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DAVID STOCKMAN HAS EXCORIATED the economic policies of Richard Nixon and Ronald Reagan for causing the current economic crisis. Too bad his solution is to adopt the policies of another Republican president, Herbert Hoover.
In an op-ed essay in Sunday's New York Times ("The Four Deformations of the Apocalypse", Aug. 1), Reagan's former budget director takes his party's past policies to task for today's travails. And to make sure nobody missed his point, even those didn't want to take the time and effort to read the piece, the pull quote asserted: "How my G.O.P. destroyed the U.S. economy."
Stockman's bill of particulars goes all the way back to 1971 with the end of the Bretton Woods international monetary system of currencies' fixed exchange rate to the dollar, which in turn was anchored at a gold price of $35 an ounce. On Aug. 15, 1971, Nixon abrogated the promise to redeem dollars for gold, and exchange rates have been floating ever since.
Milton Friedman argued for letting the market set exchange rates instead of government price-fixers. Free-floating exchange rates were touted to eliminate trade imbalances, Stockman claims. Instead, trade imbalances have swelled—to a cumulative $8 trillion—a seeming repudiation of Friedman's theory.
This naïve characterization ignores the realities of the international monetary system of the past four decades. Nations have intervened strenuously to manipulate their currencies' exchange rates to their domestic advantage.
In the case of China, it would rather peg the exchange rate of the yuan to stimulate exports. That helps to industrialize its economy and provide jobs for hundreds of millions of rural peasants. To accomplish that, Beijing has to buy up dollars, which it recycles into the U.S. economy.
To Stockman's point, the most important exchange rate—dollar-yuan—is fixed. So, there are no freely floating exchange rates. Meanwhile, where fixed exchange rates are enforced—the eurozone—has not been without economic strains.
Where Stockman's critique can't be faulted is the burgeoning of federal debt, from 40% of gross domestic product in 1970 to more than twice that currently. And true conservatives are appalled by the 65% rise in non-defense spending under George W. Bush.
But it is nonsense to contend the "tax-cutters" had slashed tax revenues to 15% of gross domestic product. The worst economic downturn since the Great Depression decimated tax revenues. A tax rate of 100% applied to an income of zero yields nil to government coffers.
Stockman's third horse of the apocalypse was the expansion of the financial sector, which set off an orgy of speculation that necessitated bailouts of institutions that became "wards of the state." This, however, was hardly unique to the U.S. British banks required bailouts. And the evident relief that most European banks passed their stress tests further attests to the international nature of the financial bubble. To lay this on the steps of the GOP leadership beggars credulity.
Finally, Stockman criticizes the "hollowing out of the larger U.S. economy," which he asserts is the result of "living beyond our means for decades by borrowing heavily from abroad." The causality, however, runs the other way.
The signal spurs to growth at the end of the twentieth century and the beginning of the present one have been technology, the lowering of trade barriers and the end of the Cold War and communism (or at least the brand associated with that era.) The freeing up of economies in Eastern Europe, the revival of Latin America, and the explosive growth in Asia have provided a massive, supply-side shock to Western economies.
At the core of the U.S. trade imbalance is oil more than anything else. Where it is produced is determined first by geology; who realizes the profits is a geopolitical question. Most oil resides in places outside the U.S., which means calls for American calls for "energy independence" are nonsense without a Draconian slash in petroleum consumption, which is completely unrealistic. That has nothing to do with Republican monetary and fiscal policies and all to do with energy policies, or lack thereof.
The solution, concludes Stockman, lies in the "old approach—balanced budgets, sound money and financial discipline." That tack was tried, and failed, under Herbert Hoover.
Raising taxes was disastrous in the 1930s. Now we face the biggest tax hike in history with the expiration of the Bush tax cuts on Jan. 1.
The Obama administration favors limiting the tax hikes to the top bracket, to 39.6% for couples making over $250,000. First off, to stave off increases for all brackets will take legislative action. Congress's failure to act on the estate tax when it lapsed this year is an not encouraging precedent for one to expect a tax bill, even in a lame-duck session in November's election.
It may be argued that a 39.6% top tax bracket didn't deter the prosperity of the 1990s. There were offsets, however. As David Goldman, senior editor of First Things magazine, has forcefully argued, growth depends on entrepreneurs, who ultimately are taxed at the capital gains rate.
During the 1990s, even while President Clinton raised ordinary-income rates, he lowered the cap-gains rate. In addition, the decline in inflation—helped by the "strong dollar" policy under Treasury Secretary Robert Rubin—made more of the capital gains "real" rather than the result of higher prices. Of course, the historic boom in technology didn't hurt, either. Now, the cap-gains rate is slated to go the other way, to 20% next year from 15% currently—not exactly pro-growth.
Taxes on dividends are slated to jump even more drastically, back to ordinary-income rates of up to 39.6% from 15% currently. The Obama tax proposals call for a rise to just 20%, historically low but still doubly taxed given government already exacts its take at the corporate level. And, as noted, Congress also has to act to prevent the huge jump in dividend tax rates from going into effect.
As for monetary policy, in the 1930s Hoover and the Federal Reserve defended the orthodox gold standard. To do that required a doubling of the discount rate to defend the dollar after the U.K. abandoned gold in 1931.
The British economy began to recover after the U.K. let the pound float while the U.S. economy would not turn around until 1933—when the dollar was devalued against gold and the Federal Reserve expanded its purchase of Treasury securities, analogous to last year's quantitative easing.
There is much to criticize in the U.S. fiscal and monetary policies of the first decade of this century. Drunken sailors take umbrage for comparisons with Dubya's spending policies. For the Greenspan Fed to ignore repeated bubbles—on the dubious notion it's impossible to know they're happening and any way it's cheaper to clean up the bust than to burst them—has been shown to be destabilizing. The moral hazard, moreover, is obvious.
The last four decades have seen orgies of speculation under lax monetary and fiscal policies. This has been anything but unique to these times, however. Financial bubbles and panics took place during the financial orthodoxy of the late nineteenth and early twentieth century. Stubborn adherence to "the old approach" of hair-shirt policies espoused by Stockman meanwhile produced the economic disaster in the 1930s.
It is imperative that America be put on a sound, long-term fiscal course. But to enact the biggest tax increase in history as penance for sins of the past could bring an economic apocalypse instead of redemption.
Email: editors@online.barrons.com
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