THE CRITICAL FIGHT AGAINST INFLATION
THE U.S. is a frustrated nation, but not all the blame for that condition attaches to the war in Viet Nam, racial bitterness, campus violence and crime in the streets. Government, business and consumers are deeply troubled by another major source of national tension: the rising pace of inflation. Though the U.S. standard of living is still the highest ever achieved, the value of the nation's currency is dwindling alarmingly. It has gone down by almost two-thirds in the past 30 years. A 1958 dollar is worth only 790 today, which means that a man must earn 26% more after taxes to buy the same goods. This year the erosion in purchasing power has sharply accelerated. A dollar received as recently as January is worth only 960 now, and at the current rate of price increases will shrink to about 920 by Christmas.
Inflation has distorted the entire economy. It has forced the Government to raise taxes, curtail its spending for social programs and reduce the supply of money. One result is that interest rates have climbed to their highest levels in a century, spreading turmoil in the financial markets and discomfort in corporate board rooms. Businessmen gloomily foresee a slow year for profits. Consumers, despite their affluence, feel financially strapped and vexed to the point of outrage at the soaring prices they must pay for both the necessities and the luxuries of life. President Nixon says that an attack on inflation is his number one domestic priority. His economists, led by Chairman Paul McCracken of the Council of Economic Advisers, are guiding a delicate effort to control inflation gradually and avoid bringing on the recession that Nixon deeply fears.
Last week the battle against inflation entered a new and crucial phase. The phase began when the nation's commercial banks raised their minimum interest charge for loans from 71% to an unprecedented 81% -- a move that was widely interpreted as a portent of a serious credit crisis. The next day, the Government's top economic policymakers managed to sound downright alarmist as they made a rare joint appearance at a Washington press conference to plead for an extension of the 10% surtax on personal and corporate incomes. That tax, which is due to expire June 30, is designed to fight inflation by reducing demand and increasing the Government's budget surplus.
Red Flags
Chairman William McChesney Martin of the Federal Reserve Board warned that without the surtax "we cannot succeed" in slowly controlling today's "critically serious" inflation. Sitting at his side, Treasury Secretary David M. Kennedy* declared: "The problem is much more difficult than I realized. We can't let this escalate into runaway inflation, and we're very close to that now." If Congress allows the tax to expire, he added, the economy could race far enough out of control to create "the possibility of a serious recession." To prevent that, Secretary Kennedy warned that the Government would have to consider further budget cuts, tighter money and perhaps, as a last and unwelcome resort, the price and wage controls that the Administration abhors.
Both men were obviously waving red flags at Congress, which in economic matters often has a low level of sophistication and which has been delaying consideration of the tax extension. The main trouble lies in the House, where many Democrats demand broad-scale and much-needed tax reform as their price for supporting the surcharge. Hoping to avoid a rapidly developing impasse, President Nixon called House leaders of both parties to the White House. Over coffee, they agreed to make the extension bill more attractive by adding a Nixon proposal to drop 2,000,000 poverty-level families from the federal income tax rolls. That should assure passage when the measure reaches the House floor this week.
Tighter money, the tax fight and the mere talk of controls made investors highly nervous about the future. On the New York Stock Exchange, the Dow Jones industrial average fell four days out of five last week. Altogether, it declined 30 points, to 895. In four weeks, the average has fallen 72 points, or 7%, and is now at its lowest level since last August. All the signals from Wall Street and Washington say that more strain, sacrifice and hard decisions lie ahead for the economy.
Inflation is to the economy what pollution is to the environment--a corrosive force that unbalances everything. Though 16% of the nation's plant capacity stands idle, businessmen have been expanding their factories at a record rate, buying machines and materials now to beat further price rises and economize on scarce and costly labor. Export prices have risen more during the past year in the U.S. than in any other major country but Canada and Britain, and the nation's traditional trade surplus has all but disappeared. Wage gains are exceeding the increase in workers' productivity, pushing up costs all around. Some of the fastest rises are in pay for service workers--laundry men, bus drivers, retail clerks--who produce no more than before and sometimes much less. "That," says Yale Economist William Fellner, "is what makes life less and less comfortable in a rich, industrial country."
Inflation has damaged the quality of life in the U.S., particularly in cities, and is cutting into the social fabric. Companies find it increasingly difficult to lure employees from field offices to head quarters cities where prices are highest, particularly in New York and Chicago. Lofty interest rates and fast-rising land and construction costs aggravate the na tion's shortage of modern housing and put homes beyond the financial reach of many people.
Who Gets Hurt
Inflation has become a favored topic of conversation. People seem to have a pecking order of complaint about which price rises are most aggravating. They are, in approximate rank, the increases in food, taxes, mortgages and rents, med ical care, home repairs and, finally, everything else. Because beef prices have climbed 8% to 10% in the past year, more and more people are shifting from steak to hamburger. When the Michael Satchells of Kansas City, Mo., had their first daughter 21 years ago, the doctor's bill was $150, and the labor room cost $25; when their first son was born this month, the doctor charged $200, and the labor room was $45. Around Boston, admission tickets to drive-in movies recently went from $1.25 to $1.75; in Manhattan and Chicago's Loop, movies commonly cost $3. Detroit's automakers will lift prices on the 1970 models this autumn.
Today, inflation hurts almost everyone, but some are damaged more than others (see box, opposite page). The impact falls most notoriously on those who have the most meager means to withstand it--the poor, the black and the aged. It cheats the thrifty, taking money from every owner of a U.S. savings bond and every depositor in a savings account. Speculators in stocks and real estate often profit from inflation, but bondholders can lose fortunes if they have to sell their securities. The recent plunge in bond prices, caused by increasing interest rates, has reduced the value of many pension and profit-sharing funds, much to the dismay of workers nearing retirement.
Prices and taxes are rising so fast that, despite full employment and increasing pay, the typical American is hardly better off than he was in the mid-'60s. Corporate profits are no higher than they were three years ago, when inflation took hold. In 1968, consumer prices rose 4.3%, the swiftest leap in 18 years, and many family incomes failed to match the pace. Economist George Frey of the Manhattan consulting firm of Lionel D. Edie & Co. figures that the standard of living for U.S. workers has remained at the same plateau for three years. During that period, prices rose by an average 3.3% a year, and taxes of all kinds paid by a typical worker with three dependents jumped by an average 15% annually. His average pre-tax earnings went up from $95.06 a week to $108.73, but after his paycheck was gutted by taxes and inflation, his real purchasing power advanced only 80, from $78.53 to $78.61.
As is usual in any price-wage spiral, labor has come in late for its share of inflation's dubious rewards. Now unions are trying to catch up by wringing huge wage increases from employers. Conservative Economist Milton Friedman argues that these increases are only another reflection of inflation, not an initial cause of it, though there is no doubt that big increases keep the spiral going. Cement workers have just won 20% increases in wages and benefits in contracts covering the next two years. Three maritime unions have accepted a threeyear, 35% raise from Eastern and Gulf Coast shipping lines. Striking Kansas City plumbers and pipefitters settled for a 35% increase over three years; it will raise a plumber's pay to $9.21 an hour.
Revolt of the Craftsman
Lately, sociologists have detected a powerful emotional backlash behind some exorbitant wage demands. Skilled craftsmen feel squeezed and cheated by the proliferation of Government programs to aid people who stand below them on the economic ladder, particularly Negroes and welfare recipients. Some of these groups also seem to threaten the social values and institutions that the craftsmen revere. Resentful, rebellious and well organized, the craftsmen are out to win all they can at the bargaining table, if only to even the score.
Voters across the U.S. are venting their irritation by rejecting more and more municipal bond issues, school budgets and local tax increases. Two weeks ago, Oregon voters rejected a proposed 3% sales tax by a margin of 8 to 1, the most lopsided defeat for a ballot proposition in Oregon's 110 years of statehood. Construction costs are so high that many communities have had to cut back on civic improvements. Kansas City has curtailed its road-building program; it is short $1,000,000 to finish a $2,000,000 jail; it has built only three, rather than the six community centers for which people voted bonds.
If inflation worsens in the months ahead, more and more federal social programs will have to be reduced or deferred. The Government simply will not be able to finance them without adding to the price spiral. On the other hand, if Nixon's anti-inflationary measures are strong enough to produce even a mild recession, the President may find himself in serious trouble with many voters.
Nixon's most delicate problem is how to overturn so-called inflation psychology--the public's feeling that inflation, like poverty, has taken permanent root in the U.S. This pervasive belief is the potent new force in the nation's economic pattern. It prompts millions of Americans to save less and to buy now, borrow now, build now, invest now. Businessmen in particular have done that on the hitherto sound theory that delay will only lead to higher costs and that inflation is likely to bail out even the most marginal venture.
Bankers realize that Washington's policymakers are deadly serious about defeating inflation, but businessmen's plans to spend a record $72.2 billion on plant expansion and modernization during 1969 show that they expect the price spiral to persist. If prices continue to go up at the current rate of 8% annually, then businessmen can easily afford to borrow at 10%. The income tax deductibility of interest cuts the real cost in half, to 5%. Then, every dollar repaid next year will be worth only 920 in today's terms, so that the real cost of the loan will be almost nil.
Many bankers and economists argue that the inflation psychology cannot be exorcised unless the Government creates a necessary element of doubt about the future of the economy and somehow makes businessmen fearful that there might be a recession. As long as businessmen expect nothing worse than brief pauses in the nation's growth, they will go right on investing in new machines and factories. Economist Albert T. Sommers of the National Industrial Conference Board, sees a flaw in the policies that guided the nation in its unprecedented period of business expansion. "The basic problem is that the Government is committed to full employment, and everybody knows it," he says. "This reduces the power of statements designed to halt inflationary psychology." Sommers adds: "There does not seem to be any riskless, costless, comfortable escape from the psychology of inflation."
The bankers struck a blow against inflationary psychology last week by raising their lending rates. Led by Manhattan's Bankers Trust Co., the banks increased their prime rate for the fifth time since December. Amid all the talk of an imminent credit crisis, some rise had been widely expected. Banks were strapped for cash at a time when corporations needed to borrow heavily to help pay some $15.8 billion in federal income taxes due this week.
Still, the size of the increase--a record-high one percentage point--caused a furor in Washington. Treasury Secretary Kennedy maintained that the banks, instead of trying to price some companies out of the market for loans, should ration credit among corporate borrowers. That is precisely what banks want to avoid, except for marginal risks and economically unproductive loans like those to finance corporate takeovers. Bankers earn only ill will if they refuse loans to their regular customers. Worse, they may also lose profitable accounts. As the bankers explain it, the primerate increase was a defensive step taken reluctantly in response to the Federal Reserve's hold-down on the money supply. Two weeks ago, interest rates on long-term corporate bonds rose so high that some companies fled the bond mar ket and sought capital help from the banks, where rates were lower. So the bankers raised their rates to try to cut the demand for loans.
Big companies will be able to pay the new price of credit. Many bankers went out of their way to assure consumers and small businessmen that the rates they pay for loans will not be raised in proportion to the new prime-rate increase. But mortgage rates immediately moved up to 91% in California and Colorado, and lenders in many cities raised the fees by which they increase their take from mortgage loans, without actually changing the interest rate. For the immediate future, the higher money rates will add to the upward pressure on prices. Companies figure interest charges as part of their cost of doing business, and the consumer must ultimately pay the bill. Like it or not, bankers will have to ration money because there is just not enough of it to meet the loan demand. Says John Holman, senior vice president of San Francisco's Wells Fargo Bank: "There are no loans for speculation of any kind--stocks, bonds, commodities, land."
Warfare and Welfare
People correctly complain that prices are going up faster under Nixon than they did under President Johnson, but the blame belongs to the Johnson Ad ministration. In the mid-1960s, Lyndon Johnson pressed ahead simultaneously with both the Great Society and the Viet Nam escalation, without requesting an increase in taxes. Between 1965 and 1968, federal spending jumped 47%, and the Government put much more money into the economy than it took out. Johnson feared that if he asked for higher taxes, Congress would balk at paying for what some economists now call the "marriage of the warfare and the welfare states." When Johnson belatedly asked for a tax increase in 1967, Congress dallied for ten months before enacting it. By the time the sur charge took effect a year ago, the fed eral deficit had swelled to $25 billion.
The Federal Reserve compounded the difficulties by unwisely permitting the money supply to grow much too fast, partly because it had to supply funds to finance the Government debt. Last summer the board's governors rroneously concluded that the surcharge might jolt the economy into recession. The board then expanded the money supply at an annual rate of 11%, which meant that there was more money around than the increased output of goods warranted. Naturally, prices went up faster than be fore. So far this year, the board has not increased the money supply at all, but its mistake of 1968 set back the campaign against inflation by about six months. With 20/20 hindsight, Arthur Okun, who was President Johnson's chief economist, concedes that "it has just been too easy to raise prices and wages. Nobody was scared of losing markets or jobs. Management knew that competitors would follow them rather than fight them. The villain of the piece was just too much demand."
The Awkward Months
How long before inflation will be stopped? Changes in monetary policy usually take six months to a year to be felt through the entire economy. Since the money supply was tightened only six months ago, White House Economist McCracken figures that the U.S. is now going through the "awkward months" of waiting for the effects to become vis ible. When money is restricted and taxes raised, the usual sequence is that pro duction slows down after some months, then profits drop and businessmen cut back on hiring. Prices are the last to fall. Usually they come down only after demand slackens substantially; some times, they rise right through a recession.
McCracken says that "we may be see ing the early signs of the cooling of inflationary pressures" -- and many other experts agree with him. The nation's out put of goods and services is expanding; only half as fast as a year ago, and that growth may stop entirely during the summer. The volume of retail sales has been sluggish for a year, and un employment, still a low 3.5%, is up slightly from 3.3% earlier this year. Of the three principal forces in the economy, two have lost most of their lift. Government spending and consumer spending are relatively flat; only businessmen's extremely large capital in vestments are keeping the economy expanding at all.
Considering all the signals of slow down, it is curious that there is so much talk about price and wage controls. Almost nobody wants them. "In peacetime they don't work," says Treasury Secretary Kennedy. Economist Paul McCracken warns that controls would not only require "a large bureaucracy" but put a premium on "string pulling, political pull or on willingness to pay for favorable governmental decisions." Milton Friedman says: "Controls do more harm than inflation it self. If you don't use prices to ration goods, you have to use something else: queues, favoritism or bribes."
Washington's traditional monetary and fiscal restraint cannot squeeze all the inflation out of the U.S. economy. The Administration will do well to shrink price increases to 3% next year and to 2% by 1971; some analysts fear that the timetable will run twice that long. Yet only if the slowdown is gradual will Nixon be able to prevent a steep rise in unemployment. An increase to much above 4% might spell political and social trouble. The aim of fed eral policy is to achieve the "2-4 tradeoff"--2% inflation with no more than 4% unemployment.
The consensus among experts is that the Administration has hit upon the right mixture of restraint--most of it inherited from the last months of the Johnson Administration!--to bring down the inflationary rate. What is needed now, as the Federal Reserve's Martin puts it, is "patience, perseverance and persistence." That means that the Government must extend the surtax, keep money tight and sharply limit federal spending.
Pitfalls are everywhere. It will be difficult, for example, for the Administration to devise a formula to keep electrical workers and other unions from winning wage increases of 6% to 7% a year in important labor negotiations coming up this fall. Harvard Economist Otto Eckstein believes that if 6% wage increases become a pattern "then that will lead to a 3% general increase in costs for three years, and we will be fighting inflation continuously, even if the economy softens."
The economy can fairly comfortably tolerate an inflation rate of 2% yearly, and the Government should aim at that. To do any better, most economists agree that there must be far-reaching reforms. As an obvious starter, Congress should scrap the farm-subsidy programs, which not only cost taxpayers $5.7 billion a year but artificially inflate the prices of cotton, wheat, corn, soybeans and rice. The subsidies also help to drive up the price of farm land, adding another push to the price of produce.
The price of many goods might be reduced if import quotas were abandoned or loosened. Such quotas already pro vide big price supports for steel and oil, and President Nixon is pressing for quotas on textiles. One paramount question for the future is whether labor unions have become too powerful. In such strike-prone industries as printing, shipping and construction, strong unions often whipsaw weak employers into granting lavish settlements. Unions in all three fields also block the introduction of cost-cutting new technology. Two steps would help redress the balance: 1) the creation of larger and better-financed employer bargaining units, and 2) pressures on recalcitrant locals to admit more job-hungry Negro youths, especially in construction trades.
Elusive Goal
For the coming decade, an inflation-weary nation should aim at a so-far elusive goal: stable prices, low unemployment and steady economic growth. The U.S. has already achieved a full-employment society, but the next job will be to devise ways to live comfortably with it. That will not be easy. The material prosperity of the 1960s has not produced tranquillity or happiness for large sections of the nation. A full-employment economy is a delicate mechanism, the clash of powerful forces, notably labor and management. Both forces will have to accept new atti tudes, new compromises and, above all, new restraint if the U.S. is to achieve price stability while maintaining its eco nomic freedoms.
* Who was accompanied by Paul Volcker, Under Secretary for Monetary Affairs, and Herbert Stein, member of the Council of Economic Advisers.
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