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Executive
Summary
Falling (as opposed to low but
stable) interest rates are lethal to the economy, especially if prolonged. They
make the rate of marginal productivity decline. As it does, it prompts
capital export. Migrating capital takes industrial jobs with it. This paper
analyzes job-drain that is threatening America with
de-industrialization. The process will continue as long as wild swings in the
rate of interest do. The cure is to be found in the stabilization of interest
rates. It can be effected by opening the U.S. Mint to the free and unlimited coinage of
gold, as mandated by the U.S.
Constitution.
De-Industrialization
of America
The true story of the de-industrialization of America
has never been told. It started with the U.S. Treasury defaulting on its gold
obligation to foreigners in 1971, thereby foisting a regime of irredeemable
currency upon the world. An unanticipated side-effect was the setting of the
rate of interest adrift. It then started its wild roller-coaster ride, first
up well into double digits by 1981, then down to zero, a move that twenty
years later is still in progress. Greenspan takes credit for the low rates as
a measure of his success in "licking inflation". The claim is an
empty one. The credit belongs to bond speculators, the big money-center banks among them, that
have got away with obscene profits on their bond holdings and long positions
in the derivatives markets. It is too early to say that the plunge of
interest rates is over. There is more dough still where these profits have
come from.
At whose expense are those obscene profits made? Why,
at the expense of the producers and laborers,
naturally. Economists have missed the curious coincidence that pari passu with
the unprecedented swings in interest rates America is being
de-industrialized. Of course, they noticed the migration of industrial jobs
from America to Asia. But they blamed it on the sweatshops in China and India. However, Asian wage rates
had been lower for the entire period of modern age, causing no migration of
jobs as long as industrialized countries adhered to the gold standard. The
difference in wage rates in itself does not establish a cause for the
job-drain.
Greenspan in a testimony before a Congressional
committee stated that the de-industrialization process is market-related as
Americans demand ever more services. This is as false as it is self-serving.
The real cause of the de-industrialization of America is the mega-swings in the
rate of interest. They are far from over. Unless interest rates are
stabilized soon, America
will be denuded of its park of capital goods and American labor
will be reduced to poverty. Labor leaders
should pay attention and demand that interest as well as foreign exchange
rates be stabilized forthwith by opening the U.S. Mint to the free and
unlimited coinage of gold, as mandated by the U.S. Constitution.
Marginal Productivity
Here is the evidence that causal relation exists
between the swinging dollar-rate of interest and progressive de-industrialization,
as manifested by the massive export of industrial jobs from America to Asia.
To understand it we have to make the concept of productivity precise.
Every industrial plant and equipment has its own
rate of productivity that can be calculated as the annualized percentage of
increase in the value it imparts to the goods under production. Not all plant
and equipment will find employment, however. Even though in each case the
value of output is greater than that of input, the opportunity cost of
employing certain capital goods may be too high. This is a point that has
been missed by all discussions of productivity so far. If we rank all
capital goods according to their rate of productivity, then we find that
there is a lowest-ranking one that can still be employed profitably in
production, but all others with a lower productivity must remain idle as
their application would be uneconomic in view of their high opportunity cost.
It is the marginal item of industrial capital, and its productivity is called
the rate of marginal productivity. It goes without saying that the
marginal item shifts constantly, and with it changes the rate of marginal
productivity.
The key question to ask is what determines this
rate. This is important because capricious changes in it could play havoc
with the economy. Contrary to conventional wisdom, an increase in the rate of
marginal productivity is not beneficial. It is actually harmful to the
economy when prolonged, as it is the chief cause of unemployment. Indeed, the
new marginal item has a higher ranking than the previous one,
therefore all capital goods below its rank must be idled, making the labor-complement superfluous. Superficial thinking may
suggest that a decrease in the rate of marginal productivity is beneficial as
it would press idle plant and equipment back into service restoring
employment. Not so. Actually, the decrease is also harmful if capital is
mobile internationally, as it is today under globalization. When the rate of
marginal productivity drops, capital will be exported to foreign countries
with abundant cheap labor. Note that the only way
to keep industrial jobs in the country is to keep the rate of marginal
productivity relatively stable. Violent changes in the rate cause capital and
labor to divorce, whereupon capital migrates abroad
taking industrial jobs with it, and leaving domestic labor
unemployed.
What then determines the rate of marginal
productivity? Since capital goods are an earning asset, they are in direct
competition with other earning assets. In particular, capital goods compete
with bonds. When the yield on the bond rises (the market price of the bond
falls), the opportunity cost of employing capital rises with it. Arbitrage
from physical capital to bonds takes place. Seeking a better return owners of
capital goods sell their plant and equipment, and buy bonds with the
proceeds. From producers of real goods they become coupon-clippers. Moreover,
not only do increasing interest rates discourage production, they actually destroy
domestic capital. This is so because an irreversible process is at work. Please
note the difference between finance capital that is mobile, and domestic
capital consisting of producer goods that is not. If and when interest rates
turn around and start falling again, arbitrage goes into reverse. Bondholders
take profit. They sell their bonds and want to put the proceeds into capital
goods. They look for the most profitable applications. They will find them
abroad where labor costs are a fraction of that at
home. They will send their capital abroad. Thus capital goods at home that
have been idled earlier when interest rates were rising will not be
re-employed. They are doomed. Falling rate of marginal productivity is the
leading cause of the export of industrial jobs, the destruction of domestic
capital, and unemployment.
We conclude that FED policy of purchasing bonds in
the open market in order to combat deflation is not only counter-productive;
it is distinctly anti-labor. The FED bids up bond
prices, which is tantamount to driving down interest rates. Falling interest
rates do, in turn, lower the rate of marginal productivity. The upshot is
that capital is exported along with industrial jobs to low wage countries.
Falling
Interest Rates and Deflation
In earlier papers I showed that while a low and
stable interest-rate structure is beneficial for producers of goods and
services, a falling one is an unmitigated disaster. Not only does it fail to
stimulate economic growth but will, in fact, underwrite deflation by actually
increasing the cost of capital for established producers. I must confess that
most of my readers have found my argument utterly counter-intuitive and
contrary to their personal experience. They have not seen any evidence of
falling prices during the period of twenty-two years of falling interest
rates.
This is because they ignore the invasion of American
super-stores by cheap consumer goods made in China
and elsewhere in Asia. They also ignore the
sales tactics of those stores in keeping the sticker price high while selling
merchandise at deep discount. Be that as it may, the fact remains that
capital has been exported from America
to China and is used to
assist Chinese labor to produce merchandise which
is then re-imported to America
and sold at incredibly low prices. There is no way American manufacturers
using domestic facilities and domestic labor can
possibly match those prices, and they are going bankrupt in droves. American
domestic manufacturing and employment shrink. If that is not deflation, then
I don't know what is.
Moreover, the deflation has not been caused by cheap
foreign labor. That has always been available. The
cause is the falling interest-rate structure that has, for the past 22 years,
made the rate of marginal productivity decline. This decline would, in and
by itself, have produced deflation even in the absence of export of capital
and jobs. Suppose for the sake of argument that the government controls
the export of capital. In that case the falling rate of marginal productivity
would have pressed previously idled plant and equipment back into service,
using new labor component at lower wages. The
additional supply of consumer goods would have depressed prices and caused
bankruptcies as well as unemployment. It is foolish to blame Chinese
sweatshops for the plight of American producers using American labor. You should blame our unconstitutional monetary
system that allows the rate of interest to shoot up to 20 percent and then to
plunge to 1 percent.
There is no comfort in the thought that the rate of
interest is already so low that it can hardly go any lower. In view of the
Japanese experience, it can. In fact, it can go on falling indefinitely. This
is because the effect of a move in the rate of interest on the economy is
commensurate, not with the size of the move itself, but with its logarithm.
In other words, cutting the rate of interest in half has the same effect,
whether it started from 20% (a 10% move) or from 1% (which is only a 0.5%
move). There are still lots of industrial jobs available for export in America. For
example, in the auto industry. What if China
wants a piece of the auto market in America? Well, just cut the rate
of interest in half three or four more times and: bingo! Auto jobs, too, are
gone to China.
Gold
Standard: Protector of Labor
Keynes disparaged the gold standard as "contractionist" and "deflation-prone". He
also charged that it has failed to stabilize prices. However, the great merit
of the gold standard must be seen not in its power to stabilize prices that
is neither possible nor desirable, but in its power to stabilize interest
rates at the lowest level compatible with the productivity of capital and labor available in the country.
Why are interest rates stable under a gold standard?
We may define the going rate of interest as the rate at which the market
price of the bond is amortized by the stream of interest payments plus the
payment of face value at maturity. Under the gold standard a gold bond has a
stable market price because it promises to pay a definite value. Compare
this with a dollar bond that is exchanged for an irredeemable promise of uncertain
value at maturity. The dollar returned to the bondholder is not the same as
the dollar he paid for the bond. Its value is lower thanks to monetary
debasement that has taken place in the interim. The market price of such a
bond changes with the fortunes of the issuer and is therefore inherently
unstable. Since the market price of the gold bond is stable, the rate of
interest under a gold standard is stable. Historical charts fully bear out
this theoretical conclusion. The wild swings we have seen in the dollar rate
of interest since 1971 have no precedent under the gold standard. Noteworthy
also is the fact that there was no bond speculation, just as there was no
foreign exchange speculation, under the international gold standard.
This means that the gold standard is a source of
great benefits to labor. It doesn't allow the rate
of marginal productivity to change capriciously. Compare this with the regime
of irredeemable dollar where the roller-coaster ride of the rate has wiped
out whole industries such as the manufacturing of TV sets and, by the same
token, threatens to wipe out auto manufacturing. In the end only the defense industry may remain. As we have seen, an
increasing marginal rate of productivity idles plant and equipment, while a
decreasing one drives capital and jobs to low wage countries. In either case,
unemployment is the result. Keynes did great disservice to labor when he instigated the overthrow of the gold
standard. Far from being contractionist or
deflation-prone, the gold standard is the sole source of stability in an
unstable world. Only when the government lends credibility to unprincipled
adventurers such as Keynes by paying attention to agitation against the gold
standard, does gold get nervous and go into hiding. But when the government
firmly stays the course of monetary and fiscal rectitude, gold comes out of
hiding and partakes in the great work of building up the productive and
financial strength of the country to benefit all segments of society, first
and foremost labor that needs protection most.
It is customary to make a case for the gold standard
by referring to features such as relative price stability; protection of the
value of savings, pensions, and life insurance; obstacle to the
"beggar-thy-neighbor policy" of predatory
governments using foreign exchange rates as a weapon promote exports;
protection of the assets of individuals against encroachment by banks and the
government; obstruction to credit abuse and unlimited debt creation; keeping
fair play between the productive and financial sectors, etc. The merit of the
gold standard in protecting the individual's right to work, and as an
obstruction to exporting capital and jobs and so to prevent the
impoverishment of labor, is never mentioned. It is time to lay out these merits
as well before American labor is put through the
wringer as it is being robbed of the industrial jobs remaining in the
country.
Under the gold standard the rate of interest and, by
implication, the rate of marginal productivity, are not set by politically
motivated central bankers and Treasury bureaucrats. They are stable. If they
change, they do so almost imperceptibly, reflecting capital accumulation and
its effect on productivity. Recall that in the early 1980's the U.S. Treasury
cavalierly printed double-digit figures on the interest-coupons attached to
its bonds, because they wouldn't otherwise sell. But these double-digit
figures were a death sentence on capital goods that consequently became idle
as higher interest rates pushed up the rate of marginal productivity, causing
wide-spread unemployment. It was a capricious transfer of wealth from the
productive sector to the financial sector. It was highway robbery. This puts
the gold standard in a new light: the policeman to prevent highway robberies.
"Honey,
I have shrunk the jobs by mistake!"
Greenspan himself admitted that the FED's war plan against deflation is wholly experimental,
as it has never happened in history that deflation had to be confronted under
a regime of fiat money. It is atrocious and revolting that unelected
bureaucrats are allowed to experiment with American society in pushing laborers, producers, and savers around like the player
pushes pawns around on the chess board, in an effort to prop up an
unconstitutional monetary regime. As a result of this experimentation
American capital and jobs are being exported. America is in the process of
being de-industrialized. America
has been turned from the greatest creditor to the greatest debtor country. All
for no better end than protecting the turf of the FED. How much more
experimentation, sacrifices, and suffering is needed
before we are allowed to conclude that the fiat money regime established by
deceit and stealth is an abysmal failure? Greenspan, being responsible to no
one but himself, can shrug. If he is compassionate, he may utter words to the
effect: "Sorry, a mistake has been made", and get on with another
experiment.
It is time for a wake-up call. Under the fiat money
system the FED has arrogated unlimited powers to itself, namely, the power to
print unlimited amounts of money. The justification offered for this
unconstitutional arrangement is the woolly theory of a monetary adventurer
from Britain,
one John Maynard Keynes, who has been dead for over 50 years and can no
longer be summoned as a witness. But Keynes was willing to admit that he
might be wrong, in which case he would have let us fall back on the gold standard.
Greenspan, on the other hand, stands in the way of drawing that conclusion.
If
You Don't Use Your Eyes for Seeing You Will Need Them for Weeping
It is not well-known that Keynes published a eulogy
of the gold standard in the Manchester Guardian Commercial
(Reconstruction Supplement, April 20, 1922). This eulogy, of course, is never
cited by latter-day Keynesians.
"If gold standards could be reintroduced
throughout Europe we all agree that this
would promote, as nothing else could, the revival of not only production and
free trade but of international credit and the movement of capital to where
it is needed most. One of the greatest elements of uncertainty would be
lifted. One of the most vital parts of pre-war organization would be
restored. Any one of the most subtle temptations to improvident national
finance would be removed; for if a national currency had once been stabilized
on a gold basis, it would be harder (because so much more openly disgraceful)
for a Finance Minister so to act as to destroy this gold basis."
No one has the right to gamble with the welfare of
the American people, neither the President, nor the Chairman of the FED, not
the politicians, not the judges, not the bureaucrats. That is why the
Republic has been given a Constitution. The Constitution denies power to the
government to monetize its debt. As we have seen, this provision is the first
line of defense to protect labor,
as it acts to keep capital and jobs together and within the country's own
borders.
The Constitution's monetary provisions have served
this country well, and the unconstitutional monetary experiments conducted by
the FED have served it badly. The latter were a series of unmitigated
failures that have gone a long way to de-industrialize America, and
threaten to drive the remaining capital and industrial jobs abroad. Open your
eyes and see for yourself. God gave us eyes so that we may see.
As Friedrich Wilhelm Foerster
(1869-1966), the great Swiss pedagogue once said: "if you don't use your
eyes for seeing you will need them for weeping".
September 19, 2003
Dr.
Antal E. Fekete
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