To Rebuild Confidence

June 18, 1962

When tens of thousands of investors buy and sell millions of shares, each for his own reasons, no one can say with certainty what specific considerations caused the rise or fall. If more than one factor is involved, which invariably happens, no one can know the precise effect of each factor. But whenever the market has a violent rise or fall it is usually possible to make a few reasonable presumptions. Two main factors seem responsible for the recent crash.

The first was the overvaluation of most shares based on the assumption of rapid and inevitable “growth,” plus the assumption of further inflation. And even though both the inflation and the growth were probable, stocks selling at an average of 23 times earnings (as compared with 11.2 to 14 times earnings in 1954–1957) got too far beyond reasonable expectations. At some time a readjustment was inevitable.

But what triggered that readjustment, and made it far more violent than otherwise, was the President’s “cold-fury” press conference of April 11, denouncing the steel price increase as “unjustifiable and irresponsible,” and ordering punitive measures against it. That action was part of a whole package of policies injurious to business. It was a culminating episode that shook confidence profoundly because it left all businessmen wondering whether they would be allowed to announce price changes or whether everything was to be decided by the President’s personal opinion.

FIVE MEASURES

What can be done now to rebuild confidence? In this column of May 14, under the title, “To Restore Confidence,” I suggested seven measures. Let us consider a few such measures again with a different emphasis:

1—The President should abandon all hints that price and wage controls may be desirable or necessary unless labor and management act (in his judgment) “responsibly.”

2—He must also abandon the notion, sold to him by his Council of Economic Advisers, that they have discovered some “scientific” formula for fixing prices and wages. The idea that such a formula is a 3-percent boost in wage rates every year, with a tight ceiling on prices, is dangerous nonsense. Free markets and free competition can decide this enormously complicated problem, not bureaucrats too cocky to understand the superficiality and pitfalls of their formula. Pushing up wage costs while holding down prices is hardly the best way to create business confidence.

Many other measures that shake confidence ought to be withdrawn or repealed. I discussed some of these in the column of May 14, but several positive measures are possible to instill confidence:

3—Faster depreciation write-off should be permitted. The proposed 8-percent tax credit is a subsidy and a needless gimmick. But a 30 or 40 percent initial write-off of new investments in the first year and short write-off terms thereafter could prove a simple and dramatic incentive.

4—Faster write-offs are not a subsidy, but though in the long run they would increase government revenue, they are equivalent to a slight tax rate cut. This and other tax cuts are desirable. One would be to keep the 52 percent corporate income tax only on retained earnings, and to tax at only 50 percent (i.e., a reduction of 2 percentage points) all dividends paid out. This would reduce the inexcusably heavy double taxation on corporate dividends. In addition, all personal income-tax rates above 65 percent should be dropped to that level, now. The result of these measures would be a probable long-run gain in government revenue, and a certain long-run gain in investment and production.

5—It is incredible that in a violently falling market the Federal Reserve should have kept margin requirements at 70 percent. As G. Keith Funston, president of the New York Stock Exchange, said in 1957: “I sometimes wonder at our sense of proportion. A man can borrow up to 75 percent to buy a car, 100 percent to buy a washing machine, and 94 percent to buy a home. But he can borrow only 30 percent to buy an interest in the company that makes the car, the washing machine or the house. We have made it much easier to borrow in order to spend, than to borrow in order to save.”