In an interview with Alex Daley of Casey Research, David Stockman gave a blunt assessment of the US’s economic outlook and how it came to this precipice. While the interview is long and sometimes technical, it is well worth a read. David Stockman is a former Congressman from Michigan and served as the director of the Office of Management and Budget under President Ronald Reagan.
The U.S. economy is not at the beginning of a recovery. We are at the end of a disastrous debt super-cycle that has gone on for the last thirty or forty years. It started when Nixon defaulted on our obligations under Bretton Woods and closed the gold window. Incrementally, year after year, we have been going in a direction of Extremely unsound money, of massive-borrowing in both the private and public sectors. We now have an economy that is saturated with debt: $54 trillion or 3.5 times the GDP – way off the charts from where it was for a hundred years prior to the beginning of this. The idea that somehow all of that debt is irrelevant, as the Keynesian’s would tell us, is fundamentally wrong and the reason why the economy can’t get up from the mat.
We’re doing all the wrong things. We’re adding to the problem, not subtracting. We are not allowing the debt to be worked down and liquidated. We’re not asking people to save more and consume less, which is what we really need to do. And current policies are just making it worse. Any day now we will have another recurrence of the kind of economic crisis we had a few years ago.
Clearly the level of debt that we have is not sustainable. We have a whole generation that are about ready to retire, and they have no retirement savings. We have a federal government tht is bankrupt, literally. Its debt is $16 trillion and growing by a trillion every year. Something’s going to give – we can’t pay for all these entitlements. There just will not be the revenue generation in the economy to do it.
We are deluding ourselves if we think we can just continue to spend. Look at the GDP that came out in the first quarter of this year. It was only 2.2%. Most of it was personal consumption expenditure, and half of that was due to a drawdown of the savings rate, not because the economy was earning more income or generating more real output. It was because of a drawdown of savings! That is exactly the wrong way to go – an indication of how severe the crisis is going to be.
I’m not saying the economy should stop spending entirely. I’m only saying you can’t save 3% of GDP and spend 97% if you are going to get out of this fix. As the savings rate goes up both in the public sector – which means a reduction of spending and the deficit, and in the household sector – which means a reduction of debt burden, the economy will slow and it will undermine profits but profits today are way overstated. They are based on a debt-bloated economy that isn’t sustainable.
The government can reduce its expenses at any time by simply reducing spending and it can reduce the debt if it brings in more tax revenue. That’s austerity! But austerity can cause massive job loss. But the clattering you hear from the Keynesian’s or the drive-by media, which is pretty clueless economically, that austerity is bad forgets the fact that austerity isn’t an elective course. Austerity is something that happens to you when you are broke. Yes, it is painful and spending will go down and unemployment will go up and incomes will be impaired, but that is a consequence of the excess debt creation that we’ve had for the last thirty years.
When you have a $15 trillion heartland of the world economy, and the $11 trillion Treasury market which is at the center of the whole global financial system bluckle and falter, the situation will be dire. This market isn’t real. When Wall Street looses confidence in the Fed’s ability to the Treasury yield curve pegged where it is today — if the bond ever starts falling in price, the message goes out – “do not pass go” – sell your bonds, unwind your overnight debt. Then the system will begin to contract – exactly what happened in September and October of 2008. Only that time it was an unwind to the repo on mortgage backed securities and CDOs, etc. That was a minor trial run for the great unwind that is going to happen when the Treasury markets finally shattered with a lack of confidence because, on the margin, no one owns a Treasury bond – they just rent it on borrowed money. If the price starts falling, they’ll get out of that trade as fast as they got out of toxic CDOs.
If people start running away from the Treasury, it sends compounding forces of contagion through the entire financial system. It hits next the MBS and the mortgage market. The mortgage market then scares the hell out of people about the housing recovery, which hasn’t happened anyway. And, if there isn’t a housing recovery, middle class Main Street confidence isn’t going to recover because their homes are the only asset they have and for 25 million households, it’s under water or close to under water. Something like that happened in 2008. Stocks and bonds went down and gold went down with them.
The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an “interest rate.” That isn’t a market price of money or a market price of five year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he’s still in a positive spread. And, you can’t have capitalism if the capital markets are dead, if the capital markets are simply a branch casino of the central bank and that is essentially what we have today.
People that believe in sound money and fiscal responsibility, that you create wealth the old-fashioned way through savings and work and effort and not by printing money or trading pieces of paper – there is a plan they could put together. One would be forced to put the Fed out of business. You don’t have to “end the Fed,”, although I like Ron Paul’s phrase. You have to get them out of discretionary, active, day-to-day meddling in the money markets. Abolish the Open Market Committee.
The Fed has taken its balance sheet to $3 trillion. That’s enough for the next 50 years. They don’ have to do a thing except maybe have a discount window that floats above the market, and if things get tight, let the interest rate go up. People who have been speculating will be carried out on a stretcher. That’s how they used to do it. It worked prior to 1914. That the first step: abolish the Open Market Committee. Abolish discretionary monetary policy.
Let the Fed, if you’re going to keep it – be only a standby source. As Walter Badgett, the great 19th century British financial thinker said “provide liquidity at a penalty rate to sound collateral.” That’s what J.P. Morgan did in 1907. He didn’t have a printing press. He didn’t bail out everybody. He didn’t do what Bernanke did and say: “stop the presses, freeze everybody, and prop up Morgan Stanley and Goldman Sachs and all the rest of the speculators.” The interest rate, the call-money interest rate, which was the open market interest rate at the time, some days went to 30, 40, 70% – and they were carrying out the speculators left and right, liquidating margin debt, taking out the real estate speculators. Eight or ten railroads went bankrupt within a couple of months. The copper magnates got carried out on their shields.
This is the only way a capital market can work, but it needs an honest interest rate. And we have no interest rate so therefore, we solve nothing and we have the kind of impaired incapacitated markets that we have today. They’re dangerous, because they’re all dependent on twelve people. It is what I call “the monetary Politburo of the Western world,” and they are just as dangerous as the Politburo in Beijing or the Politburo of memory in Moscow.
The twelve person Open Market Committee are monetary central planners who are attempting to use the crude instrument of interest rate pegging and yield-curve manipulation and essentially buying debt that no one else would buy, in order to keep this whole system afloat. It’s Ponzi economics. It is only because of the last twenty years we got so inured to prosperity out of the end of a printing press and massive incremental debt that people lost sight of the fundamental principles of sound money. It is not common sense to think that 50, 60, 70% of all the debt that’s being created by the federal government can be bought by the Federal Reserve, stuffed in a vault, and everybody can live happily ever after.
People were lured into consumer debt by bad monetary policy when Greenspan panicked in December 2000. The interest rate was 6.5%; we had an economy that was threatened by competitors around the world. We needed high interest rates, not low. He panicked after the dot-com crash, and as you remember in two years they took the interest rate all the way down to 1% and they catalyzed an explosion of mortgage borrowing, which was crazy. The run rate of mortgage borrowing was $5 trillion, 40% of GDP, at an annual rate. That was nuts! There had never been even a trillion dollar annual rate of mortgage borrowing. Anyone that had a pulse was being given mortgage loans by the brokers. The mortgage brokers didn’t have any capital or funding – they went to Wall Street. They got warehouse loans and the whole thing got out of control. Millions of households were lured into taking on debt that was insane, and now we have a generation of debt slaves.
There are 25 million households who can’t move even if they wanted to because their mortgages are under water. The cannot generate a down payment and the 5% or 6% broker fees that you need to move. So we have 25 million households immobilized, paralyzed, and worried every day about when the are going to lose their property because of what the Fed did.
If we don’t do something about the Fed, if we don’t drive the Bernankes and the Dudleys and the Yellens and the rest of these lunatic money printers out of the Fed and get it under control of people who have at least a modicum of sanity, we are just going to bury everybody deeper. It’s unfortunate. The American people are as much a victim of the Feds massive errors as anything else. People were not prudent when they took on debt at 100% of the peak value of their property at some moment in 2004 and 2005. They were lured into it.
In 1960, at the peak of what I call the golden era – the twilight of fiscal and financial discipline – we had $30 billion on the balance sheet of the Fed. It had taken 45 years to build that up. Then, as they began to rapidly expand the balance sheet of the Fed during the inflation of the 70s and the 80s, even then it took us until September 2008 – the Lehman collapse – to get to $900 billion.
Had the balance sheet only grown at 3%, which is what the capacity of the economy to grow is, it would have been $300 billion, so they were overshooting. In the next seven weeks, this crazy lunatic who’s running the Fed increased the balance sheet of the Fed as rapidly in seven weeks as it had occurred during the first 93 years of its existence. And, that’s not all, in the next six weeks they added another $900 billion. So in thirteen weeks they tripled the balance sheet of the Fed. So, no wonder we are in totally uncharted waters. Te Fed is being run by people who are clueless as to how to get out of the corner they’ve painted this country into. They really should be run out of town on a rail.
The Fed has taken itself hostage with this whole misbegotten doctrine of wealth effects, which was created by Greenspan which says that if we get the stock market going up and we get the stock averages going up, people feel wealthier, they will spend more. If they spend more, there is more production and income and you get a virtuous circle. Well, that says you can create wealth through speculation. That can’t be true, because if it is true, we should have had a totally different kind of system than we’ve had historically. When the crisis came in 2008, they panicked and pulled out the stops. They tripled the balance sheet in thirteen weeks and are now at a point where they don’t dare begin to reduce the balance sheet, begin to contract, or they’ss cause Wall Street to go into a hissy fit. They are afraid to death of Wall Street going into a hissy fit, so essentially, the robots and the boys and girls and the fast money traders on Wall Street run the Fed indirectly. As a result of that you have a doomsday machine.
When the crisis comes in the Treasury market, it will be the great margin call in the sky.
I would stay out of any security markets. These are unsafe markets at any sped. It’s all tied together. When they start selling off Treasury bonds, they’ll take everything else with it. Real estate is priced off Treasuries. Mortgaged-backed securities are priced of Treasuries. Corporates are priced off Treasuries. Junk bonds are priced off Treasuries. Everything. The stock market will go into a panic.
We don’t know when the timing will come – we’ve never been in a world where there is $15 trillion worth of central bank balance sheets, like we have today. Forget about yield. Forget about return. Just keep yourself liquid and preserve your capital, because you can’t predict the day when the great margin call in the sky comes.
People would think the dollar is going to crash. I don’t think it is because all the rest of the currencies in the world are worse.
The Keynesian’s are right – borrowing does add to GDP accounts. But it doesn’t add to wealth. It doesn’t add to real productivity, but it does add to GDP as it’s calculated and published because GDP accounts were designed by Keynesians who don’t believe in a balance sheet. We’ve gone through a thirty year expansion of artificial growth in GDP, now we’re going to have to be retracting the collective balance sheets which means that GDP will not grow. It may even contract, and no one’s prepared for that.
The economy will collapse but the dollar will be okay because we still need a medium of exchange and the dollar is the least bad currency in the world. Gold is a good asset. It’s the only currency that anybody is going to believe in after a while.
You can read the full interview at the link provided above.