Stockman's Right – U.S. Is Setting Stage for New Financial Crisis

The narrative favored by politicians, regulators and bureaucrats is that private banks caused the financial crisis of 2008. The Federal Reserve Chairman and Treasury Secretary stopped the market panic and a repeat of the Great Depression, then politicians and regulators implemented a plan that will maintain a sound financial system. The economic ship of state is stable, under full steam and accelerating.

In his new book and related New York Times article, President Ronald Reagan's outspoken budget scold David Stockman argues that political and regulatory interference in mortgage markets caused the financial crisis, and then the Federal Reserve Chairman and Treasury Secretary panicked politicians into an unnecessary and unfair bailout. The political and regulatory steps taken in the aftermath all exacerbated financial and economic instability. The economic ship of state is adrift, held afloat by Fed-inflated bubbles and moving forward only relative to other global economies, but easily sunk by modest external waves or internal turbulence.

Stockman concludes that "The future (of the global economy) is bleak … These policies have brought America to an end-stage metastasis. The way out would be so radical it can't happen … When the latest bubble pops, there will be nothing to stop the collapse." Stockman recommends a flight to cash before then. However, he argues the large universal banks – which Stockman would break up – will only be recipients should they be once again bailed out in spite of the Dodd-Frank countermeasures to "too big to fail."

Most equity market participants reject Stockman's prognosis, preferring to bask in the glow of the raging bull stock and bond markets and forecasts of a continued housing recovery, but he is certainly not alone in his pessimism. Since the U.S. economic recession technically ended four years ago, the federal government has been running annual deficits of about $1 trillion, with the Fed financing about two-thirds to three-fourths of that amount. The Fed justifies this massive intervention by arguing that unemployment remains weak and inflation is dormant.

Generally the steeper the recession the greater the rebound, but after four years of unprecedented monetary and fiscal stimulus real GDP growth has been half the average of  prior U.S. Post war recoveries. The modest improvement in job growth reflects people giving up more than new hires, as labor force participation is the lowest since the Carter Administration. If measured the same way as in Europe the comparable U.S. unemployment rate is currently 15.8% .The dormancy of inflation largely reflects the weak recovery.

Most analysts would agree that a return to the historical long-term annual rate of growth in real GDP of about 3% is the elixir for both employment and budget deficits. President Obama's budget assumes real growth will accelerate to 3.4% and the Pollyannaish CBO assumes 4%. But increases in government spending, whether financed with monetized deficits or taxes, failed to produce growth in the U.S. and Europe, just as they previously did in Japan.

Technology expert Robert Gordon thinks a long-term growth rate of 1%-2% is more realistic. But the immediate problem is that total factor productivity, a measure of the efficiency with which capital and labor is used that should have rebounded to over 6% by now is barely positive. Government policies could offset that, but the policies of the last four years and those currently being considered are – as Stockman argues – universally anti-growth.