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 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 Fed 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 favor 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 Fed prevented these and other nightmare scenarios, and staved off a second Great Depression.
The bailout of AIG, for example, 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 labor 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 U.S. 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 defense 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 defense buildup…was a great double shuffle. The war drums were sounding a strategic nuclear threat that virtually imperiled 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 defense 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 molders – 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.