7. THE LAST SWING OF THE PENDULUM

What happened? We may say that it was the Arabs and the Oil, the price of Gold, the Common Market in Europe, or the Japanese being so smart. the Seventies were "interesting time". We may pretend that is was a delayed effect of the Kennedy Era exuberance or of the Nixon Era embarrassment... The truth is probably that, once again, we became a little complacent and decided to cash in NOW on our prosperity. We decided to extend to many more the privileges of the rich. A time for distribution

Party time

Our way to distribute was "inflation financing": PROGRESSIVE TAXATION cum INFLATION. What if you make 10% interest and a 10% inflation wipes away 10% of the purchasing value of your capital? Well, in terms of "real" wealth, if you also happen to pay income tax on the interest you earned, you actively participate in the de-concentration of wealth: you have a negative "real yield" and you become poorer by the day. Most people would say this is what happened in the early Eighties; in fact, inconspicuous, the negative real yield had been with us for a decade already.

Traditionally, wealth distribution takes from the rich and gives to the poor. A peculiarity of inflation financing in the U.S. in the Seventies was that we were not taking wealth from the rich to give it to the poor, but to make things more cosy for our Middle-Class. Of course, enough money went the way of the poor to maintain the level of consumption income of the country..., but no more. No great social benefits accrued to the "losers": inflation played straight into the "small winners's" hand

Inflation profits debtors and owners of durable goods, most of all of real estate. There were winners in the corporate world, owners of fixed capital and debtors whose debt's constant dollar value decreased with inflation. But the great winners of inflation financing were not the entrepreneurs; they were the common homeowners, the Middle-Class, the members of America's effective majority of workers, at all levels, most of them alive and well in Suburbia, who owned $5 trillion in real estate. The money value of this real estate increased with inflation, so each 1% increase in prices meant that society was making them a $50 billion gift.

Homeowners gained two ways. First, the money value of their real estate increased with inflation, so that a 8% inflation, in any given year, increased by about $400 billion the global market price of American homes, giving back to homeowners as a group, in capital gains, MORE THAN THEY HAD PAID IN INCOME TAX THAT SAME YEAR! Second, this 8% inflation reduced in the same proportion the constant dollar value of their huge outstanding mortgage debt; no mean gift, since it was of the same order of magnitude as the public debt itself.! To make it better still, interest paid on his mortgage debt by the homeowner was tax-deductible!

So we used progressive income tax to collect what appeared to be a fair contribution from all, but then, through tax exemption on capital gains for homeowners and mortgage payment deducibility, we made sure that the effective majority of workers-homeowners were paying little more - or even less - than what they had been made to gain from inflation. The average homeowner was thus reimbursed in full of any contribution he had made to sponsor the Have-not's as consumers and to help maintain equilibrium.

Endangered species

Handled that way, the distribution operation became quite lethal for capitalists. The homeowner had a free ride and money-wise was even getting richer, while we had a negative real yield prevail which favored debtors against investors and had the "paper capitalist" - those dealing in bonds, securities and credit instruments - support the whole burden of maintaining the consumption level income of the masses!

Take an investor in the $75,000-plus income bracket in 1970. Not necessarily a tycoon, since chances are that you, personally, know at least a few tax-payers in this category (your physician, for instance, is a likely candidate). Suppose that this investor, single and mature, deciding that $75,000 a year is enough to live on after all, saved and invested the whole "plus" from 1970 and on, to get richer as a good capitalist should. A good prospect for wealth accumulation, wasn't he?

Certainly not if he decided to take the pure "capitalistic exploitation" path of all profits and no risks, as explained by Marxist mythology! Suppose he invested then in U.S. Government long-term bonds, continuously reinvesting thereafter his interest in the same "risk-free" securities. How rich, how fast did he get? Well, considering a marginal income tax rate for his income bracket which remained above 60% until recently, together with an inflation rate that took away 66 % of the value of his capital between 1970 and 1985, this cautious investor has seen his real wealth decline during these fifteen years.

In fact, the capitalist "exploiter", by the combined effect of progressive taxation and inflation, has seen his wealth shrink an average 6% a year during the period. Merely to hold his own, from 1970 until 1985, he would have had to obtain an average return of 19% on his investment, year after year during this whole period: about double the U.S. Treasury Bonds' yield. To make this kind of return and grow, the investor would have had to be more than a "capitalist"; he would have had to be taking risks and to become quite a successful "entrepreneur".

What was the impact of this situation on top-dogs as a class? Let's take a broader view. In 1929, before the death of Capitalism as a system, the "Top One Percent" of the taxpayers accounted for roughly 40% of the wealth in the U.S. Then, came a slow decline, gathering momentum from time to time. Between 1972 and 1976, in just four years, their net worth declined by 32 billion while the gross personal assets of all persons in the U.S. jumped by 1.3 trillion! In 1985, the Top One Percent's percentage of the national wealth was down to 15%...

Doesn't something strike you as different from the classic "capitalistic exploitation" model? Or from the converse model of socialist redistribution for that matter? In the original American model of the Seventies, we were quietly confiscating the wealth of the rich, without seriously improving the condition of the real poor amongst us. It was distribution on a grand scale, for the benefit of the middle-class effective majority only. It was also a great potlash, begging for a hangover.

The Reagan Reaction

It became obvious at the end of the Seventies that, unless we would slow down and monitor more carefully the not-so-slow confiscation of their wealth, Capitalists as we had known them would be totally extinct within one generation. Which was not what the American people had in mind

First, because we did not want wealth to disappear as the motivator and symbol of authority, nor risk-capital for entrepreneurship to be limited to what civil servants would agree upon in committees. We were far from sure that a Swedish model would provide us with the dynamism we wanted in our society. Second, because, as this particular breed of sheep would becomes scarce, we felt that it might be necessary to begin shearing less discriminably to compensate for the dwindling number of wealthy top-dogs on which we could prey, and so to redefine progressively our standards of wealth; there was a definite fear that each strata in its turn might be getting the axe.

The Reagan Presidency's mandate, coming as it did while American hostages were held in Iran, was probably first to give us back our pride. Immediately after, though, came the priority to stop the confiscation process. President Reagan undoubtedly received the mandate to give back some riches to the rich and the basic idea was clear from the start. The confiscation would have to become more extreme, though, before the pendulum would react and swing.

Giving to the rich is a purpose which is most simply achieved lowering the taxes or increasing the interest rates. Preferably raising the interest rates, which is less obvious. Attempts at tinkering with interest rates, though, to the Reaganian economists' great dismay, just made things worst. It stopped entrepreneurs dead in their track and created unemployment, as could be expected, but it did not stop inflation. It fed inflation.

Which in retrospect is not surprising, since the root of the problem was not in industry but in real estate, and no homeowner in his right mind could be convinced, after 30 years of straight growth, that home owning was not the best path to wealth. Higher interest rates would be tough, but the average homeowner could take it in stride and wait for the profit to come. Home-owning America was not one shaky entrepreneur; it was millions of sturdy, stolid, small decision-makers... who had trillions of dollars in equity to back their stand. They could out-wait the State itself !

Homeowners took in stride 15%, 20% interest rates and waited. Few bought houses but few were forced to sell, few lost. Most made a pile of money when they sold their property later on, at a profit. Inflation zoomed, since higher interest rates meant more money for the rich which had to come from somewhere. If it was not from the home owning middle-class - and the poor having none, since the level of consumption has to be maintained - it could come only from Government deficits. It did.

Not nearly enough, though, at the time to prevent the capital owners from taking their worst beating ever. To understand what went on, let's avoid obfuscation and concentrate on few figures. The key figures to scrutinize are the "net interest" paid in a year (as a share of the National Income), the "credit market debt outstanding" (for the global use of which wealth such interest can be considered to have been paid), ... and inflation, which reduces the constant-dollar value of this credit market debt as well as the real wealth of the creditors. This is not a perfect representation of reality, of course; but the relation between these figures is a decent estimator of what went on.

In 1980, with net interest reported at 192 billion, a credit market debt of $4.68 trillion and a 13.5% increase in Consumers' prices, "Capitalists", through inflation, can be said to have picked up a bill for $440 billion (the equivalent of 76.3% of the $632 billion Federal Budget!). In 1981, the year of the highest interest rates, net interest payments accounted for $241 billion of a National Income of $2.36 trillion; a high proportion that reflected the 16%-plus interest rates of the market. Concentration of wealth? Not a chance! If we compare this figure of $241 billion to the $5.17 trillion credit market debt outstanding that year - together with a 10.4% increase in consumers' prices that wiped away some $520 billion off the real value of this amount - the money holders' position appears much less comfortable: the treadmill was taking them back more than twice as fast as they could run....

From 1978 to 1982, looking at the global net income from interest, the credit market debt and inflation, we have lived with the equivalent of an average 6 % tax on capital in the "capitalistic" U.S ! Throwing the towel and stopping all pretense, the Reagan Government finally cut by about half the taxes of the rich, accepting an ever-growing deficit, and accepting to build our future with borrowed money... and borrowed time.

The Reagan Presidency, though, in a way, has filled its mandate. It can be credited with having held the "decadence" bomb in check: it is easier to stand proud in 1986 than in the days of the hostages in Tehran. Also, the days of the confiscatory income tax are now over, interest rates are down and so is inflation. The pendulum has swung back once again, and it is now possible once again to grow rich fast, honestly in America.

Much easier also, unfortunately, to get poor, to be destitute, to be excluded from it all. The time-bomb from below, the revolt of those who have nothing to lose, is ticking faster. We will have more frustration, more "marginalization", more vandalism, more terrorism, more violence and criminality, more unhappiness until those who are excluded from our society manage to swing the pendulum back again... or until a different approach altogether is applied.

The time-bomb from above is ticking much faster also, notwithstanding the present jubilation in the Upper Kennels. The public debt has increased by 80% during the last five years, and should now double about every 6 or 7 years. Until this particular bomb explodes. Until we go for one Big Bang against the convenient Hordes of the East or manage to keep the wheels in motion at a bargain price, in a myriad skirmishes with the less formidable Tribes of the South, "bargain price" in this context meaning the loss of many of their lives and rather few of ours.

This is where we stand to-day, two years away from the end of the Reagan Presidency. The time-bombs are ticking too fast for the trend of the Reagan Reaction to be pursued much longer. Will we live a counter-reaction? There are reasons to believe that this was the last swing of the old left-right pendulum and that to-morrow may bring something quite different.

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