaucrat in Washington. You bet.

The big trouble with this prescription for prosperity, worked out by the classical economists, is that it is based on unrealizable assumptions. One assumption we’ve mentioned previously: full employment. A second is that a level playing field, of the kind the Wall Street Journal pines for, isn’t enough. The players must have at least fairly equivalent equipment. Adam Smith put it this way: “The whole of the advantages and disadvantages of the different employments of labor and stock must, in the same neighborhood, be either perfectly equal or continually tending toward equality.”

In addition, there’s an assumption that economists pretend doesn’t matter. All the buyers and all the sellers are assumed to know all about all the products available and the demand for them. Whoever believes this assumption should have followed me around last week as I shopped for a new automobile. I don’t even know how to kick the tires. A contemporary school of economists gets rid of this assumption with another, namely that everyone acts rationally and rationally expects everyone else to act rationally, too.

If you accept each of the assumptions, you probably can see some sense in the notion that an invisible hand will guide us to the recovery of our dreams. Don’t be too sure. If I really knew what I was doing when I shopped for a car, I’d make the best buy possible–and so would you and everyone else. One dealer would start to get all the business. Then the competitors would lower their prices, and pretty quickly there would be one big price war.

Short of collapse, there could be no end to such wars. All competitors can lower their prices by cutting their costs. Their costs are someone else’s prices, which likewise can be lowered by cutting costs. And so on ad infinitum. David Ricardo and his followers argued that this regress would be stopped by the costs of food and other basic things (called “wage goods”) that workers need to survive.

But the costs of wage goods are not immune to cutting, so the regress would continue. Very likely some people would lose their jobs as prices tumbled, although the classical theory merely calls for wages to fall. Either way, if the free market were left to its own devices, the price-cutting, cost-cutting, payroll-cutting, demand-cutting sequence would continue unabated until prices, payrolls, production, and profits all approached zero. The free market could not stop the process – nor, if they played the game by the rules, could any of the participants. The invisible hand pushes everyone and everything inexorably down.

The drama has a different ending in the scenario of Leon Walras, the patron theorist of free market analysis. He wrote that “production in free competition, after being engaged in a great number of small enterprises, tends to distribute itself among a number less great of medium enterprises, to end finally, first in a monopoly at cost price, then in a monopoly at the price of maximum gain.”

So take your pick. The Walrasian theory has free competition ending in monopoly. The more conventional theory, though it says nothing about an end, offers no reason why general disaster should not result.

There is, of course, a third outcome – what actually happens. For we take steps to prevent disaster, either by accident or by design, and those steps reveal that we are, by turns, do-gooders, pragmatists, and sponsors of crime.

In our role as do-gooders we enact child labor laws, minimum wage laws, worker-safety laws, social welfare laws, and many other laws to mitigate the horrors of free competition. It is not bad to do good – except in the eyes of conventional economics. In his speech launching the idea of a natural rate of unemployment, Milton Friedman condemned all altruistic measures. They would, he said, increase the natural rate of unemployment. Pre-Depression America, which knew very little of such things, is touted as a time of low unemployment. It was also a time of child labor, the 12-hour work day, labor injunctions, and similar amenities.

It must be confessed that we are more comfortable thinking of ourselves as pragmatists than as altruists. In any event, whereas businesspeople applaud the pronouncements of conventional economics, very few act in accordance with them. They may compete vigorously, but very few compete primarily on price, having learned (as a book of business advice once had it), “Don’t sell the steak. Sell the sizzle.” With less pressure on prices, there is less pressure on costs.

Finally, we are sponsors of the crimes we deplore. A character in the funnies used to say, crime don’t pay well. For most practitioners that may be true, but it pays enough above the bottom of the current legitimate pay scale to entice hundreds of thousands into making a career of it. If these people were to renounce housebreaking and carjacking and mugging, and were to look for decent work, their competition for jobs would push the legitimate pay scale even lower.

AND THAT’S not all. As John E. Schwarz and Thomas J. Volgy show in grim detail in The Forgotten Americans, there are 30 million working poor in America – people who are desperately trying to live the work ethic yet still cannot afford the basic necessities at the lowest realistic cost. Heartbreaking thousands of these people take a flier at drug running or prostitution just to survive.

We are, as I say, sponsors of all this crime and squalor. It serves to retard the free fall of the economy, and with our altruistic and pragmatic practices it will eventually help us to settle at a stopping point somewhere between here and the pits. Economics, however, takes time, and it will be years before we reach that point. When we do reach it, we will find ourselves in what economists call an equilibrium, with upwards of a quarter of our productive capacity unused, with 20 million of our people unemployed or underemployed, and with probably 50 million men, women and children living lives that are far from solitary but are nevertheless (in the rest of Hobbes’ phrase) poor, nasty, brutish, and short.

I don’t suppose that, aside from a few fanatics for the apocalypse, there is anyone who is eager for such an equilibrium. But there are many millions who are capable of denying its possibility, and (as with other diseases) the denial makes its actuality the more deadly – especially since conventional economics can think of no way to upset the equilibrium, except by doing more of the same.

In the past, similar equilibria have been upset by wars. The Civil War made us a nation; World War I industrialized us; World War II got us out of the Great Depression. Professor Joseph A. Schumpeter celebrated the creative destructiveness of great new industries, like the railroads, which rendered canals obsolete, and the automobile, which doomed the horse-and-wagon. (Some expect the computer to play a similar role, but the information revolution is responsible for much of the payroll-cutting currently in progress, including its own.)

The thing about these equilibrium upsetters – these wars and these creative destroyers – is that they’ve all required ever bigger expenditures by ever bigger government. The expenditures for war are obvious; but often forgotten are the grants of public land to build the railroads, together with the postal contracts to keep them running, and the paving of streets and building of highways for the automobile. Is it conceivable that we can summon the wit and the will to make the expenditures that need to be made today?

I cannot conceive it. What is all too probable is that the welfare of the nation and of increasing millions of our fellow citizens will continue to be sacrificed to an accounting fantasy called a balanced budget.

The New Leader

By George P. Brockway, originally published August 10, 1992

1992-8-10 Are You Naturally Unemployed title

AT THE END Of my piece on “The Last Chapter in Keynes” (NL, June 29), I referred to the currently received doctrine of the natural rate of unemployment. The implications of the doctrine are such that they don’t, as the saying goes, bear thinking about. Nevertheless, I propose to try to think about them here and now.

The expression “the natural rate of unemployment” was apparently coined by Milton Friedman in his presidential address to the American Economic Association on December 29, 1967. Friedman was clear that what he called the natural rate was not a natural law (like, say, S= 1/2[gt^2]). “On the contrary,” he said, “many of the market characteristics that determine its level [such as minimum wage laws] are man-made and policy-made.” Yet he saw and, I believe, still sees something inexorable in the idea.

Friedman said he used the word “natural” because the idea was comparable to “the natural rate of interest,” a notion advanced by the Swedish economist Knut Wicksell in 1898. Wicksell is worth reading (though perhaps not on this issue), but for the moment we need note only that he is thought by many to have anticipated Keynes in some ways. And as to Keynes, we need remember particularly that his initial quarrel with the classic economists was that they believed involuntary unemployment was impossible. Since whatever is “natural” is ipso facto involuntary, Friedman, too, broke with the classics on this point. I hasten to insist that Friedman is not now and never has been a Keynesian or a neo-Keynesian, and certainly not a Post Keynesian (which, if you must know, is more or less what I am).

The natural rate of unemployment is thus an idea that resonated unexpectedly in many corners of modern economic thought. In its pure form it goes like this: Given the civil laws, customs and institutions of the economy (though Friedman is not now and never has been an institutionalist follower of Thorstein Veblen or John R. Commons), beyond a certain point any increase in the rate of unemployment will result in deflation and a recession that will continue until wages fall to a level to encourage entrepreneurs to start hiring again; on the other hand, any decrease in unemployment will result in inflation and a recession that will continue until employment returns to its natural rate.

The idea was not immediately embraced by the profession. Very likely thin-skinned economists were timid about saying that joblessness could be your patriotic duty. This difficulty was overcome when somebody (I’m sorry I don’t know who[1]) came up with a name that obscures the implications of the idea and has, moreover, an acronym that soothingly sounds like the name of a languorous South Sea isle. The new name is Non Accelerating Inflationary Rate of Unemployment, or NAIRU. The modifier “nonaccelerating” is a modifier of Friedman’s original notion and recognizes the fact that, as we know from our experience of the past half century, it is not too difficult to live with inflation if the rate is fairly low and steady.

The NAIRU was 3 or 4 per cent at the end of World War II. It reached 5 or 6 per cent in 1975, after the Federal Reserve Board raised interest rates in its quixotic response to the first OPEC embargo. And it appears to be around 5 or 6 per cent today (the current 7.7 per cent rate of unemployment is dismal from any point of view).

Let us be sure we understand what a NAIRU of 5 or 6 per cent means. It means that, given our present labor force of some 127 million men and women, about 7 million of them must be unemployed through no fault of their own. Forgive me for raising my voice, but we must see clearly that NAIRU won’t work if unemployment is the result of stupidity, poor training, laziness, lawlessness, or unreasonably high wage demands – if unemployment is, as the classical economists said, voluntary. The NAIRU people are not the people of Reaganesque anecdotes (if such people there ever were) who flit from job to unemployment insurance to job as spirit moves them. Stupid, incompetent, lazy, lawless, or grasping people do not compete for existing jobs; it is the function of NAIRU people to make holders of existing jobs fear for their positions and so acquiesce in low pay, unsafe or Quayle-approved working conditions, frayed fringe benefits, and nonunion shops.

Perhaps you will now sense another resonance of the natural rate of unemployment. It is the stern, impassioned tread of Karl Marx’ industrial reserve army. “The industrial reserve army,” Marx wrote, “during periods of stagnation and average prosperity, weighs down the active labor-army; during periods of overproduction and paroxysm, it holds its pretensions in check.” Friedman might have put it somewhat more gracefully, but he couldn’t agree with it more.

How did the soldiers of the industrial reserve army get recruited? They weren’t rounded up by press gangs like those that helped Britannia rule the waves, but their fate has not been dissimilar. They did not volunteer, and they were not drafted; they were in the wrong place at the wrong time, and many of them were simply born wrong, just as Rockefellers and such happened to be born right. They are victims of crashingly bad luck.

From time to time, demographers publish studies averring that only a percentage (say 10 per cent or 5 per cent or perhaps 1 per cent) are what we used to call lifers and spend their entire lives in the industrial reserve army, or that only some other percentage (say 12 per cent) serves more than 27 weeks at a time, while Horatio Alger and his like are discharged in a matter of days. We may accept these studies, or most of them, at their face value and still observe that those in the industrial reserve army serve as a consequence of crashingly bad luck, and that they serve in our interest and indeed in our stead. This being the case, it cannot be denied that our economic system – a system said to depend on the natural rate of unemployment – would self-destruct if it were not fundamentally unjust. It is clever to say that life is unfair; it is corrupt to raise unfairness to a principle of control.

As we noted here a short while ago (“Where Schumpeter Went [Astray],” NL, April 6[2]), Joseph Schumpeter celebrated capitalism as “the civilization of inequality and the family fortune.” I cannot do that. I cannot understand doing that. I cannot settle for NAIRU in any of its forms. I can accept the military draft and have in fact been drafted. It is possible in time of war to show citizens, chosen by lot, their duty to risk their lives in defense of the nation that nurtured them. It is not possible to show anyone a duty to lead a life of squalor in order that others may be free to choose among moderately priced commodities.

If there really is a natural rate of unemployment for our system, the system is immoral. If it is immoral, we should change it. Some will say that even with NAIRU, ours is the best system seen so far, and others will say that NAIRU applies to all systems. Despite these answers, improvements are possible.

To share the burden of NAIRU fairly, we might take Marx’ metaphor literally and institute a draft for the industrial reserve army[3]. It is unlikely that there would be volunteers, and there should be no exemptions of any kind (except for the unemployable). Membership in the army probably would be by nuclear families, unless children were put out for adoption while their parents served. There would no doubt be problems with the definition of a family, but I’m sure that, given good will, solutions could be found.

Every able-bodied family in the nation would pull at least one hitch in the army. Service would consist of living without personal assets or income (including imputed income, as for example, decent food, clothing, and shelter) for a period. I imagine two or three years would suffice at the present natural rate of unemployment. For ease of administration, it might be convenient in some cases for families to exchange homes. Certainly the houses of wealthy draftees could not be left vacant without inflating the general cost of housing.

Private charity also would have to be rigorously controlled to prevent favoritism and corruption. Food Stamps, Aid to Families with Dependent Children, Medicaid, and the like (including Workfare if finally enacted) would be available. Of course, for the army to serve its purpose, recruits must be able to work, but their availability would have to be in accordance with length of service. It wouldn’t be fair for me to be enlisted one day and hired by a friend the next.

Perhaps all that strikes you as preposterous. I hope so. It certainly seems preposterous to me. But the whole idea of placidly accepting a natural rate of unemployment strikes me as far more preposterous.

Now, looking back at the theory of NAIRU, we note that the general price level is to be controlled by holding down only one of the factors of production (labor). Why shouldn’t we also hold down the rate of interest? Since inflation of the costs of production is the issue, why shouldn’t we have NAIRI as well as NAIRU?

“But,” cry the governors of the Federal Reserve Board, “we already control inflation by raising the interest rate.” They know not what they do. In the 40 years since 1951, when the Reserve freed itself from its wartime agreement with the Treasury to hold rates down, the percentage of GNP that goes to pay interest on debt of the nonfinancial sector has gone from 4.59 per cent to 20.51 per cent. Let me put it another way: In 1951 the interest bill of American corporations was about one-twelfth of their wage bill, whereas today it is more than a third. If the 1951 ratio still applied, today’s costs would be roughly $845 billion less than they actually are, and the price level would be lower by a considerably greater amount.

By raising the interest rate (even now it is more than double what it was in 1951), the Federal Reserve Board has contributed to (if not mainly caused) inflation. It has then restrained the inflation it caused by bringing on recession, which keeps the industrial reserve army in being.

So NAIRU not only serves reactionary interests in keeping wages in check; it is a convenient reactionary ploy in other situations. Public works cannot be used to reinvigorate the economy because the increase in employment would violate NAIRU. Likewise, although doctrinaire free traders may admit that selective protection might protect or restore as many as 2 million jobs, NAIRU forbids it. And so on.

In short, the nasty theory of a natural rate of unemployment is counterproductive as well as immoral.

The New Leader

[1] Ed:  According to Wikipedia It was first introduced as NIRU (non-inflationary rate of unemployment) in Modigliani – Papademos (1975) – Wikipedia offers three references:  [3][4][5]

[2] Ed:  The actual title is “Where Schumpeter Went Astray” but when this article was written it was cited, with a lack of the author’s normal poetry, as “Where Schumpeter Went Wrong.”

[3] Ed:  In case you’re not paying attention, the next 3 paragraphs are at once both analytically correct but intended to demonstrate to the reader how insufferably wrong-headed NAIRU is… These paragraphs are, in current parlance, “snarky”

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

1990-10-1 What Color is Your Recession Title

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

1990-10-1 What Color is Your Recession Greenspan

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 The New Leader

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