Prices: Guidelines that Work

One of the stories handed down over the years tells how kings used to execute messengers who brought bad news. The nobility apparently thought—literally—that no news was good news. If only we don’t know about a catastrophe, it isn’t bad at all!

We can laugh at such an attitude today because we realize the importance of information, whether it is good or bad. The good news tells us things are going well and the bad news is a call to action. Whether the messenger carries information about an earthquake or a shaky financial structure, we respond by taking helpful and remedial actions. Bad news is no longer cause for beheading the courier but rather is an alarm that signals that something must be done.

There are those who still take the old view that bad news is somehow the fault of the messenger who car-ries that news. Their response to information about calamities is to shut down the news service. They would rather have the morning newspaper full of blank pages than have the assaults and accidents reported as they happened. Most of this crowd—the "hear-no-evil-and therefore-everything-is-fine" crowd—seem to hold public office.

That doesn’t mean that the freedom of the press is in jeopardy—not yet, at least. Those who would eliminate bad news have a much bigger target in their sights. What they are aiming at is the biggest communications system in the world.

It may come as a surprise that this system is not a broadcasting company, the phone system, nor a publishing company. The world’s biggest communications system does trillions of dollars of business each year but has no paid employees. It doesn’t use satellites or microwave towers, and it doesn’t even have a corporate headquarters.

The Price Network

This communications system is the network of prices that keeps our economy going. Whenever people start buying more of an item, the price of that item starts going up—a signal to producers to produce more. If a particular skill is needed by businesses, the price of people with that skill (their wage) goes up. Those who have that skill are allocated to that part of the economy where they are of the most value, and more people are attracted into that profession or trade as a result of the higher wages. If OPEC simply decides to shut off all oil to our country, we will quickly experience a massive shift to other energy sources—not because the Department of Energy so decrees but rather because oil prices will rise to the point that other energy sources become more attractive.

The biggest communications system in the world . . . is the network of prices that keeps our economy going.

That message system—the price network—works efficiently night and day. When it makes a mistake, it is quickly corrected. It sends the labor, the natural resources and the finished goods to the places where they are most highly valued. It tells a businessman when he has made a mistake in interpreting consumers’ wants and it rewards those who develop new or better ways of solving problems. Last year, in the U.S. alone, our price network allocated over $2 trillion of goods, services, materials and talents—and it all went smoothly.

The Burden of Inflation

Well, it almost went smoothly. The price network has had an extra burden to bear for the past decade and especially for the past few years. The extra burden is inflation. To be sure, the price system has done its job. It has reported to us that the dollar is losing its value, both at home and abroad. At the same time that the price network was delivering this message it was still having to simultaneously adjust for changes in people’s tastes, technological advances and new products. This would be similar to a juggler having to keep all of the balls in the air while riding a roller coaster!

The price network kept the messages coming despite having to adjust for the extra messages about the value of the dollar. Normally, such faithful service in the face of overwhelming demands would call for recognition of and reward for meritorious duty. But the old practice of kings is re-instituted instead. Washington declared that we should execute the messenger who dared report bad news. Their sensitivity is understandable. After all, the bad news was that there were too many dollars in circulation—and that was the fault of the Federal Reserve System, a quasi-government agency.

The execution of the messenger is to be voluntary, at least in the beginning. The government asked all of those in the economy to voluntarily ignore the price network. Even if customers have more dollars to spend, producers are not supposed to raise prices more than they have during the past couple of years (actually, one-half per cent less). Employees are not supposed to be given wage increases in excess of 7 per cent, even if an employer loses his entire work force to a competitor. If costs are restrained, and prices are restrained—so goes the Washington view—inflation will no longer be a problem. Let the messenger drink a cup of hemlock and there will no longer be any bad news!

The bad news, of course, will still be there. The price network has simply been delivering the message that there is an excess supply of dollars and that the value of the dollar is therefore lower. Now, if those excess dollars are still out there, what will happen if everyone faithfully follows the wage and price voluntary guidelines?

In doing so, we are (voluntarily) executing our economic messenger—the price system. That price network would otherwise be telling us that people have lots of dollars and that they want to spend those dollars, driving prices up. If prices and wages are voluntarily restrained, the dollars are still in circulation and the demand for goods and services still exists. But, under the guidelines, that dollar demand cannot have an effect on wages and prices (in excess of the guidelines).

The producers in the economy must receive higher prices if they are to produce more. The only way that businesses can maintain their profit margins is to charge more as inefficiencies creep in with expanded production. But if they cannot—or will not—charge more, they cannot be expected to produce more.


So, if everyone were to faithfully follow the guidelines, the demand for more goods would be unmatched by an increase in the supply of those goods. Those items in greatest demand would soon disappear from stores. Without the price network to broadcast up-to-the-minute economic news, shortages would begin to crop up.

But the consumers, thwarted in their desire for the products in greatest demand, will try something else. Second-hand goods, antiques, and all those things not under the guidelines will become popular as people seek to get out of dollars and into something of value! Even as they spend for such things, though, the dollars are still in circulation in our economy. They may have passed into the hands of used car dealers and antique store owners, but the dollars are still there.

At some point, if we cannot get the additional goods and services we want from our own economy, we are going to buy those products from another economy. To get foreign goods, though, we need to have foreign currency. As we try to purchase goods abroad, offering dollars to get francs, marks, yen and lira, the value of the dollar will start downward. We may have done away with our own economic messenger but the international price network will quickly send the same report: there are too many dollars and their value must fall.

The U.S. government could hardly stand by and let the international markets telegraph such information. For a while, our government will step in and supply the foreign currencies we need to buy foreign goods. But the government’s supply of those currencies is limited, so the dollar support program could only have a limited life. Before its demise, we can expect direct trade restrictions to be imposed, preventing us from buying French wines, Japanese stereos and German cars.

When we put our price network out of commission—voluntarily we implicitly agreed that we would resort to some other way to allocate the available goods and services. Whether we resort to government licenses to buy imported products or coupons to buy gasoline, or simply the arbitrary system of first-come, first-served, we will have to use a very inefficient means for dividing up the gross national product. Worse yet, we can expect fewer products to be available because our domestic companies have no incentive to produce more and we won’t be able to buy as much from foreign companies.

Inflation Persists, Despite the Disguise

The inflation problem is still with us, even if everyone follows the wage and price guidelines. All that we have done is disguise it. If you want to buy gasoline, you will still have to pay more for it—except that now the payment will be partly in cash and partly in a willingness to get up at 3:00 A.M. to get in line at the service station. If you want that increase in salary you deserve, you will either have to change companies or settle for non-monetary fringe benefits—a new office, more secretarial help, a fancier phone on your desk.

Total compliance with the voluntary guidelines does nothing to solve the problem of inflation. It simply drives the problem underground. The bad news is still there, and liquidating the messenger doesn’t change the message.

Ignoring the price network makes life in a complex economy exceedingly more difficult. Because the demand for goods and services cannot be expressed entirely in dollars, everyone must learn how each store or industry operates. We have to find out when the meat counter receives its daily shipment; when the gas station will be open; whether we have any friends to whom we can turn to supply what we want. Employers must try to keep their, employees without granting wage increases in excess of the guidelines and figure out how to get the materials needed for production without paying more than the guidelines allow. As the demand for products and labor will not be satisfied under the guidelines, that demand will seek its own level elsewhere. As the prices of the goods and services not under the guidelines begin to rise, we can expect governmental restrictions and controls to spread. Import controls, restrictions on investment abroad, credit controls and perhaps even an extension of the guidelines to used merchandise and individual wages and salaries are all conceivable.

Difficult as life in that type of economy would be, we could still muddle along. Most people probably don’t realize just how difficult life would be, for it is widely reported that nearly two-thirds of our adult population supports the guideline approach to controlling inflation. If there were any reasonable chance that the guidelines would in fact reduce inflation, that support might be understandable. However, the only result that we can expect from even complete compliance with the guidelines is a new face for inflation. Instead of higher dollar prices, there will be higher non-dollar prices. Instead of higher wages and salaries, there will be more money spent for redecorated offices with oriental rugs. Instead of buying imported goods at market prices, we will have to buy licenses to get those foreign goods at below-market prices.

Destroying the Messenger

The voluntary wage and price guidelines will fail to control inflation because they do nothing to rid us of the cause of inflation. The guidelines confuse the message and the messenger.

The cause of inflation is simply too many dollars available to buy too few goods and services. When there are too many dollars relative to products, the dollar price of those products will go up. The rising prices are the result, not the cause. The rising prices are just telling us that there are an excessive number of dollars chasing a scarce amount of goods around. Only when an anti-inflation policy attacks the root cause of those excess dollars will inflation be controlled.

The number of dollars—our country’s money supply—has increased about 6 per cent per year for the past 5 years. Prices have increased about 6 per cent per year over the same period of time. This close relationship between increases in our nation’s money supply and increases in prices has been traced back and verified for as many years as we have data. So, the immediate cause of inflation is an excessive increase in the supply of money. To effectively control inflation, we must get to the reasons why our money supply has been expanded at such a high rate.

Federal Spending

The basic reason for such excessive monetary expansion is that the federal government has persisted in spending far more than its income. The gross federal debt has increased by more than $300 billion in the past five years. That $300 billion was borrowed, some of which otherwise would have been available for investment in productive facilities. That diversion of funds from private investment to public spending in itself would reduce productivity and produce a sluggish economy. But the inflationary forces were unleashed when part of that $300 billion of borrowing was supplied indirectly through the Federal Reserve System.

Guidelines can bring inflation under control, but they must be guidelines to curb federal deficit spending.

The "Fed" is the agency that controls the amount of money in the economy. When the federal government borrows heavily, the Fed is under pressure to step in and help supply the needed funds. The trouble is that the Fed supplies those funds by simply printing more money! As those new dollars find their way into the economy, unmatched by an increase in goods, the inflation process begins.

The only way to end that inflation, then, is to halt the rapid increase in the supply of money. But the only way to curtail the monetary expansion is to curtail the deficit spending of the federal government. Guidelines can bring inflation under control, but they must be guidelines to curb federal deficit spending. Government spending guidelines will reduce inflation—wage and price guidelines won’t.

The Outlook

Suppose that we continue with this futile experiment in controlling inflation by wage and price guidelines. What will be the outcome?

First, inflation—in one form or another—will continue unabated. To the extent that businesses and employees comply with the guidelines, the inflation will be disguised but nonetheless present. To the extent that the guidelines are ignored, prices will continue to rise at a rapid rate. If this happens, there is certainly the possibility that mandatory wage and price controls will be imposed. If the price network won’t die through voluntary actions, we will execute it!

Test your memory: what was the rate of inflation in August, 1971, just before mandatory price controls were last instituted? In 1978, consumer prices rose in excess of 9 per cent per year, and the average increase over the past 5 years has been in excess of 6 per cent per year. If inflation were to continue at even 8 per cent per year, the general price level would double in 9 years!

Now, what was the inflation rate back in 1971? Less than 4 percent, and it was declining. Compared with the present economic conditions, that was a period of stable prices—yet mandatory controls were imposed on wages and prices because of the rate of inflation! Mandatory controls will work no better than voluntary guidelines in bringing inflation down. Mandatory controls will drive more of the inflation into disguise, but they will not get rid of it. To eliminate inflation, there is but one answer, and a simple one at that. Issue guidelines and impose controls, but aim those guidelines and controls at the real cause of inflation—federal deficit spending. Those are the only controls and guidelines that will work.

Dr. William E. Cage is an economist and administrative analyst at Tamko Asphalt Products, Inc., of Joplin, Missouri. He has also been a university professor and economic consultant.

This article, reprinted here by permission, was first published as a pamphlet by the United States Industrial Council Educational Foundation, Home Federal Building, Nashville, Tennessee 37219. Copies of the pamphlet may be ordered directly from them at $15.00 per 100, $60.00 per 1000.