Thursday, April 4, 2013

Stockman is wrong about Doomsday


Times must still be bad if publishers think that yet another Doomsday book will sell, especially David Stockman’s The Great Deformation; The Corruptions of Capitalism in America. The NY Times last week published a short version, just a few days before the book’s recent release, and you can read an excerpt from the book here.

Stockman has been predicting the-end-of-the-world-as-we-know-it for a long time, ever since 1985, when he left the post of OMB Director in the Reagan administration and warned that federal budget deficits and the failure to raise tax rates would be disastrous. His first Doomsday book was published in January, 1987: The Triumph of Politics: Why the Reagan Revolution Failed. Around that same time, Reagan pushed through another significant tax reform, including a reduction in top tax rates. Contrary to Stockman’s warnings, the economy grew at a 3-4% pace for the next several years, tax revenues soared some 30%, and the burden of the federal deficit dropped from 5% of GDP to 3%. After a brief recession in 1990-91, precipitated by a tightening of monetary policy, the economy went on to boom for most of the next decade thanks to spending restraint, welfare reform, lower taxes, and a strong dollar. And the deficit briefly turned into a surplus.

His message today hasn’t changed much, except that the coming Apocalypse will not be just the Republican’s fault, as it was back in the 1980s, but the fault of all of Washington: the Fed, the Congress, and our ever-growing entitlement programs. He’s right on many counts, but wrong on others, and I’d like to think we can avoid a calamity once again.

He’s right that we are “piling a soaring debt burden on our descendants,” and he’s right that Washington seems “unable to rein in either the warfare state or the welfare state.” But he’s wrong to suggest that the only solution is to raise taxes. We need more growth-friendly policies, such as a lower, flatter tax rate structure with fewer exemptions and loopholes, lower corporate tax rates, and reduced regulatory burdens. We need to reform social security by privatizing it and/or extending the retirement age. We need to introduce market-based reforms to healthcare, not more government controls. This is not rocket science, it’s just letting the market take over many of the functions that government has tried and failed to manage.

He’s dead wrong when he says “the Fed has resorted to a radical, uncharted spree of money printing.” I explain here why this is not true. The Fed is only swapping bank reserves for notes and bonds, and the evidence suggests that they have been doing this to satisfy the world’s demand for safe assets. The Fed may well make an inflationary mistake in the future if it fails to unwind its QE in a timely fashion, but that remains to be seen—it is not yet baked in the cake.

He’s right when he argues “we’ve had eight decades of increasingly frenetic fiscal and monetary policy activism.” Fiscal and monetary policy mistakes are at the root of almost every major economic problem this country has faced. Keynesian “stimulus” policies have proven not to work, and monetary policy is a very poor tool for fine-tuning economic growth. The Fed undoubtedly contributed to the housing bubble by keeping interest rates very low in the early- to mid-2000s. As government has grown in size and power, it has created a culture of crony capitalism (e.g., Solyndra), and by promoting housing with easy money from Freddie and Fannie and subsidized mortgage rates, it also contributed to the housing bubble. 

The list of government failures is unfortunately long and depressing. Where it looks like the market has failed and is corrupt, it's because government has not allowed the market to work. For a superb discussion of how and why government is the culprit behind the housing bubble and the financial crisis of 2008, I highly recommend John Allison's book The Financial Crisis and the Free Market Cure.  

Stockman’s fatalism is on display when he says we are at “an end-stage metastasis [and] the way out would be so radical it can’t happen.” What does he recommend? “If this sounds like advice to get out of the markets and hide out in cash, it is.” Unfortunately, most of his doomsday arguments have been the subject of headlines for years. It’s no secret that the U.S. suffers from some seemingly intractable problems. But it’s an underappreciated fact that the economy is growing and the burden of the federal deficit has declined significantly in the past three years, from 10.5% of GDP to less than 7%. I explain this here and here. It’s due to the simple combination of a growing economy and spending restraint. 

In any event, it’s arguably a little late to worry now that the end of the world is upon us. “Hiding out in cash” is extremely expensive, since it means forgoing much higher yields in other assets as long as the economy fails to crash. As I explain here, risk-free short-term interest rates are zero or very close to zero in most of the world’s major economies because investors are very risk-averse, not because the Fed is artificially driving rates to zero. Investors everywhere are already “hiding out” in cash: savings deposits at U.S. banks have swelled from $4 trillion to almost $7 trillion in the past four years, despite the fact that they pay almost no interest. U.S. currency in circulation has increased by over $300 billion since 2008, with much of that increase going overseas where $100 bills are seen as the ultimate safe haven. In the past 5 years, domestic equity mutual funds have suffered net outflows of over $500 billion, while much safer but very low-yielding bond funds have enjoyed over $1 trillion in net inflows.

Should concerned investors seek out the safety of gold instead? Here again it may be too late. Investors who fear the type of Apocalypse that Stockman is predicting have already bid up the price of gold to 3 times its inflation-adjusted price over the last 100 years.

In the end, Stockman is right to call our attention to the central problem we face, which is too much government. But there is no reason to think that calamity is unavoidable. Government can be fixed. Monetary policy is not a preordained disaster. The economy is growing and can continue to grow in spite of the fiscal and monetary policy headwinds it faces.

13 comments:

William McKibbin said...
This comment has been removed by the author.
Gloeschi said...

Bad, bad doomsday Stockman. Because there is such a scarcity of Pollyannas. Because it's them who in the end will spoil everyone's party.

Nope, don't listen to the 'idiots' talking about printing money. Because it isn't. For the little difference of six days between the issuance of fresh $13bn of 7-year T-Notes and the Fed buying back $3bn of them.

No, it's not printing money.

Who do you think you are fooling?

Sapporo89 said...

Follow you on Twitter. Enjoyed your posts.

Believe that you view of historic price of gold is flawed. Gold price was fixed from 1933 to 1971 (when Nixon killed Bretton Woods). Not really fair to use numbers from fixed market where commodity was not valued upon demand as basis for historic average price analysis.

Am I missing something?

Cheers ...

Scott Grannis said...

Re: the gold standard. Indeed the world was on a gold standard for many years. But does that invalidate my comparison? I don't think so. For most of the period in which the dollar was pegged to gold (at least up to 1965), inflation was very low in the U.S. and overseas. Done correctly, a gold standard forces all other prices to adjust to gold, so the price of gold is valid, given that an economy has enough time to adjust. I think there was plenty of time for the world to adjust to a fixed gold price. Unfortunately, the U.S. began "cheating" on the gold standard in the mid-1960s, and inflation started to rise. From 1965 to 1971 one could argue that the gold price was artificial. But thanks to Nixon's feckless devaluation of the dollar, gold then soared. By the end of the 1970s gold prices were likely high enough to correct for being artificially depressed in the late 1960s. So I think that taking an average of the real value of gold over 100 years is a valid exercise.

Donny Baseball said...

Even if you buy Stockman's analysis, his prescription is awful. Cash? Cash is the worst place to be. Today there is an opportunity cost to cash, as SG said, but if it not confiscated ala Cyprus it will be inflated away. Lost purchasing power of your cash, when it goes, is gone forever. It ain't coming back. I know of at least one other category of assets that, even if they take a temporary hit, can buck permanent impairment of value.

Benjamin said...

Excellent review of Stockman's book.

I took some small hope from Stockman's book, and that is that he is jointing a growing chorus of right-wingers in finally thinking about defense spending.

Pat Buchanan, Dick Armey, Ron Paul, the Cato Institute and now Stockman are at long last pondering why we spend $1 trillion a year on defense, VA and Homeland Security, in a world with about 1 percent of the threats posed by the old Soviet Union.

I doubt that the GOP will ever embrace a reduction in defense outlays; the money goes into GOP districts and constituent groups.

And the Dems will never embrace a reduction in the welfare state.

This is a reason to be pessimistic.

As for the Fed, to be sure there has been a swell in bank reserves. But as Grannis himself has pointed out, there has also been continuing increases in bank C&I lending, and the housing market is back.

Can we prove QE did that? Well, I don't believe deficit spending did it.

Be wary on gold. The Economist magazine just reported that many Indians buy gold to avoid taxes. That is, if you keep assets in a bank, or equities, or property, in India you will get taxed, and the Indian government will have a clue as to your wealth.

Not if you buy gold. And there is a growing Indian upper and middle class, and also the Chinese buy gold for traditional gift-giving, and they have a growing middle nd upper class as well.

The connection between Fed policy and global gold prices is really weak. Jeez, gold has cracked in dollar terms since the Fed went to serious QE. What connection explains that?

Gold may go up in the future, or down, but US monetary policy will have little to do with it.

Jeff said...

Great insight. I'll say it again, Scott Grannis for President (or at least Cheif Economic Advisor).

DownSouth said...

Scott,

Do you have any thoughts about the recent "bail-in" talks floating around the Canadian banking system?

Public Library said...

Privatizing SS is a disastrous idea. You should read Antifragility by Nassim Taleb. The last thing unsophisticated workers need is to expose their life’s work to tail risk they nor their brokers can manage or hedge. Such a clumsy + utopian idea.

Scott Grannis said...

Chile long ago came up with a great solution for privatizing social security. Let workers opt to take responsibility for themselves, or to stay in the current system. Make the privatization optional. Let people take responsibility for their lives, and you might be surprised to find that the great majority will make intelligent decisions. We don't need a nanny state to take care of us, especially when the return on your social security investment ranks as abysmally low. Politicians have mismanaged social security much more than most individuals ever would mismanage their own retirement funds.

theyenguy said...

I respond that the swapping bank reserves for seemingly “money good” US Treasuries is going to turn toxic to the Fed Balance Sheet very soon, as the value of assets taken in by QE1 are distressed investments which trade in value with those in Fidelity Mutual Fund, FAGIX, which has topped out in value.




There is every reason to be pessimistic about future stock market performance as I recently wrote, Peak Credit was achieved the week ending March 5, 2013, ... http://tinyurl.com/cg38tul ... where I wrote that the Fed has no exit plan.


Monetary policy is most assuredly a preordained disaster. The world stands at Peak Toxic Credit, as is seen in the chart of Fidelity Investments Mutual Fund FAGIX, topping out. This mutual fund contains the most distressed of investments, which were taken in under QE 1 and exchanged for “money good” US Treasuries, TLT, which were returned to the Fed and are now classified as Excess Reserves. The banks really do own the US Treasuries residing at the Fed, but will not, repeat not be selling them at any time. And indeed for a while as stocks, VT, trade lower, the US Government Debt, ZROZ, EDV, and TLT, will be increasing in value before they too fall dramatically lower in value.


Shortly the banks will become integrated with the Fed, and be known as the government banks, or Govbanks, for short. The Too Big To Fail Banks, RWW, sucha as BAC, C, KEY, BK, will be seen and will exist as Big Enough To Help Govern. The same will be true in the Eurozone, the Europaean Financials, EUFN, will be unified into a One Euro Government, as leaders meet in summits to waive national sovereignty and pool sovereignty regionally, and announce regional framework agreements to establish EU regional governance.


With the failure of credit, that is trust in the world central banks’ monetary authority to simulate global growth and trade, as well as to grow corporate earnings, investors will rapidly derisk out of small cap pure value stocks, RZV. And the Currency Demand Curve, RZV:RZG, will turn increasing lower in value, confirming that competitive currency devaluation is underway, and that the fiat money system is beginning to die; this will be reflected in Major World Currencies, DBV, and possibly also the US Dollar, $USD, UUP, trading lower in value.


Please consider that traditional carry trade investing, which is long currencies, and short the Japanese Yen, FXY, is coming to an end, as is seen in the chart of the Optimized Carry Trade ETFN, ICI, rising along an ascending wedge pattern; soon this will be falling sharply out of its consolidation pattern as the World Major Currencies, DBV and the Emerging Market Currencies, CEW, trade strongly lower on competitive currency devaluation, as the desire for risk assets evaporates, and the Risk On ETN, ONN, falls lower in value, as investors deleverage out of toxic debt such, as leveraged buyouts, PSP, High Yield Corporate Debt, HYG, and Junk Bonds, JNK, stimulating investors to derisk out of Global Producers, FXR, such as KUB, FMX, ERIC, ABB, NVS, TE, IR, BA, QCOM, CR, MTW, JBT, CFX, GE, HUB-B, FLS, MIDD, ZBRA, IEX, ROP, DOV, GPC, MMM. ET, APH, ROK, ITW, MKTAY, SNA, LECO, IP, WY, PKG, BLL, GPK, KS, MWV, seen in this Finviz Screener.


Institutional Investors such as Banks, and Insurance companies should be short the stock market using FSG, UGL, DGP, OFF, STPP, UDN, EUO, seen in this Finviz Screener, as a basis for their margin short selling account, and not only selling the Global Producers listed above but also the Small Cap Pure Value Stocks seen in this Finviz Screener ... http://tinyurl.com/bujhr78 ... and in this Finviz Screener ... http://tinyurl.com/d7etvm3


theyenguy said...

I continue in comment

Jesus Christ is at the helm of the economy of God, Ephesians 1:10, and out of his dispensation, that is out of His administrative rule of the Eurozone sovereign debt and banking crisis, He is pivoting the world from the paradigm of Liberalism into the paradigm of Authoritarianism.


Sovereignty begets seigniorage, that is moneyness. Insolvent sovereigns and their banks are unable to govern and are unable to provide moneyness. Zero Hedge reports 97% of Spanish social security pension fund in domestic bonds. There are a number of reasons why EU banks and retirement funds have loaded up on their own country treasury debts; one being that the purchase of the debt provides funding for the country’s fiscal spending that the financial markets no longer provide. This fake seigniorage, this fake moneyness, cannot continue forever. The purchase of national treasury debt by national banks and national retirement agencies in insolvent countries only concentrates moral hazard for all Euro using nations.


Liberalism was an era characterized by sovereign nations states, whose central banks practiced liberal policies of monetary expansion.

Out of growing sovereign crisis will come the new economic and political paradigm of Authoritarianism, as well as a new money system, that being the diktat money system, where diktat of sovereign regional leaders and sovereign regional bodies, serves as currency, money and power directing both economic and political activity most likely through public private partnerships, that is statist organizations, led by representatives from industry, banking and government, to oversee the factors of production.


Bears are appearing in the stock market bringing tombstones for the leaders of investment choice, such as the Too Big To Fail Banks, RWW, BAC, C, KEY, BK, the Regional Banks, KRE, RF, FITB, HBAN, SNV, STT, ZION, FHN, SUSQ, FITB, seen in this ongoing Yahoo Finance Chart, and the Small Cap Revenue Stocks, RWJ, as well as the Asset Managers, BLK, WDR, EV, STT, WETF, AMG, seen in this Finviz Screener, and the Investment Bankers, KCE, JPM, GS, MS.


EU Finance Ministers such as Olli Rehn are raising the banner of diktat ever more prominently over the Eurozone economic scene, as is seen in the Reuters report The European Commission supports Italy's plan to accelerate the liquidation of trade debt accumulated by its public administration, Olli Rehn says.


Faith in the current fiat based money and banking system is now starting to erode. Spot Gold, $GOLD, traded at $1590 on September 5, 2013. Wealth will increasingly be preserved and owing by physical ownership of gold, in bullion coins, and in global trading forms, that is in Internet trading vaults, such as BullionVault. Its only a short matter of time before gold trades higher, recovering from its death cross as is seen in Jack Chan’s chart of the Gold ETF, GLD.

Public Library said...

The return on SS should be abysmally low. Additionally, it should be fully funded. What you put in is what you get out + the deposit rate earned over the period. No need for anything more complicated than that. This provides retirees and taxpayers with a hedge against tail risk. Which would make the entire country more sound.