The Great Deformation

by David Stockman

  During the next two years, auto sales recovered smartly from the 9–10 million unit panic lows of late 2008 to a 13–15 unit level after mid-2010. However, as previously indicated, this natural but modest rebound in final sales had a bullwhip effect on production of parts and finished vehicles owing to the auto industry’s virtually depleted supply chain. Accordingly, with “booming” production, which was actually just an aggressive onetime fill of the inventory pipeline, even a sow’s ear could be positioned as a silk purse.

  As previously described, Wall Street triumphantly brought GM public at a nosebleed valuation one year later, and Lear’s stock price slipstreamed right behind the expanding auto bubble. It thus came to pass that Lear’s busted bonds (which had been swapped for stock) were now valued at the equivalent of 130 percent of par value.

  In short, speculators had quadrupled their money from the June 2009 low in just twenty months. And that’s assuming that Lear’s distressed paper had been bought for cash. Had they employed ultra-cheap and readily available portfolio leverage, hedge fund punters would have made ten times their original investment or more.

  So the cleansing therapies of the free market were once again denied. Instead, Washington’s central banking branch and fiscal authorities implemented their fixes—bailouts and money printing—and thereby supplanted a healthy adjustment process with a corrupt game of speculation.

  Twenty months after the June 2009 auto industry bottom, Wall Street speculators were pocketing massive profits on the auto sector’s busted bonds and born-again stocks. Yet this was not because a healthy rehabilitation of the industry had been completed; it was because one had, in fact, been prevented.

  THE KEYNESIAN END GAME:

  RECOVERY FOR THE 1 PERCENT IS OVER

  In the aftermath of the 2012 election the “fiscal cliff” came bounding into the picture. It was greeted by Wall Street as a singular event and inconvenient roadblock in the path to continued economic recovery and ever rising stock averages. The potentates of Wall Street—Jamie Dimon of JP-Morgan, Lloyd Blankfein of Goldman Sachs, and countless lesser lights—therefore demanded that it be rectified by means of a “grand bargain.” All that was needed was sufficient political will and bipartisan good faith, they brayed in unison. This was a grand delusion.

  The Main Street economy was at stall speed, laboring to stay afloat by means of borrowed money and borrowed time. But it was fast running out of time. In fact, it had already entered the zone of Peak Debt, a place where for the first time in forty years most of Washington’s actions and even its inactions will cause the Main Street economy to wobble, weaken, and wilt.

  In fact, peak debt will cause the Keynesian fiscal thrusters to swing into reverse. Taxes will rise and households will spend less. Federal benefits will be cut and households will also spend less. The military-industrial complex will slowly starve, meaning less weapons production and jobs, and still more shrinkage of household income and spending. Traumatic and repeated debt ceiling crises will recur, causing fear to spread and savings to rise. Accordingly, household consumption will fall further and business caution will intensify even more.

  The fiscal cliff is thus not a singular event or fixable condition on the road to a bigger and better national economy. It is the Keynesian end game: the point where both its truth and its inexorable calamity become clear. The truth is that the conservative critique of Keynesian deficits has been wrong all along. It did not recognize that deficit finance would fuel GDP growth because it didn’t reckon that the fiscal deficits could be financed with printing-press money at home and abroad and for decades on end.

  And so it was not that deficit didn’t matter; it was that printing-press money mattered even more. It permitted spending without earning and investment without saving. It resulted in an artificial prosperity erected on a mountain of debt. But in September 2008, it happened that peak debt on the private side was finally encountered, causing a four-decade-long wave of household and business debt accretion to crest and to subsequently roll over. The resulting steep drop in private spending occasioned one final resort to the Keynesian fiscal thrusters; that is, the extension of the Bush tax cuts, the Obama stimulus, the payroll tax holidays, the Noah’s ark of short-term spending, and tax stimulus measures.

  But now peak debt has also been reached on the public side of the nation’s balance sheet. To be sure, the technical ability of the Fed to print money and buy the state’s debt has not yet been exhausted. What has lapsed, however, is the political will to keep on borrowing from the public accounts with reckless abandon; that is, to keep pushing the federal debt ceiling through $20 trillion and beyond.

  The implication of the warm-up round of the debt ceiling crisis in August of 2011 was that Washington will now become paralyzed by a complete and worsening inability to secure consensus on raising the federal debt ceiling by more than token amounts, and for a good reason: if it were to be pushed higher by the $5–$10 trillion that would be needed to stay on the current path of Keynesian deficits and central bank bond buying, the national debt would become the overwhelming referendum issue of the 2014 election. In that event, the folk wisdom of the electorate would be summoned in a landslide vote against national bankruptcy—an outbreak that could send Democrats specifically and incumbents generally down to massive defeat.

  So Washington will struggle to keep the federal debt ceiling on a short leash, while attempting to push, shove, jam, and jimmy as much of the fiscal cliff’s expirations and sequesters as possible under the borrowing limit. Yet it will eventually fail because the fiscal cliff has become way too big for the politicians to finesse by means of gimmicks, phony cuts, and short-term deferrals. In fact, it currently amounts to 5 percent of GDP, or $750 billion at a full-year run rate, and is growing.

  So true fiscal contraction will now ensue. In a process of budgetary triage, selective tax credits and cuts will be allowed to expire and the most politically vulnerable spending programs will be shortchanged or abandoned al-together. More importantly, the fiscal battle will become all-consuming with short-term fixes, patches, standoffs, negotiations, and showdowns taking on a 24/7 cadence.

  Needless to say, this spectacle of paralyzed and dysfunctional fiscal governance will deliver a fatal blow to business and consumer confidence alike. That will trigger, in turn, a rise in cautionary saving by households and a further hoarding of liquidity by business. Accordingly, the phony recovery of 2009–2012 will come to a desultory end and a long twilight of austerity and deflation will inexorably settle in.

  It is no wonder, then, that unreconstructed Keynesians like Professor Krugman hate the Federal debt ceiling with a passion. It is the Achilles heel that will finally stop the nation’s mad addiction to borrow and spend. So doing, it will also end the recovery party for the 1 percent. When the great fiscal contraction begins to sap even the headline prints on consumption, GDP, and jobs, the Fed’s prosperity model will finally be exposed as fraudulent and impotent.

  Even if the monetary politburo invents new, more exotic variations of QE and doubles down on money printing still again, there is one condition it cannot survive: a prolonged run of negative prints from the “incoming data.” That will shatter confidence on Wall Street and provide daily proof that there is nothing behind the curtain in the Eccles Building except a printing press that has enabled its balance sheet to become stupid big; that is, host to a rising tower of public debt on the left side and a parallel tower of excess bank reserves on the right.

  These twin towers haven’t levitated the Main Street economy to date and have no prospect of doing so in the future. Indeed, Main Street’s simulacrum of recovery since the BlackBerry Panic has been fueled by one-time factors that are now spent: inventory replenishment and massive fiscal stimulus. Accordingly, a new Wall Street panic is inevitable as it becomes clear that the business cycle and profits are heading south on a permanent basis.

  This time the sell-off won’t be stopped by central bank money printing and an alphabet sou
p of borrowing lines because the fast money will see that the Fed is impotent in the face of endemic fiscal contraction. Accordingly, they will sell, and sell, and sell. Then the real fiscal crisis will arise. When the bond market crashes in the sell-off, the carry cost of what is already, objectively, a $20 trillion federal debt will soar. When interest rates normalize, say, by 250 basis points, debt service costs will rise by $500 billion; it will bring the final and complete demoralization to Washington.

  In November 2012 the people voted for the only real choice they were presented; that is, for paralysis and stalemate. Now it is only a matter of time before the state finally fails as a fiscal entity. It is out of balance sheet runway, yet so overloaded with mandates and missions that it cannot move forward and it cannot move back. Instead, it will become ever more paralyzed and dysfunctional.

  The cruel corollary is that free market capitalism cannot help, either. It has been abused, burdened, demoralized, and impaired by decades of central bank money printing and the speculative raids and rent-seeking deformations which it fosters. Now the White House has a vague mandate that the 1 percent should pay more, but it’s too late. The coming crash will leave a lot less to tax.

  CHAPTER 33

  SUNDOWN IN AMERICA

  The State-Wreck Ahead

  THE WAY FORWARD IS SO RADICAL IT CAN’T HAPPEN. IT WOULD NEcessitate a sweeping divorce of the state and the market economy. It would require a renunciation of crony capitalism and its first cousin: Keynesian economics in all its forms. The state would also need to get out of the economic uplift, bailout, and social insurance business and drastically shift its focus to managing and funding an effective and affordable means-tested safety net.

  Restoring fiscal solvency and free market prosperity would also require the drastic diminution of the state’s bloated machinery of warfare and central banking, meaning that the hurdles to true economic recovery are forbidding. Deep shrinkage of the military-industrial complex, for example, could happen only upon the wholly unlikely abandonment of the interventionist foreign policy that nourishes it. Likewise, eliminating the scourge of the Wall Street casino would require restoration of free market interest rates and honest price discovery in the stock market; that is to say, elimination of the Fed’s open market bond-buying operations and its régime of financial repression and risk asset levitation.

  Alas, none of these solutions are even remotely possible within our now fully corrupted constitutional framework. The latter is no longer a system of democratic choice and governance; it is a tyranny of incumbency and money politics. As such, it has set in motion a financial doomsday machine that is inexorably speeding toward national fiscal insolvency and monetary collapse.

  The perpetual fiscal stimulus that attends the two-year congressional election cycle, and the K Street lobbies and the PAC-centered campaign funding system which lubricates it, drives the public debt skyward without respite. Similarly, the Fed has become a self-declared vassal of Wall Street, meaning that no change in the current destructive policy régime is thinkable because trillions of inflated asset values depend upon its perpetuation.

  Eighty years on from the New Deal, therefore, crony capitalism has reached an end-stage metastasis. There is no solution except to drastically deflate the realm of politics and abolish incumbency itself; the machinery of the state and the machinery of reelection have become coterminous. But prying them apart would entail sweeping constitutional surgery: a package of amendments to extend congressional and presidential terms to six years, ban incumbents from reelection, provide public financing of candidates, strictly limit the duration of campaigns (say, eight weeks), and impose a lifetime ban on lobbying by anyone who has been on the legislative or executive payroll.

  Only such sweeping constitutional change could cope with the real evil of the current system; namely, the contamination of the entire economic and financial system by a money-driven 24/7 régime of electioneering and hyper-politics. The problem thus is not merely that politicians are bought and paid for by special interests, but also the fact that they are absorbed in plenary debate and maneuvering with respect to every nook and cranny of our $16 trillion national economy. In that respect, Karl Rove’s American Crossroads is as problematic as the oilmen’s American Petroleum Institute.

  Indeed, suffocation of the free market in totally mobilized political struggle is the ultimate evil of the Keynesian predicate. It causes every tick of the unemployment rate and every tenth of the GDP report to trigger waves of political praise, blame, and maneuver. The resulting nonstop partisan sound bites about how “our” plans would make the outcomes better and how “their” policies have made them worse continuously reinforce the presumption in favor of more state action to bolster the economy.

  The end stage of this oppressive din is the pompous visage of Karl Rove on Fox News ticking through his white-board list of where the Democrats have failed to create jobs, investment, growth, and happiness throughout the land. The subtext is always the same; namely that “job creators” didn’t get a big enough fix of tax cuts and the nation’s economy is faltering due to overtaxation. Needless to say, these claims are demonstrably untrue. In fact, investors and entrepreneurs among the top 1 percent have the lightest tax burden since Herbert Hoover. Likewise, the overall federal tax take of 15.2 percent of GDP in 2011 had withered to 1948 levels.

  The GOP renunciation of fiscal discipline is thus Keynesian, not fact based. In order to compete with the Democrats it has gone into the state-sponsored growth business. Republicans now effectively concede that prosperity cannot be left to the comings and goings of producers, consumers, and investors on the free market; it must be constantly dialed up through the machinery of the IRS. So Washington has become thoroughly bipartisan in its relentless pursuit of schemes for the state to fix the private economy—a modus operandi which guarantees the bankruptcy of the former and the failure of the latter.

  FULL-RETARD ANTEDILUVIAN: THE FORGOTTEN STANDARD OF HONEST PUBLIC FINANCE

  It was not always that way. Eighty years ago in the spring of 1932, during the nation’s darkest economic hour, Herbert Hoover’s Washington intensely debated what used to be the essential duty of government; that is, making its revenue and expenditure accounts balance. So doing, the Hooverites imposed economies on nearly every federal department and implemented a manufacturer’s sales tax and other revenue increases before adjourning in June 1932.

  These actions are considered full-retard antediluvian in today’s “enlightened” times. So the fact that the nation’s moribund economy actually leapt from the starting blocks within weeks has been, necessarily, Photoshopped out of the official New Deal portrait. Similarly, the economic golden age of low inflation and solid growth which accompanied Ike’s refusal to cut taxes until the budget was balanced and politicians had actually earned the right to dispense them has been airbrushed out of GOP history. Instead, JFK’s reluctant capitulation to the deficit financed tax-cut theories of Professor Walter G. Heller has taken its place in the Republican fiscal archives.

  Indeed, the memory of Washington’s pre-1960 regimen of honest public finance, like the ancients’ knowledge that the earth was round, has been extinguished, as it were, by the equivalent of a flat-earth fiscal doctrine. At its core, Keynesian doctrine amounts to the crank notion that public borrowing can create private prosperity by topping up the macroeconomic bathtub with incremental “demand.” As detailed in earlier chapters, this doctrine has evolved into numerous confessions which now extend far beyond the orthodox Keynesian catechism.

  As we have seen, the Democrats first converted to the new economics version of perpetual deficit finance back in the 1960s. But when the giant Reagan deficits broke out there emerged a revised standard version. It was manifested in the GOP’s claim that invisible supply-side “incentives” were responsible for the incremental GDP growth after 1983 that was plainly attributable to the quite visible and massive government borrowing.

  Eventually there arose the Karl
Rove–Fox News variation, and it is no less statist despite all its anti-government arm waving. Its Lafferite predicate is that by not paying its bills, Washington can cause the private economy to grow faster! Like any free lunch panacea, of course, such deficit-driven “growth” will also lead to fiscal and momentary collapse as surely as would the perma-deficits of the Democrat “big spenders.”

  To be sure, Republicans insist that the magic lies in “incentives” not “deficits,” but there is not a modicum of evidence to support the Laffer napkin at the current (moderate) range of marginal income tax rates. So in defiance of every historical tradition of sound public finance, the GOP became hooked on the patent medicine of tax cuts.

  After stealing credit for the economic recovery from Volcker’s victory over inflation, the so-called conservative party actually became a well-spring of statist schemes and cures for goosing the private economy by turning the tax code into an instrument of economic management. During the last thirty years, therefore, Republican politicians have rarely met a tax cut they couldn’t embrace. In the cause of economic stimulus through “incentives” for the prosperous classes, they cut taxes on income, capital gains, dividends, estates, carried interest, machinery investments, small business, green energy, black energy, cow pasture energy, and countless more “stimulants” that K Street had on offer.

  The GOP apostasy reached an absurd extreme in the 2012 election, when candidate Romney promised to use his four-year term not to balance the budget, but to stump up 12 million new jobs. Herbert Hoover, who well understood the imperative need to keep the state and the private economy separated by a sturdy fence, was doubtless rolling in his grave. For in proposing $5 trillion in additional deficit-financed tax cuts, the GOP candidate was thoroughly conflating the two realms—promising to improve on the private economy’s delivery of jobs and GDP by mortgaging the public sector’s balance sheet.