How Politics Caused Fiscal Disaster



This article
was written by David Stockman, who was elected to U.S. House of
Representatives for the 95th Congress and was reelected in two subsequent
elections, serving from January 1977 until his resignation January
1981. He then became 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. After leaving
government, Stockman joined Wall St. investment bank Salomon Bros.
and later became a founding partner at New York-based private equity
firm, The Blackstone Group. He left Blackstone in 1999 to start
his own private equity fund, Heartland Industrial Partners, L.P.,
based in Greenwich, CT.

My proposition
today is that we’re in a fiscal calamity caused by the further,
and perhaps, final triumph of politics. Admittedly, I issued this
very same forecast awhile back – 23 years ago to be exact. But
I’m not reluctant to try again. Having read Grant’s continuously
since 1988, I’ve learned there’s no shame whatsoever in
being early – even often!

The Triumph
of Politics was published early, mainly in the unflattering sense
that I’d not completed my homework. I was hip to statist fiscal
and regulatory evils, but had only dimly grasped the Austrian masters’
wisdom on money; that is, in printing money backed by nothing, central
banks inherently threaten prosperity. So today I’ll add the
proposition that fiscal decay is the inevitable step-child of the
very monetary rot that the Austrians – Mises, Hayek, Rothbard –
so deplored.

My tardiness
on money perhaps owes to the Reagan Revolution’s disinterest.
Secretary Don Regan averred that sound money could be readily attested
by the height of the Dow while his deputy, a monetarist, gauged
it by the width of M2.

Even Alan Greenspan,
that is, Greenspan version 1.0, urged not to worry. Gold, he assured
Ronald Reagan, was meant to anchor – not the Fed’s actual
balance sheet, but something more ethereal, like perhaps its state
of mind.

My libertarian
screed thus omitted money while cataloging the Reagan Revolution’s
lesser shortcomings. These included gargantuan deficits, subsidies
for favored Republican constituencies like farmers, homebuilders
and exporters, a complete whiff on entitlements, and protectionism
for dying industries like steel and textiles – even for a motorcycle
company whose ticker symbol, fittingly, was HOG.

Then, too,
there were tax giveaways to real estate, oil and gas, and, come
to think of it, to any other worthy industry with the foresight
to hire a pair of Gucci loafers domiciled on K-street. On top of
this, came the big defense budgets at a peacetime record 7% of GDP.
Deep Federal deficits thus stretched as far as the eye could see.

Yet, I didn’t
perceive that this already alarming fiscal ledger would be further
aggravated by two looming tectonic shifts. Oddly enough, these financial
temblors were rooted in history’s most consequential pair of
train cars.

The first was
the sealed car that took Lenin to Moscow in 1917 – a 75-year trip
to hell and back that finally ended in 1991 when a Moscow politician,
whose normal confrontations were with a Vodka bottle, was inspired
to mount a Soviet tank and command the Red Army to stand down. Promptly
thereupon the US defense budget was stood down, too, dropping overnight
to approximately 3% of GDP – half its prior size.This unexpected
game changer coupled with marginal tinkering on taxes and spending
computed out to a balanced budget. Soon enough, the fiscal all-clear
horn was sounded by no less than Wall Street’s own money man,
Secretary Rubin.

In fact, the
fiscal equation was just then tumbling into a fatal descent. And
it is here – let’s pinpoint the exact date at Greenspan’s
“irrational exuberance” call in December 1996 – where
the Austrian men separate themselves from the Keynesian and Friedmanite
boys. The latter continued to quibble about how to measure money,
whether it was growing too fast or slow and if more or less financial
regulation was needed.

Peering through
a different frame, however, the Austrian notes that US money GDP
was about $10.0 trillion at the time the Maestro let his exuberant
cat out of the bag. Under an honest monetary regime this nicely
rounded number might have stalled-out indefinitely – owing to the
Great East Asian Deflation just then gathering a head of steam.

The truth is,
the extraordinary force of economic nature represented by the mercantilist
export machine that sprung up in East Asia in the late 20th century
was profoundly deflationary. Absent puffed-up domestic credit, the
in-coming Asian trade would have flattened American employment,
wages, incomes and prices. In so doing, it would have kept money
GDP bottled-up at around $10 trillion, thereby denying the next
decade’s debt-fueled rise in both output and prices which took
money GDP to $14 trillion.

By Austrian
lights, then, this $4 trillion difference represents counterfeit
GDP, owing to the false conversion of unsupportable borrowings into
current income – debt which is now being forcibly liquidated. This
bubble-driven inflation of money GDP also caused government revenues
to swell unsustainably, thereby camouflaging for more than a decade
the fiscal deficit’s actual, far more frightful, aspect.

There’s no
mystery in this contra-factual history. With money anchored to a
standard, say gold, the armada of containerships steaming from the
Pacific Rim into Long Beach would have brought massive trade deficits,
but also would have set in motion their own correction. Taking flight
in the opposite direction, gold bullion, not paper dollars, would
have been on the backhaul to East Asia.

In turn, an
old-fashioned drain on America’s gold would have obviated a
lot of fatuous jawing about the Chinese being seven-feet-tall economically
or excessively addicted to an alleged financial opium called “over-saving."
Instead, without need for a single meeting of the open market committee,
the loss of gold would have presently caused a sharp contraction
of domestic bank reserves, a shrinkage of loans by an approximate
10 times multiple thereof and a sharp rise in the rate of interest
on the dollar markets.

consumption, imports, money wages, jobs and cost-bloated domestic
enterprises would have all been laid low by such hard money discipline.
But having thus been put to the mat, a nation of aging and now over-priced
workers – and bankers, too – wouldn’t have found it expedient
to live high on the hog. Instead, they would have discovered the
“new normal” of higher savings, fewer credit cards, lower
consumption, and slimmer paychecks – all on their own and about
a decade sooner.It goes without saying that believers in the elixir
of counterfeit money and credit, which is to say Keynesians, monetarists,
and Goldman Sachs (GS) partners, will dismiss all this as flat-earth
doctrine – fossilized ideas pre-dating the discovery of government’s
wondrous power to manage the macro-economy.

Still, a doctrine
that holds out the state as an agent of economic betterment suffers
from some deep flaws of its own. Decades of experience show, for
example, that fiscal stimulus is an exercise by which one class
and region steals from another. But the worse flaw is the hallowed
central bank doctrine that deflation is always bad. In fact, wrong-headed
deflation fighting is what generated the boom of the 1920s and the
subsequent bust – a scenario repeated almost exactly during the
last decade.

The famous
quote from "Bubbles Ben" about the Fed at Milton Friedman’s
90th birthday is thus replete with irony. Said Bernanke in November
2002: “You’re right. We did it. We’re very sorry…we
won’t do it again.” But the Fed did it again, generating
the most massive speculative bubble ever. And this time the Fed
even assured that if a bubble should ever break, it would stand
ready to – well – rinse and repeat!

Here, the Austrians
note that the central bankers’ allergy to deflation is rooted not
in sound economics, but in weak politics; in the catering to the
pressures of promoters, speculators and borrowers. In fact, the
Austrians showed that deflations owing to powerful secular cost-reduction
trends – whether based on new technologies, new economic geographies,
or new forms of enterprise – are healthy. They raise real incomes
and wealth, even as they cause commodity prices to fall.

Thus, the East
Asian export machine far outranked every other cost-crasher in recorded
history. It bested the Internet, Walmart (WMT), Henry Ford’s
moving assembly line, central station electric power, the railroads,
canals, the steam engine, the spinning jenny, and, while we’re at
it, let’s throw in the wheel, too!

The Fed’s
strategy in the face of the Great East Asian Deflation, then, was
exactly upside down. It should have raised interest rates and liquidated
credit in order to encourage a deflation of domestic wages, prices,
and corporate cost structures which were no longer competitive or
viable in the new global markets. But by keeping interest rates
absurdly low on the pretext that the “core” CPI Index
was, as it was pleased to say, “well-anchored," the Fed
thwarted the fundamental economic adjustments that were vital for
the American economy to regain its footings.

The “panic
of 2008," therefore, wasn’t a random policy error, nor was
it caused by the machinations of overly-bonused bankers. In fact,
the massive quantities of unsupportable debt and the vast malinvestments
in housing, banking, shopping malls, office buildings, and Pilates
studios, too, which came crashing down last September, were rooted
in history’s other star-crossed rail car. That was the gilded
club car which in November 1910, had secretly whisked away Senator
Nelson Aldrich and his coterie of Morgan, Rockefeller and Kuhn Loeb
bankers to a duck-hunting blind on Jekyll Island, Georgia.

the rest of the article

11, 2010

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