David Stockman’s new book The Great Deformation is a brilliant, penetrating analysis of the present state of the US economy and the US political system, and a detailed account of how the nation got into this mess. The book will upset Democrats and Republicans alike, and quite a few other constituencies as well, which can, in this case, be safely accepted as proof that Stockman’s narrative is spot on.
Stockman is an angry man and he admits so himself early in his 719-page tome. That anger adds bite and verve to his writing and keeps what is in fact a detailed historical account and economic analysis always highly entertaining. The book is long but never boring. Furthermore, Stockman does not let the anger cloud his judgement, which remains, in my view, relentlessly accurate throughout.
When dissecting Washington politics and Wall Street deal-making Stockman naturally draws on his experience as the director of the Office of Management and Budget under Ronald Reagan and his many years as an investment banker and private equity investor, and in so doing he reflects on much of his own professional life with commendable candor. But the book goes beyond these specific periods, and Stockman applies the analytical skills and insights acquired on these jobs to the critical examination of a wide spectrum of policy areas and historic periods. Stockman’s command of these topics and the masses of statistics and financial reports involved, and his powers of analytical dissection are impressive. But what is probably even more important for the success of his analysis is that it is based on an accurate understanding of essential economic relationships, in particular the importance of sound money. This is why the narrative that he develops captures America’s present challenges so truthfully and comprehensively. I very much shared Stockman’s anger when I started reading, but even more so when I had finished.
Stockman does a great service to his fellow Americans for he is providing a much-needed dose of realism that stands in stark contrast to the contrived optimism emanating from much of the political ‘debate’, from stock-pushing Wall Street experts on financial TV, and from the various Keynesian snake-oil merchants from both parties, all of whom want the public to believe that America is fundamentally healthy and just another round of ‘quantitative easing’, another deficit-funded tax break, or another ‘stimulus’ spending measure away from a bright future of self-sustained recovery. Instead, Stockman says it like it is. The US economy in 2013 is fundamentally weakened and structurally deformed by decades of artificially cheap money and a pathological debt addiction. Not the occasional artificial booms of the past twenty years, driven by Fed-induced bubbles in stocks, high-yield bonds and housing, give a correct picture of America’s long-term economic potential but the intermittent periods of slack when the fire-works on Wall Street inevitably end (and end in tears), and the persistent Main Street reality of declining employment prospects, stagnant real income and impaired competitiveness can no longer be covered up.
The Fed’s policy of cheap and then ever-cheaper credit has not only destroyed the free market by constantly distorting price signals, encouraging reckless debt accumulation and rewarding financial speculation (and consequently widening income and wealth gaps, as Stockman illustrates aplenty), it has thoroughly corrupted the political process as well. Stockman portrays a political system that, courtesy of the Fed’s cheap credit policies and interest rate repression, is now chronically incapable of living within its means, and is thus easy prey for hordes of crony capitalists – from the healthcare industry and the military-industrial complex to the ‘labor aristocracy’ of the united autoworkers union to the ‘too-big-to-fail’ banks, private-equity shops and hedge funds that play the system for a quick profit.
Crucially, Stockman puts his unsentimental assessment of America’s present reality into a broader historical context. Stockman identifies correctly the act of original sin that led America astray from the path of broadly free market economics and limited and fiscally responsible government, namely the abandonment of sound money. As America moved away from hard money, epitomized originally by the gold standard and a Federal Reserve with a strictly limited role as a bankers’ bank, and later, in already watered-down form, by the Bretton Woods gold-exchange-standard, and embraced an unconstrained fiat money system and ‘free-floating’ global paper monies it robbed the free market of its essential inner compass and ‘true north’ of market-based interest rates and market-enforced financial prudence.
The Fed, the central-banking branch of the federal government, was unleashed from its golden shackles in two historic steps in 1933 (by a Democrat president) and in 1971 (by a Republican president) but it was only over the past twenty years under the leaderships of Greenspan and Bernanke that the full destructive potential of unconstrained central banking has come to be felt. As Stockman shows with great clarity, both central bankers turned the Fed into a machine for macro-economic fine-tuning and prosperity management. Greenspan promised to watch the speculating classes’ backs by allowing them to blow bubbles and then shield them from the consequences. Bernanke took the mission one step further as he began (and still continues) to use his vast powers of fixing interest rates and printing limitless amounts of new money to steer the markets to the ‘correct’ yields on government bonds, the ‘correct’ spreads on mortgage-backed-securities, and the ‘appropriate’ shape of the yield curve, and by so doing to centrally manage the overall economy. Needless to say, such socialism for speculators, courtesy of the printing press, is happily explained by Wall Street economists as being in the public interest.
It is this deformation of money that is the root cause of the numerous deformations in the broader economy and the deformations in the political system. I am grateful that Stockman has fulfilled the important task of documenting in detail the many ways in which unsound money undermines the market economy and corrupts society.
Stockman is a myth buster par excellence. He busts myths that are cherished by Democrats and myths that are cherished by Republicans, and some cherished by both. Never pulling any punches and always happy to name names, he exposes as complicit in the deformation of American capitalism politicians, central bankers, and self-important economists of the Keynesian, monetarist and supply-side persuasion. He also identifies the many crony-capitalists, who shamelessly exploit the system’s many deformations for their own gain. But Stockman not only identifies the villains – the advocates and profiteers of unsound money – he also gives us the heroes, the defenders of sound money, people like Dwight Eisenhower, William McChesney Martin, and Paul Volcker, even if their efforts did ultimately not avert the corruption of American capitalism.
Here are the main myths that Stockman exposes:
Myth one: The 2008 financial crisis was the result of unregulated markets. TARP and the Fed saved the country from Great Depression 2.0
Nonsense, says Stockman. The financial crisis was the consequence of the Fed’s serial bubble blowing, and it should have been allowed to burn itself out in the corridors of Wall Street. Instead, Paulson and Bernanke panicked, declared economic martial law, namely that all rules of fiscal prudence and free market capitalism be tossed aside, and demanded that, via the bail-out of ‘insurance’ giant AIG, firms like Goldman Sachs, Morgan Stanley and others be saved from choking on their own outsized speculations.
Myth two: There was such a thing as the ‘Reagan Revolution’ and it revitalized American capitalism.
This is obviously a favourite whenever Republicans sit around the campfire. The reality looks different. Despite all the charisma and the eloquent free market rhetoric, the true legacy of the Reagan presidency is a Republican party that is now largely desensitized to fiscal profligacy and reconciled with endless deficits (Cheney’s famous dictum that “deficits don’t matter.”), as the party has happily joined the Democrats in the ‘aggregate demand’ management business. No longer to be outdone by ‘pro-active’ Democrats advocating Keynesian ‘spending’ to ‘stimulate’ growth, the Republicans came to embrace their own version of top-down GDP management: the Art-Laffer-inspired slashing of taxes at all cost. Fiscal prudence – and a true “hands-off” approach to the economy – was finally expunged from Republican DNA.
Myth three: The Great Depression was caused by the gold standard and was ended by Roosevelt’s Keynesian policies.
Ridiculous. The correction of the early 1930s was the combination of delayed effects of the First World War (a US agricultural boom that had led to overinvestment and distorted prices and had already ended in a bust in the 1920s) and the bursting of various bubbles blown during the Jazz-Age-version of bubble finance, such as the foreign bond market that provided funding for the purchase of then-sizable US exports, and the hot-money driven domestic equity boom. These distortions did not come about because of the gold standard but despite of the gold standard, which had been severely weakened as a disciplinary force not least due to the growing role of the Fed since 1914, and in particular since the central bank funded the war effort through money-printing in 1917-1918. By 1929 liquidation and correction were unavoidable. But what should have been a quick and decisive cleansing was turned into a drawn-out economic catastrophe by bad policy. First, there was economic nationalism – tariffs and other forms of protectionism – and then Roosevelt’s disastrous interventionism and relentless tinkering with the economy. As Stockman illustrates, Roosevelt did not enact a Keynesian textbook program at all. In fact, the clueless president had no coherent program whatsoever but instead implemented the type of potpourri of populist anti-market measures so fashionable at the time among Europe’s fascist leaders: odd infrastructure programs, price and wage fixing, state-directed resource use.
“Having triggered the demise of the old international order, the Roosevelt program of necessity was a purely domestic grab bag of experiments, gimmicks, and nonstarters. These ad-hoc Washington interventions – the Tennessee Valley Authority (TVA), National Recovery Act (NRA), Agricultural Adjustment Act (AAA) – did little to revive the dormant machinery of market capitalism and economic wealth creation and, instead, mainly shuffled income and resources randomly among regions, industries, and even individual business firms.”(Stockman, page 159)
The New Deal had meant curtains for the ‘Old Republic’ and any commitment to sound money and sound public finances. However, and luckily for America, the newly expanded tool kit for interventionist politicians and central bankers remained largely unused for two decades after the end of World War II. A happy interregnum of monetary and fiscal discipline commenced, largely due to the good fortune of having people with strong traditional beliefs in positions of power, such as Dwight D. Eisenhower in the White House and William McChesney Martin at the Fed, two of Stockman’s heroes. Eisenhower slashed military spending after the Korean War and established the ‘Eisenhower minimum’ of strictly contained military outlays. Eisenhower was a soldier who hated war. A highly decorated general himself he famously warned his fellow Americans of the growing powers of the military-industrial complex and stared down a few generals himself when letting them resign in protest of his spending cuts. (By comparison, today’s Commander-in-Chief, former community organizer Barack Obama, oversees a military budget that is twice the size of even Bill Clinton’s.)
Over at the Fed, Martin not only coined the phrase “taking the punch bowl away when the party gets started”, he actually meant it and implemented it. Martin was deeply committed to the monetary discipline of the Bretton Woods system.
Needless to say, such discipline did not last long. America’s military adventures in Far East Asia and LBJ’s great society project put new demands on state spending and, by extension, on the printing press. The last link to gold – and the last remaining constraint on paper dollar creation- was severed in August 1971.
Myth four: Free floating paper monies are a sign of free market capitalism
The importance of what happened at Camp David in August 1971 can hardly be overestimated, and Stockman conveys the magnitude of these events vividly:
“Nixon’s estimable free market advisors who gathered at the Camp David weekend were to an astonishing degree clueless as to the consequences of their recommendation to close the gold window and float the dollar. In their wildest imaginations they did not foresee that this would unhinge the monetary and financial nervous system of capitalism. They had no premonition at all that it would pave the way for a forty-year storm of financialization and a debt-besotted symbiosis between central bankers possessed by delusions of grandeur and private gamblers intoxicated with visions of delirious wealth.” (Stockman, page 281)
Stockman is particularly scathing of Milton Friedman’s influence on these events.
“The great irony, then, is that the nation’s most famous modern conservative economist became the father of Big Government, chronic deficits, and national fiscal bankruptcy. 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.” (Stockman, page 272)
Famous academic economists who willingly throw themselves into the machinery of policy-making or policy-advice are among the most tragic-comic figures in Stockman’s narrative.
Thus we meet, on the political Left, John Maynard Keynes’s vicar on earth, the pompous Larry Summers pulling really big numbers out of the air, such as $800 billion, and demanding that this be spent instantly by Washington to stimulate the economy. There is, of course, Paul Krugman, who has never met a deficit-spending program that he thought was big enough. On the political Right, there is Art Laffer, who taught the Republicans not to worry about deficits if they result from tax-cutting as tax cuts are always stimulative and thus inherently self-financing. There is Milton Friedman who could explain the evils of rent-control better than anybody else but got free market money horribly wrong and provided intellectual cover for Tricky Dick’s dollar debasement. And then, naturally, there is Ben Bernanke, the veritable Dr. Strangelove of central banking, who believes this is 1930 all over again and who uses the present crisis to re-enact the policy program he believes, based on his own subjective and highly flawed interpretation of the Great Depression, the Fed should have enacted back then. One can only hope that this litany of abject failure serves as a warning to those economists waiting in the wings for their moment in the limelight, such as John Taylor who promotes his eponymous rule as a way to make central banking workable, or those economists who currently embrace the new Keynesian fad of ‘nominal GDP targeting’ (God help us!).
The deserving heroes of Stockman’s account are instead those statesmen and bankers who stuck by the old (and indeed ancient) rules of hard money and ‘balancing the books’.
Myth five: Modern financial markets represent free market capitalism.
Of course, in a proper free market, speculation, trading and the use of leverage would not only be permissible but would have an important role to play in the process of allocating savings and channeling scarce capital to productive uses. These activities would, however, be tightly controlled and strictly limited by the free market’s most effective regulators: profit and loss. Those regulators are now largely weakened or even removed entirely by the present system of costless fiat money, unlimited central bank backstops (Greenspan/Bernanke put) and artificially low interest rates. Without proper capitalist money, hard and apolitical, at the core of the monetary system, a free market in the rest of finance is impossible. Stockman does an excellent job illustrating the extent to which manipulated money and artificially cheap credit are corrupting the entire financial infrastructure by encouraging excessive risk-taking and the misuse of capital with severely adverse long-term consequences.
“…capital markets eventually lose their capacity to honestly price securities under a regime of unsound money; they end up dancing to the tune of the central bank; that is, pricing the trading value of financial assets based on expected central bank interventions, not the intrinsic value of their cash flows, rights, and risks.” (Stockman, page 383)
Stockman analyses a range of leveraged buy-out deals (LBOs) to show how, in our deformed financial system, these can often lead to huge pay-outs for highly leveraged investors while at the same time leaving the firms financially weakened and sometimes even bankrupt. This chapter may appear long and technically challenging for some readers but it is important as it gives the lie to frequent claims by those who operate in this arena that these activities are simply the free market at work, and that they lead to more efficient allocation of corporate control, to investment in productive capital and to jobs. Stockman exposes the full irony of the Republican Party putting forward Mitt Romney as their 2012 presidential candidate and trying to sell him as an experienced business man and ‘job creator’ when, as the former head of private-equity firm Bain Capital, he would be much more suitable as a poster boy for the lucky few who disproportionally benefitted from three decades of bubble finance and all the deformations it created, a system that stands in sharp contrast to the traditional capitalism the Republicans claim to advocate.
Stockman does certainly not make many friends on the political Left with his – brilliant and entirely justified – annihilation of the Roosevelt myth and the childish ‘Keynes 101’ – programs of ‘spending ourselves to prosperity’, but his account supports to a considerable degree the allegation that the ‘1 percent’ live high on the hog at the expense of the rest of the population. However, as Stockman demonstrates at length, this is not the result of free market capitalism, and the answer to it is not regulation and confiscatory taxation. The root cause is unsound money and the possibilities that unsound money provides for the flourishing of ‘crony capitalism’.
Stockman’s outlook is not a happy one. As the nation runs out of balance sheets to leverage up and as, inevitably, ‘austerity’ sets in, he foresees ongoing political strife, further financial market manipulations, on-and-off print-operations by the Fed, and new financial crises. He closes the book with a few pages of policy recommendations, all of them sensible, I guess, and naturally following from the preceding extensive analysis. But Stockman is under no illusion that his policy ideas do not stand a snowball’s chance in hell to be implemented. In any case, the book is not really, first and foremost, about a new policy program but about shifting the parameters of the debate by providing a thorough and accurate description of America’s economic and political problems. And here the book succeeds with flying colors.
This is an important book. I wish it a wide readership.