Interviewer: Instructional Dynamics Incorporated welcomes you to another in a continuing series of commentaries on the current economic scene. With us again for the week of January 20th is Dr. Paul Samuelson, professor of economics at the Massachusetts Institute of Technology. Professor Samuelson, one of our subscribers has sent in some questions in the hope that you will answer them. "We are an investment counseling group," says the this question, "Much interested in general economic predictions. As we listen to your tapes, and those of Pro. Freedman, there is much that you are agreed on. But we are occasionally puzzled by possible differences in opinion. Our first question then is whether you agree with Pro. Freedman with floating exchange rates in some form are desirable and are likely within the next year or two, and also do you agree with what seems to be his cheerful analysis that the sliding peg would encounter no serious difficulties from speculation? 

Paul: Let me do my best with this question. There are many points of overlap between my own analysis and that of most present-day economists. And there are many points of overlap between my analysis and that of Pro. Freedman. There are some differences, I suppose that our listeners are most interested in the reasons behind our disagreements rather than just in the views expressed. With respect to the first question, I'm very happy that this is a question upon with I can express a great deal of agreement with Dr. Freedman. I do think that the flexibility of exchange rates are desirable. I think that there was a fatal and fundamental flaw in the Bretton Woods Agreements of 1944 and we have come to recognize that, namely that in a world where people will not play the rules of the Gold Standard game, will not automatically inflate and deflate a domestic economy in order to provide flexibility. It is anomalous to keep exchange rates inflexible. Now, I've expressed this agreement that we need more flexibility with Pro. Freedman, and I would go farther, I'd like to pay a personal tribute to him, as he said a couple of weeks ago on his tape, he was a lone voice crying in the wilderness, in favor of floating exchange rates just a few years ago. Well, he's no longer in the wilderness, the bulk of the academic economic fraternity has gone over to his general view. And I think that this is a tribute to the cogency of his analysis. Now, I say some measure of flexibility is desirable. This could be in the form of a crawling peg, with widened gold points around the crawling peg. I speak of gold points but I mean just import and export points even if we had no Gold Standard system. And as far as I'm concerned, I would like to see more experimentation with floating exchange rates. Although I don't insist upon having the practical men of the world become converted in a short time to that viewpoint. However, what I think is desirable, and what I think is likely are not always the same thing. I believe that the men of affairs in the central banks and finance ministries of the world are slowly being persuaded by events and the logic of academic economists toward looking more favorably upon the flexibility, but they are riding a tiger, and they don't know how to get off that tiger. And so as purely betting man I wouldn't be so sanguine that what is desirable will come about in the near future, which means in a year or two. Now I don't say that Canada might not again have a floating exchange rate or one or another small country, let's say Denmark as an example. But the question is whether any key currencies will be floating. My candidate, a year or two ago, for a floating exchange rate was the pound, itself. But the price that was exacted apparently, to support the pound against speculative capital movements by the powers that be and the group of ten, apparently precluded the pound, the British, from having that particular option. So, I guess I wouldn't at even odds, bet upon floating exchange rates within the next year or two. That doesn't mean that I disagree with Pro. Freedman, in his implied belief that we're going to have one or another major crisis in the next year or two, I would suppose that in the next two years the old Farmer's Almanac's proper odds are we're going to have about one and a half crises, one of them serious, certainly. And probably there'll be some realignment of exchange rates. I don't believe the authorities have exhausted all the remedies that are available to them. For example, the use of exchange controls has just been broached and just been begun in many of the deficit countries. And although it may lack wisdom, to push exchange controls harder, that certainly is a weapon in the arsenal of the authorities and it's the kind of weapon which in emergency times becomes very appealing because it does have some short run effectiveness. Let me, finally, go to the last part of the international question. Do I think that a sliding peg will encounter some possible problem from the standpoint of speculators? We don't have any real experience with this, and I won't pretend that I've thought through all of the intricate analytical aspects of the question. But, let me just think aloud, so to speak, off the top of my head and give some views. First, I assume that a sliding peg means that the exchange rate could adjust downward or upward about one percent per year, or two percent per year. One and a half percent. There are a dozen different devices that will determine exactly where in that range the peg would move. You may say in the beginning, "What's the importance of one percent, or one and a half percent?" Well that isn't very important. You'd have to be a real elasticity optimist to think that a small change in exchange rates of that magnitude will itself have great equilibrating efficacy. But, that's only one or two percent per year. And in a decade, one or two percent per year is the equivalent to ten or twenty percent. And I don't suppose, most econometricians after they think about the problem will be of the opinion that, in well-run countries at least, and mind you, floating exchange rates or sliding pegs are no substitutes for discipline and for making sure that you do run your country well, in any case, that in well-run countries the equilibrium change in exchange rates needed for equilibration, needed to repair that fundamental flaw in the Bretton Woods system is probably not more than 10 or 20 percent per decade. Now, if you're a country like Chile or Brazil, undergoing constant inflation greater than the rest of the world then obviously this moderate change in the peg will not do the trick but nothing will. And I don't direct my remarks to such countries. I do direct my remarks to countries like Germany, and to countries like the United States. Germany, in my opinion, has had an over-valued currency, excuse me, an under-valued currency. And the United States has had for a dozen years or so an over-valued currency. This relationship between the mark and the dollar drifted slowly into this disequilibrium and I think the sliding peg could very well have handled that particular problem as far as the magnitude of the changes concerned. How would this have worked if in 1955 we'd had a sliding peg between the common market countries and the United States? We have no experience, but I conjecture that this is the way that things would have happened. In 1955, we were probably poised between the dollar shortage, when the dollar was under-valued, and the dollar glut, when the dollar was over-valued. And so, if it had been introduced at that time that would have been a pretty good time perhaps to have made that reform. For a year or so, the exchange rate probably would have wobbled from day to day but within narrow limits, just the ordinary brownie in motion of good crops and bad crops and this rumor and that but with speculators alert to make money, by buying a currency when it goes down and is weak, because the dollar movement is a temporary operation. And this kind of scalping would tend to limit the amount of the change. However, because of our Cold War commitments abroad, because of our private business corporations learning that direct investment in the advanced countries of the common market in Japan, was extremely profitable I think that the sliding peg would have come into operation with the mark rising and the dollar falling. I'd like to leave gold out of this melodrama, because people find it more alarming if I depart from speaking about relative currency parodies and talk about gold but I suppose that if we had not had a two-tier price system at that time that probably the dollar would have declined relative to gold that is the $35 price per ounce would have gone up a little bit and in the case of the mark, the price of gold might have gone down, you might split the difference so to speak. I think this would have been a equilibrating direction, it would have been a substitute for many of our tyings of foreign aid. It would have been a substitute for the tying of our military aid, It would have been a substitute for the fiats which require the American armed services to buy things in this country even at a higher price. And I think we would have been in a better position today. But the force of the question of our subscriber is, "Would there be some problems from speculators?" Now I assume that if we had let's say one and a half percent ratchet on the sliding peg that the dollar would always have been throughout this period at the low end of that ratchet, And I think, therefore, that there would have been a slight tendency for speculators to pile on to the movement and to make the situation worse. The reason is, that that speculators could predict probably with considerable confidence, which way the peg would move. Now it is true, as I think Pro. Freedman may have said in one of his earlier tapes, that interest rates differentials within the United States could compensate for this advantage to the speculators in putting their chips on one of the currencies rather than the other. However, under the circumstances that I'm envisioning one of the main purposes of the sliding peg is to free domestic policy from the international restraints And so, in the sluggish late 1950's, it would not have been optimal domestic policy for us to have had higher interest rates than Germany. And so, I don't think that there is any warm comfort, there's only cold comfort in the notion that you could off-set the effects on speculators on the sliding peg by interest rate changes. If those are interest rate changes that we don't want for domestic purposes. Well, I don't pretend that this is a considered analysis, but let me conclude it by saying that I'm generally in agreement with Pro. Freedman, because this sliding peg with whatever little problems it might involve that I've just now discussed, involves those problems much less than a non-sliding peg which then has to give in a big way. And which gives the speculators a one-way gamble. Let's put it this way, under the Bretton Woods arrangements, when parodies get out of kilter, speculators can hope to make yields by bare-rate on a currency that are the order or magnitude of ten percent a year. Under the sliding peg, the speculator is perhaps guaranteed an easy one or two percent but one or two percent is small compared to what speculators are out for generally and this is only a minor debit item against the notion of the sliding peg. Now, I do want to put in a caveat after much reconsideration, it's possible that I would arrive at a different opinion because it just occurs to me as I am talking about it that letting a price move in the direction it ought to move but keeping it from moving as far as it ought to move might actually accentuate the psychological destabilizing effects of speculation and so a more detailed analysis might moderate what I've just now said. 

Interviewer: Our second question then, Pro. Samuelson, is what do you think may be wrong about Pro. Freedman's qualitative prediction that the first half of 1969 will be as over-exuberant as 1968 was generally? And that the last half of the year's strength will depend primarily upon how tough the Fed gets in the next six months? 

Paul: Well, this cannot be a complete love-fest here. We do develop some real differences of opinion between Pro. Freedman and myself. First, I don't think that my reading the facts would substantiate the view that the last half of 1968 has been as strong as the first half. I think the fiscal restraint has been working in some measure. Just this last week, we got the first estimates for the fourth quarter and they are higher than the estimates that the econometricians made in June, but they are statistically significantly lower than the actual facts as of last June. The GMP has increase 16.8 billion in the fourth quarter. If anything that's a bit weaker than I myself had expected. It's undoubtedly due to the fact that the poor Christmas retail sales turned out to be verified in the actual statistics. Consumptions was surprisingly weak. The savings ratio which I will remind you had been seven and a half percent of disposable income prior to the surcharge and which had mystified some of the experts by going down so much in the third quarter just six and a quarter percent, has now moved back. It has not moved back to seven and a half percent but those experts did not expect it to move back to seven and a half percent. It has moved back according to the preliminary figures to seven percent and that suggests that the fiscal restraint is having an effect even distinct from the rate of change of the money supply. So you know that mine is the more eclectic position. There is a measure of disagreement. Now similarly, I would expect going into the first and second quarter, well let me put it differently, I should be astonished if the first and second quarter of this coming year are as strong as the first and second quarter of the last year. And yet by looking at the rate of change of the money supply using any of the measures of the money supply which you cared to use, I see no qualitative rough method of estimation which would not justify a forecast qualitatively that the first half of 1969 would be at least as strong as the first half of 1968. I think at Las Vegas or down at the First National City Bank or at the the Harris's Trust Bank in Chicago you can get very good odds that will not be the case. In other words, those analysts who follow the data very closely and who generally lean towards monetarism, that is great weight upon the money supply, in fact are not betting in terms of monetarism. I saw the official forecast of the Harris Trust of which Dr. Barrell Sprinkle is Vice President, and that forecast for the year is a good deal lower than my own forecast. The private forecast of Dr. Sprinkle, who is not the economist in charge of the official forecast I understand to be a little bit higher than the official forecast but he is still, I believe, below me. Now concretely, I don't see how in making a judgment about the first and second quarter of next year, I can as a confirmed eclectic, fail to take account of the fact that the fourth quarter has shown an increase in inventory to ten billion annual rate from seven and a half billion in the third quarter. The strength of final demand, that is the strength of GMP after you purge it of temporary inventory changes declined considerably in the fourth quarter of the year. It declined, if I remember correctly, to something like 13, to 14 and a quarter billion from a previous quarter of 21 and a half billion. Now that has no certain implications for the first two quarters of the coming year, but I think it has certain probability hunches. And that is that this inventory was in part unwanted, it was accumulated because the retail sales were a little bit on the soft side in part at least. And therefore in a sense it is hanging over the market and it augers in the first half of the year, we may, we may I say, see inventory accumulation going to a lower rate. In any case, I put great store if you remember on the spread on the likely GMP increase of all the experts. And I said I was between 12 and 18 billion for the fourth quarter, this was befor the fourth quarter. And expressed my own view that it would be towards the upper end of that range. And justify my eclectic position said I would find it fantastic if it were to be 22 billion or more as a simplest reading of the money supply of figures would perhaps suggest. Well, we never have controlled experiments and we never can confirm and prove anything in economics by waiting until a quarter is over. We just have to take the bulk of a man's experience over a lifetime to form his judgment but such as it is we were well within that range of expert guesses and I think we'll be within the range of expert guesses for the current quarter. Now what are the range of expert guesses for the current quarter? I would suppose that it goes something like 8 to 16 billion. My own would be that we would probably be a little over the middle of that range. And I don't think that I could arrive at this view except by giving weight to non-money supply factors. Let me go on though, to soft pedal the disagreement by saying that I quite agree that what the Federal Reserve does in the next few months will be extremely important in connection with what happens in the of the year. But it is something that can be off-set by a fiscal policy and I think quite possibly would be. I may mention that we've had the State of the Union message by Pres. Johnson. It has confirmed the forecast that I made as to what he would have to recommend. There was a problem of political jockeying as to whether Pres. Johnson who was told by nine out ten of the experts he consulted that it was only prudent at this time to indicate that the ten percent of the surcharge probably should be maintained after the six month period, but he had the problem of politics that he didn't want to make that prudent suggestion and then to find that the facts had gone the other way and to have the new president make capitol that he had come in and he had managed to reduce taxes compared to the outgoing president. Mr. Nixon at this point had to make an agonizing decision, he had to call in all of his experts because one suspects Pres. Johnson put him on the spot behind the scenes and said, "My recommendation is going to be perhaps an imprudent one unless I get some backing from you." Well you can be sure that the measured backing for continuation of the surcharge unless we learn some important facts of the contrary which I understand President-Elect Nixon has been announced to have given, was given by Pres. Nixon only after let's say 8 out of 10 of his advisors told him that the outlook does call for this. And their analysis was based on the premise that it does make the difference for overall inflation whether the taxes go up. In other words, they wouldn't agree with the analysis in the November St. Louis Federal Reserve letter which by statistical estimation came out with the conclusion that tax rates have no predictable affect upon the rate of increase of the GMP. I think we'll have to leave to another time the deeper economic analysis of why I think that fiscal policy variables have to regarded as having a predictable effect on the average on the state of aggregate demand. 

Interviewer: Thank you, Pro. Paul Samuelson of MIT. If you have questions, comments, or suggestions please write us at: Instructional Dynamics Incorporated 166 East Superior Street, Chicago, 60611