Risk & Other Four-Letter Words

Wriston, Walter B.


The Land Where No One Speaks the Truth


Henry Wallich, who was a professor at Yale and later a governor of the Federal Reserve, likens inflation to living in a country where nobody speaks the truth. The veracity of this observation is demonstrated daily in the fears over inflation. Whenever this regressive tax rises to the point where it becomes politically intolerable, each sector of society attempts to explain the common dilemma in terms of how it affects that single sector. The housing people talk of their inability to fulfill the Great American Dream of home ownership. Labor avers that it is a victim and not the cause of the problem. Business, because of the broad horizon it spans, is both victim and villain, often simultaneously. Government blames us all. Its spokesmen travel around the country telling people that the real villains in the inflation story are businessmen who raise their prices, or labor unions that raise wages, or the media which inform about inflation, or consumers who borrow too much and save too little.

To get blamed for acts you do not commit, or for the bad news created by somebody else, is a hazard that happens to bankers, businessmen, labor leaders, and almost anyone else involved in handling money. In the business community, we


are treated to an especially strong dose of this misdirected anger because the bad news is delivered in the highly visible form of rising prices. To report that the price of everything has gone up is another way of saying that the value of your money has gone down. Since only the government prints money, it does not like people being told that the value of its product is deteriorating.

It is helpful to remember, however, that rising prices or wages do not cause inflation; they only report it. They represent an essential form of economic speech, since money is just another form of information. So are prices, which enable consumers to communicate with producers and tell them what they want or don't want. If prices are censored, or frozen, they cannot tell producers what goods or services people want or don't want. Examples abound.

When the government artificially restrained prices for natural gas some years ago, the price told consumers that this form of energy was relatively cheap and in ample supply. Believing what they heard, people built houses heated with natural gas. The same controlled price told producers that people did not want natural gas-it was not in demand-and therefore they had no incentive to increase production. Everybody was being deceived and we all learned the results in the winter of 1976-1977, when there was a severe shortage of natural gas.

People are also often deceived also about the nature of money. As a piece of paper in your pocket, money has no intrinsic value. It is worthless. Its only value is in what it represents, which is a claim on a share of the world's goods and services. If the government increases the number of pieces of paper called money faster than the private sector can produce goods and services, then every piece of paper is going to represent a smaller claim on whatever people have to sell. The only way to keep that from happening is either to increase the production of something salable, or else to slow down production of the pieces of paper.

A government traditionally exercises its political control


over 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 spending on goods, social welfare payments, or salaries to government employees. The only time 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 money and taxing it-has so bollixed up the economy that it sometimes feels obliged to go further and impose more controls on what happens to our money during its brief period of freedom between printing press and tax collector.

It usually justifies this action by blaming business for raising prices and blaming labor for raising wages, and in the process also lectures consumers on their spending habits.

Adam Smith described the scenario as long as two hundred 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 always and without exception, the greatest spendthrifts in the society. Let them look well after their own expenses and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.

Governments' ability to devastate an economy and blame it on someone else should never be underestimated. They have


been doing it for a long, long time, even before Adam Smith chronicles the tendency. The ancient Persian empire of Artaxerxes II overtaxed and overspent to such an extent that economic unrest weakened it. The resultant political instability made possible its conquest by Alexander the Great in 334 B.C. The Chinese invented paper money in A.D. 970 but were forced to abandon its use by A.D. 1425 because of inflation. Governments do not even have to use paper money to get into trouble. The riches of El Dorado-the precious metals flowing into Europe from Mexico and Peru-formed the basis for an inflation that in the end destroyed the Spanish Empire. Every time a new silver consignment arrived at Seville, a ripple of price increases spread across Europe because there was suddenly more money with which to buy things. Because the effect was always felt first and strongest in Spain, that country continuously occupied top place in the inflationary table. Spanish costs became increasingly uncompetitive, and the Dutch got rich buying cheaper goods in the north and shipping them south. The Spanish solution was to sink merchant ships and hang businessmen.

You can find the same story of unsuccessful repression of economic news being repeated all the way back to the Roman emperor Diocletian, who may have coined the best name yet for government price controls: , or argument of the club. The penalty for violating the controls set by Diocletian on fifteen thousand commodities was death, which even John Kenneth Galbraith would say was significant.

It is, as you see, an old story. Yet each era ignores the lessons of the past and is forced to relearn the bitter truth anew.

We Americans do not have to look back to China, Spain, or Rome to find examples of economic mismanagement. We have gone through the whole sequence ourselves in the past couple of decades. In fact, reading the papers today is like watching reruns on the late late show-I know what will happen in the next reel. In the wake of the Vietnam war, we


ran the gamut of , from jawboning to price freezing, and the only thing that finally moderated the rise in inflation was the recession of 1973-1975, the worst since the Great Depression up to that time. Because nothing was done about the underlying causes on a continuing basis, after that recession was over, prices went up again and interest rates reached a level in 1980-1981 that had not been seen since 1878. There we were again, doing it all over under a different administration and with a different party in the White House.

The plain fact is that we have had inflation in this country since 1967 because the government caused the money supply to grow nearly three times faster than the goods and services that could be bought with it. That statement can be fiddled with, statisticized, and footnoted until everybody forgets what is being talked about. But the bad news will not go away. No amount or kind of wage and price controls can make a government's paper money worth more of the world's goods and services than the world is prepared to give for them.

Despite all of the sophisticated statistics pouring out of Washington, the fact remains that the only institution that can create inflation is government itself. Inflation doesn't grow on trees. It's made by people, real live people, living in Washington, who collectively make up the government and like to keep their jobs. They respond to political pressures in a way that causes the government continuously to spend 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 and uses its political clout to compel them to handle their money in ways that run counter to their own self-interest. The compulsion comes with


the innocuous label "credit controls" and a promise that they will cure all economic ills quickly.

This has never worked in history. One reason it never works is that when the government tries to allocate credit, it 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 example. Within a few hours after President Carter announced his anti-inflation program in 1979, the Federal Reserve Board put out a regulation specifying that no bank could increase its total loans and investments by more than 6 to 9 percent. It took the governors of the fifty states of the Union about thirty seconds to realize that if commercial banks were prevented from buying their state bonds as an investment under this ruling, state governments would be unable to meet their payrolls. So the telephone lines began humming between Washington and the state capitals, and within forty-eight hours that particular problem disappeared. An average citizen, looking for an emergency bank loan to help meet his April 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 government credit allocation never works is that people are not stupid. The public was ripped off for decades by government regulations that prohibited banks from paying you more than 5.25 percent on savings accounts. This inequity, in combination with various state usury laws which controlled the amount of interest that could be charged on a loan or an installment purchase, merely meant that the person who worked hard and saved money subsidized all those who wished to borrow.

Learned authorities, surveying the resulting carnage of inflation, blame the consumer. One respected economist put it this way:

At the focal point [of inflation] has been the atypical behavior of the American consumer. As inflation rose . . .the consumer, instead of maintaining his savings rate and lowering his spending, did just the opposite. He maintained his spending and lowered his savings rate.... Moreover... the consumer has been steadily substituting borrowing as a means of wealth building and maintaining living standards.

It would be hard to improve on this analysis. What is surprising is that the behavior of the American consumer should be regarded as "atypical." After all, the federal government controlled the amount customers could earn on their savings. The savings account, traditional saving tool of small savers, could not pay even a third the rate of inflation. The savings certificates used by more well-to-do savers also paid considerably less than the rate of inflation. And as if limiting these earnings wasn't enough, the government also taxed them. So a typical consumer might have earned around 3.5 percent after tax from a savings account, or 9 percent after tax from a "high interest" savings certificate.

At the same time, price controls in the form of state usury laws set the rate that consumers paid to borrow. The government let borrowers write the interest off their income tax. A typical consumer might have paid, after tax, 9 percent for a mortgage or 12 percent for a personal loan. When inflation was at 18 percent at its high point and the prime rate over 16, these controls in the guise of regulations subsidized borrowing.

People are pretty smart. They had no trouble figuring out that if they earned 3 percent on their savings when inflation was in double digits, then the system was stealing them blind.


They also perceived that if they borrowed at 9 or 12 percent when inflation was 18, then they were beating the system.

Under these circumstances, consumers showed unimpeachable logic and common sense-they saved less and borrowed more. That experts found this behavior to be "atypical" is astonishing. What is even more astonishing is that the government, having made this the only logical course for a sensible consumer, then denounced this inevitable behavior as a major contributor to the inflation that threatened the nation.

Savings are the only true source of capital, and what we had in this country was 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. 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 percent and 22 percent, compared to our own paltry 3.4 percent rate.

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 has by now made some kind of handshake deal with some level of government-federal, state, or municipal. Lewis Lapham, writing in Harper's, 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.

Since the beginning of time, governments have sought simple, sugar-coated solutions. A long time ago, King Charles II instructed his Parliament: "I pray contrive any good short bills which may improve the industry of the nation."

There were no "good short bills" then, nor are there any now. All of the great issues of our time, and most of the small ones, are settled in the untidy atmosphere of give and take, negotiation and compromise.

Today, you can sell a lot of papers by saying the world is in for a replay of the tragedy of the 1930s. This scenario assumes that we have learned nothing. That is not so. All governments have become much more sophisticated in operating their monetary machinery. Most important, they have devised mechanisms of cooperation which are kept in good repair. The world has moved from the rigidity of the gold exchange standard to floating rates that now permit the system to bend without breaking. Central banks are particularly alert to their role as lenders of last resort. Various institutions for international stability, such as the International Monetary Fund and the World Bank, have grown more mature.

There is now no doubt that all governments can-if they will-curb inflation by practicing monetary and fiscal restraint and encouraging productivity. Progress in any form, however, takes time, and most bureaucracies move at a ponderous pace. Cutting the money supply, which inevitably creates some unemployment and stagnation in the economy, is often


viewed as too slow and too painful a remedy to cure the virus.

Although strong medicine is needed to take the high fever out of inflation, people become restive and demand immediate relief. This impatience, of course, is understandable in a world that has grown accustomed to miraculous cures, wonder drugs, and instant answers. The danger comes when politicians in an effort to please their constituents turn from economic to political strategies. The switch may momentarily bolster public confidence, but ultimately such action is a cosmetic device which merely breeds greater distortions in the economy. Whether or not we have the will to solve the inflation problem is a question that lies much deeper than mere economics.

Our real task for the future 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 Friedrich von Hayek 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.

Feelings aside, the reality is 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 do not know what anything is worth today, much less what it is likely to be worth tomorrow.

If we are to find lasting, long-term solutions to all these problems, we must start by telling ourselves the truth.