Tape 6 - untitled
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- | Instructional Dynamics Incorporated | 0:02 |
welcomed you to this weeks commentary | 0:04 | |
on the current economic scene. | 0:06 | |
Reporting to you will be one of the nation's | 0:08 | |
leading economists Professor Paul Samuelson | 0:10 | |
of the Massachusetts institute of technology. | 0:12 | |
Professor Samuelson, last week you were discussing | 0:15 | |
the theory of foreign exchange, | 0:18 | |
what's on the menu for today? | 0:19 | |
- | In my last tape I did begin a systematic analysis | 0:22 |
of the principles underlying the balance | 0:26 | |
of international payments. | 0:29 | |
Now that's a very large topic and much | 0:31 | |
remains still to be said on it. | 0:33 | |
I propose though today to defer theoretical | 0:36 | |
discussion until my next tape. | 0:40 | |
This will give us a change of pace, | 0:44 | |
also it will enable us to keep our eye | 0:47 | |
on the passing ephemeral scene, | 0:49 | |
and furthermore, next week I shall be in London and Paris | 0:52 | |
and that'll provide a good occasion for a continuation | 0:55 | |
of the more basic principles of the subject. | 0:58 | |
This does raise some interesting questions of method. | 1:03 | |
I was reading recently some material put out | 1:06 | |
by one of the large brokerage firms. | 1:09 | |
It's a firm that deals with institutional investors. | 1:11 | |
In it's material one sentence caught my eye. | 1:15 | |
This said quote, our research people | 1:18 | |
must be careful that they do not | 1:22 | |
degenerate into mere reporters. | 1:24 | |
They must continue to be analysts. | 1:27 | |
I think that brokers firm had a good point. | 1:30 | |
It's not the reporting of the facts | 1:34 | |
is unimportant, actually it is vital. | 1:36 | |
Some sage once said, a man's judgment | 1:40 | |
is no better than his information, | 1:43 | |
but I will even improve on that aphorism. | 1:46 | |
A man's judgment is only as good | 1:49 | |
as his ability to discern what is the important | 1:51 | |
and the relevant information in the problem at hand. | 1:55 | |
You can't make the bricks of informed | 1:59 | |
understanding without sand, but a sand pile | 2:01 | |
is not a great cathedral either. | 2:05 | |
In this connection, last month after I addressed | 2:09 | |
a large Wall Street group one of my former | 2:12 | |
graduate students came up to shake my hand. | 2:15 | |
Apparently life had been good to him. | 2:18 | |
As an investment counselor he was handling | 2:20 | |
tens of millions of dollars and his own income | 2:23 | |
was very obviously in the five figure category. | 2:26 | |
As he drove me out to the airport I asked him, | 2:30 | |
tell me the truth, did your advanced training in economics | 2:33 | |
really do you any good in terms of your present occupation? | 2:37 | |
I rather expected him to give a negative answer | 2:41 | |
and so I was a little surprised to hear him say, | 2:44 | |
and now I paraphrase what it is that he did say, | 2:47 | |
he said, that training honestly did help. | 2:51 | |
There are a lot of smart people in Wall Street, | 2:54 | |
many of them are smarter than me | 2:57 | |
and quite a number certainly have | 2:59 | |
more of a flair for a new investment situation, | 3:00 | |
but I do seem to have one great advantage. | 3:04 | |
I have a background of reference | 3:07 | |
against which to put each new economic happening. | 3:09 | |
You'd be surprised how superficial and panicky | 3:13 | |
can sometimes be the thinking of highly intelligent men | 3:16 | |
who don't have a solid grounding in economic principles. | 3:19 | |
Well, enough of a plug for my subject, | 3:24 | |
let's take a look at the news. | 3:27 | |
First, interest rates are still climbing. | 3:32 | |
I like to watch each Monday morning | 3:37 | |
in the Wall Street journal, the chart of yields | 3:39 | |
of the municipal bond index. | 3:43 | |
This is an index of high grade municipal tax exempt bonds | 3:49 | |
and I've found over the years that it's rather indicative | 3:54 | |
of the tone of the money market, | 3:58 | |
and that still continues to be up. | 4:01 | |
It wavered a bit downward in the months | 4:03 | |
just following June, but it is still on the rise. | 4:08 | |
Big news of course of recent times | 4:16 | |
was the fact that the prime rate of the banks | 4:18 | |
has gone back up to 6.5%. | 4:21 | |
It's perhaps ironic that the leader in this move | 4:24 | |
should have been the Chase Manhattan bank | 4:28 | |
because you will recall it was the Chase Manhattan bank | 4:31 | |
which had gone ahead of the pack | 4:35 | |
in reducing the rate a full half percent to 6%, | 4:38 | |
and it was not followed in this cut | 4:42 | |
by the other large banks so none of us | 4:45 | |
were the least bit surprised when the Chase, | 4:50 | |
having crawled out far on the limb, | 4:53 | |
crawled back part of the way and rejoined | 4:56 | |
the human race at 6.25% prime rate. | 4:59 | |
But I think it's a little more novel | 5:03 | |
that now the Chase should have been | 5:06 | |
the first to go back to 6.5%. | 5:08 | |
I don't think that's at all untoward | 5:12 | |
given the tightness of the general money situation. | 5:17 | |
In this connection I noticed an interesting speech | 5:24 | |
by a very good analyst of the mortgage market, | 5:27 | |
Mr Saul Clayman, who is a director of research | 5:32 | |
for the mutual savings banks. | 5:38 | |
He gave a speech in which he tried | 5:40 | |
to estimate housing for next year, | 5:44 | |
and as I read it he is rather optimistic | 5:47 | |
on the level of housing. | 5:51 | |
Whether in 1969 we reach the magic | 5:53 | |
two million housing starts, or a little bit later, | 5:56 | |
is not so important as that he thinks | 6:00 | |
the trend is definitely upward, | 6:02 | |
and he can point of course to quite a number of factors. | 6:05 | |
For one thing, the large number of births which occurred | 6:09 | |
right after the war in 1946, 1947, 1948, | 6:15 | |
if giving rise to a marriageable crop | 6:21 | |
of people in their low 20's and we know | 6:25 | |
that the housing market is most directly responsive | 6:29 | |
to increases in numbers in the age groups | 6:33 | |
just beyond that age group. | 6:37 | |
When you get to be 25, 26, you've been | 6:38 | |
married a couple of years, the second child is on the way, | 6:41 | |
then you give up that apartment and you go out | 6:45 | |
and become a mortgage ower out in the suburbs. | 6:48 | |
Well, Mr Clayman, Dr Clayman, taking that factor | 6:53 | |
into account, adding what we know about | 6:58 | |
the increases in rentals that are going on every day, | 7:01 | |
the reduction in vacancies of both apartments and homes, | 7:06 | |
and the fact the building costs | 7:13 | |
continue inexorably to rise, putting all | 7:16 | |
these things together, the outlook for housing | 7:20 | |
for next year is quite good, but of course | 7:23 | |
being an expert in the mortgage market | 7:26 | |
Dr Clayman had to form a judgment | 7:29 | |
as to whether they would be credit available. | 7:32 | |
He does see some squeeze, he does not see | 7:35 | |
a reduction in interest rates below | 7:39 | |
present levels on mortgages but he thinks that | 7:42 | |
the money will be available and people | 7:48 | |
will pay the higher rates. | 7:50 | |
In this connection he commented upon | 7:52 | |
the increase in the prime rate. | 7:55 | |
Perhaps he was interrogated as to whether that would cause | 7:58 | |
a shortage of mortgage money, | 8:01 | |
and his reply was to the effect that | 8:05 | |
the prime rate goes up and the prime rate goes down. | 8:10 | |
Dr Clayman believes that fiscal restraint | 8:16 | |
will work to some considerable quantitative degree, | 8:19 | |
that the first half of next year | 8:24 | |
will be a period of weaker growth | 8:26 | |
than has yet been evident, and that this is quite likely | 8:30 | |
to show itself in a reduction in the prime rate. | 8:34 | |
It is interesting that there's been a discussion | 8:39 | |
as to whether from now on the prime rate | 8:41 | |
will be a more volatile rate. | 8:44 | |
Will it change more often? | 8:48 | |
Will it perhaps change in smaller steps? | 8:50 | |
Quarter steps, 25 basis points, quarter of an interest rate, | 8:53 | |
six to 6.25, 6.5 to 6.75, rather than | 9:03 | |
in half of a percent steps. | 9:08 | |
Some bankers, I noticed the presence | 9:13 | |
of one of the big Boston banks | 9:17 | |
has gone on record saying that he thinks that will happen. | 9:20 | |
I might comment on this prime rate | 9:22 | |
as an economic analyst, it looks to me | 9:27 | |
to be something of the sign of a cartel. | 9:33 | |
I'm somewhat surprised that the department of justice | 9:38 | |
has been quiescent so long in the face | 9:41 | |
of this posted prime rate around which the banks can agree. | 9:45 | |
The theory of the prime rate is, | 9:51 | |
this is the rock bottom rate which is charged by a bank | 9:54 | |
to it's best and most credit worthy customers. | 9:58 | |
The rate is perhaps less clearcut than it would seem | 10:05 | |
because there is a difference in | 10:12 | |
the degree of rationing of it. | 10:16 | |
When money is very tight the prime rate | 10:20 | |
may be administered in such a way | 10:23 | |
that a large, but not the largest firm, | 10:25 | |
finds it is no longer prime. | 10:27 | |
When money is easy this firm may be elevated | 10:30 | |
into the prime rate category and will get | 10:33 | |
as good a rate as the very largest firm. | 10:37 | |
Furthermore as we all know, whenever you administer a price, | 10:41 | |
stabilize it, don't permit it to fluctuate | 10:45 | |
in response to the interplay of both supply and demand. | 10:48 | |
That price often becomes only a surface manifestation | 10:52 | |
of something deeper that's going on below, | 10:58 | |
and so it is with the prime rate. | 11:01 | |
If I today, at General Electric say, | 11:03 | |
pay 6.5% and money gets tighter, | 11:06 | |
and the prime rate continues to be 6.5%, | 11:11 | |
it's just possible even though I am General Electric, | 11:14 | |
that my friendly banker will say to me, | 11:16 | |
we wish you would keep a larger compensating balance idle | 11:18 | |
in return for our conceding this very cheap rate to you. | 11:23 | |
Naturally, if I now have available to me | 11:29 | |
only 80% of my loan instead of 100% of my loan, | 11:32 | |
the fact that I'm still paying 6.5% is misleading, | 11:37 | |
I am really paying 100/80th's of 6.5% | 11:41 | |
and the variability of that fraction of compensatory | 11:45 | |
or compensating balances does give us a flexibility | 11:50 | |
that is not shown in the public statistics. | 11:55 | |
Now, back to more fundamentals. | 11:59 | |
Why is it not surprising that interest rates should be high | 12:03 | |
and that expectations among people | 12:07 | |
in the money market should be for | 12:09 | |
a continuance of high interest rates | 12:12 | |
and perhaps even for an increase in interest rates. | 12:14 | |
From one thing, we must distinguish | 12:19 | |
between the real interest rate | 12:22 | |
and the monetary interest rate. | 12:24 | |
If I lend you a dollar and you give me back | 12:26 | |
a dollar and eight cents at the end of a year | 12:29 | |
then the money rate of interest is 8%. | 12:31 | |
But, if in the meantime the cost of living has gone up by 4% | 12:35 | |
and if I think of it this way, | 12:41 | |
what would that dollar buy in terms | 12:44 | |
of a market basket of goods? | 12:46 | |
That's what I've lent you today, | 12:48 | |
and a year from now with a dollar and eight cents | 12:49 | |
how many units of that market basket of good can I buy? | 12:53 | |
Then I discover that for each hundred | 12:59 | |
of real units I've given up I'm getting back | 13:02 | |
only 104 real units of purchasing power | 13:05 | |
and so the real rate of interest is 4%. | 13:10 | |
Evidently the arithmetic is very simple. | 13:14 | |
I take the money rate of interest, 8%, | 13:16 | |
and I subtract from it the annual | 13:20 | |
percentage increase in the price level | 13:22 | |
as measured by say the consumers price index | 13:25 | |
or any other appropriate index, | 13:29 | |
and that gives me an estimate of the real rate of interest. | 13:31 | |
People in the money market know | 13:37 | |
that consumers prices are still rising. | 13:39 | |
Indeed, the last announcement was quite a jolt. | 13:42 | |
Prices rose point six tenth's of a percent | 13:49 | |
in a single month, people can multiply by 12 | 13:54 | |
and they reckon that to be 7.2% rate of increase | 13:57 | |
in the consumers price index. | 14:02 | |
Actually, the arithmetic would call for an annual rate | 14:05 | |
of a little bit bigger than that | 14:07 | |
but realistically nobody expects that it is safe | 14:09 | |
to take one months peak figure | 14:14 | |
and multiply it by 12 to get a good estimate | 14:19 | |
of the annual rate of increase. | 14:22 | |
Nevertheless that is an indicative straw in the wind. | 14:25 | |
The back of inflation has not yet been broken. | 14:28 | |
I believe the outgoing chairman | 14:31 | |
of the counsel of economic advisors a little bit earlier | 14:34 | |
said we had turned the corner on inflation, | 14:37 | |
well if so, we have been on a detour | 14:40 | |
and we have turned the corner back | 14:45 | |
toward a continuance of inflation. | 14:48 | |
There is a very interesting chart | 14:52 | |
that anybody can construct for himself | 14:53 | |
in which he takes the actual money rates of interest | 14:56 | |
of the last four years say, and subtracts from them | 15:01 | |
changes in the price level, percentage changes annually, | 15:06 | |
to plot a new curve which is the real rate of interest | 15:11 | |
and it's remarkable how horizontal that curve is. | 15:15 | |
We are in real terms still in a 3% economy | 15:20 | |
even though we are establishing records | 15:26 | |
in terms of the money rate of interest, | 15:29 | |
and I think this is not lost upon | 15:33 | |
the investment banking fraternity, | 15:36 | |
the people who invest pension funds | 15:38 | |
and people in the money market generally. | 15:42 | |
I always say when asked to predict the interest rates | 15:45 | |
that I can predict interest rates | 15:49 | |
but first you must tell me what is going to happen | 15:53 | |
to general business conditions. | 15:55 | |
Because I think that if I know | 15:58 | |
the course of general business conditions | 16:01 | |
I can predict pretty well what the preponderance | 16:03 | |
of the forces of supply and demand | 16:07 | |
will be in the money market in terms of the natural forces | 16:09 | |
and I think that I can pretty well predict | 16:14 | |
what the federal reserve will try to about that situation. | 16:17 | |
I say try to do about that situation | 16:22 | |
because there's sometimes a miss between cup and lip | 16:24 | |
and the federal reserve doesn't always succeed | 16:29 | |
in achieving what it thinks it is trying to do. | 16:31 | |
Some people regard the behavior | 16:36 | |
of the officials in Washington as a great mystery. | 16:38 | |
As inscrutable as the Sphinx. | 16:43 | |
I must say I haven't found that to be the actual experience. | 16:48 | |
I sit down on my couch and I think, | 16:54 | |
if I were an idiot like those idiots, | 16:58 | |
or if I were as wise a man as those wise men are, | 17:01 | |
and I were confronted with the present situation, | 17:05 | |
what would I be tempted to do, | 17:07 | |
and it's remarkable how often | 17:10 | |
by that simple test, I can figure out in advance | 17:12 | |
what Washington is likely to do, | 17:18 | |
so it is with the federal reserve. | 17:22 | |
There federal reserve tries to lean against the wind. | 17:25 | |
That doesn't mean with the wind, | 17:29 | |
it means that if in the judgment of a majority | 17:33 | |
on the federal reserve board, | 17:37 | |
the economy is over exuberant, | 17:39 | |
then the federal reserve instructs | 17:42 | |
it's open market committee to put a little pressure | 17:44 | |
on the money market to let interest rates tighten a bit, | 17:48 | |
and contrary wise, if the federal reserve is afraid | 17:54 | |
that unemployment is unduly going to grow | 17:59 | |
and that inventories will be declining, | 18:03 | |
and that we are on the verge of a recession | 18:09 | |
which has no useful purpose, then the federal reserve | 18:11 | |
in it's open market operations | 18:17 | |
and in it's discount rate deliberations | 18:19 | |
will try to lean against the wind | 18:22 | |
and I think that one can pretty much | 18:25 | |
follow what's happening. | 18:31 | |
You don't have to wait that 90 days for confirmation | 18:33 | |
when the published record of the open market | 18:37 | |
committee deliberations becomes available, | 18:41 | |
and so it's pretty clear that people | 18:45 | |
in the federal reserve today like us, | 18:49 | |
do not know to what degree fiscal restraint | 18:52 | |
is going to succeed to cool down the economy. | 18:56 | |
The federal reserve knows that they were wrong | 19:02 | |
in their guess at the middle of this year | 19:06 | |
that fiscal restraint would operate promptly and strongly. | 19:11 | |
The events subsequent to the middle of the year | 19:16 | |
have brought this inescapably to their attention. | 19:20 | |
They probably believe, their staff undoubtedly believes, | 19:26 | |
that the first part of next year | 19:33 | |
will be a period of slower growth. | 19:36 | |
But they have learned not to trust their staff | 19:42 | |
in making advanced predictions. | 19:46 | |
Now I don't mean by this that they lack | 19:51 | |
confidence in their staff, but I do mean by this | 19:52 | |
that they have a measured and calculated | 19:56 | |
degree of skepticism about the ability | 20:01 | |
of even their excellent staff to be accurate | 20:03 | |
in talking about matters that are still | 20:07 | |
in the womb of history, and so they will certainly | 20:10 | |
go slow in increasing the money supply | 20:16 | |
enough to cause interest rates in the short run | 20:22 | |
to ease off from the present level. | 20:26 | |
The only hope that I could give to a person | 20:30 | |
who had a long position in long term bonds | 20:32 | |
and was looking for capital appreciation is this, | 20:36 | |
wait until the federal reserve board index | 20:41 | |
does really begin to decline in a way | 20:44 | |
that is obvious to everybody, and wait until | 20:47 | |
that unemployment level does really begin to rise | 20:52 | |
toward 4% and even beyond 4%, and wait until | 20:56 | |
we do get some solid evidence | 20:59 | |
that the pace of price inflation is decelerating. | 21:02 | |
Then and only then can you have reasoned hope | 21:08 | |
that interest rates will decline. | 21:12 | |
Now, the great guessing game is to what degree | 21:18 | |
the economy is beginning to cool off. | 21:24 | |
We've had a rash of what to my eye, | 21:27 | |
are contradictory signals from the economy itself. | 21:31 | |
Let's take the question of automobile sales. | 21:37 | |
You remember they've been very strong, | 21:41 | |
they've been one of the strongest things in the picture, | 21:43 | |
they alone can explain a good deal | 21:46 | |
of the miscalculations in some of the GMP models, | 21:49 | |
although in some of the more pessimistic models | 21:54 | |
what needs to be explained is much larger | 21:59 | |
than can be explained by buoyant automobile sales. | 22:02 | |
You recall that in the first 10 days of November | 22:07 | |
there seem to be for the first time | 22:14 | |
a languishing in the pace of automobile sales | 22:15 | |
in comparison with the October sales | 22:19 | |
and in comparison with the previous first 10 days | 22:22 | |
of November sales in the last year of 1967. | 22:26 | |
You learn to be a very slow filter in interpreting such data | 22:31 | |
because what happens one 10 days | 22:39 | |
can easily be reversed in the next, | 22:41 | |
and so it was with the automobile sales. | 22:43 | |
The second 10 days of November were very strong | 22:45 | |
in comparison both with October and with last year. | 22:49 | |
More over, there are always difficulties | 22:54 | |
in making such a comparison, you must be very careful | 22:58 | |
that there was nothing unusual | 23:01 | |
about last years second 10 days of November. | 23:03 | |
Was American Motors on strike, | 23:06 | |
had a Chrysler just introduced a promotional scheme? | 23:08 | |
All such matters experienced analysts have learned | 23:13 | |
must be taken into account. | 23:16 | |
- | Thank you very much professor Paul Samuelson | 23:19 |
of the Massachusets Institute of Technology. | 23:21 | |
If you have questions or comments | 23:24 | |
or suggestions for topics you'd like | 23:26 | |
discussed in this series, please send them | 23:28 | |
to Instructional Dynamic Incorporated, | 23:30 | |
166 East Superior Street, Chicago, 60611. | 23:32 |
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