The Great Deformation: The Corruption of Capitalism in America
by David Stockman
Public Affairs, 2013, 768 pages, US$35
As a chronicler of economic history and a policy advocate, David Stockman combines economics training with an inside operator’s knowledge gained at the highest levels of government and finance. Back in the 1980s he was plucked from relative obscurity as a junior Congressman to become President Reagan’s Budget Director. In The Triumph of Politics (1986) he lifted the lid on the Reagan revolution with its successes and its failures. The failures were associated with the “supply side” budgetary policy involving tax cuts without associated spending cuts. He vigorously opposed that at the time and considers it sowed the seeds for an acceptance of the excessive deficits now in place.
In The Great Deformation, Stockman extends and enlarges that historical analysis. He sees near-unresolvable economic problems, the cause of which he lays squarely at the door of successive governments with their extravagances, bad spending decisions, budget deficits, and artificially low interest-rate settings that have brought excessive investment in housing, savings disincentives and potential inflation. These are aggravated by what he sees as an undermining of the capitalist structure caused by owners’ agents, management, looting of company profits through financial engineering and by recent government bailouts of poorly managed firms.
Stockman blames the present endemic US current economic crisis on politicians’ spending programs and loose monetary policy. The adverse effects of these have been growing like a cancer for almost eighty years, reaching a crescendo with the Global Financial Crisis (GFC) of 2008 and an aftermath that continues to plague the world economy.
Economists’ views about the causes and resolutions of the Great Depression tend to condition their preferred approach to modern economic management. Keynesian economists attribute the 1929 Crash to general exuberance and have seen the Great Depression as partly due to policy measures like price controls and tariffs. Their antidote is increased government expenditure, if necessary using deficits—pump priming—to reignite growth.
Pump priming, however, failed to restore growth in the 1930s, which saw deficits of 5 per cent of GDP between 1931 and 1937. Indeed, once debt creation was slowed in 1937, the economy again tanked. Stockman attributes the eventual recovery not to war spending but to the effects of the war in considerably reducing overall US debt (owed by businesses and consumers, though not, of course, the government debt component).
Stockman dismisses the Keynesian analysis but also takes down Milton Friedman, among the leading conservative economists of the twentieth century. Friedman’s prescription for economic stability is founded on a steady 3 per cent a year growth in the money supply. Stockman derides this as impossible even in the event that the US monetary authority, the Fed, was genuinely independent of political interference—and over the past half-century the Paul Volcker chairmanship (1979 to 1987) was a rare example of this. Stockman demonstrates that, political interference aside, holding money supply growth to a single level, 3 per cent, is impossible because the notion of money changes markedly.
Friedman considered the fall in the supply of money after 1929 was the prime cause of the continuing slump. He did not see the credit creation of the 1920s as excessive and argued that the policy should have been continued. Stockman maintains that this was impossible—credit growth was leading to inadequate investment and simply fuelling the Wall Street frenzy and unrepayable debt from European demand for US agricultural products:
Friedman thoroughly misunderstood the Great Depression … there was no liquidity shortage and no failure by the Fed to do its job as a banker’s bank. Indeed, the six thousand member banks of the Federal Reserve System did not make heavy use of the discount window during this period and none who presented good collateral were denied access to borrowed reserves.
And the documented lack of member bank demand for discount window borrowings was not because the Fed had charged a punishingly high interest rate. In fact, the Fed’s discount rate had been progressively lowered from 6 per cent before the crash to 2.5 per cent by early 1933.
Stockman notes that the Wall Street crash wiped out margin players but banks had ample liquidity. Only the agricultural banks closed down due to plummeting commodity prices. The money supply contraction was due to bad debt liquidation, “not an avoidable cause of the depression”.
He points out that the slump had bottomed in 1931 and was recovering in 1932 with fewer bank failures, Wall Street rising, textile output reaching full capacity. This was knocked off course by the election of Roosevelt and his subsequent devaluation, bank holiday, tariff increases, wage freezes and the New Deal.
Stockman acidly concludes that the Friedman monetary injections are pretty much the same as Keynesian government spending injections and carry the same doomed hopes of reigniting an economy in the doldrums.
The current recession has different antecedents to the Great Depression but the same policy fixes are again being trotted out. Stockman’s analysis of the current ills goes back to the Vietnam War under Johnson and Nixon when the USA chose both guns and butter. The policy extravaganzas were financed with debt and from increased overseas holdings of US dollars which assumed an increasingly important role as the world’s reserve currency.
He notes that Reagan vastly expanded the size of the federal government to over 21 per cent of GDP in 1989 but, the “peace dividend” notwithstanding, expenditure continued to grow and reached 25 per cent under George W. Bush. This is an oversimplification, since the share of federal spending in Reagan’s last budget was actually smaller than Carter’s 1981 legacy of 22.2 per cent and even a tad below Nixon’s last budget. Moreover, the high point of George W. Bush was fuelled by the “temporary” measures designed to counter the GFC and even the grossly profligate Obama administration has wound this share of GDP back a percentage point or so. Nonetheless the US government does seem to have permanently raised its part in the economy from the Cold War-inflated 17 to 18 per cent under Eisenhower to 24 per cent today.
But the deficit story, rather than excessive spending, is the starter motor to Stockman’s main narrative. It initiates and aggravates the impact of what Stockman sees as progressively looser monetary policies over the past 100 years. These monetary excesses are the outcome of political pressures to force lower interest rates. Such pressures generally prevailed, a solitary exception being Paul Volcker’s courageous chairmanship of the Fed during the 1980s.
Serious budget deficits commenced under Reagan and, after disappearing under Clinton by the turn of the millennium, now following a wind-back of much “temporary” support to counter the GFC, absorb the equivalent of 9 per cent of US GDP. This is money borrowed from the future for current consumption. Exacerbating the repayment difficulties, the borrowings divert resources from investment, thereby impairing the economy’s future productive capacity. Stockman sees this and the Fed’s loose monetary policy threatening the fabric of the economic system or at best condemning the US to indefinite recession.
Prosperity in the 1990s was, for the most part, fuelled by money-printing and a cumulative $2 trillion trade deficit. But this created financial crises, each one more serious than the one before.
With the dotcom bubble bursting in 2001, even more liquidity was added, with near-zero interest rates leading to the housing boom and a supercharged Wall Street from then to 2008. However, liquidity injected into the system must eventually be spent on goods and services, the supply of which is impaired by the money supply boost misallocating spending away from new productive investment.
Loose money reached its apogee, marked by near-zero interest rates which pretty well exhausted its further potential to fuel demand. In spite of this documented failure of pump priming, this Keynesian policy was turned to in 2008 by Friedman’s pupil, the Fed chairman Ben Bernanke, and the former Goldman Sachs “bond salesman”, Treasury Secretary Henry Paulson. The USA launched its $800 billion stimulus and $700 billion Troubled Asset Relief Program (TARP).
The inevitable frittering away of these funds on faddish and heavily lobbied expenditures was seen in the exotic energy-spending failures like Solyndra and Tesla. And the USA had its equivalent of our own pink batts and superfluous school hall expenditures. The TARP included among its loans a $200 million facility to a business that planned to make auto loans set up by two totally inexperienced housewives whose husbands were executives of the already bailed-out Morgan Stanley Bank.
Deficit spending as in the 1930s has failed and left enormous debts. And there is no end in sight:
The much ballyhooed budget of [Vice Presidential candidate Paul] Ryan for fiscal 2012 added $7 trillion to the national debt, for instance, before it would achieve a balanced budget twenty-five years later; that is, in 2037. Eisenhower would have thought such a fiscal plan the scribbling of a madman.
Massive deficits cumulating year on year were added to policies like the creation of a highly unstable housing market. Low interest rates and political pressures on banks to lend to high-risk borrowers compounded this. The government-controlled re-insurer, Fannie Mae, fuelled the frenzy by facilitating debt. Home loan assets grew from $1.7 trillion in 1994 to $6 trillion in 2008, by which time the prices were falling. The securitisation “innovation” of the 82 per cent of sub-prime loans is now recognised as badly mistaken and hiding rather than smoothing risk. Similarly, the merger and acquisition frenzy of the past thirty years has been shown to have destroyed rather than created value.
Such activities have undermined previous standards of prudence on the part of businesses. One outcome has been a hollowing-out of listed companies as Wall Street brokers combined with management to create value by buying stock on the basis of which executives were rewarded.
The largest twenty-five companies on the Fortune 500 list [had] net income aggregated to $242 billion during 2007, but only 15 per cent ($35 billion) of that hefty total was reinvested in their own businesses; that is, allocated to additional capital expenditures and other working capital after funding depreciation and amortization of existing assets. By contrast, these same twenty-five companies … invested nearly $345 billion in financial engineering and shareholder distributions. This stupendous total represented 140 per cent of the aggregate net income of these leading companies.
Stockman’s focus on monetary policy and the harm from very low interest rates is well placed. However, it does lead him into some doubtful judgments. Among these is his dismissal of the shale oil and gas revolution that is now under way in the USA. He considers this has been artificially stimulated by low interest rates undervaluing the cost of capital. It is much more plausibly a function of genuine innovation in the location and tapping of hydrocarbon reserves previously uneconomic. As in the dotcom boom, there are doubtless over-exuberant investments in shale oil, but gains from the new technology are real.
Spending increases, the TARP and company bailouts were justified as a counter to prevent meltdown. But the decline in inventories that signalled the downturn (15 per cent) was little different from earlier downturns and only one quarter that of the Great Depression. Stockman considers therefore that panic was uncalled for. The Fed and Treasury’s deficits meant a massive increase in government bonds and the attempts by the authorities to restore growth by pushing liquidity onto the market meant money from these bond sales was not on-lent as there was no demand. Stockman says of those deficits, “Specifically, the excess consumption enabled by subnormal household savings resulted in year after year of recorded GDP growth that amounted to little more than theft from future generations.” There was no payoff in terms of growth, which remains at its lowest since the Great Depression. But government debt grew from 67 per cent of GDP in 2006 to 103 per cent in 2011. The liquidity was used to fuel the stock exchange, and with every move to end it the market panics. This process continues.
In 2008 the main beneficiaries of the government bail-outs and the TARP were the major banks, which had invested in the housing market, and such businesses as GM which had developed excessive costs based on poor labour market management. Among financial institutions only the majors, very highly leveraged on mortgage and other toxic debt, were in trouble. By contrast, regular banks with under-performing mortgages on their books would not collapse but would instead incur losses that would be taken over many years.
But the GFC and governments’ responses is now history. The present Armageddon is the result of the frantic efforts to stave off a financial crisis set up by government measures designed to rectify spates of excessive credit creation over the past sixty years. Stockman offers a route back to stability involving measures that include:
• allowing interest rates to be set by the market and not determined by the Fed
• allowing only deposit-taking banks not engaged in trading and derivatives to have access to Fed funding support
• requiring balanced budgets, eliminating subsidies, abolishing the minimum wage, Obamacare and a clutch of government departments and agencies
• instituting a 30 per cent wealth tax payable over a decade to eliminate government debt
Little of this is going to happen. Stockman gloomily says:
In November 2012 the people voted for the only real choice they were presented; that is, for paralysis and stalemate. Now it is only a matter of time before the state finally fails as a fiscal entity. It is … so overloaded with mandates and missions that it cannot move forward and it cannot move back. Instead, it will become ever more paralyzed and dysfunctional. The cruel corollary is that free market capitalism cannot help, either. It has been abused, burdened, demoralized, and impaired by decades of central bank money printing and the speculative raids and rent-seeking deformations which it fosters.
Alan Moran is the Director of the Deregulation Unit at the Institute of Public Affairs.