The Great Deformation (14 page)

In fact, it was being badly eroded by soaring debt at home and the explosive growth of manufacturing capacity among the currency-pegging export mercantilists of East Asia. These fundamental forces of economic decay were obscured by the celebration of the tech revolution and the stock market bubble which supposedly reflected it.

What was actually happening, however, was far less benign. Corporate earnings were rising moderately, but mainly on account of consumer spending gains fueled by easy credit and the gathering mortgage debt–driven boom in both commercial and residential real estate.

Likewise, the ready availability of debt financing for corporate takeovers, leveraged buyouts, and share buybacks jigged-up earnings per share as documented more fully in
chapters 21
and
22
. And as the Fed pushed interest rates ever lower, the so-called cap rate on real estate and other financial assets fell, generating even higher asset prices and feeding speculative appetites still further.

Indeed, the Fed's low interest rate policy caused the price of American
labor to become richer relative to Asia while the price of debt became cheaper relative to income. Accordingly, spurred on by Wall Street demands for higher EPS, corporate America soon undertook vast strip-mining operations designed to extract labor costs from the profit and loss accounts during the current quarter, while funding the resulting severance and restructuring costs over many future years out of cheap borrowed funds.

Not surprisingly, business debt soared as companies borrowed money to buy back shares, take over competitors, and buy out workers. Between 1993 and 2001 nonfinancial business debt outstanding increased by nearly 100 percent, rising from $3.5 trillion to $6.8 trillion. Pretax business income only grew by 50 percent, however, meaning that business leverage ratios were steadily rising.

The Fed ignored this evidence of weakening economic fundamentals, too. Instead, it claimed credit for a stock market boom that was in very large part fueled by the giant debt bubble and trade deficits that its own misguided policies had triggered.

At the end of the day, the Fed's Wall Street–coddling monetary policies of the 1990s masked the grave threat to the American economy that was incubating in East Asia. It is ironic in the extreme, therefore, that the credit-based boom in consumption and financial speculation that was engineered by the Greenspan Fed has been touted as evidence of the success of the Reagan Revolution's supply-side policies.

In fact, the Keynesian boom of the 1980s and the money-printing bubble of the 1990s were anti–supply side. Two decades of exporting US treasury debt and fiat dollars was generating damaging economic blowback aimed at the very heart of the economy's actual capacity to produce output and jobs.

On the evidence, it was clear at the dawn of the twenty-first century that the great Asian export machine far outranked every other cost-reducing invention in recorded history. It bested the Internet, Wal-Mart, numerically controlled machine tools, Henry Ford's assembly line, central station electric power, the railroads, steam engine, spinning jenny, and possibly even the wheel.

And the main implication was that American production, jobs, and incomes were at risk. Under the established régime of free trade, domestic jobs and incomes could be maintained only if cost and wage levels were adjusted downward 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.
This invited domestic households to load up with far more debt relative to income than ever before imagined. The household debt-to-GDP ratio, in fact, climbed steadily for three decades, rising from a historic norm of about 45 percent in 1975 to upward of 100 percent after the turn of the century.

At the same time, artificially bloated consumption spending was only partially captured by domestic suppliers of goods and services. On the margin, a rising share of the demand for consumer goods went straight to low-priced foreign suppliers, especially to Mr. Deng's “China price” factories.

The implication was straightforward. In the face of the great Asian export machine, the wage prospects of Main Street households were being impaired and their debt-carrying capacity was being rapidly eroded.

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. But the Fed was lost in its growth triumphalism and pseudoscientific policy rules.

So at the very worst time possible in the cycle of modern economic history, the nation's central bank enabled households to bury themselves in mortgage and credit card debt. It thereby pushed the production versus consumption imbalance of the national economy to even more perilous extremes.

The 1990s boom, therefore, was not the productivity and technology driven breakout of growth and prosperity that is was cracked up to be. Instead, it was rooted in a massive credit bubble, which masked deep structural challenges to the production, jobs, and income base of the US economy.

THE ANTI-SUPPLY-SIDE PROSPERITY OF 2002–2007

When the dot-com bubble burst and the mild recession of 2001 ensued, the Fed elected to juice the American economy with still another round of rock-bottom interest rates. Washington reciprocated with even more adventures in fiscal profligacy. But this time there was no way to hide the fact that the resulting cyclical rebound, as measured by the modest uptick in the GDP accounts and nonfarm payrolls during 2002–2007, was an unsustainable facade of prosperity.

More than four years after the meltdown on Wall Street, the hard economic data shows that the US economy has actually been stalled out for a decade. During the twelve years ending in December 2012, real investment in business fixed capital grew at only a microscopic 0.8 percent annual rate.

That is not supply-side prosperity by any stretch of the imagination, since failure to invest in productive capacity quashes future growth in GDP and living standards. In fact, real GDP growth has averaged only 1.7 percent during the same twelve-year period, and even that meager growth number would have been zero, or even negative, if inflation were calculated honestly.

Similarly, the September 2012 nonfarm payroll count was 133.5 million jobs, virtually the same number of nationwide jobs reported in late 2000. Of greater concern, the count of full-time breadwinner jobs stands at about 66 million, or nearly 10 percent below its level at the turn of the century. Manufacturing output is not much higher than it was in February 2000.

So the Reagan Revolution did not engender a supply-side miracle, nor cause any improvement in the trend of macroeconomic performance. Its legacy has been obscured by serial policy-induced growth bubbles: the Keynesian deficit boom of 1983–1992, the Greenspan domestic credit and stock market bubble of 1993–2000, and the giant housing and consumption boom spurred by the Fed's absurdly low interest-rate policies after the minor 2001 recession.

All of this came to a thundering collapse in autumn 2008 when the nation's multi-decade debt binge hit its natural limits and the massive imbalances between production and consumption and between exports and imports reached unsustainable extremes. Yet the Reagan Revolution's apologists have never even attempted to explain this dire turn of events, save for blaming the Obama administration for making even worse the economic debacle it found on its doorstep.

Nevertheless, when the false narrative of macroeconomic prosperity is stripped away, what remains is the real story of the Reagan era: how the nation's conservative party fostered the great fiscal breakdown now upon the land, and got away with it by pretending that the money printers it appointed to the Fed were fostering honest prosperity.

The whole narrative was wrong. Reaching back to the time of Reagan, it can be shown that fiscal discipline was destroyed first by the “neocons” who coddled the warfare state in pursuit of national security illusions; and then by the “tax-cons” who dismantled Uncle Sam's revenue base in the name of supply-side doctrine; and finally by the “just-cons,” the rank-and-file Republicans who fulminated against Big Government but cowered continuously before the assembled lobbies of the welfare state.

WHY THE RISING TIDE LIFTED VERY FEW BOATS

Nor was fiscal discipline the only casualty of the Reagan Revolution's failures and deformations. The supply-side vision had also foreseen a rising
tide lifting all boats, but the last three decades have brought the opposite: economic stagnation to the middle class and a veritable cornucopia of wealth gains and opulence to the top of the economic ladder.

In fact, the current $50,000 median household income has grown by only 0.3 percent annually after adjustment for inflation during the last thirty years, while real hourly wage rates are actually lower. Indeed, the average real wage rate of workers entering the labor force with a high school education has declined 25 percent since 1979, and has remained stagnant even for college-educated entrants.

So the answer after three decades to the fabled question of the 1980 Reagan campaign—Are you better off?—would be quite clear for the broad middle class: not so much.

Indeed, it is in the nature of financial bubbles based on leverage and speculation to deposit a large share of the winnings at the top of the economic ladder. Not surprisingly, the share of net worth held by the top 1 percent of households has risen from 20 percent to 35 percent since 1979 while their share of income has doubled to 25 percent.

When measured by the net worth aggregates reported by the Federal Reserve, the skew toward the top comes into even more dramatic focus. The top 5 percent of households currently hold about $40 trillion in net worth—a $32 trillion gain over the $8 trillion they held in 1985.

By contrast, the net worth of the bottom 95 percent of households at year-end 2011 was just $8 trillion higher than a quarter century back. The top 5 percent have thus gained four times more than the bottom 95 percent.

The rising tide envisioned by the Reagan Revolution was based on the expected societal gain from free market capitalism and the sustainable increases in productivity, output, and real wealth which it generates. In a healthy capitalist economy income distribution reflects the economic justice of the marketplace, not the political engineering of the state, and properly so.

Much of the wealth gain of the last three decades, however, was not the fruit of the free market. As will be seen in
part IV
, it originated instead in the financial and real estate bubbles which were generated by the profligate borrowing of the state and the money-printing spree of its central banking branch.

The intense political debate surrounding the nation's current palpable misdistribution of wealth—the “class war” issue of the 2012 campaign—is thus deeply ironic. The deformations of sound money brought on by Nixon and Reagan sowed the seeds of these untoward results. Yet it is the very free market that their policies betrayed which now collects the blame.

It goes without saying that the boundaries of the state did not recede, as the Reagan Revolution intended. In both its welfare state and warfare state dimensions, government has become ever more corpulent, even as the tax burden imposed to finance has been repeatedly lightened. Indeed, the Reagan campaign promise that the unstable, stagflationary economy of 1980 would be rebuilt on a foundation of sound money and financial integrity has been roundly repudiated by thirty years of history.

The hallmark of the past several decades has been a debilitating expansion of household and business debt burdens. Indeed, the nation undertook an international borrowing spree that permitted Americans to consume a staggering $8 trillion more than they produced over the past thirty years.

These deformations of the Reagan Revolution were, to some degree, implicit in the errors, contradictions, and confusions of the policy playbook itself. On the surface, its core ideas were a seductive alternative to the failed “tax, spend, regulate, inflate” paradigm that defined national policy from the Johnson administration through those of Nixon, Ford, and Carter.

But once placed on the anvil of governance, the Reagan Revolution fared little better. It eventually proved itself to be a campaign slogan, not a rigorous policy agenda. More importantly, the Republican Party has proven decade after decade since Reagan's time that the small-government principles of his patented speech were intended to be recited often and loudly but honored only in the breach.

CHAPTER 5

 

A
RIOTOUS EXPANSION OF THE WARFARE STATE WAS FOREMOST
among the policy errors of the Reagan Revolution. Within days of Reagan's taking office, the White House made a historically devastating mistake by signing over to the Pentagon a blank check known as the “7 percent real growth top line.”

This massive injection of fiscal firepower nearly tripled the annual defense budget from $140 billion to $370 billion within just six years. More importantly, it fueled powerful expansionist impulses throughout the military-industrial complex at exactly the wrong time in history.

THE SOVIET NUCLEAR WAR FIGHTING STRATEGY—A NEOCON STRAWMAN