How to Start a Recession

...And the one thing Shultz, Stein and the President have made perfectly clear is their detestation of government interference in what they wistfully perceive as free markets...

...But as the world knows, since then the dollar has twice been devalued (once officially and again unofficially), wholesale prices have taken to rising at 25 per cent annual rates, food costs have soared out of the reach of the hungry, profits have escalated, and unemployment has stuck at 5 per cent...

...To put the matter mildly, the strain on Phase IV controls, even should they be administered with improbable firmness, will be far more severe than on those of Phase II...

...Diminishing business confidence in the government bodes ill for risk-taking...

...If the Federal Reserve tightens credit further and pushes interest rates higher, the results will be familiar to Americans who recall the money crunch of 1969-70...

...AFLCIO President George Meany grumbled thunderously and most of the labor members of the Pay Board departed early, but the 5.5 per cent guidelines for wages, despite being sometimes bent and frequently stretched through ingenious interpretations, never quite lost credibility...

...The economic boom of the past two years has reduced unemployment to 5 per cent...

...Less lurid sequences of events are also possible...

...Such devices would reduce the spending of businessmen and their customers...

...Unless that power is dispersed, permanent controls are a necessity...

...none was recommended by the President...

...In common fairness, labor has a strong case for wage increases to reverse the erosion of real income and protect against further earnings loss...

...if they get less than justice mandates, flagrant inequity will be ratified, for prices are now frozen at their highest levels in modern history...

...To the astonishment of few, this Administration has presided over the kind of income redistribution conservatives admire: from the poor to the rich...

...Although the manner of recession's coming is uncertain and its timing is necessarily conjectural, there are many plausible scenarios...

...By this late date even Chicago economists ought to recognize the relationship between cost-push inflation and concentrated corporate power...

...The monetary authorities pursued a relaxed policy that supported the boom with large supplies of business and consumer credit...

...Eventually, money will be tight for major corporations, too, and business activity will slacken...

...The wage-price guidelines of Phase II that somewhat relaxed the rigidities of the freeze were comparatively successful, even though they restrained wages more than property income or prices...

...Their employers, on the other hand, are substantially more than 1 per cent richer...

...Loans to small businessmen will not be renewed by banks...

...The Equity Funding scandal, a saga of invented assets, nonexistent insurance policies, and imaginative computer programming, exemplifies the sort of thing likely to happen toward the end of speculative booms...

...Whatever the merits of their view, the sad fact is that its misfortunes are also ours...

...States and cities will be able to float new bond issues only on terms that impose politically unacceptable interest burdens on the taxpayers...

...When the gap widens between inflationary expectations of ever larger profits and actual economic performance, unfavorable earnings reports send icy tremors down investors' spines...

...A 1974 recession would be considerably more painful than its immediate predecessors...

...All one need do to start is assemble a directory of Fortune's 1,000 corporate giants and a list of the unions they negotiate with...

...Next time around, a major operator may really crash, triggering panic selling on the part of terrified investors, other brokerage failures, and precipitous declines in new investment...

...I start from the premise that those who have purchased, occasionally with cash-stuffed suitcases, influence in the White House-conglomerate magnates, oil speculators, land developers, dairy farmers, and their peers-generally oppose effective control over their profits, salaries, executive benefits, dividends, and capital gains...

...Yet, with the Administration cup running over, the pace of inflation, if anything, seemed to be slowing...

...Home mortgages, already difficult to negotiate and expensive to finance, will become all but unavailable...

...During the next two and a half years, it nearly doubled to 6.2 per cent...

...Thus, by the end of 1972, the stage was set for a classic demand-pull inflation...

...Concentrated market power is readily identified and, if the political will is present, administratively rather simple to harness...

...Even if spectacular failures and gaudy frauds do not signal boom's end, there comes a turn in the inflationary spiral where the central bankers of the Federal Reserve are impelled to do their thing and choke off the financial fuel upon which inflation runs...

...Investment, the key to recovery, runs as much on confidence as on credit...

...When they are glum, they protect their money...

...By the autumn of that year, it is sobering to recall, McDonnell & Company had already failed, and several other firms were rumored to be in grave difficulty...

...Were fraud to accompany a highly visible bankruptcy, investor suspicion and apprehension might for a time practically destroy organized securities markets...

...Demand-pull inflation-a matter of too many dollars, marks, yen, and francs pursuing too few goods and services-Is appropriately handled by subtracting some of the dollars...

...To be acceptable, controls must be equitable as well as efficacious...

...Interest rates have already risen and, as the usual corollary, housing starts are beginning to decline...

...Indeed, if my gloomy diagnosis is accurate, we are in for a new and more severe recession relatively soon: a second bout of sluggish output and higher unemployment to celebrate a second Nixon term of office...

...For the immediate future the problem of equity is virtually insoluble because of the sins against equity that have already been committed...

...Phase II allowed the White House during a preelection year to pump money into defense industries and public works in electorally critical states, while slightly reducing unemployment and greatly increasing factory output and retail sales...

...Nothing in the record of this Administration encourages the hope that the controllers will do more in the future than they have in the past to inconvenience major financiers of the Committee to Reelect the President...

...From the failure's principal architect, this concession was almost as handsome as Shultz' immediate resignation and retirement to the University of Chicago would have been...

...Another was the appearance of equity between unions and corporations achieved by freezing everything without giving advance word to any interested party...

...The third related to the fact that in those innocent pre-Watergate summer days the inflation was essentially cost-push in character-the consequence primarily of major corporate pricing policies, and secondarily of exaggerated wage claims by a few unions, notably in construction...

...If Nixon were serious instead of engaged in what White House flacks charmingly term "substantive cosmetics," he would have asked Congress to clamp a surcharge on individual and corporate income, to suspend the investment tax credit, and to tighten controls over consumer credit...

...Thanks to higher Social Security taxes, accelerating inflation and lagging wage adjustments, average working-class families are at least 1 per cent poorer than they were 12 months ago...

...The prospects of the new freeze are dismal, and not only because of the reaction to it on Wall Street and in the international currency markets...

...Workers and their leaders are not apt to content themselves much longer with noninfla-tionary contracts when all around them their employers are enriching themselves...

...Investors take chances when they are optimistic about the unknowable future...

...At the end of 1968, unemployment was a mere 3.3 per cent, the lowest since the Korean War...

...As John Maynard Keynes memorably put it, what counts is the "animal spirits" of the businessman...

...One need not be a cynic to anticipate that Phase IV controls, whatever they may be, are likely to be junked when they begin to hurt corporate profits...

...Recovery would be difficult and slow, because after Watergate Presidential prestige is low, and because Nixon economic management is now fully exposed as weak, inequitable and inconsistent...

...Largely because of this change the rest of the world is willing to hold increasing amounts of dollars...

...Renewed financial crisis among the stockbrokers might end less fortunately than the Wall Street crisis of 1970...

...Some will argue that the Nixon Administration deserves almost any conceivable disaster that may befall it...

...Controls possess the most credibility when the controllers believe in what they are doing...

...Should a new recession double unemployment, we shall be coping in a year or so with 10 per cent general unemployment, 20 per cent among blacks, and 30-40 per cent among youthful workers...

...Possibly the most important one was sheer relief that the Administration finally was doing something-It almost didn't matter what-about the persistent combinations of inflation and unemployment in which Republican Presidents specialize...

...Investors frantically committed themselves to new plant and equipment...

...Hayden Stone, one of Wall Street's big five, was trembling on the brink of bankruptcy...

...Though controls are the best treatment for cost-push inflation, unhappily a demand boom now complicates the picture...

...Consumers went on a buying binge, possibly in anticipation of still higher prices...

...Controls are likely to work when these are the parties to be controlled...

...only at the last moment could a merger be consummated between it and a more solvent new partner...

...It was scarcely an accident that after the President honorably discharged his political obligations by terminating Phase II last January, first quarter 1973 profits registered the second biggest increase for a three-month period in history...

...Treasury Secretary George Shultz told reporters on the eve of the President's June 13 speech announcing a new freeze, "Everyone thinks that Phase III was a failure, so let's not argue about that...

...The shift from Phase II to Phase III occurred just at the moment profit-margin restraints, gentle as they were, threatened further growth in corporate earnings...

...An Administration defender, I suppose, might claim plaintively that the new program-freeze plus Phase IV controls-at least addresses itself to cost-push inflation...

...When fiscal policy is avoided and controls are largely ineffective, as in the present situation, the only economic policy left is monetary restraint...

...The Phase I freeze of 1971 succeeded for three major reasons...

...But how can anyone who has lived through the fatuities of Phase HI have any confidence that Shultz and Herbert Stein, head of the Council of Economic Advisers, will do better this time...

...No wonder that last January, when Phase III was introduced, the Economic Report of the President boasted: "By the end of 1972 the American anti-inflation policy had become the marvel of the rest of the world...

...If unions get what their members deserve, however, prices will continue their sickening climb...

...The failure of a major conglomerate, of course, would shatter the business and financial fraternity's confidence in sounder enterprises...

...In solidarity with other Arabs, Saudi Arabia may cut off oil and precipitate catastrophe in Detroit and elsewhere...