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.