There is “not a chance,” that the Fed will be able to unwind its balance sheet in an orderly manner, “because everybody is front-running [them],” as the Fed is creating “serial bubbles,” that are increasingly hard to manage since “we’re getting in deeper and deeper every time.” David Stockman has been vociferously honest in the last few days and his Bloomberg Radio interview with Tom Keene was extremely so. While Keene tries his best to remain upbeat and his permabullish self, Stockman just keeps coming with body blow after body blow to the thesis that this ‘recovery’ is sustainable. “They are using a rosy scenario forecast for the next ten years that would make the rosy scenario of the 1981 Reagan administration look like an ugly duckling,,” he exclaims, adding that the Keynesian Krugmanites’ confidence is “disingenuous” – “the elephant in the room – the Fed,” that are for now enabling rates to stay where they are. The full transcript below provides much food for thought but he warns, if the Fed ever pulled back, even modestly, “there would be a tremendous panic sell off in the bond market because it is entirely propped up… It’s to late to go cold turkey.”
Via Bloomberg Radio,
On why he’s so gloomy on the U.S. since every time we’ve gotten into this mess we get out of it with technological progress:
We didn’t get out of this mess entirely with technological progress. I believe in it. I believe in the free enterprise economy, and I think it does generate productivity, growth, and wealth over time. What I am arguing in the book is that the machinery of the state has failed badly because we piled on way too much. We are out of control fiscally. It is almost a doomsday machine, I can explain. And second, the central bank is off the deep end with this money printing, which is dramatically distorting and deforming the financial markets. You can’t have capitalism without prices in the bond market, in the debt markets, in the money markets. And the fed has essentially destroyed prices. It administers everything.
On Bill Dudley of the New York Federal Reserve Bank saying that he has confidence we can unwind all the damage we’ve done with a huge balance sheet:
I don’t buy that because that huge balance sheet has gone nowhere. It has stayed right within the canyons of Wall Street. They have taken their balance sheet from $800 billion, which took 94 years to assemble, and in seven weeks they doubled it. They were printing money like $600 million an hour. It is now tripled, quadruple, up to $3.2 trillion.
And what happened? During that period, from September 2, ’08, excess reserves in the banking system went from nothing – $40 billion – to $1.7 trillion today. So the money is staying in the canyons of Wall Street. It funds the carry trade where you can buy anything that might have a return, a yield, a risk asset.
On whether the Fed is going to be able to pull money out of Wall Street in an organized manner:
Not a chance because everybody in Wall Street is basically front running the Fed. What the Fed is buying, the belly of the curve, I am buying. What the Fed is buying, short term, I’m using to fund my position. So no one really owns the treasury bonds today, it is all rented on huge repo spreads. And the minute the yields start heading up a little bit and the bond prices go down, you are going to destroy the arbitrage, the fast money is going to sell, then the slower money is going to have to sell because the fast money is selling. And where is the bid? At the bottom of the market…The Fed never gets up.
On what the alternative is given the deflationary trap that the U.S. is caught in:
I don’t think we are caught in a deflationary trap…Well, because you are suffering, my friend, from the recency bias. Yes, prices in Phoenix are way down, but they are still a heck of a lot higher in real terms than they were in 1995. The only thing that happened is a bubble collapsed which had to because it was an artificial bubble fueled by the Greenspan one percent interest rate policy and now the Fed is basically saying that bubbles can’t collapse, we’ll just do it again…
On whether the Fed is trying to manage the bubble collapse:
Well, we’re getting in deeper and deeper every time. And the ultimate consequence will be more of a train wreck. Today, at 1560 plus or minute, we are at the same point the S&P was in March 2000, 4,750 days ago. We have had two massive collapses in the interim – the dot.com $5 trillion evaporated, the Lehman meltdown $7 trillion evaporated. So it is serial bubble. They are bicycling the thing up and down. It happens in Wall Street.
On whether he has patience that the U.S. will grind its way out and get to a better place five or ten years from now:
No, because the ten year ago forecast said that we would have a surplus in 2012, that revenue would be $3.5 trillion, and it was $2.5 trillion. What they are using today is a rosy scenario forecast for ten years that would make the rosy scenario I did in 1981 in the Reagan administration look like an ugly duckling by comparison. They are saying that we are going to create 17 million jobs in ten years compared to two million in the last ten years, that we are going to go 14 years without a recession. It has never happened in history. Most cycles last 48 months. So when you actually do a forecast based on the last ten years, just say the performance in the last ten years, the growth rate, the business investment, job creation, you have $15 trillion to $20 trillion in deficits in front of us, not $7 trillion. We are not on a glide path going downward.
On what Paul Krugman, Brad DeLong and others are getting wrong right now:
They don’t see the elephant in the room called the Fed, and the other central banks buying hand over fist almost all the treasuries that are being issued. The interest rate is not two percent, that is administered, pegged, set by the fed. Ask yourself, if the Fed said we’re going fishing for six months and we are not going to be in the market, we’re gone, do you think the treasury at ten years would stay two percent? Not a chance…It would go way up. There would be a tremendous panic sell off in the bond market because it is entirely propped up. So therefore, they are disingenuous.
On deposit insurance:
Deposit insurance creates a huge moral hazard in the banking system. Abolish it and if there are blue haired old ladies or other timid people who want to save in a bank, set up a postal banking system that will be backstopped by the government and guaranteed. But commercial banks out in the real world need to have their liabilities monitored by the market just like everybody else or you are going to have moral hazard. So I would say take the big banks out of deposit insurance, that is what I meant…I don’t know that it was necessarily caused by the postal banking system.
I didn’t say the deposit insurance caused the whole bubble. I’m saying deposit insurance and the Fed window, and the Wall Street coddling policies of the Fed, and the low interest rates created these giant banks – $2 trillion balance sheets at JPMorgan, $2 trillion at Citi – that couldn’t be managed and they were able to raise massive amounts of money from depositors who didn’t care because they believed their deposits were guaranteed…It’s a bad system. Banking is a great danger in the United States and in the modern world, and it needs to be fundamentally reformed.
On the Republican party:
That is the problem. We have no conservative party left. The Republicans have simply adopted Keynesianism for the prosperous classes by using the Tax Code for this stimulus, that stimulus, to help this part of the economy or that part of the economy.
On Paul Ryan’s budget plan:
It’s a disgrace because, on the one hand, to give you three examples, one, he repeals Obamacare, says he saves $1.8 billion. I would do that, too. What he doesn’t tell you is he is keeping all the Obama taxes. He has got $1 trillion of Obama taxes hidden in his budget and he is not telling anybody. Second, he gives Medicare and Social Security the huge social insurance programs, some of which goes to the affluent middle class, a pass to ten years, not a cut, $19 trillion. He takes it all out of the safety net, which is only $7 trillion over ten years, a 30 percent cut, actually hitting hard the vulnerable people that have been left behind that we need to do something for. He doesn’t do anything about the defense. He rolls back the sequester and raises defense. We should massively cut defense.
On how much fiscal drag is appropriate:
I don’t think we should have any fiscal drag because the Keynesian formula is simply a program to tax the future generations so that we can live a little better today. It doesn’t matter whether we have one percent growth or negative one percent or positive two percent. We can’t belay massive burdens on future generations because someone finds it inconvenient that our economy can only grow one percent.
On whether he agrees with Glenn Hubbard who suggested that we need to go after entitlements on a long glide path and against the wealthy first:
No, because we have been kicking the can for decades and decades, according to the advice of Keynesians like Hubbard. Hubbard is a complete Keynesian. He is a brilliant guy who told Bush cut taxes in 2001, cut taxes in 2003, oh, while you are at it, go have two unfinanced wars and don’t worry about the deficit because it doesn’t matter. This is the kind of advice Republicans are getting from the likes of Professor Hubbard, and it is no wonder that we are heading towards national bankruptcy. It has got to stop.
On what would happen if we went cold turkey:
It’s too late to go cold turkey. Nobody is going to do it, that is why we are drifting towards the wall. The deficit is much bigger than they are saying. As I indicated, with an honest economic forecast, just like we’ve had for ten years, you are looking at $15 trillion, $20 trillion. You are looking at a national debt $30 trillion.
On whether he believes in American optimism and that we will grow and find a path through this:
No, the optimism was in the people of Main Street, the entrepreneurs, the businessmen, the hard workers, the bus drivers, the farmers. I am attacking the elite. I am attacking the people that run Wall Street, the people inside the Beltway in Washington. I am attacking all of the Keynesian professors from both parties who have gotten us into this idea, just print enough money and we are going to get wealthier, just borrow enough money and we’re going to stimulate the economy.