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The gangsters who run the US financial system have determined opponents. Among them are Elizabeth Warren, Nomi Prins, Pam and Russ Martens, Michael Hudson, and David Stockman.
I have often expressed my admiration for Warren, Prins, Martens, and Hudson. In his latest column, David Stockman has earned my admiration and forgiveness.
I say forgiveness because in my opinion Stockman came close to sabotaging President Reagan’s economic program.
None of us on whom the president was relying expected that Stockman would be the weak link. Stockman, a member of the House, was an advocate of the new policy and a friend of U.S. Rep. Jack Kemp. I knew Stockman and had worked with him in putting together a new approach to economic policy in the short time between the November election and January inauguration.
The success of the new policy depended upon Stockman, who we managed to have appointed Director of the Office of Management and Budget, on Federal Reserve Chairman Paul Volcker, and on my office in the U.S. Treasury where I was appointed Assistant Secretary for domestic Economic Policy.
The problem we confronted was the worsening “Phillips curve” tradeoffs between inflation and unemployment that had produced a situation termed “stagflation.” The Phillips curve illustrated that an increase in employment had to be “paid for” by accepting higher inflation, and a reduction in inflation had to be “paid for” in terms of higher unemployment. The trade-offs between inflation and unemployment were worsening. The dilemma came to a head when Milton Friedman showed that the Phillips curve trade-offs had broken down and that higher inflation now brought higher unemployment.
The new situation was described as “stagflation.” The Keynesian macroeconomists and policymakers could not explain the cause of stagflation and had no remedy.
Supply-side economists had both explanation and remedy.
The battles between Keynesians and supply-siders had been fought in the Congress over the previous five years. Republicans in the House and Democrats in the Senate had been won over to the new policy. In the annual budget resolutions, the Republican minority in the House offered a supply-side approach to the traditional Keynesian approach. In the Senate the Democrat majority endorsed the supply-side policy in the annual reports of the Joint Economic Committee, the chairman of which was Lloyd Bentsen. Finance Committee Chairman Russell Long was on board with the new policy, and Sam Nunn actually got the policy passed only to see it killed by the Carter administration.
I have explained many times the difference between a Keynesian and supply-side approach. Essentially, it comes down to this: In Keynesian macroeconomics, monetary and fiscal policy operate only on aggregate demand (the total demand for goods and services), not on aggregate supply. Monetary and fiscal policies cause aggregate demand to increase or decrease. For example, an income tax rate reduction (fiscal policy) raises consumers’ after-tax incomes and results in higher consumer demand.
In contrast, supply-side economics emphasizes that a reduction in marginal tax rates alters the relative prices that determine the price of leisure in terms of foregone current income and the price of current consumption in terms of foregone future income from saving and investing.
In other words, a reduction in marginal tax rates makes leisure and current consumption more expensive in terms of foregone income and results in an increase in labor supply and an increase in saving and investment. Thus, the policy increases aggregate supply.
Not realizing that fiscal policy affected aggregate supply, the Keynesian policymakers increased aggregate demand with easy monetary policy but restricted the response of supply to the higher demand with high tax rates. The result was stagflation.
The solution was to reverse the policy mix: a tighter monetary policy (less new money creation and a reduction in demand pressure on output) and lower marginal tax rates (a rise in supply or output). The result would be a repudiation of the Phillips curve. The real economy would grow while inflation fell.
New policies are always at a disadvantage. For example, a new economic policy depreciates the human capital of economists and financial journalists associated with the former policy. Leadership passes from an established order to a new one. Journalists have to retool. It amounts to a lot of work and inconvenience.
As Niccolo Machiavelli declared: “There is nothing more difficult, more perilous or more uncertain of success than to take the lead in introducing a new order of things.”
Reagan’s new policy had yet another disadvantage. It was being introduced at a time when inflation was high and people were on the point of panic. Few people understood the new policy, and as tax cuts had been explained for 40 years as an expansionary policy that increased aggregate demand, it made no sense in terms of traditional thinking to add demand stimulus to an economy suffering from high inflation. Predictions began appearing that Reagan’s policy would cause inflation to explode.
Certainly Paul Volcker thought so. The Treasury met with Volcker weekly hoping to bring him on board with the new policy, but Volcker simply could not get his mind around the new policy. He had never heard of such. Tax cuts had always been in the category of expansionary policy. They would mean fiscal deficits, and fiscal deficits were described in every economics textbook as a method of increasing consumer demand to fight unemployment. They were the antithesis of an anti-inflationary policy.
Volcker’s outside advisors had the same opinion. Alan Greenspan told Volcker in my presence that Reagan’s fiscal policy would overwhelm even the tightest monetary policy. Using language that feminists no longer permit, Greenspan told Volcker that in view of such an expansionary fiscal policy “monetary policy is a weak sister and at best can conduct a weak rearguard action.” Inflation would break loose and ravage the economy.
The Treasury asked Volcker to gradually reduce the growth rate of money as the marginal tax rate reductions fed into the economy. If this policy could be coordinated, there was a chance to bring down inflation without sending the economy into recession.
However, the advice Volcker received from his advisors reinforced his own view that the Reagan administration’s policy would send inflation higher and that he would be blamed. To protect himself and his institution, Volcker turned off the money before the tax rate reductions, which in a compromise with deficit-conscious Republicans were reduced, delayed and phased in over three years, went into effect. Thus, the economy received monetary restraint and no offsetting supply-side stimulus.
By collapsing the economy, Volcker exploded the budget deficit. The financial press and Reagan’s enemies blamed the deficit on tax reductions that had not yet gone into effect.
The Volcker Deficits put tremendous pressure on Stockman. Conservative Republicans and most of the financial community feared the consequences of deficits. Republicans feared for the Republic and Wall Street feared for their stock and bond portfolios. Deficits meant inflation. Republicans thought inflation would destroy the political order, and Wall Street knew that inflation would drop bond and stock prices.
The supply-side policy was also disadvantaged because it had to be introduced before the Treasury’s traditional static revenue estimating model could be updated to one that included the revenue increases from higher GDP growth. The Treasury model assumed that every dollar in tax cuts lost a dollar of tax revenue. Even Keynesian economists disagreed with this. Walter Heller, who was Chairman of President John F. Kennedy’s Council of Economic Advisers, said that the Kennedy tax cuts paid for themselves in higher tax revenues resulting from more employment, higher GDP growth, and reductions in unemployment and welfare benefits as a result of lower unemployment. Every economist agreed that some percentage of the lost revenues were regained because of the economic expansion.
Nevertheless, the Treasury’s model had never been updated to reflect this consensus. Stockman’s budget forecast was faced with large deficit projections reflecting the Treasury’s static revenue estimates.
In left-wing mythology, the Reagan administration forecast that the tax cuts would pay for themselves, but as every official document shows, the Reagan administration forecast that every dollar of tax cut would lose a dollar of revenue. After experiencing the Clinton, George W. Bush and Obama regimes, the ease with which propaganda substitutes lies for facts should by now be well known.
Reagan’s economic policy was also disadvantaged by being caught up in a fight over political succession. Reagan as a result of his popular support was able to take the presidential nomination away from George H.W. Bush, the Republican Establishment’s choice. The Establishment was faced with a loss of control. Outsiders would come into prominent positions, gain influence and become rivals to established insiders. Additionally, the new economic policy arose from outside the establishment. It was identified with Rep. Jack F. Kemp, a former pro-football quarterback and proven leader. The Republican establishment reckoned that eight years of Reagan followed by eight years of Kemp would leave them permanently out of power. It would be their end.
Obstacles to the new policy came from the Bush people inside the administration. They had a fine line to walk. If they caused the policy to fail or to be stillborn, Republican discredit would take them down also. Their plan was to present the policy as largely correct but too extreme. The story that they fed the media was that the Establishment would reform the extreme policy and turn it into something workable. This would allow the establishment to claim credit for Reagan’s success and keep what they saw as the Jack Kemp threat at bay.
This made it difficult for me to get Reagan’s policy out of his administration in anything close to its original form.
As if these disadvantages were not enough, White House chief-of-staff Jim Baker decided that he would make the tax cut into a Republican victory over Democrats. Therefore, Baker picked a fight with House Speaker Tip O’Neill, who, far from opposing the policy, had an alternative supply-side tax cut bill, and Baker cut the Senate Democrats, who had given the new policy much of its credibility, out of the administration’s bill.
I argued that a new policy needs consensus and that a compromise with O’Neill and inclusion of the Senate Democrats was the way to obtain it. Otherwise, I argued, the Democrats will have no stake in the new policy, and a wound would be opened that would fester.
It was at this point, I believe, that Don Regan realized that he needed to be White House chief-of-staff, not Secretary of the Treasury, if the president’s policy were to be safe. At the beginning of Reagan’s second term, Regan engineered the switch, but by then it was too late. The Democrats who had endorsed the policy in the late 1970s no longer had any stake in its success.
Stockman knew how to use the media, but, like Volcker, he was not going to risk his career and reputation on the uncertain success of establishing a new order of things. When the going got tough, Stockman began meeting secretly with journalist William Greider to establish his escape route.
Sensitive to the deficits projected by the Treasury’s static revenue estimates, Stockman had hidden the deficits by assuming a much higher forecast of inflation than we knew Volcker would deliver. I kept warning that Volcker was going to slam on the monetary brakes, but the monetarists in the administration saw the Fed as an inflation machine and did not believe it. I advised Stockman that if Volcker turned off the money, as I was sure he would, the resulting recession would produce deficits that would be blamed on the supply-side policy even though the policy was yet to be implemented. Baker had made enemies of the Democrats. Most of Wall Street and the financial press were against us, and so were the Keynesian economists. Already we were being accused of making a “Laffer curve” forecast that tax cuts would pay for themselves. It would have been much better to forecast deficits, emphasize their exaggeration by static revenue forecasts, cut a deal with the Democrats and stare down the Senate Republicans on the deficit.
But Stockman would not forecast deficits. When Volcker struck, Stockman realized his mistake, and he began planting a story line on Greider that covered Stockman’s butt. When Don Regan fired Stockman at the beginning of Reagan’s second term, Stockman wrote a book that blamed the deficit on politics that combined tax cuts with increased spending. Greider’s article based on his secret sessions with Stockman and Stockman’s book played into the hands of the new policy’s enemies.
Stockman went on to a million dollar salary on Wall Street. Those of us who had stood firm had to take the heat. The fact that inflation collapsed despite tax cuts and budget deficits, just as supply-side economists said it would, and did not rise as Wall Street and Keynesian economists predicted, was completely ignored. The Reagan economic expansion proceeded as inflation fell year by year. The Phillips curve was gone, vanished. It was a complete vindication of supply-side economics; yet the story presented by economists and media was one of failure.
Having experienced this, I was not surprised by the lies and coverups that have locked our country into years of budget-busting and reputation-destroying wars leading to unwinnable conflict with Russia and China. The United States has devolved to the point where truth has becomed an enemy of the state and of the forces that control the state. Those who lie for the state and the interest groups that control the state are rewarded. Those who tell the truth are punished.
What I have have written above is more than a history. It shows that change in behalf of the public interest is extremely difficult to achieve even when there is leadership and people in positions of power who are willing to accumulate enemies in order to bring needed change. All sorts of things overwhelm change: stupidity, egos, vested interests, lies and propaganda. The list is long.
I have concluded that corruption is so dominant in the US today that change for the better cannot come from internal sources. Change for the better, if it comes, will come from economic collapse resulting from the prostitution of public policy to serve a handful of elites.
My forecast is not altogether bleak. Evil often destroys itself when there is no one else to do it. In the meantime, we can enjoy Stockman’s assault on the financial gangsters who are destroying the lives of all of the rest of us and appreciate that Stockman’s courage has caught up with his intellect. United, the two produce a powerful voice.
Paul Craig Roberts is a former Assistant Secretary of the U.S. Treasury, and a former columnist for Business Week. He held the William E. Simon Chair in Political Economy at Georgetown University for a dozen years. He has authored several books, including, “The Supply-Side Revolution” (translated and published in China in 2013) and “How America Was Lost” (2014). His official home page is: http://www.paulcraigroberts.org/.