When the minutes of the July FOMC meeting were released this week, the big news was that Gary Stern, president of the Minneapolis Fed, cast the lone dissenting vote in the decision to leave interest rates where they were. Stern argued for an immediate increase. In understanding why, we get a clearer picture of the forces at work on Fed Chairman Alan Greenspan as he struggles to hold interest rates down at least through the November elections. Unlike other Fed presidents who have been identified as inflation hawks over the years, those whose votes are largely determined by economic theory, Stem is not an ideologue. His vote to raise interest rates follows from the fact that of the twelve Federal Reserve districts, Minneapolis has the tightest labor market and the greatest upward pressure on wage rates. In the other districts, even where employment rates are low, wage pressures remain subdued. We find an interesting exception reported by the St. Louis Fed, which finds the Kentucky poultry industry having to import foreign labor to pluck the chickens.
This is all to remind us that the United States is not a homogenous economy. There are almost always parts of the country that are technically in recession and others that are in technical booms. So it is with the relative boom in the Minnesota district, the Fed's Ninth, where the business community is feeling the distress of growing pains: '"Highly skilled people are really tough to find,' says a North Dakota manufacturing CEO reprising a familiar theme in the Ninth District. Unemployment rates remain well below national averages in all areas of the district except the Upper Peninsula of Michigan, and help wanted signs are omnipresent in most urban areas. Employment growth has occurred across most sectors and help-wanted ads range across manufacturing, retail and business services."
The problem for Greenspan is that if interest rates are raised to relieve upward wage pressures in the Ninth District, the increase also slows capital formation in the weakest districts, Atlanta, the Sixth, Richmond, the Fifth, both of which have high percentages of unemployed or underemployed African-Americans. As the saying goes in the black community, blacks are the last hired and the first fired; their concentrations may be at the lowest point in the Minneapolis district. It is understandable, then, that the loudest squawks at Fed tightenings come from the Congressional Black Caucus and Democrats who represent high concentrations of lower-income black and white Americans. If interest rates are not raised, wages will continue to rise in the Minneapolis District until sufficient numbers of skilled workers are pulled in from the surrounding districts or employers finance the training of local unskilled workers in order to capture profit opportunities. What also occurs is an outflow of capital from the Minnesota District to the others, as enterprises attempting to earn a profit in low-value added goods and services can no longer compete. Households and firms then have to import these goods from the other districts, or from abroad, which of course helps spread the prosperity.
If the collection of reports from the twelve districts (the "beige book") indicates upward wage pressure spreading through other parts of the country, Greenspan will be under greater pressure to raise interest rates to slow things down. Remember, though, that the system is tilted in favor of the business establishment. The tendency is to keep the labor market a buyer's market. In a monetary system where the dollar is tied to gold, the business establishment has no recourse to a Federal Reserve that has the freedom to slow the economy. As long as the dollar price of gold is constant or held within a narrow band, the upward pressure on wages reflects productivity increases that force employers to increase wages — or forgo profits. The labor market can become a seller's market, which is how living standards rise. With a gold link, those parts of the United States that are growing faster than other parts are forced to live with their growing pains. The pace of change often requires them to take risks they would prefer not to take, but after all, risk-taking is the source of all economic growth.
Absent gold, the dollar is inevitably subjected to political pressures of the kind that we now see flowing through the vote of the Minneapolis Fed president. Gary Stern is doing what he thinks best, but his decision nevertheless is a subjective one. The bond market has to interpret every scrap of news that suggests upward pressure on wages becoming the norm, rather than the exception, which may eventually mean the Greenspan Fed will have no choice but to choke off a healthy economic expansion. It is true enough that some of the upward pressure on wages and prices is the gradual unwinding of the 10% increase in the gold price of late 1993, to the mid-$380s from a steady $350, when the Greenspan Fed found itself accommodating the Clinton tax increase. Nevertheless, it now makes no sense to us to follow the advice of former Fed Governor Wayne Angell, who would raise short-term interest rates to deflate the gold price back to $350.
It probably couldn't be done anyway, given the Fed's current operating mechanisms. If the 1994-95 series of rate increases could not depress the gold price, we do not think another round would have any effect either. The Fed could depress gold by starving the banking system of liquidity, which it could do now by refusing legitimate demands for currency. This would be poor policy indeed. Having worked off much of the monetary accommodation that sent gold up, it is rather late in the day to correct the error with a deflation. Greenspan will simply have to figure out how to muddle through to November without a rate increase, as we believe he will. President Clinton already has a problem in keeping the Democratic Party's black and minority constituents from being lured by the Dole/Kemp initiative. Clinton would have to complain loudly — as Kemp most certainly would — if the Fed raised rates prior to the election. What happens after November 5 is another story, one that has not yet been written.