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By George P. Brockway, originally published July/August 2001[1]

7-8 2001 Why the Trade Deficit is a Blessing Title

FOR YEARS almost beyond counting we had the budget deficit to worry about and argue over, and for some 30 years we have also had the foreign trade deficit.  Many thought the two went together, like the proverbial horse-and-carriage. But the budget deficit has gone away[2] (with consequences yet to be discovered); the trade deficit is still with us and growing practically every day.

The reason for its robustness is that we import more goods and services than we export-and have done so every year, with few exceptions, since the early 1970s.  We pay for our excess imports by using dollars to acquire the necessary amounts of the exporters’ currencies, or by paying directly in dollars. Consequently, our trade deficit has risen in dollars-a growing total now approaching 1.5 trillon of them.

The countries we are importing from do not buy more of our goods and services with those dollars (that’s how the deficit developed in the first place).  They buy our bonds and stocks and other assets.  If their purchases are wise or lucky, further streams of dollars swell their accounts.  One way or another, our dividend and interest payments to foreigners now run more than $10 billion annually.

In October 1998 Congress appointed a bipartisan United States Trade Deficit Review Commission to study the imbalance.  Last November (2000) the commission issued its report.  All 12 members agreed the trade deficit is a problem of the utmost seriousness that threatens the welfare of the nation and the whole world.

The chairman of the commission (and leader of its six Republicans) wrote, “Large and growing trade deficits are neither desirable nor likely sustainable.” The vice chairman (and leader of the Democratic contingent) wrote, “It is simply irresponsible to ignore the huge threats that the growing trade deficit could pose to our economy.”

Those are pretty strong words; yet I am here to tell you there is exceedingly little chance that the ominous but unspecified disasters will befall us. Indeed, although I believe our trade deficit will continue to grow, I will argue that it is a blessing for us and for the world.  My confidence is based on a simple reality:  All the nations of the modern world need petroleum, and only a few have enough natural supplies to satisfy their needs.

Art Buchwald once wrote that when the petroleum-producing Arabs sent their sons to the United States for higher education, we made the serious mistake of directing them to Harvard Business School instead of Slippery Rock Teachers College, where they might have learned how to play basketball.  As it happened, the second-generation petroleum producers somewhere learned to play OPEC.  It is quite possible that their teachers were the Western oil companies and the Western central banks (including the Federal Reserve), who in the 1950s and ‘60s smugly rebuffed Arab pleas, first for rational drilling and pumping programs, and then (after the Arabs nationalized their oil fields) for rational terms for what their generally arid lands wanted to buy in Western markets.  No doubt they were greedy.  So were we.  In the end they learned how to play the OPEC game very well.

Their smartest move was to agree to sell their petroleum exclusively for dollars.  At first glance this decision certainly seems quixotic, given the coolness between them and us because of our support of Israel.  On reflection we see that making the dollar the petroleum market’s international currency allows them to pose as modern men too business like to hold a grudge, and also enables them to avoid being skinned alive by the international money speculators.

Under an open system, they would be in a continuous frenzy trying to determine how much each of the world’s currencies was worth to them every minute of the day.  Speculators would make (and no doubt occasionally lose) fortunes trying to outmaneuver them. Under the present system, they need worry solely about what a dollar is worth to them, or how many barrels of oil they have to sell today in order to get the dollars they need today.

The dollar is uniquely qualified to play this role because our trade deficit means that there are many billions of dollars sloshing about in the world.  No other currency can or will make that claim.  The two economies large enough to think of doing it are Japan and the European Union (EU), and both are forbidden to attempt it by their economic theories.

Let no one imaging that economic theory is just hot air.  Japan, profusely praised by Wall Street for saving rather than consuming, has saved itself into a decade of stagnation that shows no sign of ending.  As for the EU, it is run by bankers who pride themselves on tightly controlling all sorts of deficits.

IN SHORT, if you want a truly international currency you cannot do better than the United States dollar.  Our supply-siders have tried to charm us into becoming compulsive savers like the Japanese, and the neoclassical economist of the “Washington Consensus” continue to scold that we don’t save enough, but we remain a nation of carefree spenders.  Because we are the largest importers and the largest exporters in the world, dollars circulate widely around the globe.  More to the point, we are the world’s biggest importer of petroleum and possibly the biggest exporter of agricultural produce the petroleum-producing nations need, plus military material they think they must have.

So the dollar was chosen, and the petroleum-thirsty nations found themselves having to harvest it-not merely for their day-to-day purchases, but also as reserves to help protect themselves from sudden assaults on their currencies, and to ensure that they can buy at least their share of petroleum until the Arabian sands run dry.  At the moment the dollar reserves of these nations are slowly and surely reaching $1.5 trillion.

Yes, the figure for our trade deficit is in the same ball park.  In fact, if you add the foreign investments in our real estate and newspapers and book publishing and agribusiness and automobile manufacturing and the rest to the sum of foreigners’ dollar reserves, you will find the total is actually on the same yard line as our trade deficit.

7-8 2001 Why the Trade Deficit is a Blessing Oil Derrick Where else could it be?  Aside from some of the deficit dollars being hidden in mattresses or mislaid in “statistical discrepancies,” there is no place else for it.  The mathematics is simple and indefeasible[3].

Moreover, no country’s finance minister is likely to tamper with his or her dollar reserves at the risk of collapsing the country’s finances altogether. And if they all tried to tamper at once (as the Congressional commission’s scenarios suggest), their mutual competition would result in their getting poor value for their money.

Please note that this story is historically sound.  Our trade deficits were few and insignificant before the 1970s, when OPEC firs showed its power, and they have increased along with the world demand for petroleum, and hence for dollar reserves.

The foregoing is, I submit, a stunning conclusion.  Consider some corollaries:

  1. Our trade deficit is caused by foreigners’ need for dollars, not by our inability to produce goods the world wants at prices it is willing to pay. All the complaining about the alleged failure of our school system, the power of our labor unions, the greediness of our rich, the general fecklessness of our society-and there is much complaining in the commission’s report-is beside the point.  The criticisms may be justified; that is another question. But they are not the cause of our trade deficit.
  2. If we could somehow manage to increase our exports and decrease our imports enough to erase the deficit, we would upset the international economy-and ours. To be sure, the nations of the world are able to get dollars from one another, but because they are all in the same boat, they must, in the aggregate, trade enough of their goods to us for dollars to maintain their reserves and to increase them as their economies expand.
  3. Since the 1970s our bankers and mainstream economists have been saying that we save too little to finance our economy, that we have to attract foreign investors by offering high interest rates[4]. The foreign nations must put their dollar reserves where they will be both safe and liquid, though, an nothing satisfies these requirements so well as U.S. Treasury bonds.  Ergo, the high interest rates are not now, and never have been, necessary to attract foreign capital, that comes to us anyhow. But they have kept our unemployment rate higher than it otherwise would have been and thereby widened the debilitating gap between the haves and the have-nots of our society, not to mention adding to the cost of debt services.

IF WE HAVE high interest rates (and for the past 30 years they’ve been higher than in any other third of a century in our history), it is not because the Federal Reserve Board has been “forced,” as they like to say, to impose them.  Rather, it is because the Reserve has misread the state of the world and its own economic theory.

The theory in question is that of the gross domestic product or the gross national product.  It doesn’t matter which; in both cases exports are a positive factor, while imports are a negative factor.  Accordingly, a trade deficit-that is, and excess of imports-decreases the domestic or national product and should be avoided.

The key word is “product” or output.  The GDP never was intended to be a measure of consumption or satisfaction or quality of life.  For example, petroleum is probably our largest import, would our quality of life be improved if we eliminated it?  In some ways, yes; and perhaps eventually, yes.  But here and now, surely not.  And think of all the natural products we import-bauxite and tungsten and uranium, and tea and coffee and bananas.  Would our quality of life be better without them?  And suppose we could not import unique articles like works of art and antiquities for our museums and our personal pleasure.  In the other direction, would our quality of life be better if we exported all our wheat or all our silicon chips?

As you can see, a trade deficit can be greatly to our advantage, if not a necessity.  The advantage becomes a fortuitous blessing when we realize that all we have to do to enjoy it is to maintain a growing economy and restrain the Federal Reserve from going off in blundering pursuit of a misunderstood theory.

Imports are a disadvantage to us to the extent that they prevent the development of industrial or commercial opportunities we might have exploited ourselves, thus reducing our output by causing underemployment of our capital and labor.  But if our labor and capital are fully employed, every increase in imports can be an increase in our quality of life.

Again, recent history is suggestive.  The latter 1990s seemed like the storybook time of Goldilocks.  Unemployment fell, capital investment rose, and prices were comparatively steady because the interest rate was comparatively steady from 1995 to June 1999.  True, the trade deficit continued to rise, yet we continued to prosper.

TO COVER all the bases, it should be observed that there is also a cultural dimension to the trade deficit.  Many even find its economic aspect less alarming than how much of our economy foreigners have come to own.

Of particular interest to me is book publishing, about 90 percent of which-after the sale of Houghton Mifflin to France’s Vivendi International– is now said to be controlled by six conglomerates, five of them in foreign hands.  Publishers have always been a bit smug about being engaged in an ostensibly cultural endeavor that at least sometimes makes money.  Lately they have been flattered by sociologists who call them gatekeepers of the realm of ideas and values. (I was brought up to believe values are more likely to be solid if ideas circulate freely, but let that pass.) At any rate, some feel that barbarians are currently not only at the gates but in charge of them.

How did the foreigners get to be our gatekeepers?  They bought the gates, of course, and they bought them from Americans with dollars. There is nothing in such transactions to indicate that the buyers are less responsible than, or more corrupt than, or even very different from the sellers.  If the buyers are barbarians, the chances are that the sellers were, too.  Or both may have been praiseworthy.

In the 1930s and ‘40s, it seemed as though almost all the number one bestsellers were published by Doubleday, Simon and Schuster and Macmillan, with occasional assists from Scribner’s, Harper’s, Viking and Little, Brown.  And for a while it seemed as though the number one best-selling fiction writer was Margaret Mitchell, and the number one best-selling nonfiction author was always named Dale Carnegie.  Although the names and numbers are different today, the situation is not dissimilar.  No one has ever pretended that best-sellers were necessarily best by any other standard.7-8 2001 Why the Trade Deficit is a Blessing Margaret Mitchell

It will be noted that all the publishers named above have been sold and resold and conglomerated in one way or another, mostly to Germans, Australians, or Brits.  I’m not one to say that they are worse (or better) gatekeepers than those who sold out, though I have made a case (see the new edition of The End of Economic Man-advt.) that things are better for workers (and for the economy) if their firm is employee-owned.

In a conglomerating world, however, it makes a little difference to workers who their employer is, provided they are treaded decently and paid fairly.  Nor does it make much difference to consumers who produces the commodities they buy, so long as the quality and price are right and child labor is not brazenly required.  The government will be satisfied with any firm so long as it is law-abiding, generally abjures petty fraud, and pays its taxes.  As for investors, they have already indicated by their eagerness for capital gains that they don’t care who the gatekeepers are.

Furthermore, if there actually were some sense to the gatekeeping metaphor-if a gatekeeper undertook to corrupt our society-we could protect ourselves by not paying attention to his (or her) product.  Corruption is like the tango:  it takes two to do it.  A corrupter without a willing corruptee is little danger to anyone.  If there is a problem here, it is our willing corruptees.[5]

None of this should be astonishing.  After all, America was built with foreign investments.  Except for a few months immediately before (yes, before) the onset of the Depression of 1837, we were a debtor nation from 1776 until World War I.  We prospered in those prewar years.  Why should we not prosper now as we become a debtor nation again?

Finally, lets try to put the size of the problem (if anyone still thinks it is a problem) in perspective.  It has take us roughly 30 years to run up a trade deficit gradually approaching $1.5 trillion.  That’s less than a fifth of our GDP.  The stock exchanges can and do lose that kind of money in a couple of weeks, and what is lost on the exchanges is gone and lost forever.  By contrast, our trade deficit is a debt for which we received value, and from which the world economy benefits, but which we may never be asked or even permitted to discharge as long as OPEC pumps petroleum.

The New Leader

[1] Ed: This article was written before there was a Euro, before the US returned to being a net exporter of energy, before the expansion of wind and solar energy, before China grew to the largest economy.  As a result, many of the assumptions here no longer hold.  Someone smarter than I will have to say if the arguments presented are stronger or weaker.

[2] Ed: This article was published at the end of the Clinton Presidency when the annual federal budget WAS balanced

[3] Ed: re: the first footnote, this suggests the arguments still hold (though I haven’t done the research)

[4] Ed: This claim has certainly been undone by the era of “quantitative easing” where interest rates were zero, and in certain places and times, negative.

[5] Ed:  its as if in 2001 the author could foresee Fox News, Laura Ingraham, and David Hogg.

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By George P. Brockway, originally published January 8, 1990

1990-1-9 100 Million Children Can Be Wronged Title

ONE HUNDRED MILLION children are expected to die unnecessarily in the brave new decade that lies before us. The estimate is, I fear, reliable, because children are dying–unnecessarily–at that rate now: 10 million a year, 27,000 a day, 1,200 an hour, 20-30 in the time it has taken you to read this far. They are dying that fast; and while many dedicated people are desperately doing what they can about it, we as a civilized and sophisticated nation are doing nothing substantial to help, nor are we likely to. In fact, we are more likely to hinder than to help.

Forgive me for emphasizing that these deaths will be unnecessary. There will be other deaths–perhaps more than 100 million–from accidents or incurable diseases or congenital disorders. But the 100 million I’m talking about will die from common diseases like measles that we have vaccines against, from infections that would yield to an inexpensive antibiotic, from all the intestinal illnesses that can be caused by bad water. Most of the deaths will occur in the Third World, especially Africa. (The United States of America will have a shameful percentage–the highest among the industrialized nations–but that’s another story.)

This is one problem that, in the cynical phrase, could be solved by throwing money at it. The medical supplies and medical knowledge are available. Money is lacking. All sorts of dramatic comparisons are possible. Only a few dollars a head would save most of the children. The total cost would be only a little more than the Third World is now paying for arms, and less than the First and Second World military squander in a week. The millions that were spent to rescue and televise three whales trapped in the arctic ice could have saved tens of thousands of children. The millions that are spent in Right of Life political campaigns and demonstrations could save millions of children who have the right but no possibility of maintaining it. And so on. All that misses the point

You and I assuredly could spend our money more wisely and more responsibly, but we are not directly to blame for these unnecessary deaths. Nor will our attending occasional charity rock concerts or across the continent do much to end the plague. No. Those 100 million children are doomed because our bankers “want to succeed, not just survive, and because we are too timid or too lazy or too ill-informed to call the bankers to account.

Thirty years ago the outstanding indebtedness of the Third World was $7.6 billion. It is now approaching (if it has not already passed as I write) 200 times that, or $1.5 trillion. It would certainly appear that the First World (including the World Bank, the International Monetary Fund, and private and government banks) has been pretty generous. No doubt there is some generosity lurking in this huge amount of money, but most of the sum comes from the great recycling bankers like to boast about.

The whole thing started with OPEC, which made the oil-producing countries very cash-rich very quickly. The banks saved them from the worry of spending this money in the nations where the sold the oil. They all–foreign banks as well as American–rushed in and offered the Arabs and their associates high interest rates for their deposits. Having attracted a share of OPEC’s money, the banks now had to complete the cycle and find someone to lend it to. The Third World was ideal for the purpose. The countries were many and small; the needs were great; the governments were weak; and many of the rulers were rapacious, almost as rapacious as the bankers.

In their fierce competition with each other the bank’s loan officers became salesmen. Often with the advice of experts from the World Bank, useless projects were financed–like the longest power transmission line in the world, with nothing to speak of at either end, or a billion-dollar state-of-the-art steel mill that was too sophisticated to handle the low-grade ore it was supposedly built to process. Skyscrapers were put up next to mud huts. Stately mansions were built for dictators. And a great many dollars went straight into numbered accounts in Switzerland. The bankers didn’t care, because the interest rates were high, and former Citicorp CEO Walter Wriston had convinced them that countries don’t go bankrupt.

The entire gaudy tale is told in Richard W. Lombardi’s Debt Trap: Rethinking the Logic of Development. When Lombardi’s book appeared in 1985, the Third World debt had not quite reached a trillion dollars. Since it is now a trillion and a half, it would seem that the First World has been sending the Third $100 billion a year for the past five years. Well, not exactly. In fact, hardly at all. For most of the $500 billion never went to the Third World. It never left the First World, because it never really existed. The bulk of that lovely nonexistent money is usurious interest that the Third World couldn’t pay, and that the banks, after profound consideration and solemn negotiation, have simply added to the principal. So things get steadily worse.

There is no lack of suggested solutions. When James A. Baker III was Secretary of the Treasury, he had the Baker Plan, which the press pronounced brilliant–and precisely nothing came of it. Nicholas Brady, his successor, brought forth the Brady Plan about a year ago, and the papers were filled with praise of it for a while, especially after Mexico and the banks accepted it, or said they did. The actual results haven’t been so newsworthy, but Teotihuacan wasn’t built in a day.

IN THE MEANTIME the International Monetary Fund and the World Bank haven’t been idle. They publish their ideas in Finance & Development, a quarterly magazine written in the sort of mush that might be produced by crossing a banker’s banquet speech with a TV talk-show on economics. The message is that the debtor countries have to reform. This is probably true, yet the required reforms are curious. They seem to have been cribbed from the Republican campaign platform, with perhaps a thought or two from Margaret Thatcher.

Thus in a recent issue we read, “A more active policy to reduce rigidities in the labor market and in wage determination will assume an increasingly important role in sub-Saharan Africa in order to promote both employment and economic expansion, particularly as the size of the skilled labor force increases and as the trend toward public sector employment is reversed.” Do I need to translate? (Wages are too high, and so are taxes. Can it be because of high wages that Africa’s per capita income is less than $425 a year?)

A few paragraphs further we learn that the banking system suffers from “insufficient supervision, and excessive administrative interference.” This would seem a dilemma unless you understand that the IMF should supervise, while the locals mind their manners. A little later we are told that “a more flexible, market-oriented interest rate policy will contribute to enhancing financial intermediation, improving resource mobilization, and increasing the efficiency of credit allocation.” Ex-Federal Reserve Chairman Paul A. Volcker couldn’t have put it better as he transformed us from the world’s largest creditor to the world’s largest debtor.

As a final example, consider this: “The objective will be to select revenue measures that enhance the elasticity of the tax system. The former will help improve incentives [and so on and on].” Since the gap between the rich and the poor is even greater in sub-Saharan Africa than in the United States, and the African rich are notoriously casual about paying their taxes anyhow, I leave it to you to imagine how “incentives” can be improved. The IMF insists on other “reforms”: currency devaluation to bring local money closer to overvalued dollars; privatization of the few existing public services; schemes to encourage foreign speculators by making it easy for them to pull out if the going gets rough; abolition of import quotas and most tariffs. (The United States is threatening sanctions against Nigeria for trying to conserve foreign exchange by banning the importation of wheat.) The IMF demands practically guarantee that the debts cannot be paid, but it is gravely averred that their purpose is to improve the prospects of payment.

I have left for last the most bitter irony of the situation. The Bush Administration has just done a good deed, reversing a niggardly Reagan policy. It has been quiet in the act, releasing the news in Nairobi, perhaps because it is bashful about being generous, or perhaps because the money involved is too little for White House Press Secretary Marlin Fitzwater to have noticed. At any rate, it has agreed to cancel $735 million in government debts owed us by 12 African nations. (Belgium, Canada, France, West Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, and the United Kingdom have already canceled the debts owed them.)

Will not this forgiveness save at least the children of the 12 nations? Sadly, there is no reason to expect it to, for there are strings attached to our generosity. Our cancellations will take place over the next two years, and only if the lucky 12 are good little nations and do what the IMF says. True to its primary mission of helping countries correct balance of payment deficits, the IMF will see to it that the First World banks (who have not canceled their loans) have first call on the foreign exchange that becomes available, and children will die for lack of medicine.

As Calvin Coolidge remarked about World War I debts, They hired the money, didn’t they?

 The New Leader

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

1989-11-27 What Happened to Jimmy Carter Title

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

Originally published July 14, 1986

LIKE THE Ancient Mariner, we war veterans have a glittering eye.  (I have seen mine reflected, dully, in my grandchildren’s eyes as they prepare to listen dutifully.) We could tell you a tale or two-and we will. Indeed, I will, here and now, tell you war story that has a lesson for us today and for tomorrow too.

Perhaps you were there. After all these years I may be off a bit on some of the details. If so, you can correct me. But I’m sure that I have my oral straight.

It was, as I remember it, in the fall of ’37. The battlefield was not on the banks of the Ebro but in Herald Square. Macy’s let loose a barrage advertising a special on the Modern Library: three volumes for a dollar. Skirmishing had been going on for months or maybe years but the price had rarely fallen below wholesale, somewhere around 50¢ (the list was 95¢). The big battles in the last half of ’36 and the first of ’37 were fought over Gone with the Wind, which, in spite of its $3.00 list price and an ordinary wholesale price of $1.80, sold as low as 49¢ in auto supply stores. It was the big loss leader: possible profits on Margaret Mitchell’s work were expendable as-Ion- as it lured in people to buy bigger-ticket items.

By the fall of ’37, practically everybody who wanted a copy of Gone with the Wind-and many who didn’t-had one. So Macy’s tried to effect a breakthrough with the Modern Library. The book section, then on the main floor, was mobbed. We rushed in from every point of the compass as soon as the doors opened. I still have my three books: The Education of Henry Adams, The Theory of the Leisure Class, and D.H. Lawrence’s The Rainbow (a novel, I’m ashamed to confess, that I’ve never been able to finish).

Did Macy’s tell Gimbel’s? No, but Gimbel’s was not caught napping. Its comparison shoppers were in the front line, rushing the news from 34th Street to 32nd Street as fast as it occurred. And of course, Macy’s spies were doing the same in Gimbel’s.

I was a well brought up young man; so after I had elbowed my way to the table and grabbed my three books, I waited patiently for a clerk. My good manners were rewarded. Twice, as I stood there, an assistant buyer rushed in (we smartly made way for her) and lowered the price-first to 31¢, then to 28¢, the price by the time I was waited on. Maybe I’d have done better at Gimbel’s.

I don’t know. Anyway, it was a good war. Even the most flaky Harvard philosopher would call it a just war. But it had repercussions. Booksellers for miles around were hurt, or thought they were, and screamed.

Some returned their stock of the Modern Library to Random House; some refused to buy Random’s new books; all urged Random to protect the Modern Library price under the new Fair Trade Act. (This law allowed producers of copyrighted, patented or trade-marked goods to follow a complicated procedure that would require every retailer to maintain list prices. The act has since been repealed, and it is conventional to denigrate it; constant readers will not be surprised to learn that there I go again, being unconventional.)

Macy’s moved quickly. They ordered in, on top of their usual heavy inventory, an extra $50,000 worth of the Modern Library. That was a lot of money in 1937. Random was delighted. But when the publisher started talking about price maintenance, Macy’s whispered that it would have to return all those books for cash. Random decided to bear those ills it knew, and continued to do so for another four or five years, until wartime shortages allowed it to call Macy’ s bluff and declare that it would take back any books Macy’s was ready to send. End of war story.

The moral is this: If you maintain a large inventory, you can force your suppliers to play the game according to your rules. And where can we put that lesson to good use? Ina word: oil. Oil is certainly the second most screwed-up topic in political economy. I’m not sure what is first. Probably the deficit, or maybe the defense budget. No matter; they’re all related.

Everyone knows you can’t run a war or a police action or even a defense without oil. It is the absolutely essential military resource. It is not surprising, therefore, that we have at least the outlines of a policy on oil, and that we’ve followed them for a long time. But if you tried to think the problem through, calmly and rationally, you would not guess what our policy is, not in a million years. For example,

President Eisenhower, who certainly did not regard defense frivolously, imposed a partial embargo on imported oil. Ike said (if you don’t believe me, you could look it up) this was a defense measure.

Its expected and intended and actual results were (l) to reduce the importation of foreign oil, (2) to let domestic producers raise their prices, and (3) to encourage domestic producers ( a.k.a. wildcatters) to explore for new oil fields and exploit existing fields more thoroughly, Now, you, being a sober citizen, will wonder how all this made America  stronger, and I will have to say that it had the diametrically opposite effect, for it caused us to use up our oil reserves faster than we might have otherwise. To be sure, the higher price of oil may have persuaded some people to conserve a bit; but the principal consequence was a draw-down of our reserves.

The crazy thing is, people are clamoring for us to do the same thing again. This time the alleged purpose isn’t national defense but deficit reduction. Of course, if your real aim was to reduce the deficit, you would put an extra excise tax on all oil. No one, however proposes this, because it would annoy a number of politically active oilmen.

Similarly, if you really wanted to make America stronger, you would import every ounce of foreign oil you could, now that the price is down. You would move, with more than deliberate speed, to fill up those salt mines (or whatever they are) where we started, back in the discredited days of Jimmy Carter, to accumulate a ready oil reserve. Before the oil glut, OPEC warned us that if we tried to fill those mines in order to reduce our dependence on them, they’d consider it unfriendly behavior and would respond by pushing up the price of oil, or maybe slapping a new embargo on us. Today, though, with pretty bad business and pretty good conservation world- wide, OPEC has so much oil it doesn’t know what to do. In addition, we have banks failing all over the West, and the growth of Houston, especially, is being corrected. So far, the only thing we have been able to think of is a trip for Vice-president Bush to explain to the Saudis that the people he represents hope that prices won’t fall too low.

ADMITTEDLY, filling those mines would cost real money, even at present oil prices, and everyone has been programm-rudmanned to worry about the deficit. But here is where the moral of the Herald Square war comes in. Just as Macy’s excessive inventory of Modern Library books inhibited Random House from fixing the price at 95¢, so if we had all our depleted mines (and all our storage tanks) brimming with oil, it would be difficult, if not impossible, for OPEC ever to spring another embargo on us.  Those full reserves would be a new declaration of independence for us. They’d make a quicker and more effective (and probably cheaper) contribution to national defense than Star Wars or nerve gas or re-commissioning obsolete battleships.

What’s more, buying that oil would be an investment in something useful for civilian as well as military life. At the minimum, it would be a guarantee that we would not have lines at the gas pumps until oil was really running out. Charging such investments to the current budget is nonsensical accounting (but that’s another story).

Filling our reserve capacity would also give us opportunities for a creative and hard-nosed foreign policy. Consider how the reduction of Arabian pressure on us would strengthen our position in the Middle East. And consider how we might distribute the orders for the oil: Naturally, we’d buy most from friendly countries that are heavily burdened with debt (much of it owed to us).

Thus we could help, first of all, Mexico, which is on the brink of lMF-sponsored chaos. Then we could think of Venezuela, one of the struggling South American democracies, and of Nigeria, one of the struggling African democracies (at least in ideals). In the Middle East we could favor countries willing to put a bit of pressure on Syria. The possibilities are very great. Prudent friendliness on our part could earn us friendly prudence on the part of many important nations.

So why don’t we do it? You know why. Even if we weren’t hung up on the deficit issue, even if the Administration and Congress could be gotten to see the light, the program would be stopped dead by influential senators and congressmen who are obligated to, or in fear of, 50-odd men who’ve made a killing in oil. You know these people would stop it, just as they’re now stopping tax reforms that might treat them like everyone else.

These 50-odd men are not the Seven Sisters of Big Oil. Exxon and the rest usually support what they do, and their support rivals the clout of any other industry’s lobby. But the initiative and most of the money comes from the independents. What makes these few men so powerful? They are wealthy-really and truly wealthy-and they don’t give a damn about anything except having their own way. Every one of them is capable of signing checks for hundreds of thousands without worrying about the bank balance. Every one of them can make maximum contributions to political action committees as fast as the committees are invented.  If you want a rundown on who they are and how they work, I refer you to The New Politics of Inequality by Thomas B. Edsall (one of the last books I edited, and a good one).

We’re not talking about merely Texas and Oklahoma. There are appreciable amounts of oil in 10 or more states, some of them very populous. That gives the oil lobby a bloc of, say, 20 senators and 50-60 congressmen it doesn’t have to worry about. Moreover, many of these legislators have accumulated seniority and the committee chairmanships that go with it.

In spite of all this, maybe the current economic difficulties of the oil states can give us a chance to get some of our own back. Suppose we said we’d fill up those reserves with true-blue American oil. Could they resist the temptation? We would lose the chance to do something useful in foreign policy. Still, we wouldn’t be doing something harmful to our national defense. And the existence of that ready reserve just might make the oil senators a little more respectful of the rest of us in the future.

The New Leader

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