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INFLATION - A THREAT TO RETIREMENT PROGRAMS 36th Annual Convention of the National Council on Teacher Retirement of the National Education Association Morning Session, Friday, February 13, 1959 Sheraton-Ritz Carlton Hotel, Atlantic City, N. J, FOR RELEASE: 9:00 a.m., Eastern Standard Time, Friday, February 13, 1959- INFLATION - A THREAT TO RETIREMENT PROGRAMS By Karl R. Bopp President, Federal Reserve Bank of Philadelphia Before the 36th Annual Convention of the National Council on Teacher Retirement of the National Education Association Morning Session, Friday, February 13, 1959 Sheraton-Ritz Carlton Hotel, Atlantic City, N. J. In the past quarter of a century we have experienced depression, war, prosperity, and inflation« Yet, by and large, I think these have been years of economic accomplishment and progress. however, is a cloud on the horizon. The prospect of long-run inflation, It is this threat that you have asked me to discuss. We have come a far way from the depression in a brief period of time. You may recall the Report of the Committee on Economic Security in 1936 from which our Social Security laws were developed. It began this way: "The need of the people of this country for ‘some safeguard against misfortunes which cannot be wholly eliminated in this man-made world of ours' is tragically apparent at this time. . • . Many millions . . . have lost their entire savings, and there has occurred a very great deorease in earnings." Concerning the problems facing older people, the report continued: "There is insecurity in every stage of life. ... For those now old, Insecurity is doubly tragic because they are beyond the productive period. Old age comes to everyone who does not die prematurely and is a misfortune only if there is Insufficient income to provide for the remaining years of life. With a rapidly increasing number and percentage of the aged, and the impairment and loss of savings, this country faces, in the next few decades, an even greater old age security problem than that with which it is already confronted." -2- We have passed laws and made private arrangements to prevent old age from becoming a misfortune, but I believe that the savings and the economic well-being of millions of older people, as well as others, are still threatened today - not by a recurrence of depression, but by inflation. have risen in «ill but two years since 1946. cent. Consumer prices In 1958 they increased almost 3 per The value of the dollar has diminished by about one-third since the end of World War II. Last month another committee, a Federal Advisory Council, composed of representatives of industry, labor, and the public, issued a report on the Social Security System, The Council reported, unanimously, that the methods used to finance old age and survivors insurance are sound. But the Council issued a warning: ". . . the trusteeship is so large, and the number of people involved so great that the defeat of beneficiaries' expectations through inflation would gravely imperil the stability of our social, political and economic institutions•" Let me add, that while the trusteeship is great now, it is becoming larger all the time. There are almost 15 million people of retirement age today. By 1975 it is estimated there will be almost 22 million. Experience tells us that an even larger proportion will be covered by Social Security and also byprivate pension plans. Inflation threatens more than just the purchasing power of retirement benefits. By undermining efficiency and economic growth, it threatens the economic foundations that make retirement programs possible. I should like to review briefly the nature and magnitude of the economic accomplishments that have accompanied the expansion of retirement programs in the postwar period. Since World War II, our gross national product in real terms has increased about A per O cent, or about 3 per cent a year. low, averaging about U par cent* Unemployment has been relatively -3- Our economy also has worked well. in adjusting to new conditions. In the It has shown a remarkable resiliency postwar period we have won at least three battles over mass unemployment and depression. The recession was sharp, but short. after the first quarter of 1958. Last year was an example. In most respects our economy began recovering Recovery has continued and the outlook is that 1959 will be a much better year than 1958. With economic stability and growth has come the ability to provide more fully for our sick, our disabled, and our disadvantaged. The relative affluence that we now enjoy is the fundamental basis for the principle of retirement without dependency. With sustained economic expansion we can look forward to a future in which all our goals will be more fully attained. I have grave doubts, though, as to whether we can continue to have sustained and rapid economic expansion with inflation. of the late Lord Keynes. You might be interested in the opinion He wrote: "Inflation has not only diminished the capacity of the investing class to save but has destroyed the atmosphere of confidence Which is a condition of the willingness to save. Yet a growing population requires for the maintenance of the same standard of life, a proportionate growth of capital." The kind of economic system that we have will function most efficiently when the value of money remains constant. our free market economy. Prices are of strategic Importance in They allocate our resources into those employments in which they can most profitably be used. When competition is keen, resources are allocated into those employments in which our consumers want them to be used. There axe imperfections and frictions, of course. Things do not work so smoothly or so quickly as Adam Smith and some others believed. Nevertheless, as I see it, this is basically the way in which our economy operates; the consumer dictates, the quest for profit motivates, and the price system allocates. Countless decisions to earn and spend, to borrow and lend are channeled through the cold exacting calculus of a free market to allocate our resources. The standard unit of these calculations, of course, is the dollar. and income statements are written in dollar terms. Balance sheet They can reflect change accurately only if the dollar itself - the unit of measurement - remains reasonably constant* An outstanding American economist once gave an excellent illustration of how inflation leads to faulty decisions and obscures inefficiencies. In the early 1920's he bought a shirt from a woman shopkeeper on the outskirts of Berlin. woman, who wished to prove she was not a profiteer, told him: only as much as it will cost me to replace the shirt. The "I am charging you I have, of course, made my usual profit on that shirt, which I bought for less." Let us analyze some economic implications of this transaction. accepted accounting sense, the woman had made a profit. greater than her bookkeeping cost. In one Her selling price was But it is clear that if she used this "profit" to meet her living expenses, she would not be able to replace her inventory. Instead of living off income she would be living off her inventory. In real terms, she had no income even though in money terms she had a profit. If this were the only implication, one might feel sorry for the poor woman and pass on. principles. I have introduced the transaction, however, to illustrate some In an intricately balanced market system, such decisions have wider effects. Competitors, even those who are not fooled by the money illusion, will have to meet her price or lose business. They may be more efficient, but they cannot compete, except at & loss« Inflation tends to obscure such inefficiencies. It can rescue for a time some businesses which otherwise would be forced to correct their errors or fail. On the other hand, efficient businessmen may be put in jeopardy because they face -5 - competition that does not permit them to raise prices while their suppliers may not face such competition. Or businessmen who are otherwise efficient may find themselves in trouble simply because they do not understand the destructive impact that inflation can have on capital. If we accept inflation which thus frustrates efficiency and seems to reward illusion, I doubt that our economy can grow up to its potential. I doubt whether we will fully realize many worthy objectives. I further doubt that the economic growth we do manage will be continuous and stable* slumps. Time and time again inflationary excesses have culminated in severe Yet it has always been difficult to convince people that the heady wine of inflation is apt to leave a hangover* I am reminded of Thomas Hart Benton, an early Congressman from my original home state of Missouri, who kept warning the public prior to the depression of 1837 of the dangers stemming from a rapid increase in paper currency. Few listened and for his trouble he was regarded as "a little exalted in the head*n Mr. Benton was somewhat naive about the nature of banking, but he well understood the basic injustice of inflation. He declared: "This is an enormous and crying evil, the parent of unnumbered impositions upon the whole community, and especially upon the weaker part* In paying double for the necessaries of life, the effect has been precisely the same as if the purchaser had received but half a pound, half a yard, and half a bushel, when he paid for a full pound, a full yard, and a full bushel.* * Some would have us believe that a little bit of inflation is not bad. I think that this is a siren*s song. Even a creeping inflation of say 2 per cent or 3 per cent a year can be destructive to economic interests of large groups of people with fixed incomes. Conspicuous among these groups are those on retirement and those accumulating funds for retirement. A price level that rises at 2—1/2 per cent a year compounded will double in about 29 years* -6- But I wonder if we could really hold inflation to 2-1/2 per cent a year if the idea that inflation had become a way of life were held universally. There are forces at work in our economy that tend to turn a creeping inflation into a leaping inflation. Perhaps the most powerful force spurring inflation into a walk, a trot, and a gallop is man* s perverse ability to turn his fears into reality. Once people begin to expect a rising price level they do -things that tend to bring it about. If they are afraid that prices will rise next month, they have a real incentive to make next month's purchases this month. They have an incentive to trade money for goods, real estate, stock, and anything else they think will rise in value. When many people think and act this way, prices are certain to rise - not next month, but this month, and by more than originally expected. Clearly we must throw up our defenses against inflation. But what sort of defenses should they be? Schemes to protect the purchasing power of victim groups - workers, public utility stockholders, government bondholders, and others - have been adopted or proposed here and in foreign countries. By and large, I think cost-of-living and other purchasing power adjustments contribute to inflationary pressures by increasing costs. I have fequently heard it suggested that pension funds can protect themselves against inflation by investing in common stocks. It seems to me that this road is not necessarily paved with gold over its entire length. An assumption on which this suggestion is based is that corporate earnings tend to keep pace with increases in the general price level. sounds reasonable enough. it. Offhand, this assumption Nevertheless, I do not find convincing evidence to support Corporate profits after taxes are today a smaller fraction of gross national product than they were thirty years ago. How can we be sure what their relative importance will be thirty years from now? A plausible response to this objection is that investment managers should place retirement funds into the equities of growth companies. Before we accept this answer uncritically, we should remember that it is easier to select companies that have grown than those that will grow in the future. The history of American corporations is filled with blue chips that have turned pink. Not all Investors can buy at the bottom and sell at the top. There is another feature of equity investment that merits attention. It is the principle that even the sweetest substance may turn bitter when used to excess. Ultimately, it is primarily the earnings of a corporation that give value to its stock. important. Of course, it is not past but prospective earnings that are critically Increasing demand for equities forces up the so-called price-earnings ratio or the number of dollars paid for one dollar of earnings. As more and more investors attempt to hedge against inflation by purchasing equities, the priceearnings ratio rises. If this persists, is it not likely that a stage will come when neither actual nor hoped-for returns on the investment will be sufficient to offset the decline in the value of the dollar that they anticipate? When this stage is reached, the only reason they have to invest in equities is the hope that stock prices will rise further. For a time they may. Eventually, however, the idea that the speculators are merely fooling one another is likely to take hold; and, depending on the impact of the revelation, a technical or turbulent adjustment ensues. Please do not misunderstand what I am saying. Investment in equities has much to commend it* It has made possible much of our phenomenal industrial and commercial growth. It has an appropriate place in many retirement accounts. What I am saying is that investment in stocks is an imperfect and hazardous - -8- rather than a sure-fire - hedge against inflation for a whole society* It works only so long as most investors do not try to take advantage of it. You as educators are interested also in the other side of investment marketsj namely, in the demand for funds. issue equities and yet must be financed. Many important institutions cannot Governments - federal, state, and local - school and other authorities find they have to pay more to attract funds from private investors. Increasing costs in these areas affect us all, of course, as taxpayers. From an ethical point of view, it seems to me that all groups are equally entitled to protection from inflation. I must confess, however, that the plans, schemes, and proposals that have been advanced to protect particular groups seem to me economically unsound. Wouldn't we promote justice and also save a good deal of economic and political conflict by preventing inflation in the first place? Of course, there are a number of ways to attack inflation. The Government could establish ceilings; that is, we could establish direct controls over the prices of goods, services, and the factors and resources of production. I submit, that this approach would create more problems than it solved. Prices, as I have already mentioned, perform a vital and unique function in our economic system. They are the automatic rationing device that compel consumers to decide, as best they can, what and how much they want most. They also are the nerve endings that keep producers in contact with consumers' decisions. Establishment of direct controls over wages and prices means we forego the market and the price system as a means of allocating resources and rationing goods and services. Since people would demand more goods than were available at ceiling prices, new methods of distribution would have to be devised to determine whose demands would be met and whose denied. As our experiences during World VJar II plainly indicated, we would be forced to distribute our resources on the basis of -9 - centralized rationing systems. The abrogation of the market-price system would entail its replacement by a widespread, far-flung system of planning and control a system that would be costly, inefficient, and frustrating. There are other alternatives. inflation is inevitable. about it. I am not one of those who believe that It is a human phenomenon and people can do something Once it is understood, they will do something about it. For my own part, I do not find the reasoning of those who say inflation is inevitable any more convincing than the reasoning of those who in the 1930*e concluded that we were a mature economy incapable of full use of our resources. The words inevitable and perpetual are too powerful to describe future human behavior. Inflation is a result of varied and complex forces and it must be attacked on a wide front. record levels. Our output of goods and services is moving to new Certainly under these circumstances, as Chairman Martin said recently: "We must face up to the reality of either raising taxes or revising our tax structure to produce more revenue or reducing the priorities of some other programs until we can get things in better balance." Just a year ago, Carl £. Allen, President of the Federal Reserve Bank of Chicago, indicated forcefully what is needed in the private sector of the economy. He said: "It is human nature, when we overreach ourselves and have no one to blame for our excesses other than ourselves, to seek out a culprit on the one hand and a savior on the other. I believe that elements in labor are doing just that today. They turn to industry as the culprit and to the Government as their savior. And there are elements in industry which have priced themselves out of a market. They have themselves to blame for their excesses, so they look to labor as the culprit and to the Government as their savior. The culprits are different, but unfortunately the hoped-for saviors are the same - the Government. ... We can hope that management and labor in the months ahead will recognize that lasting rewards cannot come from constantly increasing prices, but rather that their mutual interests and the well-being of the country both require price stability." -10- We need also to understand the role of flexible monetary policy. We have had such a policy for eight years, easing credit When declines have been under way, as in 1957-1958, and moving away from ease as business recovers. is never popular. Monetary restraint To be effective, some borrowing and spending must be restrained. It may be. as some have urged, that certain areas of the economy should be sheltered somewhat from the impacts of credit restraint. But I should like to emphasize that expansion of the sheltered areas necessarily reduces the unsheltered areas and thus makes the impact on them greater. This in turn can create new "hardships," leading to attempts to extend the sheltered areas. Special dispensations for special groups tend to weaken general credit restraints. If special dispensations become widespread, general credit restraint becomes meaningless. I have said I do not believe that inflation is inevitable. If we understand its erosive effects and how it operates, we will as a people attack it on the wide front that is necessary. The war against inflation entails sacrifices, but the rewards far over balance them. By containing inflation we will eradicate many injustices and build a firm economic foundation for social progress. our private and public programs. We will be able to develop fully We will make our free enterprise system not only an efficient economic machine but an even more satisfying way of life.
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