4/2/13 – State-Wrecked? David Stockman’s New York Times Piece Considered

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Apr 2, 2013 11:14:04 AM

and tagged Politics and the Economy, Yesterday's News

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Several people have forwarded me “State-Wrecked: The Corruption of Capitalism in America”—a recent New York Times op-ed by David Stockman, former budget director for President Reagan—and asked for my thoughts. Having read through the piece, it’s actually not that easy to respond, as Mr. Stockman seems to be all over the place. In fact, I’m not sure exactly what he’s saying other than that we’re all doomed.

Trying to pick out the different parts of his argument, I come up with following. First, abandoning the gold standard was a huge mistake and has led to fiscal and moral debasement. Second, the Fed has been the agent of said debasement, printing money to enable the federal government’s wanton spending. Third, Wall Street has captured both the Fed and Washington, D.C., and is using them to enrich itself. Fourth, the 2008 financial crisis would have burned itself out and we would have been fine had the government not intervened. Fifth, our fiscal situation is not only worse than admitted but beyond hope. We cannot solve our present problems and face a future of poverty. In short, under the present system, we’re doomed, and we largely deserve it for past sins. Thus endeth the lesson.

Responding to this is a bit difficult, in that I agree at least in part with several of Stockman’s assertions, although I don’t agree with his conclusions. That current spending is unsustainable, for example, is true—but spending is being brought down. It’s also true that there’s some degree of regulatory capture of Washington by Wall Street, and (in my opinion) that the Glass-Steagall Act shouldn’t have been repealed. Again, though, this has happened before.

What gives Stockman’s statements their force is the inclusion of some facts and reasonable possibilities (presented as facts) that everyone would accept. The author then uses these facts and possibilities to make assertions that I would argue are not supported. Let’s walk through another way to look at the same set of facts and see how we can arrive at a different conclusion.

The core of Stockman’s argument is that government spending and debt are too high and cannot be corrected, and that this has been enabled by the abandonment of the gold standard. We’ll start with the gold standard.

The notion that economies were better run, and more stable, under the gold standard is simply wrong in my opinion. Recessions were regular events, then known as depressions, capped off by the Great Depression. Growth was limited by the supply of gold dug out of the ground—as William Jennings Bryan famously said, “You shall not crucify mankind upon a cross of gold!”—and inflation could be and was generated by discoveries of new deposits. By taking control of the economy from people and handing it to nature, some problems were solved, very true, but others were created. The gold standard was abandoned for a reason.

Not that fiat currency is without its own problems, of which Stockman identifies many. He is right about inflation, both past and potentially future; he is right about the Fed balance sheet expansion and federal deficits; and he may well be right about future deficit and debt trends. I agree with much of his take on the Washington, D.C./Wall Street axis. He’s also wrong about many issues, however. Despite the clear moral tone of his diatribe, I do not think fiat currency will necessarily lead us to doom.

Let’s take debt and deficits. U.S. federal debts have been at and above this level before, after World War II. Other countries have had debt and deficit levels as high and survived (see Reinhart and Rogoff’s This Time Is Different). Moreover, setting aside WWII, we have been here, or at least somewhere like here, before. Prior to 2008, in pretty much every postwar economic downturn, we ran deficits that were the worst since WWII. Arguably, the extent of the most recent downturn justified the extent of the fiscal support—it was an extension of degree, not of kind.

Since then, as in past downturns, the deficit has been declining as spending decreased; with the resumption of growth, it will decline as a percentage of GDP as well. The trends are in the right direction. And, as I mentioned, we’ve come out of similar situations before, as have other countries that were in even worse positions.

The final argument is that, because the accrued debt has grown too large, we cannot continue on this path. With this I agree. Will there be pain? Certainly. Will we be paying for this for decades? Yes. I believe taxes will go up, and benefits of all types—social security, Medicare, everything—will go down. Growth will be depressed while we work through this. Challenges are not doom, however.

None of this is to minimize the costs we will incur to adjust, which will be substantial, nor the potential for things to go wrong. If current policies were to continue indefinitely, with no adjustments, we would indeed be in big trouble. Therefore, we will change our policies. Winston Churchill was wise as usual when he observed that Americans will ultimately do the right thing after trying all the other options.

If you look at the U.S. political system, we are now in the process of working out what the right thing is. Both the right and the left have laid out their plans, and, ultimately, I believe we will come to a workable solution, doling out the necessary pain in what’s judged to be a fair way. The problem is solvable; the question is agreeing on which of the many possible solutions we will pick. That is the subject of the current debate.

Stockman’s call for doom amounts to saying that the U.S. cannot change its current course, a point he explicitly makes. In my view, not only is that untrue in the future, it’s even untrue in the present. Many of the issues he highlights are indeed serious, but they are being addressed by both parties as we speak. In fact, by calling more attention to the real problems that exist, his editorial will probably help move a solution along.

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