International Man: People have been warning of impending fiscal and monetary doom for a long time.
What is different now that will finally usher in the day of reckoning?
David Stockman: It is self-evident that the solution to a state-imposed supply-side shutdown of the economy is not more counterfeit money, erroneous price signals, inducements to rampant speculation and moral hazards, and further zombification of the main street economy.
Once upon a time, even Washington politicians feared large, chronic public debt, and not merely because they were especially intelligent or virtuous. We learned that in real time during 1981, when the deficit hawks among the GOP Senate college of cardinals nearly shut down the Gipper’s supply-side tax cuts out of fear of mushrooming deficits.
To be sure, these dudes didn’t know Maynard Keynes from Emanuel Kant, but they did know that Uncle Sam has exceedingly sharp elbows and that when he becomes too dominant in the contest for funds in the bond pits, private households and business borrowers get bloodied and crowded out.
That is to say, in the days before massive central bank monetization of the debt, there was a natural counter-balancing constituency in the equations of fiscal politics. We heard from them, too, in our congressional days when the car dealers, feed mill operators, tool and die shops, building contractors, restauranteurs and countless more main street businessmen of the Fourth Congressional District of Michigan let it be known loud and clear that Jimmy Carter’s big deficits were doing unwelcome harm to their bottom lines.
Nor was there any mystery as to why. Aside from the short-term expedient of foreign capital inflows that come at a heavy long-term price (chronic trade deficits and offshoring of production and jobs), the only honest source of funding for government deficits is private savings.
And when the latter—defined as household savings and retained corporate profits in the GDP accounts—are meager to begin with, an eruption of government borrowing squeezes out private investment completely, while raising the carrying cost of all existing floating-rate debt.
As it happened, by 1981, the US was already slouching toward the Big Squeeze of too little national savings and too much government borrowing. At an annualized run rate in Q2 1981, for instance, net private savings totaled $378 billion compared to net federal “dis-savings” (viz deficits) of $87 billion.
Thus, Uncle Sam was already absorbing 24% of savings, which would otherwise be available for investment in private sector growth.
The rest is history with a few twists along the way. As it happened, during the 1990s, the last generation of fiscal hawks in Washington got its revenge against the foolish abstractions of the Laffer curve and the bogus claim that you can grow your way out of large structural deficits.
On two occasions, therefore, first when George Bush the Elder moved his lips and signed a bipartisan deficit-reduction bill that included both spending cuts and tax increases and then when Bill Clinton did the same two years later, the Reagan structural deficits were substantially closed.
On top of that came two more fiscal windfalls. The first was a temporary fall in defense spending owing to the Soviet Union’s disappearing into the dustbin of history long before John Bolton and the rest of the neocon warmongers found a new enemy in Saddam Hussein and the basis for the massive defense buildup needed to conduct wars of invasion and occupation.
At the same time, Greenspan’s first round of madcap money printing, which generated a huge windfall of capital gains revenues in the late 1990s, touched off a tech-based stock market boom. So, there were three consecutive budget surpluses at the turn of the century, and that did mightily, albeit temporarily, relieve the “crowding out” effect of large government deficits.
During Q4 2000, for instance, private savings posted at a $458 billion annual rate, and that was accompanied by an actual $150 billion federal surplus.
At the time, so-called advanced thinkers in Washington, like Alan Greenspan, even began gumming about the possibility that the federal debt would be fully paid off in about 10 years’ time.
And then the Fed would have allegedly found itself unable to conduct monetary policy. Heaven forfend, there would have been no government paper available to monetize via purchases from Wall Street dealers paid for with digital credits plucked from thin air!
A high-class problem, that, but it is not one which remotely materialized. The next round of Greenspan money pumping blew up the housing and credit markets, even as two unfinanced GOP tax cuts and two unfinanced wars brought back the Reagan deficits with a vengeance.
Thus, by the eve of the financial collapse in Q4 2007, private savings stood at $618 billion (annualized rate) while the structural deficit (it was not cyclical because the economy was then at practical full employment) had ballooned to $324 billion.
Uncle Sam, therefore, was now absorbing 52% of net private savings.
Needless to say, it only got worse from there, with government dis-savings reaching a $1.37 trillion annual rate at the bottom of the Great Recession in Q1 2010, which amounted to fully 95% of private savings of $1.44 trillion.
Thereafter, of course, the macro-economy experienced a simulacrum of recovery. By Q4 2013, the cyclical elements of the deficit had been reduced modestly, causing annualized borrowing to fall to $531 billion or 38% of net private savings of $1.39 trillion.
But under even the primitive Keynesian theories of the 1960s, the deficit was supposed to keep shrinking from there through the top of the business cycle, if for no other reason than to reload for the next downturn.
That didn’t happen, of course, because the Congressional GOP commenced a new fiscal game with the Obama White House and the Capitol Hill Dems. To wit, the Dems were relieved of any demands for serious entitlement cuts, and both sides got goodly increases in annual discretionary appropriations for defense, domestic pork and welfare, alike.
Accordingly, the deficit widened to $707 billion by Q4 2016, representing nearly 50% of net private savings of $1.48 trillion.
And then today’s fiscal calamity really incepted. Along came along the king of debt, who made a mockery of the traditional notion that late in the business cycle is the time for fiscal consolidation.
Indeed, the “fix it in the good times” mantra with which Fed Chairman Powell so hypocritically importuned his congressional interlocutors during his recent testimony was literally shit-canned by the Donald’s born-again Lafferite advisors.
Mnuchin, Kudlow and the rest told him, incongruously, that the economy would grow its way out of the gratuitous $1.7 trillion late-cycle tax cut of 2017 and the giant defense increases that have been added since.
Alas, as the business expansion approached its record 128th month during Q1 2020, did Powell and his merry band of money printers pound the table on behalf of the above advice?
They did not.
In fact, when the surging federal deficit hit an annualized rate of $1.225 trillion in Q3 2019, it was now absorbing 68% of private savings. And this was at the very time that the Fed was completing its half-hearted attempt to normalize its balance sheet, having reduced it from a $4.5 trillion peak in 2015 to $3.75 trillion by August 2019.
But that’s all she wrote. After relentless attacks by the low-interest man in the Oval Office and an interest rate uprising in the repo pits in September when the old crowding out equation came back into play, the Fed returned to bond buying with a vengeance, thereby preventing honest price discovery from rearing its head one final time.
Of course, even the practical Keynesians of the 1960s and 1970s had a reason for the idea that the fiscal equation should be put in some semblance of order at the top of the business cycle. Namely, the possibility that an unexpected economic or fiscal dislocation from war or pestilence could erupt, thereby leaving policy makers in an especially unpleasant bind.
Alas, then came COVID-19, the horrible malpractice plot of the Donald’s doctors and the folly of Lockdown Nation, as eagerly implemented by his Dem opponents in mayors’ and governors’ offices of blue-state America.
So, on the eve of a plunge that is likely to be recorded as a thunderous 40% shrinkage of GDP in the current quarter, the Donald and his GOP henchman had maneuvered the federal fiscal equation into a very not “good place,” to use the specious expressions of Powell himself.
During Q1 and 128 months into the longest expansion cycle in US history, the federal deficit posted at a $1.344 trillion annual rate or 72% of net private savings of $1.875 trillion.
Viewed through the lens of subtraction, that meant there was only $500 billion of net private savings left to accommodate a federal deficit that has now mushroomed by an additional $2.7 trillion from its Q1 run rate.
So, it is no wonder that the panicked money printers in the Eccles Building threw caution and sanity to the wind by printing $2.86 trillion of new credit during the last 90 days.
Having fostered $78 trillion of public and private debt over the last three decades due to relentless interest rate repression and falsification of financial asset prices, the fools in the Eccles Building dare not let interest rates normalize or reflect the true state of supply and demand for private savings.
They have essentially green-lighted a final burst of fiscal mayhem in the months ahead via the expedient of monetizing any and all US Treasury borrowings.
Still, the long-delayed reckoning beckons. The federal budget deficit will equal 19% of the GDP this year and remain well above 10% of the GDP for years to come. Yet, even at 5% of the GDP run rate of the federal deficit in Q1 2020, there was no room left in the inn.
That is to say, net national savings, which represents private savings less the government deficit, has been reduced from 10% of GDP during America’s salad days of growth and middle-class prosperity in the 1950s and 1960s to just 1.4% of GDP today. That is, after a 50-year trek to the rock-bottom, there wasn’t remotely any headroom to absorb the Donald’s insane double-digit deficits.
So the Fed will, apparently, just keep desperately printing fiat credit, hoping to prevent a bond market implosion.
Stated differently, the Eccles Building has become a financial doomsday machine—even as the fools domiciled there feverishly pray to JM Keynes himself for a miracle.
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