The Invisible Handcuffs of Capitalism: How Market Tyranny Stifles the Economy by Stunting Workers (5 page)

A board of seven governors, appointed by the president and approved by the Senate, theoretically runs the system, but the Fed is actually quite Byzantine. “Constitutionally, the Federal Reserve is a pretty queer duck” was the verdict of the populist Texas congressman Wright Patman. Martin Mayer, author of
The Bankers
and other excellent books on finance, went further, observing that “the Federal Reserve would be a queer duck even without any Constitution, for a more awkward and complicated mixture of private and public, executive and legislative, national and regional could not possibly be imagined.”
¹⁸

In addition to the Federal Reserve Board, each of the twelve regional banks has a president, selected by bankers. These regional
presidents, directly representing the interests of the banking sector, wield enormous power.

The chief policymaking arm of the Federal Reserve, known as the Federal Open Market Committee, consists of a rotating pool of seven of the governors and four of the regional bank presidents plus the president of the New York Federal Reserve Bank. This committee makes the key decision regarding monetary policy—whether to make credit scarce or abundant.

The decisions of the Open Market Committee have a powerful effect on the economy. When the committee makes credit tight by restricting the supply of money, interest rates increase, which then discourages businesses from borrowing to finance spending on building, plants, equipment, and the like. In addition, higher interest rates depress consumers’ purchases of cars or houses on credit, because their monthly payments depend on the rate of interest.

Shrinking consumer purchases, together with the higher cost of borrowing, further discourages business from investing. As a result, the economy slows down, replenishing the pool of unemployed workers.

In effect, then, the Fed represents a collaboration between the bankers and government, free to make policy without congressional oversight. The only requirement placed on the Federal Reserve is that the chairman has to appear twice a year before the House and Senate. Just imagine the uproar if anyone suggested that labor unions have the power to determine the course of the economy with virtually no oversight.

In addition, all other things equal, high interest rates tend to redistribute wealth from the poor to the rich, because the rich as a whole are net lenders, while the poor are net borrowers. Even during the 1990s, a time when interest rates were low, over one-seventh of wage earners’ salaries went to pay interest on their loans.
¹⁹

Business does not want the economy to slow down too much, since economic growth is ultimately necessary for a sustained expansion of profits. Therefore, when the Open Market Committee deems it appropriate, it once again expands the money supply in an attempt to increase the pace of economic growth, at least until the economy begins to run short of unemployment.

Ideally, the Federal Reserve would like to maintain a Goldilocks economy, in which economic growth is just right—strong enough to increase profits, but slow enough to keep workers in check. When business is pleased with economic performance, the press portrays the chairman of the Federal Reserve Board as a hero. For example, the journalist Bob Woodward titled his book on Alan Greenspan,
Maestro
, as if the economy were his symphony orchestra.
²⁰
After the economy fell apart on his watch, Greenspan’s reputation withered.

The Hidden Procrusteanism of the Fed

One thing is fairly certain: when business fears that the economy is beginning to grow fast enough that workers might feel confident in demanding better wages or working conditions, the Federal Reserve is sure to step in and tighten the money supply.

Restrictive monetary policy does not operate in the open. One of the beauties of the monetary weapon is that few people make the connection between what the Open Market Committee decides and their own situation. Nobody seems to be responsible for the resulting hard economic times. How could the economy seem Procrustean when Procrustes is nowhere to be found? When the economy slows down, the boss can tell the workers, “Sorry, guys, but there’s nothing I can do. I would love to be able to comply with your demands, but business is not good.”

Workers are likely to resent people who directly discipline them, such as a supervisor or even the boss of the whole operation. Few workers, however, will ever think to vent their anger at the faceless president of a branch of the Federal Reserve Bank or one of the equally unknown members of the Board of Governors. No wonder that conservatives often regard the Federal Reserve’s fight against inflation as one of the nation’s highest economic priorities.

Insofar as discipline is concerned, the system works like a charm—at least for business interests. This game becomes even more effective because the Federal Reserve projects an image of standing above the
political fray. The Fed speaks in terms of its mandated responsibility to maintain long-run growth, minimize inflation, and promote price stability—all of which sounds reasonable—while ignoring that part of its mandate to create full employment.

The Federal Reserve uses price stability as a code word for holding wages in check. Paul Volcker, former chairman of the Federal Reserve Board, was clear about this relationship: “In an economy like ours, with wages and salaries accounting for two-thirds of all costs, sustaining progress [in reducing inflation] will need to be reflected in the moderation of growth of nominal wages.”
²¹

The targets of restrictive monetary policy do not include rising prices for assets, such as houses or stocks. Instead, rising asset prices are interpreted as signs of economic health, even though these prices may be the result of speculative excesses that will ultimately destabilize the economy. Nor are the multimillion-dollar salaries of executives a concern.

When Richard Nixon was running for president in 1968, he insisted that inflation was the country’s number one problem. After his election, he enlisted his Council of Economic Advisors to identify those adversely impacted by inflation. According to the council’s chairman, Herbert Stein, “If anyone was being severely hurt, the available statistics were too crude to reveal it.”
²²

Of course, Dr. Stein understood as well as anybody what David Ricardo, the most important economist of the early nineteenth century, wrote about the harm of inflation:

The depreciation of the circulating medium (meaning inflation) has been more injurious to monied men … It may be laid down as a principle of universal application, that every man injured or benefited by the variation of the value of the circulating medium in proportion as his property consists of money.
²³

As later research has shown, a modest level of inflation is beneficial for the economy because it allows business more flexibility in dealing with workers. Employees are resentful when business demands wage
cuts. Inflation allows business a back door for reducing wages—at least what wages can buy. In this way, management can alter the wage structure, rewarding some workers, with higher wages while letting the real wages of less-favored workers erode.
²⁴
In addition, a number of studies indicate that inflation does no damage to the middle or lower classes as a whole. Although inflation does harm those on fixed incomes, inflation (within limits) is associated with higher economic growth, bringing more prosperity, especially to unskilled workers. Inflation, however, does have a detrimental effect on the rich, because it erodes the value of their financial assets.
²⁵

Creating Unemployment

Economist Edwin Dickens has written a series of significant articles analyzing the minutes of the meetings of the Open Market Committee of the Federal Reserve Board, dating back to the 1950s. Dickens’s research shows convincingly that the Federal Reserve’s partisan behavior is designed to tilt the economy in the direction of the wealthy by making workers more compliant. Dickens reported numerous occasions when participants voted to tighten the money supply just before major union contracts were about to expire. The minutes indicate that the specific intent was to force employers to be less generous with their wage offers during contract negotiations.
²⁶

A recent study formalized Dickens’s work by attempting to distinguish whether the policy actions of the Federal Reserve were a response to inflation or to low unemployment. The study concluded that “a baseless fear of full employment” rather than the prevention of inflation was the guiding principle of the Federal Reserve.
²⁷
The conclusion of this study should come as little surprise to people familiar with the Federal Reserve’s obsession with the danger of high wages.

Defenders of such policies justify the temporary restriction of job creation, contending that the Federal Reserve is merely trying to curb excessive growth. According to this school of thought, the Federal Reserve is simply preventing the kind of excesses that lead to severe
recessions or depressions. Slowing down growth today may be necessary to provide for a higher, sustainable growth rate in the future. Most economists argue that the cumulative effect of even a fairly small increase in growth rate can be substantial, more than enough to compensate for a temporary slowdown.

The periodic slowdowns that the Federal Reserve engineered to undermine wage growth are unlikely to stimulate economic growth. According to a study by the Bank for International Settlements, slowdowns actually seem to diminish rather than promote long-term growth.
²⁸
Over and above the dramatic effects of intentionally engineered slowdowns, the more steady effort to keep wages in check also probably reduces the rate of growth. As economists continually warn, the cumulative effect of a reduced rate of economic growth can be substantial. This loss must count as another cost of Procrusteanism.

In the 1920s, John Maynard Keynes described the effect of this sort of monetary policy on workers:

The object of credit restriction … is to withdraw from employers the financial means to employ labour at the existing level of wages and prices. The policy can only attain its end by intensifying unemployment without limit, until the workers are ready to accept the necessary reduction of money wages under the pressure of hard facts.
²⁹

Keynes’s description of this policy seemed to frame it as a form of Procrustean class warfare:

Those who are attacked first are faced with a depression of their standard of life, because the cost of living will not fall until all the others have been successfully attacked too; and, therefore, they are justified in defending themselves…. They are bound to resist so long as they can; and it must be war, until those who are economically weakest are beaten to the ground.
³⁰

Keynes concluded: “It is a policy, nevertheless, from which any humane or judicious person must shrink.”
³¹

Sado-Monetarism

The Federal Reserve’s fight against wages can be intense. In 1979, shortly after taking the reins at the Federal Reserve, Paul Volcker announced new operating procedures and a determination to hold inflation in check.

At first, many powerful people doubted whether Volcker would be willing to follow through with his plans, which were sure to create enormous casualties. A front-page story in the
Wall Street Journal
, “Monetary Medicine: Fed’s ‘Cure’ Is Likely to Hurt in Short Run by Depressing Economy, Analysts Say,” expressed this sentiment. The paper noted:

Among those who are skeptical that the Fed will really stick to an aggregate target is Alan Greenspan … who questions whether, if unemployment begins to climb significantly, monetary authorities will have the fortitude to “stick to the new policy.”
³²

Around this time, possibly in response to the article, Volcker invited the editor of the paper’s editorial page, his deputy, and the features editor to a lunch at the New York branch bank of the Federal Reserve. Volcker asked his guests, “When there’s blood all over the floor, will you guys still support me?” The deputy editor responded affirmatively, later proudly recollecting, “There was blood indeed, as overextended Latin borrowers and American farmers were caught out by a return to a sound dollar. But we held fast.”
³³

Volcker’s militaristic analogy (expressed privately to the staff of the
Wall Street Journal
) let the cat out of the bag. The effort to tame inflation was, in reality, mostly a class war, what might be called “sado-monetarism.” Indeed, Volcker himself had intended to spill blood. Volcker expressed his intentions in another way:

[Volcker] carried in his pocket a little card on which he kept track of the latest wage settlements by major labor unions. From time to time, he called various people around the country and took soundings on the status
of current contract negotiations. What is the UAW asking for? What does organized labor think? Volcker wanted wages to fall, the faster the better. In crude terms, the Fed was determined to break labor.
³⁴

Volcker tightened the money supply so extremely that the United States experienced what was then the worst economic downturn since the Great Depression. Volcker only let up when the collateral damage became too great. Mexico, which owed a great deal of money to U.S. banks, seemed to be on the brink of bankruptcy, threatening the U.S. banking system. Citibank was effectively bankrupt.

Later, Michael Mussa, director of the Department of Research at the International Monetary Fund, looked back fondly at Volcker’s accomplishment. Mussa continued the military analogy, praising Volcker’s victory in vanquishing “the demon of inflation”: