Chapter 4 – The Reagan Revolution. Repudiations and Deformations
- Fixed exchange rates arising from the gold standard coupled with continuous settlements of trade balances means that chronic deficits lead to outflow of reserves and domestic tightening.
- When Nixon closed the gold window and defaulted on the Bretton Woods obligations, this check against chronic deficits was removed.
- Greenspan quote: “Opposition to the gold standard… was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending.“
- Exporting nations eagerly bought the US debt to keep their currencies pegged low. These treasuries sat in the various central banks. This enabled the debt monetization that allowed the usual effects of deficit spending, high inflation, and high interest rates, to be deferred.
Two myths of Reagan economics:
- Reagan stopped march of ‘big government’. Demonstrably false. Federal outlays did not decrease during Reagan administration.
- Reagan enabled the robust free-market growth of the next several decades. Also false. The growth actually came from two massive stimulus programs (Reagan deficit spending, and loose monetary policy).
- Keynesian Boom Under Reagan and Bush. Massive Keynesian deficit finance carried out during Reagan and Bush Sr. administrations.
- $2.4 trillion increase in federal debt in this time period accounted for 70% of GDP growth during those 12 years.
- In the past such deficit spending would have caused inflation and not been sustainable. “In the new era of irredeemable floating dollars, however, this was no longer true. Much of the treasury debt issued to finance the deficit went into the vaults of central banks around the globe, and the spending they financed went into fatter GDP accounts at home.“
- Asian exports, primarily China, pegged their currencies to the US dollar (and pegged them cheap). This required them to purchase more and more US treasuries to maintain the peg. This is what enabled the sustained deficit spending and trade deficit of the US.
By the turn of the century the United States was living far beyond its means, as measured by the cumulative trade deficit of nearly $2 trillion that had been incurred just since the 1991 recession. Under traditional fixed exchange rate discipline, the job of the central bank in these circumstances had always been to tighten money, raise interest rates, and curtail domestic demand sufficiently to eliminate the trade deficit and the associated loss of monetary reserves.
The Greenspan Fed did the just opposite…
The great prosperity celebrated in the late 1990s was thus nothing of the kind, and in fact reflected an artificial domestic demand that was bloated by the massive Greenspan debt bubble. Moreover, this artificial domestic demand generated even greater imports and trade deficits, thereby further unbalancing the national economy.
The cure for excess demand and borrowing , of course, is higher interest rates. Yet after the 1991 recession ended, the Greenspan Fed never even returned rates to the prerecession levels. It thereby abdicated the historic job of sound central banking – namely, to lean hard against a current account deficit by curtailing domestic demand.
- The surge in vastly cheaper Chinese products should have caused the CPI to fall. Instead, the CPI continued to rise. Thus, the true rate of inflation was the current CPI PLUS the amount of the deflation that should have been occurring but wasn’t.
- The US needed to have falling wages to remain competitive in production. This would have been feasible had the CPI been decreasing since real wages would have been maintained. But the Fed easy money policies circumvented this process and destroyed the competitiveness of the US manufacturing sector.
…the Greenspan Fed blew it. Rather than allowing the US economy to harvest the living standard gains of deflation and to adjust to the pains of falling nominal wages and profits, it declared a debt party.
…And the main implication was the American production, jobs, and incomes were at risk. Under the established regime of free trade, domestic jobs and incomes could be maintained only if cost and wage levels were adjusted downwards to meet the powerful deflationary challenge of the Asian exporters.
Under these conditions, the very last thing the American economy needed was lower interest rates and rapid household credit expansion.
…Under these conditions, the Fed should have pushed interest rates far higher to encourage savings and a reduction of household debt, not enabled a spectacular accumulation of even more borrowings.
- A side effect of the Fed’s policies has been to greatly enrich the top 1% at the expense of the middle class. This is the class war.
- The irony is that the free market is blamed for this wealth transfer from the bottom 99% to the top 1%. In fact it is the undermining of the free market that has caused this.
Chapter 5 – Triumph of the Warfare State. How the Budget Battle Was Lost
- By the time Reagan came to power in the early 80’s, the Soviet Union was already in decline.
- The Neocons pushed forward an alleged arms ‘gap’ that required immediate and substantial increases in US DOD spending.
- Reagan agreed to increase the Pentagon budget by 7% (after inflation) each year for 5 years. This number was arrived at with no real analysis of needs. It was essentially pulled out of the air.
- The defence budget for 1980 was $142 billion. By 1986 it was $370 billion.
- Though the nuclear threat from the USSR was used to justify the buildup, virtually all of the money was used to build up the conventional forces (tanks, helicopters, ships, etc.). These were completely useless as both a strategic deterrent or in any war with the USSR (which would be nuclear).
- Mutually Assured Destruction (MAD), provided by the submarine based Trident missiles and Minuteman ICBMs, long before 1980. Not one additional dime needed to be spend in the 80’s to deter the Soviets. Indeed the arms buildup of the 80’s did nothing to alter the nuclear balance of power.
- The idea the the Reagan buildup somehow forced the Soviets into collapse as they tried to keep up is a myth. The now open Soviet archives show clearly they didn’t attempt to keep pace with US military spending and were not actively developing additional strategic weapons.
Ronald Reagan had swallowed hook, line, and sinker the neocon narrative, with its vastly exaggerated notions of the Soviet threat and its spurious theory that the Kremlin was pursuing nuclear war-winning strategies.
Reagan was an out-an-out statist in the realm of the military and national security. All the well-warranted skepticism he had about Big Government – the empire building tendency of the bureaucracy, the inherent inefficiency and waste of public sector monopolies, the self-serving propensity of bureaucrats to hide the facts and twist the truth – did not apply on the Pentagon side of the Potomac.
Nor did he have any sense that money spent on defence imposed the same burden on taxpayers and drain on the economy as did all other kinds of government spending.
- The real result of the Reagan buildup was to leave the US with a massive conventional expeditionary force with nothing to do.
There can be little doubt, therefore, that George W. Bush, and his father before him, carried out their imperial adventures in the lands ringing the Persian Gulf because they could. An accident of history had bestowed upon them a massive conventional war-fighting machine, so they went to war without having to prove the case or raise an army by taxing the people and getting a declaration from Congress.
- Eisenhower was the only professional military man to serve as president since WWII. He sharply reduced the conventional forces of the US and believing that limited warfare was an illusion in the nuclear age and that the USSR was best contained by the threat of massive nuclear retaliation.
In his farewell address, Ike famously warned the nation that “we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”
Foremost among these potential abuses of political power was the obvious possibility that the military industrial complex would extract unwarranted and excessive defence spending through the mobilization of fear the the enormous pork barrel dynamics inherent in the warfare state.
Eisenhower held the old-fashioned view that military spending is inherently wasteful. It consumes resources that would otherwise be available to meet the needs of the civilian economy.
Indeed, in a stunningly lyrical rift he had once insisted that “every gun that is made, every warship launched, every rocket fired signifies in the final sense, a theft from those who hunger and are not fed, those who are cold and not clothed. This world in arms is not spending money alone. It is spending the sweat of the labourers, the genius of its scientists, the hopes of its children… Under the cloud of war, it is humanity hanging from a cross of iron.
- The irony is that Reagan came to power on the promise to end Big Government and the welfare state. Instead, he created a massive, debt-financed, warfare state that became “an incubator of imperialist calamity in the decades ahead”.
Chapter 6 – Triumph of the Welfare State. How the GOP Anti-Tax Religion Was Born
- When Reagan took office he was confronted by high inflation. This was causing ‘bracket creep’ – i.e. people were moving into higher tax brackets simply due to inflation. Unchecked this bracket creep would amount to a massive increase in the tax burden on the average American.
- It was the recognition of this problem that lead to the Reagan 10-10-10 tax cut plan. These cuts simply maintained the status quo in light of the high inflation that was expected to continue.
- Reagan’s budget assumed the ‘Rosy Scenario’ in which there would be no recession and simply immediate growth as inflation was brought into check.
- The reality was that the growth expected did occur but only after a two years of of contracting growth and soaring unemployment as tight monetary policy reined in the beast on inflation. By that time, the real numbers had diverged so much from the Rosy Scenario projects that large deficit spending continued.
In short, the Reagan tax-cutting program had started with inherited Carter budget policy. The latter had penciled out to a substantial surplus by the mid-1980’s. But this was a mirage. It represented an inflation-swollen economy that was unsustainable but which caused the Office of Management and Budget (OMB) to spit out a windfall of phantom revenues from the pernicious process of bracket creep.
So for all practical purposes, the nation was already mired in deep budget deficits when Ronald Reagan took the oath of office; they were just hidden in a nonsustainable inflation-ridden economy. After the huge Reagan tax cuts were layered on top of this inherited red ink, the fiscal math was prohibitive. It became a generational albatross.
- The July 1981 tax bill required massive compromises to garner sufficient support. For each dollar of cuts for individual tax payers, the White House had to hand out another dollar to the lobbies and special interest groups. The genesis of crony capitalism.
- Reagan subsequently signed a half-dozen tax increases to recover nearly 45% of the revenue that had been lost in his initial tax cut bill.
- But any attempts to address the underlying structural problems as required to truly put the brakes on deficit financing were dead-on-arrival. The Social Security Reform Plan is a good example of this. It was resoundingly defeated and condemned by all.
Not only did that vote permanently bury any prospect for reforming the dense complex of social insurance programs which comprised the core of the welfare state, but it also implanted a fiscal litmus test for the ages: whenever politicians talk about shrinking the size of government and returning the tax burden to pre-1980 levels, they are either indulging in pure pettifoggery or they mean to embrace the [social security reform plan] at the very least. The fiscal math simply admits of no other alternative.
- The bipartisan 1983 Greenspan Commission plan did the only thing possible in the climate – it raised taxes to keep the social security plan solvent in the intermediate term.
- This clearly marked the end of any hope of Reagan addressing the structural problems – he simply became “the tax collector for the welfare state”.
- The experience of the latter Reagan years was of high growth and low inflation and yet still rising fiscal deficits. From 1982 until 1990 the economy has 31 quarters of growth averaging 4.3% GDP per year and full employment was obtained. Yet, the deficit never went below 4% GDP. “The deficit gap was plain and simply structural – the result of policy choices, not a weak economy”.
- There has never exists a more pure test of the theory that lower taxes can eliminate deficits by spurring growth. While this theory is true to some extent, it was its limits and the underlying structural problems must be addressed or no amount of tax cuts can spur sufficient growth.
So the “grow your way out” theory had been invalid from the very beginning. Yet by embracing it in the decades since then, congressional Republicans have transformed their real job, managing the finances of the US government, into a sub-branch of statist pretension; that is, centrally managing the growth of the private economy through chronic fiddling with taxes.
[The] faux prosperity [of the 80s and 90s boom] reinforced the wrong-headed narrative that the Reagan Revolution had been a success; that the 1981 tax cut bill had been the incubator of two decades of prosperity; and the fiscal deficits didn’t matter.
As has been indicated, the massive Republican deficits after 1980, which reached their ultimate conclusion in George W. Bush’s final trillion-dollar-bailout-nation era, had not been “on the level”. Beneath the economic surface, the pernicious force of printing-press money had been gathering volcanic momentum since 1971. And it was this unprecedented monetary deformation which finally accounted for both the debt-fueled illusion of prosperity and for the long, extended deferral of the day of fiscal reckoning.
Chapter 7 – Why the Chickens Didn’t Come Home to Roost. The Nixon Abomination of August 1971.