Pardon me if I don’t understand this, Mr. and Ms. Economist: You are correcting against the possibility of deflation-that is, a general and continuous drop in prices-by cutting prices? If that’s your story, stick to it, but please explain the rationale for this last cut in the price of money more cogently than you have done so far.
Are interest rates being cut to prevent a deflation, or to end a recession, or both? And, if so, how does all this work? As of now, there is no deflation-only a lessening in the inflation rate, which the economists call “disinflation.” In short, prices are still going up. Some are not rising as fast as they were in the recent past-a situation you’d think would be the cause of rational exuberance, not to say joyful hurrahs, over at the Federal Reserve Board, where Dr. Alan Greenspan has dedicated his life to cutting off the heads of the inflation hydra. Nevertheless, Dr. Greenspan-who says there is no deflation now, and that he doesn’t believe there will be deflation later-is cutting interest rates to prevent deflation.
As for ending the recession (assuming this is a recession, and not something else we’re living through): How is this last quarter-of-a-percent rate cut going to help? They tell us with condescending patience that by making money cheap, businesses will want to borrow it and use it for buying new equipment, etc., which puts people back to work. The great axiom is that cheap money spurs investment, although experience and history teach us that this statement is valid only with a long list of qualifications and exceptions.
Cheap money will entice businessmen and women to borrow if they believe they can put the money to profitable use. It matters not what the interest rate is-high or low, 1 percent or 15 percent. People will borrow at 20 percent if they can get 23 percent back on the borrowed money. The key element is not how low the interest rate is, but how good are the prospects for making a profit. Japan has had years of zero interest rates and no rush to borrow and invest.
In real terms, as the economists say, some interest rates have been hovering around zero for several years now. “Real terms” means figuring in what the money is worth after deducting for inflation. So if you borrow money at 2 percent and the inflation rate is 2.5 percent, you are actually making half a percent on the loan even before you’ve invested it.
That being the case, you might wonder why companies haven’t been borrowing like crazy to put up new plant and expand. The fact of the matter is that two years of interest-rate cutting by the federal government hasn’t gotten us very far.
On the brighter side, corporations and individuals have been taking advantage of the lower interest rates to refinance their debts, be they credit cards or home mortgages or gigantic, stupid borrowing to buy companies at ridiculous prices. Lower monthly interest payments should help a lot of people and institutions stay out of bankruptcy and pay their bills each month. Or lower interest rates and easy credit may entice people to refinance and borrow more in the process. The trouble with that is, regardless of the interest rate, debt is debt, and you have to pay it back-and if you’re paying it back, you don’t have money to buy a lot of new things, and therefore companies may have little incentive to expand, buy new equipment and take on new staff.
A complicating element is the huge jump in productivity of the last few years. The high tech we are always being impressed with is paying off, and companies are able to make more of whatever it is they make with fewer people. Indeed, there now are some companies which continue manufacturing all night long with no staff on the premises, only the security guards. Business history suggests that it takes between 10 and 20 years for an industry to learn how to take advantage of major technological changes. Thus, it may be that the benefits of investments made a decade ago are now kicking in. To the extent this is true, a lot of businesses have no need to make new investments. They’ve already made them, so they’re not going to borrow money for those purposes. They may borrow it to make financial mischief, which will cause us yet more trouble down the road, but that’s a story for another time.
If we go back 40 years or so, to the dawn of what the Sunday supplement used to call the age of automation, it was freely predicted that the new machines would not only confer prosperity but undreamt-of leisure on our grandparents’ children, which, I guess, is us. The prosperity is certainly here for most of us, but as for leisure, that’s another story. By all accounts, Americans work longer hours than people in European countries with a comparable standard of living.
Not that some of us aren’t enjoying greater leisure, as these figures indicate: In the last few months, over half a million non-farm jobs have been lost; in the last couple of years, two million jobs have vanished. Altogether, there are 12 million people out of work, or working part-time because they can’t get full-time work.
On top of those people, there are the unknown millions who have taken pay cuts over the last few years. Also to be counted are the companies whose policy it is to fire their best-paid workers, even though they are also often the best producers. If that seems strange, the truth of the matter is that as the system-which is the machines plus the organization of the enterprise-gets better and better, there is less need for outstanding workers. So why pay top dollar for top employees if you don’t need quality staff? And more pay cuts are coming: The Bush administration is in the process of changing the rules by which the Fair Labor Standards Act is administered, so millions of workers will no longer get overtime pay for overtime work.
In the aggregate, millions and millions have less money to spend, which may reduce demand to the point that prices are forced down. All we can say as of now is that the rate at which prices have increased has slowed to a creep compared to what it has been in the not-too-distant past. If shrinking purchasing power due to unemployment, underemployment and pay cuts is killing business, cutting the interest rate another quarter of a percent doesn’t seem like much of a help. Dr. Greenspan has been whacking away at interest rates for a couple of years, and the best you can say for it is that maybe-just maybe-things would be worse if he hadn’t cut the rates.
The chronic overcapacity of world manufacturing is certainly having some downward effect on prices. Too many automobiles are chasing too few customers, and what is true of cars is true of textiles and many other items. So either the manufacturers cut capacity or get some new customers. It’s against the law for companies to agree on production quotas among themselves, which leaves stealing customers or market share or putting more money into people’s pockets. This last is an activity which the Bush administration is only fitfully interested in. Mostly, it’s the rich getting richer: In the last 10 years, the 400 richest people in the United States have had the pleasure of seeing their average income zoom from a mere $46.8 million to a somewhat unsightly 174 million skins per annum. That’s fine for them, but it isn’t going to bail out Ford or General Motors, which can only survive with a mass market, not a class market.
It’s not that Dr. Greenspan, Mr. Bush et al. haven’t been throwing the money around, although whether it’s sticking is another question. They’ve been printing money like it’s going out of style; they’ve been cutting some people’s taxes a lot and a lot of people’s taxes a little; and they’re running up a fat federal deficit whose counter-deflationary effects are somewhat canceled out by Washington’s forcing the states to raise their taxes.
They’ve broken their backs to force up the prices on Wall Street, and they have succeeded. If nothing else, these rate cuts have driven people to cash in their savings and go back to buying stocks. They have left no trick unturned to light the inflationary fires. You know the old adage: A rising tide lifts all boats. But you may not know the codicil, which is that if you don’t own a boat, all you get is a mouthful of salt
With all that said and done, we might still get an eyeful of deflation. It’s come to Japan, and Germany is on the verge of same. Nobody understands how this vast national and international tangle of systems works. We only know that every so often, a mood, a moment, an inexplicable universal fact comes rolling in on us, and we don’t know why, and we don’t know what to do about it.