Stockman Warns of Crash of Fed-Fueled Bubble Economy

The U.S. economy is in a bubble inflated by “phony money” from the Federal Reserve and will burst within a few years, warned David Stockman, who was budget director for President Ronald Reagan.
In an essay published yesterday in the New York Times (NYT), Stockman wrote that the Fed’s quantitative easing policies following the credit crisis have flooded stock markets with cash even while the “Main Street economy” remains weak. The combination, he wrote, is “unsustainable.”

Enlarge image

David Stockman, who was budget director for U.S. President Ronald Reagan, is the author of “The Great Deformation: The Corruption of Capitalism in America,” which will be published April 2. Photographer: Douglas Healey/Bloomberg

7:48

April 1 (Bloomberg) -- David Stockman, former director of the Office of Management and Budget under President Ronald Reagan, talks about the impact of Federal Reserve policy on financial markets and the outlook for the U.S. economy. Stockman, author of “The Great Deformation: The Corruption of Capitalism in America,” speaks with Betty Liu on Bloomberg Television's "In the Loop." (Source: Bloomberg)

8:53

April 1 (Bloomberg) -- Alfred Broaddus, former president of the Federal Reserve Bank of Richmond, talks about the Fed's ability to wind down its stimulus measures and Chairman Ben S. Bernanke's future at the central bank. Broaddus speaks with Sara Eisen and Erik Schatzker on Bloomberg Television's "Market Makers." (Source: Bloomberg)

“When it bursts, there will be no new round of bailouts like the ones the banks got in 2008,” wrote Stockman, a former senior managing director at Blackstone Group LP (BX) and a former Republican congressman from Michigan. “Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.”
Stockman, 66, is the author of “The Great Deformation: The Corruption of Capitalism in America,” which will be published tomorrow.
He rose to prominence during the early 1980s in the Reagan administration while pushing supply-side economics, which held that income tax cuts would boost economic growth and raise more revenue for the government.

‘Trojan Horse’

Stockman quickly turned on supply-side economics. He said the benefits would only “trickle down” to the non-wealthy and that the tax plan “was always a Trojan horse” for accomplishing the primary goal. That objective was bringing down the top income-tax rate to 50 percent from 70 percent.
He resigned as budget director in 1985 and published a book criticizing the Reagan administration.
In an interview today on Bloomberg Television, Stockman said, “We’re borrowing money and burying the future generations in debt.”
The Fed, led by Ben S. Bernanke, is purchasing $85 billion in assets every month. The Fed is leaving its key interest rate near zero while it tries to reduce unemployment below 6.5 percent and hold inflation below 2.5 percent.
Those policies, Stockman said today, benefit speculators and bond traders and have created the “greatest bond bubble in history.”
The Standard & Poor’s 500 Index (SPX) rose to a record high last week, closing at 1,569.19 on March 28. That surpassed the previous record of 1,565.15 set in October 2007. Today, the S&P 500 fell 0.3 percent to 1,565.05 as of 10:06 a.m. in New York.

‘State Wreck’

Among the culprits Stockman blamed for what he termed a “state-wreck” are President Franklin Delano Roosevelt for weakening the gold standard in 1933, President Richard Nixon for removing the convertibility of dollars to gold and “lapsed hero” Alan Greenspan, the former Fed chairman, for keeping interest rates too low for too long.
Investors will sell, Stockman wrote, at any hint that the Fed is starting to remove assets from its balance sheet.
“Notwithstanding Bernanke’s assurances about eventually, gradually making a smooth exit, the Fed is domiciled in a monetary prison of its own making,” he wrote, warning of unsustainable fiscal policies as well. “These policies have brought America to an end-stage metastasis. The way out would be so radical it can’t happen.”
In 2010, Stockman agreed to pay $7.2 million to settle a lawsuit with the Securities and Exchange Commission that claimed he had misled investors as chief executive officer of Collins & Aikman Corp., a maker of auto parts.

‘Inflate’ Income

According to the SEC’s announcement, Stockman participated in transactions designed to “inflate” the company’s reported income and “obtained false documents from suppliers to mislead” auditors. Stockman neither admitted nor denied wrongdoing.
Paul Krugman, the Princeton University economist and New York Times columnist, responded on his blog yesterday, saying that he was “disappointed” in Stockman’s “gee-whiz, context- and model-free numbers embedded in a rant -- and not even an interesting rant.”
Krugman called Stockman’s piece “cranky old man stuff,” and summarized it this way:
“We’ve been doomed, yes doomed, ever since FDR took us off the gold standard and introduced unemployment insurance. What about those 80 years of non-doom? Just a series of lucky accidents. Now we’re really doomed. I mean it!”