BOOK NOTE: “The Great Deformation” by David Stockman

Ah, Summers time is over.  And with Larry Summers withdrawing from consideration for the position of Fed Chairman, I’d like to nominate David Stockman.  His book The Great Deformation: The Corruption of American Capitalism may be the most important and most frightening thing I have ever read.  I got a copy when he spoke at a Reason event (one of the inspirations for this blog’s ongoing “Month of Reason”), but The Nation likes him too.

Once most famous for being the naysayer in the Reagan administration who said it’d all end in huge deficits, the aptly-named Stockman has now written the depressing (so to speak) tale of 100 years of the Federal Reserve’s corrupting influence on banking, the financial sector, business in general, and politics. 

The shortest version of perhaps the most important disaster story every told is that continually printing a larger number of dollar bills, as the Fed has done ever more readily over the past four decades in particular (since the gold standard was abandoned), creates the subtle illusion of increasing returns even at times when pessimism (and the lost virtue of frugality) might be perfectly rational, and that delusional state disproportionately rewards risk-takers, loan-seekers, and (perhaps most rationally) obsessive Fed policy-watchers (and international central banks-watchers more generally) instead of just inventors and real wealth-creators. 

Combine that with the unspoken assurance that interest rates will be kept artificially low any time things look gloomy -- and that government will goose things through massive bailouts and stimulus spending -- and it’s no wonder so many stupid-yet-arrogant loudmouth douchebags who think they can’t fail (and are touted as living embodiments of American entrepreneurship) have been living in a ritzy house of cards at the southern tip of the island I live on. 

At 700 pages, Stockman’s book has room to go into detail (naming names while recounting a century of tragic bad decisions) about how the banking and finance sector became a monstrous thing that looks superficially like the most glitzily free-market part of the economy but in fact richly (so to speak) deserves most of the hate it gets from the bank-bashing Occupy movement, the bailout-resenting Tea Party, and the conspiracy-spotting Ron Paul fans. 

Stockman’s book is evidence that you can start from more-moderate, less-ideological premises than those leftist, rightist, and libertarian factions (respectively) and still end up telling roughly the same deeply alarming tale.  If it weren’t for the near-impossibility of ending the usual right/left political paralysis, one could almost imagine a new, more rational political consensus arising around the lessons derived herein, orthogonal to the usual political spectrum, leading perhaps to the end not just of the welfare state but of the Federal Reserve and the banking and financial sector as we know them.

•••

We probably never should have allowed governments to print currency.  Or created central banks.  Or gone off the gold standard.  Or created deposit insurance.  Or trusted mutual funds.  Or allowed a revolving door between Wall Street and the White House.  Or created a government big enough to engage in bailouts and stimulus spending.

Trying to imagine the establishment allowing all that to end -- when they tend to end up with a disproportionate share of all those newly-printed dollars under the current shaky system -- is so difficult, it is enough to make a libertarian feel like a pessimistic leftist and vice versa.  We may just be screwed. 

(For a shorter, even more mainstream but still dire version of the tale, you might check out the documentary Money for Nothing: Inside the Federal Reserve, out this past weekend, which I saw not with Larry Summers but with the much more libertarian Summer and Phil Saxton.  I asked the director afterwards if he talked to any experts who suggested the Fed should simply be abolished and he said he had but kept the documentary, understandably, largely within the bounds of the debate occurring within the Fed itself, where the consensus is mainly just that interest rates should be far higher than they were kept during the illusion-maintaining Greenspan era.  None of this kept one guy in the audience from suggesting that what we need is complete nationalization of the banks, as if he hadn’t just watched two hours of the government’s central bank destroying the economy.)

On the less technical level of political philosophy, where dopes like me normally dwell, it is tempting to desire a “do over” of the past century or so of political conflict, since (as I had begun to fear three years ago after reading a book by Martin Sklar) so many of our problems since 2001 are really problems we’ve had since about 1901, when Progressives of

both parties encouraged the very cronyism -- the entanglement between government, banking, and big business -- that everyone now decries, like members of a chain gang who’ve all grown to hate each other but continue to fight over whether to run to the left or to the right instead of breaking the chains (calls for unity, solidarity, and solving things as one big national family don’t help foster clear thinking about such things, either). 

Progressives aren’t just the U.S. version of England’s gradualist Fabian Socialists.  They’re the ones who wanted this government/corporate muddle -- and tend to profit from it (as I fear Hillary Clinton, who has taken pains to say she is more a Progressive than a liberal, knows -- which may yield a very interesting subtextual battle between her and Rand Paul in 2016, if they are their parties’ nominees and we have in Paul a rare chance, perhaps, to fix this mess). 

If we could go back to 1901, we probably should have listened to the anarchists more and the government and corporate experts less, but then, back then anarchists weren’t touting pure free markets as the logical alternative to government but were instead doing unhelpful things like assassinating McKinley and putting ur-Progressive Teddy Roosevelt in the Oval Office.  Things have been on the wrong track for a very long time. 

(Things can evolve in efficient directions over time -- like this insect developing gears, which Walter Olson noted -- but they can also grow more deformed over the generations with sufficiently perverse incentives and no small amount of incest.)

•••

Karl Smith wrote a recent Forbes article that’s not too surprising by Stockman/Paul standards, about how the Fed in the 1970s (and always, he might add) imagined continual inflation to be a necessary part of maintaining businesses’ irrational optimism.  But even when writers such as Smith -- or stock analysts -- make that basic, troubling point, they still tend to get overawed by the power and supposed insight of the stock-picking gurus and Fed chairmen.  So instead of getting a headline screaming “We have to end this madness,” you get a wonky passage like this from Smith, about the 1970s inflation:

Reading [former Fed chairman] Burns’s words with the advantage of hindsight it is clear that he was grappling with the issue of multiple expectations-based dynamic feedback loops.  Though he uses only regular English words and no complex math, he essentially seems to be saying that the economy traces a complex path in higher dimensional space and that what we witness is the shadow of that path cast on to our two dimensions of unemployment and inflation.

I have no doubt there are nuances to our situation I do not begin to grasp, but I don’t think writing about them as if they’re explorations of hyperspace is going to make 99% of the population (to pick a number at random) feel qualified to demand changes.  (Most of us barely get the jokes at EconLOLCats, noted by Gerard Perry.) 

The elites just have a huge incentive (even if it is subconscious, fueled by pride) to pretend this slow-mo disaster we’ve been living through for a century is more complex than it is, but it comes down to this, I think: Keep printing more and more mere currency and people get reckless and cocky about their imagined wealth-generating abilities, which is not the same thing.  Our most arrogant, testosterone-fueled Wall Streeters have been tricked by government into thinking they’re productive members of society even at times when they barely are.  “Capitalism” as we’ve know it my whole lifetime is a paper tiger, you might say (an apt pejorative after all). 

It’s not easy to admit you’ve been had on a colossal scale, but we are caught between two pincers: a government that pretends to redistribute money for the sake of marginal populations while mostly redistributing money toward wealthier segments of the population (the elderly, defense contractors, businesses and banks, itself) and a financial sector loved with a guard dog’s intensity by “fiscal conservatives” that is in fact an inflation-fueled delusion. 

Complicating matters, neither middle-of-the-road moderation nor anti-elite populism can help (both tending toward slightly-dumber versions of the current muddle).  Only the radical laissez-faire move of getting government out of the currency-printing business seems likely to do the trick.  We may need Bitcoin after all.

•••

Though government created this mess, it is “fiscal conservatives” who probably stand to learn the most from Stockman’s tale, since it’s largely an embarrassing account of how easy it is to make people think they’re defending free markets when they’re only defending a crude simulation of them.

He has a very different set of politician heroes and villains than you might expect from a veteran of the Reagan administration, since his concern is not so much the current level of government spending as the long-term implications for debt and the discouragement of smoke-and-mirrors economic tricks.  He has more respect for Eisenhower, Truman, and Ford, all of whom thought that spending and taxes should be strongly correlated in the present than for LBJ, Nixon, or Reagan -- who all tended toward a “worry about it later” mindset, despite superficially very divergent policies. 

He recounts economy-altering decision being made among Reagan advisors through casual, brief meetings with almost arbitrary growth and interest rate numbers being dashed off on scraps of paper and then hewed to with religious fervor by feuding factions within the Cabinet.  To the extent all presidents since Nixon have hoped the Fed would pull their fat out of the fire as needed with interest rate changes, sparing both parties the pain of matching spending to tax rates, we are all indeed Keynesians now, argues Stockman, and that’s really an insult to Keynes, who would not have approved. 

Stockman sees even the Laffer-influenced supply-siders as welfare statists, since their desire to grow the economy without having to make budget cuts (thus in theory shrinking the government as a proportion of the economy) was just one more way the Fed-dominated era has been characterized by avoidance of hard choices.  Stockman is as offended by the myth that the Reagan administration was fiscally responsible as he is by the myth peddled by Paul Krugman and others that New Deal spending ended the Depression (and can do so again). 

He frankly calls the New Deal a set of “quasi-fascist schemes to regiment industry” yielding a grab bag of incoherent, random policies with little clear effect and a great deal of leader-aggrandizing rhetoric, not to mention an unprecedented confiscation of gold, in defiance of FDR’s campaign pledge to defend “sound money” backed by gold (the traditional guarantor against random or stealthy inflation).  Truman and Eisenhower would hew closer to a humble, traditional “pay your bills” ethos. 

But FDR isn’t the only villain here.  Nixon’s departure from the gold standard altogether in the early 70s was made possible in part by the blessing that move got from none other than libertarian economist Milton Friedman.  The dean of free markets was pivotal in reassuring experts that floating exchange rates would create sufficient competition between central banks that none would dare inflate its currency wildly, for fear the world would shift toward using other currencies.  Despite the potential to inflate as desired for political purposes (goosing the economy near election time, nudging employment rates upward, etc.), the world’s central banks would keep each other in check and print new currency at steady, predictable rates. 

But it didn’t work out that way, central banks aren’t real market entities, and they are moved more by domestic political pressures than by pure market forces.  Worse, they can coordinate their inflation through tacit and explicit political agreements, not just price-signal-watching.  Where there should be a world of people devising new goods and services, there is a world of currency speculators.

•••

We’ve lived for decades now in a world where the Fed assumes its job is to keep Wall Street happy through stability and Wall Street assumes its job is to watch what the Fed does, argues Stockman.  Somewhat like mutual funds, it sounds like the essence of stability and security but is basically the blind leading the blind, fine until everyone goes over a cliff together (a danger that is only made more likely by the homogenizing effects of regulation, as the journal Critical Review has noted).

Another shallowly political-philosophical thought that strikes me is how dangerous “fiscal conservatism” (as opposed to radical libertarianism) begins to look if it is essentially the endorsement of this artificial maintenance of steadily rising stock prices (with a complementary copy of the Wall Street Journal for your coffee table) rather than acceptance of unpredictable, “chaotic” market activity.  Likewise, to the extent currency itself becomes the most important good -- instead of a mere marker of trades in more readily usable goods -- Marx’s use of the term “capitalism” as a pejorative almost starts to seem fair. 

Fiat currency and its built-in abuses look like dangers so profound that the usual right-left culture squabbles look like an argument over how expensive, Middle Eastern-influenced, or gay-looking to make the deck chairs on the Titanic.  No wonder Stockman and Ron Paul are so obsessed.  No matter how radical they may sound, they both know it’s virtually inconceivable that we’ll hear a politician -- right or left -- call for doing anything that really rocks this (sinking) boat, such as, say, abolishing the bond market.  

(As the aforementioned documentary Money for Nothing notes, reliance on Fed stock-price-goosing may be a huge contributing factor to the oft-noted policy paralysis in DC: Politicians, much like investors, keep hoping the Fed will do something to spare them having to study the details, worry about trade-offs, or make tough choices.)

Instead of right and left offering drastic choices, their mutual maintenance of an inflationary system has mostly just mutated their ostensible ideologies to accommodate a Fed-dominated worldview: Conservatives might decry the redistributionist mandates causing Fannie and Freddie to subsidize bad loans, but not so loudly as to lead to Fannie and Freddie being abolished altogether -- and not so loudly as to clash with both Bushes’ calls for construction subsidies and greatly-increased home ownership.  Whether Clinton was calling for more loans in black neighborhoods or Bush was praising “the Ownership Society,” they were all banking on the housing bubble never ending (and they managed to turn the homeowners themselves delusional in the process). 

Kicking the can down the road isn’t just a recurring bad behavior -- it may be the foundation of the whole system.  Stockman sees irrationality on Wall Street (and an increase in temporarily stock-boosting bad ideas like the AOL-TimeWarner merger) but doesn’t see it as an inevitable result of real markets (that is, mere contracts and property rights): “Feeding the speculative mob while pocketing low-tax capital gains is what drives CEOs to act.  Cheap debt and a stock market badly deformed by the Greenspan-Bernanke Put are what enable the game.”

•••

Crony capitalism is made harder to detect when it is a function in part of government’s effect on stock prices, not just outright subsidy payments. 

Stockman cites the example of Republican former Senate Majority Leader from the mid-Bush era, Bill Frist, who showed a curious enthusiasm for government involvement in healthcare and hospital subsidies (I recall Eli Lehrer, who worked for Frist then, surprising me at lunch once with his own seeming-acceptance of less-than-laissez-faire Bush-era tweaking of Medicare).  Frist’s family, it turns out, owns one of the biggest hospital chains, HCA, and had little incentive to facilitate the big cuts in Medicare payments that some reformers were talking about at the time.  HCA revenues have increased by about 5% per year since then.

It used to be recognized that bubbles were dangerous because they were followed by busts.  Rather than ending that cycle by ending money-printing and inflation, the goal has long since become trying to make bubbles permanent.  No Romney (himself an expert at creating short-term gains through moves designed to jack up stock prices rather than creating long-term improvements) or Ryan (making an admirable effort to encourage budget cuts, but ones still so tiny they could not begin to rescue us) is radical enough to fix things, either, warns Stockman.  As libertarians have often said, we might be better off with a leftist face on the inevitable disasters to come than a faux-capitalist face that will cause people to draw the wrong lessons and think that more spending and more regulation is the solution. 

But the truth is that the financial system -- like the more narrow phenomenon of the welfare state proper -- is not quite what either the left or right typically imagine it to be but instead a weird and likely unsustainable hybrid.  Stockman warns that we can only be saved by going “full-retard antediluvian: [return to] the forgotten standard of honest public finance.”  Pay your bills now, don’t steal from the future, don’t paper over deficits and debts, in government as in personal finances.  He advises both raising taxes and abolishing the welfare state if we want to avoid the even more painful route of total systemic collapse. 

My bet -- and I don’t pretend to know enough about the stock market to have any idea how to profit from it -- is that we will opt for the painful collapse.  Prepare for rioting and shortages.