Reaganomics and the Interest Syndrome; E. Groseclose

Elgin Groseclose REAGANOMICS AND THE INTEREST SYNDROME THE Administration's efforts to bal ance the budget and reactivate the economy recall the county fair con tests of an earlier generation known as climbing the greased pole. Just as it appears that inflation is being brought under control, interest rates start rising again, bringing the seed of inflation, erosion of savings, re duced capital investment, slower business and continued deficits. How to control interest rates? Should the Federal Reserve lower its lending rate, push more reserves into the banking system, or use some other mechanisms? Professor Milton Dr. Groseclose, a financial consultant in Washington, D.C., is the author of Money and Man (1934, 4th edi tion 1976) and America's Money Machine (1966, 1980). He serves as executive director of the Institute for Monetary Research. Friedman, an advocate of steady in crease in what is c~lled money sup ply, has complained that the FED did not use the right tools, and ad ded that there was 'no historical pre cedent for the constant interest rate fluctuations of the past few years.

For decades the' Federal Reserve has assumed responsibility for de termining how much money/debt/ credit the country needs, and in 1978 was required by law to set and an nounce "targets" for money supply. An Open Market Committee-a group of twel ve-meets periodically and with the assistance of batteries of computers and r¢ams of charts de cides the amount qf "money" needed by the economy to maintain steady growth at reasonaple interest rates. Its main device is! to buy or sell in 395 396 THE FREEMAN Ju( the market its own debt instru ments (notes or deposit credits) which thereafter become money equi va lents and reserves in the banks. This system permits the banks to extend their own debt commitments through deposit liabilities and thereby in crease the "money supply." Whipping a Dead Horse "Money supply," taken to repre sent the current purchasing power in the economy, is generally defined as the note liabilities of the Federal Reserve Banks plus the demand li abilities of banking and like insti tutions; it is called Ml (or Mlb ). A simpler definition is the amount of demand debt in the economy.

The futility in trying to control "money supply," and thereby inter est rates, was illustrated by a speech by Anthony M. Solomon, president of the Federal Reserve Bank of New York before the American Economic and American Finance Associations on December 28,1981. Mr. Solomon pointed out that during the first eleven months of 1981, the money supply figure used by the Federal Reserve (Ml ) rose at a modest 2.5 percentage rate; the figure, how ever, was deceptive; other money equivalents in the form of Eurodol lars, money market funds and the like, called M2 and M3 , rose at 10.1 per cent and 11.1 per cent respec tively. In short, as Mr. Solomon conceded, "A fundamental re-evalu~ tion of our use of monetary target may be necessary." Vestigial Marxism This observation is one that shoull have been apparent years ago t monetary historians and students c monetary phenomena. That mone: supply through debt formation Cal be controlled by a select group of e:x perts sitting in a marble mausoleuTI on Washington's Constitution Av€ nue is a vestigial relic of Marxis economics-the theory that the statl is the repository of all economic wis dom and hence the ultimate author ity for economic planning.

The reason debt and money sup ply and interest rates can not h controlled, but will continue to in crease, lies in the nature of wha passes for money. The currency il circulation, apart from debased to ken coinage, consists mainly of Fed eral Reserve notes. Until 1934 thesl notes were payable on demand iI gold coin. Since 1934, the notes havl been redeemable only in otheJ notes-a perpetual rollover of deh without maturity, with the interes' payable only in more debt. Deb' multiplies upon itself without limit with each increment lowering thl purchasing power of the total. Here is the basic explanation 0 the upward pressure on interesl rates, the effects of which filtel through into the general price struc· 1982 REAGANOMICS AND THE INTEREST SYNDROME 397 ture. Until 1946 these effects were hidden by reason of the great influx of gold during the preceding decade, an influx that anesthetized the in flationary effects of Federal Reserve policy. The awakening came after the close of World War II, when the flow of gold seeking security here ceased, and a reverse movement began.

As prices rose, investors grew in creasingly reluctant to put funds out at long term except at the higher rates of interest required to offset the loss of purchasing power of the dol lars received at maturity. This is re flected statistically in the amount of government debt that increasingly had to be incurred at short term. In 1946, the mean interest rate on gov ernment bonds was 2.19 per cent, and 23 per cent of the public debt was at long term. In 1981, the mean inter est rate was 12.87 per cent, and only 6 per cent of government debt was long term. How Much Debt? The Federal Reserve System sits over the economy, breeding debt like a queen bee of a hive spending its existence in laying eggs. Can a sta ble price level and stable interest Francis Adams Truslow IDEAS ON rates be achieved while this debt creation continues? Total dollar debt that ten years ago was calculated at around $1.8 tril~ion is today around $5.5 trillion, thJ largest increase oc curring during the past 5 years.

During 198~, M3 , the broadest measure of "Ihoney supply," in creased by $222ibillion. Federal debt in the hands of ,the public increased by $93 billion. )Who were the other borrowers? Billions were lent to fi nance mergers :jl.nd acquisitions, like those by du Pont and U.S. Steel. One bank alone (First Boston Corpora tion) boasted that it had underwrit ten or particip*ted in mergers and acquisitions involving over $30 bil lion. Other amounts were sunk in loans to indigent foreigners, like Po land and Turkel)!. Reduction of interest rates, the price level, and, the debt burden, de mand what neither the Administra tion, nor the Federal Reserve, nor the monetarist school yet accept, namely, a restQration of a money of substance. The country can not prosper on a system ofperpetual debt, or a system in which the only means of debt paymen~ is another LO.U. @ UBERlY THE CITIZEN who calls on government to supplYihim with security from the cradle to the grave, thereby encouraging goyernment spending, is a danger to himself and his fellow citizens. If his;pleas are successful, he can lose his freedom and gain no security in exchange.