All Commentary
Friday, July 1, 1983

Prescription for Economic Health

Dr. Elgin Groseclose (deceased April 4, 1983) was a financial consultant in Washington, D.C. He was the author of Money and Man (1934, 4th edition 1976) and America’s Money Machine (1966, 1980). He sewed also as executive director of the Institute for Monetary Research.

That radical reform is needed for an economic system that periodically produces booms and busts, inflation and deflation, is recognized by a growing number of students. The prescriptions for reform are numerous and varied. Among the defects of the system, however, are several that continue to be ignored—indeed, are regarded not as defects but with reverence as healthful agents of progress.

At the risk of being read out of the profession as eccentric or iconoclastic, I list a few that have produced more confusion than progress, more chaos than order, and that need examination as to their utility.

The Statistics Syndrome

Statistics have been characterized by the English industrialist Arnold Wilson as something economists collect as others gather antiques. So treasured are they that a vast computer industry today is devoted to compiling, analyzing and storing statistical data. No self-respecting administrator would think of making a decision without the aid of his computer. Chief among the statistical totems are various kinds of indexes, and high on the column is one which business and government decision makers watch with the avidity of a gambler watching a roulette wheel. This is the Gross National Product, or GNP. Purportedly, the GNP records the changing volume of goods and services produced by the economy. A rising GNP suggests that the country is producing more, and the figure suffuses the observer with a pleasant euphoria.

Actually the GNP is not a measure of production, but of consumption. A rising GNP may indicate that the country is producing more while actually it is producing less.

Thus, a restaurant meal for two may add as much as $100 to the GNP, if taken at the Lion door, but only $5 if eaten at Burger King, and even less if prepared at home. In an inflationary period, when vast sums are spent in restaurants, theatres, travel and Las Vegas casinos, the GNP index may indicate a state of economic well-being when actually physical production is declining and general poverty rising.

Better political and business decisions and improved economic health would follow if the GNP index were abolished or radically modified.

The Dilemma of the CPI

Another index that has gotten the government into trouble is that of the consumer price index—since pensions, Social Security and welfare payments are adjusted periodically with the indicated change in this index. How accurately the index measures the real burden of rising prices is a question few examine, and how unwillingly the public would accept a correction has been recently demonstrated by the hullabaloo over the substitution of rental costs for housing costs in the series upon which the index is based. In any case, the process has now bankrupted the Social Security system, and those who can—like state and municipal and non-profit employees—are leaving it with the good sense of rats abandoning a sinking ship.

The latest indexing, which has become a political dilemma since it may bankrupt the federal treasury, is to be applied in 1985 to income tax rates. The purpose is to relieve taxpayers of what is called bracket creep—the higher tax burden that applies as income increases as a result of inflation. The effect will be to reduce federal revenues at a time when the indexing of the entitlement payments is increasing expenses. If the price level were stabilized, there would be no need for the indexes and indexation. They serve, instead, to push prices steadily higher, like a ratchet on a tire lift. If honest money were restored to the country, there would be little need of these indexes.

The Money Mill

The whole mess created by indexes and indexing would not have arisen except for the money mill on the Potomac which keeps issuing paper currency like the legendary mill at the bottom of the sea that grinds out salt with nobody to stop it. Money in circulation—and we mean the legal tender currency issued by the Fed, not the M1, M2, and the like, of the economists—has doubled in the past decade alone, from $54.6 billion in 1972 to $126.6 billion today. And this goes on despite the impression given out of a “tight money policy.”

It is too well known to require theoretical demonstration that prices are influenced by the amount of purchasing power in the market, and that inflation is the result of too much money in circulation.

Instead of curtailing the power of the Fed to issue currency, Congress has steadily broadened its powers until today the Fed can turn into legal tender currency practically any debt obligation it sees fit, including Polish, Turkish, Brazilian or Argentinian bonds. This brings us to our next proposal.

Wean the Banks

The Federal Reserve System came into being as a system of super banks—actually pawn shops—to assist commercial banks in distress by taking up their short term loans and giving them cash in the form of legal tender currency, or a deposit at the reserve bank that was equivalent to cash (since it could at any time be turned in for cash).

The so-called panics, depressions, or crises which the country goes through periodically are not the result of a shortage of money in the economy, but a shortage of cash or credit on the part of debtors. The principal debtors, of course, are the banks, since their balance sheets represent mostly liabilities supported by a thin margin of proprietors’ capital (less than 10 per cent generally).

After the passage of the Federal Reserve Act, banks gradually let their capital drop from a mean of 25 per cent or more of total liabilities to the present low ratios (for the 15 biggest banks’ the ratio is less than 5 per cent).

The banking system is like a brood of pigs, grown to sizable porkers, but still clinging to mother sow. It is time they were weaned and made to forage for themselves. In short, too long have money and banking been linked in economic literature. The management of the banking system should be separated from the administration of the money system.

Subsidized Debt

The world today would not be in the depression it is in but for the burden of debt. Farmers complain they can’t meet their mortgage payments; home owners, likewise; corporate bankruptcies—now at flood—occur because companies cannot meet their debt payments. Third World countries are half a trillion dollars in debt, a third of it owing to U.S. banks.

How did the world get in this mess? Largely from encouragement by government. Through the International Monetary Fund and the World Bank, indigent governments around the world have been led to borrow beyond their means for all sorts of doubtfully viable projects until now they are bogged down in a mire of debt. Home ownership has been fostered—no doubt, for the public good-by low cost loans, or government guaranteed loans and deductibility of interest payments. Farmers have been encouraged to expand their food production; many increased their acreage by buying land at high prices, financed by mortgages.

Banks have been permitted to increase their debt (deposit liabilities) in relation to equity capita] until most banks are in difficulty, many of them technically insolvent.

One measure to reduce the mania for going into debt is to restrict the deductibility of interest payment from taxable income. While no doubt justified as a social measure to encourage home ownership, the deductibility of corporate interest payments is contrary to shareholders’ best interests since it encourages corporate managers to leverage assets, engage in mergers that are justified only by tax advantages, and shift the enterprise from producing goods to that of producing financial gain.