Austin S. Murphy, chairman and president, East River Savings Bank. George J. Nelson, president, The Nelson Fund, Inc. James O'Leary, vice chairman of the board, United States Trust Co. of New York. Robert Ortner, vice president and ecoonmist, the Bank of New York. Gary L. Pote, vice president, Halsey Stuart & Co., Inc. Norman C. Ramsey, consultant, Sulzberger-Rolfe. C. H. Reing, economist, Mobil Oil Corp. Charles E. Saltzman, partner, Goldman Sachs & Co. Malcolm D. Strickler, vice president, Finance, Provident National Corp. Hans A. Widenmann, partner (Ltd.), Loeb, Rhoades & Co. Walter R. Williams, Jr., chairman, Union Dime Savings Bank. John D. Wilson, senior vice president, the Chase Manhattan Bank. Donald E. Woolley, vice president, Economic Division, Bankers Trust Co. Andries D. Woudhuysen, executive vice president and director, Drexel Burnham & Co., Inc. Frank A. Brady, Jr., staff coordinator. OUTPUT SYSTEMS CORP. (By Matthew J. Kerbec*) I am Matthew J. Kerbec, engineer, economist and author of the study "Superinflation/Recession-Causes, Effects and Cures." This was one product of a research program which started in 1970. This effort also provided the theoretical basis for predicting the present economic crisis in 1973. Attached is the latest of seven Economic Reports I have sent to the Office of the President since 1973, warning of the dangers associated with massive sudden price increases for energy and other basic products. My analysis of the present and future state of the economy is much more pessimistic than that contained in the 1976 Economic Report of the President (ERP) in that I consider 1975 an economic disaster and project a grim outlook for 1976. Due to the one-time tax and other fiscal actions taken by the Federal Government in 1975, the monthly and quarterly statistics suffered large distortions. It is only when year-to-year statistics are compared that the real depth of our economic problems becomes frighteningly apparent. Despite $70 billion in added Government spending in 1976, real Gross National Product (GNP) dropped another 2 percent, which was greater than the 1.8 percent drop in 1974 and was the largest one year decrease since the 1930's. It was also the first time real GNP went down two years in a row (ref: ERP, page 1973). Unemployment increased from 5.6 percent in 1974 to 8.5 percent in 1975. When part time workers looking for full time jobs; and discouraged workers are added, the total number of workers in these three categories jumped from 9.9 percent in 1974 to 14.5 percent in 1975. A one year increase of 3,812,000. This caused a tremendous drop in consumer purchasing power which still has not been restored. Another shocker was the $41.1 billion (23 percent) decrease in the "Gross Private Domestic Investment" component of the GNP in 1975 compared to 1974. With the exception of 1974, this was over two-andone-half times lower than any year since 1946, which is as far back as the series goes (ref: ERP, page 172). Machine tool orders fell 53 percent in 1975 which guarantees shipments will be down in 1976. The monthly contracting rate for new construction work fell in the last three months of 1975 and was down 23 percent in December 1975, below the year-ago rate. This is grim news for the construction and capital goods industries for 1976. Those familiar with the "Investment Multiplier" effect of economic theory will recognize how these huge decreases can affect purchasing power and income in 1976. *President, Output Systems Corp. Based on the above considerations and other facts in the attached Economic Report, I believe real GNP will be closer to zero growth and unemployment will continue to hover between 7.5 and 8.5 percent. Inflation will vary between six and nine percent depending upon how wages and energy costs vary in 1976. It must be remembered that the Energy Policy and Conservation Act has a built in escalator which could increase domestic oil prices 10 percent each year until total decontrol is achieved. If, in addition, deregulation of natural gas is implemented, another round of Economic Ripple Effects will be created, resulting in more inflation and layoffs. It was heartening to see that Government economists, after two years, are finally starting to publicly recognize what virulent energy price stimulated Cost-Push inflation/recession can do to an economic system (ref: ERP, page 31). However, this recognition does not extend to action. Adopting a rigid policy of "no price control actions" selective or otherwise, is the greatest single contributor to our continuing economic problems. Canada has taken positive steps to cope with the same kind of problems. The following is an excerpt from their "Anti-inflation Program." In its present cost-push form, inflation threatens to price our goods out of world market and to lessen the capacity of our business firms to expand their operations. It disrupts financial markets and impairs rational planning by business and government. It undermines the effectiveness of the traditional instruments of demand management policy to keep the economy on course. When inflation reaches a certain point, the stimulation of spending may simply lead to higher prices rather than more goods and more jobs; in the longer run, it actually makes unemployment worse. The heart of the Canadian Program is a plan for price and wage controls. A brief listing showing how prices for energy, steel and chemicals rose from 1973 to 1975 is found in item L of the attached table. Prices in the U.S. for these commodities increased over 69 percent in 1974. There is nothing in the Nation's history that can even come close to matching these events. To review, I was able to predict the massive economic distortions we are now experiencing, back in 1973. These trends were completely missed by most economists. A list of references verifying these projections is given in the attached report. Attachment A defines "Kerbec's Energy Law" and two new economic theories which formed the basis for the early predictions. I realize this is outside of the scope of these hearings. However, I would welcome an opportunity to brief the members of the Joint Economic Committee on how these concepts can help formulate economic policies that will be responsive to real world events. One of the great dangers facing us in 1976 is a continuation of the false optimism that is generated when only the optimistic side of a statistical report is headlined. This could lead to legislation that could harm more than help a specific economic problem. For example, the Public Works Employment Act of 1975 missed becoming a law by three Senate votes which were required to override the President's veto. A number of Senators voted against the Act because they thought the economy was recovering. Whether the legislation was "good" or "bad" is beside the question on this point. The important consideration is whether the economy is becoming weaker or recovering. My considered belief is that there are more signs pointing to a continuing economic slump than there are signalling a re covery. Another real threat to any real economic recovery is the fact that energy and basic product prices continue to increase in the face of falling demand. Prices continued to increase in 1975 although production decreased. With steady upward price pressures for basic products classical supply-demand-price relationships become meaningless and there is no real basis for anticipating an economic rebound from so-called normal "free market forces." ATTACHMENT A DEFINITION OF THEORIES Relative economic impact,' theory of.—A theory stating that changes in availability, costs and prices of goods have an economic impact on final sales and prices whose magnitude will depend on the basic need for these goods and will be approximately proportional to the number of profit centers or transactions they must go through before reaching the final customer. The Kerbec Economic Pyramid model of an industrial economic system conceptually represents the economy as six general levels of activity. In broad terms, relative to the need for goods and how they flow through the economy, the activities are: (1) energy producers; (2) basic industries; (3) intermediate industries; (4) finished goods industries; (5) wholesale; and (6) retail operations. To illustrate, the two most pervasive needs in a profit oriented economic system are labor and energy. Changes in cost or availability of these needs have rapid and cumulative effects on all organizations and sectors of the economy. For example, a $1 billion change in either labor or energy costs in the basic steel industry has a much greater impact on customer prices than a similar $1 billion increase on the wholesale level. In the above model, changes in basic steel costs will be subject to five cumulative markups while a similar cost change in the wholesale level will only be subject to two markups and the "relative economic impact" will be less. If many cost changes for energy and labor were to occur simultaneously in any of the levels, the total economic impact would be synergistic (the total effect would be greater than the sum of the effects taken alone). See Economic Ripple Effects. Economic ripple effects,' theory of.-Based on the proposition that an industrialized profit oriented economic system is made up of a network of interdependent subsystems, the theory supposes that variations in: raw material costs; labor costs; selling prices; and other inputs to production and pricing policies will force more changes. This process creates and propagates new effects which inIclude, but are not limited to, further changes in prices; sales; wages; employment; interest rates: budget deficits; national sceurity; and possible social and political disorders. The severity and life of these effects will depend upon where in the system the original variation(s) occurred; the pervasive impact of the change (s); the rate at which they were applied; the duration of the change(s); the magnitude of the change(s) and the need by customers for the goods and services affected. ABSTRACT Since the second quarter of 1975, the Ford Administration has showered the American public with misleading optimistic reports that have totally obscured the true state of the economy. This report, using Government published figures, proves that the economy in 1975 was much worse than 1974 and that the economic picture is bleak for 1976. False optimism is a deterrent to real economic health. 1 Based on concepts from the publication, "Superinflation/Recession-Causes. Effects and Cures" by Matthew J. Kerbec; published by Output Systems Corp., Arlington, Va. Note. The above theories were an offshoot from the corollaries derived from Kerbec's Law-"Energy is required to perpetuate, change the form of and move all living and nonliving matter. The Law provided a scientific basis for recognizing that commodities had different economic characteristics that could be used to better understand the precise mechanisms that govern the behavior of an economic system under varying conditions. In 1975, the Federal Government spent over $70 billion more than in 1974. Despite this record expenditure, real Gross National Product (GNP) had a greater drop (2 percent in 1975 than the 1.8 percent decrease in 1974. If the Department of Commerce had not switched calculations of real GNP from a 1958 to a 1972 base year, in the third quarter of 1975, the decline in real GNP would have been even higher. Not since the depression in the 1930's has the GNP declined two years in a row. This represents an unstable economy with more bad news to come. It is truly frightening to realize what the economy would have been like if the $70 billion had not been spent. In 1975, unemployment went up to 8.5 percent. When part time and discouraged workers are added, the total number of workers in these three categories jumped from 9.9 percent in 1974 to 14.5 percent in 1975. An increase of 3.812 million in one year. Another shocker was the drop in the "Gross Private Domestic Investment" (GPDI) component of the GNP in 1975 which amounted to $41.1 billion. With the exception of 1974 this was over 2.5 times lower than any year since 1946 which is as far back as the statistics go. Specifically, new orders for machine tools dropped a huge 52 percent in 1975. These events foreshadow more unemployment in the construction and capital goods industries in 1976. As prices increased, sales of houses and automobiles decreased in 1975 (see Attachment 1-E, F). Prices for energy, steel and chemicals continued to climb, after an average 69.58 percent increase in 1974, even when there was a significant drop in demand. Total sales (manufacturing, wholesale and retail) were lower in 1975 when corrected for inflation. Massive inventories are still with us, $18 billion higher than in 1973 and only lower by $1 billion compared to 1974 (see Attachment 1-D, L). We are still in a virulent recession. Recall the headlines announcing a huge 12 percent GNP increase in the third quarter of 1975, and the satisfaction expressed by some Government spokesmen who declared the 5.4 percent increase in the fourth quarter was a good sign the economy was healing at a more conservative rate. However, there were no headlines explaining why-with all this good news, the GNP actually decreased by 2 percent for the year and private investment skidded a record $41.1 billion. Telling the American people the economy is improving, when the GNP is dropping, not only causes great harm, but it is a serious perversion of the truth and can only lead to a further erosion of public confidence in Government Businessmen in energy and other industries which produce products people need to survive have reacted to these optimistic reports by continuing to raise prices as sales decline. Under these conditions, there is no possibility for a normal economic rebound. DISCUSSION For most of 1975 we have been exposed to a continuous barrage of explosively optimistic week-to-week, month-to-month and quarter-to-quarter economic reports published by the Federal Government. In 1975 the Government spent $70 billion ($20 billion in tax rebates, social security bonuses and reduced income taxes; $34.6 billion in Transfer Payments; and an estimated $15.4 billion in housing subsidies, grant programs, make work projects and pay raises for Government employees) more than in 1974. This was still not enough to compensate for the 8.7 percent (GNP Implicit Deflator) inflation which caused a loss of purchasing power of about $120 billion in 1975. While some of this was returned in the form of higher wages, the amount was not enough to cancel the Economic Ripple Effects resulting from the higher prices. The Government is forecasting a 6 percent inflation for 1976 with a $1.684 trillion GNP. This indicates there will be a loss of purchasing power in 1976 in the order of $95 billion. If the Government's present plans to cut taxes by another $10 billion while cutting Government spending by $28 billion are implemented, the economy will continue to decline at a faster rate. The ultimate irony is that until something is done to cure the huge distortions in prices for energy and basic products there is no way the Government can restore purchasing power at the rate at which it is being drained away in higher prices. The drops in GNP in 1974 and 1975 are real world reminders of how an economic system can deteriorate when vital key prices go through the roof. It is important to see what really happened in 1975 when the key year-to-year statistics are analyzed. |