The economics of American militarism

The Great Deformation

by Justin Raimondo

David Stockman rocketed to fame as Ronald Reagan’s chief of the Office of Management and Budget (OMB), his name loosely associated with the "trickle down economics" of the supply-siders, but his recent book, The Great Deformation: The Corruption of Capitalism in America, will correct the record: Stockman is not only a libertarian critic of the Milton Friedman school of monetarism and supply side economics, he is also a principled opponent of American militarism. His new book is a massive 700 pages-plus, but don’t let that deter you: inside you will find a scintillating analysis of where, why, and how America went wrong, starting with the New Deal and ending with the Great Recession of ’08 and the subsequent Obama-Bernanke attempts to re-inflate the bubble of America’s debt-driven "prosperity."

His basic thesis is that the Federal Reserve, starting with Richard Nixon’s decouplingof the dollar from gold, has acted as the central planner of the American economy, blowing up the bubble of a false prosperity. This mostly served to fatten the wallets of the One Percent, giving Wall Street a blank check while looting the savings and aspirations of Main Street.

His is a complex argument, and it assumes a knowledge of economic theory that I fear many – including myself – do not possess, but his analysis is clear and forthright: the Fed, instead of acting as a neutral arbiter and manager of the money supply, has engaged in "prosperity management," as he terms it, implanting a "borrow, spend, gamble, and get-rich-quick regimen" that poisoned and deformed the economy and the culture. The decoupling of gold from the value of money led to the financialization – and bifurcation – of the American economy, so that the financial manipulations of Wall Street increasingly had little to do with the production of actual things, and the real performance and value of the financial "assets" they were dealing in, but instead were based on the "free" money being printed hand over heels by the all-powerful Federal Reserve. The hedge funds, the wild speculations of Wall Street’s most distended-from-reality "assets" – like those sliced-and-diced toxic mortgages that led to the housing bust – are all products of the Fed’s central planning: "They consume," says Stockman, "vast resources without adding to society’s output or wealth, and flush income and net worth to the very top rungs of the economic ladder." Although the free market is getting the blame for this, the reality, says Stockman, is that these deformations of capitalism were made possible by massive State intervention via the Fed, which enabled politicians to spend without taxing – and the militarism of the alleged "conservatives" was a key factor in all this.

"A riotous expansion of the Warfare State was foremost among the policy errors of the Reagan Revolution," writes Stockman:

"Within days of Reagan’s taking office, the White House made a historically devastating mistake by signing over to the Pentagon a blank check known as the ’7 percent real growth top line.’ This massive injection of fiscal firepower nearly tripled the defense budget from $140 billion to $370 billion within just six years. More importantly, it fueled powerful expansionist impulses throughout the military-industrial complex at exactly the wrong time in history."

After all, the Soviet Union was on its last legs, you’ll recall, but, says Stockman, "the neocon branch of the military-industrial complex trumpeted a new version of the phony missile gap that John Kennedy had promoted during the 1960 campaign." The neocons were hyperventilating about a supposed Soviet effort to give the Kremlin a first-strike capability, building a new fleet of heavy bombers and vastly improved long-range missiles. Yet the evidence for this alleged drive to achieve first-strike capabilitynever really existed. Furthermore, the Reagan administration’s efforts to counteract this phony "threat" had nothing to do with mounting the appropriate countermeasures. Instead, as Stockman points out, the US embarked on an unprecedented buildup of conventional forces: "land, sea, and air forces that were utterly irrelevant to the imaginary Soviet nuclear first strike."

They were, however, "well-suited to imperialistic missions of invasion and occupation," writes Stockman. "Ironically, therefore, the Reagan defense buildup was justified by an Evil Empire that was rapidly fading but was eventually used to launch elective wars against an Axis of Evil which didn’t even exist." And, says Stockman, it wasn’t just a question of wasting a few percentage points of GDP:

"The Reagan defense buildup gave birth to a historical monstrosity: the Bush wars of occupation and imperial pretension that were possible only because of the immense conventional war machine the Gipper left behind."

That machine was useless for its ostensible intended purpose – deterring and defeating the declining Soviet empire – but perfect for policing, occupying, and pacifying "the vast open deserts and the crumbling mud and stone walls" of the Middle Eastern battlefields of the future.

Much of the blame goes to the bad advice Reagan got from Caspar Weinberger, his defense chief, but Stockman also issues a full-throated condemnation of the sainted President himself:

"In fact, Reagan was an out-an-out statist in the realm of the military and national security. All the well-warranted skepticism he had about Big Government – the empire-building tendency of the bureaucracy, the inherent inefficiency and waste of public sector monopolies, the self-serving propensity of bureaucrats to hide the facts and twist the truth – did not apply on the Pentagon side of the Potomac."

In tracing the long, winding history of how we became a nation of debtors, Stockman goes back to the New Deal and the war economy that prevailed after Pearl Harbor. The Fed became an arm of the War Department (as it was then called), becoming the biggest buyer of Treasury securities, "thereby ‘monetizing’ federal debt on a scale never before imagined." The Fed thus positioned itself as the motor and central control panel of the American economy, "rigging the government bond market and the Treasury curve yield by persistent massive open-market purchases of Treasury paper. Today this is business as usual, but then it was a radical departure, a theretofore rarely used tool that now became institutionalized owing to the exigencies of wartime finance."

War is the health of the State, as Randolph Bourne famously noted, and Stockman fills us in on the economic details, down to the numbers in the Fed’s balance sheet footings – which, as he shows, underwent "a twelve-fold expansion during the four years of world war." As he puts it:

"The Fed opened its doors in November 1914. But owing to the exigencies of wartime its purpose and modus operandi were twice turned upside down during its first thirty-one years. It can fairly be said that the Fed became a permanent denizen of the government debt market during its service to the warfare state, forging the T-bill standard, as it were, in the crucible of war."

Stockman points out that the Fed was sold to the politicians and the American public as a "banker’s bank," a ready source of liquidity that would prevent the disruption of commerce during recessions, and obviate the need to call in loans. It was never intended to be a dumping ground for the national debt, or so its congressional supporters believed. Thirty years later, however, the main selling point of the Fed – that it would be the impartial custodian of the nation’s reserve funds and a bulwark of fiscal discipline – were turned up side down. "This development," Stockman writes, "was the result of two wartime borrowing sprees and the resulting wholesale abandonment of the nation’s historic balanced-budget discipline. The public debt thereby grew from midget to giant dimension."

War increased the power and reach of the Fed by leaps and bounds, leading it to assume its eventual role as the primary mover of the national economy – displacing the original version of the Fed’s role, which was supposed to respond to trends in the real economy. "Under the original version of the 1913 act," avers Stockman, "the business economy was in the monetary driver’s seat. It generated the ebb and flow of loans, deposits, and reserves in the banking system and the final aggregates of money and credit. Federal Reserve credit arose from commerce that already existed: it did not seek to add even a dime to existing bank loans or GNP."

But World War II changed all that:

"By contrast, during the period of war finance between 1942 and 1945, the Federal Reserve became a powerful, proactive manager and manipulator of the nation’s entire commercial banking system. Its purpose during that interval of national crisis was to manage the nation’s ballooning war debt, but these very same tools of banking system management were later adapted to management of the GDP itself.

"It’s apotheosis came six decades later, when the Fed orchestrated a veritable dance of the zombies during the aftermath of the September 2008 meltdown. Reaching back to its school days in war finance, the Fed again engineered a steep Treasury yield curve by driving front-end rates to nearly zero. In doing so, it gifted legions of insolvent banks with a simulacrum of profits. It thereby reduced depositors to penury, of course, even as it kept zombie institutions alive and their executives in bonuses a while longer."

How much longer? Stockman’s thesis is that we haven’t got much time left. The Great Deformation took decades to work its destructive effects into the fabric of the nation’s economic life, corrupting its integrity and financializing a hollowed-out productive capacity that had once been the envy of the world. Yet the warning signals – the crash of ’08, and its many precedents – have been flashing for some time, and if alarm bells aren’t going off in Washington, particularly in the Eccles Building, then that is due to the illusion of a debt-based "prosperity."

This sounds like standard old-style fiscal conservatism, but Stockman serves it up with a twist. Unlike most "free market" economists of the sort that hang around the Heritage Foundation and other "conservative" thinktanks, Stockman understands the origins and development of the system that led to the current crony capitalist regime are firmly rooted in the soil of militarism.

In his chapter on "War Finance," Stockman busts the Keynesian myth that we spent our way out of the Great Depression because of huge government expenditures during wartime. He points out that 80 percent of the costs were financed by the forced "savings" of confiscatory taxation and the "voluntary" purchase of war bonds by private citizens. Of course, since essentials were rationed, and "luxuries" virtually nonexistent, there was nothing much for anyone to buy. Stockman points out that, contra the Keynesians, who point to World War II to illustrate the alleged "success" of deficit spending," total debt did not rise during the war years: instead, it actually declined. In 1945, the total debt – private and governmental – was lower than under the peacetime New Deal, circa 1938. The lesson of the facts and figures Stockman presents in numbing detail is a point that conservatives of today would do well to absorb:

"What the warfare state of 1941-1945 proved was that wars should be funded with taxes and savings, not that federal deficits are harmless or that they were a cure for the Great Depression."

At the end of the most destructive war in history, the machinery that would enable the metastasis of the Warfare-Welfare State was firmly in place: a Federal Reserve system that had grown beyond its original mandate into the central planner and supreme arbiter of the nation’s economic condition, and a worldwide military presence that haddisplaced the British empire as the policeman of the world.

Yet there was to be a brief reprieve from this looming prospect in the fiscally conservative pay-as-you-go wartime spending of the Truman administration during the Korean conflict, and what Stockman regards as Eisenhower’s golden age of fiscal conservatism and Pentagon budget-cutting. I briefly discussed Stockman’s treatment of the Eisenhower era in my speech to the Republican Liberty Caucus of California, at their recent convention, but I’ll go into it in more depth in my next column – because it is truly a fascinating and little known story.

Part II

Eisenhower’s Reprieve and the Descent Into Fiscal Insanity

David Stockman’s The Great Deformation is an economic history of the United States as seen through the eyes of a devoted fiscal conservative whose number-crunching abilities have led him to the ineluctable conclusion that the Warfare State is one of the main drivers of that old devil the Welfare State.

The result is that we get an analysis that in no way resembles the cookie-cutter Heritage Foundation/American Enterprise Institute "conservatism" that insists onausterity for the masses and tax cuts for the wealthy, while throwing money at the Pentagon hand over fist.

Instead, we get praise for such an unlikely conservative hero as Harry Truman, whoinsisted that the Korean war "be financed the old-fashioned way – with taxes." As a libertarian, my instant reaction is horror – but wait. We often hear some peace advocates say that if we had a draft there would be less wars of "choice," but to me this has always seemed an absurd trade-off: legalized slavery in return for the prospect of peace? No thanks. Besides, it didn’t work out that way during the Vietnam war, now did it? However, Stockman’s praise of Truman for financing the Korean war with taxes seems like a more reasonable trade-off: make them finance their wars with new taxes so that the population feels some tangible pain. Now that may very well be a more credible deterrent.

In any case, while Stockman avers that "from a contemporary vantage point, it is not clear what purpose US intervention on the Korean peninsula ultimately served" – a point brought home by the current Korean crisis – once the decision to go to war was made, Truman refused to borrow the money. Federal spending metastasized by almost 80 percent during the Korean conflict, but it wasn’t a budget-buster – and Truman’s pay-as-you-go policy encouraged Republicans to support a swift end to the war: "Owing to Truman’s unwavering insistence on stiff war taxes," Stockman notes, "GOP conservatives had no stomach for open-ended war in the barren hills of Korea if it meant permanently high taxes."

That, however, was the last hurrah of the old fiscal orthodoxy, as Stockman points out:

"After that, America’s imperialistic misadventures in other strategically barren redoubts of the planet faced no such political constraints. Lyndon Johnson set the new tone with his ‘guns and butter’ adventure in Southeast Asia, even when the historical record shows tha the Chinese people were now starving in their villages, not fixing to pour across the border of another purported domino.

"Yet LBJ couldn’t bring himself to ask for war taxes until the very end, a drastic failing that opened the way for equally irresponsible war finance by future GOP administrations. Indeed, four decades later George W. Bush’s equally bootless imperial missions were carried out entirely tax free. Indeed, what poured out of China this time was the money to fund them."

The old fiscal orthodoxy persisted in the generation that was rapidly passing from the scene: a generation exemplified by Fed chairman William McChesney Martin, who managed to put a temporary brake on the growing role of the Federal Reserve as the Prime Mover of the American economy. Between 1954 and 1963, as Stockman points out, real economic growth averaged 3.4 percent while inflation was tamed at 1.4 percent. It was a brief golden age, before the darkness overcame us: "There was no subsequent nine-year period that had a better combined performance of these core variables," writes Stockman. "And none which left the overall economic and financial system so healthy and stable."

And, I might add, there was no subsequent period in American history in which theculture was so healthy and stable: the much-derided Fifties, that era of the "organization man," the "man in the gray flannel suit," conformist and bourgeois to the core. The presidency of Dwight David Eisenhower – Stockman describes him as "a military hero who hated war" – was the last hurrah of the Old America.

Eisenhower’s signal achievement, in Stockman’s view, is that he succeeded in actually shrinking the federal budget in real terms during his eight years in office, and he did it by "taming the warfare state." Contrast this with the fiscal profligacy of his war-making successors: LBJ, Reagan, and Bush II: "In each case," avers Stockman, "the plunge of the nation’s fiscal accounts deep into the red was triggered by a resurgence of the kind of massive warfare state budgets that Ike so resolutely resisted."

The theoretical basis of our post-Eisenhower fiscal madness came in "left" and "right"-wing versions: "Keynesian theories of prosperity management that manifested themselves in both a leftist ‘new economics’ version and rightist ‘supply side" version." Armed with this new doctrine, the political class believed they could engineer unprecedented rates of economic growth, "such as 5 percent annually, or even better." They could have "guns and butter," and wind up ahead of the game – all without raising taxes!

But of course what they got was massive war deficits, and "yet this was a good thing, according to the Keynesian professors," says Stockman, "because such deficits inject demand into the economy, thereby lifting output closer to its full-employment potential." The supply-side Lafferites chimed in with their own version of a free lunch for all: growth would pay for everything, including all the wars anybody felt like starting. The reality, as Stockman points out, is quite different, however:

"In fact, war deficits are the worst fiscal policy imaginable. They add to civilian demand but generate no marketable output of consumer products or capital goods. Accordingly, war deficits tip the economy toward excess demand, inflationary bottlenecks, rising interest rates, and financial instability. They destroy wealth and lower living standards."

Feel poorer after the last decade or so? That’s why.

Eisenhower gave the country an eight-year reprieve from such a fate by quickly ending the Korean war, slashing the Pentagon’s budget, and cutting Truman’s wartime spending by nearly one third. The Democrats responded by accusing the President and the GOP of "allowing their Neanderthal fiscal views to endanger the national security." Yet Eisenhower’s approach was to actually spend military appropriations on thedefense of the United States, as opposed to imperial adventurism abroad. This was the theme and purpose of his "New Look" national security strategy, which called for a big reduction in land and naval forces, and shifting spending to our nuclear deterrent. He also made our European allies pay more of the costs of their own defense – a proposal that, these days, would be denounced as "isolationist."

Stockman contrasts Eisenhower’s "New Look" with Truman’s national security strategy as summarized by the infamous NSC-68, which called for maintaining a capacity to fight at least two land wars simultaneously with conventional forces. The interventionist bias of NSC-68 violated not only Eisenhower’s reluctance to be drawn into the "limited" land wars that would consume policymakers in subsequent administrations, but also contradicted his own fiscal conservatism and the traditional Republican green-eyeshades approach to government spending: he feared, as Stockman puts it, "that the massive permanent budgets required by the limited war doctrines of NSC-68 would erode the economic foundation on which true national security depended." The Army, the instrument of what was essentially an offensive strategy pursued by NSC-68, was allocated a mere 22 percent of Eisenhower’s military budget, while the Air Force – a vital component of the new "massive retaliation" orientation – got 47 percent.

This led to a revolt of the generals: Generals Matthew Ridgeway and Maxwell Taylorresigned in protest from the joint chiefs of staff. Stockman trenchantly points out that these two were brought back by none other than Robert McNamara, the "whiz kid" of the Vietnam war era. McNamara also brought back NSC-68, during his stint as Secretary of Defense, and beefed up the Army, in preparation for the Vietnam intervention. The Democrats in power brought military spending back up to Trumanesque levels. The American empire was saved!

No President after Eisenhower succeeded in reining in the Warfare State as he did: indeed, after he left office, the Welfare-Warfare State began to take on the gigantism we have come to know and loathe:

"Indeed, in a few short years after Ike left office, the profound danger of a symbiotic nexus among the warfare state and welfare state became starkly apparent. Reflecting the imprint of the Hubert Humphrey "guns and butter" liberals, both sides of the budget hit simultaneous peaks in fiscal 1968. With constant-dollar defense spending back to the $515 billion Korean War peak, domestic outlays followed suit, reaching an all-time peak of $455 billion" [in 2005 dollars]."

After Vietnam, there was no "peace dividend": instead, the log-rolling operation conducted by the military-industrial complex and big spending liberals simply recycled the $200 billion in "savings" into increased domestic spending. Under Nixon, the spending continued, exceeding "even the Kennedy-Johnson record spree." By the time Ronald Reagan took office, domestic spending had doubled. What this meant was that the Reagan military build up had to be financed with borrowed money: and this marked the death of the old Republican fiscal orthodoxy, and the rise of a "right-wing" variant of Keynesianism – dubbed "supply side economics" – to rationalize the abandonment of sound economics.

The end of the cold war gave us no relief, only "a modest rollback," as Stockman characterizes it. Bill Clinton‘s military budget was as large as Eisenhower’s, even though, at that point, there was no major threat to America’s unprecedented military hegemony. As for George W. Bush – well, we all know what he did:

"Then followed George W. Bush’s senseless misadventures in the barren expanse of the Hindu Kush and on the bloody plains of the Tigris-Euphrates. These campaigns generated the third great post-Eisenhower surge in constant-dollar defense spending – an all-time high of nearly $600 billion in constant dollars."

The relationship between military spending and actual threats to our national security was long gone. And Obama, who as a candidate campaigned in favor of ending Bush’s wars, wound up topping Bush’s record military spending. I can’t resist quoting Stockman on Obama’s record in full:

"On exactly the fiftieth budget anniversary of Eisenhower’s farewell warning, evidence of the insuperable power of the military-industrial complex was stunningly evident in Obama’s fiscal 2011 budget. The 2008 election, of course, had been even more unequivocally a ‘peace’ election than 1968 had been, because this time the ‘peace’ candidate actually won. Yet election mandate or no, the third great surge in the post-Eisenhower warfare state gave no ground whatsoever.

"In fact, inflation-adjusted defense spending in fiscal 2011 of $670 billion was a new record, eclipsing even George W. Bush’s final war budget. It was thus abundantly evident that even an out-and-out ‘peace’ president is no match for the modern warfare state and the crony capitalist lobbies which safeguard its budgetary requisites.

"Indeed, Barack Obama pushed the frontiers of the warfare state further than ever before. Beating his mandate for plowshares into an even mightier sword, the peace president pushed defense spending to a level 80 percent greater than General Eisenhower concluded was necessary."

The symbiosis of conservative militarists calling for more guns, and liberals calling for more butter, is today complete: the log-rolling continues apace. The War Party pushes for more intervention, more threat-inflation, and more "defense" spending, while the "progressives" campaign for deficit spending, monetary inflation, and more domestic spending. These two factions happily coexist, egging each other on, and therein lies the road to bankruptcy – and endless war.

There is more – much more – to The Great Deformation, but it is, for the most part, beyond the purview of a column devoted to analyzing the effects of militarism on our society. Libertarians will find much to agree with in this volume – Ludwig von Mises merits a mention as the founder of the Austrian school theory of the business cycle, and goldbugs will glory in Stockman’s defense of the gold standard. But liberals and the abovementioned progressives will find themselves nodding in agreement, too, as Stockman describes the ills effects generated by the Federal Reserve and the resulting financialization of the US economy.

The book is already generating a storm of controversy, and is being attacked by all the right people – the Keynesians, on the "left," and the Reagan-idolators on the "right."Go out and buy it, then settle down in your favorite comfy chair: unlike most texts dealing with economics, it’s a real page-turner, as the author describes what led to the biggest bubble in American economic history – and hints, along the way, at a spectacular climax, a day of economic reckoning this book will hopefully help to prevent.