Was David Stockman’s jeremiad about the US and its economy, Sundown in America, recently published in the New York Times (March 31, 2012), correct? Or has he lost his mind?
I would say Stockman is mainly correct. Let’s examine some of what he said, from the opening paragraph of the article.
The Dow Jones and Standard & Poor’s 500 indexes reached record highs on Thursday, having completely erased the losses since the stock market’s last peak, in 2007. But instead of cheering, we should be very afraid.
I fully agree. And for most of the same reasons he later cites. The market highs are reflective of the adage that it is never smart to fight the Fed. In an economy with profound overcapacity, and with no real prospects for sopping up excess capacity with increased demand, the Fed has managed to not only forestall price declines, but to revivify inflation. Prices everywhere, which should be going down due to excess capacity, are instead going up. Just check out the following charts from FRED (the data bank maintained by the Federal Reserve Bank of St. Louis). The first chart is of CPI, and the second, of home prices:
CPI, after having plunged very briefly, far exceeds the level it was upon entering the Great Recession (unlike, for instance, employment).
Housing prices have lately seen a quite rapid increase, though they remain well below the bubble years of the mid aughts. Yet the price increases have come in the face of vast excess housing capacity, unless, as before, houses are considered as investments, rather than places to live. As places to live, there are more than enough houses. As the latest hedge fund play, there will never be enough houses, until there are too many. The Fed is coming very close to reigniting housing mania, which seems to be their intent. Mortgage rates are bouncing around near all-time lows, helped along no doubt by the Fed’s monthly mortgage bond purchases of about $85 billion.
Stockman goes on to explain exactly why these recent stock market highs are nothing to cheer about:
Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later — within a few years, I predict — this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too.
Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.
As I read in a Bloomberg article explaining why Stockman’s gloom and doom is misplaced, “But the S & P is up about 131% from its recent low in 2009”. Which shows the depths to which it fell after topping out in 2007, and is a perspective taking no account of inflation. It takes an almost intentional myopia to look at what has obtained over the last several years–Stockman goes back to the dot com bubble–and not conclude that this latest return to a previous high is nothing to cheer. Especially given the massive Keynesian stimulus (read, the massive cheapening of the money) that has been in play.
The following charts illustrate the Keynesian stimuli which has been supplied since the crash. The first two are of the Fed’s main holdings–mortgage-backed securities and US Treasury securities (yes, the money that was printed to buy the securities is pure Keynesian); the second is of fiscal deficits:
Graphically portraying the Fed’s balance sheet explosion in such a manner should almost rate an “M” as only for mature audiences. As is obvious, the Fed owns about $3 trillion total of mortgage-backed securities and US Treasuries, and since the vast majority of its mortgage-backed securities are obligations of entities now held in conservatorship by the US Treasury (Fannie, Freddie), the Fed has created out of thin air over $2 trillion new dollars since the recession began (its pre-recession balance sheet was about $800b). This is the monetary portion of the stimulus. Now the fiscal portion, represented by the annual fiscal deficit, as Keynes advised is the way to spend an economy out of a contraction:
Each year since the recession hit, the federal government has spent in excess of a trillion dollars more than it has taken in. That’s well over five trillion dollars. While some of this is double counting the fiscal and monetary side of stimulus–the Federal Reserve has bought and owns about forty percent of the five trillion in new debt–still the amount of stimulus is staggering, even looking at it as a percent of gross domestic product:
The last time the US went on this wild a borrowing and spending spree was to pay for World War Two, which ultimately yielded American hegemony the world over. Is there any likelihood that this sort of borrowing and spending will provide the same returns? At over 7% of GDP even now, the US would not be eligible for admission to the European Union (under its old rules for admission). It would be taking regular scoldings from the International Monetary Fund. The only thing preventing this from being an immediate disaster is US military might (which seems likely to be tested in the coming years, if not months, and mainly because the US has reached the end of its fiscal rope). It can’t continue to indulge its populace with deficit spending while also maintaining its military preeminence. The US won the Cold War because it didn’t have to sacrifice guns for butter, while the Soviet Union did. Such will not be the case in any future hegemonic conflicts.
In view of all this money creation, why have overall price increases been modest, averaging less than two percent a year? It must first be understood that the Fed is fighting to keep prices steadily climbing against a gale of deflationary headwinds. The population is aging and fertility is declining, implying less robust demand growth for years to come. Technology is continuing to positively impact productivity, yielding cost declines in production that would otherwise see their way into the marketplace. Wage rates and domestic employment rates are suppressed by the lack of demand and international wage arbitrage. Each hundred billion of new dollars added to the supply has had less and less impact, as money velocity has steadily declined through the money printing mania, as the following chart shows:
Essentially all that has happened since the Great Recession began in 2007 is that the Fed has socialized risk while rewards are mainly still private. The economy of 2013 looks and feels very similar to that of 2007, except with the Fed having already emptied its cartridge of policy bullets. And all just to keep a bunch of bankers from going broke. The next fat tail event that arises–war, natural disaster, the bursting of the Chinese property bubble, the implosion of the Euro area…whatever–will expose the precariousness of the economic and financial situation. All that can be hoped is that in the event, the US will be the cleanest dirty shirt around.
About my only disagreement with Stockman concerned his views on the gold standard. Stockman believes that FDR and Nixon both unforgivably erred when they abandoned the gold standard because it then led to huge expansions in deficit spending and inflation, which did in fact happen in FDR’s case, but because of the war, not for having abandoned the gold standard. And did not necessarily have to be true in Nixon’s case, except that the costs of Johnson’s Great Society and the windup of the Vietnam War and the first Arab oil embargo left the US in a very precarious monetary and fiscal position. The dollar crisis of the late seventies can be traced to Nixon’s abandonment of the gold standard, but it was an effect, not a cause, and it arose from conditions beyond the control of the presidency. FDR’s abandonment of the gold standard shortly after assuming office could be credited for the ensuing economic recovery that lasted until the second dip in 1937.
In any event, gold is, like Keynes said, a barbarous relic, so far as currencies go. But fiat currency isn’t much better, as the one doing the fiat-ing always is tempted to collect taxes through inflation rather than by the ordinary means, thereby funding perpetual deficits with little more than an illusory magician’s trick. The only way much of Europe, Japan and the US will be able to service debts is through inflation. The better answer to the fiat currency problem would finding a metric representing something of human value (perhaps a calorie of energy), and price things according to it, doing away with fiat currency the world over. Oh, but the despotic governments dependent on stealing from their people would howl, but that would be the point.
I haven’t much to argue with Stockman’s final points:
THE state-wreck ahead is a far cry from the “Great Moderation” proclaimed in 2004 by Mr. Bernanke, who predicted that prosperity would be everlasting because the Fed had tamed the business cycle and, as late as March 2007, testified that the impact of the subprime meltdown “seems likely to be contained.” Instead of moderation, what’s at hand is a Great Deformation, arising from a rogue central bank that has abetted the Wall Street casino, crucified savers on a cross of zero interest rates and fueled a global commodity bubble that erodes Main Street living standards through rising food and energy prices — a form of inflation that the Fed fecklessly disregards in calculating inflation.
These policies have brought America to an end-stage metastasis. The way out would be so radical it can’t happen. It would necessitate a sweeping divorce of the state and the market economy. It would require a renunciation of crony capitalism and its first cousin: Keynesian economics in all its forms. The state would need to get out of the business of imperial hubris, economic uplift and social insurance and shift its focus to managing and financing an effective, affordable, means-tested safety net.
All this would require drastic deflation of the realm of politics and the abolition of incumbency itself, because the machinery of the state and the machinery of re-election have become conterminous. Prying them apart would entail sweeping constitutional surgery: amendments to give the president and members of Congress a single six-year term, with no re-election; providing 100 percent public financing for candidates; strictly limiting the duration of campaigns (say, to eight weeks); and prohibiting, for life, lobbying by anyone who has been on a legislative or executive payroll. It would also require overturning Citizens United and mandating that Congress pass a balanced budget, or face an automatic sequester of spending.
It would also require purging the corrosive financialization that has turned the economy into a giant casino since the 1970s. This would mean putting the great Wall Street banks out in the cold to compete as at-risk free enterprises, without access to cheap Fed loans or deposit insurance. Banks would be able to take deposits and make commercial loans, but be banned from trading, underwriting and money management in all its forms.
It would require, finally, benching the Fed’s central planners, and restoring the central bank’s original mission: to provide liquidity in times of crisis but never to buy government debt or try to micromanage the economy. Getting the Fed out of the financial markets is the only way to put free markets and genuine wealth creation back into capitalism.
That, of course, will never happen because there are trillions of dollars of assets, from Shanghai skyscrapers to Fortune 1000 stocks to the latest housing market “recovery,” artificially propped up by the Fed’s interest-rate repression. The United States is broke — fiscally, morally, intellectually — and the Fed has incited a global currency war (Japan just signed up, the Brazilians and Chinese are angry, and the German-dominated euro zone is crumbling) that will soon overwhelm it. When the latest bubble pops, there will be nothing to stop the collapse. If this sounds like advice to get out of the markets and hide out in cash, it is.
I’m mostly hiding out there myself.