The Dow Jones and Standard & Poor’s 500
indexes reached record highs on Thursday, having completely erased the
losses since the stock market’s last peak, in 2007. But instead of
cheering, we should be very afraid.
Over the last 13 years, the stock market has twice crashed and touched
off a recession: American households lost $5 trillion in the 2000
dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner
or later — within a few years, I predict — this latest Wall Street
bubble, inflated by an egregious flood of phony money from the Federal
Reserve rather than real economic gains, will explode, too.
Since the S.&P. 500 first reached its current level, in March 2000,
the mad money printers at the Federal Reserve have expanded their
balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during
that stretch, economic output has grown by an average of 1.7 percent a
year (the slowest since the Civil War); real business investment has
crawled forward at only 0.8 percent per year; and the payroll job count
has crept up at a negligible 0.1 percent annually. Real median family
income growth has dropped 8 percent, and the number of full-time middle
class jobs, 6 percent. The real net worth of the “bottom” 90 percent has
dropped by one-fourth. The number of food stamp and disability aid
recipients has more than doubled, to 59 million, about one in five
So the Main Street economy is failing while Washington is piling a
soaring debt burden on our descendants, unable to rein in either the
warfare state or the welfare state or raise the taxes needed to pay the
nation’s bills. By default, the Fed has resorted to a radical, uncharted
spree of money printing. But the flood of liquidity, instead of
spurring banks to lend and corporations to spend, has stayed trapped in
the canyons of Wall Street, where it is inflating yet another
When it bursts, there will be no new round of bailouts like the ones the
banks got in 2008. Instead, America will descend into an era of
zero-sum austerity and virulent political conflict, extinguishing even
today’s feeble remnants of economic growth.
THIS dyspeptic prospect results from the fact that we are now
state-wrecked. With only brief interruptions, we’ve had eight decades of
increasingly frenetic fiscal and monetary policy activism intended to
counter the cyclical bumps and grinds of the free market and its
purported tendency to underproduce jobs and economic output. The toll
has been heavy.
As the federal government and its central-bank sidekick, the Fed, have
groped for one goal after another — smoothing out the business cycle,
minimizing inflation and unemployment at the same time, rolling out a
giant social insurance blanket, promoting homeownership, subsidizing
medical care, propping up old industries (agriculture, automobiles) and
fostering new ones (“clean” energy, biotechnology) and, above all,
bailing out Wall Street — they have now succumbed to overload, overreach
and outside capture by powerful interests. The modern Keynesian state
is broke, paralyzed and mired in empty ritual incantations about
stimulating “demand,” even as it fosters a mutant crony capitalism that
periodically lavishes the top 1 percent with speculative windfalls.
The culprits are bipartisan, though you’d never guess that from the
blather that passes for political discourse these days. The state-wreck
originated in 1933, when Franklin D. Roosevelt opted for fiat money
(currency not fundamentally backed by gold), economic nationalism and
capitalist cartels in agriculture and industry.
Under the exigencies of World War II (which did far more to end the
Depression than the New Deal did), the state got hugely bloated, but
remarkably, the bloat was put into brief remission during a midcentury
golden era of sound money and fiscal rectitude with Dwight D. Eisenhower
in the White House and William McChesney Martin Jr. at the Fed.
Then came Lyndon B. Johnson’s “guns and butter” excesses, which were
intensified over one perfidious weekend at Camp David, Md., in 1971,
when Richard M. Nixon essentially defaulted on the nation’s debt
obligations by finally ending the convertibility of gold to the dollar.
That one act — arguably a sin graver than Watergate — meant the end of
national financial discipline and the start of a four-decade spree
during which we have lived high on the hog, running a cumulative $8
trillion current-account deficit. In effect, America underwent an
internal leveraged buyout, raising our ratio of total debt (public and
private) to economic output to about 3.6 from its historic level of
about 1.6. Hence the $30 trillion in excess debt (more than half the
total debt, $56 trillion) that hangs over the American economy today.
This explosion of borrowing was the stepchild of the floating-money
contraption deposited in the Nixon White House by Milton Friedman, the
supposed hero of free-market economics who in fact sowed the seed for a
never-ending expansion of the money supply. The Fed, which celebrates
its centenary this year, fueled a roaring inflation in goods and
commodities during the 1970s that was brought under control only by the
iron resolve of Paul A. Volcker, its chairman from 1979 to 1987.
Under his successor, the lapsed hero Alan Greenspan, the Fed dropped
Friedman’s penurious rules for monetary expansion, keeping interest
rates too low for too long and flooding Wall Street with freshly minted
cash. What became known as the “Greenspan put” — the implicit assumption
that the Fed would step in if asset prices dropped, as they did after
the 1987 stock-market crash — was reinforced by the Fed’s unforgivable
1998 bailout of the hedge fund Long-Term Capital Management.
That Mr. Greenspan’s loose monetary policies didn’t set off inflation
was only because domestic prices for goods and labor were crushed by the
huge flow of imports from the factories of Asia. By offshoring
America’s tradable-goods sector, the Fed kept the Consumer Price Index
contained, but also permitted the excess liquidity to foster a roaring
inflation in financial assets. Mr. Greenspan’s pandering incited the
greatest equity boom in history, with the stock market rising fivefold
between the 1987 crash and the 2000 dot-com bust.
Soon Americans stopped saving and consumed everything they earned and
all they could borrow. The Asians, burned by their own 1997 financial
crisis, were happy to oblige us. They — China and Japan above all —
accumulated huge dollar reserves, transforming their central banks into a
string of monetary roach motels where sovereign debt goes in but never
comes out. We’ve been living on borrowed time — and spending Asians’
This dynamic reinforced the Reaganite shibboleth that “deficits don’t
matter” and the fact that nearly $5 trillion of the nation’s $12
trillion in “publicly held” debt is actually sequestered in the vaults
of central banks. The destruction of fiscal rectitude under Ronald
Reagan — one reason I resigned as his budget chief in 1985 — was the
greatest of his many dramatic acts. It created a template for the
Republicans’ utter abandonment of the balanced-budget policies of Calvin
Coolidge and allowed George W. Bush to dive into the deep end,
bankrupting the nation through two misbegotten and unfinanced wars, a
giant expansion of Medicare and a tax-cutting spree for the wealthy that
turned K Street lobbyists into the de facto office of national tax
policy. In effect, the G.O.P. embraced Keynesianism — for the wealthy.
The explosion of the housing market, abetted by phony credit ratings,
securitization shenanigans and willful malpractice by mortgage lenders,
originators and brokers, has been well documented. Less known is the
balance-sheet explosion among the top 10 Wall Street banks during the
eight years ending in 2008. Though their tiny sliver of equity capital
hardly grew, their dependence on unstable “hot money” soared as the
regulatory harness the Glass-Steagall Act
had wisely imposed during the Depression was totally dismantled.
Within weeks of the Lehman Brothers bankruptcy in September 2008,
Washington, with Wall Street’s gun to its head, propped up the remnants
of this financial mess in a panic-stricken melee of bailouts and
money-printing that is the single most shameful chapter in American
There was never a remote threat of a Great Depression 2.0 or of a
financial nuclear winter, contrary to the dire warnings of Ben S.
Bernanke, the Fed chairman since 2006. The Great Fear — manifested by
the stock market plunge when the House voted down the TARP bailout
before caving and passing it — was purely another Wall Street
concoction. Had President Bush and his Goldman Sachs adviser (a k a
Treasury Secretary) Henry M. Paulson Jr. stood firm, the crisis would
have burned out on its own and meted out to speculators the losses they
so richly deserved. The Main Street banking system was never in serious
jeopardy, ATMs were not going dark and the money market industry was not
Instead, the White House, Congress and the Fed, under Mr. Bush and then
President Obama, made a series of desperate, reckless maneuvers that
were not only unnecessary but ruinous. The auto bailouts, for example,
simply shifted jobs around — particularly to the aging, electorally
vital Rust Belt — rather than saving them. The “green energy” component
of Mr. Obama’s stimulus was mainly a nearly $1 billion giveaway to crony
capitalists, like the venture capitalist John Doerr
and the self-proclaimed outer-space visionary Elon Musk
, to make new toys for the affluent.
Less than 5 percent of the $800 billion Obama stimulus went to the truly
needy for food stamps, earned-income tax credits and other forms of
poverty relief. The preponderant share ended up in money dumps to state
and local governments, pork-barrel infrastructure projects, business tax
loopholes and indiscriminate middle-class tax cuts. The Democratic
Keynesians, as intellectually bankrupt as their Republican counterparts
(though less hypocritical), had no solution beyond handing out borrowed
money to consumers, hoping they would buy a lawn mower, a flat-screen TV
or, at least, dinner at Red Lobster.
But even Mr. Obama’s hopelessly glib policies could not match the
audacity of the Fed, which dropped interest rates to zero and then
digitally printed new money at the astounding rate of $600 million per
hour. Fast-money speculators have been “purchasing” giant piles of
Treasury debt and mortgage-backed securities, almost entirely by using
short-term overnight money borrowed at essentially zero cost, thanks to
the Fed. Uncle Ben has lined their pockets.
If and when the Fed — which now promises to get unemployment below 6.5
percent as long as inflation doesn’t exceed 2.5 percent — even hints at
shrinking its balance sheet, it will elicit a tidal wave of sell orders,
because even a modest drop in bond prices would destroy the
arbitrageurs’ profits. Notwithstanding Mr. Bernanke’s assurances about
eventually, gradually making a smooth exit, the Fed is domiciled in a
monetary prison of its own making.
While the Fed fiddles, Congress burns. Self-titled fiscal hawks like
Paul D. Ryan, the chairman of the House Budget Committee, are terrified
of telling the truth: that the 10-year deficit is actually $15 trillion
to $20 trillion, far larger than the Congressional Budget Office’s
estimate of $7 trillion. Its latest forecast, which imagines 16.4
million new jobs in the next decade, compared with only 2.5 million in
the last 10 years, is only one of the more extreme examples of
Even a supposedly “bold” measure — linking the cost-of-living adjustment
for Social Security payments to a different kind of inflation index —
would save just $200 billion over a decade, amounting to hardly 1
percent of the problem. Mr. Ryan’s latest budget shamelessly gives
Social Security and Medicare a 10-year pass, notwithstanding that a fair
portion of their nearly $19 trillion cost over that decade would go to
the affluent elderly. At the same time, his proposal for draconian 30
percent cuts over a decade on the $7 trillion safety net — Medicaid,
food stamps and the earned-income tax credit — is another front in the
G.O.P.’s war against the 99 percent.
Without any changes, over the next decade or so, the gross federal debt,
now nearly $17 trillion, will hurtle toward $30 trillion and soar to
150 percent of gross domestic product from around 105 percent today.
Since our constitutional stasis rules out any prospect of a “grand
bargain,” the nation’s fiscal collapse will play out incrementally, like
a Greek/Cypriot tragedy, in carefully choreographed crises over debt
ceilings, continuing resolutions and temporary budgetary patches.
The future is bleak. The greatest construction boom in recorded history —
China’s money dump on infrastructure over the last 15 years — is
slowing. Brazil, India, Russia, Turkey, South Africa and all the other
growing middle-income nations cannot make up for the shortfall in
demand. The American machinery of monetary and fiscal stimulus has
reached its limits. Japan is sinking into old-age bankruptcy and Europe
into welfare-state senescence. The new rulers enthroned in Beijing last
year know that after two decades of wild lending, speculation and
building, even they will face a day of reckoning, too.
THE state-wreck ahead is a far cry from the “Great Moderation
proclaimed in 2004 by Mr. Bernanke, who predicted that prosperity would
be everlasting because the Fed had tamed the business cycle and, as
late as March 2007, testified
that the impact of the subprime meltdown “seems likely to be
contained.” Instead of moderation, what’s at hand is a Great
Deformation, arising from a rogue central bank that has abetted the Wall
Street casino, crucified savers on a cross of zero interest rates and
fueled a global commodity bubble that erodes Main Street living
standards through rising food and energy prices — a form of inflation
that the Fed fecklessly disregards in calculating inflation.
These policies have brought America to an end-stage metastasis. The way
out would be 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 need to get out of the
business of imperial hubris, economic uplift and social insurance and
shift its focus to managing and financing an effective, affordable,
means-tested safety net.
All this would require drastic deflation of the realm of politics and
the abolition of incumbency itself, because the machinery of the state
and the machinery of re-election have become conterminous.
apart would entail sweeping constitutional surgery: amendments to give
the president and members of Congress a single six-year term, with no
re-election; providing 100 percent public financing for candidates;
strictly limiting the duration of campaigns (say, to eight weeks); and
prohibiting, for life, lobbying by anyone who has been on a legislative
or executive payroll. It would also require overturning Citizens United
and mandating that Congress pass a balanced budget, or face an automatic
sequester of spending.
It would also require purging the corrosive financialization that has
turned the economy into a giant casino since the 1970s. This would mean
putting the great Wall Street banks out in the cold to compete as
at-risk free enterprises, without access to cheap Fed loans or deposit
insurance. Banks would be able to take deposits and make commercial
loans, but be banned from trading, underwriting and money management in
all its forms.
It would require, finally, benching the Fed’s central planners, and
restoring the central bank’s original mission: to provide liquidity in
times of crisis but never to buy government debt or try to micromanage
the economy. Getting the Fed out of the financial markets is the only
way to put free markets and genuine wealth creation back into
That, of course, will never happen because there are trillions of
dollars of assets, from Shanghai skyscrapers to Fortune 1000 stocks to
the latest housing market “recovery,” artificially propped up by the
Fed’s interest-rate repression. The United States is broke — fiscally,
morally, intellectually — and the Fed has incited a global currency war
(Japan just signed up, the Brazilians and Chinese are angry, and the
German-dominated euro zone is crumbling) that will soon overwhelm it.
When the latest bubble pops, there will be nothing to stop the collapse.
If this sounds like advice to get out of the markets and hide out in
cash, it is.
David A. Stockman is a former Republican congressman
from Michigan, President Ronald Reagan
’s budget director from 1981
and the author
, most recently, of “The Great Deformation: The Corruption of Capitalism in America.”