WASHINGTON (MarketWatch) — Fresh off an explosive essay in the New York Times, a debate with former Obama official Peter Orszag and a torrent of criticism, former Reagan budget director David Stockman says the gold standard gets a bad rap and that the Fed’s low interest rates spur Congress to spend.
Stockman, speaking to MarketWatch here as part of a tour to promote his new book “The Great Deformation.” perhaps to little surprise was critical of Paul Krugman, the Nobel laureate and Times columnist who dismissed the ex-congressman as “a cranky old man.” Perhaps more surprising, though, was Stockman’s disdain toward Eric Rosengren, the president of the Boston Fed.
The following is an edited transcript of his remarks.
MarketWatch : One of the criticisms of your essay is during the gold standard, they had plenty of ups and downs including more frequent recessions, so that’s not a cure-all.
Stockman : We don’t want to get into a discussion of 19th century economic history, but frankly the whole idea of too many recessions and too much instability is a Keynesian myth. If you look at the real history, the problem that they did have in the period from 1870 let’s say to 1914, was the National Banking Act. The national banking system was fundamentally unstable. It was set up during the Civil War to finance the war, and it put state banks out of existence as currency issuers. It said national banks could issue currency if it was backed by government bonds.
The problem was massive amount of debt was issued to finance the Civil War. When the war was over, there was still fiscal rectitude at large in the land, and in the next 40 years they paid down large amounts of the public debt. As a result of that, there was an inelastic currency, but it was the inelastic currency, not the gold standard, that caused the problem.
Secondly, the economy performed brilliantly during that period. Real GDP growth, it was nearly 4% continuously without inflation. Now there were periodic panics, mostly those happened in Wall Street. They didn’t spill over into Main Street and the middle and western sections of the country. For instance, the panic of 1884 had no effect on the economy of Ohio. Therefore, that was a period of good economic performance.
They had this silly chart created, who knows, 40 years ago by the National Bureau of Economic Research that shows all these periods of recession, without telling you that one, they couldn’t even measure GDP in those days. It’s all guesses, they didn’t have quarterly GDP and we can hardly trust what we have today. Those numbers were a lot of noise.
But you can tell the living standard rose over time, real income rose consistently and substantially, and the real GDP growth is unquestionably the best we ever had.
Stop beating up on the gold standard. I’m not talking about necessarily that now. What am I saying is, we didn’t have a Fed that was printing money like there is no tomorrow hand over fist. We didn’t have a Fed that was trying to micromanage, macromanage, adjust, manipulate, every aspect of the financial market and the national economy. That’s the problem.
MarketWatch : Since Nixon’s “abomination” as you call it, we have had some periods where government spending to GDP actually went down, like during the Clinton era. Doesn’t that show it’s just the choices made by Congress rather than the Fed to blame [for rising debt]?
Stockman : There is the issue that Congress ultimately is the fiscal authority. But my argument is, when the Fed becomes a massive buyer of bonds and debt and artificially suppresses interest rate below market-clearing levels, it’s a terrible signal to the Congress that debt is cheap, that running deficits is a viable strategy. So therefore they are induced to kick the can, to let it drift and avoid hard choices. Who wants to tell the public you are going to take your broccoli of higher taxes and lower benefits and spending if you can issue debt on a three-year basis for 40 basis points. That’s free. I was in Congress, they don’t do decimal math, OK? And they think the money is free, it’s a bad problem philosophically, we should not be doing this for the great long run, but it’s no harm today.
Then they have professors like Krugman who give them the disingenuous advice that the bond vigilantes don’t care. The market is saying, “fine with us, we don't care, keep piling the debt on, we love it.” That is so much baloney. The reason the interest rate on the 10-year bond today is 1.8% or whatever it happened to settle today, is the market knows the Fed is buying half of the debt and is front running the Fed. And it is renting the bond on repo, 98 cents on the dollar, based on overnight money that’s free thanks to Bubbles Ben as well.
For a so-called Nobel laureate to claim the vigilantes are validating this crazy deficit expansion through the fact the interest rate is 1.8% is the height of disingenuous.
MarketWatch : But Bernanke did a recent speech on this, and he pointed out the bond yields of every industrialized nation, including Germany, have dropped.
Stockman : You know why? Because every central bank in the world is putting out the same heroin, the same monetary policy poison. Because the Fed is doing this, and this is part of my theme in the book, that once we started going into the massive balance sheet expansion, other central banks had to reciprocate or otherwise their currencies would be disadvantaged.
The whole world of central banks is now administering the same bad medicine. To say it works because everyone is doing the same thing, again, I think is utterly disingenuous.
MarketWatch : With what we’ve seen in Cyprus, doesn’t that argue for more and a more credible deposit insurance system rather than pulling back?
Stockman : No, I say deposit insurance is the great moral hazard. It’s what allowed the banks after we repealed Glass-Steagall to grow to this enormous magnitude and engage in all this speculation. And remember, Glass was opposed to deposit insurance, Steagall wanted it, Glass said, “OK, the quid pro is we’re not going to let the banks get outside the narrow walls of commercial banking.” Now when you repeal Glass-Steagall, you got the worst of both worlds. You got moral hazard of deposit insurance without the regulatory protections and separation of basically trading and gambling as Carter Glass would have seen it from deposit banking.
My argument is that if blue-haired ladies and timid people want to have safe places to save, create postal savings banks. Just a few government banks, they don’t earn any interest, and they get charged a penalty on their interest rate because the government’s credit is being used, but it’s safe, they sleep at night, and they can honestly save, because under a free-market interest rate the deposit rate would be helluva lot higher than today, half a percent under Bernanke imperialism.
After you take care of the timid saver, you tell the chartered commercial banks, have at it. You can make loans, you take deposits, but we’re not going to guarantee your deposits. If the big banks on Wall Street want to be less constrained by regulation, fine, but they’re put in the cold on the free market. No deposit insurance, no Fed window. If they want to gamble into delirium, that’s fine.
MarketWatch : For the people who look at your essay and say, I agree, what can they realistically do? What would you tell an investor right now?
Stockman : If you have your money in a 401(k) but you get it out of the stock market or ETFs or bond funds that have duration exposure, and you stay very liquid even if you’re making almost no return, thanks to Ben Bernanke, who’s crucifying the savers of America on a cross of ZIRP, at least you’re safe. In the world ahead, there is such a huge collapse coming in the financial markets, the third one since 2000, it’s better to preserve your capital, stay liquid, keep your head down, don’t borrow money unless you absolutely have to. That is very discouraging because people would like to earn a return on their savings.
That is why the current monetary policy is so profoundly wrong. When we have this character Rosengren up in Boston saying, it’s a good thing, we are trying to induce people to go into risk assets. Who in the hell is Rosengren to tell old ladies of America they have to buy junk bonds because the Fed tells them to. If the old ladies feel safer in a CD, they ought to be able to earn something besides dog food money on it. There is going to be a revolt against these arrogant mandarins running the Fed, they will rue the day they arrogated to themselves such massive power.
MarketWatch : Bernanke gets asked a similar question at every news conference, and he points to the 12 million or so unemployed and says, if our low rates can get companies to invest more and hire more, why shouldn’t we be doing that?
Stockman : If our low rates could get companies to invest more, and if dogs could whistle the world would be a chorus. They are just making it up. There is no reason to think zero interest rates, pounding and crushing savers, is going to make the main street economy better, unless as Bernanke and all the other Keynesians on there think, that debt is the magical elixir that causes economic life.
If you don’t believe that, if you think economic life comes from work, sweat and putting your nose to the grindstone, you don’t need any more debt in this economy, we got too damn much already.
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