"...unhinged bragging about a booming economy, which isn’t; wars he has settled, which he didn’t; falling gas prices & inflation rates that were none of his doing; winning so much that imaginary people are begging for less; & touting an utterly delusional golden age future that is not even remotely on the horizon."

"Well, if there was ever any doubt, now we know. Donald J. Trump is a very badly deformed personality, who is a walking grievance machine. And he has turned his own demons into a toxic form of Rightwing Statism, which threatens to ruin what is left of free market prosperity and constitutional liberty in America.

"Having apparently accumulated 79 years worth of wrongs, slights, rebukes, disses and disappointments, the Donald is now, and for most of his adult life has been, all about getting even. He pursues his revenges via a combination of self-glorifying braggadocio and pugilistic verbal aggression against any and all designated enemies who come to top of mind at any given moment.

"That was on full display Tuesday night in the form of his unhinged bragging about a booming economy, which isn’t; wars he has settled, which he didn’t; falling gas prices and inflation rates that were none of his doing; winning so much that imaginary people are begging for less; and touting an utterly delusional golden age future that is not even remotely on the horizon. ...

"We have had the privilege of viewing every State of the Union address for the last 56 years, including 13 of them from the very floor of the House of Representatives that the Donald defiled Tuesday night.

"Over that span we have heard them all: Nixon, Ford, Carter, Reagan, Bush the Elder, Clinton, Bush the Younger, Obama, Trump 1.0 and Biden. But no US president before him has even remotely approached the level of vitriol, rancour, bombast, rudeness, raw partisanship and bully-boy acrimony that flooded the Chamber in ill-tempered bursts for the better part of the Donald’s two hours at the podium.

"At the end of the day, therefore, Trump finally did it. Not only is he a loud-mouth egomaniac who sports no compass except his own fame, fortune and glory, as we have long understood. But now he has made himself a National Disgrace like no other leader in the very 250 years that he claimed to be celebrating last night."

~ former Reagan Budget Director David Stockman on 'Trump's State of the Union: Two Hours Of Demons Unbound And Rightwing Statism On The Boil'

Pay no attention to the (mad) men behind the curtain [updated]

Readers here might remember I got some stick for calling John Key a fucking moron a while back. A fucking moron, specifically, for repeated calls for the Reserve Bank to juice up house prices again, just so home-owning voters will feel better again. Feel better again, and then vote National.

"The guts of what’s wrong," explained the moron, "is that the housing market is going down, not up" — and "then you have a negative wealth effect," and voters feel bad. And when they feel bad, they vote for the other team.

Classic short-termism.  Stuff rocket fuel into the economy, and then all things will be jake for the governing political parties. This, by the way, was Key's "one simple trick" while Prime Minister: ensure massive house-price inflation, no matter the economic and social dislocation, and then sit back and watch home-owners fooled into feeling better off, and borrowing and consuming more, regardless of the economic consequences. (Consequences for which we're all still paying, by the way.)

In the US, the discredited "wealth effect" — "a gussied-up version of Keynesian stimulus, only targeted at the prosperous classes rather than the government’s client classes" — is generally felt in the stock market. Pundits there are starting to get nervous about a soaring stock market with anaemic growth in the economic system itself, with "important implications for the path of America’s stockmarket boom and its economy."

The good times could continue, at least for a bit longer [says 'The Economist']. ... [But] might a wealthier society also take a harder fall? Bears would point to the bursting of the dotcom bubble in 2000, when a brutal stockmarket slump pushed America into recession. ... The stockmarket might be more of the economy. It still is not all of it.

It's not. And nor is the housing market. We can't get rich just by selling each other houses. (And kudos to one National minister at least who understands that.)

Yet David Stockman is concerned that nothing has been learned from the last major crash. 

Roughly 15 years ago it was reasonably well understood that the Great Financial Crisis of 2008-2009 had been case of speculation run amuck on both Wall Street and main street alike. These credit and housing bubbles, in turn, had been fuelled by the massive money-printing sprees of the Greenspan and Bernanke Fed.

It might have been presumed, therefore, that the mad money-printers [at the US central bank] would have had second thoughts about the underlying cause of these great economic disasters—that is, the dubious Greenspan policy known as the “wealth effects” doctrine. In simple terms the latter held that if people felt richer owing to soaring home prices and their stock market winnings, they would spend more freely and fulsomely, thereby goosing the Keynesian cycle of ever more spending-sales-production-income-and spending, which was to be rinsed and repeated in an endless round of rising prosperity.

At the end of the day, of course, Greenspan and his heirs and assigns at the Fed turned out to be unreconstructed Keynesians and the wealth effects doctrine a monumental economic con job. The latter did not make society richer; it just made the rich richer. Or stated more directly, main street got inflation at the grocery store, gas pump and doctor’s office—even as the asset-holding class experienced unspeakable windfalls in their brokerage accounts.

Let's not repeat the same mistake again here — especially when local interest rates are already below our trading partners, with no noticeable effect on genuine economic progress. Please: pay no attention to the mad men behind the curtain.

UPDATE:

"The advocates of annual increases in the quantity of money never mention the fact that for all those who do not get a share of the newly created additional quantity of money, the government's action means a drop in their purchasing power which forces them to restrict their consumption. It is ignorance of this fundamental fact that induces various authors of economic books and articles to suggest a yearly increase of money without realising that such a measure necessarily brings about an undesirable impoverishment of a great part, even the majority, of the population."

~ Ludwig von Mises from an interview 'On Current Monetary Problems'

"GreenMageddon is no hyperbole." #COP26

Data on disaster deaths come from EM-DAT, CRED / UCLouvain, Brussels, Belgium 

– http://emdat.be (D. Guha-Sapir)

"GreenMageddon is no hyperbole. It’s is the virtually certain outcome of attempting to purge CO2 emissions from a modern energy system and economy that literally breathes and exhales fossilised carbon. Indeed, the very idea of converting today’s economy to an alternative energy respiratory system is so far beyond rational possibility as to defy common sense."
           ~ David Stockman, from his post 'GreenMageddon, Part Five'

FURTHER READING:

"While climate catastrophists claim that our climate is less livable than ever because of fossil fuels, it is actually more liveable than ever thanks to our fossil-fuel powered climate protection..."

    Climate Crisis - Energy Talking Points

"The upcoming UN Climate Conference, COP 26, is a continuation of the celebrated "Paris Climate Accords." But these accords required, among many other evils, the senseless sacrifice of America."
    Paris Climate Accords - Energy Talking Points

The only practical way to lower global CO2 emissions is to encourage innovation that could make low-carbon energy cheap for everyone. 

    CO2 Emissions - Energy Talking Points 

'The Great Inflation Sabbatical Is Over' [updated]

"The Fed’s obsession with its inflation targeting goals has led to the worst of all possible worlds: Namely, roaring financial asset inflation which is profoundly inequitable and destructive of capitalist prosperity, followed by a renewed outburst of goods and services inflation that has come out of hiding from ... China ... "
          ~ David Stockman declaring 'The Great Inflation Sabbatical Is Over, Part 1'

UPDATE: 

"It should be damn obvious by now that the Fed’s massive monetary inflation of the last several decades has manifest itself primarily in asset prices. And that’s a very sharp change from the initial period of fiat money after August 1971 when goods and services inflation predominated. For want of doubt, here is the smoking gun ..."

 

"The 'everything bubble' is deflating. The fact that it’s happening relatively slowly shouldn’t blind us to the real threat: The world is dangerously underestimating how hard it’ll be to deal with the fallout once it pops." #QotD

"The 'everything bubble' is deflating. The fact that it’s happening relatively slowly shouldn’t blind us to the real threat: The world is dangerously underestimating how hard it’ll be to deal with the fallout once it pops."
        ~ David Stockman, commenting on the article 'The Bubble’s Losing Air. Get Ready for a Crisis'

Quote of the Day: On ‘growth by deficits,’ i.e., the supply-side fantasy

Former Reagan budget director David Stockman (from his book The Great Deformation: The Corruption of Capitalism in America) writing on the modern Republican Party fantasy that is about to be tried by another new president:

“A bastardised variation of supply-side theory has been embraced by Republican politicians in the years since Reagan. They have not explicitly claimed that deficits are harmless—they have just attempted to define the issue away.
    “The argument has been that deficits are essentially the by-product of a weak economy and that the solution, therefore, is to undertake policy actions directed at growing the GDP, not shrinking the budget columns. Not surprisingly, the way to get more GDP growth is claimed always and everywhere to be through lower taxes. In due course, fiscal deficits disappear because the economy grows the revenue line back to balance.
    “The trouble with this shibboleth is that it was put to the test and failed a long time ago, during the Reagan-Bush recovery after 1982… It is not reasonable to expect a better macroeconomic backdrop than this eight-year expansion, yet spending remained close to 22 percent of GDP and revenues were at 18 percent of GDP right up to the downturn in the second half of 1990. The deficit gap was plain and simply structural—the result of policy choices, not a weak economy. …
    “So the “grow your way out” theory had been invalid from the very beginning. Yet by embracing it in the decades since then, congressional Republicans have transformed their real job, managing the finances of the US government, into a sub-branch of statist pretension; that is, centrally managing the growth of the private economy through chronic fiddling with taxes.
    “These numbers are bad enough, yet they fail to capture the more significant fiscal legacy of the Reagan Revolution. The more profound outcome was that the old-time taboo against chronic deficit finance in peacetime had been jettisoned by the Republican Party.  …
    “How can economic growth remain high and inflation low for the long run when the Administration’s policy is to consume two-thirds of the nation’s net private savings to fund the Federal deficit? …
    “The massive Republican deficits after 1980, which reached their ultimate conclusion in George W. Bush’s final trillion-dollar-bailout-nation era, had not been ‘on the level.’ Beneath the economic surface, the pernicious force of printing-press money had been gathering volcanic momentum since 1971. And it was this unprecedented monetary deformation which finally accounted for both the debt-fuelled illusion of prosperity and for the long, extended deferral of the day of fiscal reckoning… In the epigrammatic phrase of the great French monetary economist Jacques Rueff, the door had been opened to ‘deficits without tears.’ The GOP was thus relieved of the conservative party’s true calling in a modern welfare state democracy; that is, hard labour on the oars of fiscal rectitude. Indeed, with the fear of deficits gone, the GOP drifted into what amounted to Keynesianism for the prosperous classes.”

.

Good on You, Alexis Tsipras (Part I) #GreeceCrisis

Guest post by David Stockman

Late Friday night a solid blow was struck for sound money, free markets and limited government by a most unlikely force.
Namely, the hard core statist and crypto-Marxist prime minister of Greece, Alexis Tsipras, set in motion a cascade of disruption that will shake the corrupt status quo to its very foundations. And just in the nick of time, too.

After 15 years of rampant money printing, falsification of financial market prices and usurpation of democratic rule, his antagonists -- the ECB, the EU superstate and the IMF -- have become a terminal threat to the very survival of the kind of liberal society of which these values are part and parcel.

Keynesian central banking and the Brussels and IMF style bailout regime -- which has become nearly universal -- eventually fosters a form of soft-core economic totalitarianism. That’s because the former destroys honest financial markets by falsifying the price of debt.

So doing, Keynesian central bankers enable governments to issue far more debt than their taxpayers and national economies can shoulder. At the same time they force investors and savers to desperately chase yield in a marketplace where the so-called risk free interest rate has been pegged at ridiculously low levels.

That means, in turn, that banks, bond funds and fast money traders alike take on increasing levels of unacknowledged and uncompensated risk, and that the natural checks and balances of honest financial markets are stymied and disabled.

Short sellers are soon destroyed because the purpose of Keynesian central banking is to drive the price of securities to artificially high and unnatural levels. At the same time, hedge fund gamblers are able to engage in highly leveraged carry trades based on state subsidized (free) overnight money, and to purchase downside market risk insurance (“puts”) for a pittance.

Eventually bond and stock “markets” become central bank enabled casinos -- riven with mispriced securities, dangerous carry trades, massive unearned windfall profits and endemic instability.

When an unexpected shock or “black swan” event threatens to shatter confidence and trigger a sell-off of these drastically over-priced securities, the bailout state swings into action indiscriminately propping up the gamblers.

That’s what the Fed and TARP did in behalf of Morgan Stanley and Goldman back in September 2008. And it’s what the troika did in behalf of the French, German, Dutch, Italian and other European banks, which were stuffed with un-payable Greek and PIIGS debt, beginning in 2010.

Needless to say, repeated and predictable bailouts create enormous moral hazard while extirpating all remnants of financial discipline in financial markets and legislative chambers alike. Since 2010, the Greeks have done little more than pretend to restructure their state finances and private economy, and the Italians, Portuguese, Spanish and Irish have done virtually nothing at all.

The modest uptick in the reported GDP of the latter two hopeless debt serfs are just unsustainable rounding errors. The numbers are flattered by the phony speculative boom in their debt securities that was temporarily fuelled by Mario Draghi’s money-printing ukase that is presently in drastic retreat.

This Monday morning push has come to shove; Angela Merkel and her posse of politicians and policy apparatchiks were not able to kick the can one more time after all.

Instead, the troika’s authoritarian bailout regime has stimulated political revolt throughout the continent. Tsipras’ defiance is only the leading indicator and initial actualization -- the match that is lighting the fire of revolt.

But what it means is that there is now doubt, confusion and fear in the gambling halls. The punters who have grown rich on the one-way trades enabled by the money printing central banks and their fiscal bailout adjutants are being suddenly struck by the realisation that the game might not be permanently rigged after all.

So let the price discovery begin. In the days ahead, we will catalogue the desperate efforts of the regime to reassert its authority and control and to stabilise the suddenly turbulent casino.

In riding the central bank bubbles to unconscionable riches, the big axes in the casino have falsely claimed to be doing “God's work.”

As they are now being forced to liquidate these inflated assets, they actually are.

Last autumn one of the most detestable members of the regime, Jean-Claude Juncker, arrogantly issued the following boast:

“I say to all those who bet against Greece and against Europe: You lost and Greece won. You lost and Europe won.”

This morning that smug proclamation is in complete tatters. Good on you, Alexis Tsipras.

---

David Stockman was director of the Office of Management and Budget under President Ronald Reagan, serving from 1981 until August 1985. He was the youngest cabinet member in the 20th century.
This article first appeared at the Daily Reckoning.

The futility of our global monetary experiment

Guest post.

Jeff Deist from the Mises Weekend recently sat down with for Reagan Budget Director David Stockman to talk through the failure of monetary and fiscal stimulus to ignite much more than “hope,” and very little of that.

Jeff Deist: The US Federal Reserve [The Fed] recently announced just this past week that it would not use specific dates for targeting higher Fed funds rate this year and you almost get the sense that poor Janet Yellen [Fed chairman] is at the end of this Greenspan-Bernanke experiment and there’s not much left for her to do. I mean, what’s our sense of Yellen and her position?

David Stockman: Yeah, I agree with that. I think in some ways they’re petrified as to where they ended up or they should be. After all, we’re in an experiment of monumental proportions.

Let’s just assess where we are. If they don’t raise the interest rate in June — and I think all the signals now are pretty clear they’re going to find another reason to delay — that will mean seventy-eight straight months of zero rates in the money market. As I always say, the money-market price, that is the Federal Funds Rate or Overnight Money or a short term treasury bill, is the most important price in all of capitalism because that determines the cost of carry, the cost of speculation and gambling.

When you conduct a monetary policy that says to the speculators, to the gamblers, “come and get it,” you are guaranteed free money to carry your positions, whether you’re buying German Bonds or you’re buying the S&P 500 Stock Index or the whole array of yielding or price gaining assets that are available in the financial market. This monetary policy also sends the message that you can leverage and carry those positions for free and roll it day after day without worry because the central bank has pegged your cost and production, and in a sense has pledged on its solemn honour that it will not change without many months of warning. And that’s what this whole thing is about — changing the language and so forth. I think you have created a massive distortion in the very heart of capitalism in the financial system.

Second, I think even though they stopped actually adding to their balance sheet in October — when QE supposedly ended in a technical sense — the Fed has put $3.5 trillion worth of basic financial fraud into the world financial system and economy. After all, when they bought all of that treasury debt and all of those GSE securities, what did they use to pay for it with? It was digital money conjured out of thin air and they certainly haven’t destroyed or repealed the law of supply and demand.

So, if you put three-and-a-half trillion of demand into the fixed income market at points along the yield curve all the way from two years to thirty years, that is an enormous fat sum on the scale. That is an enormous distortion of pricing because you can’t have that much demand without affecting the price. Now, with the ECB at full throttle, and with Japan being almost a lunatic in its mimicking of QE, you are creating the greatest distortion of fixed income pricing or bond market pricing in the history of the world, and the bond market is the monster of the midway.

The distortion is tens of trillions of dollars big, and meanwhile, the central banks are in some kind of quasi-coordinated unison in levitating the prices enormously. They’ve brought the yields right down almost to the zero line — to the zero bound, as they call it, and therefore have set up the world’s financial system for a huge day of reckoning somewhere down the road and perhaps not that far away.

After all, only two weeks ago I believe, they had the German ten-year Bund yielding five basis points. That is crazy in any kind of world that makes economic sense or that’s sustainable. Already, some of the more aggressive bond traders in the world are jumping on that, calling it the short of a generation. We’ll see about that, but the point is, five basis points of yield even on the mighty German Bund for ten year money is just a major measure of the lunacy that has been injected into the financial system.

Jeff Deist: David, when you talk about the injections, when you talk about the thumb on the scale, as you discussed in Contra Corner recently, it’s not working, right? The commerce department just announced anaemic first quarter GDP growth. I mean is there any honest growth in the US economy at this point?

David Stockman: No, and this is one of the things that I’ve been harping on. Sometimes we get so caught up in the monthly so-called incoming data and the short-term releases — that are seasonally maladjusted anyway and get revised four times over — that we really lose track of where we are. So, the other day I said let’s just look at two extended periods of time that occurred in different economic and policy environments and do an assessment of where we are.

I took 1953 to 1971, that representing the end of the Korean War and the beginning of the Great Prosperity in the middle century, ending in the August 1971 fatal mistake that Nixon made when he closed down Bretton Woods and the rest. I call that the Golden Era of Prosperity. During that period, the economy grew and I use real final sales to measure the growth because that takes out the inventory fluctuations and distortions that are in the GDP number per se. But, if you take real final sales for that eighteen-year period, it was 3.6 percent a year compounded during a time in which the Fed was run by William McChesney Martin, a survivor — or veteran, you might say — of the 1929 crash and the trauma of the 1930s. He was a man who wasn’t necessarily, in the classic sense, a hard-money gold-standard advocate, but he certainly was a wise financial hedge who understood the dangers of speculation in the financial markets and of too much heavy-handed intervention in the financial system.

During that eighteen-year period from 1953 to 1971, the balance sheet of the Federal Reserve expanded by only $42 billion over eighteen years. (Now during QE, that was about two weeks worth of expansion at the peak.) More importantly, if you look at it in real terms — in inflation-adjusted terms — the balance sheet of the Fed in that period grew about 3 percent a year, and the economy grew at nearly 4 percent. Therefore, the Fed was engaged in a very modest light-touch policy allowing the mechanism of capitalism, including the financial markets at the heart of it, to function. The balance sheet of the Fed grew by 0.8 percent of the growth in the GDP.

Now, let’s take the last fourteen years, we’re in a totally different world. Greenspan has changed the whole notion of the role of the central bank, followed by Bernanke and Yellen. During that period, GDP growth of the economy has down shifted sharply to 1.8 percent a year over the last fourteen years, half of what occurred during the golden era. By contrast, the balance sheet of the Fed grew from $500 billion to four and a half trillion. But look at it in the same annual terms: 17 percent a year growth in the balance sheet, and 15 percent after adjusting for inflation.

That means that the Fed’s balance sheet grew eight times more rapidly than the economy during the last fourteen years. That’s just the inverse of the relationship that occurred back in the Golden Era.

So, I think if you need any proof at all of this massive intrusion into the financial system isn’t working; the huge amount of money printing and balance sheet expansion; the unremitting financial repression and pegging of interest rates; look at the fundamental comparison that I just made. It’s not working in the real economy. That is, it’s not generating expansion and giving standard gains on Main Street.

The only thing it’s really doing is simply inflating the serial bubble that ultimately reach unsustainable peaks and collapse. We’ve had two of them this century already from that policy and we’re now overwhelmingly — if you really look at the evidence — in a third great bubble that is in some ways more fantastic than the earlier two. It’s only a matter of time before it bursts and implodes and we’ll then be back to square one.

Hopefully on the third strike, the people who gave us these bubbles will be out. I think that might be a fair metaphor or proposition to make. Hopefully, when this next big bust comes — and surely it will when you look at the degree of speculation of the stock market in the high yield market or many other sectors that we can talk about — there will be a great day of reckoning in the country in terms of demanding a fundamental change in monetary policy and we’ll see the resignation of all the people who are sitting on the Fed today that have led us right into this gargantuan financial trap.

---

David Stockman was director of the Office of Management and Budget under President Ronald Reagan, serving from 1981 until August 1985. He was the youngest cabinet member in the 20th century.
This article is adapted from David Stockman’s May 1 Interview on Mises Weekends.

David Stockman on his Book and the Bailouts

I’ve been recommending to friends the bestselling book by former Reagan Budget Director, David Stockman: The Great Deformation: The Corruption of Capitalism in America—a telling account of the twentieth-century’s monetary and political breakdown, and how mistakes begun in the Reagan era and perpetuated by the GOP helped bring about the global financial meltdown.
In this interview with the Mises Institute, Stockman discusses his book, the gold standard, bailouts, and the problems the American economy faces today.

Mises Institute: In the book, you oppose Bernanke’s view of the Great Depression, which you point out relies heavily on the views of Milton Friedman.

David Stockman: Bernanke has cultivated this idea that he is a brilliant scholar of The Great Depression, but that’s not true at all. What Bernanke did was basically copy Milton Friedman’s misguided and very damaging theory that the Federal Reserve didn’t expand its balance sheet fast enough by massive open market purchases of government debt during the Great Depression. Bernanke therefore claimed that monetary stringency deepened and lengthened the depression, but in fact interest rates plummeted during the crucial 1930-1933 period: credit contracted due to genuine and widespread insolvencies in the agricultural districts and industrial boom towns, causing bank deposits to shrink as a passive consequence. So Bernanke had cause and effect upside down — a historical error that he replicated with reckless abandon in response to the bursting of the housing and credit bubble in 2008.
    Friedman’s error about the great depression led him, albeit inadvertently, into the deep waters of statism. He claimed to be the tribune of free markets, but in urging Nixon to scrap the Bretton Woods gold standard he inaugurated the present era of fiat central banking. He held that the central banking branch of the state could improve upon the performance of the free market by targeting the correct level of M1 (money supply) and thereby ensure optimum performance of aggregate demand, real GDP, and inflation. That’s Keynesianism through the monetary control dials, and has led to outright monetary central planning under Greenspan, Bernanke, and most of the other central banks of the world today.

Unshackling ‘The Fed’: Richard Nixon, Milton Friedman and the rise of the floating dollar

Since the end of World War II, the US Federal Reserve Bank has set the tone for all the world’s central banks.  From then until 1971, the US Dollar (under the “management” of the US Federal Reserve*) was the world’s reserve currency and the last official link between money and gold—the “gold-exchange standard” for which it was the buttress forming the “anchor” that “fixed” exchange rates between all the world’s currencies, and provided some last discipline on their spending.

In 1971, after a quarter-century of indiscipline, this “Bretton Woods” system collapsed when Richard Nixon and his advisers defaulted spectacularly on US promises. David Stockman describes the world we’ve been living in ever since.

(Excerpt from THE GREAT DEFORMATION: The Corruption of Capitalism in America by David A. Stockman. Published by PublicAffairs.)

[In 1971, after a quarter-century of Fed-driven inflation,] the stage was … set for the final “run” on the dollar and for a spectacular default by the designated “reserve currency” provider under the gold exchange standard’s second outing. And as it happened, the American people saw fit to install in the White House in January 1969 just the man to crush what remained of gold-based money and the financial discipline that it enabled.

Richard M. Nixon, as we know, possessed numerous and notable flaws. Foremost was his capacity to carry a grudge against anyone whom he believed had caused him to lose an election, especially any economist, policy maker, or bystander who could be pinned with accountability for the mild 1960 recession that he believed responsible for his loss to John F. Kennedy.

Nixon’s vendetta on the matter of the 1960 election literally knew no limits. For example, he insisted that a mid-level career bureaucrat named Jack Goldstein, who headed the Bureau of Labor Statistics (BLS), had deliberately spun the monthly unemployment report issued on the eve of the 1960 election so as to damage his campaign. Eight years later, Nixon informed the White House staff that job one was to determine if Goldstein was still at the BLS, and to get him fired if he was.

It is not surprising, therefore, that Nixon rolled into the Oval Office obsessed with replacing Federal Reserve Chairman William McChesney Martin [who he blamed for tanking the economy when then-Vice President Nixon was beginning his electioneering], and bringing the Fed to heel. To be sure, his only real interest in monetary policy consisted of ensuring that the one great threat to Republican success, a rising unemployment rate, did not happen again in the vicinity of an election.

Yet it was that very cynicism which made him prey to Milton Friedman’s alluring doctrine of floating paper money. As has been seen, Nixon wanted absolute freedom to cause the domestic economy to boom during his 1972 re-election campaign. Friedman’s disciples at Camp David served up exactly that gift, and wrapped it in the monetary doctrine of the nation’s leading conservative intellectual.

Friedman’s Rule of Fixed Money Supply Growth Was Academic Poppycock

Those adhering to traditional monetary doctrine always and properly feared the inflationary threat of state-issued fiat money. So when the Consumer Price Index reached the unheard of peacetime level of 6.3 percent by January 1969, it was a warning that the tottering structure of Bretton Woods was reaching a dangerous turning point and that the monetary foundation of the post-war world was in peril.

But not according to Professor Milton Friedman. As was typical of the Chicago school conservatives, he simply brushed off the gathering inflationary crisis as the product of dimwits at the Fed. Martin’s “mistake” in succumbing to pressure to open up the monetary spigot to fund LBJ’s deficits, Friedman insisted, could be easily fixed. Literally, with the flick of a switch.

According to Professor Friedman’s vast archive of historic data, inflation would be rapidly extinguished if money supply was harnessed to a fixed and unwavering rate of growth, such as 3 percent per annum. If that discipline was adhered to consistently, nothing more was needed to unleash capitalist prosperity—not gold convertibility, fixed exchange rates, currency swap lines, or any of the other accoutrements of central banking which had grown up around the Bretton Woods system.

Indeed, once the central bank got the money supply growth rate into a fixed and reliable groove, the free market would take care of everything else, including determination of the correct exchange rate between the dollar and every other currency on the planet. Under Friedman’s monetary deus ex machina, for example, the unseen hand would silently and efficiently mete out rewards for success and punishments for failure in the banking and securities markets. The need for clumsy and inefficient regulation of financial institutions would be eliminated.

Friedman’s “fixed rule” monetary theory was fundamentally flawed, however, for reasons Martin had long ago discovered down in the trenches of the financial markets. The killer was that the Federal Reserve couldn’t control Friedman’s single variable, which is to say, the “money supply” as measured by the sum of demand deposits and currency (M1).

During nearly two decades at the helm, Martin learned that the only thing the Fed could roughly gauge was the level of bank reserves in the system. Beyond that there simply weren’t any fixed arithmetic ratios, starting with the “money multiplier.”

The latter measured the ratio between bank reserves, which are potential money, and bank deposits, which are actual money. Commercial banks don’t create actual money (checking account deposits) directly; they make loans and then credit the proceeds to customer accounts. So the transmission process between bank reserves and money supply wends through bank lending departments and the credit creation process.

Needless to say, the Fed couldn’t control the animal spirits of either lenders or borrowers; that was the job of free market interest rates. Accordingly, banks would utilize their reserves aggressively during periods of robust loan demand until borrower exuberance was choked off by high interest rates. By contrast, bank reserves would lie fallow during times of slumping loan demand and low free market rates. The “money multiplier” therefore varied enormously, depending upon economic and financial conditions.

Furthermore, even if the resulting “money supply” could be accurately measured and controlled, which was not the case, it did not have a fixed “velocity” or relationship to economic activity or GDP, either. In fact, during  times of weak credit expansion, this “velocity” tended to fall, meaning less new GDP for each new dollar of M1. On the other hand, during more inflationary times of rapid bank credit expansion it would tend to rise, resulting in higher GDP gains per dollar of M1 growth.

So the chain of causation was long and opaque. The linkages from open market operations (adding to bank reserves) to commercial bank credit creation (adding to the money supply) to credit-fuelled additional spending (adding to GDP) resembled nothing so much as the loose steering gear on an old jalopy: turning the steering wheel did not necessarily mean the ditch would be avoided.

Most certainly there was no possible reason to believe that M1 could be managed to an unerring 3 percent growth rate, and that, in any event, keeping M1 growth on the straight and narrow would lead to any predictable rate of economic activity or mix of real growth and inflation. In short, Friedman’s single variable–fixed money supply growth rule was basically academic poppycock.

The monetarists, of course, had a ready answer to all of these disabilities; namely, that there were “leads and lags” in the transmission of monetary policy, and that given sufficient time the money multipliers and velocity would regress to a standard rate. Yet that “sufficient time” caveat had two insurmountable flaws: it meant that Friedman’s fixed rule could not be implemented in the real day-to-day world of fast-moving financial markets; and more importantly, it betrayed the deep, hopeless political naïveté of the monetarists and Professor Friedman especially.

The Monetarist Cone: Silly Putty on the White House Graphs

As to practicality, I had a real-time encounter with it later, during the Reagan years, when the Treasury’s monetary policy post was held by a religious disciple of Friedman: Beryl Wayne Sprinkel. Week after week at White House economic briefings he presented a graph based on the patented “monetarist cone.” The graph consisted of two upward-sloping dotted lines from a common starting date which showed where the money supply would be if it had been growing at an upper boundary of, say, 4 percent and a lower boundary of, say, 2 percent.

The implication was that if the Fed were following Professor Friedman’s rule, the path of the actual money supply would fall snugly inside the “cone” as it extended out over months and quarters, thereby indicating that all was well on the monetary front, the only thing which mattered. Except the solid line on the graph tracking the actual week-to-week growth of money supply gyrated wildly and was almost always outside the cone, sometimes on the high side and other times on the low.

In other words, the greatest central banker of modern times, Paul Volcker [the Fed chairman who ended the Nixon stagflation], was flunking the monetarists’ test week after week, causing Sprinkel to engage in alternating bouts of table pounding because the Fed was either dangerously too tight or too loose. Fortunately, Sprinkel’s graphs didn’t lead to much: President Reagan would look puzzled, Jim Baker, the chief of staff, would yawn, and domestic policy advisor Ed Meese would suggest moving on to the next topic.

More importantly, Volcker could easily explain the manifold complexities and anomalies in the short-term movement of the reported money supply numbers, and that on an “adjusted” basis he was actually inside the cone. Besides that, credit growth was slowing sharply, from a rate of 12 percent in 1979 to 7 percent in 1981 and 3 percent in 1982. That caused the economy to temporarily buckle and inflation to plunge from double digits to under 4 percent in less than twenty-four months. Volcker was getting the job done, in compliance with the monetarist cone or not.

In fact, the monetarist cone was just a Silly Putty numbers exercise, representing annualized rates of change from an arbitrary starting date that kept getting reset owing to one alleged anomaly or another. The far more relevant imperative was to slow the perilous expansion of the Fed’s balance sheet. It had doubled from $60 billion to $125 billion in the nine years before Volcker’s arrival at the Eccles Building, thereby saturating the banking system with newly minted reserves and the wherewithal for inflationary credit growth.

Volcker accomplished this true anti-inflation objective with alacrity. By curtailing the Fed’s balance sheet growth rate to less than 5 percent by 1982, Volcker convinced the markets that the Fed would not continue to passively validate inflation, as Burns and Miller had done, and that speculating on rising prices was no longer a one-way bet. Volcker thus cracked the inflation spiral through a display of central bank resolve, not through a single-variable focus on a rubbery monetary statistic called M1.

Volcker also demonstrated that the short-run growth rate of M1 was largely irrelevant and impossible to manage, but that the Fed could nevertheless contain the inflationary furies by tough-minded discipline of its own balance sheet. Yet that very success went straight to an even more fatal flaw in the monetarist fixed money growth rule: Friedman never explained how the Fed, once liberated from the external discipline of the Bretton Woods gold exchange standard, would be continuously populated with iron-willed statesmen like Volcker, and how they would even remain in office when push came to shove like it did during the monetary crunch of 1982.

In fact, Volcker’s reappointment the next year was a close call because most of the White House staff and the Senate Republican leadership wanted to take him down, owing to the considerable political inconvenience of the recessionary trauma his policies had induced. Senate leader Howard Baker, for example, angrily demanded that Volcker “get his foot off the neck of American business now.”

Volcker survived only because of Ronald Reagan’s stubborn (and correct) belief that the Fed’s long bout of profligacy had caused inflation and that only a period of painful monetary parsimony could cure it. The next several decades would prove decisively, however, that the process of American governance produces few Reagans and even fewer Volckers.

So Friedman unleashed the demon of floating-rate money based on the naïve view that the inhabitants of the Eccles Building could and would follow his monetary rules. That was a surprising posture because Friedman’s splendid scholarship on the free market, going all the way back to his pioneering critique of New York City rent controls in the late 1940s, was infused in almost every other case with an abiding skepticism of politicians and all of their mischievous works.

Yet by unshackling the Fed from the constraints of fixed exchange rates and the redemption of dollar liabilities for gold, Friedman’s monetary doctrine actually handed politicians a stupendous new prize. It rendered trivial by comparison the ills owing to garden variety insults to the free market, such as rent control or the regulation of interstate trucking.

Implicit Rule by Monetary Eunuchs

The Friedman monetary theory actually placed the nation’s stock of bank reserves, money, and credit under the unfettered sway of what amounted to a twelve-member monetary politburo. Once relieved of the gold standard’s external discipline, the central banking branch of the state thus had unlimited scope to extend its mission to plenary management of the nation’s entire GDP and for deep, persistent, and ultimately suffocating intervention in the money and capital markets.

It goes without saying, of course, that the libertarian professor was not peddling a statist scheme. So the implication was that the Fed would be run by self-abnegating monetary eunuchs who would never be tempted to deviate from the fixed money growth rule or by any other manifestation of mission creep. Needless to say, Friedman never sought a franchise to train and appoint such governors, nor did he propose any significant reforms with respect to the Fed’s selection process or of the manner in which its normal operations were conducted.

This glaring omission, however, is what made Friedman’s monetarism all the more dangerous. His monetary opus, A Monetary History of the United States, was published only four years before his disciples, led by George Shultz, filled the ranks of the Nixon White House in 1969.

Possessed with the zeal of recent converts, they soon caused a real-world experiment in Friedman’s grand theory. In so doing, they were also implicitly betting on an improbable proposition: that monetarism would work because the run-of-the-mill political appointees—bankers, economists, businessmen, and ex-politicians who then sat on the Federal Open Market Committee (FOMC), along with their successors—would be forever smitten with the logic of 3 percent annual money supply growth.

Friedman’s Great Gift to Wall Street

The very idea that the FOMC would function as faithful monetary eunuchs, keeping their eyes on the M1 gauge and deftly adjusting the dial in either direction upon any deviation from the 3 percent target, was sheer fantasy. And not only because of its political naïveté, something Nixon’s brutalization of the hapless Fed Chairman Arthur Burns aptly conveyed.

Friedman’s austere, rule-bound version of discretionary central banking also completely ignored the Fed’s susceptibility to capture by the Wall Street bond dealers and the vast network of member banks, large and small, which maintained their cash reserves on deposit there. Yet once the Fed no longer had to worry about protecting the dollar’s foreign exchange value and the US gold reserve, it had a much wider scope to pursue financial repression policies, such as low interest rates and a steep yield curve, that inherently fuel Wall Street prosperity.

As it happened, the Fed’s drift into these Wall Street–pleasing policies was temporarily stalled by Volcker’s epic campaign against the Great Inflation. Dousing inflation the hard way, through brutal tightening of money market conditions, Volcker had produced the singular nightmare that Wall Street and the banking system loathe; namely, a violent and unprecedented inversion of the yield curve.

With short-term interest rates at 20 percent or more and way above long-term bond yields (12–15 percent), it meant that speculators and banks could not make money on the “carry trade,” and that the value of dealer stock and bond inventories got clobbered: high and rising interest rates mean low and falling financial asset values. Accordingly, the Volcker Fed did not even dream of levitating the economy through the “wealth effects” or by coddling Wall Street speculators.

Yet once Volcker scored an initial success and was unceremoniously dumped by the Baker Treasury Department (in 1987), the anti-inflation brief passed on to a more congenial mechanism; that is, Mr. Deng’s industrial army and the “China price” deflation that rolled across the US economy in the 1990s and after. With inflation-fighting stringency no longer having such immediate urgency, it did not take long for the Greenspan Fed to adopt a prosperity promotion agenda.

First, however, it had to rid itself of any vestigial restraints owing to the Friedman fixed money-growth rule. The latter was dispatched easily by a regulatory change in the early 1990s which allowed banks to offer “sweep” accounts; that is, checking accounts by day which turned into savings accounts overnight. Accordingly, Professor Friedman’s M1 could no longer be measured accurately.

Out of sight was apparently out of mind: for the last two decades, the central bank that Friedman caused to be liberated from the alleged tyranny of Bretton Woods so that it could swear an oath of fixed money supply growth has not even bothered to review or mention money supply. Indeed, the Greenspan and Bernanke Fed have been wholly preoccupied with manipulation of the price of money, that is, interest rates, and have relegated Friedman’s entire quantity theory of money to the dustbin of history. And Bernanke claims to have been a disciple!

Constrained neither by gold nor a fixed money growth rule, the Fed in due course declared itself to be the open market committee for the management and planning of the nation’s entire GDP. In this Brobdingnagian endeavor, of course, the Wall Street bond dealers were the vital transmission belt which brought credit-fuelled short-term prosperity to Main Street, and delivered the elixir of asset price inflation to the speculative classes. Consequently, when it came to Wall Street, the Fed became solicitous at first, and craven in the end.

Apologists might claim that Milton Friedman could not have foreseen that the great experiment in discretionary central banking unleashed by his disciples in the Nixon White House would result in the abject capitulation to Wall Street which emerged during the Greenspan era and became a noxious, unyielding reality under Bernanke. But financial statesmen of an earlier era had embraced the gold standard for good reason: it was the ultimate bulwark against the pretensions and follies of central bankers.

David Stockman was director of the Office of Management and Budget under President Ronald Reagan, serving from 1981 until August 1985. He was the youngest cabinet member in the 20th century.
This post first appeared at Mises Daily, with the author’s permission.

* “Management” that saw the dollar devalued to around one-sixty-fifth of its value in just over half a century!

Oliver Hartwich, the Euro, and the “dangerous naivety” of floating exchange rates

We’re famous!

I’m very happy to see that a debate on the Euro crisis hosted by our Auckland University Economics Group earlier in the month has now slipped into Australia’s wide read Business Spectator.

Oliver Hartwich from the NZ Initiative talked to our Group a few weeks back on The Never-Ending Euro Crisis - the Anatomy of an Economic Policy Disaster, in which he

covered the history and pre-history of European monetary union, Europe’s fiscal and monetary problems, the eurozone’s governance issues and their political implications.
    But in the ensuing discussion, one of the economics professors, a renowned Austrian School theorist, asked two questions that were both unbelievably simple and incredibly sharp. The first: “So what does this euro crisis really have to do with money?” And the second: “Why have you not talked much about markets in your presentation?”
    At first, I was a little startled by these two questions. After all, when you give a whole lecture on the failings of a monetary union, surely this must have something do with money, right? And secondly, didn’t the euro crisis play itself out in the markets? Isn’t that where all the drama of these past years happened? How could I not have talked about markets?
    After the initial shock, I managed to give a reasonable answer to both his questions. However, I have been thinking about them for the past few days. And the more I do, the more it seems to me that they are not only valid questions: they also provide the answers to many of Europe’s current problems.

He’s right. They do. But because he’s left himself in the intellectual straitjacket of thinking that floating exchange rates would be the only way out, he doesn’t see that answer. 

How do economies adjust?

You see, Oliver insists

without the euro currency many of the problems we now observe would have never developed… trade imbalances between European nations probably would have corrected themselves through adjustments in the exchange rate. This is how such tensions had always been overcome when Europe still had many national currencies, and it certainly would have provided temporary relief…

Temporary relief only, because as he identifies, the real crisis “is really the crisis of the countries’ respective economies” :

These are economies that are in desperate need of economic reforms. Their problems have little to do with monetary union as such; the union merely brought their problems to light. Without the escape route of flexible exchange rates, their deep-seated problems could no longer be glossed over.

Note the first and last sentence: “These are economies that are in desperate need of economic reforms… Without the escape route of flexible exchange rates, their deep-seated problems could no longer be glossed over.”

Now, remove the intellectual straitjacket, and see what happens: The problem of the single currency zone with economies in desperate need of reforms suddenly becomes the solution. If no other escape route is offered them (and herein lies the present problem) the discipline provided by the single currency encourages the reform in those economies that is so desperately needed, and gives the public a reason to demand it.

Maybe the Euro is not so bad after all

The leading Austrian theorist in Spain, Jesus Huerta De Soto makes this point in “An Austrian defence of the Euro”:

The introduction of the euro in 1999 and its culmination beginning in 2002 meant …  the different member states of the monetary union completely relinquished and lost their monetary autonomy, that is, the possibility of manipulating their local currency by placing it at the service of the political needs of the moment. In this sense, at least with respect to the countries in the eurozone, the euro began to act and continues to act very much like the gold standard did in its day.

Simply put, the “fixed exchange rates” of a Bretton Woods system, of a gold standard, or of a single Eurozone currency—in which systems, trade imbalances are corrected through adjustments in prices and interest rates—all impose monetary discipline on a government, whereas the monetary nationalism of floating exchange rates allows printing press money to let rip.

Because Hartwich still seems to contemplate the crisis through the intellectual cracked lens of floating exchange rates however, he doesn’t see this.  He still sees floating exchange rates as the only way to make the markets correct the issue.

But the big Euro problem really is a lack of market process—as our Auckland Austrian theorist above seemed to be suggesting. And the fly in the ointment here is really the central bank.  The main thing lacking in the present arrangement of the Euro currency unit—in which a central bank imposes interest rates across a whole continent—is any mechanism whereby price signals are able to work their magic.  Because if the central bank got out of the way and stopped dictating interest rates across the whole zone, there is a benevolent mechanism present in the system of (essentially) fixed exchange rates that would re-emerge: encouraging investors to withdraw marginal quantities of their money from relatively overheated areas (where prices are higher and interest rates too low), and delivering it to areas shorter of investment capital (where prices are lower, and interest rates paid to investors are higher).

And then instead of acting as a doomsday machine, the main thing that’s destroying the setup presently (the monetary transfer system) would instead become the mechanism encouraging each economy’s reform.

Fixed  versus floating exchange rates

Since this issue, of fixed versus floating exchange rates, is so little canvassed these days it’s worth making it a final postscript—in the hope, perhaps, that you too might rethink the issue.

It was Hayek who in his 1937 book Monetary Nationalism and International Stability argued

flexible exchange rates preclude an efficient allocation of resources on an international level, as they immediately hinder and distort real flows of consumption and investment. Moreover, they make it inevitable that the necessary real downward adjustments in costs take place …  in a chaotic environment of competitive devaluations, credit expansion, and inflation

Which almost exactly describes the modern world of endless currency wars, where desperate economic problems are able to be put off for tomorrow by the printing press—with all the destruction that creates.  De Soto quotes Hayek from 1975, where he summarises his argument

It is, I believe, undeniable that the demand for flexible rates of exchange originated wholly from countries such as Great Britain, some of whose economists wanted a wider margin for inflationary expansion (called "full employment policy"). They later received support, unfortunately, from other economists[4] who were not inspired by the desire for inflation, but who seem to have overlooked the strongest argument in favor of fixed rates of exchange, that they constitute the practically irreplaceable curb we need to compel the politicians, and the monetary authorities responsible to them, to maintain a stable currency. (emphasis added)

To clarify his argument yet further, Hayek adds,

The maintenance of the value of money and the avoidance of inflation constantly demand from the politician highly unpopular measures. Only by showing that government is compelled to take these measures can the politician justify them to people adversely affected. So long as the preservation of the external value of the national currency is regarded as an indisputable necessity, as it is with fixed exchange rates, politicians can resist the constant demands for cheaper credits, for avoidance of a rise in interest rates, for more expenditure on "public works," and so on. With fixed exchange rates, a fall in the foreign value of the currency, or an outflow of gold or foreign exchange reserves acts as a signal requiring prompt government action.[5] With flexible exchange rates, the effect of an increase in the quantity of money on the internal price level is much too slow to be generally apparent or to be charged to those ultimately responsible for it. Moreover, the inflation of prices is usually preceded by a welcome increase in employment; it may therefore even be welcomed because its harmful effects are not visible until later.

Hayek concludes,

I do not believe we shall regain a system of international stability without returning to a system of fixed exchange rates, which imposes on the national central banks the restraint essential for successfully resisting the pressure of the advocates of inflation in their countries — usually including ministers of finance.

In which Keynes and Friedman see eye to eye

Perhaps I could point out too, as Ludwig Von Mises did, that floating exchange rates were much loved by Keynes…

Stability of foreign exchange rates was in [big-spending governments’] eyes a mischief, not a blessing. Such is the essence of the monetary teachings of Lord Keynes. The Keynesian School passionately advocates instability of foreign exchange rates.

Much loved they were too by Milton Friedman, who in this area as in so much else shakes hands with John Maynard Keynes. 

David Stockman, who in his recent book recounting the destruction of western capitalism by its supposed defenders, gives Milton Friedman the punch in his gut he deserves for his role in fulfilling the floating Keynesian dream, nailing him and US President Richard Nixon who between them put the final nail in the gold standard and instituted the modern world of floating exchange rates.

It was Friedman who first urged the removal of the Bretton Woods gold standard restraints on central bank money printing, and then added insult to injury by giving conservative sanction to perpetual open market purchases of government debt by the Fed.  Friedman’s monetarism thereby institutionalized a regime which allowed politicians to chronically spend without taxing…
    Nixonian cynicism and Professor Milton Friedman’s alluring but dangerously naive doctrines of floating exchange rates and the quantity theory of money picked up where Franklin Roosevelt left off. Notwithstanding Friedman’s aura of intellectual respectability, Nixon's crass political manoeuvres amounted to a primitive economic nationalism that harkened back to the worst of the disaster that Franklin Roosevelt had first sown in the 1930s…
    [B]y unshackling the Fed from the constraints of fixed exchange rates and the redemption of dollar liabilities for gold, Friedman’s monetary doctrine actually handed politicians a stupendous new prize.  It rendered trivial by comparison the ills owing to garden variety insults to the free market, such as rent control or the regulation of interstate trucking…
    The very idea that the FOMC would function as faithful monetary eunuchs, keeping their eyes on the M1 guage and deftly adjusting the dial in either direction upon any deviation from the 3 percent target, was sheer fantasy…

He gave more reasons for his disgust in a 2011 speech amounting to another punch to Friedman’s solar plexus.

“That the demise of the gold standard should have been as destructive as it was of monetary probity can hardly be gainsaid.  Under the ancient regime of fixed exchange rates and currency convertibility, fiscal deficits without tears were simply 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 on the monetary reserves; and if deficits were financed out of savings, interest rates were pushed up – thereby crowding out private domestic investment.”

and

“During the four decades since [Richard Nixon closed off the last monetary tie to gold], the rules of the 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 monies. But there can never be a drain on US monetary reserves because dollar claims are not convertible. This infernal regime of fiat dollars, therefore, has had numerous lamentable consequences but among the worst is that it has facilitated open-ended monetization of US government debt.”

and

“So at the end of the day, American lawmakers have been freed of the classic monetary constraints.  There is no monetary squeeze and there is no reserve asset drain.  The Fed always supplies enough reserves to the banking system to fund any and all private credit demand at policy rates that are invariably low. The notion of  fiscal ’crowding out’ thus belongs to the museum of monetary history.”

and

“In fact, the United States is clocking a 10-percent-of-GDP-deficit for the third year running because this latest budgetary fling is just another episode in the epochal collapse of US financial discipline that began 40 years ago at Camp David.”

I think Messrs Stockman and De Soto might have a point.

Don’t you?

Peter Schiff on David Stockman

Peter Schiff talks about the impact and arguments of former Reagan Budget Director David Stockman, and his new book The Great Deformation: Corruption of Capitalism in America.  Because it was written by a former insider, it’s been making waves, Stockman’s critics “shooting the messenger” rather than dealing with his severe criticisms …

In reference to an op-ed piece by Stockman in the New York Times, for example, “Corruption of Capitalism in America,” Krugman dismissed the ex-congressman as a "cranky old man" without even reading the book.

Actually, I was disappointed in Stockman’s piece. I thought there would be some kind of real argument, some presentation, however tendentious, of evidence. Instead it’s just a series of gee-whiz, context- and model-free numbers embedded in a rant — and not even an interesting rant. It’s cranky old man stuff…

Naturally, Stockman fired back.

The Great Deformation of 2008, and beyond!

Guest review by Llewellyn Rockwell

It didn’t take long for opponents of the market to pounce after the events of 2008. The crash was said to prove how destructive “unregulated capitalism” could be and how dangerous its supporters were—after all, free-marketeers opposed the bailouts, which had allegedly saved Americans from another Great Depression.

In The Great Deformation, David Stockman—former US congressman and budget director under Ronald Reagan—tells the story of the recent crisis, and takes direct aim at the conventional wisdom that credits government policy and US Federal Reserve chairman Ben Bernanke with rescuing Americans from another Great Depression. In this he has made a seminal contribution. But he does much more than this. He offers a sweeping, revisionist account of US economic history from the New Deal to the present. He refutes widely held myths about the Reagan years and the demise of the Soviet Union. He covers the growth and expansion of the warfare state. He shows precisely how the American central bank, the US Federal Reserve, enriches the powerful and shelters them from free markets. He demonstrates the flimsiness of the present so-called recovery. Above all, he shows that attempts to blame our economic problems on “capitalism” are preposterous, and reveal a complete lack of understanding of how the economy has been deformed over the past several decades.

The Great Deformation takes on the stock arguments in favour of the bailouts that we heard in 2008 and which constitute the conventional wisdom even today. A “contagion effect” would spread the financial crisis throughout the economy, well beyond the confines of a few Wall Street firms, we were told. Without bailouts, payroll would not be met. ATMs would go dark. Wise policy decisions by the Treasury and the Federal Reserve prevented these and other nightmare scenarios, and staved off a second Great Depression.

The bailout of insurance company AIG, for example (whose name now appears on All Black chests), was carried out against a backdrop of utter hysteria. AIG was bailed out in order to protect Main Street, the public was told, but virtually none of AIG’s busted CDS insurance was held by Main Street banks. Even on Wall Street the effects were confined to about a dozen firms, every one of which had ample cushion for absorbing the losses. Thanks to the bailout, they did not take one dollar in such losses. “The bailout,” says Stockman, “was all about protecting short-term earnings and current-year executive and trader bonuses.”

Ten years earlier, the “Fed” had sent a clear enough signal of its future policy when it arranged for a bailout of a hedge fund called Long Term Capital Management (LTCM). If this firm was to be bailed out, Wall Street concluded, then there was no limit to the madness the Fed would backstop with easy money.

LTCM, says Stockman, was “an egregious financial train wreck that had amassed leverage ratios of 100 to 1 in order to fund giant speculative bets in currency, equity, bond, and derivatives markets around the globe. The sheer recklessness and scale of LTCM’s speculations had no parallel in American financial history…. LTCM stunk to high heaven, and had absolutely no claim on public authority, resources, or even sympathy.”

When the S&P 500 soared by 50 percent over the next fifteen months, this was not a sign that American companies were seeing their profit outlooks increase by half. It instead indicated a confidence on Wall Street that the Fed would prevent investment errors from receiving the usual free-market punishment. Under this “ersatz capitalism,” stock market averages reflected “expected monetary juice from the central bank, not anticipated growth of profits from free-market enterprises.”

It wasn’t just specific firms that would enjoy Fed largesse under chairmen Alan Greenspan and Ben Bernanke; it was the stock market itself. According to Stockman, Fed policy came to focus on the “wealth effect”: if the Fed pushed stock prices higher, Americans would feel wealthier and would be likely to spend and borrow more, thereby stimulating economic activity.

This policy approach, in turn, practically compelled the bailouts that were one day to come. Anything that might send stock prices lower would frustrate the wealth effect. So the system had to be propped up by whatever means necessary.

What does this policy have to show for itself? Stockman gives the answer:

If the monetary central planners have been trying to create jobs through the roundabout method of “wealth effects,” they ought to be profoundly embarrassed by their incompetence. The only thing that has happened on the job-creation front over the last decade is a massive expansion of the bedpan and diploma mill brigade; that is, employment in nursing homes, hospitals, home health agencies, and for-profit colleges. Indeed, the HES complex accounts for the totality of American job creation since the late 1990s.

Meanwhile, the number of breadwinner jobs did not increase at all between January 2000 and January 2007, remaining at 71.8 million. The booms in housing, the stock market, and household consumption had only this grim statistic to show for themselves. When we consider the entire twelve-year period beginning in the year 2000, there has been a net gain of 18,000 jobs per month—one-eighth of the growth rate in the labour force.

In the wake of the crash, the Fed has continued to gin up the stock market. By September 2012 the S&P had increased by 115 percent over its lows during the bust. Of the 5.6 million breadwinner jobs lost during the correction, only 200,000 had been restored by then. And during the vaunted recovery, American households spent $30 billion less on food and groceries in the fall of 2012 than they did during the same period in 2007.

The sudden emergence of enormous budget deficits in recent years, Stockman explains, simply made manifest what the bubble conditions of the Bush years had concealed. The phony wealth of the housing and consumption booms temporarily lowered the amount of money spent on safety-net programs, and temporarily increased the amount of tax revenue received by the government. With this false prosperity abating, the true deficit, which had simply been suppressed by these temporary factors, began to appear.

All along, the Fed had assured us that the United States was experiencing genuine prosperity. “Flooding Wall Street with easy money,” Stockman writes, the Fed

saw the stock averages soar and pronounced itself pleased with the resulting “wealth effects.” Turning the nation’s homes into debt-dispensing ATMs, it witnessed a household consumption spree and marveled that the “incoming” macroeconomic data was better than expected. That these deformations were mistaken for prosperity and sustainable economic growth gives witness to the everlasting folly of the monetary doctrines now in vogue in the Eccles Building.

Stockman also discusses the fiscal condition of the US government. Part of that history takes him through the Reagan military buildup. Stockman’s isn’t the story you heard at the Republican conventions of the 1980s. The real story is as you suspected: a feeding frenzy of arbitrary and irrelevant programs which, once begun, could be stopped only with great difficulty if at all, given the jobs that depended on them.

But at least this buildup brought about the collapse of the Soviet Union, right? Stockman doesn’t buy it.

The $3.5 trillion (2005$) spent on defence during the Gipper’s term did not cause the Kremlin to raise the white flag of surrender. Virtually none of it was spent on programs which threatened Soviet security or undermined its strategic nuclear deterrent.

At the heart of the Reagan defence buildup … was a great double shuffle. The war drums were sounding a strategic nuclear threat that virtually imperilled American civilization. Yet the money was actually being allocated to tanks, amphibious landing craft, close air support helicopters, and a vast conventional armada of ships and planes.

These weapons were of little use in the existing nuclear standoff, but were well suited to imperialistic missions of invasion and occupation. Ironically, therefore, the Reagan defence buildup was justified by an Evil Empire that was rapidly fading but was eventually used to launch elective wars against an Axis of Evil which didn’t even exist.

What would actually bring the Soviet Union down was its command economy itself—a point, Stockman notes, that “libertarian” economists had been making for some time. Neoconservatives, on the other hand, advanced ludicrous claims about Soviet capabilities and the Soviet economy at a time when its decrepitude should have been obvious to everyone. These inflated claims about the regime’s enemies continued to be standard practice for the neocons long after the Reagan years were over.

To do it justice, The Great Deformation really requires two or three reviews. One could be devoted just to Stockman’s striking analysis of the New Deal. Stockman advances and then defends these and other arguments: the banking system had stabilized well before FDR’s ill-advised “bank holiday”; the economy had already turned the corner before FDR’s accession and worsened again as a result of FDR’s conduct during the interregnum; the New Deal was not a coherent program of Keynesian demand stimulus, so it makes no sense for Keynesians to draw lessons from it; the 1937 “depression within the Depression” was not caused by fiscal retrenchment; and FDR’s primary legacy is not the economic recovery, which would have occurred faster without him, but rather the impetus he gave to crony capitalism in one sector of the economy after another.

You may have gathered that The Great Deformation must be a long book. It is. But its subject matter is so interesting, and its prose style so lively and engaging, that you will hardly notice the pages going by.

The target of Stockman’s book is just about everyone in the political and media establishments. Left-liberal opinion moulders—defenders of the common man, they would have us believe—supported the bailouts in overwhelming numbers. Herman Cain, meanwhile, lectured “free-market purists” for opposing TARP, and virtually the entire slate of GOP candidates in 2012 had supported it. Both sides, in tandem with the official media, repeated the regime’s scare stories without cavil. And both sides could think of nothing but good things to say about how the Fed had managed the economy for the past quarter century.

The free market stands exonerated of the charges hurled by the state and its allies.

Thanks to The Great Deformation, not a shred of the regime’s propaganda is left standing. This is truly the book we have been waiting for, and we owe David Stockman a great debt.

This review first appeared at Rockwell.Com.