Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  But the truth is, a sound-money policy would have led to falling consumer prices, high interest rates and an upsurge of household savings in response to strong rewards for deferring current consumption. From that enhanced flow of honest domestic savings the supply side of the American economy could have been rebuilt with capital and technology designed to shrink costs and catalyze productivity.

  But instead of consumer price deflation and a savings-based era of supply-side reinvestment, the Greenspan Fed opted for a comprehensive inflation regime. That is, sustained inflation of consumer prices and nominal wages, massive inflation of household debt and stupendous inflation of financial assets.

  To be sure, the double-talking Greenspan actually bragged about his prowess in generating something he called “disinflation.” But that’s a weasel word. What he meant, in fact, was that the purchasing power of increasingly higher (and therefore increasingly more uncompetitive) nominal American wages was being reduced slightly less rapidly than it had been in the 1980s.

  Still, the consumer price level has more than doubled since 1987, meaning that prices of goods and services have risen at 2.5% per year on average even on the BLS’s downwardly biased reckoning. Notwithstanding all the Fed’s palaver about “low-flation” and undershooting its phony 2.00% target, American workers have had to push their nominal wages higher and higher just to keep up with the cost of living.

  But in a free-trade economy the wage-price inflation treadmill of the Greenspan Fed was catastrophic. It drove a wider and wider wedge between nominal U.S. wage rates and the marginal source of goods and services in the global economy.

  That is, U.S. production was originally off-shored owing to the China price with respect to manufactured goods. But with the passage of time and spread of the central bank driven global credit boom, goods and services were off-shored to places all over the EM.

  The high nominal price of U.S. labor enabled the India price, for example, to capture massive amounts of call-center activity, engineering and architectural-support services, financial company back-office activity and much more.

  At the end of the day, it was the Greenspan Fed that hollowed out the American economy. Without the massive and continuous inflation it injected into the U.S. economy represented by the 120% rise in domestic prices since 1987, nominal wages would have been far lower, and on the margin far more competitive with offshore wages.

  That’s because there is a significant cost-per-labor-hour premium for offshoring. The 12,000 mile supply pipeline gives rise to heavy transportation charges, logistics control and complexity, increased inventory carry in the supply chain, quality-control and reputation-protection expenses, lower average productivity per worker, product-delivery and interruption risk and much more.

  In a sound-money economy of falling nominal wages and even more rapidly falling consumer prices, American workers would have had a fighting chance to remain competitive, given this significant offshoring premium.

  But the demand-side Keynesians running policy at the Fed and U.S. treasury didn’t even notice that their wage-and price-inflation policy functioned to override the offshoring premium and to thereby send American production and jobs fleeing abroad.

  Indeed, they actually managed to twist this heavy outflow of goods and services production into what they claimed to be an economic-welfare gain in the form of higher corporate profits and lower consumer costs.

  Needless to say, the basic law of economics—Say’s law of supply—says societal welfare and wealth arise from production; spending and demand follow output and income.

  By contrast, our Keynesian central bankers claim prosperity flows from spending. So they had a ready (but phony) solution for the gap in household consumer spending that initially resulted when jobs and incomes were sent off-shore.

  The de facto solution of the Greenspan Fed was to supplant the organic spending power of lost production and wages with a simulacrum of demand issuing from an immense and continuous run-up of household debt. As we saw in Chapter 2, what had been a steady 75–80% ratio of household debt to wage and salary income before 1980 erupted to 220% by the time of Peak Debt in 2007.

  The nexus between household-debt inflation and the explosion of Chinese imports is hard to miss. Today monthly Chinese imports are 75X larger than they were when Greenspan took office in August 1987.

  At the same time, American households have buried themselves in debt, which has risen from $2.7 trillion in 1987 to $14.3 trillion at present. Even after the financial crisis and supposed resulting deleveraging, the household leverage ratio is still in the nosebleed section of history at 180% of wage and salary earnings.

  Stated differently, had the household-leverage ratio not been levitated in this nearly parabolic fashion, total household debt at the time of the financial crisis would have been $6 trillion, not $14 trillion.

  In effect, the inflationary policies of the Greenspan Fed and its successors created a giant offshoring hole in the supply side of the U.S. economy, and then filled it with $8 trillion of incremental debt, which has now become a permanent albatross on the Main Street economy.

  At the end of the day, the only policy compatible with Greenspan’s inflationary monetary regime was reversion to completely managed trade and a shift to historically high tariffs on imported goods and services.

  That would have dramatically slowed the off-shoring of production, and would also have remained faithful to the Great Thinker’s economics. As we indicated earlier, in 1931 Keynes turned into a vociferous protectionist and even wrote an ode to the virtues of “homespun goods.”

  Alas, inflation in one country behind protective trade barriers doesn’t work either, as was demonstrated during the inflationary spiral of the late 1960s and ‘70s. That’s because in a closed economy surrounded by trade barriers, easy money does lead to a spiral of rising domestic wages and prices owing to too much credit-based spending; and this spiral eventually soars out of control in the absence of the discipline imposed by lower-priced foreign goods and services.

  In perverse fashion, therefore, the Greenspan Fed operated a bread-and-circuses economy. Unlimited imports massively displaced domestic production and incomes—even as they imposed an upper boundary on the rate of CPI gains.

  The China price for goods and India price for services, in effect, throttled domestic inflation and prevented a runaway inflationary spiral. The ever-increasing debt-funded U.S. household demand for goods and services, therefore, was channeled on the margin into import purchases that drew on virtually unlimited labor and production supply available from the rice paddies and agricultural villages of the emerging market (EM) economies.

  In a word, the Fed’s monetary inflation was exported.

  Free trade also permitted many companies to fatten their profits by arbitraging the wedge between Greenspan’s inflated wages in the U.S. and the rice paddy wages of the EM. Indeed, the alliance of the Business Roundtable, the Keynesian Fed and Wall Street speculators in behalf of free money and free trade is one of history’s most destructive arrangements of convenience.

  In any event, the graph below nails the story. During the 29 years since Greenspan took office, the nominal wages of domestic production workers have soared, rising from $9.22 per hour in August 1987 to $21.26 per hour at present. It was this 2.3X leap in nominal wages, of course, that sent jobs packing for China, India and the EM.

  At the same time, the inflation-adjusted wages of domestic workers who did retain their jobs went nowhere at all. That’s right. There were tens of millions of jobs off-shored, but in constant dollars of purchasing power, the average production-worker wage of $383 per week in mid-1987 has ended up at $380 per week 29 years later.

  And that’s based on the Fed’s understated inflation. Based on the Flyover CPI, real wages have declined substantially since 1987.

  By contrast, during the span of that 29-year period the Fed’s balance sheet grew from $200 billion to $4.5 trillion. That’s a 23X gain during less than an a
verage working lifetime.

  Greenspan claimed he was the nation’s savior for getting the CPI inflation rate down to around 2% during his tenure; and Bernanke and Yellen have postured as would-be saviors owing to their strenuous money-pumping efforts to keep it from failing the target from below.

  But 2% inflation is a fundamental Keynesian fallacy, and the massive central bank balance-sheet explosion that fueled it is the greatest monetary travesty in history.

  Dunderheads like Bernanke and Yellen say 2% inflation is just fine, because under their benign monetary management everything comes out in the wash at the end—wages, prices, rents, profits, living costs and indexed social benefits all march higher together with tolerable leads and lags.

  No they don’t. Jobs in their millions march away to the offshore world when nominal wages double—even though the purchasing power of the dollar is cut in half over 29 years.

  These academic fools apparently believe they live in Keynes’ imaginary homespun economy of 1931!

  The evident economic distress in the Flyover America and among the Trump voters now arising from it in their tens of millions are telling establishment policy makers that they are full of it; that they have had enough of free trade and free money.

  But this is all a historical travesty. The immediate issue is, what can be done now to wind-back the clock?

  The solution lies in the counterfactual to the Greenspan/Fed Inflation Regime. Under sound money, the balance sheet of the Fed would still be $200 billion, household debt would be a fraction of its current level, the CPI would have shrunk 1–2% per year rather than the opposite and nominal wages would have shrunk by slightly less.

  Under those circumstances, there would have been no explosion of U.S. imports because U.S. suppliers would have remained far more competitive and domestic demand for imported goods and services far more subdued. To wit, what amounts to a statistical Trump Tower in our trade accounts—where total imports exploded by 6X—couldn’t have happened under a regime of sound money.

  For instance, if the CPI had shrunk by 1.5% annually since 1987 and nominal wages by 0.5%, the average nominal production wage today would be $8 per hour, meaning that American labor would be dramatically more competitive in the world economy versus the EM price than it currently is at $22 per hour.

  But real wages would be nearly one-third higher at $500 per week compared to the actual of $380 per week shown above (1982 $). At the same time, solid breadwinner jobs in both goods and services would be far more plentiful than reported currently by the BLS.

  Needless to say, the clock cannot be turned back, and a resort to Keynes’ out-and-out protectionism in the context of an economy that suckles on nearly $3 trillion of annual goods and services imports is a non-starter. It would wreak havoc beyond imagination.

  But it is not too late to attempt the second best in the face of the giant historical detour from sound money that has soured the practice of free trade. To wit, public policy can undo some of the damage by sharply lowering the nominal price of domestic wages and salaries in order to reduce the cost wedge versus the rest of the world.

  A BETTER ALTERNATIVE THAN PROTECTIONISM—ELIMINATE THE PAYROLL TAX WEDGE ON THE COST OF AMERICAN LABOR

  It is currently estimated that during 2016 federal social insurance levies on employers and employees will add a staggering $1.1 trillion to the U.S. wage bill. Most of that represents Social Security and Medicare payroll taxes.

  The single greatest things that could be done to shrink the Greenspan/Fed nominal-wage wedge, therefore, is to rapidly phase out all federal payroll taxes, and thereby dramatically improve the terms of U.S. labor trade with China and the rest of the EM world. Given that the nation’s total wage bill (including benefit costs) is about $10 trillion, elimination of federal payroll taxes would amount to an 11% cut in the cost of U.S. labor.

  On the one hand, such a bold move would dramatically elevate Main Street take-home pay, owing to the fact that half of the payroll tax levy is extracted from worker pay packets in advance. In the case of a Rust Belt industrial worker making $25 per hour, for example, it would amount to an additional $4,000 per year in take home pay.

  Moreover, elimination of payroll taxes would be far more efficacious from a political point of view in Trump’s Flyover America constituencies than traditional Reaganite income tax rate cuts. That’s because nearly 160 million Americans pay social insurance taxes compared to fewer than 50 million who actually pay any net federal income taxes after deductions and credits.

  At the same time, elimination of the employer share of federal payroll taxes would reduce the direct cost of labor to domestic business by upwards of $575 billion per year. And as we have proposed in the Jobs Deal, the simultaneous elimination of the corporate income tax would reduce the burden on business by another $350 billion annually.

  By all fair accounts, the corporate income tax is the most irrational and unproductive element of the U.S. tax code. But as I learned working on its replacement as a young aid on Capitol Hill in the early 1970s, it gets demagogued by the political left and harvested for loopholes by the K-Street lobbies in a never-ending and pointless legislative joust.

  Therefore, when you hear mainstream politicians talking about reforming or cutting the corporate tax rate because it is the highest in the world, yawn. The nominal rate is 35% but the effective rate averages under 20% and last quarter the likes of IBM posted a negative rate.

  Indeed, during the eight years ending in 2014, nearly two-thirds of U.S. corporations paid no taxes at all. That’s why the corporate income tax—which generates barely $350 billion in receipts per year—is better understood to be the lawyers, accountants, consultants and K-Street lobby full employment act

  Needless to say, that is a mighty force of inertia, and in that sense is emblematic of why the status quo is failing. It is no secret that the corporate tax has always posed an insuperable challenge to match business income and expense during any arbitrary tax period, but that in a globalized economy in which capital is infinitely mobile on paper, as well as in fact, the attempt to collect corporate-profits taxes in one country has become pointless and impossible.

  It simply gives rise to massive accounting and legal maneuvers such as the headline-grapping tax inversions of recent years. Yet notwithstanding 75,000 pages of IRS code and multiples more of that in tax rulings and litigation, corporate tax departments will always remain one step ahead of the IRS.

  That is, the corporate tax generates immense deadweight economic costs and dislocation—including a huge boost to off-shoring of production to low-tax havens—while generating a meager harvest of actual revenues. Last year, for example, corporate tax collections amounted to just 1.8% of GDP compared to upwards of 9% during the heyday of the American industrial economy during the 1950s.

  By pairing the elimination of the corporate tax with a giant increase in worker take-home pay, however, Donald Trump might actually make some progress where the GOP has tilted at windmills for decades.

  Needless to say, you don’t have to be a believer in supply-side miracles to agree that a nearly $1 trillion tax cut on American business from the elimination of payroll and corporate income taxes would amount to the mother of all jobs-stimulus programs!

  Self-evidently, the approximate $1.5 trillion revenue loss at the federal level from eliminating these taxes would need to be replaced. We are not advocating any Laffer Curve miracles here—although over time the re-shoring of jobs that would result from this 11% labor tax cut would surely generate a higher rate of growth than the anemic 1.3% annual real GDP growth rate the nation has experienced since the turn of the century.

  It is not my purpose to delve into the details of the giant tax swap proposed here. But suffice it to say that with $3 trillion of imported goods and services and $10 trillion of total household consumption, the thing to tax would be exactly what we have too much of and which is the invalid fruit of inflationary monetary policy in the first place.

  T
o wit, the foregone payroll- and corporate-tax revenue should be extracted from imports, consumption and foreign oil. An approximate 15% value-added tax on roughly $9 trillion of final-consumption spending (assuming medical care and other necessities are exempted) would generate about $1.4 trillion per year and fall heavily on imported goods.

  The balance of the $1.5 trillion revenue loss could be recouped via a variable levy designed to peg landed petroleum prices at $85 per barrel. That would generate about $100 billion, assuming world oil prices average $35 per barrel in the period immediately ahead.

  At the same time, a variable levy on petroleum (and other energy) imports would establish an $85 per BOE price umbrella under which domestic shale, alternative energy and conservation could thrive in response to domestic prices that were guaranteed to remain in place, and not be whipsawed by short-run volatility in crude market prices.

  Such a price-driven scheme would also permit the cancellation of the massive array of green- and black-energy subsidies, tax credits and guarantees that give rise to far more crony-capitalist waste and corruption than they do competitive energy.

  CHAPTER 6

  America’s Rolling LBO and Why There Have Been No Breadwinner Job Gains Since the Year 2000

  IN EFFECT, AMERICA HAS UNDERGONE A ROLLING NATIONAL LEVERAGED buyout (LBO) since the Gipper’s time in office. It is the result of the Washington and Wall Street policy consensus in favor of permanent deficit finance, stock market–centered “trickle-down” stimulus by the Fed and massive borrowing by the household and business sectors of the private economy.

  So the U.S. economy is now stuck in the ditch because it has leveraged itself to the hilt over the past three decades. The vast majority of Americans are no longer living the dream because Wall Street speculators and Washington politicians alike have led them into a debt-fueled fantasy world that is coming to a dead end.

  Indeed, this deformation has been long in the making and reaches back nearly a half-century. To wit, once the Federal Reserve was liberated from the yoke of Bretton Woods and the redeemability of dollars for gold by Nixon’s folly at Camp David in August 1971, financial history broke into an altogether new channel.