Narrator: Welcome once again as MIT professor, Paul Samuelson discusses the current economic scene. This series is produced by Instructional Dynamics Incorporated. This program was recorded July 30th. 

- [Professor Samuelson] Before I analyze where we now stand in the American economy and where we're likely to be going til the end of the year, I'd like to try to field two questions that have been sent in to me. The first is from a retired investment banker. The second is from a business school professor. Here's the first question. What are the arguments against the United States government actively intervening to support the dollar? Actually in recent times, I've veered over towards counseling the treasury and the council reserve to agree in principle to such support operations, and I've subsequently learned from reading the newspapers that we have in fact, changed over to that position. The Fed seems in fact already to have engaged in some support operations. The details are not clear on the actual magnitudes of such operations, nor is it clear, or at least it's not clear to me, whether this is in some kind of formerly agreed upon concert, along with support operations by various European countries, or whether we're going alone. What does seem clear is that we are not now facing absolutely clean floating. And hence, I suppose, in a sense we can't be sure in what directions the winds of unfederated competition are really tending to push for an exchange rate. For example, it might be the case that the underlying speculative forces are still against the dollar. But that these forces are being covered up by some amount of defensive support. Such a fundamental speculative trend, if indeed it does exist, must of course be distinguished sharply from the underlying basic trend in the balance of payments. The basic balance of the United States may well be improving, as so many experts profess to be the case. And yet at the same time, the speculative forces could still be pushing in the other direction. Well, why my own shift in position? It certainly wasn't to accommodate the French, or to gain favors with other nations abroad that have been urging us to support our dollar. This doesn't mean that I agree that giving such accommodation in order to gain popularity with ones allies is never to be recommended. Often we still have good reason to wish to keep the good will of Japan and western Europe. I myself have never believed in the doctrine that you can kick your allies around, that you can treat them with benign neglect, that you can just forget completely about their wishes, and let them unilaterally appreciate their currencies if they don't want to accumulate dollars. But nonetheless, for a dozen years, I had to warn against defending the indefensible. When your good friend wants you to support your overvalued currency, you must tell him politely that this makes no sense. No sense for you, the deficit country, or for him, the surplus country. The reason then for my changing over to the view that the US government might now judiciously intervene to support a dollar that is being depressed only because of Watergate jitters, and because of self fulfilling but wrong minded speculative hopes and fears, is this- there's now accumulating evidence that the dollar is no longer overvalued at a long term basis. Therefore, the smart long run position, both for the speculator and the so called investor, is against betting on further depreciation of the dollar. I see no reason why our government, if it has carefully analyzed the odds, should not invest on the right side, on the long run profitable side. In doing this successfully, it will inflict losses on the speculators and on the nervous hedgers. But I must say, that couldn't happen to a nicer bunch of guys. I do not believe that the government has no business in principle, in investing or speculating. On the contrary, I think it has a duty to counter speculate when reason and information convince rational and well informed authorities that the market is temporarily speculating against fundamental economic forces. Now of course I do recognize that there's always a danger that governments will not act in a well informed and reasonable way for clearly legitimate goals. Thus, because of political pressures, a government may support the price of wheat when fundamental economic forces say that its market price should be tending downward. Maybe doing that just to curry favor with farmers. It may be doing that in austriacus, irrational fashion. But 1973 support of the dollar does not in my view fall into such a category. And actually, those among us who favor flexible exchange rates, ought to realize that the apparent instability of the dollar in the face of what seems to be an improving basic balance, is itself definitely undermining their good cause of greater flexibility in the exchange rates. Judicious support that is likely to make the government win money in the long run, and is likely to speed up the approach to the true emerging nonequilibrium, is therefore a desirable thing. Now, those are the reasons upon which I would rest my case for such support. But let me try to be responsive to the question asked. What are the arguments against this position of mine? Well, first there is the argument that we should give clean floating a chance, so that the market can prove to doubters that it will rapidly adjust its speculative flurries to long run equilibrium trends. And in a measure, I suppose that's what we've been doing in delaying our support so long. But there's not very much interesting that I know of to say about that first argument. More weighty is the following second argument against support of the dollar by the US government. We have the recognize that there may be up to 80 billion dollars of unwanted reserves abroad in the hands of the central banks. Suppose that every time the dollar improves, those unwanted dollars try to come back here in exchange for francs, marks, and other currencies. Indeed, even in the absence of such improvement of the dollar, suppose such unwanted dollars keep trying to get converted back into foreign currencies. Then the dollar will always tend to sag. Indeed, if we include a big item of such returning dollars in the basic predictable balance of the next five years, then perhaps our basic balance, even though it's improving, is still in deficit. In other words, taking into account such a predictable return flow of several billions of dollars per year, the dollar may still be overvalued on a half decade basis. In that case, it would indeed be a mistake for us to be supporting an overvalued dollar. Of course, in that case it's even sillier for France and other countries to be objecting to the sagging of the dollar. The dollar rate should, under this assumption, sag. The other countries can't have their cake and eat it too. They can't want to redeem dollars, and also refuse the United States a whopping surplus in its merchandising current accounts to give it the where with all to redeem those dollars. So in effect, under those circumstances, when other countries encourage us to support the dollar under the assumption that the 80 billion of past overhang is not removed from the picture, they are in effect asking us to do surreptitiously what we have rightly refused to do on an outright basis. Namely, they are asking us to use our support operations as a leaver to fund our dollar debts abroad, in effect granting them some kind of an exchange rate guarantee on those dollar obligations. And in effect committing out government through the mechanism of swap loan agreements to stand behind those dollars in terms of some foreign currencies. Now, that kind of support I'm not in favor of, and if it appears that in the future, as we do support the dollar, that the response is a return of these past dollars of overhang, then I shall counsel cessation of such support. Well, after answering the second question, if time permits, I'd like to return to the question of whether this is not a good time for foreigners actually to be buying up our capital, to be buying up our stocks, to be buying up our plants, and also to be buying up our going concerns. Let me turn now to the second question. It reads as follows- I heard a rumor that you had taken monetarism apart at a forecasting conference somewhere this summer. How did that analysis go? On July 13th I took part in a seminar here in Cambridge that dealt with forecasting. And my morning's assignment was to conduct a dialog on monetaristic methods. I believe the members of the seminar had heard the case for monetarism on an earlier day. I don't think it's quite correct to say that I took monetarism apart. Actually, I had then the say that the monetarism stock, it's quotation in the market as a technique of policy analysis, has been depressed so low at the present time, that there's danger the people will overlook the element of value in the stress that among the many factors that forecasters and policy advisors must taken account of, ought to be given to the behavior of the money supply and of the credit markets. What I did first was to review the record. For a few years, the federal reserve bank of St. Louis had pretty good success in its quarter to quarter forecasting. And then its year to year forecasting. And indeed, at that time, it seemed to do better than most of the other monetarists. Better than the city bank, for example. Better than the three leading academic monetaristic forecasters, whose forecasts I've informally monitored over the years. But as I think I must have mentioned before in these tapes, in recent years, St. Louis has been running into worse luck in its forecast of nominal GNP. I'm not now referring to its abandoning of its forecast of real GNP, of the breakdown of nominal GNP into real end price factor. Their phases one, two, three, three and a half, four, perhaps have contaminated their record. But I'm not referring to that which monetarism is supposed to be able to deliver the goods on, nominal GNP forecast. Indeed, when Professor Fare of Princeton did a recent roundup, which I mentioned, of ten or so different forecasters, the only method that did worse in recent years than a straight mechanical computer forecast with no adjustment of the coefficients for judgment, was the St. Louis reduced form model. Not only did Fare's own mechanical computer do better than the reduced form of monetarism, but so did Epstein at resources they'd incorporated. The unkindest blow of all is that even the median business forecaster reporting to the national bureau did better in at least square sense, and the Wharton school and the Chase Evans model and the University of Michigan and a number of other models which Fare didn't keep track of, but which I informally monitor in my own records, did better. I also cited, and here I had to be very impressionistic, from my informal collection of forecasters, any monetarists other monetarist forecasts, which I've been able to collect over the recent years. And indeed I had to report that I couldn't find in my records a single monetarist who deviated systematically from the consensus for clearly monetarist factors, came out with a long run batting average as measured by squared error, which was very good in recent years. But I warned against making the fundamental error of some of the monetarists themselves, namely trying to judge the worth of a method by its crypto positivistic correlation coefficients. Although, those who claim to triumph by the sword must in a sense be prepared to die by the sword. I don't think we can take such rash warriors at their own word, at their own crude methodology. Then I described some of the methods used by monetarists to dig themselves out of the hole of their own making. As for example, to put in an odd hope trend into velocity, so as to enable you to lift the St. Louis kind of estimate to the neighborhood of the consensus crowd. Or, you can call yourself a monetarist by putting enough fudge factors so as to give you the typical ecclesiastic forecast. In short, I suggested that recent skepticism of coincidental empirical irregularities that lack prior probability ought to be entertained. Thus, anyone who knows neoclassical economics, why should he think that one M1 measure, or M2, or M7, or M39 measure, ought to be in the future, a simple causal, reversible relationship with nominal GNP So that it can do better for policy purposes, for forecasting purposes, then a more complicated model that takes into account investment intentions, technical changes, crop phases, and a host of other dull things? So, I guess some of my message is that monetarism is now somewhat subject to overvaluation, but if you believe in contrary opinion, if you believe in sticking to value as against price, maybe a canny investor might in this time pick up a little of the monetarism stock for his portfolio. Let me turn to the current situation of business before I go back to the subject of whether this is or isn't a good time for foreigners to be buying up American capital. We still are in a period of some confusion. The second quarter, first estimates of GNP have now come in. They're even lower than the forecast I gave you which was to take the eight percent first quarter rate of growth and bring it down to three and a half percent. The first estimate actually is, there's only two point six percent a real growth in the second quarter. But I want to warn you against attaching too much importance to that weak number because there's quite a debate going on among the experts as to whether it's really credible. We may be running into a problem here involved in seasonal correction. It's proper I think to seasonally adjust economic data so we can get out of them the mirror vicissitudes of the changing weather. We expect retail sales to be up at Christmas, and if retail sales are up that doesn't mean we're in a boom, it just means that the snow is beginning to fall and Santa Claus will soon be here, so we properly deflate as best we can for seasonal trends. But I want to emphasize that as best we can. We're not dealing here with something here like Plutonian tide tables. You can predict the position of a comet several centuries ahead. You can predict tides with great accuracy. You can predict the way a pendulum will osculate to a microsecond of precision, but you cannot by fore analysis or spectral analysis or by any method known to mankind get accurately the seasonal element out. Now, what I've been saying of course should be remembered at all times, but it's especially appropriate now because here's how the argument goes. Your argument goes that the weakening in the second quarter, part of which is certainly genuine, may be due to reasons of supply and not to a weakening of demand. I've already commented on that view, in my last tape I mentioned the view of Al Summers of the conference board, and I think of Greenspan and some others, as against the view of data resources that there was a substantial weakening in demand, these authorities have argued that the economy is still running flat out, but we are pressing up against capacity limitations. Good man power is no longer available. The federal reserve index of surplus capacity isn't to be trusted, according to this group of observers, and you better look at the Wharton measures of capacity, which show very little surplus. Now if the economy is running flat out, that means that the normal ups and downs of production, which can be associated with the first quarter and the second quarter, with the third quarter, and with the fourth quarter, can't work themselves out, because you're right up against the ceiling. And so, the second quarter generally shows a whopping increase for purely seasonal reasons. And generally, we sensibly correct for that, and take out the seasonal influence. But if, at the end of the first quarter, we already were up against the ceiling, how can that normal seasonal factor show itself? And so, it's argued by these experts, it couldn't. If you use unseasonably corrected data, we had one of the biggest output increases in the second quarter on record. And it's only this artificial tinkering with the data, normally appropriate but not appropriate in this 1973 phase of the business cycle that made this look like slow growth, so goes the argument. Now if that's the case, we should see in the third quarter the opposite happening. Because what's the normal pattern in the third quarter? Normal pattern in the third quarter is you're in summer, people are taking vacations, there's an easing up, there isn't any occasion for overtime. But according to this hypothesis, the economy is still very strong, is still running flat out, it's still bumping right up there against the ceiling. Then, according to this hypothesis, we should not see that normal relaxation, and therefore, they're saying, don't be surprised if real output bounces back from allegedly only being two point six percent rate of real growth in the second quarter to something like say five and a half or six percent in the third quarter. In any case, without my trying to adjudicate the matter, I would say that it's best to not go by any one quarter, smooth out your data by using two or three quarters, an then see where we stand. And from that viewpoint, I must say, the situation is still a bit clouded. For example, it looks as if retail sales were very good in the first part of July. Extremely strong. Any beginning weakness or letup earlier. Now, this may be due to the fact, one of those factors which an ecclecticist would take into account in making his forecast and interpreting the passing scene. It may be due to the fact that the freeze of of phase three and a half presented itself to consumers as a very good time to buy because they could figure that after the freeze was suspended, after we moved into phase four, you wouldn't be able to buy at such favorable prices, and that could explain some of the strength in demand, and it may be borrowing against the future. On the other hand, we have to take the straws as they are, and the straws were that in July, automobile sales were very good and retail sales generally seemed to have been quite strong, so it maybe be that we have not yet really turned the corner towards that growth recession, which all the camps, generally speaking, tend to agree is waiting for us around the end of the year. The main differences of opinion have to do with whether that growth recession is going to move into a genuine recession, measured let's say by the Krudos national bureau criterion of two fold quarters of negative growth in the real GNP. I don't want to spend more time in detailed analysis of the second quarter data and what they may be telling us, but I should point out to you what the towns in Greenspan has pointed out, namely that there was a whopping price increase as measured by the GNP deflator, that tends to reduce the real component, and the question is whether all of that is genuine. Now, part of it is undoubtedly due to a weight shift towards goods which there isn't a lot in prices. I'm not sure that is asperious effect, but in case you think it is asperious effect and want to rule it out, you can make a computation using a chain index with the same weights of the GNP prices. And if you do that, that will raise the two point six percent to eight percent. Now, I've heard even stronger reasons for withholding judgment that the first quarter data may a year from this July, well a year from, July in '74, be revised downward, and the second quarter revised upward. I guess then all that we really can conclude is that there does seem to be a beginning of a weakening of real growth, but it's premature to know whether it is primarily due to supply reasons or demand reasons, and until you can resolve that last question, you of course aren't in a position to make policy recommendations. When I am asked, for example, whether it is still time to have a tax increase, you know there's quite an authoritative rumor that the President's advisors both inside the administration and in some of the other non executive agencies, I won't be more specific, did advise him to ask for a tax increase but because of Watergate and other problems which he has, he overruled them, and put in the phase three and a half, and the phase four. Well, I think I have just a few minutes to begin to comment on the question as to whether the United States is a happy hunting ground now for foreign capital. I spoke of the 80 billion dollars that are abroad. Well of course those are in the central banks, but there's a counter part of those in the hands of individuals abroad, and it seems to me that it might well be rational for a typical corporation or a typical investment trust or a typical person of means in Japan, in Germany, in Holland, in western Europe, generally, to want to have a bigger stake in the American economy than he now has. First, the American economy is about 25 percent of the world GNP, a bit more than that still perhaps. And if you believe in risk aversion and diversification, then I don't think that most investors abroad are as fully invested in the American economy as they ought to be. I could have made this remark at any time in recorded history, certainly any time in the last 15 years, and it's always in season. That's point number one. Particularly you see a foreign investor who has all his eggs, let's say, in the French market, should want to get something which will have independent movements, because in independent probability movements you get diversification and a reduction of variants. Well that's a long run factor. Second, our price earning ratios are cheap. And if you believe that there has not been a long term erosion of profitability in American corporations, then they are indeed bargains. If you're a foreign investor and you have equity investment, you can apply even a less stringent task, namely, if there's an erosion of profitability here in America, then there probably is one also abroad because capital competes with capital by international trade across boundaries of nations. And so, it could be that the American earnings, price ratios, are more depressed from a long run viewpoint than foreign markets, particularly those foreign markets which have done better in the last boom, than the American market. Thirdly, you may find yourself with a reversal of the adverse experience which foreigners have been having in recent months. Let's take a typical foreigner who had a good eye for picking American stocks, he's a rare bird by the way. I don't want to go into details on how a foreigner ought to invest, I don't have time in this tape. But suppose he had a good eye and he picked good stocks which held up better than the American market in which in fact held up and are equal now to their early January levels. To this foreigner, given the depreciation of the dollar, if he reckons, as undoubtedly he does, his net worth in terms of his own currency, because that's where he's gonna spend the rest of his life, that's where his expenses come, then he finds himself with the rather considerable loss due just to the depreciation of the dollar. But my time is just about up, but you see, once you form a judgment and you must form that judgment as to whether the dollar has hit rock bottom, then after you've formed the judgment that Wall Street has hit rock bottom, and that rock bottom has not recognized the inflation which has been going on in the American economy for the last few years, and has discounted all the adverse news that could possibly happen, then that would be a great time for foreigners to invest in good American stocks if they know how to pick good American stocks. 

Narrator: If you have any comments or questions for Professor Samuelson, address them to Instructional Dynamics Incorporated 166 East Superior Street, Chicago, Illinois, 60611.