5:   Here We Go Again!!

From C.O.M.E.R. COMMENTS Vol. 1, No. 1 Summer 1988

John H. Hotson Professor of Economics, Executive Director of COMER

Drs. Volcker and Bouey didn't cure the disease and darn near killed the patient. So now Drs. Greenspan and Crow are going to double the dose.

John Crow, the new head of the Bank of Canada, and Alan Greenspan, the new man at the U.S. Federal Reserve Board, have given a lot of speeches and interviews lately saying that if there is one thing they can't stand it's inflation. So they are going to get inflation down to zero (any day now) even if it kills somebody! Yes, they say they are going to haul inflation down to zero with high interest rates.

Now, that's never worked before. The fact is that we've had inflation in every year (but one) since the Bank of Canada was invented in 1934, and every year since the U.S. Fed was invented (in 1913) except years when we were having a depression or a war. So we'd better not hold our breath waiting for the new team to wrestle inflation down to zero. The facts also suggest that if our political leaders allow Greenspan and Crow to play doctor with the economy that the result will be a replay of 1979-83 if we're lucky and a replay of 1929-33 if we are not.

From 1979 through mid 1982 Paul Volcker raised U.S. interest rates into the 20% range, while Gerald Bouey out did him and clobbered Canadians with even higher rates The economy went into a free fall with waves of bankruptcies, the greatest unemployment level since the dirty thirties, the Third World and Dome Petroleum debt crises, and vast human misery. Only when Mexico threatened to default on its debts and bring down the banking system did Volcker, Bouey & Co. relent, and cut interest rates in half, to the still excessive rates we pay today. And only after interest rates were cut did inflation subside (from 10% to 4%) as the economy made a partial recovery.

Have Greenspan and Crow learned anything from the disasters caused by their predecessors? No. The first thing the new "doctors of money" did was to raise interest rates during the summer of 1987 "just to be on the safe side" --thereby causing the October stock market crash. And now they are raising rates again to "beat inflation to the punch."

Inflation is a serious disease of the body politic, and it is important to "cure" it if we can. The first step in curing a disease is to understand it. The second is to devise medicine which helps the patient rather than making him sicker--that cures instead of kills. Greenspan and Crow have done neither.

When you get right down to it there are at least eight things wrong with the policy of trying to stop the price level from increasing by increasing the rate of interest. First the policy is immoral. Second the policy is illegal. Third the policy is irrational. Fourth the policy has surrendered North America's economic leadership to the Japanese. Fifth the policy has made all our economic problems worse. Sixth the policy has caused the large U. S. and Canadian budget deficits, and the U.S. foreign trade deficit. Seventh the policy has increased the banking system's propensity to self destruct. Eighth the policy has resulted in a world wide debt crisis where our only choices appear to be between a world wide debt repudiation, depression and accelerating inflation.

Except for these shortcomings high interest rates are a pretty good policy.

Figure 1 Real GNP Creeps Up•Money GNP Crawls Up•Wages and Profits Struggle Up
•Taxes Surge Up•Interest Explodes Up

The Bank of Canada's Phony War on Inflation

Inflation happens when money income (GNP) rises faster than real income (real GNP). As Figure 1 shows, from 1950 to 1987 real GNP in Canada rose from an index of 1 to 4.7. But money GNP rose from an index of 1 to 29 as the price level increased from 100 to 607 -- so that it took about $6.07 in 1987 to buy what $1.00 would in 1950. Who caused the inflation? Every group that was able to raise its money income faster than real output could increase. People blame inflation on the "working man" because we paid out/received $31.90 in pay in 1987 for every $1.00 in 1950, when we were producing only $4.70 for every $1.00 then. Or people blame "big business" because Corporation profits before taxes were $21.80 in 1987 for every $1.00 in 1950. Nobody who knows the figures would blame Canadian farmers for inflation: they got only $4.30 in 1987 for every $1.00 in 1950 and are the only non-inflationary group in Canada!

But what of the Government and the Bankers -the very groups who claim to hate inflation and who are going to make it stop if they have to kill somebody to do it? Read Figure 1 and weep. For every dollar the governments of Canada (Federal + Provincial + Local) collected in 1950 they collected $47.00 in 1987. Thus tax receipts increased ten times as much as real income did! And for every dollar in interest & miscellaneous investment income in 1950 Canadians paid/received $110.40 in 1987!! Indeed, the Canadian statistics understate the explosive growth of interest incomes since they lump together interest with slower growing dividends. Comparisons with U.S. figures suggest that Canadians are now paying $200 in interest for every $1.00 in 1950!

The Bank of Canada, as the chief engineer of the interest explosion, is the chief cause of the inflation it always pretends to be curing!!


High Interest Policy Is Immoral

It is immoral to cause an "administered depression" even if the policy would stop prices from rising. Rising prices are a nuisance to "everyone." A depression is a disaster to those who lose their livelihood. It is immoral to cause people to lose their jobs, farmers to lose their farms, businesses to fail, in short, to cause some people to suffer great losses, even if the policy saves "everybody" the annoyance of inflation.

It is particularly immoral to do all these bad things to the many-- including the most innocent of bystanders, the children of the poor--when high interest rates very much benefit the few--those with money to lend, and especially bankers, who create the money they lend "out of the air." Each year some 13 to 15 million people die of hunger and hunger related disease in the Third World, mostly children under the age of five. Efforts to end this needless tragedy have been handicapped, and in some countries thrown into reverse, by the administered depression engineered by the First World's central bankers on the phony excuse that it was the only way to "stop inflation."

Certainly Drs. Volcker and Bouey then, and Greenspan and Crow now, did not set out deliberately to condemn millions of children to death. But that is exactly what they have done by insisting that "licking inflation" is more important than world economic development.

It is immoral to clobber wage recipients, to stop "wage push inflation" while ignoring a far more explosive "interest push inflation." (Total wages have increased 21 fold in the U.S. and 48 fold in Canada since World War Two. Net interest income has increased 186 fold in the U.S. and 224 fold in Canada over the same period.)

It is immoral to add to the woes of the "wretched of the earth" to alleviate the problems of the rich countries even if it worked. But it has not--indeed it cannot.

High Interest Policy Is Illegal

At the end of World War Two the governments of the United Kingdom, United States, Canada, and others assumed government responsibility to maintain full employment and achieve rapid growth of real output. In the United States the operative legislation was The Employment Act of 1946 which requires all organs of the government "to use all practical means ... to promote maximum employment, production and purchasing power." The Act does not direct the Fed to stabilize the price level, or to sacrifice "maximum" employment in pursuit of stable prices, nor does Canada's White Paper on Employment and Income of April 1945 direct the Bank of Canada to do so.

Therefore, "our" central banks' long "tight money crusade" is an illegal, vigilante attack upon the livelihoods of the great bulk of the population to promote the interests of a small group of money lenders.

It is illegal to use governmental power to disemploy citizens and to destroy their livelihoods.

High Interest Policy is Irrational

It is irrational to seek to lower prices by policies which raise costs. It is inefficient to use blunt instruments such as high interest rates, when selective credit and incomes controls are so much more cost effective.

Now, just as it is possible to get from Chicago to New York by travelling west, north, or south instead of east, since the earth is a ball, it is possible to reduce inflation with high interest rates. It is just an extraordinarily inefficient and expensive way to "get there." We see around us in a damaged world economy proof of the proposition that if "tight money" is maintained long enough the direct inflationary impact of the policy will be, at least temporarily, more than offset by wage and profit deflation because of the unemployment and bankruptcy such policies cause. The word temporarily should be stressed because the reduction of inflation high interest rates achieve is only "cyclical" while the long term debt contracts entered into (and lowered productivity from reduced investment) lock a higher "secular" rate of inflation into the system.

It is irrational to attempt to keep prices from rising by raising costs and reducing investment, real income, and growth.

High Interest Policy has surrendered North America's economic leadership to the Japanese.

Ever since the "oil shock" of 1973 the Fed and the Bank of Canada have persisted in crippling the North American economy with extortionate interest rates. Japan, which unlike Canada and the U.S., has no oil and must import nearly all its food and raw materials, kept its interest rates as low as 2.5% while it modernized and adopted its industries to the new realities of high cost energy.

No nation with unemployed labour should raise its interest rates and foreign exchange rate to attract "foreign investment." Instead it should keep interest rates low and create its own money to employ its own workers.

High Interest Policy has made all our economic problems worse.

Whether one thinks our greatest economic problem to be environmental decay; the breakdown of our social infrastructure, educational, and health care systems; decreased international competitiveness; youth unemployment and alienation, or increasing extremes of wealth and poverty, the high interest rate policy must be listed as either the prime cause or a contributing aggravater of the problem.

The world economy has lost several trillion dollars in lost output since the "oil shock" of 1973, and borne the human costs those dollars represented, in a futile attempt to stop inflation by stagflationary means. High interest rates force potential investors to discount heavily long run payoffs to depressingly low "present values."

High Interest Policy has caused the large U. S. and Canadian budget deficits, and the U.S. foreign trade deficit.

The North American policy of high nominal and real interest rates is directly responsible for the fact that Ronald Reagan has borrowed more money than all his predecessors put together, and that the U.S. has in his administration gone from the world's largest creditor to the world's largest debtor. High interest rates cause a rapid increase in the national debt for several reasons. First of all, by throwing the economy into recession the policy reduces tax receipts, especially corporate profits tax receipts, but also personal income tax and sales tax receipts. (The U.S. policy of allowing most interest payments to be deducted by households as well as by business compounds this tax shrinking effect.) At the same time, transfer payments to the poor automatically increase as unemployment compensation and welfare rolls swell, while the transfer to the rich represented by government interest payments become the fastest growing--and the most perverse – item in government budgets. To the extent that hard times trigger an increase in discretionary government "make work projects," such as a speed up of defense procurement, the deficit is further compounded. All of the above "budget busting" effects, except interest deductability for householders, applies equally to Canada.

The Fed's policy of maintaining unnatural, or disequilibrating, interest rates in the U.S. from the late 1970s brought about perhaps the greatest folly caused by this immoral, illegal, irrational policy – the overvalued U.S. dollar and massive trade deficit. Much has been written elsewhere concerning the damage caused by this policy--which future historians will surely rank with the Fed's policies in the 1920s and 1930s as some sort of record in asininity. Suffice to say here that to for the largest, and once richest, national economy to borrow from foreign banks at extortionate interest rates billions of dollars which its own central bank was perfectly capable of creating for practically zero interest (as it did in World War Two) was folly raised to as higher power.

No wealthy country with excessive unemployment should ever borrow any money from foreigners. It should increase its own domestic money supply at low interest rates (or zero interest, a whole additional topic to which we will turn in later issues of COMER COMMENTS) until full employment is obtained. No country which refuses to borrow internationally can run a current account deficit on its balance of payments. (Go back and read the above paragraph again. It's important, that's why I put it in bold type). In a world of floating exchange rates, a country which does not wish to have a foreign payments deficit need only allow its rate of interest and foreign exchange rate to fall until foreigners are unwilling to lend to it net and its own people lose their excessive appetite for imports.

In the short run it is always possible for a country to prop up (over value) its currency by offering a high enough interest rate. However, the longer this is done the greater the damage to its own economy from unemployment, reduced investment, and increased foreign debt, and in consequence the greater the eventual fall in its foreign exchange rate. The dramatic fall in the U.S. and Canadian dollars relative to all other major currencies is the direct result of the overvaluation of these currencies caused earlier by our still excessive interest rates.

High Interest Policy has increased the banking system's propensity to self destruct.

Ever since fractional reserve banking was first developed several hundred years ago, it has demonstrated a high propensity to self destruct in panics and bank runs. The cause is always the same, a tendency for debt and interest on debt to increase faster than money and income with which to repay debt. Unless interest rates are kept quite low, and debt buildup is restrained by other means, debt tends to grow faster than real income and collateral (wealth). The attempt of money lenders to compensate themselves by higher interest rates for the increasing risk that they will not be repaid only aggravates the situation. If ever increasing amounts of money are borrowed at ever increasing interest rates the trouble will take the form of inflation – at least for a while. Eventually, however, the debt load and interest payments will become too much to bear and the inflation will give way to debt repudiation and depression.

The policy of the Fed and the Bank of Canada of deliberately jacking up interest rates does not eliminate the self destructive tendency of our fragile financial system. Instead it merely means we will enter the depression phase sooner rather than later. This brings us to the eighth defect of the high interest policy.

High Interest Policy has resulted in a world wide debt crisis where our only choices appear to be between a world wide debt repudiation depression and accelerating inflation.

There is a saying with major truth content that goes as follows: "If I owe $100 to the bank and can't pay I'm in trouble. But if I owe a million dollars to the bank and can't pay the bank's in trouble." This saying needs to be updated to "If anybody owes the banks a trillion dollars and can't pay then we're all in trouble."

We are all, indeed, in great trouble because the Third World alone owes the banks of the First World $1.2 trillion and there is no hope that they can even pay the some $120 billion of annual interest, much less reduce the principal as their loan contracts call on them to do. When we add huge insolvent corporations, like Canada's Dome Petroleum, to the list of bad debts we see that the major banks are broke twice over because the bad debts on their books are twice as large as their capital and surplus.

Although Volcker, Bouey, Greenspan, and Crow like to claim that their "first duty" is to prevent inflation, their first duty is actually to keep the banking system from being destroyed, and inflation is the means they have used. Brazil can't pay its debts unless it can borrow more money and earn more money from higher priced exports? Well, create more money and lend it to Brazil. Dome Petroleum can't pay its debts unless oil prices go back up? Well, create more money until they do.

Thus each time since World War Two the world economic "ship of state" – on which you and I and all of us as well as the bankers sail – has threatened to break up on the rocks of a debt repudiation depression the central banks have sent forth a flood of dollars to float us off – and into a worsened inflation.

There is no hope that Greenspan and Crow will do even as well as Volcker and Bouey because only accelerating inflation can, at least, postpone the next debt liquidation crisis. No hope, that is, unless we force ourselves to think through the alternatives to our present system: one in which, as Figure 1 shows, money income grows by the square of real income, debt grows even faster, and interest on debt grows by the cube of real income! But the worst of it all is that even accelerating inflation can't solve our problems. As Figures 1 and 2 [on back page] show, interest is increasing far more rapidly than is GNP, so rapidly that if interest income should increase relative to GNP for another 40 years as it has for the last 40 years it would become greater than GNP itself. Long before that happens our economy would collapse into a debt repudiation depression which would make the Great Depression of the 1930s look like happy times indeed.

The Committee On Monetary and Economic Reform seeks to be a strategic organization which looks beyond existing problems and opportunities to the creation of new futures which might not otherwise occur. On the pages of this and future issues of COMER COMMENTS COMER economists will sketch a few alternative means of escape from the world our civilization has created by its low level of thought!

[See also item 16]