A Preview Of Our Keynote Speaker

Q&A With Brian Domitrovic

Sponsored by:

Domitrovic is the Richard S. Strong Scholar at the Laffer Center and Professor of History at Sam Houston State University. He holds a Ph.D. from Harvard University and is the author of several books, including Econoclasts: The Rebels who Sparked The Supply-Side Revolution And Restored American Prosperity, considered the standard history of supply-side economics.

He co-authored with Larry Kudlow (Former Director of the National Economic Council of the United States)  JFK And The Reagan Revolution: A Secret History of American Prosperity.  (Prof. Domitrovic will be available to sign books following his presentation.)

Prior to speaking at PFA's Spring Meeting. Prof. Domtrovic answered a few quesitions about economics with our Executive Director, Russ Batson.

We are experiencing a bout of inflation reminiscent of the days when the Pittsburgh Steelers dominated the NFL, and Saturday Night Live was actually funny.  What factors led to that experience in the 1970’s?  Then we can talk about what’s going on today.

The Steelers championship seasons of 1974-1975 and 1979-1980 actually corresponded to the highest inflation years of the stagflation period. In the first two years, inflation totaled 21 percent, and in the latter two 26 percent. Overall, from 1966-1982, consumer prices tripled.

Innumerable explanations have been put forth about the causes of that “Great Inflation.” The 1973 oil shock, the wage-price spiral, and the decline of American competitiveness are commonly cited. The clearest explanation, however, is that fundamental change came to the monetary system at the outset of this period. The world left fixed for floating exchange rates and the historical link of money to gold came to an end. These events happened progressively in the five years after 1968. By 1973, no major currency was on gold—unheard of in peacetime history—and exchange rates were not fixed but floating—also unheard of.

This unprecedented switch prompted a decade’s worth of price discovery in the markets about what any currency was worth. The manifestation of this was inflation, in particular in the most durable, and among these the most tradeable, goods—gold, oil, land, collectibles. While prices in general tripled, oil went up 13-fold; gold 23-fold.  In the 1980s, price discovery at last abated, indeed largely ended with the big tax-rate cuts in the United States.  These cuts sharply increased the rate of return on dollar-denominated investments. Therefore, demand for the dollar soared. This eliminated the basis of inflation.

A different mix of factors is at work today, I guess. No revamp of the monetary system, right?

Today, there has been no official switch in the monetary regime. In fact, finance leaders disavow even contemplating monetary reform. The Fed’s huge balance sheets, the tremendous governmental budget deficits (each round of new debt almost wholly bought by the Fed), and super-low interest rates for years are markers of a system that is content to claim that there is no restraint on the monetary and fiscal powers of the received institutions.

However, as a practical matter, creative destruction began to come to the field of money with Bitcoin in 2009. In cryptocurrency’s third decade,  its challenge to the official monetary system is now considerable . The combination of incredibly non-restrictive monetary and fiscal policy with the rise of a monetary alternative playing the long game has convinced the money markets of something. This is that another period of price discovery of official money is upon us. The manifestation is inflation.

Last week’s GDP report showed that the U.S. economy shrank slightly in Q1 2022.  Should inflation and contraction be happening at the same time?

Economic theory used to teach that there is a tradeoff between inflation and low employment. The idea was that increases in employment result in such an increase in total wages that prices must go up. The flaw in this theory (known as the Phillips Curve) was not accounting for the increase in production that comes with the increase in employment and wages.

Our stagflation today makes sense. The managers of the dollar--the fiscal and monetary authorities--have shown little regard for restraint. Therefore the dollar is depreciating. Labor-force participation is at historic lows--therefore growth is negative. There is no contradiction. Less production means less goods and services, which means what is for sale can cost more.

What policies could increase the economy’s capacity to grow more rapidly w/o inflation. 

An increase in the natural demand for the dollar for use in investment is the antidote to inflation. People will not trade the dollar for goods and services if they think that investing via the dollar—with future returns in the dollar—has good prospects. The easiest way to increase this natural demand is to cut tax rates that investors face. These are, mainly, marginal rates of the income tax and the capital gains rate. When inflation departed in the 1980s, it was precisely in the context of sustained cuts in these rates. The after-tax return to investment and earning rose so much that people borrowed money—which had been depreciating for 16 years— for investment purposes at a furious clip. Bond prices soared as it became clear that corporations (and governments) could cover principal given the increase in the after-tax rate of return.

Today,  with millions of people receiving government benefits, labor force participation is way down. Therefore businesses have less of a chance to contract labor. This lowers the rate of return on an investment and decreases the real demand for the dollar. A government stacking up $30 trillion in debt shows no resolve toward avoiding currency devaluation. This discourages people from wanting future returns in dollars. Government spending gobbles up resources that investors might wish to use profitably, again lowering the natural demand for the dollar.

Increasing the return on work and investment would abate inflation today. Challenging crypto by making the dollar naturally competitive, ultimately probably inclusive of letting private entities and not just the Fed create the dollar (as before in history) would compete the job.

Immigration is one of those topics often viewed through a political lens rather than an economic one. As the U.S experiences labor shortages and inflation, could sensible immigration policies help?  Do we have the right criteria in place to decide who gets admitted, i.e., is there sufficient focus on job skills?

Never in American history has robust economic growth occurred without immigration. This includes in the 1960s, when engineering-oriented immigration was the order of the day.  Immigration is a natural consequence of significant economic growth. The labor markets of the world want to come to the place with opportunities.

Today, the nearly 10 million dropouts from the labor force in the US since the mid-2000s requires a remedy. Business cannot succeed—there cannot be good returns on investment—unless labor can engage capital. Freeing up the domestic labor market by eliminating means testing of government benefits and moderating the huge increase in quasi-welfare programs since 2008 would begin to accomplish this task.

Job skills correlate most of all to the habit of working. The domestic dropouts have seen skills atrophy. If legal immigration became more expansive, business would figure out quickly how to train workers and get them productive.

Your writing has focused on supply-chain policies designed to encourage investment in businesses and productive assets.  However, do you see a time and place for demand-side (Keynesian) measures that encourage spending?  The stimulus checks and related policies during the pandemic did seem to prop up consumer purchases.

There is a flaw at the heart of Keynesian spending programs. All the direct effects cancel out. Stimulus checks come from somewhere—taxes, borrowing, new money creation. On that other side of the ledger, stimulus deprives people of money. Banks have less to lend, capital markets have already made their move, new money does not go to investors. These things mathematically cancel out, those of the stimulus receivers and stimulus financiers.

In addition, however, stimulus spending imposes barriers to production. Giving people money is an incentive to work and earn less, at the margin. Stimulus necessarily means that production achieves less than it could than under a regime in which real rates of return are high and markets are left to clear. The greatest case of all was the several years after war’s end in 1945. Government spending fell by three-quarters as unemployment never got above 4 percent. There was a huge re-privatization of the economy, and non-governmental, or “real sector” GDP soared.  

During Covid, GDP fell precipitously. One of the effects of stimulus was to make people less intrepid in gaining income. Stimulus correlated directly to GDP loss. 

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