David Stockman, President Reagan’s former budget director, wrote an impassioned editorial in the New York Times this past Sunday essentially predicting financial death for the United States. While the points about the sluggish recovery from the financial crisis of 2008 are essentially correct, Mr. Stockman glosses over the risks faced in 2008 of a much more serious 1930s-style depression. Although the policies pursued by Bernanke and the Bush and Obama administrations in response to the financial crisis may not have been ideal, they were effective in averting a deeper crisis. While government debt expanded, aggregate debt levels have declined since 2008 – reflecting a deleveraging of household and corporate balance sheets. Now with the S&P 500 reaching new highs, employment slowly recovering, and animal spirits beginning to stir, Stockman expresses what seems to be a common angst among hard-money purists – that the economy could be doing as well as it is without the fiscal and monetary penitence that they have been advocating.
Keynes may not have been right about everything, but his key insight about the impossibility of the government, household and corporate sectors practicing thrift simultaneously has been proven correct. A dollar saved in expenditures by one party is a loss of income to another. The tightening of the public belt when the private sector had collapsed in the early 1930s was a key factor in contributing to the magnitude of the Great Depression. The recent experience of Europe, particularly the UK, which pursued a policy of austerity since 2008, demonstrates this. While Stockman is correct in stating that both the warfare and welfare states will need to be restructured for America to regain a sound financial footing, it would have been a counterproductive and grievous mistake to attempt this in the depths of the 2009 recession.
Societal wealth is created by people exchanging the products of their labor and skills with one another through the medium of money. One economic or monetary policy is better than another only to the extent that it better facilitates these exchanges. Stockman claims that the financial system of the US has been headed for ruin since the departure from the gold standard which was initiated under FDR and finalized under Nixon. Somehow we have managed to survive and prosper for eighty years with ‘fake’ money. The recovery since 2008 has not been an illusion; people have worked and exchanged valuable goods and services (albeit at a suboptimal level). Corporate profits reflect this and accordingly the markets have appreciated in value. By this measure the policies enacted in response to the financial crises have succeeded.
Mr. Stockman’s final mistake is the contention that, granting all his points, that investors should sell their stocks and go to cash. If the US monetary system is a house of cards with a looming collapse of the dollar then a portfolio of high quality real assets is the only possible defense. When the German Mark collapsed in the early 1920s in a hyperinflationary death spiral, only the German stock market survived. Cash investments were rendered worthless but hard assets retained value. A globally diversified portfolio of high quality companies provides much better insurance against the government’s monetary malfeasance than concentrating one’s wealth in the one asset whose value that Washington DC can completely control.