April 29, 2024
This is an excerpt from David Stockmans book: Trump's War on Capitalism.
As we have seen, The Donald's economic policy actions and nostrums were thoroughly wrong-headed and counterpro- ductive. But the opposite assumption-that market capitalism was working according to the texts penned by Adam Smith- was also dead wrong and had been for decades. Today's bailout- ridden crony capitalism is not remotely the real thing, and that's especially because free markets can't function efficiently and pro- ductively when they are flooded with cheap credit printed by the central bank.
The ill effects of these perversions are legion, but one of the most obnoxious is the massive financial windfall to a tiny elite of the wealthy and a concomitant depletion of the middle class. Ironically, The Donald was elected and heralded by the latter, but his policies did absolutely nothing to change the system's long-standing windfalls to the rich.
Here is but one of the smoking guns that can be offered in evi- dence. To wit, in 1989 the collective net worth of the top 1 percent of households weighed in at $4.8 trillion, which was 6.2x the $775 billion net worth of the bottom 50 percent of households. By Q1 2022, however, those figures were $45 trillion versus $3.7 trillion, meaning that the wealth differential was now 12.2x.
In round numbers, therefore, the top 1 percent gained $40 tril- lion of wealth over that thirty-three-year period compared to the mere $3 trillion gain of the bottom 50 percent. Stated differently, there are currently 65 million households in the bottom 50 per- cent, which have an average net worth of just $56,000. This com- pares to the 1.2 million households in the top 1 percent which currently sport an average net worth of $38,000,000.
Needless to say, there is no reason to believe that left to its own devices free market capitalism would generate this 680:1 wealth differential per household. Indeed, three decades ago-and well before the Fed went into money-printing overdrive-the per household wealth differential between the top 1 percent and the bottom 50 percent was barely half of today's level.
Back in the heyday of America's post-war prosperity, in fact, President Kennedy's famous aphorism that "a rising tide lifts all boats" was repeatedly confirmed. But once Alan Greenspan inaugu- rated the current era of rampant central bank money printing, stock market coddling and egregious bailouts, the more accurate charac- terization is that a rising tide mainly has been lifting all the yachts. And it goes without saying that only a teensy-tiny number of MAGA red caps were to be found actually lounging aboard these vessels.
The truth is, Donald Trump's tenure in the Oval Office wit- nessed the steepest climb ever in the wealth of the top 1 percent. Nor is that surprising. The Donald was relentless in demanding that the Fed push interest rates ever lower and run the printing presses ever faster. Most of the billionaires, however, have never bothered to thank him for the resulting windfall.
There is no mystery, of course, as to why capitalism lost its historic middle class growth mojo during recent decades. Or why that occurred even as financial markets became bubble-ridden fountains, pumping egregious amounts of windfall wealth to the very top of the economic ladder.
The culprit was "financialization." By inducing relentless debt creation and leveraged speculation, the Fed and other central banks have bloated the financial asset sector out of all historic proportion to the real economy.
Net Worth of Top 1 percent versus Bottom 90 percent, 1989 to 2022.
Thus, between 1954 and the mid-1990s, total household finan- cial assets oscillated around 2.5x-3.0x GDP, as tracked by the purple line below. But once the Fed's printing presses went into high gear under the Greenspan "wealth effects" doctrine and the serial bailouts that flowed thereafter, the ratio escalated steadily skyward, reaching nearly 5.0x GDP in 2021.
The fact is, there was no sustainable or sound basis for the eruption shown in the chart below. As we indicated with respect to total assets in Chapter 2, this ratio amounts to the price-earnings (PE) multiple for the entire economy. And since the trend rate of economic growth and productivity has deteriorated notably sincem the turn of the century, if anything the macroeconomic PE multi- ple should have been falling, not rising.
Nor is this eruption of the de facto macroeconomic PE ratio merely an academic curiosity. At the 1954-1987 average of 2.7x GDP, household financial assets in 2021 would have totaled $64 trillion, not the actual level of $114 trillion. That is to say, finan- cialization has generated upwards of $50 trillion of extra house- hold financial assets out of thin air. And about three-fourths of that bloated asset total is held by the top 10 percent of households.
Financialization of the US Economy: Financial Assets as Multiple of GDP, 1948 to 2021.
What has kept the financialization ratio trending skyward was the very opposite of sound, sustainable economics. After 1990 the savings rate dropped precipitously, even as the debt-to-GDP ratio rose to new heights. America did not save its way to solid financial prosperity but borrowed its way to a fantasyland of phony wealth for the few and deteriorating economics for the many.
The cornerstone of long-term growth and wealth creation is net savings from current economic output. The latter measures true savings or the amount of economic resources left for new investment in productivity and growth after government borrow- ings have been subtracted from private household and business savings.
But as to the current trend, fuhgeddaboudit. This measure aver- aged a healthy 7.5 percent to 10 percent of GDP in the economic heyday before 1980. But especially after the money-pumping era of Greenspan and his heirs and assigns commenced in the early 1990s, the net national savings ratio headed relentlessly south. By 2022 the ratio was an anemic 1.0 percent of GDP-a sheer rounding error in the sweep of post-war history.
Again, the actual net national savings in 2022 was just $260 billion, but that figure would have computed to $1.96 trillion at the 7.5 percent net savings rate of the pre-1980 period.
That $1.7 trillion of net national savings has gone missing, of course, does make a huge difference. Gross savings by the private sector had fallen sharply, and then The Donald came along and enabled governments to scarf-up most of the available new sav- ings to fund massive, serial budget deficits.
So, the obvious question answers itself. A true MAGA policy would have reversed the Fed's long-standing war on savers via dramatically higher, normalized interest rates, while at the same time getting the US Treasury's sharp elbows out of the bond pits by balancing the federal budget.
That would have generated the surge in net national savings needed to revitalize investment in productivity and growth. Alas, sound money and fiscal rectitude were not terms that the Donald had any familiarity with whatsoever. In fact, his stance on these crucial matters was worse than that of every Democrat presi- dent of modern times, starting with Joe Biden and going all the way back through Obama, Clinton, Carter, Johnson, Kennedy, Truman, and FDR.
That's right. At the end of the day, The Donald's monetary and fiscal policy bacchanalia amounted to an outright war on capi- talist prosperity. That alone should disqualify him from another berth on the Republican ticket and term in the Oval Office.
The nation can ill-afford four more years of The Donald's apos- tasy on the core issues of central banking and the public debt. That's because neither public nor private debts liquidate them- selves over time. If the badly unbalanced income/outgo rela- tionship is not addressed, chronic cash shortfalls from current operations just cause debts to accumulate and compound.
It is not surprising, therefore, that during the past half century the nation's combined public and private debt-to-income (GDP) ratio soared skyward. In fact, the 150 percent debt-to-GDP ratio which had prevailed through the 1970s went vertical thereafter, reaching 358 percent by the time of the Great Financial Crisis, where it remains stranded to this day.
As it happened, once the Fed got into the money-printing busi- ness after 1970, everybody joined the debt accumulation parade- governments, businesses, financial institutions, and households, too. Accordingly, the $1.7 trillion of total public and private debt outstanding on the eve of Nixon's dollar default in August 1971 rose to $10.7 trillion upon Greenspan's arrival at the Fed in August 1987; and it then reached $50.0 trillion on the eve of the Great Financial Crisis in late 2007, stood at $66 trillion when The Donald was sworn in, and totters at just under $95 trillion at present.
In effect, continuous Federal Reserve money-printing has resulted in what amounts to a massive national leveraged buyout. Just during the thirty-six years since Greenspan took over the Fed, total public and private debt (i.e., held by households, businesses, and financial institutions) has soared by a factor of 9.2x. By con- trast, America's nominal income (GDP) rose by just 5.6x during the same period.
Again, we are not talking about mere academics. Had the red line in the chart remained at its 1.5x level of historic times, which ratio was pretty much constant all the way back to 1870 and which had accompanied the greatest century of economic growth and middle-class prosperity in human history, the nation's total debt today would be about $40 trillion.
Accordingly, the aforementioned actual figure of $95 trillion means that the main street economy is now lugging around an incremental debt burden of $55 trillion. And that's why aggregate economic growth and middle-class prosperity is faltering badly.
Yet, did Trump-the King of Debt-have a clue during his presidency or after?
He most definitely did not.
National Leverage Ratio: Total Debt to GDP, 1947 to 2022.
In fact, real economic growth has dropped from a trend rate of 3.5 percent per year before the turn of the century to barely 1.5 percent per annum since then. And the reason for that is real fixed private investment has stopped growing because the meager private savings available have been channeled into private specu- lation and public debts.
Since the year 2000, real net fixed private investment-which strains out the inflation and the annual depreciation from the gross investment figures-has dropped from $933 billion to just $621 billion during The Donald's final year in office. Relative to national income, this figure plunged from 7.1 percent of GDP at the turn of the century to 3.4 percent in 2020.
Stated differently, main street has experienced a continuing deterioration in the share of national income being plowed back into new investment-the motor fuel of growth and rising pros- perity. But then again, Donald Trump's MAGA notwithstanding, the 1 percent did get their yachts.
Real Net Private Investment Percent of Real GDP, 1997 to 2020.
The Sound Money Road Not Taken
Had he accepted it, the true mission of the Low Interest Man was to make the dollar good as gold again. That meant big budget surpluses, high interest rates, a tumbling stock market, the end of financial engineering in the C-suites, and the painful sweating out of inflation that became embedded over the last several decades in wages, prices, costs, house prices, and much more on main street.
Those were the things which draining the Swamp was actually all about.
But none of that was in The Donald's DNA. Not even remotely. Nevertheless, deflationary austerity was and remains the only viable alternative to the failed spend, borrow, print, and inflate economic policies of the Washington uniparty-the embedded groupthink apostasy that Donald Trump embraced with unre- served gusto.
The truth is, all of today's maladies-low growth, high infla- tion, a shrinking middle class, and the concentration of vast wind- fall wealth at the tippy-top of the economic ladder-stem from the central bank's basic modus operandi. That is, the Fed's over- whelming presence in Wall Street money and capital markets via massive bond-buying, interest rate pegging, yield curve manipu- lation and price keeping operations designed to prop-up equities and other risk assets.
This modern form of Wall Street-centric central banking has been an abject failure and not just because it is anti-growth, pro-inflation, and deeply biased in favor of the super-rich, who own most of the financial assets which have been inflated to a fare-thee-well. Its even more fatal defect is that it led to near total capture of the Fed by Wall Street operators, traders, speculators, and their shills in the financial press.
The result was crony capitalism in capital letters. And that put the Eccles Building at the very epicenter of the Swamp.
There is no mystery as to why this is the case-even crediting the arguably good intentions of the twelve people who serve on the FOMC (Federal Open Market Committee). With every Fed meeting there are extant literally tens of trillions worth of bets that have been placed by Wall Street's fast money-operators based on the expected FOMC policy announcement. The latter include changes in money market rates by as little as twenty-five basis points, guidance on the monthly rate of bond-buying or selling to the nearest $5 billion, and hints in the post-meeting statement and chairman's press conference as to what hairline maneuver the FOMC might undertake at the next monthly meeting and in the months immediately beyond that.
In a word, the rise at the Fed of what Alan Greenspan called "the wealth effects doctrine" has fundamentally changed Wall Street. In days of yore it invested based on the facts embedded in the flow of business and financial information on the free market. But now it trades overwhelmingly on the flow of monetary policy tweaks coursing through the brains of the twelve FOMC mem- bers and a handful of Wall Street gurus who attempt to divine their latest revelations and intentions.
Accordingly, the Fed dare not disappoint the momentary Wall Street consensus because its entire "policy transmittal" process works through the Wall Street-centered financial markets, not the main street banks and S&Ls of times gone by. Under today's Fed model, prices in the money, bond, stock, and real estate markets are actually the transmission mechanism which purportedly con- veys the Fed's policy signals and intentions to main street.
So, for want of a better term, Wall Street has the FOMC by the short hairs. And it never lets go. Doing Wall Street's short-term bid- ding at meeting after meeting after meeting leads to nothing less than permanent policy capture of the Fed by traders and speculators.
And we do mean traders, not investors. In theory the latter were historically happy with honest market-based pricing of financial assets on Wall Street and a convertible dollar linked to a fixed weight of gold. After all, old-fashioned "investors" were in the business of picking profitable investments for the long-haul based on the intrinsic facts of the instrument in question.
That's not the case with today's Wall Street traders. Not by a long shot. To the contrary, they make their money through Fed subsidized carry trades or options market positioning based on zero or negative cost of capital in real terms, and also via artificially low cap rates (i.e., long-term interest rates and their reciprocal in the form of higher P-E ratios). So if you are invested in assets that are appreciating due to rising valuation multiples and are funding them to the tune of 80 percent or more in zero cost overnight debt markets, it is truly a case of shooting fish in a barrel.
This proposition cannot be overstated. Dwelling down in the canyons of Wall Street cheek-by-jowl with the traders and specu- lators, the members of the FOMC lose all contact with the long- term trends they are fostering through their day-to-day capitula- tion to the demands of the fast money. For instance, the overnight interest rate (Fed funds and money market rates which track it) is of little use to main street because prudent businesses do not wish to finance either fixed or short-term capital in overnight markets that can be here today and gone tomorrow in terms of rate lev- els, conditions, and availability. And that's for the obvious reason that their funded capital-buildings, machinery, inventory, receiv- ables, etc.-is not highly liquid or capable of being monetized at book value on a moment's notice.
Besides, their capital stock is designed to support the long- term capacity of an enterprise to produce goods or services. It's not there to be liquidated in order to pay off short-term funding that can't be rolled over. So the Fed's number one policy tool- the Fed funds rate-is essentially irrelevant to the main street economy.
But in contrast to main street businesses, Wall Street traders' books are far more liquid, meaning that assets can generally be quickly liquidated, even if it involves a mark to market loss, if funding is interrupted. It also means traders are inherently incen- tivized to borrow short and cheap and to invest in longer term assets with more yield and and/or appreciation potential. In this context, therefore, cheap carry trade finance is the mother's milk of speculative riches.
As it turns out, during the years of egregious money-printing, the inflation-adjusted or "real" cost of carry trades has been neg- ative during the preponderance of time. For instance, during the 108 months between February 2008 and Trump's arrival in the Oval Office, the real federal funds rate was negative every single month. And when that span is extended out to the present-184 months-the data shows it has been negative 96 percent of the time.
So, if you were a fast money operator on Wall Street you made profits by borrowing on the money market and rolling it over day after day, even as the longer-duration assets being funded were producing higher yields or better rates of appreciation and there- fore a positive spread on the carry.
In the great scheme of things, this was damn near criminal. It showered Wall Street speculators with hideous riches, and pro- vided a giant incentive for capital and talent to flow into finan- cial speculation. And also, for the corporate C-suites to indulge in massive financial engineering-huge stock buybacks, overvalued M&A deals, leveraged recapitalizations, etc.-in lieu of produc- tive investment on main street.
The latter point cannot be emphasized strongly enough. The Fed's day-by-day Wall Street coddling, subsidizing, and price-sup- porting actions have turned the capital markets into a casino where short-term trading is everything, and investing for the long run is hardly an afterthought.
Unfortunately, stock options-endowed corporate executives cannot resist the resulting temptation to get richer quicker. That is, the opportunity to goose options' value via financial engineer- ing machinations that generate stock price gains in the short-run, even as they undermine long-run earnings growth through too much debt accumulation and too little investment in plant, equip- ment, technology, and human capital.
A succinct word for this perverse process, of course, is finan- cial strip-mining.
The question therefore recurs. How did the monetary policy mechanism work before the Fed fell into bed with Wall Street after Greenspan's post Black Monday bailouts in October 1987? And why in those now forgotten earlier times did the US economy thrive just fine absent the heavy hand of Fed micro-management of the nation's total GDP?
The answer is that even Volcker did not target interest rates or attempt plenary management of the GDP. His goal was the restoration of sound money and returning goods and ser- vices inflation to absolutely minimal levels. Likewise, the great William McChesney Martin before him had no pretense that he and the FOMC were running the US economy. He knew that was the job of businessmen, investors, savers, workers, consum- ers, and even speculators pursing their own best interest on the free market.
In short, for the Fed's first seventy-three years of existence up until Greenspan's arrival in August 1987, its modus operandi had not strayed too far from the original vision of its legislative author, Congressman Carter Glass. The latter's vision was that the Fed's purpose would be to safeguard sound money and to ensure that the commercial banking system remained liquid as the US econ- omy expanded in the normal course or encountered temporary rough patches from time to time.
But the watchwords were sound money and a well-func- tioning banking system. The pre-Greenspan Fed was not in the jobs, growth, housing, business investment, and 2 percent infla- tion business. All that claptrap was invented by Greenspan and his heirs and assigns based on the excuse that the misbegotten Humphrey-Hawkins mandates of 1978 made them do it.
The latter did not-there are no rigid inflation or unemploy- ment targets in the legislation, just a motherhood-type aspiration for full employment and low inflation. But the Fed's subsequent mission creep into outright monetary central planning has now gone so far that the damage can only be undone by returning to a strict Carter Glass approach to central banking.
That is to say, the one decisive reform that is needed is to jet- tison the FOMC and all activist day-to-day Fed intervention in financial markets and return to a passive discount window modal- ity. That shift and that shift alone would rescue the Fed from its captive status deep down in the bowels of Wall Street.
To be very clear, under this alternative monetary regime the banking system could get liquidity when it was needed, but only at a penalty spread above a market-driven floating rate at the Fed's discount window. Under a revived Glassian model the money market, not the FOMC, would set the discount rate based on the supply of savings and the demand for borrowings. And the discount window would be open for business one commercial bank-borrower at a time, day in and day out.
There would be no monthly Fed meeting drama-endlessly amplified by financial TV-about the Fed funds rate and level of bond-buying. Nor would there be a massive concentration of bets (i.e., front-running) around the Fed's expected action because policy-action would be delivered in tiny fragments and via contin- uous pricing bits at the market-driven discount window, not via a "breaking-news" flash on bubblevision ten times per year.
Moreover, the remit of the Fed under the Glassian model would be strictly limited to support for commercial bank liquid- ity. Period. The private economy would take care of growth, jobs, and the other elements of GDP. And White House bullies like LBJ and Donald Trump could huff and puff at length about eas- ier money, but to no avail because there would be no FOMC or monetary politburo to heed their wishes.
At the same time, there would be no financial bubbles or main street goods and services inflation, either. That's because the mechanism by which the Fed fosters financial bubbles and CPI inflation-artificially low interest rates and inflated financial asset prices-would be disabled.
The vast unearned windfalls garnered by the super-rich in recent years were not the natural product of capitalism at work. Bubbles happen when the central bank subsidizes debt and cod- dles speculation. This inherently attracts talent and capital to the speculative trading pits, leading to even higher asset prices and ever larger speculative bubbles.
However, under a Glassian model, attempts at debt-fueled speculation would self-correct. That's because the interest rate at the discount window would automatically rise in response to surging demand for credit, and appreciably so. That was effec- tively demonstrated by the Volcker interlude in the early 1980s when Tall Paul essentially enabled the Fed funds rate to find its own market-clearing level. It did-at 22 percent in the face of the virulent inflation that had been unleashed by the money-printers during the previous decade.
At the same time, the banking system would not be left high and dry. But instead of validating the Wall Street canard that discount window borrowing is a bad thing because it taints the reputation of the bank obtaining the Fed advance, such discount borrowing would become par for the course. It would become the one and only source of sound money liquidity injections into the banking system to support real growth and productive main street investment.
In the historic monetary literature this was called a "mobilized discount rate." This kind of free-ranging market rate not con- strained by the Fed's heavy foot would choke off excess demand for credit, and do so long before today's plague of Fed-subsidized financial asset inflation had time to build up a head of steam.
One more feature of a restored Glassian discount window model is crucial and would guarantee that its modus operandi would be non-inflationary at the CPI level, as well. Glass never intended for the Fed to be in the business of buying and holding Uncle Sam's debt paper, thereby subsidizing the government bor- rowing rate and encouraging the politicians to run-up the public debt. Government debt came to dominate the Fed's portfolio only by the accident of enlisting it to finance WWI.
By contrast, Congressman Glass was a believer in what was called the "real bills" doctrine back in the day. In simplified terms it held that bank loans backed by already produced goods (i.e., finished inventory or receivables paper due for settlement within a set period such as ninety days) were the only suitable collateral for loans at the Fed discount windows. Accordingly, when the Fed printed new money to advance a discount loan to a commercial bank member, the associated collateral would signify that new supply of goods had already been brought into existence to match with the expanded credit.
To be sure, the real bills route to Fed liquidity support for the banking system was not perfect. But it stands head and shoulders above the current defective arrangement where the Fed creates endless amounts of new credit by buying government paper with- out regard to the supply-side of the economy.
For this to work in the present era only one change would be needed, and it would bring the Fed inflationary money-printing spree and endless showering of windfall wealth on the 1 percent to an abrupt hall. A present day Glassian Fed would accept only secured commercial loans as collateral for new Fed credit. It would therefore cap its current holdings of federal debt and guaranteed housing paper at the present $8.3 trillion level and undertake a fixed plan of paydown.
For example, as long as it was fixed and irrevocable, the Fed's current rate of $95 billion per month of government debt liquida- tion (called quantitative tightening or QT) would result in an end game of zero holdings of government and GSE paper roughly seven years down the road. Under that scheme the Fed would never buy another US Treasury bill, note, bond, or guaranteed GSE security, ever again.
Accordingly, the Fed's heavy-handed price supports for Uncle Sam's debt emissions would end and legislators would have to service the public debt in the bond pits out of private savings at honest market rates. Upon the Fed's ending of public debt mon- etization, therefore, yields on Treasury paper would soar, caus- ing profligate spending by the Washington War Machine and the domestic stimulus racketeers to come to an abrupt halt.
That would also end the current inflationary disconnect between excess demand fueled by US Treasury debt monetized by the Fed and the available supply of goods and services. Under a Glassian discount model, Say's Law would prevail: new supply would come into being first and only then could new central bank credit follow.
Equally important, the cavalcade of money-printing central banks that have enabled the collapse of America's trade accounts and industrial economy would undergo a decisive volte-face. Dollar- denominated interest rates would rise, causing the dollar's FX rate to sharply strengthen. And that would be unrelenting bad news for the mercantilist exporters, which, as The Donald so unartfully described it, were stealing production and jobs from America.
More precisely, these great mercantilist production machines have had one Achilles heel all along. Namely, they converted their dollar-based imports of energy, metals, and myriad other com- modities into processed goods and finished manufactures and components, which, in turn, were resold to the US and other advanced economies at a profitable mark-up. However, were these goods converters to allow their currencies to abruptly collapse in the face of a newly hardened dollar, their domestic economies would face gale-force inflation as the domestic currency cost of imported supplies soared.
At length, China and the other mercantilist exporters of the world would need to severely tighten their monetary policies by raising rates and shrinking their own domestic money supplies. This would be necessary in order to support plunging FX rates and thereby counter the severe imported inflation that would be generated by a strong global dollar. Even then, local wages would have gone up with rising domestic inflation, while debt service and capital costs would also rise owing to higher interest rates and credit scarcity. In short order, the artificially competitive advan- tage that had materialized during the Fed's money-printing era would be substantially vaporized.
In a word, a sound dollar has been the key all along to revers- ing the accumulating main street disaster in trade, industrial pro- duction, jobs, and middle-class incomes. And yet, Donald Trump was and remains surely the most pig-headed dollar-trasher to rise to the top of American politics. Ever.
The current roadblock to fixing the Fed, and therefore fixing the American economy and restoring sustainable prosperity, is that the conservative party in America has come under the thrall of a dangerous protectionist, statist bully, and monetary quack. Unless he is sent to the showers decisively there is literally no hope for an outcome that does not end in financial, fiscal, and economic disaster.