February 8, 1978

Money Policies Can't Control Inflation

We're off on a new round of inflation.

The nation's wage earners received a general pay increase last month as Congress mandated a 45 percent increase in the minimum wage.  The unnegotiated hike is rippling upward through the economy justifying increases also for steel workers, coal miners and grain farmers.  Other special interest job groups are gearing up for new demands.

At the same time, prices are skyrocketing for everything - with autos, energy fuels and food leading the way.

The net gain: a deeper hole.

Interest rates on loans spurt to new highs.  The stock market slumps at a rate approaching the infamous Crash of '29.  The balance of trade is the worst on record.  Social Security benefits shrink while costs climb.

In recognition of these difficulties, the value of the dollar against foreign currencies falls under the German mark and the Japanese yen.

Inflation, of course, is simply that portion of spending which exceeds income.  Congress, in a perpetual sweat of re-election fever, commits the folly of spending.  Presidents, often co-conspirators, seek the best of both worlds - pump priming and fiscal responsibility - by money management.

President Franklin D.  Roosevelt and his "egg heads" introduced the theory that money could be manipulated to achieve something from nothing.  It didn't really make sense then, but the nation was deep in the throes of the Great Depression.  It made more sense to eat now and pay later.

Thus was the Federal Reserve Board created in 1935 to manage the nation's money supply, to put back at one end of the pipe what the politicians drained off at the other end.

It seemed to work while our credit was good.  But our credit is about used up.  We seem baffled that investors aren't fighting to finance our inflationary deficit.

The moment of truth is upon us.

And truth is - we can't get there from here.

I wish it were possible to hold out hope that we will yet discover some financial legerdemain that will pull unearned prosperity out of a silk hat.

Yet, it cannot be.

The time has come to heed the reality of Professor Milton Friedman, who won a Nobel Prize for Economics with this assertion: It is almost impossible for a free nation to manipulate its money supply and interest rates with any degree of stability or certainty of effect.

Friedman points out that the Federal Reserve has only two tools with which to manipulate money and interest rates.

It attempts to control the supply of money with its "open market operations."  To increase the amount of money in circulation, the Fed buys U.S. Treasury notes from its member banks.

This gives commercial banks immediate cash they can loan to you and me for homes, cars, college education or whatever.  Unfortunately, that "ole debbil" law of supply and demand takes over.  If no body wants to borrow money, the Fed cash lies idle in bank vaults.  If loan demand is high, banks can loan against reserves six times or more and put money in circulation faster than the Fed intended.

Individual decisions of thousands of banks and millions of customers can - and usually do - thwart the best intentions of the Fed.

The second tool at the disposal of Fed is the raising or lowering of interest charged to member banks for short-term loans to each other.

This "federal funds rate" also is a crude process because it affects only a small share of the total flow of short-term credit in the nation's banking system.  It can be - and usually is - discounted, neutralized or accelerated by bankers who anticipate Fed actions.

Ranged against these two imprecise mechanisms is all the skill, wit and intuition of the nation's borrowers, lenders and investors.  It is estimated that 216 million Americans and 2 million firms make some five trillion decisions each year that affect the two decisions the Fed can make.

The odds are beyond the control of all the monetary planners, no matter how smart and dedicated they might be.

The Fed's first great job was to fight depression.  After World War II, the Fed's main occupation has been to counter the inflationary tendencies of populist presidents and congressmen.

The Federal Reserve chairman during the administration of President Harry S. Truman forecast the principal objective of the monetary watchdog.

"If we fail in this task (of fighting inflation), history may well record that we were responsible in great measure for helping to bring about the destruction of America's system of government," said Marriner Eccles.

"We know what we should do in this inflationary situation.  If Congress objects to our actions it can change the law, but until it does that we have a clear responsibility to check inflation - in so far as we can do this within the frame work or our authority - by preventing a further growth in the supply of money and credit at this time."

Arthur Burns, retiring Fed chairman, was a steadfast fighter against inflation -though he lost his resolve somewhat last year under the strident cries of President Carter and the majority of Congressmen for "stimulation" of the economy.

That brief relapse to "easy money" has cost all of us a bundle.

President Carter's new Federal Reserve chairman, G.  William Miller, is expected to domesticate inflation without any discomfort to the citizens.  He can not do it alone.  He can not alleviate the symptoms of inflation until Congress cures the disease of spending.

Author: Lindsey Williams