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Untested
Management Team for the US Economy
By
Henry C.K. Liu
This article appeared in AToL
on June 16, 2006
All top posts in the management team of the world biggest economy
are now headed by untested appointees with little high-level experience
in
government or proven policy predilections. First Ben S. Bernanke, a
respected academician
with little market experience, replaced Alan Greenspan as Chairman of
the
Federal Reserve in February. So far, every time the new Fed Chairman
made a
public statement about his resolve on price stability, a technical
euphemism
for inflation and deflation, the market showed its lack of confidence
by a
substantial price correction. Edward P. Lazear, a noted labor economist
among
whose published papers is: “The Peter Principle:
A Theory of Decline,” replaced Bernanke as Chairman of the
President’s Council
of Economic Advisers (CEA). For those who are not familiar with the
Peter
Principle, it states that routine promotion in organizations continues
until
incompetence surfaces. Then Rob Portman, former Republican Congressman
from
Ohio and recent US Trade Representative, replaced Josh Bolton as
Director of the
Office of Management and Budget, while the latter moved to the White
House as Chief
of Staff in April. Word was that Bolton was instrumental in persuading
Henry
Paulson, his former colleague at Goldman Sachs, to accept the post of
Treasury
Secretary, replacing John W Snow.
According to the Center of Responsive Politics, Bolten had
originally joined the White House as Bush’s deputy chief of staff to
handle domestic
policy. However, as the administration soured on the independent-minded
National
Economic Advisor Larry Lindsay, Bolten gradually began controlling
economic policymaking
by framing economic issues for presidential consideration. As Chief of
Staff,
Bolton is credited as the chief architect of the Bush tax cuts as well
as the
hiring of another former colleague at Goldman Sachs, Stephen Friedman,
to
replace Lindsey as Assistant to the President for Economic Policy and
Director
of the National Economic Council.
At Goldman, Friedman was a fearsome strategist for corporate
takeovers. He was co-director along with future Clinton Treasury
Secretary
Robert Rubin from 1990-1992 and sole director from 1992-94 after Rubin
left for
Washington. After leaving Goldman Sachs in 1994, Friedman became
a senior
principal for Marsh & McLennan Capital, an investment-insurance
unit whose
parent company faced a government probe
into bid
rigging and price fixing which has since been settled out of court.
Many are puzzled why Henry Paulson would leave his top job
at Goldman Sachs, the world’s preeminent investment banking power
house, to
take the job of US Treasury Secretary under a premature lame-duck
president
with an approval rating languishing in the low 30% range.
After all, David Rockefeller declined a
personal telephone appeal from President Jimmy Carter to join a
demoralized
administration after Carter, in response to popular discontent and
declining
presidential authority, desperately imposed wholesale resignation on
his entire
cabinet in 1979, the third year of his first and only four-year term,.
After
isolating himself for 10 days in introspective agonizing at Camp David,
Carter
emerged back in the White House to make his disconcerting speech of
“crisis of
the soul and confidence” to a restless nation facing rising gasoline
prices at
$1.25 a gallon, with gold rising to $300 an ounce but with the US
enjoying a
trade surplus with China for another 14 years. Today, gasoline is above
$3 a
gallon and gold broke above $700 while US trade deficit with China is
at record
high of over $200 billion a year and still rising; yet President Bush
continues
to tell the nation that the economy is fundamentally strong which begs
the
question of why the wholesale cabinet changeover.
The Treasury, the top cabinet post that leads the
president’s economic team, has not been performing at its most
effective level in
the past six years of the Bush administration. This was not because of
a
shortage of talent at the top. Both Paul H. O'Neill, who ran Aluminum Company of America, and John W.
Snow, who headed
of the CSX transportation network, were successful captains of industry
with
outstanding performance records in the private sector.
But in a world where industry has been
increasingly dominated by finance, their experience in industry might
not have prepared
them to deal with the complex challenges facing a Treasury Secretary of
the
world’s top economic hegemon, or to survive in the political jungle of
a
faith-based ideological administration.
Both men had difficult tenures as cabinet officers,
routinely sidetracked by White House inner-circle cliques whose members
aggressively
guarded executive prerogative to set erratic economic policies driven
proactively
by neo-conservative ideology and reactively by near-term domestic
political considerations
rather than steady long-range rational responses to developing global
economic
conditions. Cabinet officers are politically-appointed captains of the
bureaucracy. Executive power often regards the bureaucracy as an
obstructionist
enemy, yet it is the bureaucracy that provides stable continuous
implementation
of national policies that transcend partisan politics. Just as a strong
White
House National Security Council chairman can overshadow a weak
Secretary of
State, most glaringly evidenced in the case of Henry Kissinger over
William
Rogers, and the case of the Zbigniew
Brzezinski over Cyrus Vance, White House political advisor Karl
Rove has
until the CIA leak scandal this year overshadowed all cabinet
appointees over the
setting of US economic policies. The
difference is that Kissinger and Brzezinsky formulated foreign policies
based
on long-range geopolitical interests of the nation while Rove
formulated economic
policies based mostly on short-term partisan political expediencies.
The Washington Post reported that before finally and
reluctantly agreeing to be nominated Treasury Secretary, Paulson sought
assurances in a long meeting with the president that “the post, which
at times
has been seen as subordinated by the White House, would have the proper
kind of
stature.”
The Importance of
the Post of Treasury Secretary
The power of modern nations
rests on economic foundations. Historically,
the Treasury Secretary is the vicar of the US economic policy. It was
first held
by Alexander Hamilton who created the Bank of the United States in a
national
banking regime that provided needed sovereign credit to finance the
development
of the young nation and thus launched the US on the path toward
becoming a
major economic power in record time. Hamilton
engaged Thomas Jefferson, then
Secretary of State, in a fateful
contest between centralized elitism and decentralized populism in
economic
policy. He also fought Albert Gallatin, then a Congressman, over the
creation
of a powerful Treasury for the Federal government with independent
financing authority
from the states of the union. He designed the collection and disbursing
of Federal
revenue for the promotion of the economic development of the young
nation in an
era when market fundamentalism in the context of free trade was an
economic
weapon employed by a hostile and belligerent Great Britain on its
former
colonies.
The
is responsible for formulating and recommending domestic and
international
financial, economic, and tax policy, participating in the formulation
of broad
fiscal policies that have general significance for the economy, and
managing
the public debt. The Secretary oversees the activities of the Treasury
Department in carrying out major law enforcement responsibilities; in
serving
as the financial agent for the US Government; and in manufacturing
coins and
currency. The chief financial officer of the Government, the Secretary
serves
on the President's National Economic Council. He is also Chairman of
the Boards
and Managing Trustee of the Social Security and Medicare Trust Funds,
Chairman
of the Thrift Depositor Protection Oversight Board, and serves as US
Governor
of the International Monetary Fund, the International Bank for
Reconstruction
and Development, the Inter-American Development Bank, the Asian
Development
Bank, the African Development Bank, and the European Bank for
Reconstruction
and Development.
Today, with a globalized economy dominated by finance framed
largely by the US, the post of US Treasury Secretary is even more
critical, for
no nation can carry out its foreign policy with its domestic economy in
disarray, much less a superpower. Logic would suggest that the top post
of the
cabinet in today’s world should be the Treasury Secretary rather than
the
Secretary of State, as super-national financial institutions emerge as
powerful
agencies of superpower financial hegemony. Instead, in today’s White
House, the
National Economic Advisor is subordinate to the National Security
Advisor. Apparently, in the high temple of
free
markets, national security trumps market fundamentalism. The nation
that leads
in the promotion global free trade is also the most vocal nation in
defending economic
nationalism.
Albert Gallatin came of an old and noble Swiss family in
Geneva who played a vital part in establishing the financial soundness
of his
adopted new nation. He graduated with
honors from the Geneva Academy, but in 1780 gave up fortune and social
position
to immigrate to the US, a nation barely 14 years old, to fulfill “a
love for
independence in the freest country of the universe.” In 1785, he took
the Oath
of Allegiance in Virginia and settling finally in Pennsylvania. A
member of the
State Legislature before being sent by voters to the US Senate, where
his tentative
citizenship caused him to be rejected by that august body, but not
before
calling on the Senate floor for a statement of the public debt as of
January 1,
1794 from the Treasury Secretary, listing revenue received under each
government
branch and money expended under each appropriation. When Gallatin was
again
returned by voters to the House of Representatives, he immediately
became a
member of the new Standing Committee on Finance, the forerunner of the
Ways and
Means Committee, the most powerful body on US government finance. While opposing Hamilton on the issue of
expanding
Federal authority, Gallatin actually reinforced Hamilton’s ambitious
plan for a
powerful US by making certain that the nation’s finances and currency
remained strong.
In July 1800, Gallatin prepared a report entitled: , still
regarded today
as a classic, analyzing the fiscal operations of the Government under
the
Constitution. In Congress, he worked
relentlessly and successfully to keep down appropriations, particularly
those
for “warlike purposes.” Thomas Jefferson believed the Sedition Bill was
framed
to drive the foreign-born Gallatin from office. When Jefferson was
elected
President in 1801, he tendered Gallatin the post of Secretary of the
Treasury.
Gallatin took office on a "platform" of debt
reduction, the necessity for specific appropriations, and strict and
immediate
accountability for disbursements. Eight years after assuming office,
his
estimates on revenues and debt reduction proved uncannily
accurate, reducing the public debt
by $14 million to build up a surplus even after expending $15 million
for the
purchase of the Louisiana Territory, an acquisition which established
the
United States as a great continental power. Many accounting practices
still in
use in the Treasury date back to those introduced by Gallatin. He also sponsored the establishment of , the forerunner of the
present . In 1807
he submitted to Congress
an extensive plan for internal improvement through the construction of
highways
and canals. Under Gallatin, the Treasury began the practice of
submitting to
Congress a detailed annual report of the country's fiscal situation
with a
breakdown of receipts, a concise statement of the public debt, and an
estimate
of expected revenue.
After leaving government, Gallatin became the President of
the National Bank of the City of New York, later known as the Gallatin
National
Bank of the City of New York, a forerunner of CitiGroup of today. He
was a
founder of New York University, the New York Historical Society and the
American Ethnological Society, making valuable contributions on the
study of languages
of the Native American tribes.
Andrew Mellon and
Alan Greenspan
Andrew Mellon, the 49th Treasury Secretary, demonstrated
precocious financial ability early in life. At 17, he started a
successful
lumber company, joined at 19 his father's banking firm, T. Mellon &
Sons,
and became controlling owner in 1882 at the age of 27. In 1889, he
organized the
Union Trust Company and the Union Savings Bank of Pittsburgh, branched
out from
banking into industrial activities and built a great personal fortune
from oil,
steel, shipbuilding, and construction by investing
in
growth industries such as coke, coal and iron. Mellon established the
Aluminum
Company of America, the Gulf Oil Corporation (1895), the Union Trust
Company
(1898) and the Pittsburgh Coal Company (1899). In 1937, he gave
the
Nation his magnificent art collection, plus $10 million, to build the
National
Gallery of Art in Washington, D.C.
Mellon was appointed by President Harding in 1921 to be Treasury
Secretary to deal with the post-WWI economy. Along with Mellon, Herbert
Hoover was
appointed Secretary of Commerce. Harding’s Presidential address on
March 4,
1921 reflected Mellon’s ideas of a revision of the tax system, an
emergency
tariff act, readjustment of war taxes and the creation of a Federal
budget
system. Mellon campaigned to Congress for tax cuts and lower government
spending to reduce the public debt.
In November 1923, Secretary Mellon presented to the House
Ways and Means Committee what has come to be known as “The Mellon
Plan”, a
program for tax reform which subsequently became law as the Revenue Act
of 1924,
reducing the top income tax rate to 25%. Through the roaring 1920’s,
Mellon was
a popular official, much like the way Alan Greenspan was throughout the
irrational exuberant 1990s. Despite his open conservatism in government
finance,
Mellon presided over an unprecedented growth of private debt in the
economy during
his tenure. Total private debt at the time of the 1929 crash reached
$200
billion, the equivalent of over $3 trillion in 2005 as relative share
of GDP,
or about 25%. As late as 1930, Secretary of the Treasury Andrew Mellon
held
that a financial panic might not be such a bad thing. “It will purge
the
rottenness out of the system,” he added. “High costs of living...will
come
down. People will work harder, live a moral life. Values will be
adjusted, and
enterprising people will pick up the wrecks from less competent
people.” But
the rottenness came from easy credit which Mellon was centrally
responsible in
releasing. And predators picked up the wrecks from unfortunate
hard-working
people who lost everything they owned through no fault of their own.
It was comparable to Greenspan’s testimony before the Joint
Economic Committee of the US Congress on October 29, 1997, on
Turbulence in World
Financial Markets: “Yet provided the decline in financial markets does
not
cumulate, it is quite conceivable that a few years hence we will look
back at
this episode, as we now look back at the 1987 crash, as a salutary
event in
terms of its implications for the macro-economy.” The Asian economies
saw their
assets lose up 80% of their market value within a few days. The US did
better. From
the market peak to the October lows, the S&P 500 lost 35.9% of its
peak
value but regained the lost value about two years later by the Fed’s
massive
injection of liquidity. The Greenspan formula was to print money
whenever the
market faltered. The Asian economies were less lucky. As international
finance
was denominated mostly in dollars, the Asian central banks were not
able to print
local currencies to provide needed liquidity to their collapsing
markets. They
learned from direct experience that dollar hegemony is not benign.
Under Greenspan, the US had
amassed $44 trillion of debt by 2005: $10 trillion
by the Federal Government, $2 trillion by State and local governments
and $32
trillion by the private sector of which the business sector held $8.3
trillion,
the finance sector held $12.5 trillion and the household sector held
$11.5
trillion. In addition, the nation faces
an unfunded contingent liability of $7 trillion in Social Security and
$37
trillion in Medicare obligations. The Greenspan debt monkey is ten
folds larger
than Mellon’s even after adjustment for inflation. The delayed but
unavoidable bursting
of Greenspan’s debt bubble will make the 1930 Depression look like
minor storm.
Ironically, the onslaught of the depression in 1929 was blamed by voters on Mellon’s fiscal
policies, not on
his monetary policy or his tolerance if not promotion of private debt.
And it contributed
to the defeat of Herbert Hoover in 1932 by Franklin D. Roosevelt. There are clear indications that history
would not treat Greenspan’s liquidity joyride with more lenience. This
time,
since the Greenspan legacy spanned over both political parties, voters
having
no third party to turn to as they did in 1930 may well vote against the
apocalyptic
black knight of neo-conservative foreign policy galloping on a
neo-liberal
free-trade horse.
Henry Morganthau
Henry Morgenthau was nominated by President Roosevelt to be
the 52nd Secretary of the Treasury and served from January
1, 1934
until July 22, 1945 in FDR’s “New Deal” and War Administration. During
his historic
long term, Morgenthau exercised a stabilizing effect on US monetary
policies through
progressive taxation and sovereign credit, raising $450 billion ($45
trillion
in 2005 dollars in relative share of GDP) for anti-depression
government spending
programs and for war costs. This amount was more than all the money
raised by
all of the previous 51 Secretaries, enough in current dollar equivalent
to pay
off all the debts in the US economy today. This shows that under
effective
leadership the US can be a debt free nation with the proper resolve and
fairly-distributed
sacrifice to re-emerge as a great nation with unprecedented prosperity
without
exploitation either at home or abroad.
For seven years during the Depression, from 1934 through December
7, 1941, the day Japan attacked Pearl Harbor, Morgenthau defended the
dollar
against devaluation by intervening in the world financial markets in an
effort
to make the dollar the strongest currency in the world despite a weak
domestic
economy, particularly from the rising strength of the German currency
as the
Nazi economic miracle took off. This
effort led to an international monetary stabilization agreement reached
among
the great powers after the Munich Pact of 1938, which did not have a
chance to
test its worth. When war in Europe broke out in 1939 over German
invasion of
Poland, Morgenthau established a procurement service in the Treasury
Department
to facilitate the purchase of US munitions on credit by Britain and
France. He provided the US economy with
unlimited sovereign credit to meet enormously expanded spending
requirements
that followed the attack on Pearl Harbor. War
mobilization for WWII began first in the
financial sector.
Morgenthau financed the war with a program of war bonds
which in the first year of the war alone amounted to a $1 billion
distribution.
The war bonds not only supported war spending, but also prevented a
serious
inflationary wave by siphoning off excess funds from the private sector
to
prevent the emergence of a black market out of the government’s
war-time price
control program. The war-time black
market did not flourish simply because few people had the money to pay
black-market
prices.
In 1944, the Morgenthau plan, under which post-war Germany
would be stripped of its industry, the basis for war-making, and be
converted
into an agricultural nation, became policy until the beginning of the
Cold War
when the US decided it needed a strong capitalistic, even neo-fascist
Germany with
a credible military to resist the spread of communism in Europe. At the
Bretton
Woods conference in 1944, Morgenthau assumed a leading role in
establishing
post-war economic policies and currency stabilization with the
introduction of
a gold-backed dollar with fixed exchange rate to finance a revival of
world
trade under US leadership. In July 1945, three months after the death
of
President Roosevelt, Morgenthau resigned as Treasury Secretary, but
remained in
office until President Truman returned from the "Big Three"
conference in Potsdam, Germany in early August. The
Potsdam Conference and the surrender of Japan on
August 14, 1945 brought on the beginning of the Cold War.
From 1947 until 1950, Morganthau was Chairman of the United
Jewish Appeal, which raised $465 million during that time, and from
1951 to
1954, he served as Chairman of the Board of Governors of the American
Financial
and Development Corporation for Israel, which handled a $500 million
bond issue
for the new nation. It is an ironic tragedy of history that the
anti-Semitic
sins of Europe are being atoned by the Arab nation with intractable
conflicts
in the Middle East that will endanger the future peace of the whole
world.
Nixon’s Treasury
Secretaries
Appointing Democrat John B. Connally as Treasury Secretary
was a shrewd political move for Republican President Nixon, who had to
reorganize his cabinet in response to Democratic gains in the 1970
mid-term
congressional elections. In response to deteriorating domestic and
international economic conditions, Nixon announced his "New Economic
Policy" in 1971. In monetary terms, this meant “closing the gold
window”,
ending US legal obligation to exchange dollars held by foreign banks
for gold
at $35 per ounce, abandoning the 1944 Bretton Woods regime of a dollar
pegged
to gold and fixed exchange rates for world currencies to keep trading
partners
honest. Floating exchange rates allow countries an escape valve from
having to
correct their economic inefficiencies through currency devaluation.
With Nixon proclaiming: “We are all Keynesian now,” Connally
resurrected New Deal anti-cyclical deficit spending with a "full
employment budget," and imposed a wage and price freeze to halt
inflation.
Connally was described by New York Times columnist James Reston as "the
spunkiest character in Washington these days.... He is tossing away
computerized Treasury speeches, and telling American business and labor
off the
cuff to get off their duffs if they want more jobs, more profits and a
larger
share of the competitive world market.” Nixon’s left-leaning NEP, not
dissimilar to Lenin’s right-leaning NEP, failed to work because it was
merely a
revisionist label with little substantive content for lack of
ideological
commitment. Price control without central planning caused supply
bottlenecks in
failed markets, the most bizarre example manifested itself in a
shortage of
toilet seats for new residential construction that delayed occupancy
and
created cash-flow problems for the mortgage banking sector. FDR forbade
US
citizens to buy or own gold and devalued the dollar by 60% and kept
interest
rates at historical low levels. Still, US export trade did not rise
with dollar
devaluation nor employment in the domestic private sector picked up.
Most of
the unemployment was absorbed by the expanded public sector. The economy did not revive until WWII. In
contrast, Nixon’s NEP aimed to prevent the dollar from falling by
allowing
interest rates to rise. Monetarily, the US was heading for run-away
inflation
not from excess money in circulation, but from fiscal deficits caused
by the
Vietnam War which, unlike WWII, was not a war whose burden was equally
or
equitably shared by all. Foreign wars
cannot be sustained without evenly-shared nation-wide sacrifice.
Conversely, an
all voluntary army takes the wind from the anti-war movements and makes
undeclared executive wars routine. A more war-like foreign policy can
then
prevail because it is easy to risk other people’s lives for one’s own
patriotism.
Having served as Secretary of Labor in 1968 and head of the
Office of Management and Budget in 1970, George P. Shultz was appointed
Treasury
Secretary by Nixon in 1973. During his tenure, Shultz reversed Nixon’s
New
Economic Policy begun under Conally by lifting price control
domestically and
shifted his attention to the international arena to deal with a renewed
dollar
crisis that broke out in February 1973. Shultz organized an
international
monetary conference in Paris in 1973 to formalize the 1971 US decision
to close
the gold window and the abolition of the fixed rate exchange system,
which had actually
begun to collapse in 1971, causing all key currencies since to float.
However,
cross-border flow of funds continued to be restricted to keep
contagious financial
instability at bay.
1973 was a very bad year for the US economy. Phasing out
domestic price control released pent-up inflation in the US, causing
the dollar
to fall in the new foreign exchange market in London. Then in autumn,
OPEC
induced an oil crisis, pushing the US economy into a severe recession
not seen
since 1929, with industrial production shrinking 15%, unemployment
reaching
above 9% and economic output declining 6%. Shultz
resigned shortly before Nixon did, only
to return to Washington in 1982 as Reagan’s Secretary of State.
William E. Simon, Deputy Secretary of the Treasury under
Secretary George Shultz, served concurrently as the director of the
Federal Energy
Office during the oil crisis of 1973. He was named as the 63rd
Secretary
of the Treasury by President Nixon in 1974 and continued under
President Gerald
Ford after Nixon resigned. Domestically, Simon faced a worsening
economic slump
as he took control of the Treasury. In response to the oil crisis, he
strong-armed
oil-producing nations to deposit their petrodollar in US banks but
discouraged
them from direct investment in US corporations. This led US banks to
lend the
petrodollars to developing economies who could only repay the loans
with
earning from export to US markets. This was the beginning of
globalization, the
dependence of the emerging economies on US markets for consumer goods
forced
them to open their financial markets to US capital denominated in
dollars. This
deregulated flow of dollar –denominated funds across national borders
led to
financial crises in Mexico, Latin America and eventually ended up with
the 1997
Asian Financial Crisis. As Treasury Secretary, Simon continued the
policies begun
under Shultz of pressuring Europe, Japan and the Soviet Bloc with US
financial prowess,
keeping international economic policy initiative in US hands to ensure
a
competitive advantage for the US. Simon resigned at the end of Ford’s
partial term
when Jimmy Carter won the presidency in the 1976.
Carter and the Fed
under Volcker
William G Milller, after only 17 months as Chairman of the
Federal Reserve, was named the 65th Treasury Secretary on
August 6,
1979 as part of President Carter’s desperate wholesale cabinet shakeup
in
response to popular discontent and declining presidential authority.
After
isolating himself for 10 days of introspective agonizing at Camp David,
Carter
emerged to make his confessional speech of “crisis of the soul and
confidence” to
a restless nation. In response to a national political leader consumed
with
self-doubt, the market dropped in free fall. Miller was a fallback
choice for
the Treasury, after numerous other potential appointees, including
David
Rockefeller, declined personal telephone offers by Carter to join a
demoralized
administration facing a difficult election in 14 months.
In August 1979 Carter felt that he needed someone like Paul A. Volcker,
an
intelligent if not intellectual Republican, a term many liberal
Democrats
considered an oxymoron, who was highly respected on Wall Street, if not
in
academia, to be at the Fed to regenerate needed bipartisan support in
his time
of presidential leadership crisis. Bert Lance, Carter's chief of staff,
was
reported to have told Carter that by appointing Volcker, the president
was
mortgaging his own re-election a year later to a less-than-sympathetic
Fed
chairman. As it turned out, the Ayatollah Khomeini of Iran held
Carter’s second
term in his hands.
Volcker won a Pyrrhic victory against inflation by letting financial
blood run
all over the country and most of the world. It was a toss-up whether
the cure
was worse than the disease. He observed
correctly
that inflation ceases to be stimulative once it is anticipated by the
market
because lenders will raise interest rates above anticipated inflation
rates,
leading to economic stagflation.
But what was worse than temporary high interest rates was
that the temporary deregulation that had made limited sense under
conditions of
near hyper-inflation was kept permanent under conditions of restored
normal
inflation. Deregulation, particularly of interest-rate ceilings and
credit
market segregation and restrictions, put an end to market diversity by
killing
off small independent firms in the financial sector since they could
not
compete with the larger institutions without the protection of
regulated
financial markets. Small operations had to offer increasingly higher
interest
rates to attract funds while their localized lending could not compete
with the
big volume, narrow rate-spreads of the big institutions. Big banks
could take
advantage of their access to lower-cost funds in global markets to
assume
higher risk and therefore play in higher-interest-rate loan markets
nationally
and internationally, quite the opposite of what Keynes predicted, that
the
abundant supply of capital would lower interest rates to bring about
the “euthanasia
of the rentier.” Securitization of unbundled risk levels
allowed
high-yield, or junk, bonds with high rates to dominate the credit
market,
giving birth to new breeds of super rentiers.
Ultimately, Keynes will turn out to be prescient, as the finance
sector, not
unlike the transportation sectors such as railroads, trucking and
airlines in
earlier waves, or the communication sector such as telecom companies in
recent
years, has been plagued by predatory mergers of the big fish eating
smaller
fish, after which the big fish, having grown accustomed to an
unsustainably
rich diet that damaged their financial livers, begin to die from
self-generated
starvation from a collapse of the food chain. Financial diversity,
similar to
bio-diversity, is critical to the maintenance of a sustainable
ecosystem which
can be endangered by the extinction of any component species. Survival of the fittest is merely an
acknowledgment
of primitive savagery, not a theory of progress. All species enjoy
equal
fitness in any ecosystem. Eagles die when small preys are gone.
The Fed has traditionally never been keen on changing interest rates
too
abruptly, trying always to prevent inflation without stalling the
economy
excessively - thus resulting in interest rates increases often trailing
rampant
inflation, or stimulating the economy without triggering inflation down
the
road, thus resulting in interest rates reductions trailing a stalling
economy.
Market demand for new loans, or the pace of new lending, obviously
would not be
moderated by raising the price of money, as long as the
inflation/interest gap
remains profitable. Deflation has a more direct effect in moderating
loan
demands, causing what is known as a liquidity trap or the Fed pushing
on a
credit string.
Yet bank deregulation has diluted the Fed's control of the supply of
credit,
leaving the price of short-term money as the only lever. Price is not
always an
effective lever against runaway demand, as Fed chairman Alan Greenspan
was also
to find out in the 1990s. Raising the price of money to fight inflation
is by
definition self-neutralizing because high interest cost is itself
inflationary
in a debt-driven economy. Lowering the price of money to fight
deflation is
also futile because low interest cost is deflationary for creditors who
would
be hit by both loss of asset price, deteriorating collateral value and
falling
interest income. Abnormal gaps between short- and long-term interest
rates, as
expressed in an inverted yield curve, do violence to the health of many
financial sectors that depend on long-term financing, such as
insurance, energy
and communication. Deregulation also allows the price of money to
allocate
credit within the economy, often directing credit to where the economy
needs it
least, namely the high-risk speculative arena, or desperate borrowers
who need
money at any price.
Reagan
Voodoo Economics
The monetary disorder that elected Reagan in
1980 followed him into office.
Carter blamed inflation on prodigal consumer demand and promised
government
action to halt hyper-inflation. Reagan reversed the blame for inflation
and put
it on big government. Yet Reagan’s economic agenda of tax cuts, defense
spending and supply-side economic growth was in conflict with the Fed’s
anti-inflation tight-money policy. The monetarists in the Reagan
administration
were all longtime right-wing critics of the Fed, which they condemned
as being
infected with a Keynesian virus. Yet the self-contradicting aims in
fiscal
policies of the Reagan administration (a balanced budget in the face of
massive
tax cuts and increased defense spending) overshadowed its fundamental
monetary-policy inconsistency. Economic growth with shrinking money
supply is
simply not internally consistent, monetarism or no monetarism.
The Reagan presidency marked the rehabilitation of classical economic
doctrines
that had been in eclipse for half a century. Economics students since
World War
II had been taught classical economics as a historical relic, like
creationism
in biology. They viewed its theories as negative examples of
intellectual
underdevelopment attendant with a lower stage of civilization. Three
strands of
classical economics theory were evident in the Reagan program:
monetarism,
supply-side theory, and phobia against deficit financing (but not
deficit
itself) coupled with a fixation on tax cuts but no on government
spending. Yet
these three strands are mutually contradictory if pursued with equal
vigor,
what Volcker gently warned about in his esoteric speeches as a
“collision of
purposes”. Supply-side tax cuts and investment-led economic growth
conflict
with monetarist money-supply deceleration, while massive military
spending with
tax cuts means inescapable budgetary deficits. Voodoo economics was in
full
swing, with the politician who coined the term during the primary,
George H W
Bush, would later serve as the administration’s vice president. Reagan,
the
shining white knight of small-government conservatism, left the US
economy with
the biggest national debt in history.
A tightening of money supply alongside a budget deficit is a sure
recipe for a
recession. Long-term high-grade corporate and government bonds were
seeing
their market rates jump 100 basis points in one month. New issues had
difficulty selling at any price. The possibility of a "double dip"
recession was bandied about by commentators. The Volcker Fed was
attacked from
all sides, including the commercial banks, which held substantial bond
portfolios, and Reagan White House supply-siders, despite the fact that
everyone knew the trouble originated with Reagan's ideology-fixated
economic
agenda. The Democrats were attacking the Fed for raising interest rates
in a
slowing economy, which was at least conceptually consistent.
The Reagan White House accused the Volcker Fed of targeting interest
rates
again instead of focusing on controlling monetary aggregates, and
Volcker
himself was accused of undermining the president's re-election chances
in 1984.
Reagan publicly discussed “abolishing” the Fed, notwithstanding his
disingenuous defense of the Fed from attacks by Carter during the 1980
election
campaign. Earlier, back in mid-April 1984, Volcker had publicly
committed
himself to gradualism in reining in the money supply and avoiding shock
therapy, to give the economy time to adjust. But he reneged on his
promise by
May, and decided to further tighten on an economy already weakened by
high rates
imposed six months earlier, yielding to White House pressure and
bond-market
signals. Gradualism in interest-rate policy was again discarded.
Volcker’s
justification was amazing, in fact farcical. He told a group of Wall
Street
finance experts in a two-day invited seminar that since policy mistakes
in the
past had been on the side of excessive ease, in the future it made
sense to err
on the side of restraint. Feast-and-famine was now not only a policy
effect but
a policy rationale as well. Compound errors, like compound interest,
were
selected as the magical cure for the sick economy.
Financial Markets
Not the Real Economy
Financial markets are not the real economy. They are shadows of the
real
economy. The shape and fidelity of the shadows are affected by the
position and
intensity of the light source that comes from market sentiments on the
future
performance of the economy, and by the fluctuating ideological surface
on which
the shadow is cast. The institutional character of the Fed over the
decades has
since developed more allegiance to the soundness of the
financial-market system
than to the health of the real economy, let alone the welfare of all
the
people. Granted, conservative economists argue that a sound
financial-market
system ultimately serves the interest of all. But the economy is not
homogenous
throughout or even neatly hierarchical. In reality, some sectors of the
economy
and segments of the population, through no fault of their own, may not,
and
often do not, survive the down cycles to enjoy the long-term benefits,
and even
if they survive are permanently put in the bottom heap of perpetual
depression.
The late John Kenneth Galbraith said famously about trickling down
economics:
“When you feed the horse enough oats, the sparrows will eventually
benefit.”
The corollary is that the sparrows can survive very well without the
horse
being overfed.
Periodically, the Fed has failed to distinguish a healthy
growth in the financial markets from a speculative debt bubble. Under
Greenspan, this failure is accepted as a policy initiative, equivalent
to “when
rape is inevitable, relax and enjoy it”. Debt is accepted as the
financial
magic cure for all ills economic.
The Reagan administration by its second term discovered an escape valve
from
Volcker's independent domestic policy of stable-valued money. In an era
of
growing international trade among allies in the Western block, with the
mini-globalization to include the emerging developing countries before
the
final collapse of the Soviet bloc, a booming market for foreign
exchange had
been developing since Nixon's abandonment of the gold standard and the
Bretton
Woods regime of fixed exchange rates in 1971. The exchange value of the
dollar
thus became a matter of national security and as such fell within the
authority
of the president that required the Fed's patriotic support.
Martin Feldstein and
Disciples
Council of Economic Advisers chairman Martin Feldstein, a highly
respected
conservative economist from Harvard with a reputation for intellectual
honesty,
had advocated a strong dollar in Reagan's first term, arguing that the
loss
suffered by US manufacturing for export was a fair cost for national
financial
strength. But such views were not music to the ears of the
nationalistic Reagan
White House and the Treasury under Donald Reagan, former head of
Merrill Lynch,
whose roster of clients included all major manufacturing giants which
had not
caught on to the escape valves of outsourcing labor intensive
manufacturing to
low-wage countries and that it was more profitable to import low
price-goods
from overseas than to export high-priced goods overseas. Feldstein,
given the
brush-off by the White House, went back to Harvard to continue his
quest for
truth in theoretical global geo-economics after serving two years in
the Reagan
White House, where voodoo economics reigned.
Feldstein went on to train many influential economists who later would
hold key
positions in government, including Lawrence Summers, treasury secretary
under
president Bill Clinton and later failed president of Harvard
University;
Lawrence Lindsey, dismissed Presidential Economic Advisor to President
George
W. Bush; and Gregory Mankiew, Chairman of the Bush White House Council
of
Economic Advisers, who sparked an uproar by saying, in the same
intellectual
tradition: “Outsourcing is a growing phenomenon, but it's something
that we
should realize is probably a plus for the [US] economy in the long
run.” Whether
that is true depends of course on which part of the us economy one is
housed.
Nearly 2.8 million factory jobs have been lost since
President George W Bush took office in 2000. Democrats seized on
Mankiew’s
comments as evidence that the Bush White House is insensitive to the
plight of the
unemployed and the underemployed, who are likely to be active voters,
notwithstanding that the Clinton economic team held in essence the same
views. Senate
Minority Leader Tom Daschle called Mankiew’s assessment “Alice in
Wonderland
economics.”
Since the press frequently fails to ask sophisticated technical
questions of economics, government economists can usually give a
carefully formulated
sentence that appears to be consistent with White House policy that is
not
literally false technically. Mankiew’s immediate predecessor, Glenn
Hubbard,
signed on to the White House position that “interest rates don’t move
in
lockstep with budget deficits”, despite having written, as Mankiew also
did, a popular
textbook with a standard model linking interest rates to budget
deficits. But because the sentence as
qualified with
“lockstep” can be true, Hubbard remained within the bounds of fidelity
in
economic science, preserving his credibility in the profession.
Presidents and their
Economic Advisors
President Lyndon B. Johnson rejected the advice of his CEA
chairman Gardner Ackley that the war in Vietnam could not be pursued
simultaneously
with Johnson’s ambitious Great Society domestic spending programs
without
inflationary consequences unless taxes were raised. In 1971, Richard
Nixon
imposed wage and price controls, considered a cardinal sin by CEA
chairmen Paul
McCracken and Herb Stein. In 1983-84, Martin Feldstein, Ronald Reagan's
CEA
chairman, publicly predicted protracted record-high budget and trade
deficits,
upsetting the White House, notwithstanding that the prediction came
true. Michael
Boskin, CEA chairman under George HW Bush tried in vain to warn his
president about
a developing weak economy, contrary to the “Be Happy” tune Bush
projected. The 1988
Bush presidential campaign used as its theme the popular song “Don’t
Worry, Be
Happy” by jazz composer Bobby McFerrin as its theme until McFerrin
objected.
It’s the Economy,
Stupid
James Carville, candidate Bill Clinton campaign strategist
coined four famous words that became political lore: “It's the economy,
stupid”,
with which an unknown from Arkansas defeated an incumbent president
fresh from
victory in foreign war. Three weeks before the 1992 election, as a
desperate Bush
campaign moved to demonstrate that the president saw the light, the
White House
tried to blame the economic troubles on Boskin and the sitting economic
team by
announcing that if re-elected Bush would appoint a fresh new team. A
“kill the
messenger” attitude was also displayed by George W. Bush in December
2002, in
the unceremonious manner in which the departures of Paul O'Neill,
Treasury
secretary, and Larry Lindsey, economic adviser, were announced. Their
replacements quickly learned to tote the White House line, at least in
public.
Some advisers did resign over policy but almost none in protest,
with the exception of perhaps O’Neill. McCracken considered leaving
when Nixon
rejected his advice on wage-price controls but postponed the
resignation for
four months to minimize negative publicity. Murray Weidenbaum, Reagan’s
first
CEA chairman, unhappy over the issue of Reagan’s rhetoric against
government
spending made empty by his actual irresponsible fiscal policy that
produced
historically high budget deficits, resigned but not in protest.
James Baker and the
Plaza Accord
By Reagan's second term, it became undeniable that the US
policy of a strong dollar was doing much damage to the manufacturing
sector of
the US economy and threatening the Republicans with the loss of
political
support from key industrial states, not to mention the unions, which
the
Republican Party was trying to woo with a theme of Cold War patriotism.
Treasury secretary James Baker and his deputy Richard Darman, with the
support
of manufacturing corporate interest, then adopted an interventionist
exchange-rate policy to push the fundamentally overvalued dollar down.
A truce
was called between the Fed and the Treasury, though each continued to
work
quietly toward opposite policy aims, much like the situation in 2000 on
interest rates, with the Greenspan Fed raising the short-term Fed funds
rate
while the Summers Treasury pushed down long-term rates by buying back
30-year
bonds with its budget surplus, resulting in an inverted rate curve, a
classical
signal for recession down the road, while expensive talk of the End of
the Business
Cycle was extravagantly entertained in the same vein as Francis
Fujiyama’s “End
of History”.
Thus, a deal was struck to allow Volcker to continue his battle against
domestic inflation with high interest rates while the overvalued dollar
would
be pushed down by the Treasury through the Plaza Accord of 1985 with a
global
backing-off of high interest rates. Notwithstanding the subsequent
Louvre
Accord of 1987 to halt the continued decline of the dollar started by
the Plaza
Accord only two years earlier, the cheap-dollar trend did not reverse
until
1997, when the Asian financial crisis brought about a rise of the
dollar by
default, through the panic devaluation of Asian currencies. The paradox
is that
in order to have a stable-valued dollar domestically, the Fed had to
permit a
destabilizing appreciation of the foreign-exchange value of the dollar
internationally. For the first time since end of World War II,
foreign-exchange
consideration dominated the Fed's monetary-policy deliberations, as the
Fed did
under Benjamin Strong after World War I. The net result was the
dilution of the
Fed's power to dictate to the globalized domestic economy and a
blurring of
monetary and fiscal policy distinctions. The high foreign-exchange
value of the
dollar had to be maintained because too many dollar-denominated assets
were
held by foreigners or to be more precise, non-domestic entities, which
could be
subsidiaries of US companies. A fall in the dollar would trigger
sell-offs as
it did after the Plaza/Louvre Accords of 1985 and 1987, which
contributed to
the 1987 stock market crash.
Robert Rubin and
Dollar Hegemony
It was not until Robert Rubin became special economic assistant to
President
Clinton in 1992 that the US would figure out its strategy of dollar
hegemony through
the promotion of unregulated globalization of financial markets. Rubin,
a
consummate international bond trader at Goldman Sachs who earned $60
million
the year he left to join the White House, figured out how the US was
able to
have its monetary cake and eat it too, by controlling domestic
inflation with
cheap imports bought with a strong dollar, and having its trade deficit
financed by a capital account surplus made possible by the same strong
dollar.
Thus dollar hegemony was born.
With his vast experience in evolving globalization of
financial markets, Rubin helped Clinton, developed an economic policy
based on
global open markets, and investments in education, training and the
environment. This program helped to spark and sustain the longest
economic
expansion in the nation’s history to date, transforming the nation’s
budgetary
position from deficit to surplus, and produce the lowest national rates
of
unemployment in decades. As Treasury Secretary, Rubin faced threats to
the
nation’s creditworthiness and to the stability of the global financial
system.
He used statutory authority to safeguard the Federal government’s
finances and
make timely payments of the Federal debt when the Congress did not
raise the
debt limit during an extensive budgetary confrontation. During his
tenure,
financial crises flared in Mexico and Asia posing real risks to global
financial
stability. Rubin led efforts–with the IMF, Fe |
