-: Welcome to this week's commentary
on the current economic scene.
This for the week of February 25th.
With us again this week is Professor Paul Samuelson
from the Massachusetts Institute of Technology.
Professor Samuelson, first of all,
how do you stand on the great guessing game
that is going on at the moment?
Will the prime rate move,
and which way will it go when it does move?
-: My guess, for what it's worth,
is that the next move of the prime rate
will be definitely upward.
This rate, which is what banks charge
to their best customers, is now 7%.
The discount rate of the Federal Reserve
is five and a half percent.
The actual going rate for euro dollars,
which the banks have been relying upon
to a great extent, is over 8%.
As the president of the First National Bank of Boston,
Mr. Damon said recently, something has to give.
I think maybe a couple of things will have to give,
and one of them, I suspect, will be the prime rate.
I shouldn't be surprised, I ought to add,
that we'd get another twist of the screw
with respect to the discount rate
because, make no mistake about it, we are now in a period
of tight money by any definition.
I had predicted on these tapes
that we would have more of this,
and I have to simply reiterate that.
I expect interest rates to harden even father
before they go down again.
Now, why do I think the prime rate will go up?
I think it will go up because the demand for credit
on the part of customers, I think, is still very strong.
On the other hand, the supply of credit,
which the banks have to do a lot to those customers,
is being severely squeezed.
There was a conference board meeting last week
that some of you may have attended
or read about in the newspapers,
and there was considerable testimony at that meeting
that an uncomfortable process
of credit rationing is now going on.
Walter Hoadley, of the Bank of America on the west coast,
the largest bank in the country and in the world,
said that they have put in a new order of rationing.
There are many loan purposes,
which previously had been honored,
which today will not be honored
if you go to your branch manager,
or even to central headquarters of the Bank of America.
Such activities as takeover activities,
which always are regarded
as having something of the unsavory
in them as against the,
and I quote now from the 1913 Federal Reserve Act,
the legitimate credit needs
of business, agriculture, and manufacturing.
Commerce, agriculture, and manufacturing.
They're clamping down.
Well, if they're clamping down on those purposes,
you can be sure that the definition
of what is credit-worthy is rapidly changing.
I think the prime rate is already, in a hidden way, gone up.
The marginal firms, who sometimes qualify
for the prime rate, are, this very day,
not qualifying for the prime rate.
And most of the firms who do qualify for the prime rate
are finding that it's good diplomacy
to keep a larger compensating balance idle,
earning no interest, with the banker who's extending
that prime rate to you.
But explicitly I would expect it to go up.
One more straw in the wind,
at the same conference board meeting,
a first vice president of the prestigious
New York Federal Reserve Bank
spoke out candidly to the assembled bankers there
and told them to ration their credit more tightly.
He said, "Mere credit-worthiness isn't any longer enough."
And he implied that the social purpose required
that they squeeze down pretty hard.
Well, their self-interest in a time of limited funds
demands that they squeeze down pretty hard.
And they will, and their self-interest, to my mind,
suggests that over a longer period of time,
instead of rationing the credit
by a non-market mechanism,
which means that you make a free gift to the lucky fellow
who happens to qualify for the rationed item
and you deprive an almost equally worthy person
of any advantage by refusing him a loan completely,
or cutting his loan down drastically,
a more profitable and a more even-handed way of doing it
would be to raise the rate for everybody
to that rate which clears the market.
And I think that that process is going on,
I think it will go on more in the future.
I would like to comment on one other matter,
one of our subscribers, in a telephone call to me,
said that he had read the famous article
by Ed Dale in the New York Times of a few weeks ago,
in which he spoke about the big joke
that's going around everywhere in knowing circles,
the object of laughter being the Federal Reserve.
All of us sophisticated people are saying, "ha ha ha"
at the stupid, comical Federal Reserve.
And he asked me, "What about that?
"What is the joke?"
Because although he's a fairly prominent New York banker,
he wasn't in on it.
I hate to confess my provincial ignorance,
but I said to him, "Well, I'm not in on it either,
"but I'll find out."
and so when I went to some New York meetings
where the real elite of the financial world were,
I said to them, "What's the big joke
"that we're all laughing about?"
And each one confessed that he didn't know either.
It was the case of the Emperor's Clothes,
nobody wanted to admit that he wasn't in on this,
but nobody really knew what it was all about.
It's the way some of us feel
when we're at a very sophisticated dinner party
and such terribly, terribly amusing stories are told
in French, and our graduate student knowledge of French,
which is pretty rusty, doesn't do us good service,
and so we nervously laugh along with the crowd.
I thought, well then I'll go down to Washington
and I'll find out from sophisticated people there
what the big joke is.
And it turned out that they didn't know.
Then I went to the Federal Reserve,
and they felt a little bit, I think,
like a professor when the class suddenly snickers
and you look down and see
whether all your buttons are buttoned.
But they weren't sure just what the joke was.
Well Dale didn't tip his hand,
which is a very good idea, I think, in this case.
He indicated that part of the joke was
that although the Fed was squeezing,
the banks were responding to that squeeze
by using euro dollars.
Well, I don't know what's so novel about that.
I don't know what's so comical about that.
It's exactly what one would've expected
from economic law to happen.
It has been happening to a considerable degree,
and the joke of the joke is that just as Dale was writing,
their turning to euro dollars was not sufficient
to offset the squeeze by the Federal Reserve
because now that we have the first few weeks' figures
of the credit base and the money supply,
and the growth of credit proxy in all these matters,
we find that there has been a severe squeeze.
The other thing, which is just hinted on
in the Dale article,
would have to do with something more interesting
and even more serious.
Namely, that the Fed thinks it's squeezing
and is looking at the wrong variables,
such as interest rates, and in fact isn't squeezing
because if you look at the right variable,
such as the rate of growth of the money supply,
you would find that money wasn't tight.
Well, at the time that Dale was writing,
and for some time earlier than that, you couldn't say that.
If that had been the intention of the joke
and if it had been written back in,
oh, let us say July or even back in November,
then one might've had a little innocent merriment
at the expense of the Fed,
and I may say, it couldn't happen to a nicer bunch of guys,
on this particular point.
So I conclude that my subscribers
had better call up Ed Dale personally
and find out from him what it is
that we all are laughing at.
-: Professor Samuelson, do you think
that the recent weakness in the stock market
has anything to do with new Nixon policies?
-: I never pretend that I can explain
the movements of the stock market before the fact.
And actually, I never claim that I can explain
the movements of the stock market after the fact,
although there are many more who feel themselves eligible
to that task than to the earlier task.
However, I'll just speculate,
if I may use that word, on the matter.
I believe that the testimony by Paul McCracken,
and by members of the Council of Economic Advisors,
and by the Treasury,
indicating that the surtax would, in all likelihood,
be maintained after July 1st, was noted by the market.
I find it hard to believe
that such a sophisticated group as Wall Street
would consider this to be new news at this time
and would not have discounted and re-discounted
that particular bit of news in advance.
But I suppose every increase
in one's confidence in a bit of news
is an essential change in one's information pattern.
So that could be a part of the argument.
The second is a little bit broader
and a little bit, perhaps, more ideological.
The testimony by the Council Advisors
and by various Treasury officials
has indicated that there is a real serious concern
on the part of the Nixon Administration
about the current rate of inflation.
And there is a willingness to pay something
in the way of cost to slow down that rate of inflation.
Now, the cost has to do with overall unemployment,
has to do with unemployment among the marginal groups
who suffer the highest rate of unemployment,
and has something to do with the rate of real growth
of the American economy in the period ahead.
Well, with officials making noises like that,
I suppose that that would be a market influence.
But, again, this is not a new element.
And one would've thought
that much of it would be discounted.
Perhaps what is new about it is that
when the new team came in at the very first,
there seemed to be a soft-pedaling of that kind of talk
beyond what would really be credible
to any sophisticated observer.
And so perhaps the market was reminded of something
which it had wished, in a Freudian fashion,
to push to the back of its mind.
Third, and now we're getting back to the first topic
I discussed, which is the state
of the interest rate picture,
I think that the sophisticated forecasters
of business activity have themselves
now become convinced on the basis of a few weeks,
rather severe tightness by the Federal Reserve,
that the Federal Reserve does mean business.
And if the Federal Reserve means business
not just for another few weeks,
but that this may be a long campaign
right throughout the year
of tighter money by any one of the definitions.
And so this is causing some of them, perhaps,
to make some write-downs in their quarterly estimates
of the gross national product
in some estimates on housing, in particular,
late in the year,
and what's very important to stock market analysts,
perhaps some write-downs in the pattern
of corporate profits, which they envisage
over the next six or eight quarters.
It's that picture with respect to profits
that is quite important, presumably,
for the determination of stock values.
Now, I don't know how important that has been.
If we take housing as an example,
we've had a really startling first month figures in January,
housing starts shot up to 1.8 million housing starts,
which is perhaps their all-time record,
and certainly the highest they've been
for a long, long time.
And more than one would've expected
on the basis of the slight faltering in housing,
which was detectable towards the end of last year.
I don't think we should make too much
of any one month's figures,
and certainly don't make too much of January figure
because it's a seasonally corrected figure
and it's pretty much a phantom figure.
I can't remember whether it's 8,000 starts
blown up by seasonal correction,
but except in the South and in the West,
January is not a good building month.
And you may get a nice seasonally corrected figure,
but it doesn't actually serve as a token
of very much that is happening.
Moreover, there's a technical factor
one has to watch out for.
You would think that the technicians would be paid
to watch out for it for us,
but apparently they don't take this
into account in their report.
There were 22 working days in January.
That is not a recurring January phenomenon,
that's a day more than happens in many Januarys,
and since they make a seasonal correction
only for the January-ness of January,
and do not divide by the number of working days,
you have a fictitious element of 1 in 22,
that's up to almost 5% increase,
that could be a purely fictitious one,
and that means that 1.7 million housing starts
might be just as good a figure as 1.8 million.
Nevertheless, I take this to be a straw in the wind
that credit availability has not yet become
too terribly restrictive in the markets
which are open weather-wise for building,
and I regard this as an indication of strength
in the first part of the year for housing.
I think that strength in the first part of the year
will be taxed quite severely
by the problem of credit availability later.
Well, all the glosses I've been making up 'til now
on the possible causes for the degree of weakness
that we've seen in the stock markets
in the last couple of weeks
have had to do with the possibility of a slow down
in the rate of growth of business
due to policies of the new administration,
or policies of the new look Federal Reserve Board.
But there is a more direct effect
which ought to be mentioned
in connection with the tightening of interest rates.
Bonds are competitors for stocks.
And interest rates can be thought of
as kind of an inverted price earnings ratio.
It's a price earnings ratio for a bond,
but the earning, of course, is the coupon of the bond.
If you can get five, six percent
on a tax exempt municipal bond,
and you can get that today
on some quite good tax exempt municipal bonds,
you have to feel, as a high bracket tax payer,
that you're pretty smart these days
in picking out conglomerate equities
that are gonna give you capital gains
that will end you up after taxes better off than that.
And I don't have to talk simply about tax exempts,
you're getting a sweeter yield on mortgages
and on all kinds of alternative investments to equities.
so at the margin, as we economists say,
where you are deciding between what percentage
of your portfolio you should put in equities
and what percentage you should put in, let's say,
short-term bonds with the high interest rates
that short-term bonds are now paying,
and which, I may point out, are almost free
of any default risk, and are almost free of any decline
in principal because interest rates will harden
in accordance with my own forecast,
they're almost free of that
because they're very short-term.
Well, that does change the marginal amount of money
that is going into the stock market.
If the effect that I'm talking about,
the competitive effect of interest yields,
upon investment in inequities
doesn't affect you directly,
you may be one of these chaps who says,
"Well, it'll affect other people
"and therefore it must affect me indirectly."
There's plenty of superficial evidence
that tight money measured by high
and growing interest rates, even when the outlook
for business is very strong,
and I think 1966 would be a case.
Let's take a date like August of 1966 or July of 1966.
All of the forecasts that were going
through Wall Street were for a strong outlook
for business ahead.
So strong that those people recommended
and went along with a recommendation
that the investment tax credit be suspended,
an act which took place
only a couple months later in September.
But money was very tight at that time,
and we did have weakness in the Dow Jones averages.
I should warn you and I should remind myself
that we don't know, in 1966, that the tightness
of money was the proximate cause
of the mid-year weakness in the stock market.
Because we have no controlled experiment on that.
Still, people in Wall Street whose judgment
I've learned to respect in the past, at that time,
were giving weight to that causal factor
and the subsequent pattern of events
suggests that they may have had a point.
I'd put it forward for your consideration here.
-: Professor Samuelson, we've been hearing
a great deal of talk lately about tax reform.
Do you have any views on this subject for our listeners?
-: That's a very, very large topic,
and I don't think that in the time that is left to me today
I can more than scratch the surface.
But let me say a few things about it.
First, I want to remind myself
that a little bit of the day-to-day weakness
in the stock market might've come about
because of a little jolt that the market got
when it read the news on the tape
that in the testimony of the Secretary of Treasury,
and Undersecretaries of Treasury,
there seemed to be, for the first time under consideration,
an actual suspension of the investment tax credit.
In September of 1966, the investment tax credit
was suspended as a new weapon
in our arsenal of business cycle control.
And the Secretary of Treasury and his Undersecretaries
in response to a question,
I believe from Representative Reuss of Milwaukee,
said yes, along with the problem
of continuation of the 10% surtax,
which was under consideration and reconsideration.
There was, under consideration,
a suspension of the investment tax credit.
That could make quite a bit of difference
to the earnings of railroads
and quite a number of industrial concerns.
Now, that could go under the heading of tax reform.
Let me give you a wild guess in this matter.
I think I know the records of Charles Walker,
the Undersecretary of the Treasury,
and David Kennedy, the Secretary of the Treasury,
and I do not believe that at any time
they have had, under serious consideration at all,
a suspension of the investment tax credit.
This goes counter to republican philosophy at its core.
This is a typical John F. Kennedy
new frontier kind of gimmick.
And I can say that in all good faith
because it's my kind of gimmick.
It's the kind of thing that I very strongly recommend,
but I don't think I could persuade
good ol' Charles Walker of the wisdom of this.
So corporate controllers, and accountants,
and treasurers, sleep well tonight.
Professor Samuelson assures you with great probability
that after this reconsideration of the surcharge is made,
the new team in the United States Treasury
will decide that it's in the best interest
of long-term growth of the United States
not to change it.
Now, let me turn, very briefly,
to the problem of general tax reform.
In a later tape, I'd like to expand on this.
But if you wanted to get in mind, very clearly,
what it is that typical experts in public finance
think is wrong with our present tax system,
which loopholes the academic professors
of public finance regard as abhorrent,
I suggest that you get hold of the report
of the Commission on Taxation from our neighbor in Canada.
A royal commission was held, it took testimony,
it met over a long period of time and deliberated,
and it came out with what must be regarded
as a splendid report by academic experts
in the field of taxation.
I may add, just in case I've frightened you by this,
by saying that it has not been legislated
by our Canadian neighbors,
nor do I see any prospect that most of its features
will be so legislated because it's too good,
in this case, to be politically acceptable.
If I were to give a single example of a loophole,
which is deemed most inequitable,
and the most in need of being closed up
by academic experts on public finance,
what will leap to your mind
is twenty-seven and a half percent oil depletion.
Well, that isn't at all what I have in mind.
I think that in the words
of the Dean of the Harvard Law School,
who's now the Solicitor General of the United States,
and who may become the Chief Justice
of the Supreme Court of the United States,
Erwin Griswald, oil stinks.
But it's precisely because oil stinks so loud,
to mix the metaphor, in the field of taxes,
that politically it would be dynamite
to remove the depletion.
And you may have noticed that in all of the discussions
by the Treasury in discussing tax reform,
one of the opening depositions have been,
we will not, at this point, touch the oil depletion problem.
Well, bad says to them for that, but that is the case.
The loophole that I have in mind
is the loophole in capital gains taxation.
If I have General Motors stock and it goes up in price
and I don't sell it,
I don't have to pay any tax
because I have not realized the capital gains.
If I do sell it, and if I've held it more than six months,
I'd pay tax at a very light rate.
Relatively light rate.
Instead of my very high marginal tax rate,
I pay, in this year, at a twenty-seven and a half
percent rate at most.
But there's an even bigger loophole
aside from my waiting to realize it,
until it pleases my fancy.
Namely, I can wait until I die
and have that General Motors stock pass in my estate.
Now, that stock in my estate,
like any other item in my estate,
will be subject to estate inheritance taxation.
I know a thousand gimmicks for lessening that,
but that's another story.
However, it will escape forever capital gain taxation.
My heirs, my widow, my numerous children,
will get good old daddy's General Motors stock,
which he bought at a price of $1,
and which is now worth $100 a share,
and has a $99 of capital gains tax liability on it,
they get it free of any of that liability.
It's just washed out at my death.
There's no taxation.
Well, you'd be surprised how much
escapes taxation ever by this particular loophole.
And so, in Canada, they would like
to get rid of that feature,
and for many, many years,
the United States treasury has made recommendations
trying to get rid of that feature.
It's very important to get rid of it,
but the Congress of the United States,
which consists of elderly gentlemen in part,
who have, themselves, stocks like this
or know people like this,
have never deemed it, in the interest of the country,
to close this loophole.
And quite candidly, I don't really think it'll be
in a Nixon administration that we see this loophole closed.
-: Thank you, Professor Paul Samuelson
of the Massachusetts Institute of Technology.
IDI welcomes your comments, questions, or suggestions.
Simply write to:
IDI 166th East Superior Street Chicago, 60611.