Inflation: Attacking Public Enemy No.1
Central bankers are by tradition an aloof bunch, awed into solemnity by their own eminence as arbiters of a nation's money supply and guardians of the value of its currency. They immerse themselves in financial esoterica, dress somberly in three-piece blue suits, and give the impression that they speak only to one another and to God. When they do appear in public, they issue Delphian warnings, usually of impending inflationary doom. An optimistic central banker has been defined as "one who thinks the situation is deteriorating less rapidly than before."
So what is one to make of G. (for George) William Miller? As chairman of the U.S. Federal Reserve Board, Miller, 53, is the most powerful of all central bankers--but he is far outside the mold. He delights in reminiscing about his boyhood in the oil boomtown of Borger, Texas, a throwback to the wild West of unpaved streets and gun fights. Miller vividly remembers the day that the town's founder, Ace Borger, was shot dead in the post office. He cheerfully relates that his last exposure to classroom economics was a basic course at the Coast Guard Academy 33 years ago. All his knowledge of money markets was picked up while he ran Textron Inc., the $2.8 billion conglomerate based in Providence that makes thousands of products, ranging from helicopters to watchbands.
Far from affecting bankerly reserve, Miller roars with laughter at his own often corn-pone jokes, some directed at the august but arcane institution that he heads. He has invented a mythical poll in which 23% of the U.S. population thought the Federal Reserve was an Indian reservation, 26% judged it to be a wildlife preserve and 51% identified it as a brand of whisky. Most important, he speaks almost garrulously in tones of unabashed can-do optimism. The nation, he insists, can bring down its frightening rate of inflation without suffering another recession--indeed, while working toward a "model economy" in the 1980s.
That may sound less like optimism than Pollyannaism. So far this year inflation has exploded. From March through May, it averaged 11.3% at an annual rate, one of the worst three-month performances ever. Though no one expects the surge to remain that bad, the Carter Administration last week forecast a 7.2% rise for the full year, and some economists expect an 8% increase.
A healthy economy cannot tolerate that pace. It wipes away most wage and salary gains, lowers standards of living and sets poor, middle class and rich to snarling at one another. It also weakens the dollar overseas: foreign moneymen rush to dump greenbacks out of fear that inflation will steadily erode their value. Last week the dollar slipped to a record low of 201 Japanese yen, down almost 17% just since January. The dollar's slide, in turn, makes U.S. inflation worse because it raises the prices that Americans pay for imported goods.
One of Miller's advantages in fighting inflation is that the battle has become Topic A for consumer and Cabinet officer alike. As recently as March 8, when Miller was sworn in, Government policy was still focused on stimulating the economy to faster growth in order to bring down unemployment. That goal has been achieved, at an inflationary price; the jobless rate in June fell to a four-year low of 5.7%. Now the talk in Washington and the country is all of tight budgets, spending hold-downs and the long effort needed to bring prices under control.
Miller himself has done enough to produce this switch to make businessmen and bankers look on him as the white hat in a kind of financial western: the new gun who arrived in Washington to rally the citizenry against the enemy, much as the Texas Rangers rode in to restore law-and-order in the Borger of his youth. He quickly put the Fed on a course of raising interest rates sharply, to hold back the inflationary growth of money supply and to keep dollars at home. In private debates and public remarks, Miller has pleaded with the White House, of which he is independent, to launch a determined anti-inflationary policy of its own. Neither his actions nor his words differed greatly from those of his predecessor, Arthur Burns. But while Burns' pontificating only annoyed the White House, Miller's unpretentious yet urgent advocacy has had a marked effect.
Shortly after taking office, Miller asserted openly that Carter should declare inflation to be the nation's No. 1 economic problem. The President did, a month later. Miller publicly advised Carter to delay the $25 billion tax cut that the President had proposed to take effect Oct. 1, and to shrink the budget deficit. Carter has agreed to make the tax reduction effective Jan. 1, and to squeeze it down to $15 billion. That and other actions, according to Administration forecasts announced last week, are supposed to lower the budget deficit for fiscal 1979 from the $60.6 billion that Carter had recommended in January to $48.5 billion, which is closely in line with Miller's goals.
In Washington, Miller is widely regarded as one of the best appointments that Carter has made. Private bankers commonly echo Milton W. Hudson, vice president of Manhattan's Morgan Guaranty Trust Co., who says Miller has put on "a virtuoso performance." Foreign leaders agree. Typically, West German Chancellor Helmut Schmidt, who has long railed at Washington for failing to appreciate the dangers of the dollar's slide, feels that he has at last found a firm ally in Miller.
This is not to say that Miller will succeed. He and Carter are engaged in the trickiest and riskiest of all economic maneuvers: an attempt to slow a surging but vulnerable economy just enough so that inflation gradually subsides, but not so much as to sink the nation into a recession. Administration officials refer to this as guiding the economy to a "soft landing" from its too-rapid pace in the quarter just ended. Estimates of production growth in the second quarter cluster around an annual rate of 9%. Miller prefers to talk of reaching a "sustainable path of growth" of about 4% that can be followed year in, year out without either accelerating inflation or raising joblessness. A 3% rate, he says, would mean more unemployment, a 5% growth bad inflation.
It is a feat that almost all democracies have tried, and usually failed to bring off. They have either pressed too hard and too fast on the brakes, jolting the economy into recession, or let up too soon, permitting inflation to keep on rising. All too often, they have followed erratic stop-go policies that produced inflation and recession combined. Washington's soft-landing rhetoric of today is unnervingly reminiscent of the Nixon-Burns "game plan" to achieve a gentle slowing in 1969-70. That led to a recession in 1970, wage-price controls in 1971-72, double-digit inflation in 1973-74, and finally the violent recession of 1974-75.
The U.S. is now in its 40th month of recovery from that slump, and clearly inflation is its greatest immediate danger--but the threat of recession is real. Business spending for new plant and equipment has not hit the levels necessary to keep the expansion going, largely because executives fear that the cost of operating a new factory will rise faster than the prices of the products it sells, thus erasing potential profit. Consumers have kept up a rapid buying pace only by plunging into debt; installment credit rose a record $11.7 billion between March 1 and June 1.
If a recession strikes, it almost certainly will be blamed on Bill Miller's Federal Reserve. The potential script: The Fed pushes interest rates up still more and doles out new money at a miserly pace. Seeking higher interest payments, people put their money into high-yielding bonds and pull it out of savings institutions, leaving them with no funds to make mortgage loans; so housing collapses. Small and new businesses cannot borrow because only the blue-chip corporations can afford to pay the high interest rates. Finally, Treasury borrowing to cover Government deficits soaks up most of what lendable money is still available at any price.
Starved for credit, companies slash production and lay off workers.
The worst part is that such a "credit crunch" might not bring any lasting gains against inflation. It takes a very deep recession to reduce the rate of price increases significantly, and then the effect may be ephemeral: witness the rapid rise in prices today, only three years after the last punishing downturn.
The U.S. certainly is not in a credit crunch now. Money supply during the past three months has grown at an annual rate of 11.4%, which is well above the Federal Reserve's own target of 4% to 6.5%. But interest rates have spiraled up fast enough to worry some economists. Since Miller has become chairman, the "Fed funds" rate at which banks borrow from each other has jumped a full point, to 7 3/4%. The prime rate on bank loans has just hit 9%, a level that some bankers even in early June had thought it would not reach until the end of the year.
Though Washington still rings with praise of Miller, some liberals in the Administration and Congress are grumbling that every new Federal Reserve chairman seems to bring about a recession out of excessive anti-inflationary zeal--and "Miller has to have his recession too." Last week Robert Strauss, Carter's special counsellor on inflation, complained that the Federal Reserve's course was "counterproductive"; and Charles Schultze, chairman of the President's Council of Economic Advisers, expressed fear that any further tightening of monetary policy could hold back economic growth. Otto Eckstein, a member of TIME'S Board of Economists, warns: "There is not a single instance of success in raising interest rates to moderate the economy without creating a major disturbance. The Federal Reserve has carried the policy too far every single time."
The peril is recognized by Miller, but he says that it will become a reality only if the Administration forces him to fight the anti-inflation battle all alone--for example, if Carter & Co. keep running gargantuan deficits and let environmental and safety watchdogs impose ever more costly regulations on business. If the Administration and Congress cooperate by restraining spending, he insists, the Federal Reserve can make enough loan money available for every "productive use," but not so much as to tempt business into inflationary inventory hoarding and payroll padding.
Miller is convinced that if Government will stop feeding inflation by running big deficits, "we can look forward toward a model economy five, six, seven years from now." He has even drawn up a detailed timetable: shrink the deficit further to $35 billion in fiscal 1980, $17 billion in 1981, zero in 1982. In consequence, as much as $ 100 billion that the Government might pour out in deficit spending would be transferred to private industry and consumers for their own, noninflationary purposes. '
In a long talk, Miller outlined other elements of his five-year plan to TIME Economic Correspondent George Taber: "It's important to move our investment level up from the present 8% or 9% of G.N.P. to 12%. That would mean $75 billion more investment per year. We would once again assure ourselves a modern productive capacity and technological leadership. In this model economy, the housing industry must be thought of. To 1.8 million new houses and apartments this year, we should add 100,000 starts a year until we get to 2.3 million or 2.4 million, which is what we really need. Then I'd like to see exports, which are now 7% of G.N.P., grow to 10%. And I'd like to see us seriously address our regulatory burden and reduce it. The consequences will be full employment and price stability and a sound dollar."
Investment should be encouraged, Miller believes, by allowing businessmen to take faster tax write-offs on their new plant and equipment. That change can be enacted only by the Administration and Congress. His whole program is based on the idea that Government spending must be reduced from the current 22% of the G.N.P. to 20% by the early 1980s.
Miller does have a club: if Congress and the White House will not cooperate, the Federal Reserve will have to crack down so hard on money supply, and push interest rates so high, that there really will be a recession. Characteristically, he put it to Taber in tones of promise rather than threat: "The Fed fits into this model in a rather selfish way. Any economic strategy that works toward lessening inflation will inevitably lessen the pressure on the central bank," and allow it to put out enough money to promote his cherished 4% growth rate.
Optimistically, Miller sees signs that opinion is swinging his way. Says he: "The cynicism and divisiveness and skepticism of the past seem to be fading. We are starting to see that we do have a common enemy: inflation. Now we are beginning to see people saying, 'We don't want any more Government --and I'll have to give up my pet project too.' I don't think there could be a nicer tune in anyone's life than when you have everyone coming to a common understanding."
That seems a rather blithe overstatement: a tough budget-cutting policy will in fact arouse furious opposition. And "model economy" is a phrase so reminiscent of the naive expansiveness of the mid-1960s that hardly anyone else in Washington would dare utter it. But it sounds natural coming from Miller; self-assurance is as marked a strain in his character as his relaxed informality. At Textron he peppered fellow executives with what they called "Millerisms," such as "Don't rationalize mediocrity" and "There is no penalty for overachievement." Miller set an example by rising meteorically to become the company's president at the age of 35.
He also plunged into public service and ran national programs to hire Viet Nam veterans and train unemployed blacks. That won him a justified reputation for social concern. Though his dedicated inflation fighting satisfies the most conservative Republicans, Miller is a registered Democrat who worries greatly about unemployment; in the past he supported the abortive presidential bid of Liberal Hubert Humphrey. So it was not surprising that when Carter had had enough of Arthur Burns' professorial nagging, a search team headed by Vice President Walter Mondale put Miller on a short list of potential successors at the Fed. Carter, aware that dumping the conservative Burns might frighten bankers and industrialists who already mistrusted the President's economic judgment, was looking for a progressive corporate chief--preferably a Democrat--whom Burns' admirers in "business could hail as one of their own.
Miller also had a strong supporter in Treasury Secretary W. Michael Blumenthal, an acquaintance from days when Blumenthal was running Bendix Corp. An interview with Carter, who had met him briefly four times before, clinched the job for Miller. It seems fitting that two self-confident businessmen from rural backgrounds, who had initially sought success by going to military academies and who styled themselves economic moderates and social liberals, should hit it off. Miller faced a tough grilling by the Senate Banking Committee about bribes paid by Textron to spur sales of its Bell helicopters in Iran. His cool, precise answers convinced all the Senators except Chairman William Proxmire that he had had no idea that the Shah's brother-in-law was the secret owner of a company to which Textron paid commissions. Some documents that subsequently came to light indicate that lower-ranking Textron officials did know, but there is no evidence that they told Miller.*
The job that he stepped into is as tough as any in Washington. The Federal Reserve is a kind of bankers' bank: it regulates commercial banks that account for more than 70% of all bank deposits, holds the funds that they are required to keep on reserve, clears checks for them. But its most important functions are to determine the supply of money and the level of interest rates--and no questions touch off more disagreement in American policymaking. If the Federal Reserve is not condemned by the AFL-CIO's George Meany for causing unemployment by being too stingy, it is certain to be damned by Economist Milton Friedman for spurring inflation by being too generous. All too often it will simultaneously incur the wrath of liberals and conservatives.
The chairman has a prickly relationship with the rest of Government. The President appoints and the Senate confirms the chairman and the six other governors of the board, and thereafter neither can give them orders. Burns has boasted that once, when Nixon's Treasury Secretary George Shultz called on him to plead that the Fed pump out more money, Burns angrily ordered Shultz out of his office.
However, the Federal Reserve and the Administration must try to get along. The Fed cannot press a tight-money policy so far as to prevent the Treasury from borrowing enough to cover the budget deficit (that would mean Government failure to pay its bills, which would shake the whole financial structure), but it can foil Administration policy by being tight or loose. So every chairman becomes a nonofficial adviser to the President.
At the Fed, the chairman has no statutory power to command. He has only one of seven votes on the board and one of twelve on the Federal Open Market Committee (FOMC), which makes the key operating decisions on money supply and interest rates. The practice is to have discussion go around and around the table until a consensus emerges, and take a vote only after its outcome has become a foregone conclusion. A forceful chairman can guide and shape the debate, but it had been thought that Miller's lack of training in banking might cause him to defer to his strong-minded colleagues.
Instead, Miller moved swiftly to take charge. Board meetings that rambled on endlessly under Burns begin promptly and proceed crisply with Miller in the chair. He can move outside channels to get things done. Only two days after he was sworn in, he convened an extraordinary meeting of the FOMC in a conference telephone call to reach agreement on a $2 billion increase in West German support for the dollar. Not all is harmony, however; two weeks ago Miller voted against a quarter-point increase in the discount rate at which the Federal Reserve lends to member banks, but lost--a most unusual occurrence. The dispute seems to have been more over tactics and timing than fundamental policy, but it indicates that there may be hot debates in the future as the board tries to decide an exquisitely difficult question: At what point has it squeezed hard enough?
Miller seems to rely on a businessman's instinct rather than recondite financial learning. At one meeting that considered rules for a sale of Government-guaranteed mortgage bonds, he spoke of encouraging legitimate speculation but cracking down on market manipulation by bond houses. Another governor laughingly asked how the difference could be defined. Miller replied: "I can smell it."
He has also repaired the Federal Reserve's strained relations with the Administration. Miller meets regularly with Carter's economic aides (especially Blumenthal, a close ally, with whom he has breakfast at least once a week). Burns did too, but Carter aides complained that he gave them lectures about Administration policy while loftily declining to discuss what the Reserve was doing. Miller debates policy patiently enough to win high marks as a team player.
His advice has been highly effective so far, in part because Miller arrived in Washington just in time to tip the scales in a backroom debate. The Administration had started the year with a misguided program aimed at a continued strong growth, centering on the $25 billion tax cut. It assumed that unemployment was stuck at 7% and that inflation was at least stable. According to Washington gossip, Jimmy Carter has lately mused to aides that he might as well have listened to a fortuneteller in Americus, Ga., as to his economic advisers.
By March, Blumenthal and Barry Bosworth, head of the Council on Wage and Price Stability, were arguing for an about-face to an anti-inflationary policy; Domestic Affairs Adviser Stuart Eizenstat and Mondale contended that the necessity was not great enough to justify alienating various interest groups that would be hurt by spending restraints. Miller, at the independent Fed, was able to voice publicly the arguments that Blumenthal and Bosworth could make only in private, and thus build pressure on Carter. The President responded in April, launching a new policy that is still evolving.
Its main elements are now familiar: the White House is to veto inflationary spending bills, reduce the cost to business of Government regulation and aim to start an era of tighter budgets, declining deficits and moderate, less inflationary economic growth. Meanwhile, the Government will plead with business and labor to hold price and wage increases below the average of the past two years. All this fits Miller's ideas so well that there is speculation that he and Carter have struck a bargain under which the Administration practices tax-and-spending restraint and Miller refrains from a stern hold-down on credit. Miller and Carter have no formal deal but a tacit understanding to roughly that effect.
Unfortunately, the anti-inflationary policy has got off to a stumbling start. In the first regulatory battle, over a proposal by the Occupational Safety and Health Administration to lower the level of cotton dust in mills--a proposal Carter's economic advisers considered too costly--the President gave in to the regulators. The Administration has won a few mostly symbolic pledges from some steel, aluminum-and automakers to limit price rises and executive salary increases. More dangerously, labor has refused to promise wage restraint. Meany calls Bosworth, a prune pleader for a wage hold-down, "that skinny redheaded s--."
Worse, inflation has built up unsettling momentum. One reason is a long series of past blunders by the Carter Administration: backing a huge increase in the minimum wage, promoting Social Security tax increases and thus jacking up business costs, forcing an expensive settlement of the coal strike. Another reason is that food prices are jumping, partly because of supply shortages caused by the brutal winter. Propelled largely by food costs, wholesale prices in June rose at an annual rate of 8.7%.
There are structural imbalances in the economy too that seem inaccessible to either monetary or budget policy. To cite just two: many of the unemployed are unskilled women, blacks and/or teenagers, whom employers are reluctant to hire unless demand reaches inflationary heights; medical and hospital costs seem to rise rapidly and inexorably no matter what is happening to business in general. Miller recognizes that such troubles need special attention, but they are no part of his responsibility at the Federal Reserve.
His formal duties are daunting enough. Eager though he is to promote a steady 4% growth, Miller vows that he will not pour out enough money "to validate the present inflation"--that is, to make credit available to anyone for whatever purpose. If he does, he says, "you will have runaway inflation and double-digit interest rates." If he holds the growth of money supply within his target range of 4% to 6 1/2%, Miller thinks, growth will continue while inflation will run out of monetary fuel. But there is always a chance that growth will suffer instead.
It is a risk that Arthur Burns would approve. Carter, a low-interest populist, probably hoped for a policy change to easier money when he appointed Miller, but he must know better by now. Both Miller's target and some of his rhetoric are so close to Burns' as to make many moneymen contend that, for all the differences in personality and style, Miller is a bred-in-the-bone central banker after all. Says Charls Walker, former Deputy Secretary of the Treasury: "I lost about $100 in bets that Burns would be reappointed. I'm thinking of asking for my money back. Arthur Burns was reappointed, only his name is now William Miller."
Miller has probably set the right money-growth target, but hitting it is about as difficult as fine-tuning a color TV set while wearing boxing gloves. The Federal Reserve controls money by the indirect method of buying or selling Government securities. When it buys, it creates money out of thin air; it pays with its own checks, which the sellers--individuals and corporations--deposit in their bank accounts. The checks become new money, available to be loaned out. When the Fed sells Government securities, it withdraws money from circulation; the buyers pay with checks that disappear into Federal Reserve vaults, never more to be seen. The less money that banks have to lend, the higher interest rates will rise. The FOMC focuses on the Fed funds rate at which banks lend to each other, targeting its buying and selling to push up or pull down that rate to a desired level. The Fed funds rate influences all other interest rates.
In theory it all sounds neat, but in practice dozens of factors can throw off Federal Reserve calculations. The necessity of creating at least enough money for the Treasury to borrow to cover budget deficits is one. The strength or weakness of loan demand is perhaps the most important consideration. The Federal Reserve may set an interest-rate target of, say, 7 1/4% to 7 3/4% for Fed funds-- which is believed to have been its goal in June. But if loan demand is exceptionally strong, it may have to put out more money than it wants to in order to keep the rate from rising above the upper limit.
There are various measures of the money supply, and right now the most important two are behaving contrarily. Ml, which is currency plus checking accounts, has recently been growing at about an 11.4% annual rate, much faster than Miller wants, partly because loan demand in the year's second quarter was exceptionally strong. But M2, which is currency plus checking accounts and most time deposits in banks, grew at 8.3% in the second quarter, more slowly than Miller wants. A possible reason: investors have been switching from time deposits to higher-yielding short-term securities, like Treasury bills.
During Burns' last year, the Federal Reserve constantly overshot or undershot its targets, for reasons that no one seems fully to understand. The Ml growth rate swung crazily from almost 14% in one month to nearly zero in another, and the gyrations confused and alarmed moneymen. Miller aims for more stability by not pushing down wildly on the pedal or slamming on the brakes in one month to correct the previous month's error.
Even if he fulfills his goals, the prospects for the economy are touch and go. The standard forecast is that growth of real G.N.P. will slow to about 4% in the current quarter and 2% or 3% in the fourth--partly because the recent pace just cannot be sustained, partly because inflation will weaken the economy. Real G.N.P. is expected to be essentially flat in the first half of 1979. It is anyone's guess whether the slowdown will fulfill the definition of recession: two straight quarters of decline in real G.N.P. and mounting unemployment.
The bright side of the orthodox wisdom is that growth will resume, moderately, in the second half of next year and the economy will not suffer a credit crunch but only a squeeze late this year and early next. In the New York financial community, the betting is that interest rates will go up a bit more, but not much; that Miller will get the money supply under control; that loan demand will fall as the economy slows; that Government borrowing will be heavy, but enough money will be left to meet the reduced borrowing demands of most--not all --companies and individuals.
There are two catches. First, this unexciting prospect is a best-case vision. It would take only minor errors by the Federal Reserve, the Administration and/or Congress to produce recession, an accelerating inflation or both. Worse, even under the moderate-slowdown script, inflation will simmer down only very gradually because it has become so deeply embedded in the economy.
In these difficult times, the prime policy requisites are steadiness and sensible coordination of policies among the Federal Reserve, the White House and Congress. Miller has made a promising start at both, but the complexities facing him in keeping it up are formidable. Says William McChesney Martin, a revered former Fed chairman: "He is like a golfer who has made four birdies in a row, but there are some more holes to play. He has a tough job ahead." Fortunately, he is tackling it in a spirit of optimism. A pessimist would be whipped before he began.
*Proxmire also claimed that Miller was not expert enough in financial markets. In fact, Miller had been a director of the Boston Federal Reserve Bank for seven years, and FORTUNE judged him "a whiz" at managing Textron's pension funds. In early 1974 he took management of those funds away from banks and shifted most of their assets from stocks into bonds. The move was well timed and caused Textron's pension funds to prosper far more than funds generally from then on.
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