Former Reagan Administration Budget Director David Stockman created a stir this week while promoting his new book, which predicts the U.S. economy is headed for a hard fall -- largely because of its fiscal and monetary policies.
These words of warning, which Stockman details in "The Great Deformation: The Corruption of Capitalism in America," come in direct contrast to the growing mood of optimism on Wall Street. Several financial commentators sharply criticized Stockman for his "Chicken Little" predictions. Prophets of doom are never particularly popular when the market's still making money, though that's when words of caution can be most useful. Here is a review of some of Stockman's concerns:
- Deficit spending is unsustainable. Economist Paul Krugman has taken Stockman to task for complaining about deficits, since Stockman oversaw huge deficit increases as Reagan's budget director. Still, Stockman is entitled to change his mind about deficits, and more to the point, the wisdom of deficit spending is really a matter of circumstances. Modest deficits to goose a sluggish economy can be useful. What every President except Clinton has failed to do in the last 40 years is bring the budget back into surplus during economic expansions. As a result, deficits have gotten steadily larger over time, and the accumulated debt total has continued to build.
- A "warfare state" is being built on top of a welfare state. One criticism of social programs is that they create continuing obligations which become increasingly hard to meet, and military spending takes on a similar momentum. The wars in Afghanistan and Iraq were instrumental in setting the latest cycle of deficit increases in motion, and with potential nuclear threats from Iran and North Korea, it will be hard to cut back on defense now -- unless more people start to view the deficit itself as a national defense concern.
- Fed policies have created an asset bubble. By lowering interest rates on everything from savings accounts to long bonds, the Fed has created an investment climate in which stocks seem like the only worthwhile game in town. With CD, savings, and money market rates losing ground to inflation, investors are more likely to turn to riskier alternatives in search of higher returns. As a result, stock prices have soared, but could the market sustain these levels without low interest rates? Until the Fed's stimulative policies generate enough earnings growth to support today's stock valuations, the fast-rising market will look more and more like a bubble.
Stockman's concerns are valid, but his predicted outcomes don't necessarily have to come true. If the private sector of the economy finally gets moving, and if the government takes advantage of that stronger economy to backtrack to more conservative fiscal and monetary policies, then the stimulative measures of high deficits and low interest rates may pay off. Still, Stockman's words serve as a warning for what could happen if all those "ifs" don't fall into place.