MAKING SENSE -- May 30, 2013 at 1:15 PM ET
David Stockman: We're Blind to the Debt Bubble
David Stockman, former director of the Office of Management and Budget under President Reagan, says America has become addicted to debt and that there's no way to avoid catastrophe. Still from NewsHour Footage.
Paul Solman: On yesterday's Making Sen$e post, Paul Krugman argued that the U.S. government's debt load should not be our chief concern at the moment. Today, President Reagan's first budget boss (until he resigned in disgust), David Stockman, argues vehemently to the contrary. I interviewed Stockman at length about his new tome, "The Great Deformation." Some of that interview will appear on the PBS NewsHour. Here's an extended excerpt from the interview to keep you occupied until it does:
Paul Solman: How did you come to be a member of the prosperous class?
David Stockman: I think everybody in this generation, and I'm the leading edge of the baby boom -- I was born in 1946 -- has benefitted from a 30-year explosion of debt, which created temporary but unsustainable economic prosperity and a financialization of the system through lower, and lower, and lower interest rates that has created massive rewards to speculation but not real investments so I benefitted from it. Almost everyone who has been in the market has benefitted but they didn't earn it.
Paul Solman: You didn't earn it either?
David Stockman: No. One of the things I say in my book is we need a wealth tax that on a one-time basis is going to take back at least some small fraction of the great windfall that the upper 1 percent, or 5 percent and pay down the government debt, pay back the federal debt because we can't put this on the next generation or they're going to be buried paying taxes.
Paul Solman: So, you're in favor of taxing yourself now for your fortune or perhaps ill-gotten gains?
David Stockman: I think everybody benefitted from what I am calling a bubble finance system, a bubble economy and if we're ever going to right the system, we're going to have to stop this explosion of the federal debt. We need huge spending cuts, OK? Don't get me wrong, we need to raise regular taxes too but even beyond that it's not going to hurt if we want to reset the system to ask those who have benefitted disproportionately -- remember, we got $60 trillion of net worth in the household sector. $45 trillion of that belongs to the top 5 percent...
Paul Solman: Yeah, I don't forget that ...
David Stockman: OK, so the top 5 percent is going to have to chip in along with everybody else. We're going to have to reform Social Security, cut back defense, all the rest of it. Look at what's happening between Main Street and Wall Street. The stock market index is up 136 percent from the bottom. Middle class jobs lost during the correction: six million. Middle class jobs recovered: one million. So therefore we're up 16 percent on the jobs that were lost. These are only born-again jobs. We don't really have any new jobs, and there's a massive speculative frenzy going on in Wall Street that is disconnected from the real economy.
Paul Solman: So, you're not, I take it, invested in stocks at the moment?
David Stockman: I wouldn't do it. I think it's a very dangerous place to be at the present time. In fact, the stock market today is almost identical to where it was in October 2007 and then there was a $7 trillion crash and before that in March 2000. In other words, the stock market today is identical to where it was 13 years ago and we've had two massive crashes in between. The middle class has been invited to come and buy stocks and get sheared like so many sheep. They've done it twice and I certainly hope they're not lured into this again because it's not sustainable because our economy really is failing. Yes, in the short run it's recovered, or recreated jobs that existed in 2005. You know, the number of jobs today is the same as it was in 2005.
Paul Solman: I had a very knowledgeable esteemed friend who teaches economics. He thinks the stock market is going to go down to, well, I think he thinks to around 1,500 on the Dow. Will it go that low?
David Stockman: I don't think it even matters because if the stock market does go through a crisis of confidence, which I think clearly will happen one of these days, no one can predict just like you couldn't the dot com crash or the Lehman crash, but when it goes down it will go down by thousands of points because everyone will panic. No one owns this market today because they believe there's a huge sunny future for the United States economy. They're buying because they think the Fed can keep the thing pumped up, the bubble expanding.
Paul Solman: By keeping credit cheap.
David Stockman: Yeah, but 0 percent interest rates is crazy. It's lunacy. The Fed put the overnight rate at zero in December '08. You know what that does? It doesn't help Main Street. Main Street has too much debt already. It is simply a bonanza for speculators who can borrow the overnight money and then buy something that they can speculate on.
Paul Solman: But, interest rates are by historical standards impossibly low all over the world. It's not just the Fed. Switzerland is borrowing money for 10 years and paying 0.5 percent. Japan 0.6 percent and they have a huge amount of government debt as a percentage of their economy. Germany 1.2 percent or something like that. The United States 1.7 percent to borrow for 10 years and we have inflation that's as high as that, a little higher even. (Note: This interview took place on April 29.)
David Stockman: I think you've recited the monologue that comes from the land of the bubble blind. Every central bank in the world is doing the same thing. The rate of expansion of balance sheets is unprecedented, off the charts. No one even dreamed of doing it 15 years ago. So, Japan is a massive bubble, has been for 20 years. Their bank has driven the interest rate down to zero because they're buying everything in sight. The same is true with the (European Central Bank). The Bank of England is a disgrace.
Paul Solman: But if a bubble has been in existence for 20 years how can you know when it's a bubble? It could go on forever. Keynes said "in the long run we're all dead." I'll be dead by the time the Japanese bubble bursts.
David Stockman: There was a massive bubble in Japan. Half the real estate value in the world in 1989 was in Japan. It crashed. Real estate in Japan has been declining ever since. It's one of the great deformations, malinvestments, that's ever occurred in world history. The stock market in Japan was half the world market and where has the Japan economy gone since the 1990s? Nowhere. They've been struggling for two decades in the aftermath of a massive bubble that's collapsed. They've tried to work their way out of it by printing even more money and it hasn't worked. Now, I'm saying this is what all the central banks are doing. There is no honest interest rate in the world today.
Paul Solman: But how can anybody lend to them unless there's arguably too much capital, too much money in the world with no particularly good place to invest?
David Stockman: The problem is that you're creating a system of bubble finance where interest rates are so low that people can speculate. An asset value goes up. You put it up as collateral. You borrow against it. You buy more of the asset. You then take the rising asset. You borrow against it again. This is the nature of what's going on in the world. This isn't an excess of real savings. This is an excess of artificial credit that's being fueled by all the central banks.
Paul Solman: So, your solution to this is to impose discipline by pegging the currency to how much gold you have, right?
David Stockman: Well, my solution before that is to say let's have honest interest rates. Let's let the free market set interest rates in that zone where supply of savings is matched up with demand for real borrowing for capital projects. And if you freed the interest rate, which is what Carter Glass wanted to do in 1914 when the Fed was created, he never intended that the Fed would set interest rates and anybody who denies the Fed is setting interest rates is bubble blind. They can't see what they're doing. But, if you let interest rates be freed, be set by the free market, they would rise dramatically. There would be a lot of broken furniture on Wall Street. It needs to be broken. The back of the speculative bubble would be broken and we could slowly heal the financial system. That's what I think we need to do but it's never going to happen because there's trillions of asset values dependent on the Fed continuing to suppress, repress interest rates and shovel $85 billion a month of liquidity into the market.
Paul Solman: Then, why isn't there rampant inflation all over the world? Why is inflation below 2 percent in this country?
David Stockman: Because, you're in a race to the bottom by all the central banks in the world that are expanding their balance sheets at rates that have never been seen before. This money is not leaving the financial markets. All of the liquidity the Fed has pumped in, this balance sheet has gone from $800 billion to $3.2 trillion in just a few years, all of that liquidity is just circulating through the canyons of Wall Street. A lot of it comes back as excess reserves in the banking system which gets deposited at the Fed. It doesn't go into credit on Main Street because Main Street is already saturated with debt. But, it does suppress interest rates and it makes gambling highly rewarding. When you put interest rates at zero, you'll buy anything that's going up and fund it with zero cost money. You will buy anything with a yield and fund it 98 percent, $0.98 on the dollar with zero cost money. So what this is, is a gambler's dream. The 1 percent are just laughing all the way to the bank
Paul Solman: So, what happens now? What's going to happen now?
David Stockman: I think we're so addicted to bubble finance at the Fed that they can't get out of the corner they painted themselves into. I think the Fed is making federal debt so cheap that Congress has no interest, Washington has no incentive to ever face up to our massive fiscal gap that is going to grow, and grow as we go forward in time and so we have a paralyzed system. Bernanke is making it up by the day. He has no clue how he got where he is or how he's going to get out of the massive balance sheet expansion that's already happened.
Paul Solman: But he says that if, for example, inflation takes off what he'll do is raise the interest rate, right now it's only 0.25 percent, that he's paying to banks to redeposit their excess reserves with him. He'll raise that to 0.75 percent and so money that starts to circulate will come back to the Fed just as most of the money he's created so far is at the Fed at this very moment.
David Stockman: But that supposes that the problem is goods and services inflation or labor inflation. I don't believe that is the problem. I believe the problem is speculation. I believe he keeps the interest rate at 0 percent because he doesn't see any CPI which, again, is a little distorted. Real inflation is higher than CPI.
Paul Solman: CPI is the Consumer Price Index. It's a measure of inflation.
David Stockman: Right, right. As long as he doesn't see any consumer price inflation that you're not going to have in a world where people are still coming out of the rice patties to take a job at $0.70 an hour, then he's going to keep the interest rates artificially low, totally medicated and rigged, and that will encourage speculators to just keep going, and going, and going until the next bubble. He's making bubbles and he doesn't know it. He's already made two bubbles and he doesn't have a clue. He didn't see subprime. He didn't see the housing bubble. He didn't see the economy about ready to crater under the credit bubble in '07 and '08. He's seen nothing. He's been wrong ever since he's been in public office and yet you have this confidence that somehow they can get out of this corner that they're in. I think it's not even likely.
Paul Solman: How soon do you think this collapse is going to come? I know nobody can time these things but what's your guess?
David Stockman: Well, a lot of people said in 1999, "Yeah, maybe there's a little bit of froth out there." But, you don't understand this time is different and then within three months, devastating collapse. Remember they called it the "Goldilocks Economy" in late 2007/2008? You had the Chairman of the Council of Economic Advisors saying, "No recession in sight anywhere," in June. Okay, so no one sees it coming until suddenly there is an event, a black swan, something unexpected or unpredicted that tells everybody that the emperor is naked. You know who is naked? The Fed. They're running a con game.