Memo To: Website fans, browsers and clients
From: Jude Wanniski
Re: The Northwest Strike
Under normal circumstances, the collective bargaining process would have been able to produce a contract prior to the deadline. What is not normal is that the national economy is being whipsawed by the worst monetary turbulence since the 1870s, although it is similar to the monetary deflation of 1981-82. The breakdown between Northwest management and the Northwest pilots is due to the fact that both sides are unaware of the external financial forces over which they have no control. The turbulence has been caused by policy errors at the Federal Reserve, our central bank. Here is what I mean:
1. In a true monetary inflation, the entire general price level moves up to get back in line with a fall in the dollar's value relative to gold. Gold is the most monetary of all commodities, which is why it is always the first dollar price to rise when the Fed makes an inflationary error. When there is this kind of upward shift in the gold price because the error persists, other commodity prices will follow in train, and eventually prices of everything in the price universe will settle at the new higher plateau. Because oil also has more monetary properties than most other commodities -- it won't spoil, for example -- it is among the first to follow a gold price rise. We observed this in 1971-73, when President Nixon took us off the gold standard and the gold price quadrupled, to $140/oz. from $35/oz. Only then was it possible for the world price of oil to follow in tandem, quadrupling to $10/bbl. from $2.50/bbl.
2. When the central bank makes an error in the opposite direction, by not supplying the liquidity the market economy demands, the first price to fall also is gold. That is, when "dollars" become scarce relative to gold, the dollar price of gold falls. Other commodity prices are forced to follow in train, the order in the train depending on their monetary characteristics. Again, oil will be among the first to adjust to the new, lower general price level demanded by the dollar/gold price change.
3. In understanding why your contract talks thus far have failed, note that in the last five years the dollar/gold price has followed an inflationary path from 1993 to late 1996, and from then has followed a deflationary path. That is, a relatively steady gold price from 1985 to 1993 ended in late 1993 when the Fed supplied more liquidity than the market demanded. The gold price rose to a $385 plateau from the $350 plateau. Other prices began to rise in train, including the price of oil. In late 1996, the market began demanding more dollar liquidity, but the Fed refused to supply it. The price of gold has been dropping ever since, fed by global demands for dollar liquidity associated with this scarcity. This is a true monetary deflation — not simply a temporary fall in SOME prices associated with a recessionary decline in the demand for goods.
4. In such a deflationary scenario, an airline is subject to the abnormal forces in an unusual way, because its cost of doing business is so heavily dependent upon the price of oil. In the first instance, an airline company will enjoy unusual profits, because the price of fuel declines sharply. An airline in the United States, which is not primarily a commodity economy, will benefit even more than an airline in a country that primarily serves commodity production. That is, traffic remains high while costs decline, thus producing extraordinary profits.
5. In the second instance, though, other prices caught in the deflation scenario change the profit picture for the airline. Its passenger traffic begins to decline, first because its own commodity producers — U.S. farmers, miners, oil producers and the communities that serve them ~ are forced to economize on air travel. As the deflation plays out, all other producers are forced to economize on their air travel as well, with the airline company forced to cut ticket prices to offset the decline in demand.
6. The stock market, as we know, anticipates the profit picture. As it sees the dollar/gold price at $280 instead of the $385 plateau, it knows the happy time for airline profits are behind it, with the crush of competition on the near horizon. This is why airline stocks rose last year and have fallen in recent months. Unless the Federal Reserve allows for sufficient liquidity to push the gold price up to at least $325, the economy will remain in this deflationary environment.
7. Unfortunately, Northwest pilots began their contract planning in last year's happy time. They had taken pay cuts during the recession caused by the Bush tax increase of 1990 and hoped to return to at least that pay scale in this contract period. This was an entirely reasonable goal, and one Northwest could have met if the Federal Reserve had stopped the dollar deflation a year ago at $325 gold. This would have meant slightly lower fuel prices, but would not have wrecked other commodity producers who are part of the passenger picture. At $280 gold, no airline could afford to pay its pilots at the scale now in effect throughout the system. If Northwest agreed to the pilot demands, it would soon be bankrupt.
8. The only reasonable solution at Northwest would be a one-year extension of the current contract. This is because nobody in the world knows what the Federal Reserve will do about the deflation. On the record, its most recent pronouncement was that it is still more worried about inflation than deflation. A great policy debate is now unfolding, with Jack Kemp having the political lead in arguing that the Fed should add liquidity until gold reaches $325. If the Fed tomorrow announced this as policy, the market would immediately bid gold to $325, knowing the liquidity would follow.
9. At this level, the gap between management and labor at Northwest would vanish, for the most part, and a contract would soon be in hand. Because we are not likely to see the Fed follow Kemp's advice in the immediate future, the risks associated with these monetary uncertainties cannot be accepted by Northwest management, nor should the unions insist they do so. A simple extension of the current contract, with a handshake understanding that it will be reopened when the smoke clears, is the most reasonable and logical course of action.
10. With so much acrimony in the air between management and labor, it would be wise for President Clinton to get Northwest back into the air with an executive order, and encourage discussion along the lines suggested here. Once both sides realize why the unusual deflationary episode is the root cause of their ability to come to terms, the air should clear and a constructive path of discussion opened.
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This open letter is being faxed to Northwest Airlines, the union, and the AFL-CIO this afternoon. We will post it on our website at Friday noon, to run over the weekend for the benefit of Northwest employees, shareholders, vendors and customers. It is also being faxed to Chairman Janet Yellen of the President's Council of Economic Advisors and to Erskine Bowles, White House Chief of Staff. Please pass the letter on to anyone you might know at the company as I have no personal contacts there. The topic may arise on "FoxNewsSunday" with Tony Snow, as his guest Sunday at 9 a.m. EST will be Jack Kemp, who will discuss several political and economic matters that are in the news.