Is Inflation a Handshake Deal?

Wriston, Walter B.


The last time I had dinner with Tom Storrs was about five weeks ago in Boca Raton. The occasion was the annual meeting of the Reserve City Bankers Association, during which much time was spent speculating about the future of the world in general and of bankers in particular. The nature of what we heard on that occasion was such that it would not have surprised me to learn that tonight's celebration had been indefinitely postponed. I thought that Tom might have returned home and, after some reflection, decided that the honor of heading an association of bankers in these times was one he could easily forego.

Indeed one of the speakers there suggested that maybe a bank would have to give up its banking charter if it wanted to compete across the country with 22,000 other financial intermediaries not so inhibited. He might have recalled the old story about the fellow who had been tarred and feathered and was being ridden out of town on a rail: "If it weren't for the honor of this thing," he said, "I believe I'd just as soon walk."

But then I remembered that Tom Storrs is a man who has not only survived having a destroyer torpedoed out from under him during the Normandy Invasion, but even more recently found himself trying to help Chairman Arthur Burns and the Federal Reserve Board of that day steer us through the 1974 recession. So he is undoubtedly a man who can survive almost anything--and if he survives 1980, he might even become "Man of the Year."

cover story two or three weeks ago, you may recall, was devoted to the question, "Is capitalism working?" It summarized what we are all experiencing in the following words:

The litany of U.S. economic woes at times seems endless. Week after week, interest rates crack new records; homeowners face 17 percent mortgages; and companies confront 20 percent business loans. Energy, the oxygen of industrial life, has become so costly and politically controlled that the U.S. can no longer be certain of enough fuel to keep its factories running and homes heated. The output of goods per hour worked has stagnated. From 1948 to 1973, the productivity of American employees increased 2.9 percent annually, thus permitting steadily higher real wages and higher standards of living. Last year, productivity dropped 0.9 percent. The real median income of American families jumped 64 percent from 1950 to 1970, but has crawled up by less than 1 percent a year in the past decade. Weekly real take-home pay has been declining for two years. That gauge of American economic health, the stock market, has been sharply depressed.

So much for the good news. Now for the bad news. The same article points out that what seems to be our continuously accelerating inflation is attributable in no small part to the government's attempts to create a risk free economy--an economy in which there will never be a danger of serious business slumps or steep unemployment. And it says, "The search for a fail-safe society is also pursued by businessmen. Though they still extol free enterprise's virtues in after-dinner speeches, American capitalists can often be the system's most dangerous opponents. Rather than embracing the marketplace and competition, many businessmen look longingly to those which the government intervenes to sponsor, subsidize, or otherwise ease the way for business. These U.S. "free enterprisers" demand that their government protect sales from foreign or domestic rivals, oppose steps to remove regulation whenever it shelters their own business, and lobby hard for federal or local grants."

If it is really true that American businessmen have joined in the endless pursuit of a life without risk, and if, as late economist Arthur Okun once remarked, Adam Smith's "invisible hand" has indeed been replaced by the "invisible handshake," then we are doomed. I, for one, would like to enter a dissenting opinion, I observe that about 300,000 small businesses are formed every year in this country, and five years later, only about 10 to 15 percent of them are still there. Yet the new businesses are still being created and some of them continue to grow up to be Xeroxes and IBMs. I believe that the spirit of entrepreneurship that built this country is still there. It took Citibank 100 years to gather $8 billion of deposits. It took the money market mutual funds a single month to do likewise, by giving the customer what he or she wanted in an innovative fashion unfettered by government regulation. And I also believe that in America, business and government could not merge if they wanted to, because there is a fundamental difference between the way businesses and governments conduct their affairs.

The main difference between a business and a government is that the businessman has only a string, but the government has a stick. The businessman tries to pull income or capital in his direction, but the money moves only when its owners think he has something worth exchanging it for. He can invent new ways to pull the investors and the customers in, but they can never be pushed. The government, on the other hand, can push people and money around in an almost unlimited number of ways. In fact, there seems to be very little under the law that the government today cannot do. The difference between the largest corporation and the smallest nation is the existence and use of police power.

We are discovering this difference almost daily. The right to spend our own money or lend it to the borrower of our choice appears to enjoy no Constitutional protection comparable to the First Amendment protection for our right to say whatever comes into our minds. The thought has sometimes occurred to me that this apparent oversight on the part of the Founding Fathers may be one reason why we seem to be becoming a nation of talkers and critics rather than doers.

Government traditionally exercises its political control of the economy in two major ways: It decides how much money to print, and then it decides how much of that money to take back in the form of taxes. Most of the tax money, of course, is later pumped or pushed back into the economy in the form of government contracts, social welfare payments, or salaries to government employees. The only time when the money moves with something like its own free will is during the brief interval between coming off the printing presses and being captured by the tax collector. One might think that such cradle-to-grave control would satisfy the government and give the various bureaucracies enough to keep them busy. But the way the government has handled its two main operations--printing the money and then taxing and redistributing it--has so bollixed up the economy that the government now feels obliged to impose more controls on what happens to our money even during its brief period of freedom when it flows through the private sector between the printing press and the tax collector.

That is what the political allocation of credit is really all about and the dangerous game in which we are now engaged. The present administration has finally wielded a club that has been suspended over our heads ever since passage of the Credit Control Act of 1969. Very few Americans were even aware of the existence of that law, but it can quite properly be termed the nucleus of an economic police state, and I can assure you that what we have experienced to date is only a light tap on the head compared to what this particular bludgeon is capable of delivering. Only the total disinterest of the media has permitted such an assault on individual freedom to go unnoticed.

The Credit Control Act of 1969 armed the President of the United States with authority to license all lenders and register all extensions of credit, to prohibit credit for any purpose deemed inappropriate by the government, to prescribe maximum credits that may be extended, and to establish maximum rates of interest, as well as minimum down payments and specific conditions for the repayments of loans. These standby powers had never been invoked until now, but it appears that the government now intends to punish us for its own sins.

Adam Smith said it well some 200 years ago:

"It is the highest impertinence and presumption... in kings and ministers, to pretend to watch over the economy of private people and to restrain their expense, either by sumptuary laws, or by prohibiting the importation of foreign luxuries. They are themselves always and without exception, the greatest spendthrifts in the society. Let them look well after their own expense and they may safely trust people with theirs. If their own extravagance does not ruin the state, that of their subjects never will."

Credit crunches are creatures of inflation, and despite all of the sophisticated statistics pouring out of Washington, the fact remains that the only institution that can create inflation is government itself. The story is always the same. The government responds to political pressures in a way that causes it to spend continuously more money, and when it finds itself spending more than it is taking in, it solves the problem by printing more money. Our fiscal and monetary authorities, the Congress and the Federal Reserve Board, can always spare the country the disaster of inflation by simply avoiding the overspending and the overprinting.

Unable to control itself in these two critical areas, the government periodically decides to control everyone else. It goes after the borrowers and lenders in our society and uses its political clout to compel them to handle their own money in ways that run counter to their own self-interest.

This has never worked in history and we are not likely to have better luck this time. One reason why it never works is that when it tries to allocate credit, the government is subject to the same irresistible political pressures that make it print and spend too much money in the first place.

Let me cite just one recent example. Within a few hours after President Carter announced his anti-inflation program, the Federal Reserve Board put out a regulation specifying that no bank could increase its total loans and investments by more than some 6 to 9 percent. It took the governors of the 50 states of the union about 30 seconds to realize that if commercial banks were prevented from buying their state bonds as an investment under this ruling, state governments would not be able to meet their payrolls. So the telephone lines began humming between Washington and the state capitols, and within 48 hours that particular problem disappeared. An average citizen, looking for an emergency bank loan to help meet his April 15th income tax payment, of course, might have been out of luck. His need may have been as great, and even the government would have to admit that he intended to put the money to good use, but he lacked the political clout.

Once the government reaches its hands into the credit markets, it is no longer enough to have a good credit rating--you must also have friends in government. The invisible handshake is the inevitable by-product of allocating credit through the political process and not through the economic process.

The second reason that government credit allocation never works is that people are not stupid. The 1969 Credit Control Act may now be giving us an exceptionally strong dose of political medicine, but we have been obliged to swallow similar medicine for a good many years, and people have learned how to live with it. The public has been ripped off for decades by government regulations that prohibit banks from paying more than 5 or 5 1/2 percent on your savings account. This inequity in combination with various state usury laws that control the amount of interest you can be charged on a loan or installment purchase merely means the person who works hard and saves money subsidizes all who wish to borrow.

The saver has had to pay income taxes on whatever interest he did earn, while the interest he paid on his loans was deductible from his income tax. So the average American, being intelligent, pursued his own best interest even as Adam Smith said he would--and produced the lowest savings rate in the industrialized world, plus a huge volume of installment credit. In short, Americans reacted in a highly logical fashion to the laws their government imposed on them. The government is not going to solve the problem by preaching to us about our spending habits.

Savings are the only true source of capital, and what we have in this country is a set of laws designed to penalize people for saving money. To say that America has the lowest savings rate of any industrialized nation is also to say that it is accumulating capital at a slower rate than anyone else. The longer this process continues, the worse our situation will become. Without capital, we cannot produce the goods and services necessary to soak up the output of the government's money presses. And in the long run, we will lose our competitive position in the world because we cannot produce the new technologies and efficiencies necessary to compete with countries like Germany and Japan, where the savings rate is 13 1/2 percent and 22 percent compared to our own 3.4 percent.

There are a number of encouraging signs that Washington has begun to get the message. The same sorts of political pressures that encouraged profligate government spending and a plethora of printing press money are now working to persuade the government that inflation is our most important problem. I regard that as a very significant plus. Furthermore, the Federal Reserve Board, under the leadership of Paul Volcker, began last October 6th a serious program to do something about the money supply. If political events do not interfere, and the Federal Reserve is allowed to continue on the course it started in a slow and steady manner, our inflation will unquestionably diminish.

I cannot offer a timetable for all this because there are just too many variables. Some of you may recall that the great financial wizard from Carolina, Bernard Baruch, once defined an economist as "A man with a gold watchchain and no watch." Perhaps that is why the famous recession most of them have been predicting for the past two years only just now seems to be arriving. I do not know whether it will be as mild and short as President Carter now predicts, but I have enormous faith in the marketplace, which has absorbed one disaster after another--the REIT debacle, the OPEC price increases, the bankruptcy of the Penn Central Railroad--without once losing its fundamental equilibrium.

At the same time, as a veteran of the New York City financial crisis, I am acutely aware that every line in the government's budget has a constituency. Everyone in America--including those of us in this room--has by now made some kind of handshake deal with some level of government, Federal, State, or municipal. Lewis Lapham, writing in [1]  recently only mildly overstated the case when he pointed out that "Within its own borders the United States awards nearly 50 percent of its tax revenues as transfer payments to whatever lobbies, special interests, and racial or sexual minorities hold the government hostage in Washington. The huge sums of money listed in the budget as fundings for the purposes of health, education, welfare, and social security represent only a small part of the annual ransom paid to the more successful syndicates in the society." So the political pressure on government to run deficits is very heavy. A government's promise to stop printing money is frequently like the alcoholic's resolution to have just one more drink.

If we are to find lasting, long-term solutions to all these problems, we must start telling ourselves the truth. As Governor Wallich of the Federal Reserve Board once remarked, "Inflation is like living in a country where everybody lies." By that he meant that the relationship of wages, prices, profits, losses, and deficits are all out of kilter--they no longer tell us the true value of anything. It is impossible to make rational business decisions when you don't know what anything is worth today, or what it is likely to be worth tomorrow.

But that is only the economic side of the problem. We know how to solve that problem--if we have the will to solve it. Whether or not we have the will is a question that lies much deeper than mere economics.

Our real task for the 1980s is to rethink our basic goals. The most hopeful sign I have seen of late is that people in all walks of life--business, labor, and government itself--are beginning to rethink the functions of the government. We are beginning to ask ourselves in a serious way what governments should do, and can do well, and what governments should not even try to do. But in a democratic society, of course, what government does is really only a reflection of what the people demand of it.

As the Nobel laureate, Frederic von Hayek[2] , reminds us:

"Most people are still unwilling to face the most alarming lesson of modern history: that the greatest crimes of our time have been committed by governments that had the enthusiastic support of millions of people guided by moral principles. It is simply not true that Hitler or Mussolini, Lenin or Stalin, appealed to the lowest instincts of their people: they also appealed to some of the feelings which also dominate contemporary democracies."

We may now be standing at a crossroad in which we Americans must decide whether to shift our emphasis as a nation.

In 1899, the closing year of America's astonishing century of progress, a future president named Theodore Roosevelt captured the spirit of his times in these words:

Far better is it to dare mighty things, to win glorious triumphs, even though checkered by failure, than take rank with those poor spirits who neither enjoy much nor suffer much, because they live in the gray twilight that knows not victory nor defeat.

We might contrast that sentiment with a description of our own times by the English journalist, Henry Fairlie, when he wrote:

If the American people for the first time no longer believe that life will be better for their children, it is at least in part because they are beginning to think that there will be no food which their children will be able to eat without dying like rats of cancer, no form of transport that will be considered safe enough to get them from here to there, and in fact nothing that their children may safely do except sit like Narcissus by a riverbank and gaze at their wan and delicate forms as they throw the last speck of Granola to the fish.

Somewhere between those two manifestations of the American spirit lies our hope for the future. Perhaps I am an incurable optimist, but I do believe that there is light on the horizon--that we may indeed be girding to face the future by rediscovering some of our past. The man we are honoring here tonight, Tom Storrs, is himself a living example of what those old virtues can produce, and I should like to think that he also represents the wave of the future.

Thank you.


[1] May 1980

[2] Law, Legislation and Liberty, page 137

  • This document was created from the speech, "Is Inflation a Handshake Deal?," written by Walter B. Wriston for the Tom Storrs Testimonial on 7 May 1980. The original is located in MS134.001.004.00015.
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