The Forgotten Cause of Sound Money
by David Stockman: Mitt
Romney: The Great Deformer
Hazlitt Memorial Lecture, Austrian Scholars Conference, March 10-12,
to the podcast.
Well, it's great to have as our Henry Hazlitt Memorial lecturer
this year, Mr. David Stockman. David is a graduate of Michigan State
University. He did graduate work at Harvard University. He was elected
to Congress three times from the state of Michigan.
And back when
I first went to work for Ron Paul in the reign of Jimmy I
of admiring our own boss, the Ron Paul staff always admired David
Stockman, who got a chance to work with him on things like the draft,
draft registration and other issues. And in fact, among the Republican
staffers, he was generally considered one of the most brilliant
people ever to be elected to Congress. That might seem like faint
praise but it's actually not.
So obviously the talent spotters for the Reagan administration had
the same view. They brought him on board as director of the Office
of Management and Budget. He was the youngest cabinet secretary
in the 20th century when he took that job.
Now, he was
very unusual in that job. I would say unique in the Reagan administration
and maybe unique in Republican politics at the presidential level.
He actually tried to cut spending. And his opponents were people
like Ed Meese, the Conservatives, who always talked a good game
but, in fact, of course, were for bigger and bigger government.
When he left
that job, he wrote one of the most wonderful books ever written
on American politics. I think The
Triumph of Politics was a best-seller. As I say, a very
significant book, too. And in fact, I hope he'll talk to us today
about the book that he is writing right now about crony capitalism
and the very unfortunate current American political and economic
left the Reagan administration and finished his book, he went to
work for Salomon Brothers and then he became a founding partner
of the Blackstone Group, thereby, proving the Republican staffers'
view of him as smart some years before. He now runs his own investment
bank, the Heartland Industrial Partners.
so glad to have you here. It's an honor that you've flown down here
as and he's donating his travel expenses, or an honorary. He's
doing this all on his own as a gift to the Mises Institute and a
gift to us and to everybody who will watch this on the Internet
and in the future on Mises.org.
So please help
me welcome Mr. David Stockman.
Well, thank you, Lew.
And let me
start by saying, like everyone mis-educated in the 1960s
enormously from the economic from Economics
in One Lesson, The
Failure of the New Economics, and all of the other work
of Henry Hazlitt.
But I have
to confess that my mis-education was at Harvard Divinity School,
and the subject was not economics. But I did try to get economically
mis-educated anyway by auditing John Kenneth Galbraith's course
on economics, not knowing at the time that I was going right to
the heartland of error.
seems that his lectures were exceedingly popular. Something like
a thousand students would fight outside the hall to get in. But
I soon learned that it was for the entertainment value. The first
30 minutes or so were non-stop, canned jokes about the stupidity
of Republicans, of businessmen, of Wall Street, of most economists,
and generally anyone who wasn't John Kenneth Galbraith.
But, of course,
I came from I came to these lectures for the substance which followed,
and that was canned, too. But only later did I learn that this part
of the lecture was the real joke of the thing
all was said and done.
Anyway, I escaped
Harvard not being mis-educated in economics. I went to work on Capital
Hill. I worked for a moderate Republican. We were allowed to read
Newsweek in that office.
And as a result,
I became educated directly for the first time by Henry Hazlitt's
columns week after week. And so it really is a great honor to try
to give a lecture today that may update and incorporate and apply
to the circumstances of the moment some of the enormous wisdom and
fundamentally correct economics that he wrote about and stood for
for so long.
So I would
start today by saying the triumph of crony capitalism occurred on
October 3, 2008. The event was the enactment of TARP, the single
greatest economic policy abomination since the 1930s or perhaps
ever. Like most other quantum leaps in statist intervention, the
Wall Street bailout was justified as a last resort exercise in breaking
the rules to save the system. In the immortal words of George W.
Bush, our most economically befuddled president
"I've abandoned free-market principles in order to save the free-market
Now I've checked
that out several times and he did say that, just in case anyone
thinks I'm exaggerating.
Based on the
panicked advice of Paulson and Bernanke, of course, the president
had the misapprehension that without a bailout, quote, "This sucker
is going down," unquote.
Yet, 30 months
after the fact, evidence that the American economy had been on the
edge of a nuclear-style meltdown is nowhere to be found. In fact,
the only real difference with Iraq is that in the campaign against
Saddam, we found no weapons of mass destruction. By contrast, in
the campaign to save the economy, we actually used them
or at least
their economic equivalent.
urban legend persists that in September 2008, this payment system
was on the cusp of crashing and that absent the bailouts, companies
would have missed payrolls, ATMs would have gone dark and general
financial disintegration would have ensured. But the only thing
that even faintly hints at this fiction is the commercial paper
market dislocation that occurred at the time. Upon examination,
however, it is evident that what actually evaporated in this sector
was not the cash needed for payrolls but billions in phony book
profits, which banks had previously obtained through yield-curve
arbitrages which were now violently unwinding.
At the time,
the commercial paper market was about $2 trillion and was heavily
owned by institutional money market funds, including First Reserve,
which was the granddaddy, with about $60 billion in footings. Most
of this was rock solid, but its portfolio also included a moderate
batch of Lehman commercial paper, a performance enhancer I guess
you might call it, designed to garner a few extra bips of yield.
As it happened, this foolish exposure to a defacto hedge fund, which
was leveraged 30 to one, resulted in the humiliating disclosure
that First Reserve broke the buck and that the somnolent institutional
fund mangers, who were its clients, would suffer a loss, all of
should have been a so-what moment except then all the other lending
institutions, who were actually paying fees to money market funds
for the privilege of getting return-free risk, decided to panic
and demand redemption of their deposits. This further step in the
chain reaction basically meant that some maturing commercial paper
would not be rolled over due to money market redemptions.
But this outcome,
too, was a so-what. Nowhere was it written that G.E. Capital or
Bank One's credit card conduit, to pick two heavy users of this
space, had a federal entitlement to cheap commercial paper so that
they could earn fat spreads on their loan books. Regardless, the
nation's number-one crony capitalist, Jeff Immelt, of G.E., jumped
on the phone to Secretary Paulson and yelled "fire." Soon the Fed
and the FDIC stopped the commercial paper unwind dead in its tracks
by essentially nationalizing the entire market.
Even a cursory
look at the data, however, shows that Immelt's SOS call was a self-serving
cry. First, about $1 trillion of the $2 trillion in outstanding
commercial paper was of the so-called ABCP type, asset-backed commercial
paper, paper backed by packages of consumer loans, such as credit
cards, auto loans and student loans. The ABCP issuers were off-balance-sheet
conduits of commercial banks and finance companies. The latter originated
the primary loans and then scalped profits upfront by selling these
loan packages to their own conduits. In short, had every single
ABCP conduit and there was a trillion been liquidated for want
of commercial paper funding in the fall of 2008 and over the past
three years most have been not a single consumer would have been
denied a credit-card authorization or a car loan. His or her bank
would have merely booked the loan as an on-balance-sheet asset rather
than an off-balance-sheet asset. The only noticeable difference
on the entire financial planet would have been that a few banks
wouldn't have been able to scalp profits from unseasoned loans.
In this instance, it appears that President George W. Bush did,
in fact, bomb the village to save it.
billion of this sector was industrial company C.P., the kind of
facility that some blue chip companies did use to fund their payroll.
But there was not a single industrial company in America then issuing
commercial paper which did not also have a standby bank line behind
its C.P. program. Moreover, since these companies had been paying
a 15 or 20 basis-point standby fee for years, their banks had a
contractual obligation to fund these back-up lines, and none refused.
In short, there never was a chance that payrolls wouldn't be met.
The last $600
billion of C.P. is where the real crony capitalist stench lies.
There were two huge users of the finance company C.P. sector this
last $600 billion GMAC and G.E. Capital. At the time of the crisis,
G.E. Capital had asset footings of $600 billion, most of which were
long-term highly illiquid and sometimes sketchy corporate and commercial
real estate loans. In violation of every rule of sound banking,
more than $80 billion of these positions were funded in the super-cheap
commercial paper market. This maneuver, of course, produced fat
spreads on G.E.'s loan book and big management bonuses, too. But
it also raised to a whole new level the ancient banking folly of
mismatching short and hot liabilities with long and slow assets.
Under free-market rules, an inability to roll $80 billion in C.P.
would have forced G.E. Capital into a fire sale of illiquid loan
assets at deep discounts, thereby, incurring heavy losses and a
reversal of its prior phony profits. Or in the alternative, it could
have held the loan book and issued massively dilutive amounts of
common stock or subordinated debt to close its sudden funding gap.
Either way, G.E. shareholders would have taken the beating they
deserved for overvaluing the company's true earnings and for putting
reckless managers in charge of the store.
So my point
is that the financial meltdown during those eventful weeks was not
triggered by the financial equivalent of a comet from deep space,
but resulted from leveraged speculation that should have been punishable
by ordinary market rules.
broadly, or more broadly, the carnage on Wall Street in September
2008 was the inevitable crash from a 40-year financial bubble spawned
by the Fed after Nixon closed the gold window in August 1971. As
time passed, the Fed's market-rigging and money printing actions
had become increasingly destructive, leaving the banking system
ever more unstable and populated with a growing bevy of too-big-to-fail
institutions. The 1984 rescue of Continental Illinois, the 1994
Mexican Peso crisis bailouts, the Fed's 1998 life-support operation
for long-term capital were all just steps along the way to September
2008. Then, at that point, faced with a collapse of its own handiwork,
Washington panicked and joined the Fed in unleashing an indiscriminant
bail-out capitalism that has now thoroughly corrupted the halls
of government even as it has become a debilitating blight on the
So in this
context, the linkage between printing-press money and fiscal profligacy
merit special attention. Now, there are no fiscal rules at all.
And already we have had Cash for Clunkers, Cash for Caulkers
the homeowner's credit, Cash for Convicts
it seems like 2,000 or 3,000 people filed who didn't really need
a home at the moment.
In any event,
my belief is that the subprime meltdown was only a warm up. The
real financial widow maker of the present era is likely to be U.S.
government debt itself. The sheer budgetary facts are bracing enough.
It needs to be recalled that fiscal year 2011, now under way, will
encompass not a recession bottom but the 6th through the 9th quarter
of recovery. During this interval of purported rebound, however,
the White House now projects red ink of $1.645 trillion. This means
that 43 cents on every dollar will be borrowed every dollar spent,
will be borrowed, thereby, generating a financing requirement just
shy of 11 percent of national income. These elephantine figures
mark a big lurch southward since the deficits only half this size
were expected for the current year as recently as last spring.
a full year of green shoots and booming stocks, however, Washington
embraced a monumental round of new fiscal stimulus in December,
as you all recall. The result was a trillion-dollar Christmas tree
festooned with fiscal largess for every citizen, inclusive of the
quick as well as the dead. Moreover
bounty was extended without prejudice to each and every social class,
with workers, the unemployed, the middle class, the merely rich
and billionaires, too, getting a share. It would be foolish in the
extreme to dismiss this budgetary eruption as a fit of tranchet
exuberance even if, by the president's own admission, the White
House was in a shellacked state of mind and in no position to restrain
December's bipartisan stampeded. In fact, the United States is clocking
a 10 percent of GDP deficit for the third year running because this
latest fling of budgetary excess is just another episode in the
epical collapse of U.S. financial discipline that began 40 years
ago at Camp David.
That the demise
of the gold standard should have been as destructive of fiscal discipline
as it was of monetary probity can hardly been gainsaid. Under the
ancient regime of fixed exchange rates and currency convertibility,
fiscal deficits without tiers simply were not sustainable no matter
what errant economic doctrines lawmakers got into their heads. Back
then, the machinery of honest money could be relied upon to trump
bad policy. Thus, if budget deficits were monetized by the central
bank, this weakened the currency and caused a damaging external
drain of monetary reserves. And if the deficits were financed out
of savings, interest rates were pushed up, thereby crowding out
private domestic investment. Politicians did not have to be deeply
schooled in Bastiat's parable of the seen and the unseen. The bitter
fruits of chronic deficit finance were all too visible and immediate.
the four decades since the gold window was closed, the rules of
the fiscal game have been profoundly altered. Specifically, under
Professor Friedman's contraption of floating paper money, foreigners
may accumulate dollar claims or exchange them for other paper money.
But there could never be a drain on U.S. monetary reserves because
dollar claims are not convertible. The infernal engine of the fiat
dollar, therefore, has had numerous lamentable consequences, but
among the worst is that it facilitated open-ended monetization of
the U.S. government's debt.
as I'm sure you all know, can be done in two ways. First, there
is out-right monetization as is now being conducted by the Fed through
its POMO program; that is, it's daily purchase of $4 billion to
$8 billion of treasury debt. Indeed, the Fed's Q.E.2 bond purchases
of late have been so massive that it is literally buying treasury
paper in the secondary market almost as fast as new bonds are being
issued. During January, for example, fully 40 percent of the Fed's
$100 billion bond buy was from numbers of F Series of bonds that
were less than 90 days old. Needless to say, putting brand new treasury
bonds in the Fed's vault before they have paid even a single coupon
is functionally equivalent to printing greenbacks. After all, under
this type of high-speed round trip, virtually all the coupons from
newly issued bonds will end up as incremental profit at the Fed
and be remitted back to the Treasury at year end. Hence, the money
never leaves. Stated differently, in the present era of massive
quantitative easing, newly issued treasury securities amount to
non-interest bearing currency without the circulation privilege.
But over the
last several decades, the preferred course has been indirect monetization.
That is the world's legion of willing mercantilist exporters from
China to the Persian Gulf have printed their own money in vast quantities,
ostensively to peg their exchange rates, but with the effect of
absorbing trillions of U.S. treasury paper. To be sure, the people's
money warehouse in China and those in other mercantilist lands are
pleased to label these accumulations as sovereign wealth portfolios.
But the fact is these hordes of sequestered dollars are not classic
monetary reserves derived from a true sustainable surplus on current
account. Instead, they are simply the book entry offset to the inflated
local money supplies that have been emitted by this global convoy
of peggers; that is, the mercantilist nation central banks tethered
to the Fed.
That this convoy
is a potent mechanism for monetizing the U.S. debt is readily evident
by way of contrast with classic monetary systems anchored on a true
reserve asset. At the peak of its glory, before the guns of August
1914 laid it low, the sterling-based gold standard operated smoothly
with a London gold reserve amounting to 1 to 2 percent of British
GDP. Likewise, in 1959, at the peak of Bretton Woods, the U.S. held
$20 billion of gold reserves against GDP of $500 billion. Again,
at about 4 percent of GDP, the hard monetary reserves needed to
operate the system were extremely modest.
Now the reason
for parsimonious reserve quantities under the gold standard was
the fact of continuous settlement of trade accounts via the flow
of monetary assets. In the case of a balance-of-payments deficit,
for example, the outflow of reserve assets directly and immediately
contracted domestic money markets and banking systems, setting in
motion an automatic downward adjustment of domestic wages, prices
and demand, and encouraging an upward move in exports and domestic
production. In the case of surplus countries, the adjustments were
in the opposite direction. Most importantly, with real economies
constantly in adjustment, central bank balance sheets stayed lean
under the contraption that Professor Freidman inspired, trade account
balances are never settled. They just grow and grow and grow until
one day they become the object of fruitless jabbering at a photo
op society called G-20.
In all fairness,
Professor Friedman did not envision a world of rampant dirty floating.
Indeed, it would have taken a powerful imagination to foresee four
decades ago that China would accumulate $3 trillion of foreign currency
claims, or more than 50 percent of its GDP, and then insist over
a period of years and decades that it did not manipulate its exchange
rate. Still, today, there can be little doubt that China and other
mercantilist exporters operate massive monetary warehouses where
they deposit treasury bonds acquired during their endless dollar-buying
U.S. Treasury Department can now stop splitting hairs about whether
China is a currency manipulator because China just admitted it.
Recently, the vice chairman of the People's Bank of China, Yi Gang,
asked a good question: Why do we have so much base money, he wondered.
Said Mr. Yi, answering his own question, quote, "The central bank
buys up foreign exchange inflows. If it didn't, the Yuan wouldn't
be so stable." Hmm.
I would say, there's one for the Guinness book of understatements
if I ever
So at the end
of the day, American lawmakers had been freed of the classic monetary
constraints. There is no monetary squeeze and there is no reserve
asset drain. The Fed always supplies reserve to the banking system
to fund any and all private credit demand at policy rates that are
invariably low. The notion of fiscal, quote, "crowding out" thus
belongs to the museum of monetary history.
At the same
time, the seemingly limitless emission of dollar claims by the U.S.
central bank results not in a contractionary drain of monetary reserves
from the domestic banking system, but in an expansionary accumulation
of these claims in the vaults of central banks. In less polite language,
a growing portion of the federal debt has ended up in what amounts
to a global chain of monetary Roach Motels, places where treasury
bonds go in but they never come out.
In fact, foreign
central banks hold $2.6 trillion of U.S. treasuries at the New York
Fed, while the Fed itself owns $1.2 trillion of treasury debt. Add
in at least a half trillion more treasury paper that is officially
held elsewhere and you have the startling fact that about $4.5 trillion,
or 50 percent of all the publically held federal debt ever issued,
has now been sequestered by central bankers. With such a mighty
bid from the world's central bankers, we have thus experienced what
our classically trained forbearers held to be impossible, a prolonged
era of fiscal deficits without tears.
To be sure,
it took American politicians a decade or so to realize that the
old rules were no longer operative. Helped immeasurably by the collapse
of the Soviet war machine, Orthodox Senate Republicans and Bourbon
Democrats achieved for a fleeting moment the appearance of fiscal
balance at the turn of the century, but it was not long before the
cat was out of the bag. In making the case for the Bush tax cuts
of 2001, then-Vice President Chaney summed up the new reality, postulating
that, quote, "Reagan proved deficits don't matter." He proved nothing.
He proved no such thing, of course. The Republican politicians of
the George W. Bush-era had most assuredly discovered that they could
borrow with relative impunity. Soon, the GOP transformed the policy
based idea of lower marginal income tax rates from the Reagan era
into a faith-based religion of tax cutting anywhere, anytime, for
any reason. So intense was the reawakening that the floor of the
U.S. House became thronged with fiscal holy rollers, throbbing and
shaking and jerking and gesticulating
exercised section after section of the revenue code. By the time
Bush and the congressional Republicans were through in fiscal 2009,
the revenue had been reduced to 14.9 percent of GDP, the lowest
level since 1950 and far below the 18.4 percent level extant when
Ronald Reagan left office.
To be sure,
lowering the burden of taxation on the American economy is a compelling
idea from both a philosophical and an economic policy viewpoint.
But deficit-financed tax cuts are a politician's snare and illusion.
Such fiscal actions do not actually reduce tax payments; they just
defer the timing. Moreover, the evidence of the last 30 years shows
that preemptive tax cuts don't actually, quote, "starve the beast,"
not withstanding the popularity of this nostrum among certain K
Street philosophers whose day job involves panhandling outside the
Ways and Means Committee hearing room.
as the tax-cutting branch of the GOP busied itself giving every
organized constituency in America some kind of special break, including
incentives to Iowa pig farmers to distill motor moonshine that they
were pleased to call ethanol, the dual fiscal burden of the American
welfare state and warfare state were getting heavier, not lighter.
Here, the GOP's Neo-Con war department and its domestic porker division
were busy, too, pushing federal spending-to-GDP ratio to record
levels. In this respect, the Neo-Cons deserve a special chapter
in the annals of fiscal infamy. Having pushed the American Empire
to take its stand on real estate of dubious merit historically,
that is the bloody plains of the Tigris, Euphrates and the desolate
expanse of the Hindu Kush, they persisted for the better part of
the decade in refusing to finance with honest taxation wars which
they could not win and would not end. The cumulative tab for Iraq
and Afghanistan now stands at $1.26 trillion. And therein lies a
stark tribute to the efficacy with which Professor Friedman's contraption
absorbs the federal debt. The fact is America's conservative party,
so called, did not even break a sweat as it debt-financed what were
assuredly two of the most elective foreign policy misadventures
contrast with canons of classical finance helps crystallize the
picture. Writing in 1924, Hartley Withers, imminent editor of The
Economist and keeper of vignettes of wisdom on matters of money
and central banking, lamented that British finances were in shambles
because the government had broken all the rules of proper war finance
during its battle with the Hun. Rather than obtaining at least 50
percent of its revenue from current taxation and the balance from
the people's savings at an honest wage for capital, it had resorted
to massive inflation of bank credit and issuance of paper money
shin plasters, as they were known then to pay His Majesty's
bills. Withers took special aim at England's first war chancellor,
Lloyd George, thundering as follows, quote, "It is difficult to
exaggerate the evil effects of the economic crime economic crime
that he committed when in the spring of 1915 he imposed no taxation
whatever to meet the massive deficit which faced him."
So at the zenith
of the monetary golden age, sound opinion held that it was an economic
crime to run the printing presses even when a million enemy soldiers
were bivouacked across the channel. Now, a hundred years later,
monetizing the expense of pursuing a tall man and a hundred followers
lost in the high Himalayas apparently doesn't even rank as a misdemeanor.
far we've come.
It was in the
domestic spending arena, however, where the newly liberated Bush
Republicans put the peddle to the metal. During the Reagan era,
there had been a modicum of progress in throttling the domestic
welfare state with domestic spending dropping to 13.4 percent of
GDP after having averaged 15.2 percent of GDP during the Carter
years. Moreover, after the next decade of divided government in
the '90s, the size of the domestic welfare state had drifted upwards
but only a touch, clocking in at 13.5 percent of GDP by fiscal year
thing about the American fiscal future lays in what happened next
with Republican control of both houses of Congress and the White
House for six full years. Now apologists, such as Newt Gingrich,
had excused Reagan's mega deficits on the grounds that conservatives
were not obligated to serve as tax collectors for the welfare state.
And fair enough. With divided government during Reagan's entire
eight years, the political horsepower simply didn't exist to take
on the three core entitlement programs Social Security, Medicare
and Medicaid. By fiscal 2000, however, the big three entitlements
alone costs $740 billion or 7.5 percent of GDP. The time for fundamental
reform is long overdue. But a Republican policy offensive against
the fiscal heartland of the American welfare state never came. Instead,
Medicaid was actually expanded moderately at the behest of Republican
governors; Medicare spending was swollen by a huge new entitlement
for prescription drugs, courtesy of Big Pharma; and Social Security
rolled along without even a sideways glance from the anti-spenders.
Consequently, outlays for the big three entitlements doubled to
$1.425 trillion, or 10.1 percent of GDP in Bush's final budget,
thus upping the fiscal burden by one-third in only eight years.
But wait, as
the late-night commercial admonishes
In that modest
15 percent corner of the federal budget, known as domestic discretionary
spending, Bush-era Republicans went on a veritable rampage. Homeland
security spending, for example, soared fivefold, from $13 billion
in 2000 to $59 billion in 2009. Likewise, outlays for veteran programs
rose from $47 billion in 2000 to nearly $100 billion by 2009. Next
there is the one President Reagan tried to abolish, the Department
of Education. Steaming in the opposite direction, the Bush Republicans
doubled it, from $33 billion to $66 billion. While they touted this
education spending explosion as evidence of, quote, "compassionate
conservatism," the more apt characterization is that once Republicans
embraced yet another function for the American welfare state, they
saw to it that no education lobby group would ever be left behind.
in the numbers.
same eight years, housing and community development spending also
doubled to $60 billion, along with a 75 percent rise in transportation,
a swelling of farm support programs, and enactment of a $60 billion
energy bill providing subsidies for solar, wind, fuel cells, clean
coal, fusion, ethanol the exact menu Republicans once held could
best be sorted out by the free market.
In all, domestic
spending during fiscal 2008 came in at a record $2.3 trillion. After
30 years of a rolling referendum on the welfare state, then the
verdict was clear eight years of Republican government had brought
the burden of domestic spending to 15.8 percent of national income,
a figure materially higher than the average during the last period
of unified Democratic government under Carter. Thus, while the impact
of the Reagan revolution on the size of the U.S. government has
always been immeasurably immodest, it was now totally erased.
The sorry Republican
record on fiscal matters is not merely a morality tale. When the
conservative party and democracy embraces "starve the beast" on
taxing and "feed the beast" on spending, then fiscal governance
breaks down badly; you end up with two free-lunch parties competing
for the affections of the electorate, alternately depleting the
revenue base and then pumping up the spending.
say, this outcome bespeaks irony. Milton Friedman was an unrelenting
foe of big government and the American welfare state, yet the global
monetary contraption he inspired assured its perpetuation. Consider,
for example, how the two-party free-lunch competition has perverted
the basic budgeting process. Here, the basic tool of long-term fiscal
policy, the so-called 10-year budget projection, has been utterly
corrupted by the need of both parties to disguise the full measure
of their profligacy. The most recent CBO baseline, for example,
shows the federal deficit declining from 11 percent of GDP this
year to 3 percent by 2015, a trend which looks like progress. Unfortunately,
this baseline outlook is now useless as it is riddled with fiscal
booby traps, as I call them, in the form of major costly entitlement
and tax law provisions that expire in an arbitrary cliff-wise fashion
one, two or three years down the road.
known, of course, that the Bush income tax rate cuts expire promptly
at midnight on December 31, 2012, causing a $200 billion per year
pickup in the revenue baseline thereafter, at least in the projections.
But what also happens on January 1, 2012, is that the $100 billion
abatement of payroll taxes abruptly expires and so does the so-called
AMT patch. The latter means that the number of taxpayers facing
the alternate minimum tax jumps from four million to 33 million,
causing the projected annual revenue take to rise from $34 billion
under the patch, temporary, to $129 billion, permanent. Likewise,
the 15 percent tax rate in corporate dividends will jump to 40 percent
in 2013. The estate tax goes back up. All the tax credits that are
now in place expire and so forth.
the December Christmas tree contained temporary tax provisions worth
3.8 percent of GDP, the equivalent of $650 billion annually, that
will have completely expired by 2014. The resulting big uptick in
revenue seems antiseptic enough when viewed on the computer screen.
However, were these provisions to expire in real life, upwards of
100 million different taxpayers would take a hit. Consequently,
most of these tax breaks won't expire; their due date will just
be kicked down the road a couple of years as part of the annual,
quote, "rinse and repeat exercise"
passes for budget making.
is not much different on the spending side. Something called the
Doc Fix has been enacted repeatedly; a measure which temporarily
waives the 20 percent drop in Medicare fees built into current law.
Now upon passage, the politicians collect their election year medications
from the grateful physicians lobby while taking credit for a $30
billion future annual spending reduction when the waiver expires.
But, of course, it won't.
extended unemployment benefits, 10 million workers get various,
quote, "extended tiers" of the Unemployment Insurance Program at
an annual cost of $150 billion. But under current law, nearly two-thirds
of this cost is deemed temporary; meaning that out-year budget projections
only show $50 billion of annual expense. The reality, however, is
that to avoid a cold-turkey shock, Congress has repeatedly voted
extensions at the 11th hour and will again in 2012.
there can be little doubt that the GOP is determined to forestall
nearly all of the tax law expirations currently scheduled, including
the rate cuts, capital gains, estate tax, dividends, business credits
and so forth. This means that baseline revenue is only about 16
to 17 percent of GDP according to current Republican policy doctrine.
At the same time, when you remove the spending expiration booby
traps, it appears that current policy for outlays advocated by the
Democrats and most of the Republicans, too, is about 24 percent
So if you go
by the math of it, the current bipartisan policy path results in
a permanent fiscal deficit of 7 to 8 percent of GDP. Now, that would
amount to about $7 trillion in new bond issuance over the next five
years alone and take the total public debt in the United States
to over 100 percent of GDP.
telling, of course, as to how much more of Uncle Sam's debt the
monetary Roach Motels of the world can ultimately absorb. But since
American politicians no longer fear deficits, because they have
been successfully monetized for decades now, we will surely put
the matter to the test.
There is one
powerful factor, however, suggesting that the man with his "The
end is near," sign may show up any day now. Specifically, the afore-mentioned
$1.5 trillion per year of current policy deficits as far as the
eye can see assumes that we are having a Keynesian moment, not an
Austrian one. The new White House budget, for example, postulates
that the Keynesian medication has worked like a charm, thus, there
will be no recession for the next 10 years, although we have averaged
one every 4.3 years since 1947. It also assumes that real GDP growth
will average 3.2 percent over the next decade or double the 1.7
percent average during the past decade. Finally, it projects the
U.S. economy will generate 20 million new jobs during the coming
decade compared to only 1.7 million during the last 10 years. As
the man with the sign also said, "Good luck with that."
In any event,
the already baleful deficit projections would grow by trillions
more under plausible economic assumptions. But the more crucial
point is that the dead hand of Richard Nixon keeps showing up on
the fiscal playing field. Echoing Tricky Dick, today's GOP has once
again embraced the Keynesian faith, even if it has been robed in
the ideological vestments of the prosperous classes; that is, in
a preference to ameliorate cyclical weakness with tax cut stimulants
rather than spending sprees. But not withstanding choice of stimulants,
Republicans, too, believe the U.S. economy is in a conventional
business cycle and that the rebound remains much too fragile to
tolerate any jarring fiscal actions. Thus, the renascent Keynesian
consensus will result in kicking the fiscal can down the road again,
again and again.
It is here
that the true fiscal nightmare arises owing to the possibility that
this mainstream outlook is completely erroneous and that the nation's
deep economy ills are rooted in the massive excess debt burden accumulated
on the U.S. balance sheet after 1971. In that event, we would be
in the midst of an Austrian debt deflation, not a Keynesian cyclical
From a fiscal
perspective, a prolonged debt deflation would be the coup de grace.
That's because debt deflations crush nominal GDP growth owing to
the evaporation of credit-fueled additions to spending. In turn,
lower nominal GDP growth is bad news for revenues because what we
tax obviously is money incomes. Moreover, the actual GDP data suggests
that debt deflation is already resident in the numbers. Total U.S.
credit market debt essentially stopped growing in late 2007 at a
level slightly above $50 trillion compared to $14.3 trillion of
GDP. During the three years since late 2007, total debt growth has
been a tepid 1.5 percent annual rate with public debt growing much
faster than this and financial and household sector liabilities
actually shrinking. Not surprisingly, nominal or money GDP growth
has gained only $530 billion during the 36 months since the peak;
meaning that the annualized growth rate has only been 1.2 percent.
There is no three-year streak that anemic anywhere in the data since
the 1930s. Moreover, even if you allow for the alleged rebound since
Q2 2009, June 2009, the rate of money GDP growth has been only 3.8
percent and was actually just 3.2 percent in the most recent quarter.
the new White House budget projects money GDP growth of 5.6 percent
per annum over the next five years; meaning that nominal GDP would
reach $20 trillion by that latter date. At a 3.5 percent lower rate,
however, which is triple the growth rate of the last three years
and in line with the post-June 2009 rate of advance, money GDP would
come in at only $18 trillion by 2016.
Now this $2
trillion variance might be written off to wild blue speculation,
then again, at the current marginal federal tax yield, the implied
revenue shortfall of $400 billion annually. Stated differently,
the current policy deficit may actually be in the $2 trillion range
after factoring in realistic incomes and revenues.
engine of the dollar may, thus, have been doubly diabolical on the
fiscal front. First, it hooked the American political system on
the "deficits don't matter" theorem by eliminating the economically
painful squeezes and drain on the monetary system that traditionally
accompanied fiscal deficits. Secondly, to the extent that it fueled
a debt super cycle that swelled from 1980 until 2008 that generated
a false prosperity and bubble-derived fiscal windfalls that have
Nixon closed the gold window in August 1971, Secretary Connelly
many of you recall him
told an assemblage of foreign central bankers that, quote, "The
dollar is our currency but it's your problem."
the esteemed secretary had studied at the "Wright Patman School
of Texas Finance," of course, and not the University of Chicago.
But he nevertheless shared Professor Friedman's assurance that floating
the dollar would eliminate the meddlesome problem of the U.S. current
account deficit; that is, such trade objections as might be needed
would be done by non-dollar speakers in the global economy. History
now says otherwise and resoundingly so. Indeed, once relieved of
the immediate pain of self-correcting contractionary drains on our
domestic money markets and banking systems, the U.S. was free to
go on a monumental borrowing spree denominated in the world's reserve
currency. At the same time, there emerged up and down the East Asian
Main, rulers enamored with a development model amounting to export
mercantilism. This scheme produced a plentitude of factory jobs
and social quietude internally while generating massive external
surpluses that could be recycled into vendor financing for ever-expanding
mutant symbiosis between the American economy and the East Asian
mercantilist exporters spawned a long-term outcome that Milton Friedman
held to be impossible under floating exchange rates, namely 33 consecutive
years of deep current account deficits at 3 percent to 5 percent
of GDP, external deficits, which now have accumulated to more than
$7 trillion since the late 1970s.
Now the fly
in the theoretical ointment, of course, is that by pegging their
currencies, the East Asian exporters and Persian Gulf Oilies have
permanently forestalled balancing their external accounts by accepting
cheaper and cheaper dollars as prescribed by Texas-styled monetarism.
Thereby, retaining their export surpluses, the mercantilist exporters
have accumulated treasury bonds from the back hall. Accordingly,
the $9 trillion of current global Forex reserves, mostly held by
the afore-mentioned peggers, are not monetary reserves in any meaningful
sense. They are effectively vendor-financed export loans and they
are what make the present economic world go around.
They are also
what made the U.S. balance sheet go parabolic. For a century after
the resumption of convertibility in 1879, the ratio of total U.S.
debt, both private and public, to national income was remarkably
stable. Despite cycles of war and peace, and boom and bust, this
national leverage ratio oscillated closely around 1.6 times. Call
this remarkably stable ratio of total debt to national income the
Golden Constant. Note further that after the events of August 1971,
this heretofore stable ratio, national level ratio broke out to
the upside and never looked back. By the middle 1990s, it had reached
2.6 times and then soared to 3.6 times national income by 2007,
where it remains. Stated differently, we have added two full turns
of debt on the national income since 1980, an outcome which amounts
to a nationwide LBO.
Now the volume
of incremental debt now being lugged about by the national economy
owing to this debt spree is startling. In round dollar terms, total
credit market debt would currently be $22 billion under the Golden
Constant, i.e., 1.6 times $14.5 trillion of GDP. But today, it is
actually $52 trillion, or 3.6 times.
Now Wall Street
bulls and Keynesian economists, to indulge in a redundancy, insist
that this extra $30 billion of debt is no sweat. Presumably, they
would otherwise not be forecasting 10 years of standard growth with
no recession and would not be capitalizing corporate earnings at
the conventional 15 times EPS. Put another way, by the lights of
mainstream opinion, our parabolic departure from the Golden Constant,
Gold Constant of leverage apparently represents nothing more than
a late-blooming enlightenment, the shedding of ancient superstitions
about the perils of too much debt in households, businesses and
government. If this were true, it would be a pity. Had our benighted
financial forebears only known better, they would have levered up
the U.S. economy long ago, producing unimagined surges of growth
and wealth. Indeed, economic miracles like the Internet might have
been generated at a far earlier time, say in 1950, not 1990. And
it might have been invented by Senator Albert Gore Sr of Tennessee
his son, Albert Gore Jr of Hollywood.
One never knows.
possibility, however, is that our financial forebears actually knew
a thing or two about finance. Perhaps they understood that in not
settling our accounts with the world, we were merely borrowing GDP,
not growing it. The numbers, in fact, suggest exactly that. During
the era of the Golden Constant, about $1.50 of debt growth accompanied
each dollar of GDP growth. By 1989, each dollar of GDP growth took
$2.50 of debt increase. And by 1999, the ratio rose to $3.30. After
this, it was off to the races. When the debt super cycle apogee
came in 2007, it took $4 trillion of debt growth that year alone
to produce just $700 billion of incremental GDP. At that point,
the debt-to-income ratio had climbed debt-to-income growth ratio
had climbed to six times. And shortly thereafter, the man from Citigroup
finally stopped dancing, as you all remember.
of artificially inflated income growth and the bursting of the asset
bubbles, which inexorably follow this kind of debt super cycle,
have arrived at their appointed time. And the financial condition
of the household sector suggests that the postulated Austrian moment
may have a hang time measured in years or even a decade, not months
or a quarter. First, the adjustment in household balance sheets
to date has been in the marking down of housing assets, not any
material shrinkage of debt outstanding. Specifically, household
net worth has dropped by $9 trillion, or about 14 percent since
the final quarter of 2007, however, only $380 billion or 4 percent
of this decline is attributable to reduced debt. The rest is owing
to shrinking asset values.
So by the lights
of the Golden Constant, we still have a long way to go. Indeed,
back in 1975, when America's baby boomers were still young, total
household debt, including mortgages, car loans, credit cards and
billion or about 45 percent of GDP. But today, the far older baby
boom-led household sector has shed almost no pounds since the crisis
of 2008. Total household sector debt outstanding is still $13.4
trillion or 91 percent of GDP, double where we started.
It is always
possible, of course, that the 78 million baby boomers now marching
straight away into retirement will hit the credit juice one more
time. But the only household debt still growing is on the other
end of the demographic curve. Total student loans outstanding, subprime
credits by definition, now total $1 trillion and exceed all of the
nation's outstanding credit-card debt. We've seen this movie before
and it doesn't end happily. If, in the future, households have to
earn, not borrow what they spend, that 3.5 percent assumption about
money GDP growth might look a lot more plausible. The fact is organic
income is not growing at even 3 percent.
point buried in the statistics in our government-Medcaided recovery
is that since the Q3 2008 meltdown, personal consumption spending
is up by $400 billion or nearly 4 percent. But private wages and
salaries are still $100 billion or 2 percent below where they were
before the plunge. Again, these figures are in nominal, not deflated
dollars. Looking at the data since 1950, you can't find a period
in which private money wages were down for even three months, let
alone nearly 2.5 years.
we have been able to keep up the appearance of consumption spending
growth, even if tepid, only by resort to Uncle Sam's credit card.
Specially, the gap between wages, which are still down, and spending,
which is up, has been filled by government transfer payments, all
of which were funded on the margin with new borrowings. Transfer
payments have risen by nearly $500 billion from the Q3 2008 rate.
Thus, the Fed and its global convoy of monetary Roach Motels have
been the source of the entire intervening game in U.S. personal
consumption expenditures and then some. When all else fails, of
course, the possibility remains that a rebound of job growth could
revive wage and salary incomes and get the GDP juices flowing again
at more normal rates, rates compatible with a Keynesian recovery
rather than an Austrian deflation. Well, as the man also said, "Good
luck with that one, too."
non-farm payroll number was $130.5 million, a figure first reached
in November 1999, 12 years ago. And that is the encouraging part
of the story.
Way back then,
there were 72 million I call them bread-winner jobs in the U.S.
economy that is jobs in manufacturing, construction, distribution,
finance, insurance, real estate, information technology, the professions
and white collar services. Average pay levels were $50,000 per year
in today's dollars. A decade later, in February 2011, there were
only 65 million of these same bread-winner jobs left in the economy,
10 percent less. To be sure, this large drain was offset by a six-million
job gain over the decade in what I call the HES complex health,
education and social services. But the 30 million total jobs in
the HES complex have much lower average pay, at about $35,000 per
year, so we were trading down, and their funding is almost entirely
derived from the public purse, which is broke. Consequently, the
era of robust job growth in the HES complex is nearly over. After
experiencing job gains averaging $50,000 per month in health, education,
social services during all of 2000 to 2007, the rate has now dropped
to less than $20,000 per month as the fiscal noose has tightened.
That leaves what might be termed the part-time economy, 35 million
jobs in retail, bars, restaurants, hotels, personal services and
temp agencies. The average wage in this segment is just $19,000
per year. Thus, from the point of view of economic throw weight,
not so much. Other than providing intermittent spells of gainful
employment for bellboys and bar hops, this segment supports no families
and funds no savings, even if it does give Wall Street economists
something to count.
Now none of
this bodes well for a spirited Keynesian recovery or even a toothless
one. Accordingly, the U.S. economy is likely stuck in an extended
Austrian moment and the U.S. government deficit is likely beached
in the $1.5 to $2 trillion annual range as far as the eye can see.
When it soon
becomes evident that most of the $60 billion of appropriations,
so noisily cut by the House Republicans, is mainly smoke and mirrors
and a fiscal rounding error to boot, the test of Professor Friedman's
floating-rate, fiat-money contraption may finally come. Maybe there
is room for trillions more of government bonds to be absorbed by
the mighty bid of the Fed and its chain of monetary Roach Motels.
But looking back to 1971, it seems possible that even the ever-visionary
Richard Nixon did not then realize the ultimate consequence of closing
the gold window and opening the door to China in such close couple.
At that moment,
the China economy the China rural economy, the only one it ever
had, was prostrate under the weight of 45 million dead from starvation
and far more debilitated and destitute, owing to the great helmsman's
economic follies. By underwriting a 40-year debt super cycle, however,
the newly unshackled Fed fueled unstinting American demand for the
output of east China's rapidly expanding export factories. In so
doing, it also drained China's stricken rice paddies of their nimble
young fingers and strong young backs by the tens of millions. Willing
to work the Keynesian hours for quasi-slave pay rates, this army
of refugees from Miles Mayhem put the world's wage and cost structure
through a three-decade long deflationary wringer. In this context,
a clue to the next phase of this saga may lie in the contra-factual.
Had Nixon kept the gold window open, China would have accumulated
bullion, not bonds. America would have experienced deflationary
austerity, not inflationary bubbles. And federal deficits fiscal
deficits would have mattered a lot. Thus, today's terminally imbalanced
world has evolved at complete variance with the outcome that could
have been expected under a regime of sound money.
The risk is
that the doomsday system for global money and trade, which has metastasized
since 1971, may be approaching its end game. By all appearances,
Mile's great rural swamp has now pretty much been drained. Global
wages will therefore start rising because even Wal-Mart has not
been able to discover another country inhabited by millions of $1-per-day
workers. In that environment, the people's printing press in China
will have to drastically slow its creation of RMB and, therefore,
its capacity to absorb treasury bonds. Its fellow traveling central
banks throughout its feeder system of mercantilist exporters will
likely follow its lead. At that point, the Fed will be the last
bid standing. But if it keeps buying bonds, Mr. Market may be inclined
to sell dollars with prejudice, if not violence. If it stops buying
the bond, at what price can trillions more of federal debt find
a place in real risk-based private portfolios? Either way, it will
be a grand experiment. But as they say on television, "It's definitely
not something that should be tried at home."
Congressman David A. Stockman was Reagan's OMB director, which he
wrote about in his best-selling book, The
Triumph of Politics. His latest book is The
Great Deformation: The Corruption of Capitalism in America.
He was an original partner in the Blackstone Group, and reads LRC
the first thing every morning.
© 2013 by LewRockwell.com. Permission to reprint in whole or in
part is gladly granted, provided full credit is given.
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