US 'Chicken Littles': why they doubt Reaganomics

Clearly the "leap of faith" which President Reagan's economic program requires is being taken by fewer and fewer people -- at least among those who manage money on a grand scale.

The President lashes out at the "Chicken Littles" on Wall Street and elsewhere who keep interest rates high, because of their doubts that his radical program tax and spending cuts will work.

In two ways those soaring rates wreak havoc on what Mr. Reagan is trying to do:

* They add daily to the debt burden carried by the US government. This in turn widens the budget deficits which the President vows to erase.

* High interest rates symbolize growing skepticism about the Reagan program among those people who are supposed to know the most about money and its future.

Why, then, are the Chicken Littles acting the way they do?

To extent that interest rates reflect current inflation, rates might well have dropped more than they have, because inflation has come down.

The consumer price index (CPI) and the prime interest rate -- charged by banks to their best corporate customers -- serve as examples:

Inflation as measured by the CPI how runs about 9 percent. The prime interest rate stands at 20 percent. Subtract 9 from 20 and you get a "real" interest rate of 11 percent, which lenders earn on their loans.

This is greater than the spread between the CPI and the prime rate at times during the past couples of years when inflation was hotter than it is today.

Since April of this year, in fact, a reverse movement has taken place. The CPI has fallen and the prime has moved up.

Why? The answer lies in the word "expectations." Current inflation may be moving down, but money managers manifestly expect uncertain times ahead, based on present government policy.

As long as the Federal Reserve Board maintains its current course, credit -- or money available to lend -- will remain tight, partly because the US Treasury will continue to borrow huge amounts of money to pay government bills.

Money men anticipate that the US Treasury's revenue loss from tax cuts, combined with higher defense outlays, will push the budget deeper into red ink, not toward balance.

If this indeed works out to be true, interest rates are bound to stay high.

Many economists foresee a surge of consumer spending, when the Reagan tax cuts begin to leave more cash in people's pockets. Not necessarily a rush to acquire cars and houses (though pent-up demand is there), but lesser household and personal goods which families need but have not had the extra money to buy.

Expanded business activity resulting from this demand would increase competition for limited credit, forcing interest rates upward. Some experts also believe that an upsurge of consumer spending would be inflationary.

Putting all this together, the specialists who lend and manage their own and other people's money, lumped together as "Wall Street," are hedging their bets.

As best as they can, they want to insulate themselves against losing money on the long-term loans they make today. So they charge high interest.

By contrast to the prime rate, interest on short-term loans -- such as the federal funds rate, charged by banks on overnight loans to each other -- have been coming down.

Lenders realize, in other words, that inflation is down for the immediate future and that they can safely lower interest rates on loans of short duration. It is the long term that troubles them.

They become "Chicken Littles," pumping up long-term rates beyond what current inflation would indicate is necessary. This has several consequences:

* The stock and bond markets are devastated, as investors turn to money market funds and other instruments which bring bigger and faster returns.

* The economy is hobbled, as farmers and small-business men postpone borrowing to expand output, because they cannot afford interest rates in the 20 percent range. Interest-sensitive industries like housing and autos are in a slump.

* President Reagan finds the confidence of Wall Street, if not of Main Street , ebbing away -- unless he and Congress together slash government spending to the bone.

of 5 stories this month > Get unlimited stories
You've read 5 of 5 free stories

Only $1 for your first month.

Get unlimited Monitor journalism.