Almost thirty years ago, David Stockman was taken to the woodshed for allegedly disturbing the Reagan doctrine on fiscal conservatism. His ‘mistake’ was pointing out that the Great Communicator’s budget communications were – well disturbingly opaque. Specifically, putting asterisks in place of numbers on politically sensitive social spending cuts looked a little like trying to fool the electorate. At that time, it was almost like the dumb leading the dumb, since neither the Great Communicator nor his fiscal vocal chords understood the difference between real and nominal values.
Whether President Reagan ever learned the difference is a matter of opinion. But once he was out of Reagan’s cabinet, David Stockman surely did. And on March 12, 2011, as part of his Henry Hazlitt Memorial Lecture, David Stockman places some very telling blows on a body politic and an economics sub-profession that has taken the United States down the road to unsound money and fiscal lunacy. In this column, I focus on Stockman’s organ-damaging punches, aimed at the solar plexi of US President Richard Nixon and Chicago economics guru, Milton Friedman. And gut-busters they most surely are!
“That the demise of the gold standard should have been as destructive as it was of monetary probity can hardly be gainsaid. Under the ancient regime of fixed exchange rates and currency convertibility, fiscal deficits without tears were simply not sustainable – no matter what errant economic doctrines lawmakers got into their heads. Back then, the machinery of honest money could be relied upon to trump bad policy. Thus, if budget deficits were monetized by the central bank, this weakened the currency and caused a damaging external drain on the monetary reserves; and if deficits were financed out of savings, interest rates were pushed up – thereby crowding out private domestic investment.” (Stockman, March 2011)
“During the four decades since the gold window was closed – the rules of the game have been profoundly altered. Specifically, under Professor Friedman’s contraption of floating paper money, foreigners may accumulate dollar claims or exchange them for other paper monies. But there can never be a drain on US monetary reserves because dollar claims are not convertible. This infernal regime of fiat dollars, therefore, has had numerous lamentable consequences but among the worst is that it has facilitated open-ended monetization of US government debt.” ibid.
“So at the end of the day, American lawmakers have been freed of the classic monetary constraints. There is no monetary squeeze and there is no reserve asset drain. The Fed always supplies enough reserves to the banking system to fund any and all private credit demand at policy rates that are invariably low. The notion of fiscal ’crowding out’ thus belongs to the museum of monetary history.” ibid.
“In fact, the United States is clocking a 10-percent-of-GDP-deficit for the third year running because this latest budgetary fling is just another episode in the epochal collapse of US financial discipline that began 40 years ago at Camp David.” ibid.
Tricky Dick’s ghost may may well not be entirely unhappy to absorb Stockman’s deadly body blow – for after all President Nixon was a compassionate progressive at heart. However, Milton Friedman’s ghost may well wince with pain. For, like so many of his economic ideas – floating exchange rates and income tax withholding being the worst – what looks like good conservative economics from the blinkered perspective of the University of Chicago turns out to be seriously bad political economy from the perspective of the Virginia School.