Now we shall see if there are guts in high places. Will the Federal Reserve and the White House hold to their policy or will they fold in the face of an upsy-downsy market?
The pressure to bring interest rates down will be judge. High interest rates are as good as high oil prices to blame all our problems on, but don't believe that high interest rates bring recessions any more than high oil prices do.
If the prime interest rate, the rate the most credit-worthy industrial customer (i.e. General Motors, not Chrysler) pay for borrowing money, is up to 15 percent, that is no reason to assume you'll be thrown out of work next week.
In 1934 the prime rate was one and a half percent. You can't get much lower than that and you can't have many more people out of work than THEY HAD THAT YEAR, U.S. Treasury bills, I.O.U.'s that came due in three months, have recently been paying in the neighborhood of 10 percent, a figure many men in the money world find appallingly high. In the botton of the Great Depression, they were paying eight-tenth of one percent.
When it comes to interest rates, how high is high? Any businessman will happily pay 20 percent interest if he thinks he can make 21 percent on his borrowed money. As the microscopic interest rates in the Depression show, cheap money is just as worthless as expensive money if you can't figure out a way to turn a profit with it.
For many corporations, of course, borrowing money at a 15 percent is borrowing it at very advantageous prices. The inflation rate is 14 percent, so the real interest they're paying is zero; since interest payments are tax deductible as a cost of doing business, company actually ends up making a profit by borrowing, even at what are called these high rates.
If the Federal Reserve Board wanted to make a serious run at stopping inflation, it had no choice but to let interest rates go wherever the market take them. It had been battling to keep the rates down by increasing the supply of money on the same theory that the price of wheat goes down when there is a bumper crop. But money doesn't necessarily obey the law of supply and demand because, when the Fed prints more money to keep down the interest rates, it cheapens the purchasing power of money and fuels inflation. Lenders react to that by hiking interest rates; in the past this has then pushed the Fed into printing more money to get the rates down.
It is this downward spiral that the Fed says it's abandoning. From now on, it promises to concentrate on guarding against excessive additions to the money supply, even if that means temporarily higher interest.
It's one thing to make the announcement and another to have anybody believe you. The publication of the news of the Fed's change in policy was immediately followed by a massive parachute jump out of dollars into other currencies or gold. There have been so many stern declarations of new-leaf-turning and monetary temperance in the past 100 years that people don't believe them any more.
1980 is a particularly good year for not believing. Presidential election years, when a White House incumbent is seeking a second term, are customarily a time when the most recklessly short-sighted things are done in an effort to pump up the economy and assure the tenant a renewal on his lease.
In theory, the Federal Reserve Board is independent of a presidential and/or congressional power; in the real world, it has no hope of hewing to a perhaps painful and certainly difficult-to-understand policy without strong presidential backup.
As long as the employment figures hold and the hysterics on Wall Street don't ruin the stock market, the Fed should be able to stay on its course. the only one that can end inflation. But let things get a little wobbly, and we'll find out if there are guts in high places.