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David A. Stockman, The Great Deformation: The Corruption of Capitalism in America (Public Affairs, New York, 2013)
David Stockman’s background made him uniquely qualified to write this insightful analysis of the follies committed by politicians, economists, investors, and business leaders over the past half century. He graduated as a history major at Michigan State, did graduate work at Harvard in 1968-70, served in the House of Representatives from 1977 until his resignation in 1981 to join the Reagan Administration and served as Director of the Office of Management and Budget until his resignation in 1985. He spent the decades since then working first for Salomon Brothers and left to create his own investment fund, and headed an auto parts firm that went bankrupt in 2005. Paul Krugman, commenting on the book, called him “a cranky old man”. Unlike Stockman, Krugman does not worry about the deficit, believing it is manageable whereas Stockman believes that “the fiscal cliff is permanent and insurmountable." ..."It stands at the edge of a $20 trillion abyss of deficits over the next decade.” He writes that it is now “Sundown in America: the end of free markets and democracy.”
Stockman is right that we are close to the end of free markets and democracy. How did we arrive at this point? Who was responsible? What brought us to this point? This book is an attempt to answer those questions.
There is something to learn in every chapter. The book begins with a chapter entitled, “Paulson’s Folly: The Needless Rescue of AIG and Wall Street.” Henry Paulson, former head of Goldman Sachs, was Pres. G. W. Bush’s Secretary of the Treasury. Facing the possibility of the bankruptcy of the leading banks and other financial enterprises, he secured the passage of TARP (Troubled Asset Relief Program), a $700 billion program which he used to bail out leading banks and other financial institutions. Among them were Goldman Sachs, General Electric Acceptance Corp, AIG and many others. The Fed under Alan Greenspan bailed out Long Term Capital Management which Stockman labels the “FED’s horrid bailout”. He writes that had these enterprises been allowed to fail, it would have been “profoundly therapeutic” exposing the awful practices that had been pursued by these establishments during the previous decadeS. Instead, the perpetrators were rewarded, kept their jobs, and even received huge bonuses.
Throughout the book he makes valid criticisms of government practices and Wall Street practices. And he mentions the names of the those responsible.
If the author has a weakness, it is his lack of understanding of monetary theory so he criticizes Milton Friedman as though Friedman would have approved Bernanke’s foolish monetary policies. Bernanke is a Keynesian while Friedman is the economist most famous for his anti-Keynesian writings. Stockman favors the gold standard which probably explains his criticism of Friedman.
The huge budget deficits are the result of economists of both parties pursuing Keynesian fiscal policies when the policies had long been discredited. Presidents rely on their economic advisers. Bush and Obama were advised by economists who told them what they wanted to hear. He begins by noting that the Republicans were no better than the Democrats when it came to balancing the budget. Pres. Nixon took the country off the gold standard and “ushered in the era of deficits don’t matter.” That pleased Bush and Obama.
Pres. Reagan did not make the spending cuts that ought to have accompanied his tax cuts and Pres. G.W. Bush engaged in a spending spree including not paying for his interventions in Iraq and Afghanistan, inaugurating a costly Medicare prescription drug plan, massive increases in education spending, etc. (It is worth noting that Pres. Clinton balanced the budget in the year before Bush took office.)
Stockman criticizes the TARP bailouts, which he calls Paulson’s folly, begun under Bush, and the tax rebate Bush granted. Then Stockman criticizes Pres. Obama’s $800 billion economic stimulus plan enacted in 2009. Keynes paid no attention to what the money was spent on. There were very few “shovel-ready” infrastructure programs. Most of the money was spent on projects that provided no economic stimulus. It was a giant pork barrel project with money doled out to the President’s cronies and political allies, including the man-made-global-warming crowd. It made no lasting contribution to the economy. Any stimulus it provided was temporary.
He criticizes the notion of enterprises “too big to fail”. Coming under severe criticism, usually justifiably, are heads of the Fed, principally Alan Greenspan and Ben Bernanke, heads of large industrial and financial firms like Jeff Immelt of GE, John Mack of Morgan Stanley, academics like Glenn Hubbard of Columbia and Greg Mankiew of Harvard arvard, advisers to George Bush, who found huge deficits to be no problem, George Shultz for bad advice given Pres. Nixon, and so on. Prof. Friedman of the University of Chicago, one of my mentors, merits a chapter all by himself entitled “Milton Friedman’s Folly”. A few come in for approval like Douglas Dillon, Kennedy’s Treasury Secretary, and Paul O‘Neill, under Pres. Bush. But they weren’t academics.
The book reveals Stockman as a public figure who understands both economics and politics. But he does not know how much he does not know. For example, he is right that we are losing jobs as a result of our foreign trade imbalance. He writes: "Under the established regime of free trade, domestic jobs and incomes could be maintained only if cost and wage levels were adjusted downward to meet the powerful deflationary challenge of the Asian exporters.” The possibility of single-country variable tariffs to be used against countries with which we have large chronic trade deficits, our invention, escaped his notice.
The purpose of trade is an exchange of goods and services for goods and services, balanced trade. The doctrine of free trade assumes that all countries are playing by the same rules. But if one country employs mercantilist practices, such as tariffs, quotas, and other barriers or subsidizes exports it can achieve economic growth at the expense of its trade partners. As readers of this blog know, we advocate a policy of balanced trade. Free trade as a policy is an ideal that works when trade is balanced. As Keynes recognized, countries need to protect their economies from foreign predators that intentionally keep trade out of balance.
Yet Stockman is very perspicacious. He recognizes that private investment is the sine qua non for economic growth and that government fiscal and monetary policies and politics are responsible for America’s decline.
Reagan’s failure to balance tax cuts with expenditure cuts requires a reassessment of his reputation. It turns out to be a failing of many Republicans leaders. He calls it “The GOP Tax Religion”. GW Bush’s record of cutting taxes and engaging in a “spending spree” is a example of this failing. But he also attacks Keynesian myths and the New Deal. Recovery was under way under Pres. Hoover when FDR took office, he writes. The New Deal, its reputation, and Keynesianism were rescued by WW II. But the real recovery was the private sector’s dynamism facilitated by the hands-off policy of Dwight Eisenhower.
He decries the abandonment of the gold standard in favor of fiat money that led, he believes, to what he calls the Age of Bubble Finance. He considers but rejects the possibility that the growth of the money supply could be restricted to a fixed amount per year, say the desired rate of growth in the GDP, because the “velocity”, the rapidity of its turnover, cannot be controlled.
He does not consider the fact that velocity cannot be controlled under the gold standard either. It is our view that central banks should be in the business of controlling the rate of inflation due to changes in the money supply and the velocity of money, not saddled with the responsibility of promoting recovery from a recession that monetary policy did not cause. It is our view that the Fed cannot take responsibility for countering bad government policies.
He spends a large part of the book criticizing the rise of speculative finance – the growth of the futures markets, Wall Street practices, the “serial bubbles”, the large investment banks like Goldman Sachs, the notion of banks “too large to fail”. This is must reading for every investor. Throughout he criticizes Greenspan and Bernanke’s policies.
He analyses what he calls “the great housing deformation,” government sponsored enterprises (Fanny Mae and Feddie Mac) and the government’s policies of low mortgage standards. (He writes that the controversial ACORN was virtually a wholly owned subsidiary of the Fanny Mae Foundation which also directed funding to nonprofit arms of the congressional black caucus. He blames the resulting explosion and crash of the high risk mortgage market on the Fed. Eighty-two percent of the sub-prime loans written during 2004-06 were bundled and sold on the securities markets and not retained by the original lenders. This is must reading.
Candidate Romney and other Republicans come under criticism . But he is also critical of Democrats. He refers to Larry Summers, head of Obama’s Nationa Economic Council as “Keynes’s current vicar on earth”. Consumption stimulus backed by Bush and Obama, he writes, is like the Laffer curve, “a foolish macroeconomic nostrum”. He criticizes bailouts, including the bailouts of GM, first by Paulson then by Obama.
He criticizes the massive subsidies accorded green enterprises as crony capitalism. He calls Tesla “the People’s car from Goldman Sachs”.
He analyzes the government’s economic stimulus policies and the Fed’s interest rate and quantitative easing policie and finds that they produced “no recovery on main street” only a boom in stock market prices and other financial assets, a growth in food stamps and welfare payments, but no increase in private investment, without which there is no economic growth.
What is needed he writes is to restore fiscal solvency, the diminution of the state’s bloated spending, and the restoration of free markets. He would require Congress to balance the budget, abolish bailouts and subsidies, eliminate ten federal agencies and departments, abolish the minimum wage. Among his proposals are to repeal the income tax and replace it with a tax on consumption and to impose a 30% wealth tax to pay down the national debt.
We agree that drastic measures are needed. We favor the consumption tax, but not the wealth tax. We favor balanced monetary growth, not a return to the gold standard. And we understand that the key to everything is balanced trade. If trade were kept in balance, the economy would grow, led by business investment. We agree with Stockman that our current policies of massive trade deficits, massive budget deficits and massive monetary growth are leading to disaster.
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