Stockman's Rant Ignores What's Right with America

Former Reagan budget director David Stockman is worried. "When the latest bubble pops, there will be nothing to stop the collapse," he wrote in a bipartisan rant in Sunday’s New York Times.

Stockman blames Democrats and Republicans alike for America’s economic problems. No one escapes, not even the storied Ronald Reagan, in whose administration Stockman served as budget director before quitting in 1985 in a huff over excessive spending.

For good measure, Stockman attacks Fed Chairs Alan Greenspan and Ben Bernanke, House Budget Committee Chairman Paul Ryan, and Milton Friedman, who he describes as "the supposed hero of free-market economics."

It’s pessimistic, it’s no way to make friends and influence people, but it makes entertaining reading, and some of it is right on the mark.

Stockman’s article is based on his new book, "The Great Deformation: The Corruption of Capitalism in America," out this month from PublicAffairs. A column attacking conservatives and predicting "the state-wreck ahead" is a sure-fire way to make the best-seller list.

Despite Stockman’s over-the-top style, it’s a public service for him to shine a spotlight on the Federal Reserve. As I reported in my conversation with Carnegie Mellon professor and monetarist Allan Meltzer last month, the Fed is on its third bout of quantitative easing, busily buying $85 billion in mortgage-backed securities and Treasury bonds every month.

Meltzer shares Stockman’s pessimism. He told me, "We’re in the biggest mess we’ve been in since the 1930s. We’ve never had a more problematic future."

The Fed is calculating that it can engineer a rise in confidence by inflating asset prices, leading to stronger consumption and investment.

Asset values are indeed reflating, even though growth is still slow. (Perhaps the public sees through the Fed’s sleight of hand?) But the Fed’s actions have some negative consequences in the short term, as low interest rates discourage savings, devalue the dollar, and leave those on fixed incomes chasing risky returns. Stockman describes the Fed as "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."

Debt has skyrocketed from an average of 160% of gross domestic product between 1880 and 1980 to 355% of GDP today.

As well as being right on the money about the Fed, Stockman suggests that Congress should not have bailed out the banks in 2008, leaving them to stand and fall on their own merits. "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," he writes.

There’s a lot to be said for allowing financial institutions to reap what they sow, but Stockman’s suggestion to do away with deposit insurance won’t help the banking sector. Public confidence in banks is of the essence, as the fiasco in Cyprus has taught us.

The Federal Deposit Insurance Corp., an independent agency, charges banks for insuring their deposits, with the insurance coming out of customers’ returns. Up to $250,000 per customer account is insured, and the FDIC can raise premiums. Without deposit insurance, every bank failure would mean a run on all banks, and individuals would keep money in proverbial mattresses.

Stockman obviously has a score to settle with Milton Friedman, whom he describes as "the supposed hero of free-market economics who in fact sowed the seed for a never-ending expansion of the money supply."

Friedman was a real hero who believed in a slow, constant expansion of the money supply, without taking into account economic cycles and unemployment — a route that would lead to a stable currency. In the next paragraph, Stockman accuses Greenspan (rightly, in my view) of abandoning "Friedman’s penurious rules for monetary expansion … and flooding Wall Street with freshly minted cash." America would have been stronger with Friedman’s penurious rules.

Stockman correctly attacks industrial policy and crony capitalism as factors chipping away at the efficiency of the economy. Republicans are partly to blame. I was in the White House in 2001 when the farm bill was being negotiated, and Republicans from farm states were pressing President George W. Bush to increase agricultural spending. At the end of 2012, House Republicans renewed requirements to use ethanol in motor fuel and to extend wind-power subsidies — policies that benefit farm states.

But to say that Republicans believe that "deficits don’t matter" ignores history. It was the Republican Congress in the 1990s that brought the budget into balance and created a surplus. The Republican Congress sent President Bill Clinton welfare reform bills three times before he signed the Personal Responsibility and Work Opportunity Reconciliation Act into law in 1996. Over the next decade, the welfare rolls declined from 12.2 million to 4.5 million.

President Bush spent the surplus on the wars in Iraq and Afghanistan, but he bought America’s safety. We’ve had no new 9/11 attack more than a decade later.

More recently, the Republican House of Representatives has passed a series of budgets that cut spending. The latest, passed on March 21, balances the budget in 10 years and cuts $5 trillion from baseline spending.

Economists often think their solutions are obvious, when in reality they are fraught with political difficulty.

Stockman writes that "Mr. Ryan’s latest budget shamelessly gives Social Security and Medicare a 10-year pass." But it’s politically impossible for Ryan’s Medicare reform proposals, which would give seniors a choice of plans like the Federal Employees Health Benefits Program, to take effect next year. Democrats have demonized his plan by showing him pushing an elderly woman off a cliff in a wheelchair. The program becomes more politically acceptable if it excludes current beneficiaries, as well as those approaching retirement.

What’s especially puzzling is Stockman’s criticism of the House-proposed "draconian" 30% budget cuts for Medicaid, food stamps, and the earned income tax credit, which have soared over the past four years. These programs have expanded more than 30% over the past four years. For instance, spending on food and nutrition assistance has almost doubled over the past four years, from $61 billion in 2008 to $113 billion in 2012. Unemployment insurance spending was $41 billion in 2008 and $109 billion in 2012. Cutting them by 30% over the next decade from their new heights is not "draconian."

Stockman’s endorsement of a balanced budget amendment, if carefully crafted to tie government spending to some multiple of tax revenues three years earlier, would help stem the red ink pouring out of Washington. Congress is now debating the budget for fiscal year 2014, beginning next Oct.1, but tax receipts from fiscal year 2014 won’t be known until mid-2015, after returns have been filed. The IRS only knows 2011 tax receipts. A workable balanced budget amendment would require 2014 spending to be matched to 2011 tax receipts, plus some measure of expected revenue growth.

However, some of Stockman’s other policy recommendations would have little effect on the economy, are practically unworkable, and may violate the Constitution.

Take his suggestion to require members of Congress and the president to have single term limits of 6 years. This would not solve our economic problems. If you’re happy with your representatives, you should be allowed to elect them to another term. They may do an outstanding job of cutting the budget.

Then, Stockman recommends 100% government funding for candidates running for office. It’s unclear that the government has the power to spend money on political activity. That’s why the president needs to reimburse the government for campaign trips on Air Force One. Furthermore, the government cannot stop hundreds of people putting up signs or running ads for candidates of their choice, because it violates constitutional free-speech laws.

Limiting campaigns to eight weeks, another impractical Stockman idea, likely also violates freedom of speech. How can the government forbid people from discussing the campaign of their favorite politicians in advance of the eight-week period? People are already speculating about presidential candidates for 2016.

It’s uncertain how prohibiting lifetime lobbying for anyone who has worked for the executive or congressional branches, another odd Stockman recommendation, will help the economy. Excessive lobbying is not a problem. The current limits are stringent. Lobbyists need to register and record when they speak with the president, members of Congress, and other high-ranking officials.

Stockman paints a grim picture, but despite his pessimism America remains a magnet for the world.

Some of this week’s headlines: European companies want to relocate to America due to low natural gas prices. Congress is trying to craft an immigration bill to open up more legal visas to those who want to come to stay. The H-1B visa allocation for skilled immigrants, which opened on April 1, is expected to reach its annual limit on April 5. Until the flood is reversed, and Americans start leaving for other countries, our problems are somehow fixable.

This piece originally appeared in WSJ's MarketWatch

This piece originally appeared in WSJ's MarketWatch