On October 26, I joined an otherwise distinguished group of businessmen for breakfast at the White House with Messrs. Strauss, Schultze, Blumenthal, Bosworth, and Kahn. The purpose, of course, was to convert us all into missionaries to spread the gospel of the president's latest inflation plan (perhaps I should say anti-inflation plan). Although the food was mediocre, the cigars and entertainment were good, so I'll make a sincere effort to sing for my supper.
Dr. Schultze spoke of the "three stools" of the effort: fiscal restraint, deregulation, and wage-price guidelines. The pledge to trim the budget to 21 percent of GNP in 1980 at least has the direction right for a change, even if it is too little and too late. I listed over $51 billion in Fortune (August 28) as initial candidates for the ax; the president only hopes to trim $15 to $20 billion from the otherwise automatic rise in spending.
Given the shaky state of the economy, the president is bound to be hit with the argument that the economy needs to finance more government salaries and transfer payments by drawing funds out of the stock and mortgage markets and putting them into government IOUs. In the Keynesian theology, this is somehow regarded as a "stimulus."
Even if the president and Congress go along with a 1980 budget of around $535 billion, there is little chance of raising enough revenue to keep the deficit anywhere near the announced target of $30 billion. More inflation might do the trick by tossing everyone into a 50 percent tax bracket. Rising effective tax rates are indeed assumed in the president's goal of balancing the budget at 21 percent of GNP, since federal taxes have lately been well below 20 percent GNP. But steeper tax progressions would further depress effort and investment, and you can't squeeze blood out of a stagnant economy. Moreover, the "wage insurance" scheme would lose $5 to $10 billion in tax revenue for each percentage point that inflation exceeded 7 percent.
Dr. Kahn's apparently sincere interest in eliminating a few government-mandated cost increases might improve the economy's efficiency, but the effect on inflation would be small and mostly temporary. Deregulation of the airlines was quite an accomplishment, but I remain skeptical regarding a major assault on the Interstate Commerce Commission. It may just be a threat to get the Teamsters to settle cheap in 1979, since unions generally syphon off most of the potential monopoly profit of regulated cartels.
A White House fact sheet on the new Regulatory Council says, "The council will have the important task of coordinating duplicative and overlapping regulations." Always nice to have coordinated duplication, but elimination might be more helpful. While OSHA dumped a thousand silly regulations, that leaves about 9,000 to go. And if they churned out so much nonsense before, what stops them from doing it again?
The missing link in the program—immediately reflected in sinking values of stocks, bonds, and the dollar—was, of course, money. Nobody in the administration or Federal Reserve has yet so much as hinted that the growth of money and the related expansion of credit has been excessive or needs to be slowed. That is rather scary and suggests that the costly schemes to "support" the dollar may be wasting the taxpayers' money. The Fed is speculating on the wrong currency.
Soon after the markets passed judgment on the anti-inflation package, clearly judging it to be an official blessing of roaring inflation, the Federal Reserve was forced into a modest gesture of restraint. The discount rate was hiked a point, and reserve requirements on large certificates of deposit were tightened. Not much, but it helped. The values of stocks, bonds, and the dollar all soared before doubts set in about whether or not this was just another respite, like the brief flirtation with monetary restraint in April.
In any case, the experiment showed that when inflation is the main threat, and expectations are rational, the economy thrives on disinflationary policies. In this situation, monetary "stimulus" just hikes expectations of inflation, boosting wage and interest rates while sinking the dollar.
Monetary restraint, on the other hand, can have paradoxically beneficial effects by (1) raising the dollar (thus easing threats of protection or dumping the dollar as the main reserve and trade vehicle), (2) raising the stock market (thus bolstering stockholder wealth and discouraging less-useful investments in supposed "hedges"), and (3) reducing expected future inflation and related costs (wage increases, commodity prices, long-term interest rates).
I have studiously avoided mentioning guidelines, since their only effect was to help discredit the rest of the program. Markets viewed guidelines as a sign of insincerity.
As long as the Fed continues to feed money to the inflation, somebody will spend that money and somebody will receive it. Guidelines or controls only affect who gets what share of the new money—that is, they are just another form of redistribution of income (usually away from organized labor and toward recipients of government salaries and transfer payments).
The only effect of guidelines on inflation is to make it worse by reducing real growth. The economy loses the incentive to move resources from relatively surplus uses to uses that consumers value more highly (as shown by "shortages"). Firms facing profit limits also have no incentive to watch costs; workers facing pay limits have no incentive to excel; firms facing price limits have an incentive to skimp on quality or size. Since inflation is "too much money chasing too few goods," guidelines or other forms of controls only give us fewer (and worse) goods, and more inflation.
Scrap the guidelines, press forward with more of the rest, and it might deserve to be called an anti-inflation program. Above all, the people must be convinced that, unlike all recent gestures toward monetary restraint, this effort will not be abandoned in less than a year. Otherwise, workers and firms will just sit it out without giving an inch on wage or price gains, figuring they will again be washed back on shore with the next tide of greenbacks.
A world in which Michigan surveys show consumers expecting 10 percent inflation, and everyone is rushing to get in debt to hedge or speculate against inflation, is a classical world, a world of profoundly sensible expectations. To remedy that illness requires classical medicine—a believably permanent shift toward negligible money growth. And, contrary to the economic quacks who have bled the economy's vitality while putting it on a nourishing diet of paper, the classical medicine wouldn't taste nearly as bad as the alternative.
This article originally appeared in print under the headline "Viewpoint: Phase 6½".