Yesterday, I began my review of Morris’s The Trillion Dollar Meltdown. Today we continue with
Chapter Two: Wall Street Finds Religion
I don’t know if the author meant this to sound ironic but it’s clear he does mean to show us how people bought into “monetarism” whole heartedly. “Chicago school economics has mutated from a style of analysis into a Theory of Everything.” is how he puts it. The theory of finance that Milton Friedman proposed had been not so patiently waiting in the wings for quite a few years as Keynesian style liberalism held sway. In 1979 things were ready to change.
Morris points us to two events that took place: the 1978 cut in capitol gains taxes and the 1981decontrol of oil prices. Both of these events took on what Morris calls “foundation myth” status but he quickly points out the flaw in this belief. It wasn’t the corporations and individuals that used the benefits of the tax cuts to invest,
When the regulations were finally eased in 1979, it was pension funds, foundations, and endowments that were the source of most of the new venture money. Those investors are tax-exempt, of course, and couldn’t have cared less about “Steiger.” It’s not that tax rates don’t matter. It’s just that if you try to trace exactly how much they matter, the usual answer is”not a lot.”
The story with Reagan’s decontrol of oil is a little more complex. According to Morris,
The ratio of national output to energy inputs, it turns out, started improving sharply in 1973, by about 2 percent a year, with no help from the Chicago school.
So why did the price break happen in 1981? In all likelihood, seven years of global efficiency gains, coupled with the 1981 recession, which was substantially global in its effect unblalnced OPEC’s demand/supply assumptions. That happened to coincide with the peak of the Iran-Iraq war, when Arabs were pouring money into Iraq to forestall an Iranian victory.
In other words, the market worked. But it worked over the long haul, across multiple regimes, and policy dispensations, reflecting tidal currents, like the advanced-country shift toward services, that policy-makers were only dimly aware of.
Since in 1980, I was the recipient of the benefits of the incredibly high interest rate cycle, my CD’s earned 18% for about a year and at the same time I was living a frugal life style with no car, TV, or phone, I was severely depressed when Paul Volker’s controls began to take effect. Well, not severely depressed actually, just puzzled by it all since I had no idea of what inflation or stagflation or recession really meant. Apparently, the U.S. was trapped between the rock of recession and the hardplace of inflation. It was Volker’s job as chairman of the Fed to bring this situation under control. To do so he adopted the strategy suggested by Milton Friedman.
He taught that inflation could be controlled solely by controlling the stock of money – the quantity of M1, the sum of all check money and all circulating cash. If the Fed merely insured that the stock of money grew at roughly the same pace as the economy, all prices would remain on an even keel.
What happened next is truly amusing to read because it both supports the free market philosophy of the Chicago school and points out its major weakness. As Adam Smith had pointed out so long ago, there is public interest and there is self interest. “The transcripts of the Federal Open Market Committee (FOMC) through most of 1980 betray an air of semicomic desperation as the members try to discern which numbers they should count as the money supply.” Volker’s success hinged on three things, his conviction to stay with the policy, Reagan’s support, and the committment of the American people to endure and rideout the situation. “From that point, America’s committment to Price statbility was assumed as a matter of course.”
Thus, with all hope in the goodness of mankind and the efficacy of the free market place, the Decade of Greed, the LBO (Leveraged Buy Out) boom began. Efficiency became the watchword. Businesses were pared down, restructured, and top heavy management was rolled up. It started out friendly but in 1986 when the stock market reported the average P/E averages had tripled,
the markets went crazy. Returns on the first wave of deals were so spectacular that big investors, like pension funds and endowments, were clamoring to get in, while the fund start-ups multiplied like roaches.
At the same time that LBO’s were playing out to their eventual busts, the growth of the non-regulated Savings and Loans Industry was taking place.
But the second half of the LBO boom and the S&L debacle demonstrate the dangers of loose financial markets regulation. In the raw markets, the scent of money deadens all other sensory and ethical organs. In both cases the quick, the deadly, and the unprincipled made a lot of money fast, while the ordinary workers and the taxpayer took it in the ear.
This chapter concludes with an analysis of what happened during the “Interlude: The Goldilocks Economy of the 1990s” wherein the budget deficits created during Reagan’s tax cutting years were directly addressed by Clinton’s ability to pass an almost pure tax increase and the incredible boom of the dot-com bubble. As usual, economists claimed theoretical victory but as Morris again points out, the tax increases were overwhelmed by the upsurge in capitol gains taxes from the stock market boom.
Morris concludes this chapter with what I call an ominous warning. Despite the presence of multiple market bubble bursts and failures through out the previous 20 years, there was an increased conservative conviction that free market deregulated were what really worked. Hello President Bush.
Tomorrow, Chapter Three: Bubble Land:Practice Runs