The Great Deformation

by David Stockman

  Thus, by 2012 the national defense cost $700 billion, or nearly 80 percent more in constant dollars than Clinton’s perfectly adequate outgoing budget, and that does not include some $50 billion for security assistance and foreign aid that has also grown immensely during the last twelve years. Yet when the Congress stumbled into the accident of a one-time level change of $55 billion per year owing to the automatic sequester, that prospect uncorked a frenzy of clacking about “the sky is falling” from the neocon Republicans, including Romney-Ryan, that would have made Chicken Little proud.

  In truth, the DOD sequester would result in constant-dollar defense outlays of about $620 billion in 2022, not even a 10 percent reduction from the current wildly bloated levels which mainly keep the generals and military industrial complex in business but have no rational relationship to national security in the twenty-first century. In fact, the post-sequester budget level would still exceed the Eisenhower Minimum by 50 percent, and it is that startling fact that dramatizes the fiscal infamy that should be accorded the neocons.

  In today’s world what is expensive is military manpower and hardware; that is, the stuff of massive land and sea forces and the capacity for global intervention, invasion, occupation, and resupply. The half billion dollar per week cost of operating the resupply lines over the Hindu Kush is a dramatic case in point. By contrast, what is increasingly and radically cheaper is silicon, and the cost of standby nuclear deterrence and satellite- and technology-based intelligence gathering.

  The Republican Party thus desperately needs an Eisenhower or a Taft to champion flinty-eyed austerity and realism in national security policy. Yet populating the congressional defense committees with acolytes of Cheney and Rumsfeld, it is positioning for an all-out battle to keep the defense budget at the high end of the $620 billion to $700 billion corridor that brackets current policy with and without the sequester. So doing, it will squander the political capital of the conservative party, thereby prolonging and worsening the fiscal cliff rather than showing the way forward. Ironically, the Keynesian state is on the road to failure because the conservative party which is supposed to fight it became enamored with carrier battle groups and cruise missiles and a figment of neocon imagination called the new caliphate of Islam.

  THE FISCAL CLIFF AND THE YAWNING GAP BELOW

  The current CBO ten-year budget baseline should be thrown on the scrap heap because it is an iterative loop of unwarranted economic optimism and policy assumptions that do not remotely embody the stalemated politics of Washington, a reality made starkly evident during the first battle of the fiscal cliff at year-end 2012. To be sure, I no longer have access to the massive computer models from which the budget forecasts are generated, but I have retained the bitter lessons stemming from the original Rosy Scenario and political imperatives that rule the fiscal course of the nation.

  Foremost among these is that long-term budget baselines—five years then and an even more preposterous ten years now—are an utterly destructive device. They turn budget-making into an incoherent and unaccountable numbers game that enables politicians to keep the state large and deep in red ink today, and to pretend that it will shrink and become solvent in the by-and-by. In fact, the fiscal cliff that looms permanently ahead is just an ugly symptom of the stage-four fiscal cancer that has crept into the nation’s financial organs under the cover of the ten-year budget.

  Needless to say, the Keynesian predicate and the crony capitalist money packs are so thoroughly in control of Washington that there is no chance that the nation’s government will adopt an honest budget for the current fiscal year or the next. Instead, it will continue to maximize current year red ink based on eleventh hour crisis action by transient majorities, and roll the nation’s massive fiscal gap forward under the cover of meaningless ten-year budget aggregates until the final collapse.

  The permanent fiscal cliff, therefore, redounds to the everlasting ignominy of the Keynesian professors, from Heller to Laffer, who introduced the nation’s politicians to the witch’s brew of deficit finance. In trying to improve upon the people’s work on the free market, they unleashed a great deformation; that is, a state which lacked any reason to stop the larceny of the K Street lobbies and the plunder of crony capitalist raiders from General Electric to Goldman Sachs, the cotton growers, the UAW, the timber barons, the ethanol distillers, the venture capital industry, the Medicaid mills, and the scooter chair manufacturers, too.

  Nevertheless, a ballpark adjustment of the CBO ten-year baseline underscores why it is too late to turn back from the fiscal cliff and the budgetary abyss which lies below. CBO’s January 2012 baseline for total federal spending over the next decade was about $45 trillion. That figure would readily go to $50 trillion, however, under an unrosy scenario and with the entitlement and defense policy positions taken by both parties during the 2012 campaign and at the midnight hour of the first encounter with the fiscal cliff.

  About $2 trillion of the extra spending would be due to the drastic shortfall in current estimates of safety net and social insurance spending. Another $2 trillion would be from higher interest expense after removal of the current drastically overestimated revenue in the CBO baseline. And the balance would come from unsequestering defense and discretionary domestic spending as advocated by noisy factions of Republicans and Democrats, respectively.

  On the other side of the budget, the CBO ten-year revenue baseline of $41 trillion is sheer illusion. With an unrosy scenario based on the nominal GDP and wage and salary growth rates of the last decade and the post-cliff tax law, ten-year revenues would barely come to $30 trillion. In short, as the nation begins its long and debilitating struggle with the permanent fiscal cliff, there is a $20 trillion fiscal abyss looming ahead.

  Undoubtedly, small concessions will be forthcoming from each side, but these are rounding errors relative to the $20 trillion deficit monster lurking behind the CBO smoke screen. If the Democrats were to concede on the so-called chained CPI for the Social Security COLA adjustment, it would save $200 billion over the next decade. Likewise, by conceding to the Clinton-era tax rates on families with incomes above $450,000, Republicans have paved the way for additional revenue inflows of about $600 billion over the next decade. These concessions literally provoked blood in the streets on the respective sides of the partisan aisle, but amount to 1 percent and 2 percent, respectively, of the true fiscal gap.

  In truth, only a thorough-going dismantlement of the warfare state and the welfare state would make any real difference. If DOD were throttled back to the Eisenhower Minimum (40 percent cut) and social insurance were drastically means tested to eliminate one-sixth of current Social Security and Medicare benefit costs ($400 billion per year savings), spending by 2022 could be reduced to about $5 trillion annually, or 21.7 percent of GDP. The latter figure undoubtedly amounts to spurious accuracy, but it also happens to be exactly the federal spending share of GDP achieved during Ronald Reagan’s second term. With a population nearly forty years older by 2022, the Gipper’s benchmark would be a miracle to achieve.

  Needless to say, the arrival of peak debt will also mean that revenues would need to be lifted to the vicinity of 21.7 percent of GDP, as well. In round numbers that would amount to a $2 trillion annual tax hike relative to the current Republican gospel of low taxes. In theory, that could be achieved with a 15 percent consumption or value added tax (VAT) on most items which comprise the personal consumption expenditure component of GDP.

  In a sundown economy fighting for fiscal solvency VAT is probably the only viable solution. Yet in a political culture contaminated by five decades of Keynesian fiscal profligacy, its prospects would be the same as the Schweiker social insurance reform package of May 1981: it would be voted down 100–0 in the Senate, and in well less than ten days.

  THE GANGS OF CRONY CAPITALISM: GRAND FINALE

  As the nation struggles with the permanent fiscal cliff and the $20 trillion deficit that lurks below, fiscal politics will degenerate into a blood
sport. In that unfortunate arena, the gangs of crony capitalism will fight tooth and nail to preserve their slice of an imperiled pie, thereby disenfranchising even further ordinary taxpayers and citizens who have no voice in the Washington policy auctions. In that context, the military-industrial complex and the housing-mortgage finance complex are only the most obvious combatants, but their powers of preservation merely illustrate the truth about all of the crony capitalist gangs, including the energy boondogglers, the medical care complex, and most especially Wall Street.

  The military industrial complex vivifies the problem because today the primary purpose of the DOD budget is to make jobs and prop up the manufacturing economy, not provide national security. Bin Laden is dead, the Iraq war was lost, the Afghanistan surge has already petered out, and Al Qaeda is down to its last few hundred warriors lurking in the barren redoubts of Yemen, Mali, and Somalia. Yet the defense budget has not yet shed one dollar of spending in real terms from its all-time high under the Cheney-Bush imperium.

  As indicated earlier, the markers of irrational perpetuation of senseless military spending are everywhere: the DOD budget continues to modernize M1 battle tanks each year when there is no real need for most of the 9,000 ultra-lethal tracked machines we already have. Likewise, the Pentagon still has 800,000 civilian employees, one for every two members of the uniformed forces. Furthermore, the active armed forces still totals 1.5 million plus 1.1 million reserves, a massive war fighting machine of occupation and invasion that has virtually no defensive purpose at all.

  This is why the coming fiscal collapse is so certain. The nation is war weary, it has a peace president, and no enemies with modern military capacity. But the DOD spending cannot be stopped; not in the aggregate and not in the weeds of purposeless tank modernizations and a $250 billion payroll of civilians and soldiers who by and large do not have a justifiable mission.

  In the same manner, the vast complex of housing credit agencies and tax subsidies nearly destroyed the nation’s residential housing market with a lot of help from the Fed. But five years after the housing crash, Fannie and Freddie have not had a comma of their legislative charters altered, the FHA has massively increased its book of business, and the homeowner’s tax subsidies have been taken off the table even before the upcoming campaign to close tax loopholes and broaden the basis has started.

  More importantly, the overwhelming share of the home mortgage origination and servicing business is now dominated by four giant banks: JPMorgan, Citigroup, Bank of America, and Wells Fargo. The latter have thus far settled litigation for various fraudulent and predatory practices during the mortgage fiasco years to the tune of nearly $100 billion collectively; but traders have gladly ignored the resulting hit to their balance sheets as a meaningless “one-timer,” while the proceeds that didn’t go to the lawyers are being used to keep defaulted properties off the market and deadbeat borrowers in their homes. The effect is to dispense unfair wind-falls all around and to prevent price discovery from doing its job.

  Worse still, the four banks carry on the unproductive business of churning the nation’s $10 trillion mortgage pool under the Fed’s repression of mortgage rates, scalping handsome profits each and every time the same home is refinanced. Meanwhile, the big Wall Street banks are pumping billions of high-risk loans into the latest new thing in LBO speculation; namely, leveraged pools of buy-to-rent capital that are now accounting for upward of 50 percent of existing home sales in former distressed markets like Phoenix, Southern California, Las Vegas, and Florida.

  One thing is certain: the fast money marauders swooping into former subprime neighborhoods are not setting up shop to become long-term local landlords; they are not buying lawnmowers and provisioning HVAC repair parts. Instead, they are setting up local markets for a price pop, so that they can scalp a gain and leave the hindmost to virtually nonexistent buy-to-occupy first-time and trade-up home owners. In short, between the Fed, the big banks, the home builder and real estate lobbies and Wall Street speculators, there is not a chance that the nation’s busted residential housing market can recover a healthy balance and honest pricing.

  Instead, residential housing will remain a financial playground where crony capitalist gangs are enabled to extract tens of billions of ill-gotten gains from taxpayers and savers alike. In truth, the housing sector needs drastic reform and a clearing of the decks from the statist deformations of a half century. But with Washington paralyzed and hostage to the permanent fiscal cliff and an economy that is perpetually “weak” and in need of a “housing stimulus,” the squeaky wheels of crony capitalism and their K Street agents will get the grease. The nation’s giant housing market will remain a den where speculators and the big banks churn and burn, and also a place in the years ahead where financially desperate baby boomers will go to pawn their castles for comparatively meager recompense.

  SIREN SONG OF THE ENERGY GANGS

  Indeed, as the free market economy becomes steadily weaker, the crony capitalist gangs are even more emboldened to raid the public purse under the cover of boosting jobs and economic recovery. Nowhere is this more salient than in the energy sector where the spurious idea that an expensive barrel of domestic energy is better than a cheaper barrel of imported energy has taken deep hold. Accordingly, both black energy and green energy lobbies are lined up at the public trough prepared to ferociously protect subsidies they already have and pounding the table for more on the grounds that an energy renaissance is under way that can create millions of American jobs. Indeed, the black and green energy gangs are conducting a logrolling operating that will soon make the farm cartels look like pikers.

  But the central proposition of the energy gangs is wrong; namely, that there is an oil and gas production renaissance in the United States, and that with enough tax breaks, cheap federal loans, and outright subsidies, it can be extended to an entire Noah’s ark of energy flavors. In fact, the recent blip in US oil production is just a swiggle upward on a forty-year trend line of declining output. For all the talk of shale oil production in the Bakken and Texas, US production during 2012 (6.4 million barrels per day) was lower than it was in 1995, and 33 percent lower than in 1970.

  As indicated earlier with respect to shale gas, the recent production boomlet is due to ultra-cheap debt capital being drilled on Wall Street thanks to the Fed’s destruction of interest rates, not new discoveries or even new technologies such as fracking. The fact is, the “lower 48” is the most drilled-over zone on the planet, having been host to 75 percent of all the oil and gas wells ever drilled in human history. What is left is high-cost, low-grade hydrocarbon deposits, such as oil and gas trapped in shale, which can be extracted only by the brute force of massive material and capital consumption.

  This means that the economics don’t work unless capital is ultra-cheap and world oil prices stay near $100 per barrel. Accordingly, when the next worldwide recession sets in and oil prices drop to $50 per barrel, the North Dakota shale-oil patch will return to weeds and scrub, just as is already happening in the shale-gas patch where massive reserves that were drilled under the brute force of cheap capital are now deeply underwater at today’s rock-bottom natural gas prices.

  So the siren song of energy independence, now forty years old and reaching back to the foolishness of Nixon’s FEA (Federal Energy Administration), is just being replayed at a different octave. While oil and gas output has increased by about a 3-million-barrel-per-day oil equivalent from prior all-time lows, that amounts to just 10 percent of the 28 million barrels of oil and natural gas consumed by the US economy every day, and even these slightly improved levels of production have nothing to do with the jobs problem.

  In fact, the total job count in the oil and gas extraction industry is just 195,000, and is up by only 30,000 jobs since the fall of 2008, when Bernanke began pumping ultra-cheap debt into the oil and gas patch by way of Wall Street drilling funds and other vehicles of high-yield speculation. Accordingly, the next bubble bursting may well be the shale bubb
le, and the next bailout demands will come from the junk oil speculators who have recently moved from the sand belts to the Black Hills.

  Meanwhile, $100 billion annually is being wasted on energy tax breaks, subsidies, and credits. All the varieties of black and green energy are noisily lined up under the banner of jobs and growth, but most of the beneficiaries would not survive in an honest free market. Indeed, so desperate are these hothouse energy wards of the state that even the wind farms managed to climb aboard the Christmas tree of tax-cut extenders that passed on New Year’s Day 2013. That spoke volumes: the wind is free and the nation is broke, but the crony capitalists of energy plundered on.

  THE MEDICAL CARE COMPLEX:

  ULTIMATE DEFORMATION OF THE STATE

  When it comes to plunder, however, the medical care complex is in a league all by itself. The greatest of all abominations on the free market is employer health insurance, a product that would not exist if it were taxed like other wage income and which is not insurance at all but merely a form of prepayment for health services. Like many of the other deformations which distort the free market, today’s giant $200 billion per year tax subsidy for employer health plans was a New Deal special (wartime phase).

  Organized labor wanted higher pay, but FDR’s wage and price controllers didn’t want to break the wage cap visibly, so they invited organized labor to visit the backdoor of the IRS after hours. In some long forgotten conference in 1943, it was decreed that employee wages paid in the form of pre-paid health services were not taxable. The rest was history: so-called employer health insurance plans drove a giant wedge between the higher prices received by doctors and hospitals and the negligible out-of-pocket costs felt by medical service consumers.

  In the fullness of time, health-care inflation came to occupy its own perch far above all others. During the last half-century, for example, the consumer price index has risen by 8X, average wages by 10X and hospital costs per day by 40X. Inflation in physician costs, drugs, lab tests, and most other health services has been only slightly less explosive, but the underlying cause is the same: routine health services are not insurable risks because both providers and consumers heavily drive the frequency and cost of service.