CINCINNATI BUSINESS COURIER
July 14 -20, 1986
INVESTMENTS
Charles D. Vaughan
NO, YOU CAN’T push a piece of string. That’s what the Federal Reserve Board is finally beginning to figure out. Despite their best efforts to reel out huge balls of the stuff in the form of easy money, the economy stubbornly refuses to budge.
This concept that easy money alone would not necessarily bolster the economy was first stated by John Maynard Keynes during the Great Depression. His idea was that at certain times fiscal policy (the management of the federal budget and the creation of surpluses and deficits) could be more effective in stimulating the economy. He is thus credited wrongly with being the father of the deficit, because his ideas have been consistently perverted.
Now that we have a $2 trillion federal debt and a clamor to reduce it we have lost fiscal policy as an effective tool. Keynes’ idea was that deficit financing should be used in combination with a simulative monetary policy to pull the economy out of a recession. Then, reduced spending and tax increases should be employed in conjunction with tighter money policies to keep a boom from becoming overheated while reducing prior indebtedness.
Such theories have never really been tested, because politicians have proven more than willing to reduce taxes and spend money to stimulate the economy but totally unwilling to make the harder decision to raise taxes and cut spending to reverse the process. The deficit has continued to rise through bad times and good and now poses the greatest political problem of the day. So we are forced to have a policy of fiscal contraction at a time when we want to foster a growing economy. Monetary policy alone has been expected to carry the day. No way.
Gramm Rudman seemed to offer politicians the perfect copout. Spending cuts without having to take the blame. Coupling these cuts with a tax increase that disguises itself as a tax cut, the legislator seemed to have himself well covered. The Supreme Court denied Congress the right to put fiscal policy on automatic pilot and business leaders have exposed the downdrafts in the tax proposals.
The key element in the health of the economy at any time is confidence. Regardless of the rate of interest at which you can borrow, you must believe that you can reinvest that money to earn a higher net return. Both the very sick capital goods industry and the overbuilt commercial real estate industry are karate – chopped by the tax proposal. The combination of extended depreciation lives and repeal of the investment tax credit is devastating to both. Nothing in the proposal augurs to the benefit of the agribusiness or energy production sectors that threaten to wipe out a vast number of regional banks.
Many point with pride at the low inflation rate and marvel at the magnificent rise in the value of financial assets. Others believe that the lack of inflation in the real goods sector has been shifted to become an inflation in the financial and service sectors. Some experts think that dollars which might have been channeled into new plant, equipment, real estate, agriculture and energy development have gone instead into stocks and bonds. They see a correlation between the growth of money supply beyond Fed targets and the massive move of major corporations to cannibalize each other by takeover and themselves through treasury stock purchases and leveraged buyouts rather than develop new businesses.
These signs suggest that the capital formation process may have gone askew. The focus is not on growth through expansion but on concentration of ownership. In a low inflation economy, such concentration seems beneficial and profitable. But the lack of vigorous competition in a more inflationary environment may facilitate excessive price increases.
The huge monetary expansion currently under way may pile up as a harmless ball of string today but may really be the fuse that ignites an explosive inflation if the economy ever pulls it taut.