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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

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

By George P. Brockway, originally published May 7, 1999

5-7-99-why-nairu-is-nonesense-title

MANY YEARS AGO, when I was a college undergraduate, there was some talk on campus about The Fountainhead[1], a massive novel by Ayn Rand. I was aware of it because one of my close friends told me a bit about it, and the older brother of a classmate had edited it, but I never read the book nor did I see the movie. Perhaps it was too huge for me (I was reading Ernest Hemingway‘s stories and Gertrude Stein‘s scribblings). Perhaps I was sufficiently law-abiding to be put off by the novel’s intensely self-centered architect hero[2], whose action at the end was the principal topic of what I heard (he destroyed an allegedly supremely beautiful building he had built because the owner wanted some changes).

I never read Atlas Shrugged either, or any of the other works by Ayn Rand, and I was not aware that she was a self- invented economist until I became one myself. Even then I was-and still am-put off by the name she gave to her philosophy (“objectivism“). But despite my ignorance of what she has written, I am prepared to claim that she has had a great and salutary effect on the present and possible prosperity of the United States of America. Maybe of the world.

One of Ayn Rand’s disciples was Alan Greenspan, who grew up to be Chairman of the Federal Reserve Board. So far as I know, Greenspan has never made a public reference to her, and so far as I am aware, only three of her doctrines may have slipped into the proceedings of the august body he heads. He has spoken some odd words on the movement of the price of gold as an indicator of the future course of the price level. His aversion to regulation of the rogue multitrillion-dollar derivatives market may be linked in his mind with the behavior of the hero of The Fountainhead. And almost alone among the public men of our time, he doesn’t believe in the barbarous theory of a natural rate of unemployment.

In any case, I suspect that her influence has been both more profound and more beneficial than her ideas. As a result of his association with her, Greenspan learned how to be at once the consummate insider and the consummate outsider.

Because he is a consummate insider, he got to where he is. Because he is a consummate outsider, he has not been overawed by the high-powered bankers and economists with whom he does business. Because he is not overawed by these worthies, we have not had a boost in the interest rate since March 1994, and in fact had three quarter-of-a -point cuts last summer and fall.

These 60-odd months without a rate increase constitute the longest, indeed the only, period of tranquility the Federal Reserve Board has allowed the American economy in the 30 years since the Reserve launched its all-out war against inflation-which propelled the Consumer Price Index from 36.7 in 1969 to 99.6 in 1984, a record-breaking and stupefying leap of 272 per cent in 14 years. It is for the present period of tranquility (and for its continuance, if he can bring it off) that Greenspan is renowned today and will be forever famous in the annals of economics and of political economy.

There is no doubt that if Greenspan had polled the economics profession and the banking profession he would have had them almost solidly against him. On July 19, 1995, Greenspan said in Congressional testimony, “I don’t believe that any particular unemployment rate-that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with-is something desirable in and of itself. I don’t believe that.”

Neither the New York Times nor the Wall Street Journal reported this testimony (but THE NEW LEADER did, and I have the videotape). As I said at the time, this was earthshaking testimony. It directly contradicted what then was the first or second most sacred economic law, namely the natural rate of unemployment, a.k.a. the nonaccelerating inflation rate of unemployment, a.k.a. NAIRU. It is possible, but not certain, that the ancient “law” of supply and demand had a tighter grip than NAIRU on the hearts and minds of economists and those who pretended to an interest in economics. Yet Greenspan contradicted this barbarous doctrine, and got away with it.

As it happened, the economy jogged along pretty well. The stock market boomed, because the Baby Boomers were worried about saving for retirement and didn’t know where else to put their money. As the market soared, more and more of them made nice killings and began to spend some of their capital gains. Retail sales, especially of automobiles and other big-ticket items, picked up. Unemployment began to fall, and so, to almost everyone’s surprise, did inflation.

After a while the media began looking for someone to give the credit to. President Clinton was willing, but no matter what he claimed, and no matter what photo ops were arranged, people kept saying that he was too preoccupied with impeachment to run the country. Perhaps they were right, and, obviously the Republicans were too preoccupied, for the same reason.

Greenspan was available, and an interview with him was almost as good copy as the stories quoting Casey Stengel used to be. He talked about the free market, so he became the leader of the free world.

Of course, I wasn’t there, but I have a clear picture of what happened next. At meeting after meeting, the Federal Reserve Board staffers brought in sheaves of disturbing figures showing that Wendy’s in Sandusky was having trouble holding dishwashers and hiring cashiers; that Kmart in New Jersey had constant openings for stock clerks; that Boeing in Seattle was looking for riveters. Everywhere, in other words, the unemployment rate was falling-falling steadily below the rate at which all the bankers in the country knew, and all the mainline economists in the country absolutely knew, that inflation definitely had to break out again. The financial press talked nervously of the importance of being ahead of the curve, and Greenspan himself spoke of making a pre-emptive strike against inflation.

Nevertheless, Greenspan has not acted. He tried jawboning the stock market-and quickly learned that his reputation as economic wise man of the Western World was in jeopardy because practically no one was in favor of repeating the 1987 market crash.

Lately he has made a series of speeches suggesting that an increase in the productivity index explains our “miraculous” combination of falling unemployment and falling inflation. Since the productivity index is a fraction (output divided by hours worked), its value rises when the denominator falls. Greater productivity, therefore, is hardly an explanation of increasing employment.

WELL, maybe Greenspan can pull it off, but it would help if he could make clear why NAIRU has not performed as advertised. Since the business and financial press has not been able to do that either, the professional belief in NAIRU has been muted but not stilled. The true believers are prepared to stay the course, because they have been given no reason not to.

We shall continue to live in fear that our tranquil days of steadily expanding prosperity will soon be over unless somebody sets them straight. So, it might as well be me, here and now.

It isn’t enough to remind the believers that not so long ago they insisted the telltale rate of unemployment was 7.0 per cent, then 6.5 per cent, then 6.0 per cent, then 5.5 per cent, then 5.0 per cent, then 4.5 per cent, and now it must be 4.0 per cent or lower. They shrug off this embarrassment with the complaint that the available statistics are imperfect or that, as Humphrey Bogart said when told there were no waters in Casablanca, they were misinformed.

It also is not enough to show them that every one of the nine recessions since World War II has been preceded by boosts in the interest rate. The boosts were said to be necessary to nip inflation in the bud. But in fact inflation accelerated more rapidly after the boosts than before them. Another fact: In all the years since World War II, no matter what the Federal Reserve Board has tried, the price level has fallen only once, and in that year (1955) the interest rate fell too. Again, of course, the statistics are imperfect. And without a coherent theory everything is anecdotal, the diehards argue, as the doctors did when Linus Pauling tried to tell them about Vitamin C.

Yet the reason NAIRU is nonsense is not far to seek. To begin with, the interest rate and the unemployment rate are both percentages, just as apples and oranges are both fruits. Interest is a direct cost or an opportunity cost on both sides of every economic transaction. Labor costs are similarly universal. But interest costs are closely uniform for comparable risks throughout the economy; labor costs vary widely from industry to industry, job to job, locality to locality, and (shamefully) from ethnic group to ethnic group as well as from gender to gender.

The two percentages are so radically different in composition that NAIRU theorists themselves never had a theory of their interaction. All they had were some empirical observations that occasionally made pretty graphs, like the Phillips curve. As with all empirical observations, though, theirs were liable to falsification by events.

The serious recessions of 1974-75 and 1980-82 were certainly falsification enough. But those events were disregarded, perhaps because practitioners of this dismal science tend to believe that dismal outcomes must be true, while relatively happy outcomes (like the present situation) must nurture some occult seeds of their own distraction.

Moreover, a 1 point fall in the unemployment rate causes little more than a 1 point rise in the national wage bill (which itself is only three-fifths of the costs of production), whereas a 1 point rise in the basic interest rate (now 4.75 per cent) eventually results in a drop of about 20 per cent in the purchasing power of money (which is, of course, equivalent to a 20 per cent rise of the price level, or a pretty stiff dose of inflation).

Far more important, the interest hike would produce a 16.7 per cent decline in the borrowing power of money, resulting, as we shall see, in a 33 per cent drop in the value of investments that must be made to keep the capitalist system going. If the interest rate is 5 per cent, $500 will get you a year’s use of $10,000. You can invest that $10,000 in an enterprise of your choice, and, unless you are unwise or unlucky, you will earn back your $500 interest plus a profit to boot and be ready to do more of the same.

But if the rate rises to 6 per cent, you will be able to borrow only $8,333 with your $500. Worse yet, the purchasing power of the $8,333 you borrow will have been reduced 20 per cent; so in the end you will have only $6,667 worth of goods to invest in, compared with the $10,000 worth you would have had before the interest hike.

Any way you look at it, the “punishment” of a 1 per cent increase in the interest rate does not fit the “crime” of a 1 per cent decrease in the unemployment rate.

Federal Reserve Bulletin please copy.

The New Leader

[1] Ed: Not likely as an undergraduate.  The author graduated college in 1936.  The Fountainhead was published in 1943

[2] Ed: Howard Roark is no more self-centered, say, than Donald Trump…

By George P. Brockway, originally published August 10, 1998

1998-8-10 A Fortunate Experiment titleONE OF THE mysteries of life in the United States today is why we are not in the midst of a raging inflation, a depressing recession, or both. The answer, though, is staring us in the face.

For the past 30 years, hard-nosed devotion to the theory of a natural rate of unemployment (a frequent target in this space) has been a prerequisite for appointment to the economics faculties of our major colleges and universities. Hence the doctrine has not only been taught at those institutions, it has been accepted respectfully in editorial rooms and enthusiastically in board rooms across the land.

The theory, of course, claims that if too few people are unemployed, inflation will accelerate rapidly, and the only way to slow it down is to raise and keep raising the interest rate. Chairman Alan Greenspan of the Federal Reserve says he does not altogether agree with the theory. He keeps talking, however, about raising the interest rate on some unspecified occasion in the future.

Yet today unemployment is lower than it has been for decades, while inflation (especially if you figure it as the Boskin Commission did a couple of years ago) has been practically invisible for at least four years. Moreover, during the same period the interest rate has been relatively stable. If mainstream economic theory were sound, the world would not move in this way.

Nevertheless, the world does move in this way and, I make bold to predict, will continue to do so until the Baby Boomers start retiring in substantial numbers, at which point the present stock market boom will come to an end. I hasten to explain that I agree with Mr. Greenspan that the market is overenthusiastic, overpriced and in danger of collapsing. But I also think that as long as the Baby Boomers keep pouring their savings into it, and as long as the interest rate does not go up, the market will continue to rise in a classic example of the “law” of supply and demand.

The situation is beautifully ironic. The market is all the bad and dangerous things Mr. Greenspan says, and he could stop them by jumping the interest rate-as the Reserve did in 1978 (not to mention 1929). But the Federal Reserve Board does not dare to act. Every three months the Reserve Board meets and the bankers anguish over their belief that inflation must be around the comer. Their terror, though, is that if they raise the interest rate to stop the inflation no one else can see, they will be remembered for having precipitated one of the great economic crashes of all time[1].

So the booming stock market that concerns Mr. Greenspan has incidentally forced the Reserve into an unnoticed experiment that lays bare the fallacies of conventional interest rate policy. If the economics profession can bring itself to pay attention to what is happening in this accidental experiment, we may be spared further exposure to the barbarous theory of a natural rate of unemployment.

Even without the experiment, the Reserve should have learned a few of the effects of raising the interest rate-at least five bad effects and one claimed to be good. The first thing it does is cause a drop in investment. By investment I don’t mean speculating in mutual stock funds and derivatives; I mean helping to finance the organization, continuation or expansion of companies that will produce goods and services to be sold in the marketplace and enjoyed by everyone. In the capitalist system, almost all investment depends directly or indirectly on credit, that is to say, borrowing.

Let’s look at the record. In the early 1960s, when the Federal funds rate averaged about 2.7 per cent, annual investment ran over 21 per cent of the gross domestic product. Today the Federal funds rate is at 5.5 per cent, and investment is only 16 per cent of GDP in an economy that, according to Mr. Greenspan’s recent Congressional testimony, is one of the best he has seen.

Second, an increase in the interest rate favors established and big businesses over small and start-up businesses. Since the latter provide most of the new jobs, any impediment to new business is an additional handicap for the poor, as well as for middle-class would-be entrepreneurs. Indeed, the percentage of American families living below the poverty line is higher in this economy that is one of the best Mr. Greenspan has seen than it was 25 years ago.

The third thing raising the interest rate does is raise the unemployment rate. According to conventional theory this cruel absurdity is a good thing and the way things are supposed to be. Howsoever that may be, the unemployment rate today is 4.5 per cent, or lower than it has been since 1969. In the quarter century before 1969, though, there were no fewer than 12 years with a lower rate of unemployment than the 4.5 per cent of this economy that is one of the best Mr. Greenspan has seen.

Fourth, raising the interest rate raises Federal, state, local, and school taxes, as the recent hoo-ha over the deficit has taught us all.

Fifth, raising the interest rate is a principal way for the rich to become richer. Mr. Greenspan has more than once cited the widening gap between the rich and the poor as dangerous to our democracy. He has protested that it is a problem for Congress, not for him. But every interest payment is a transfer to the haves from the have-nots. To be sure, not everyone who borrows is down and out. Still, as a general rule, people who lend money are richer than those who borrow[2].

The shift from 4 per cent (or lower) FHA and VA mortgages of 50 years ago to today’s “low” rate of 7 or 7.5 per cent has been a gift of billions (if not trillions) of dollars to mortgagees and a corresponding drain on mortgagers. No wonder the rate of home ownership has fallen in this economy that is one of the best Mr. Greenspan has seen.

Now, I am not saying that the interest rate is solely responsible for the rich becoming richer and the poor poorer, and I am emphatically not against borrowing and lending and the charging of interest. I am saying that interest always has the immediate effect of taking from the poor and giving to the rich; that therefore the rich are richer and the poor poorer; that increasing the interest rate increases this effect; that the present rate does not improve matters (except in relation to the rates Mr. Greenspan’s predecessors gloried in); and that an unnecessary uncertainty is introduced into the economy by Mr. Greenspan’s unwillingness to specify conditions that would prompt him to raise the rates further.

THAT’S the bad news-or some of it-about raising the interest rate. The good news-or what’s supposed to be good-is that raising the interest rate stops inflation. Well, no one can say it quite does that, because since World War II the Consumer Price Index has gone up in every year except 1955 (and that year the prime interest rate was lower than in any subsequent year) [3].

But there have been 10 surges of the economy since World War II, and except for the present surge, every one of them was seen by economists as threatening to spiral into inflation and snubbed down by the Federal Reserve Board. In short, its raising the interest rate reduced the investment rate, increased the bankruptcy rate of businesses, increased the poverty rate, increased the cost of living, raised taxes, made the rich richer, caused nine recessions-and thus slowed the rate of inflation.

Those consequences were not unpredictable. They are inherent in the nature of money, something conventional economics has archaic ideas about. Money has no price (there is no point in paying a dollar for a dollar bill). What money has is power-purchasing power and borrowing power. The piece of greenbacked paper you have in your pocket has no practical use as paper. It is an IOU of the state, was issued by the government in payment for some goods or services, and will be accepted by the government in payment of some tax or fee. It is accepted in private transactions because there are always, somewhere in the economy, citizens who need government IOUs to pay taxes or government fees.

You may borrow the use of someone else’s money by paying a fee (interest), which is a cost to you and has the effect of diminishing the amount you can borrow. The relation of money to the fee for its use is similar to the relation of the price of a government bond (also an IOU) to the rate of interest. In both cases, the higher the interest rate, the lower the purchasing power (the effect on borrowing power, essential for investment, is even more severe).

When one speaks of low purchasing power, it is the same as speaking of a high general price level. By upping the interest rate, the Federal Reserve Board reduces everyone’s purchasing power and thus increases the general price level.

Raising the interest rate does not cure inflation; it causes it. (This, you may remember, is Brockway’s Law Number Two, first proclaimed here in the issue of January 9, 1989.) Raising the interest rate gives the appearance of stopping inflation because, on the supply side, it increases the costs of operating a business, discourages expansion and leads to downsizing, which, in turn, reduces wages and thereby contracts the demand side. In other words, raising the interest rate tends to bring about a recession.

That is the way all threats of inflation have been contained since World War II -with a single exception, the present one. This time the Federal Reserve Board has refrained from raising the interest rate, as its governors would normally be inclined to.

The current stock market boom has accidentally forced upon us an economic experiment of world shaking possibilities. We are finding that holding the interest rate steady does not cause inflation, even when the unemployment rate steadily falls[4]. All the dismal prophecies of a natural rate of unemployment have proved false. Also proved false is the immoral claim that a decent minimum wage causes unemployment.

With such empirical results in hand, we may be emboldened to take the next step and discover that lowering the interest rate can lower the price level, increase productive enterprise, and start the long task of healing the suppurating wound in our society that gapes between the rich and the poor.

Do we dare?

The New Leader

[1] Ed –  this experiment has been repeated during the Obama administration when the Fed under Bernanke and now Yellen kept interest rates low whilst talking on end about raising them

[2] Ed – on this fifth factor, despite low interest rates in the Obama years the separation continues.  Just speculatin’, but the current economy is fully “globalized” and has no Glass-Steagall.

[3] Ed – current tables add only one other year, 2009, the deepest year of the Great Recession

[4] Ed – as has happened during the Obama Administration

By George P. Brockway, originally published September 22, 1997

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

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

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

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

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

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

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

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

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

Look at the crosscurrents we have drifted into:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

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

By George P. Brockway, originally published August 11, 1997

1997-8-11 Madness is Not StatesmanshipI SUBMIT that it’s time to give it up, quit, call a halt, put an end to the nonsense and the grief it has caused. The charade has had a run of almost 30 years. That is surely long enough for any group of people to toy with the wealth, health and happiness of their fellows.

It was on December 29, 1967, that Professor Milton Friedman, then of the University of Chicago, in his presidential address to the American Economic Association, publicized the notion of a natural rate of unemployment-now known as the nonaccelerating inflation rate of unemployment, or NAIRU. The idea proved to be protean. Theorizing about it was a game anyone could play, and the game soon had as little resemblance to the one Friedman invented as the slam-dunk has to the shots invented by Dr. James Naismith of the YMCA College in Springfield, Massachusetts, in 1891.

Friedman himself based the theory on mumbo-jumbo about nominal wages and real wages that would make inflation rise à outrance if unemployment fell below the natural rate. Some stirred that up with the productivity scam; a standard reference book disregarded the foregoing ploys but introduced three others; and an international conference was devoted to the imagined connection between NAIRU and hysteresis, a phenomenon characteristic of ferrous metals in an electromagnetic field. (No, no, I did not make that up.)

1997-8-11 Madness is Not Statesmanship Milton FriedmanAs the natural rate theories began to unfold, their beauty, not to say elegance, began to be appreciated. For, look you: If there is a natural rate of unemployment, the most difficult and most important questions of economics-those that have to do with people-are answered. Better, they’re made to disappear; there’s no point in asking them.

To struggling scholars, the theory of a natural rate of unemployment has been a godsend. The frosting on the cake is Professor Friedman’s dictum that, for certain technical reasons, “the monetary authority [aka the Federal Reserve Board] cannot know what the ‘natural’ rate is.” This being accepted, tenure-track economists can consolidate their careers by writing learned articles conclusively demonstrating whatever rate tickles their fancy, and no one can say them nay.

Well, that’s not quite right. Reasoning from the pronouncements of professional economists, we conclude that, whatever the actual rate of unemployment, the natural rate must always be higher, because the actual rate is always low enough to convince pundits that a lot of people must be fired at once to prevent runaway inflation, or to allow us to compete in the new global economy, or to keep the Federal Reserve from raising the interest rate and disquieting the stock market.

In the new welfare-as-we-never-knew-it-world, we are beginning to push people off welfare and onto workfare, and we are beginning to see the absurdities and the nastiness of the schemes. In New York an attempt is being made to unionize the new workers. The local authorities are resisting on the ground that the new workers are not really workers at all, because they don’t work full time, and they don’t have vacations, and they don’t have proper tools and equipment, and they aren’t paid a living wage.

I expect that the Bureau of Labor Statistics will go along and not count them, just as it didn’t count as employed the millions who worked for the CCC and WPA and the rest of the “alphabet soup” programs of New Deal days. (How else do you think unemployment hit 17.2 percent in 1939, as the books say it did, under that Old Democrat FDR?) These people were paid for what they did, and much of it survives for our pleasure and enlightenment to this day, but they didn’t get counted.

Think what would happen to the natural rate of unemployment if the millions of victims of workfare were counted as really-truly workers. Once the states got the new system in full swing, unemployment would theoretically be cut at least in half-say, to 2 or 2.5 per cent. Inflation would of course go straight up; its curve would be vertical; and the interest rate would have to follow in hot pursuit.

Think of it.

I, too, think that is absurd. But I ask you: Why is it absurd? Don’t tell me that most workfare workers aren’t eager to work. The same can be said for more than a few in the private sector, even at fairly exalted levels-which may explain why golf courses and ski runs are busy seven days a week, in season. After all, the “classics” held that work is a “disutility” that is overcome only when workers are tempted with high wages.

The absurdity is not in the people, whether employed or unemployed. The absurdity is in the theory of a natural rate of unemployment. The theory is fallacious as well as vicious. The fallacy appears at the very beginning, where it is assumed that inflation is caused on the supply side by the cost of labor and on the demand side by the purchases of laborers.

Labor costs are indeed the largest category of expenses, but they are only about 60 per cent of the Gross Domestic Product (GDP). The other 40 per cent includes rent, interest, insurance, taxes, and profits, which obviously don’t all move at the same slow pace as wages, or even in the same direction. Labor costs, moreover, are not homogeneous, but can be usefully divided into three categories with pretty distinctive behavior: the takings of the working rich (say, those with annual incomes in excess of $175,000); the wages of the working poor (those mired below the poverty level); and the salaries of the working middle class.

So we have eight factor costs that affect the supply side of the price level, instead of the single omnibus wage cost of the NAIRU theory. Of the eight, four have certainly soared during the past couple of decades: interest, insurance, profits, and the takings of the working rich (entertainers’ professional athletes, business executives, and other celebrities). The salaries of the middle class, though, have stagnated, while the wages of the working poor have grievously fallen[1].

Now, when the unemployment rate falls a tenth of a point because several hundred thousand people get jobs, who are the new workers? Well, a handful may be newly minted celebrities or previously downsized executives, but most of the rest meld into the bottom half of the working middle class or the working poor-categories that have not been responsible for inflation’s costs.

Nor will the lower categories be responsible for any substantial increase on the demand side. These people, even when unemployed, already did a bit of demanding or consuming. They weren’t quite starving or freezing to death. The welfare reformers, in fact, thought they had it too good. Since most of the new workers will be paid close to the minimum wage (which is below the poverty level), they will not be able to demand much more in the way of goods and services than they did when unemployed. That is not the way things ought to be, but it shamefully is the way they are and will be for the foreseeable future.

When unemployment falls, the new members of the working poor will not make a crucial difference to either the supply side or the demand side. Their effect on the price level will be negligible. They will, however, make a salutary contribution to the GDP, cause a great fall in welfare expenses, and add nicely to Federal and state and local tax receipts.

IT IS IN EVERYWAY, at all levels, a good thing for unemployment to fall-and in a rational economy that would be a principal objective of public policy. Yet in the world of conventional economics, this happy event is irrationally supposed by NAIRU theorists to be the harbinger of inflation to come. It sets off a great hue and cry in the universities and on Wall Street, explaining why the Federal Reserve Board will have towill be required by economic law to[2]-raise the interest rate high enough to induce recession.

As an example of the wild claims made by conventional economists, we may consider a 1990 proclamation by Professor Paul Krugman of MIT that if we tried to increase employment by 2 million people, “inflation would begin to accelerate rapidly.” In the event, employment was essentially unchanged for two years, and the Consumer Price Index (CPI) fell from 5.4 per cent to 3.0 per cent. Since 1992, employment has increased by over 4 million a year, and the CPI has, yes, fallen to 1.4 per cent. If we use the figures of the Boskin Commission that economists were praising last winter, inflation now is only 0.3 per cent-repeat, three-tenths of one per cent-a year.

In its perennial struggle with the inflation banshee, the Federal Reserve has sponsored eight recessions since World War II. Not only were trillions of dollars’ worth of commodities never produced (it can be argued that we have too much stuff anyway), but millions of our fellow men and women were forced into poverty, their hopes for a better life dashed.

That is a monstrous shame we all bear, a shame brought about by arrogance in league with ignorance. After 30 years, the ignorance is no longer excusable-if it ever was. We are at present in an economy whose unemployment rate is falling -even without counting our workfare fellows as employed-and whose inflation rate is approaching zero. And we have seen unemployment fall despite the conventionally feared minimum wage law, specifically mentioned by Professor Friedman as increasing the natural rate of unemployment.

Federal Reserve Chairman Alan Greenspan, we have noted hopefully here more than once, claims not to be a believer in NAIRU. Nevertheless, in his recent semiannual testimony before Congress he felt obligated to warn that if things don’t slow down, the Reserve will raise the interest rate. Should he carry out his threat, he will hurt the poor and especially the lower middle class, who, as we have seen, are not responsible for inflation, and he will benefit the rich, who are to blame. This is not statesmanship; it is madness.

Perhaps the Chairman still fears an over exuberant stock market. That may be sensible, but raising the interest rate will attempt to exorcise the fear by taking billions of dollars from the borrowers among us and giving them to the lenders. The attempt will succeed only if he manages to bring on another recession. This, too, is madness, not statesmanship.

It is also NAIRU by another name. The natural rate of unemployment, the nonaccelerating inflation rate of unemployment, NAIRU-the whole mess-is fallacious in theory, erroneous in fact, and immoral in consequence. Let there be an end to it.

The New Leader

[1] Italics are not in the original

[2] THESE italics ARE in the original…

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

By George P. Brockway, originally published 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 October 9, 1995

1995-10-9 Japan Does It Again TitleTHE TEXT for today’s lesson comes from the second act of The Mikado, where Ko-Ko, Nanki-Poo and Yum-Yum sing in unison, “Here’s a pretty how-de-doc!”

For Japan has done it again. Last year

I reported in “Unemployment Japanese Style” (NL, May 9-23, 1994) how Japan has given the lie to the most awesome and awesomely barbarous-notion of American economics. I mean the theory of the “natural rate of unemployment,” or, in proper academic gobbledygook, the “non-accelerating inflation rate of unemployment,” or, in a fashionable acronym, NAIRU.

As you will remember, NAIRU says that if unemployment falls below a certain level, inflation will accelerate without limit until the central bank (a.k.a. the Federal Reserve Board) raises the interest rate high enough to cause a recession. In the United States, the “desired” rate of unemployment is said to be about 6 per cent. At present it is hovering around 5.5 per cent, and the inflation rate is about 3 per cent. We maintain it all with a 9 per cent prime, and are expected to make a soft landing (from where to where no one says).

The Japanese, however, have already landed. Their unemployment rate has not been higher than 3 per cent for decades, and their inflation rate is lower than ours. In short, they have made the natural rate of unemployment and its advocates look foolish.

And now they have done the same thing to the second most hallowed doctrine of contemporary American economics productivity theory. The dogma of productivity is among the most widely invoked in economics, especially when practical policies are at issue. It is dominant at all levels, from microeconomic downsizing to macroeconomic competitiveness in the new global economy. It is central in labor and environmental disputes. Along with NAIRU, it guides the deliberations of the Federal Reserve Board. It is brought to bear on matters not strictly economic, from education to highway design.

How have the Japanese made this sublime theory (and its practitioners) look foolish? Well, it tums out that the assembly plants in the United States of two major Japanese automobile manufacturers, Nissan and Toyota, have higher productivity ratings than those of any American manufacturer. So what’s new? What’s new is that both Japanese plants lost money last year, while American automobile manufacturers were rolling in it.

There are, to be sure, plenty of reasons for the poor profit showing of the Japanese plants. First is the “strong” yen, which renders anything made of Japanese parts expensive in comparison with the same things produced in countries with “weak” currencies. Second is the Japanese determination to use only their own parts, no matter where they are assembled (a casus belli in the trade dust-up last June). Third is the evident Japanese decision to accept the losses for the sake of maintaining or improving their share of the American market. Fourth could be a Japanese preference for losses rather than paying corporate taxes in the United States (since Nissan as a whole lost ¥166.1 billion or $1.86 billion-last year, this is not a probable motive). Fifth is the Japanese policy of slighting their home market in favor of their export market, with the result that a sluggish world economy has been translated, these past three or four years, into a stagnant or recessive Japanese economy.

All these reasons for poor profits would be even more forceful if Japanese plants were less efficient and less “productive.” And American automobile manufacturers would very likely increase their profits by becoming more efficient. The point, though, is this: You can be “unproductive” yet profitable and stay in business. But you can’t stay in business forever, no matter how productive you are, if you don’t make ends meet. (Of course, the American assembly plants of Nissan and Toyota are scarcely noticeable elements of their businesses; these factories could probably be run at a loss indefinitely without much hurting long-term corporate profits.)

In a free economy, productivity may sound nice (at least if you haven’t been downsized), but profitability is essential. This being the case, one must wonder why the economics profession is enthralled by the idea of productivity. You can produce a table and chairs, knives and forks, plants and food, and sustain yourself, but productivity for its own sake is, as Midas found gold to be, not good to eat. Productivity is a less important concept than profit. It is also a slipshod, if not flatly fallacious, idea[i].

I have, over the years, worked up examples of the absurd consequences of applying standard productivity theory to micro-economic and macroeconomic problems, and (you may not believe this) I’m tired of repeating myself. If you missed those lessons, I would advise you to rush to order the third edition of The End of Economic Man, due at your bookseller’s in January.

In the meantime, I will repeat a baseball example, since that sport may again be the national pastime. Once upon a time, the Washington Senators got a rookie centerfielder by the name of Joe Hardy. On Hardy’s first time at bat in the majors (as I heard the story), he hit a grand slam home run. When he was due up next, there were only two men on base; so the manager[1], who had majored in economics, yanked him for a pinch hitter. Otherwise Hardy’s productivity (the number of runs he knocked in per at bat) would have had to go down-unless he drew a base on balls or got hit by a pitch, and neither could be counted on. I forget the manager’s name; I think M.I.T. snapped him up to coach their entry in the Neoclassical Synthesis League.

I know our baseball analogy reeks of metaphysics. So does productivity theory, and I’m sorry, but we’re going to have to think about it.

Productivity is defined as output divided by input. The output part presents no particular difficulty. It can be as definite as the 48,000 pins produced in a day by the “small manufactory” Adam Smith tells us about; but usually it is as diffuse as the Gross Domestic Product, and so has to be reduced to dollars, as the GDP is.

You might think that the input part would also be reduced to dollars, for it, too, is pretty diffuse, including at least land, labor and capital. The fact of the matter, however, is that economists tend to be embarrassed by money. Victorians thought it vulgar to talk about it. Today’s economists, like medieval scholastics and contemporary analytic philosophers, think money is merely nominal-unreal. Mathematical economists who fancy general equilibrium theory can’t find a place for money in their model. Unreal.

The obvious way to avoid using money in the denominator of the productivity fraction is to select the largest factor of input and make it a surrogate for the whole. Very well. Labor is today the single largest factor in the U.S., year after year amounting to close to 60 per cent of total costs. You will have noticed that total costs have to be stated in terms of money, and therefore that 60 per cent of the total also has to be stated in terms of money. (We’re going to have to let that pass, or this column will become a book.)

ANYWAY, the Productivity Index prepared by the Bureau of Labor Statistics of the Department of Labor divides the Gross Domestic Product of a period by the number of hours worked by all persons “engaged” in the period, including the hours of proprietors and unpaid family members. “Hours worked,” especially by unpaid workers, certainly is not money, and the category presents other problems. Most important, the hours are not homogeneous. Lee Iacocca’s hours, or some of them, undoubtedly yield a greater output than do a machinist’s, and a machinist’s hours yield a greater output than do a floor sweeper’s; but they’re all the same to the Department of Labor. Indeed, when you stop to think of it you realize that land and capital also work hours, probably more hours than labor, because they never sleep, and therefore might be thought more suitable than labor as surrogates for all inputs.

There is also an Employment Cost Index, which divides the total annual compensation of all employees of private business, from handyman to CEO, by the annual total of hours worked for pay. This gives us a figure that I frankly can see only cynical use for. Since it combines rapidly growing executive salaries with slowly falling common laborer wages, it has almost doubled from 64.8 in 1980 to 123.5 in 1994, and so can be used by readers of the Wall Street Journal to prove to their seat mates on the commuting train that labor never had it so good.

The conclusions drawn from the Productivity Index are similarly not remarkably reliable or even useful. During our autumn of discontent, mainstream economists recommended single-minded devotion to productivity to prepare us for the explosive competitiveness of the brave new global village. We learned that to become more productive, we must reduce “hours worked,” and to reduce “hours worked,” we must downsize.

Well, you don’t need a productivity index to know that you could make more money if you could turn out the same quantity of commodities with fewer employees. I could do that one with my eyes closed. With my eyes open, I can see that you make more money by producing the same output while borrowing less and paying lower interest on the sum borrowed, or paying lower taxes, or reducing advertising, or having fewer three-martini lunches, or organizing your business more rationally.

What I see with my eyes open as well are a lot of situations where input and output are stated in terms of money. That is not as strange as modern economists seem to think. When we divide total output in dollars by total input in dollars, our answer is the rate of profit, which is not an esoteric new idea at all. Business managers seeking to compare their firm’s current operations with those of their competitors, and with their own in other years, have used such ratios for generations. It’s nothing to them how many hours are required to make their product; what they’re after is the minimum cost.

For years the Japanese have demonstrated that you don’t have to have unnaturally high unemployment to maintain low inflation. Now Nissan and Toyota offer empirical proof that although yours may be the most “productive” outfit in the village, it may profit you nothing. Thus the Japanese have cooled off the two hottest tickets of modern American economics.

What will they think of next?

The New Leader

[1] Benny Van Buren

[i] Shades of Clayton Christensen and, among other things “When Giants Fail”

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 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

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