Regimentation or Democracy
A GREAT DEAL DEPENDS ON SOUND FINANCE
By W. RANDOLPH BURGESS, Vice-Chairman of the Board, The National City Bank of New York
Delivered before the National Bank Division, American Bankers Association, Atlantic City, New JerseySeptember 23, 1940
Vital Speeches of the Day, Vol. VII, pp. 12-15
A NUMBER of years ago bankers, businessmen, and economists were seriously worried because the United States Government was failing to balance its budget. There were predictions of a break-down of government credit and of inflation. That was a perfectly reasonable belief, for the history of government finance seemed to show pretty clearly that the wages of financial sin is death. Yet for nine years now the budget of this government has been seriously out of balance. We are looking forward to a still larger deficit in the current fiscal year and as far as we can see into the future. But people are less worried today about inflation or other serious financial consequences than they were six or seven years ago. Government bonds are selling at approximately the lowest yields of all time, and it would now appear that the government can borrow easily and at very low interest rates all the money it is likely to need. How shall we account for our extraordinary complacencyin these unusual circumstances? It is no doubt partly that we have become accustomed to them. Those who have cried "wolf" have been wrong so often that we no longer trust them. Also there has been growing up a considerable school of thought to the effect that the old experience as to the inflationary consequence of unbalanced budgets was not necessary, but was due to archaic economic processes which may be superseded today.
A number of recent writers have suggested that Germany has discovered the answer, which is that war is a matter of production and not of money, and that if a nation will only order its production properly it can fight a war almost indefinitely without involving itself in serious financial difficulties. The suggestion is that if we would only think in terms of men rather than of money, we no longer need concern ourselves seriously about budgetary deficits and the old shibboleths of monetary science. To any who have studiedfinancial history it sounds a little like saying that the wages of sin is not death but life everlasting.
In judging the truth of this somewhat startling suggestion we ought to note that the last chapter of the German experiment has not yet been written. It is worth recalling that the historic German inflation did not take place mainly during the last war, but after its close. After the first year of war there had been little price advance, and even at the end of the war prices in Germany were only twice as high as at its beginning. The current experiment is not finished, and it remains to be seen what the final consequences will be.
The lesson of history is pretty clear, that major wars lead to inflation. It was true in this country in the Revolution, the War of 1812, the Civil War, and the World War. It has been true of other wars in other countries; the link between war and inflation appears to have been practically unbroken. It is a record which places the burden of proof on those who suggest that a new era has arrived in this respect.
Theory of War Finance
Yet the subject is too vital to be dismissed with general statements or historical analogies. The size of the financial undertaking now facing this and other countries makes it essential for us to examine more fully the economics of the problem. There is a considerable literature on the subject. One of the briefest and most complete statements of the essential principles is to be found in an address before the Army War College in 1922 by Benjamin Strong, former Governor of the Federal Reserve Bank of New York. More recently, they have been discussed by the English economist, J. Maynard Keynes, and by Jerome Frank, Chairman of the Securities Exchange Commission. In their broad outlines these three discussions of the problem are in agreement. It is theoretically possible to conduct a war without inflation. The heart of the problem is the relation between the increase in the volume and activity of money and the increase in the production of goods. If as a consequence of government spending people have more money to buy things with than there are things to be bought, prices tend to rise. Now theoretically it ought to be possible for a country to finance a war or huge defense program without excessive increases in money and in prices. There are four areas for action in seeking to accomplish this feat.
1. Keep down government spending.
2. Collect large taxes.
3. Divert the people's savings to meet war costs.
4. Control the effects of increased buying power by controlling prices and consumption.
Germany has been active in all four fields. Its war costs are kept down by paying low wages and requiring long hours of work. It collects large taxes. It forces business and individuals to buy government securities and so diverts savings to war uses. It prevents added purchasing power from raising prices or competing for goods by rigid price control and rationing most articles of consumption. Even so it appears from the available figures that Germany is not avoiding some substantial increase in money. The government is borrowing from the Central Bank and from the private banks. Both the volume of bank credit and paper money circulation are increasing. The usual effects on prices have been avoided as yet, partly through the direct control of prices and consumption. But the very fact that there has been an increase in credit and in the government debt leads to some doubt whether even with her controls Germany can in the long run wholly escape the normal consequences of war finance. But for us the significant part of this analysis is the complete and detailed governmental control of the economic life of the country required by this sort of program for avoidinginflation. The analysis makes it clear why wars have in the Past practically always meant inflation. The easiest way is to borrow. Few countries have been prepared to subject themselves to the stringent and thoroughgoing control implied in the formula suggested above, and practiced in Germany.
In the face of these facts the question which inevitably arises is how a democracy can compete in war with a totalitarian state which is able to control all these elements. Certainly it would appear on the surface that any democracy is at a great disadvantage compared with the authoritarian state. How can we meet this situation?
Regimentation or Democracy?
In war or a huge defense program like ours there are two directions in which we might travel. One is to copy the authoritarian methods, to become ourselves a socialistic state in the sense that the government would be given absolute control over the life of the people. It is appalling to discover how many people are willing to adopt that sort of solution for the present problems of the United States. In order to combat Nazism as a form of government some propose that we surrender in advance, and adopt that form of government ourselves in the hope possibly that when the conflict is over we might be able to revert to a democracy once more. The proposed cartel plan for South America was an example of exactly this sort. It was a proposal to establish complete authoritarian control over the production and marketing of goods. It was fortunate that this plan died of its own weight before the Havana conference, and that conference under the leadership of Secretary Hull, adopted wiser and more liberal proposals. There are other examples arising constantly in recent discussions of legislation before Congress, such as the proposal to take over plants for the defense program by force rather than establishing conditions for and a spirit of cooperation.
Certain compulsions beyond those of peacetime are unquestionably required in time of war and emergency, but how far must they go? Is there another alternative to complete regimentation of the lives of the people? I believe there is, and that it is to be found in the capacity of a democracy for analyzing its problems and for subjecting itself voluntarily to the disciplines required by the situation. It is our democratic faith that a people so disciplining itself will win wars from a people enslaved by its government. Woodrow Wilson stated it, "The highest and best form of efficiency is the spontaneous cooperation of a free people."
It is worth recalling that we fought and won the last war in this general way, and that the inflation in this country was limited, at least in some measure, by deliberate forms of self-restraint. We limited the expansion of bank credit in two ways: first, by the Liberty Loan campaigns, through which a considerable part of war costs was met out of savings rather than bank credit, and second by voluntary curtailment of enterprises requiring credit. One of the special restraints which applied particularly to the country's money was that the government did not borrow directly from the central bank, although the newly created Federal Reserve System was available as a facility which might have been abused.
On looking back at the war experience we can now see that there were a number of other steps which might have been taken which would in retrospect have limited the inflation. The most important lapse perhaps was that we were not sufficiently conscious of the price problem; and business, labor, and government did not resist sufficiently the upward spiral of costs and prices. We are today fortunately much more conscious of that problem, and there has already been definite voluntary resistance to upward price movements.
We are, moreover, starting this defense program with a level of tax rates in effect far higher than was true at the beginning of the last war; so that in any period of expansion we should be likely to collect taxes more rapidly.
Problem Still Underproduction
A more important difference still between the present position and that of the World War is that we start this period of national defense with substantial unemployment, with large excess supplies of food and raw materials and with the volume of industrial production far under the country's reasonable capacity. That is a distinction which should greatly affect the policies to be adopted. For if we revert to our formula, which was that inflation took place when purchasing power increased more rapidly than production, this country has today the facilities by which a further increase in purchasing power may, with wisdom, be paralleled by largely increased production. Hence inflation should be easier to avoid. In theory at least there is no inherent reason why a $5,000,000,000 a year defense program should not be added to our present national production without substantial decreases in the total of production for other purposes. We have the labor, we have the money in super-abundance, and we have the engineering and business ability.
Our industrial position is quite different from that of Germany or England, for those two countries are working at approximately maximum capacity, and they can only produce additional war materials by reducing their production and consumption in other directions. What they need is a redistribution of their national effort. What we need is a stimulation of our total national effort. While England and Germany may require methods which will cut down the nation's consumption in one direction to make available man power and capacity for the defense program, we do not need as yet to cut down our national consumption, but rather to increase it. We have been suffering from under-stimulation, and that is still our problem. Our need is for initiative, enterprise, hard work, increased production. We face a problem in addition rather than subtraction.
Defense Comes First
Two qualifications, however, must be made. The first is that, while as a whole we have excess production potentialities, there are many areas in which the defense program will require diversion of skilled men and machines. Where defense and peacetime programs clash defense must come first. Our guiding principle cannot be "business as usual." We face a situation as critical as though we were actually at war, for our avoidance of war and our future position and influence in the world probably depend on prompt arming. Our defense program is laggard, held back by red tape, technicalities, a failure to put first things first. Nothing must now stand in its way. Concentration on this program means readjustments by business, labor, and government, some of them painful and laborious. It remains to be seen whether we can make these readjustments rapidly enough to meet the emergency, and do it without so damaging our economic machinery as to impair productive power in other directions.
The second qualification to stimulation as an objective is that we launch our defense program under conditions which could become inflationary. Our present bank credit and national debt, and our surplus of bank funds are at ludicrously swollen figures. Our defense spending is piled on top of a huge annual budgetary deficit. We have been on a wild governmental spending spree and our habits and powers of control are impaired. As a people we have not suffered the usual consequences of these abortions and have come to believe we never will, a highly dangerous frame of mind. Thus our present problem is not simple but complex. Weneed first and foremost stimulation,—increased output. But we need second to begin to get under control some of our loose fiscal and monetary policies and powers.
One way of picturing to ourselves this confusing situation in which we find ourselves is to attempt to visualize two alternative courses which now appear to be open to this country.
The Choice—Depression or Recovery
The first is to continue the way we have been going, that is, to continue in the depression which has now lasted for nearly ten years, with continued large unemployment as a moral and social as well as economic drag on the whole country. In this situation and without substantial recovery the defense program would become an almost unbearable burden. If that program can be carried through only by a decrease of other production and other consumption it means a further decrease in the standard of living, a decrease which might be socially dangerous at a time of large unemployment and sub-standard consumption in many population groups. This is not the moral atmosphere for an energetic defense effort. This course would leave us at the conclusion of war with a greatly weakened economy.
A gloomy outlook indeed, but not an impossible one. If we continue to follow public policies which discourage business enterprise, and if in a zeal to avoid inflation and eliminate profits we place premature checks on production and consumption we may find ourselves, after some temporary lift, in continued depression.
The second alternative is that, under the stimulus of the defense program we might again put the whole nation to work; so that the defense program is added to and not subtracted from our present output. If we thus lift the total national income there will be large increases in government tax receipts, and decreases in unemployment which should make possible large reductions in relief expenditures and thus bring the budget nearer to balance and lessen technical causes for inflation. But more important still a nation at work without the drag of unemployment is a more effective nation both for defense and for progress.
The pursuit of this second course might indeed lead us to the point where over expansion and inflation, resulting from the more active use of money already created, might become a real danger and not just a bugaboo. We should have to be alert to see its approach and try to avoid it, but only when it really threatened. The machinery should be prepared in advance.
Clearly the second course is the only sane choice. If we prefer it we must seek it consciously and intelligently. That i means two sorts of action: 1, the encouragement of enterprise and production and 2, preliminary steps in getting under control the potential factors of inflation.
How to Encourage Production
What are the essential steps of public policy which must be taken to make progress in these directions? As to the encouragement of enterprise the story is long and familiar but it certainly includes the need of a vigorous and active security market, less hampered by stringent controls and technical rulings and laws. We need a revision of the labor relations act to give the employer as well as the employee a square deal. At a time when the all-important task is to increase efficiency and production, we would do well to consider the effects of mandatory provisions of the wage-hour law with respect to reduction of working hours and payment of overtime, which tend to raise costs and prices both to the government and to the general public. We need railroad legislation to help clear up the debris of insolvencies. We need revision of the utility holding company act to open the
way for the utilities to finance, through the open market, additions and improvements. We need an intelligent and sympathetic administration of these and other laws. We need a careful revision of tax laws to encourage and not discourage enterprise.
But on the other side of the picture we must begin to put our house in order against the time when expansion may be followed by over-expansion and inflation. Here again all that can be done within the compass of this discussion is to suggest somewhat dogmatically several avenues in which action is desirable. We surely must get the government budget under better control, and should make a beginning at cutting expenditures outside the defense program. With any recovery in business activity that should not be too difficult. Likewise this is no time to be launching forth on costly long-term state, county, and city undertakings which will place added burdens on the taxpayer and compete with the Federal Government in the markets for labor and supplies. The mechanisms of monetary control greatly distorted by the depression legislation need overhauling. In particular it is unnecessarily dangerous and disturbing to confidence to continue on the statute books power for the President to issue $3,000,000,000 greenbacks solely at his own discretion. In similar position are the power and instruction to buy huge additional amounts of silver and the power to devalue the dollar still further. The repeal of these powers will concentrate monetary controls more fully in the Federal Reserve System, where they belong. The Federal Reserve legislation itself needs review as to the System's real independence of politics and the adequacy of its power of control.
We need to begin to watch more carefully the movement of prices. Theoretically an argument may be made for a somewhat higher price level. Practically an upward movement is so difficult to control once it gets under way, and dislocations of the whole cost structure are so disturbing, that we should probably do better to rely on volume for recovery rather than higher prices. But nowhere is it more important to keep our processes within the democratic framework, for price fixing is a highly dangerous process. We should certainly review those acts of Congress which have created in several spheres the machinery of monopoly to raise prices deliberately. The best way to avoid price inflation is to produce abundantly.
The mechanism of financing the defense program needs study. If inflation really threatens we need to collect more taxes, sell bonds to savers rather than banks. We ought now to finance defense industries as far as possible privately rather than with government funds.
But here, in the case of taxes especially, we run into trouble. For our two objectives are contradictory. Stimulation requires lowering some tax rates, control of inflation requires high rates. Actually the contradiction is less thanit appears, for some of the present rates are so high that they pass the point of diminishing returns. They penalize the operation taxed to a point where it is avoided and tax returns thereby reduced. At present any conflict should be resolved in favor of stimulation rather than control. The inflation danger is latent, not immediate. It must be prepared for, but it is too early to put repressive controls into effect. In taxation, for example, we do well to let people earn some money before we take it away.
What Bankers Can Do
Up to this point we have been talking largely about what other people ought to do. What responsibilities have we as bankers in these matters?
First comes our responsibility as leaders of opinion. We know or should know more about these matters than most other people; and the time has come when we may speak out more freely.
Second, we have a direct responsibility in financing the defense program. It will come to our desk in two forms: the chance to finance directly business working on defense orders and the chance to subscribe to government bonds. The direct financing is complicated and difficult to arrange safely; taking government securities is easy. But for our own good and the good of the country the more we finance directly and correspondingly the less government securities we buy the better. As we finance directly we shall put good business on our books, and keep the banking business in private hands. To the extent we turn the business over to the RFC or other government agencies, we encourage the government in taking over the banking business and increase the government debt and the danger of inflation. Admittedly, there are serious difficulties in lending for defense but they are difficulties we should seek to surmount.
Let me summarize by suggesting still another approach to this situation. We have been looking for a new industry, like automobiles, to lead us out of the desert into the promised land. Many have felt that only so could we get our unemployed to work, get the wheels of industry stirring, and get the national income up. Here is a new industry in the form of a defense program,—a tragic sort of a leader—but one on which the nation can again unite after some years of bickering and disunity and looking for scapegoats. We all know we must get results and must operate efficiently. For our place as a nation and the preservation of our way of life is in the balance.
Can we rise to this challenge? Have we the energy, initiative, and national unity for the speed of output we must have? Can we act sanely and reasonably so as to carry forward this new activity without disrupting the economic machine? If the wheels start turning too fast have we the wisdom and courage to keep it under control? And can we do this within the framework of democracy? These are our problems.