Wednesday, August 6, 2008

U.S. Dollar Excess - Cause and Effect

U.S. Dollar Excess - Cause and Effect

by Theodore W. Noon, Jr.
July 22, 2008

My thesis is that by not following the advice of Congress in the Full Employment Act of 1946, the Federal Reserve Bank (FRB) has put many distortions throughout the U.S. economy that have caused or contributed to a worsening of most of our current problems.

This Act called for a stable value maintained by the FRB for the U.S. dollar and to take action to lessen U.S. unemployment when it rose above 6%.

Instead of compliance with the Act, inflation has risen every year for the past 60 years, resulting in a marked decline in the purchasing power of the dollar which occurred in a period when there were few times that unemployment rose above 6%, the latest being in the early 1980s (and only briefly), to justify using the 6% trigger level for action. FRB Chairman Greenspan’s term of office almost coincided with the Humphrey-Hawkins Bill by Congress in 1978 which changed these two principles and explicitly stated that “unemployment rates should not be more than 3% for persons 16 or over and not more than 4% for persons 16 or over, and inflation rates should not be over 4%. By 1988 inflation should be 0%.”

President Truman signed the 1946 Act. Three later Presidents provided input. President Nixon freed the U.S. dollar completely in 1971 from any tie to gold. President Carter signed the Humphrey-Hawkins Bill, which had the goal of price stability seemingly inconsistent with striving for 3% unemployment. President Reagan appointed Paul Volker to stop the late 1970s’ and early 1980s’ inflation when short-term rates rose to 14% with the inflation.

The supply of labor in the U.S. has risen markedly since 1946. Women have taken many jobs after their considerable involvement in the World War II labor force. About 65% of mothers today are working. In the 1950s one worker could support a family. In the ensuing decades it has taken two workers to do so. When the supply of anything increases, the price of it tends to go down.

The supply of labor also increased with many immigrants coming into the U.S., including millions of illegal ones in recent years. Only recently, with the slowing U.S. economy, have fewer been coming in.

The demand for labor in the U.S. declined as imports from Japan and China, using their cheap labor, have come increasingly into our ports. Many of our corporations reached out to this labor abroad, reducing such production here, transferring U.S. know-how and U.S. jobs to China and helping the Chinese greatly with China’s move to capitalism. China’s population will be a source of cheap labor for decades ahead and a downward influence on demand for U.S. labor. When the demand for anything goes down, the price of it tends to go down.

Thus we have the supply of women’s and immigrants’ labor going up and the demand for U.S. workers affected by cheap foreign labor going down, both tending to reduce U.S. labor costs and both getting the FRB to increase the money supply. We have seen the continuous U.S. inflation over the past 60 years reducing the purchasing power of the dollar as a result of the FRB’s attempts to keep unemployment low. If the FRB had used the 6% level, where it did not strive to reduce unemployment until unemployment had reached to the 6% level, I submit that we would not have many of the problems of today. Maximizing employment is a key element contributing to our current troubles, in my opinion. Unemployment has just risen to 5.5% from 3.0 to 3.5% over the past two years, with a big increase last May.

FRB has used an inflation index from which energy and food prices have been excluded. Inflation for the FRB purposes was kept low, in part by low-cost imports that, as noted, decreased demand for U.S. labor but still induced FRB to keep money liquidity high and interest rates low so that the unemployed affected by these imports would not have to look long for a job. Congress has also provided retraining moneys for workers so affected.

No one is against full employment, but how full — when overfull brings on our present basket of severe financial and cultural problems?

Both the FRB and the unemployed in the U.S. seem to have forgotten that the U.S. has unemployment insurance, as the level of 300,000 to 400,000 new weekly unemployment insurance claims has not changed much over 30 years despite about a 50% increase in the U.S. labor force.

A breath of fresh air has just come in. It stems from an extended jobs benefits bill (HR 5749) that passed on July 3, 2008. This bill made an additional 13 weeks of benefits available for states with at least a 6% unemployment rate. Someone remembered the 1946 Full Employment Act for this 6% trigger figure. It appears that unemployment has not risen much over 6% in the past 30 years and, then, only for a brief time in the early 1980s. Thus, much of the massive liquidity added to the U.S. in the attempt to push unemployment well below 6% unnecessarily caused many problems.

Inflation is up about 20 times over the 60 years. A nickel (5 cents) in 1939 had the purchasing power of a dollar today. We see a lot of millionaires now because about $50,000 in 1939 had the purchasing power of a million dollars today, and even some billionaires too. A gallon of gasoline in 1936 cost 16 cents. It should cost about $3.20 a gallon today just because of inflation. Gasoline price during the 60 years has rarely kept up with inflation until very recently.

When the supply of money goes up, interest rates tend to go down. They are low again now. These low rates when combined with lower costs of labor have been a big influence as to why corporations are making so much money and their managements getting such good salaries. Enhanced Corporate power, vis-a-vis Labor has enabled corporations to back out of retirement plans, reduce or eliminate health benefits, and not keep workers’ pay up with inflation increases. Labor unions, outside of those of government workers, are weak and in general disarray with about two-thirds fewer members than in the 1950s. In addition, less costly labor and at the same time low interest rates have meant less income for many in the middle class, and particularly older people.

U.S. corporations have increased their profits from low interest rates and by using cheap labor overseas by way of our free trade agreements as they import their products here.

A major effect of increased corporate power has given us the picture of both parents working in many households. This picture accompanies the increase in divorce rates to the present 50% of marriages. Single parents have real financial problems. The 40 to 50 million level of abortions over the past several decades has been influenced by the two-worker home and by the inflation costs of raising children, including the vastly increased costs of colleges, as well as the working mothers’ needs of their time by their children.

The easy availability of money and low interest rates gave us the home building boom to the extent of two housing bubbles within 16 years, both of which burst, leaving investment banks in real trouble and the banking system somewhat frozen, as well as many buyers holding mortgage paper losing money. Speculators got into building houses, too, where it seemed to them prices could do nothing but go up. Speculation has been rampant in many commodities, particularly in oil, as has gambling in Las Vegas and at Indian casinos.

The quality of a lot of mortgages was much lower than it ever should have been and made that way by pressuring people who could not afford buying a home into doing so with a zero down payment and low initial interest rates for long term mortgages.

Freddie Mac and Fannie Mae are in great trouble because of the decline of many home mortgages where the quality was set too high by the rating agencies as well as the idea of packaging mortgages without many of the originators of the mortgages holding them to service them. Moreover, it is hard to know where the low quality mortgages are in the $5 trillion of mortgages these two companies hold.

The Federal government should make no more guarantees. It should back out of its present ones where it can. These often compound trouble in a down economic period, As examples, we had the Savings-and-Loan problem and two housing bubbles. In 16 years that burst. Entities “too big to fail” should be allowed to fail, despite strong lobbies, except for the United States itself.

The steeply rising home prices made their owners feel richer. Many borrowed against the equity and spent more than they otherwise would have. Home building is a form of consumption, not true investment in broad economic thought. Now we have large investment dollar requirements for our energy needs, for a new electric grid system, and for new transportation to areas where about half our population lives who are solely dependent on autos and trucks. The economic context today is not favorable for these.

The need to fund these large investments comes at a time when the Federal government has about $10 trillion of debt, a negative trade balance as well as a budget out of balance, a weak banking system, the U.S. dollar falling, and an oil import bill of close to $1 trillion (versus $4 billion In 1972). Households are carrying large mortgage and credit card debts.

We have low interest rates for potential savers and high interest rates for credit cards. 10% interest rates were illegal in many states as being usury quite some years ago. Inflation has become embedded in common stock prices over many years. Total mutual fund holdings are now up to several trillion dollars (where this figure was about $40 to $50 billion in 1979).

The First Rule of Holes is when you get into one, stop digging. We are in one now in our country. It is deep and became so in much of former Chairman Greenspan’s term with the encouragement of Congress. It is going to be hard to get out of, yet we are still digging deeper.

The FRB is now trying to avoid the consequences of a policy of too many years of encouraging too much economic growth by trying to keep unemployment well below 6%. We have used up some of the tools that have helped us get out of holes in the past. One main tool has been to lower interest rates. We cannot go much lower, if any, because we are on the edge of rising inflation and have a weak, declining dollar. In the 1950s and 1960s FRB chairmen took away the punch bowl when the party got too lively. Congress should change its advice in 1978 to the FRB and revert to a 6% unemployment level as a trigger to aid unemployment only above that level.

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