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The Message From The Supply-Siders The world is experiencing a liquidity crisis that is being exacerbated by an overly restrictive monetary policy on the part of the United States Federal Reserve Board. The availability of credit is drying up internationally, as loan defaults destroy foreign bank reserves and foreign depositors, wary of the collapse of financial institutions, remove their savings from banks and convert them into U.S. greenbacks. (This is called "disintermediation.") Indeed, the U.S. economy is itself slowing and may soon enter recession. Signs of deflation are everywhere, yet until recently, the Federal Reserve has been fearing inflation. What has the Federal Reserve Board been thinking? Monetarists believe that individual product prices are a function of supply and demand, but economy wide inflation rates are a function of supply and money. This difference occurs because demand for a given product generally is limited, but the total demand in an economy never is. People typically want an infinite number of things; therefore, total demand in an economy is always infinite. What limits consumer activity is not the limited demand of consumers, but the limited amount of money people have available. Economy wide inflation is not driven by supply and demand, therefore, but by supply and money. This understanding on the part of supply-sider monetarists -- such as Jack Kemp, Steve Forbes and me -- leads us not to fear the inflationary impact of tight labor markets. We appreciate the fact that an economy marked by a great demand for and low supply of labor will be one in which labor rates are rising. But we do not believe rising wages necessarily produce inflation. If the total amount of money circulating in an economy is kept in balance with the total supply of goods available, overall inflation will be flat. Every good or service price increase will be offset by a good or service price decrease. This means it is possible to achieve fast economic growth without rising inflation. It means it is possible to have real wages rising even as the goods or services that working families want to buy remain stable in price. It means it is possible to enjoy a great prosperity that truly touches the lives of all Americans -- not just those at the top. Th achieve these goals requires sound governmental policies. Taxes on labor and investment must be kept low in order to quickly grow an economy's supply of goods and services (i.e., its total "wealth"). Simultaneously, the money circulating in an economy must be kept in balance with this supply growth. Achieving this balance between supply and money is tricky. It is not just a matter of increasing monetary aggregates by the growth rate of domestic production. Goods and services can be imported or exported -- which affects their local availability -- and so can money. When US. greenbacks are stuffed into Russian mattresses, they are not available for circulation in the United States. Hence, keeping supply and money in balance necessitates that the Federal Reserve Board have some other indicators from which it can take guidance. Inflation indices -- such as the CPI or PPI -- will not work for this purpose. They are measures of current inflation. In contrast, the inflationary impact of monetary growth has an approximately two-year lag. If the Federal Reserve Board were to use inflation indicies to guide its monetary policy, it would be acting like a driver who is searching for a highway sign two miles after passing his desired exit. It surely would see plenty of signs, but never the right ones. So upon what indicators can the Federal Reserve Board base its decision-making? The answer, proved by historical experience, is upon gold and commodity prices. Gold and commodity prices are good leading indicators of future directional changes in an economy's general rate of inflation. I will not go into the reasons why, but suffice it so say that they work. Yet tragically, the Fed has been ignoring the message of these indicators. Over the past year, gold and commodity prices have been imploding. We monetarists believe that the Federal Reserve Board should have taken heed of these signals and begun easing long ago. But the Federal Reserve Board has not been easing. In fact, until recently, many Fed governors have been speaking of a need to increase interest rates. Why? The answer is that President Clinton's appointees now hold sway at the Federal Reserve, and they are not monetarists. Many are neoKeynesians who forget that it is supply and money, not supply and demand, that determines general inflation rates. Accordingly, it makes them nervous when unemployed people get jobs. They believe this increases not only wage pressures, but also consumer demand, and automatically leads to higher inflation. They forget that putting someone productively to work increases an economy's supply of goods and services, which has a deflationary impact upon prices, and that properly managing money growth makes it possible to enjoy low unemployment, rising wages and low price inflation simultaneously. This forgetfulness makes them enemies of the working class, as their flawed economic theories lead them, in practice, to apply the brakes to the economy whenever unemployment rates get low and wages start to rise. America is not the only country that is suffering because of the Clinton administrations poor Federal Reserve Board appointments. Almost the entire Third World is suffering as well. Political leaders in Asia, Eastern Europe and Latin America have done much to create their national financial problems, but our overly tight monetary policy, by maintaining excessively high interest rates and putting upward pressure on the dollar, also has contributed to the economic devastation in these countries. A rising dollar makes it difficult for these countries to make their dollar denominated international loan repayments. It also increases the local price for oil and other commodities that are internationally traded in dollars. One could go on and on. Our Federal Reserve Board is hurting the world. Some people consider us supply-sider monetarists to be congenital optimists because we believe in the possibility of extremely fast, non-inflationary growth. We are not, however, always optimistic. We come to our hopeful outlook as a result of our understanding of free markets. We know that fast, non-inflationary growth is possible. We know that an America where unemployment is low and opportunity is great is possible. We know that sustained. non-inflationary growth can help with problems from crime to the funding of the baby boomers, Social Security entitlements. But , that does not mean that we necessarily expect these things will happen. Only enlightened monetary. and fiscal policies will lead to these results, and when we see the Federal Reserve Board holding money tight even as gold and commodity prices are plummeting - and see Mr. Clinton resisting tax cuts at a time when the economy so greatly needs them - it scares us to death. All those who yearn for a prosperous America ought to echo this call for monetary easing to continue until gold and commodity prices are stabilized -- which when achieved, will signal that the Federal Reserve Board once again is, providing the correct amount of money to the economy. Our falling stock market and slowing economy will not recover until the Fed provides this needed liquidity. Bret Schundler, the mayor of Jersey City, N.J., was formerly an investment professional at Salomon Bros. and C.J. Lawrence. |
