David Stockman: Free Money Is the Profound Enemy of Free Markets

Jim Grant recently interviewed former Ronald Reagan Officer of Budget and Management David Stockman on his Grant’s Interest Rate Observer podcast.

Their conclusion?

America is broke.

And central bank free money broke it.

Grant started the podcast playing a clip from the Simpsons. Lisa incredulously asks, “We’re broke? How can that be?”

Well, Stockman said, “It can and it is. And it’s heading in that direction for the last 40 years.”

So what happened?

Stockman said Allen Greenspan happened, along with the other central bank chiefs.

The public debt was absorbed massively by central banking, led by the United States, by the Greenspan era, creating what I call a disease that eventually enveloped the entire financial system of the world. Every central bank began to imitate what the Fed was doing, or bought dollars in order to prevent their exchange rates from appreciating, all of them being good mercantilists and statists. And before we knew it, the balance sheets of the central banks of the world, which were less than $400 billion at the time that Greenspan took the job, ended up, three decades later, at $22 trillion today. Now that a lot of bond buying.”

As Stockman put it, it was the “big fat thumb of the central banks” that jumped into the bond market absorbed the excess supply and removed the factor that had kept politicians quasi-fiscally honest.

Grant asked the obvious question: what’s the harm. Interest rates are at 5,000-year lows, the stock market is roaring. unemployment is reasonably low.

Stockman replied, “Ultimately there is not a free lunch.”

Ultimately, the central banks could not continue to monetize public debt at the rate they were doing.”

And Grant chimed in, “So, ultimately there will be a protest made in free markets, no?”

But what is the check on these unprecedented and indeed here-to-for unimagined policies?

Well, I think ultimately free money is the profound enemy of free markets, and the two don’t play together well for extended periods of time. In the short-run, the free market has basically piggy-backed onto the central banks, and you’ve had speculators, and what I call the fast-money traders, figuring out that they could make bundles of money by buying what the Fed was buying, by buying what the ECB is buying … The issue is though, at some point, even the operators at the central bank realized they couldn’t continue to monetize at that pace.”

Grant pointed out that today is not unlike the early 1960s during the “epiphany of the Keynesians.” We had low interest rates, low inflation, solid employment solid GDP growth and financial prosperity. But that all ended with the “onset of the monetary disorder of the 1970s.” Stockman said there’s a big difference today that makes things even more ominous – central bank balance sheets are massive and they have made a pivot toward trying to shrink them.

Stockman raised an issue we’ve brought up – who is going to buy all of this government debt?

My calculations say $1.8 trillion of debt – government debt – in fiscal 2019 needs to find a home somewhere in the bond market – $1.2 trillion in new issue, $600 billion that the Fed will be dumping in QT. So, we have never been there before.”

Stockman argues that Greenspan put us on this path. It’s taken 30 years to get here. But now we’re at the end of the road.

The pivot is take the inflation out and insert the Fed, the other central banks, essentially you deferred a crisis that was seeded long ago for 30 years. And now we’re at the end of the deferral.”

So what do investors do? Stockman said now is the time for capital preservation.

The only thing we do know is the casino, as I call it, is a very unsafe place. That furniture is going to be broken. That pricing is going to reset. And that this is a time for capital preservation, not for sticking your neck out.”

Historically, buying gold has been a great way to preserve wealth. Stockman said that might be a good option considering what’s on the horizon.

I have no doubt that gold is going to rise systematically. I think gold will go up because when this adjustment takes place, the great confidence in central banking is going to collapse, and there will be a bid for a safe haven, an asset which will no longer be the bond.”

You can listen to Grant’s full interview with David Stockman here.

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Photo by Gage Skidmore