As will be seen, the causes and roots of the Great Depression were dramatically different than the 2008 collapse of the Wall Street casino and the debt-saturated national economy. The only relevance of the New Deal, ironically, was that it had been the original wellspring of the ills currently at hand; that is, the displacement of sound money and an honest free market economy with statist economics and the crony capitalist régime which inexorably arises from it.
In fact, by the turn of the century New Deal interventionism and welfare state expansion had conjoined with Reaganite fiscal profligacy: Supply-side tax cutting became the Keynesian opiate of the prosperous classes. But what made this unholy union possible was the Great Deformation of central banking, money, and credit which was initiated by FDR but had been crystallized by the Camp David abomination of August 1971.
In an act that cascaded down through the decades, Richard Nixon caused the United States to default on its Bretton Woods obligations to redeem unwanted dollars in gold, and thereby inaugurated an era of global trade imbalance, currency pegging and manipulation, massive debt creation, and financial speculation that had no historic antecedents. It became the era of bubble finance which is chronicled in all its dismal particulars in part IV.
So the triumph of crony capitalism was only confirmed by the bailout spasms of 2008. Its roots were actually buried deep in the decades that had passed between August 1914 and the BlackBerry Panic of 2008. In the intervening decades, a leviathan was arising through a process of economic governance that was halting, piecemeal, and more often than not driven by fleeting emergencies that were of no lasting moment.
But the common thread was the proposition that modern industrial capitalism was unstable and prone to chronic cyclical fluctuations and shortfalls that could be ameliorated by the interventions and corrective actions of the state, and most especially its central banking branch. That was upside down. The far greater imperfections and threat to the people’s welfare were embedded in the state itself, and in its vulnerability to capture by special interests—the vast expanse of K Street lobbies and campaign-money-dispensing PACs. Trying to improve capitalism, modern economic policy has thus fatally overloaded the state with missions and mandates far beyond its capacity to fulfill. The result is crony capitalism—a freakish deformation that fatally corrupts free markets and democracy.
PART II
THE REAGAN ERA REVISITED:
FALSE NARRATIVES OF OUR TIMES
CHAPTER 4
THE REAGAN REVOLUTION
Repudiations and Deformations
THE FINANCIAL BREAKDOWN AND CONVULSIVE GOVERNMENT INterventions of September 2008 were the very antithesis of the promised land of private prosperity and frugal government that the Reagan Revolution envisioned three decades earlier. In truth, these promises were long faded ideological dreams, but the passage of the Troubled Asset Relief Program (TARP) by a Republican government was the final, jarring end note. It amounted to a stark repudiation of the Reagan Revolution.
It proved that the great tax and spending cut campaigns of 1981 had not bent the contours of history in the slightest. They had been a flash in the pan, which twenty-seven years later illuminated nothing at all.
In fact, there was a Reagan-era fiscal legacy still alive in September 2008, but it was an ironic one which presented itself in twisted, perverse aspect. Ronald Reagan had spent a political lifetime excoriating deficits, but the takeaway from his presidency among Republican politicians was that he had proved the contrary: that deficits don’t matter.
Moreover, during the George W. Bush era this insidious idea became operational policy. It was embodied in two costly unfinanced wars and two giant tax cuts which were paid for by massive issuance of treasury bonds.
So when the once-in-a-generation test of the nation’s fiscal mettle came in the midst of the Wall Street storm, there was no conservative party left to safeguard the gates to the treasury. In fact, Republican politicians had embraced a dangerous rationalization that weakened any vestigial fiscal resolve; namely, that deficits were the passive result of an underperforming economy, not the deliberate consequence of profligate fiscal policy.
Accordingly, the GOP shifted its deficit-fighting efforts to a more pleasant chore; that is, peddling new tax cut gimmicks to spur “growth.” The implication was that without constant ministrations from Washington, the nation’s economy would falter. In the heat of crisis, therefore, the GOP became an easy mark for the Bernanke–Paulson canard that Wall Street’s long overdue meltdown would pull Main Street America into a vortex of economic collapse.
Republican politicians thus concluded, anomalously, that issuing a $700 billion blank check would result in lower, not higher, federal deficits. It was just another variation of the pro-business Keynesianism that morphed out of the Reaganite tax-cutting religion. Indeed, Republicans became suckers for practically any rendition of the supply-side shibboleth that higher growth means lower deficits, so they quickly rationalized that propping up Wall Street would produce more revenue.
RICHARD NIXON’S FOLLY AND THE CENTRAL BANK WAREHOUSE FOR TREASURY DEBT
Yet the real culprit behind the fiscal profligacy which descended upon the nation was the final destruction of sound money way back in August 1971. While not evident for decades to come, it was Richard Nixon’s default on the nation’s Bretton Woods obligation to redeem its foreign debts in gold that actually ushered in the era of “deficits don’t matter.”
After the gold window was closed in favor of floating fiat currencies, the Fed and the other major central banks of the world, especially those of the Asian mercantilist exporters, went on a rampage of paper money expansion and currency pegging. Financial discipline thus lost its anchor and fiscal rectitude its necessity.
The virtue of fixed exchange rates and continuous settlement of international account imbalances was that chronic budget deficits led to an outflow of reserves and a domestic financial squeeze. The need to counter this threat, in turn, gave politicians cover to enact unpopular spending cuts or tax increases.
When activist fiscal policy gained ascendency after the war, however, Keynesian theorists at first, and statist politicians later, became strongly anti-gold. As the younger Alan Greenspan observed near the end of Bretton Woods: “Opposition to the gold standard … was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending.”
In the decades after 1971 Nixon’s floating-rate currency régime offered a way out. As the flood of unwanted dollars washed around the globe, mercantilist exporters never ceased pegging their currencies to keep the dollar price of their manufactures low.
This currency market intervention resulted in vast accumulations of dollar-denominated assets such as treasury bonds and bills, which were then sequestered in the vaults of these same money-printing central banks. In fact, by the end of 2012 fully $5 trillion of the nearly $12 trillion in publicly held US treasury debt was locked up in central banks and other official institutions, including the Fed.
By this process of debt monetization both at home and abroad, the classic ill effects of fiscal deficits including monetary inflation, higher interest rates, and a squeeze on private investment were circumvented. Yet this monetary miscarriage did not eliminate but only deferred the day of reckoning.
Indeed, the counterpart to the flood of dollars abroad was the buildup of towering debts on domestic balance sheets and the associated leveraged speculation in real estate and every class of financial asset. Ironically, then, the fruit of the cheap dollar policy which made fiscal deficits painless had suddenly, in September 2008, turned into a full-fledged financial bust that was to be remedied with even greater budgetary red ink.
By the time of the revote on TARP, after the first vote failed and had unleashed another fear-inducing stock plunge, the nation was self-evidently fiscally incontinent. There were now two “free lunch” parties operating in a political arena from which all of the ancient taboos and f
ears about deficit finance had been purged.
In fact, the absorption by central banks of much of the treasury debt issued during the three decades after the Reagan deficits first exploded on the scene enabled the rise of an even more pernicious legend; namely, that the Reagan-era fiscal disaster was actually a splendid success because it drew the line on taxes and triggered an extended era of economic growth and capitalist prosperity.
This narrative is demonstrably untrue and amounts to blatant myth making. Moreover, it is these unsupportable Reagan-era fiscal legends that make Washington so vulnerable to the endless financial raids of crony capitalism.
THE REAGANITE LEGENDS OF FISCAL RESTRAINT AND ECONOMIC REVIVAL
The Reaganite legend begins with the false proposition that the Reagan Administration stopped the march of “Big Government” and brought a new fiscal restraint to Washington. Yet after the economy had rebounded and recession-bloated spending had subsided during Reagan’s second term, federal outlays averaged 21.7 percent of gross domestic product (GDP). That was obviously no improvement at all on the 21.1 percent of GDP average during the alleged “big spending” Carter years, and compared quite miserably to the 19.3 percent of GDP recorded during Lyndon Johnson’s final four years of “guns and butter” extravagance.
Nor had the Reagan Revolution planted any seeds of future fiscal restraint. During the administration of George H. W. Bush, federal spending averaged nearly 22 percent of GDP—still another presidential record and one that came after the end of the Cold War and the resulting 15 percent decline in real defense spending.
But it was the second Bush who took Reaganomics to its logical extreme, demolishing Republican fiscal rectitude once and for all in a fury of “guns and butter,” and tax giveaways, too. Federal outlays in the final budget of George W. Bush soared to 25 percent of GDP. That was a post–World War II record by a long shot, but even that figure did not assay the full extent of the Bush fiscal debacle.
Measured in inflation-adjusted dollars (2005$), federal spending increased by 50 percent, rising from $2.1 trillion to $3.2 trillion in only eight years. Accordingly, just the gain on George Bush’s watch—$1.1 trillion—dwarfed all prior episodes of profligacy. It was more than the entire $1 trillion federal budget, in the same inflation-adjusted dollars, posted under what Republican orators had long ago pilloried as Lyndon B. Johnson’s calamitous “guns and butter” budget of 1968.
Republican apologists have long managed to deny the Reagan fiscal debauch and its (two) Bush progeny, however, by claiming that the Reagan Revolution worked where it counted: in reviving the national economy and then causing it to grow smartly for several decades. The trouble is, that didn’t happen either.
Rather than a permanent era of robust free market growth, the Reagan Revolution ushered in two spells of massive statist policy stimulation before it finally ran out of steam at the turn of the century. The first spell of Washington-induced prosperity flowed from the giant Reagan deficits, the second from the money-printing and Wall Street–coddling policies of the Greenspan Fed in the 1990s.
But the proof that these were unsustainable bubbles fostered by the state rather than real growth and prosperity arising from the free market became acutely evident after the turn of the century. Then another round of Greenspan bubble finance and the George W. Bush fiscal profligacy converged in a temporary spree of phony prosperity: the domestic consumption boom and the real estate bubble. Yet now that these have gone resoundingly bust, the data starkly reveal that the nation’s economic fundamentals have relentlessly deteriorated for more than a decade.
Long-term investment has grown by less than 1 percent annually since 2000 and the nonfarm payroll count has hardly increased at all for 12 years. Likewise, the real incomes of the middle class have fallen back to 1996 levels—even as the American economy has tumbled into a frightful debt to the rest of the world. In short, the American economy did not falter due to a mysterious “contagion” in September 2008. It had been heading for a crash landing for the better part of three decades.
THE KEYNESIAN BOOM UNDER REAGAN AND BUSH
The first spell of false prosperity was the unacknowledged yet massive exercise in Keynesian deficit finance carried out during the terms of Ronald Reagan and George H. W. Bush. The cumulative federal deficit was an astonishing $2.4 trillion, meaning that the public debt tripled and Federal red ink amounted to nearly 70 percent of GDP growth during those twelve years of Republican rule.
Apologists claim that the Reagan–Bush flood of red ink had nothing to do with the gains embedded in the GDP numbers, but, alas, the nation’s GDP accounts were designed by Keynesian economists in the 1930s and 1940s. They most certainly believed that gross borrowings of the public sector are spent in a way that adds to GDP. Government wages and purchases, for example, go straight to GDP, and transfer payments also quickly end-up in the PCE (personal consumption expenditure) component of GDP. Since these three budget items doubled during 1980–1992 it is undeniable that the Reagan deficits gave a mighty boost to GDP.
Moreover, there wasn’t much that resembled “supply-side” gains in the makeup of the GDP internals. Real private investment spending—the ultimate measure of supply-side growth—expanded at just 2.5 percent annually during the period. That was far below the 4.7 percent average for 1954–2000. Likewise, private sector productivity, another key supply-side metric, grew at only 1.7 percent per annum and therefore also at a lower rate than the postwar average.
By contrast, the demand side of the GDP accounts, consumption expenditures and government spending, grew nearly 25 percent faster than their long-term average. In combination, therefore, a weaker supply side and stronger demand side added up to nothing special; that is, a 3 percent average GDP growth rate during the twelve-year period which was dead-on the fifty-year average.
Traditional conservative economists, of course, would counter that deficit-fueled GDP growth is illusory because historically some part of deficit spending went into monetary inflation, not real growth, and some private investment spending was crowded out by higher interest rates owing to Uncle Sam’s competition for savings.
In the new era of irredeemable floating dollars, however, this was no longer true. Much of the treasury debt issued to finance the deficit went into the vaults of central banks around the globe, and the spending they financed went into fatter GDP accounts at home. There weren’t many offsets.
Nixon famously declared himself to be a conventional Keynesian in 1971. But in striking down the international monetary discipline of the Bretton Woods system, he became much more; namely, the Keynesian godfather of the worldwide boom of the late twentieth century.
In fact, the vast new capacity of global central banks to monetize US treasury debt which inexorably evolved from Nixon’s floating-dollar arrangement was laden with a supreme irony. Just one decade later it permitted the most conservative president in a generation to launch a deficit-financed Keynesian boom and get away with it.
GLORIOUS TO BE RICH IN CHINA AND TO BORROW MONEY IN AMERICA
The second spell of phony prosperity was also owing to Nixon’s 1971 blow to global financial discipline. During Greenspan’s first thirteen years at the Fed (1987–2000), the S&P 500 index rose from 300 to nearly 1,500. This humongous fivefold gain has been celebrated by Republican orators as the unfolding of the Reagan prosperity, but it actually measured the arrival of central bank–driven bubble finance: a false prosperity purchased with debt, speculation, and the offshoring of the tradable goods core of the American economy.
In 1994, Deng Xiaoping, the Chinese leader who was the driving force behind his country’s radical economic transformation in the late twentieth century, declared it was “glorious to be rich.” His government would therefore ensure that much glory came to the new export factories of China’s Guangdong Province. To that end, the People’s Printing Press of China flooded the economy with newly minted renminbi (RMB) and lowered its exchange rate against the dollar by 60 percent.
Not surprisingly, millions of Chinese teenagers, trapped in the hopeless poverty created by Mao Zedong’s disastrous experiments in farm collectivization and backyard industrialization, flocked to Mr. Deng’s bright new factories in the east. Whether they came to get rich or just eat, they constituted the greatest migration of quasi-slave labor in human history.
Fueled by virtually cost-free labor, cheap capital and land, nonexistent environmental standards, and a newly trashed currency, the Chinese export machine took off like a rocket. During the decade ending in the year 2000, for example, annual US imports from China rose from $5 billion to $100 billion.
More importantly, China was only the newest entrant in the convoy of East Asian nations which had learned how to peg their currencies to the floating dollar and thereby fuel a powerful new development model of export mercantilism. To spur ever rising exports of manufactures to the United States, they pegged their currencies cheap; and to keep these pegs intact, they bought and hoarded more and more US treasury bonds and bills.
This arrangement defied every tradition of sound international finance, and the harm was soon glaringly evident. During the nine years after 1991, the US trade accounts literally collapsed, with imports growing at 11 percent annually, or nearly double the gain in exports. The trade deficit thus surged from $66 billion in 1991 to $450 billion by the year 2000, thereby reaching nearly 5 percent of GDP. It was an unfathomable figure by the canons of classic finance because it was literally upside down. The reserve currency country was supposed to run a trade surplus and export capital to less developed trading partners, not incur massive deficits and drain capital from them.
The Great Deformation Page 9
