Darrell Montgomery, a resident of Fairfax, Va., has cut right to the heart of the interest rate issue. "Why," he asked me on the telephone, "should a businessman invest $1 million in some sort of risk enterprise when he can sit back and enjoy life by drawing 17.5 percent or more interest on his money?"
I can't argue with Montgomery. Why go into business, suffering the costs of high interest rates, when you can get very high returns by lending the money to somebody else? The sustained pattern of high interest rates is indeed counterproductive. It helps explain the disastrous course of the stock and bond markets, which believe there will be no expansionary trust for the American economy so long as interest rates stay high. And they are convinced that interest rates will stay high so long as Reagan's budget deficits are climbing.
"You've got very heavy credit demands continuing in the economy," Federal Reserve Chairman Paul A. Volcker told television interviewer Jim Lehrer the other night, "not the least, of course, from the U.S. government itself that is pre-empting and absorbing a good deal of the savings that is available."
When press aide Larry Speakes brushes off the Monday crash in stocks and bonds as nothing more than a "temporary state of mind," it suggests either that the White House doesn't understand what's going on or is being deliberately obtuse.
Businessmen all over the country are acting -- and failing to act -- exactly as Montgomery suggests. For example, the Baltimore Gas & Electric Co. postponed the sale of $100 million in 10 year bonds when dealers jumped their guess of how "sweet" the interest rate would have to be from 16.5 percent on Monday to 17.25 percent on Tuesday. This is precisely what has been happening to billions of dollars worth of potential expansionary thrust for the economy.
The reagan bear market this week at one point dropped the Dow-Jones industrial stock average under 900, a decline of more than 110 points since mid-June, when it was riding over the 1,000 mark in response to a brief flurry of lower interest rates. The losses in the bond market and in U.S. Treasury issues have been colossal. Only the word "crash" describes what has been happening in the tax-free municipal bond market -- ice is more salable in Alaska than municipal bonds on Wall Street.
From the beginning, the business and financial community has been dubious about the twin and probably incompatible economic underpinnings of Reaganomics: "supply-side" tax magic to expand the economy, and monetarist tactics to control inflation. Hard-headed analysts in the business world cannot ignore the inflationary impact of a Reagan fiscal policy that will result in $732 billion worth of tax cuts between now and 1986, far exceeding the most generous estimate of civilian expenditure cuts. And military spending, as well-advertised, is to zoom at a projected 7 percent growth rate.
Financial men, thus, flat-out just don't believe the Reagan projections calling for lower inflation, lower interest rates, lower unemployment, lower deficits -- and higher economic growth -- all at the same time.
What are the stock and bond markets trying to tell us? The message is precisely the same as Montgomery's: very few people are interested in making productive investments so long as interest rates -- uncontrolled in a monetarist world -- are this high, and appear to be going higher. And the depressing effects threaten to be more pervasive than either The Wall Street Journal or Volcker would have us believe.
"Nobody believes this budget will ever get balanced," New York banker Robert V. Roosa told me. "Therefore interest rates will continue to go up. But it's a real Catch-22 situation: if the Fed should ease its pressure to keep money tight, the markets would conclude that a new inflation would be triggered."
The only route out of this dilemma is a change in Reagan's fiscal policy that would take some of the inflation fighting-burden off monetary policy. The big mistake -- and possibly fatal flaw -- of Reaganomics is the so-called "supply-side" tax cut, which is nothing more than a device setting up new tax dodges and draining federal revenues. It also is becoming increasingly clear that Reagan oversold the extent of his budget-cutting accomplishments to date.
As a result, he now faces the same kind of credibility gap on economic management that President Carter did. Given the mind-set of financial markets, about the only route offering long-term hope of lower interest rates is a very substantial further reduction in planned federal outlays, including Social Security and federal pensions, but especially in that 7 percent annual military budget growth target.