 Our guest this week is David Stockman, who returns for the second part of an interview we began last week. Also last week, David spoke at our Mises Circle event in Stanford, Connecticut, along with Jim Grant and Judge Andrew Napolitano, and he really enjoyed a great reception there. Stockman was a congressman. He was Ronald Reagan's OMB budget director, and he was a private equity fund manager. He wrote a phenomenal book called The Great Deformation, which really exposes and chronicles crony capitalism like no other book written, and I think it's one of the most important books on capitalism written in the 20th century. His Contra Corner website is unrelevably prolific, and I really encourage you to read it daily. So if you're interested in how the economy works and how it really should work, stay tuned for part two of a fascinating interview with David Stockman. I heard Rand Paul say something the other day that relates to this. He said it's very important to understand whether it was capitalism, in fact, that caused the crash of 08. And this is really what you're talking about. This is the question I think you answer in The Great Deformation. Right. I mean, I would say in 08, and now again in 215, the world financial system, not just here in the United States, but around the world, because all the central banks are doing the same thing, is rife with dangerous combustible speculation. But that's not due to the flaws of capitalism or the greed of human nature. It is a result of massive central bank intrusion in the money and capital markets and the destruction of price discovery everywhere. And if you don't have honest pricing in the money market, in the debt markets, in the equity markets based on supply and demand, and a marketplace that is not dominated and manipulated by an external agency of the state, that is the central bank, you're going to be in big trouble. And therefore, you leave markets flying blind, pricing everything based on what they think. The 12 members of the Hope and Market Committee are going to do next, when in fact the financial market should be pricing based on the views of millions of people, traders and investors and borrowers and savers and all the rest trying to decide and discover the right price for things hour by hour, day by day. The system would work wonderfully. It's proven historically, but it has been totally disabled, set aside by this massive central bank intrusion. Every price today, from the federal funds rate to the 30-year bond to the S&P index to almost all the stocks indirectly in the market, the five or 8,000, are overwhelmingly being determined by central bank policy and central bank intervention rather than the marketplace forces of supply and demand. We can go back to 208 and I think the story is about 208 is the number of urban legends that have been built up that justified everything that the Fed did and the massive intervention in the form of CARP has become so much part of the mainstream narrative that the Fed is allowed to continue to repeat the same mistake over and over. And what I tried to do in the great deformation was go back and look at each of the events almost day by day, week by week that occurred from the time that they bailed out Fannie and Freddie and then a few weeks later the Lehman bankruptcy came and before we knew it, CARP was on the floor of the house, voted down appropriately, markets cratered, they made them walk the plant again and pass it against their better judgment. When you go through all of that, you know, there was just flat out lies that were being told by a few people, Bernanke and Paulson and they simply created a herd panic in Washington that led to some awful policy and precedence. There was no great depression 2.0 around the corner, that's just waltzy nonsense that Bernanke conjured up in his own mind because he thinks he's a great scholar of the 1930s and almost everything he's ever written about the great depression in the 1930s I think is wrong and can be readily refuted and I did that in my book as well. Obviously Paulson was hearing all kinds of panic prize from his buddies at Goldman Sachs and on Wall Street who had been gambling for years and now didn't want to face the music. One of the bigger of those were good reasons. AIG was bankrupt at the insurance subsidiary level only at the holding company where they were selling, you know, the mortgage product insurance, that easily could have been taken to a bankruptcy court and no one's insurance would have been impacted anywhere in the United States or elsewhere around the world. I go through a lot of these events that occurred at the time of the so-called 2.0 age financial crisis and demonstrate that we weren't on the edge of Armageddon. We should have allowed the marketplace to work its will. This wasn't a threat to the main street banking system in America. There was not going to be lines at the teller windows all over the United States. This was a crisis in the canyons of Wall Street due to the massive mismatch on balance sheets and leverage that had been created over the previous five or six years. It should have been allowed to finish, you know, the online should have been allowed to finish and my argument is that the whole meltdown would have burned out in the canyons of Wall Street. There would have been no investment banks left. Goldman would have gone under. Morgan Stanley was clearly insolvent, saved for huge bailout lines from the Fed in Washington. But the world would be a lot better today if both of those firms had been liquidated and forced to start over. But none of that happened and so we have simply doubled down at the central bank with even more fantastic expansion of balance sheets and intrusion into the financial system. And we're on the lip, I think, of the next great financial crisis. It's interesting in your book, The Great Deformation. It's actually on page 544, folks. You list the four reasons why what you consider an ersatz panic of Wall Street would not have made its way to Main Street. And I think that page is one of the most important pages written in any book in the 21st century. But you know, going back to your years in private equity, obviously you know the M&A world. Can you talk a bit about how the merger and stock buyback mania doesn't produce any real value for shareholders or for the economy? Yeah, I mean, there is nothing wrong in a healthy capitalist system per se with either stock buybacks or mergers. But if you have a heavily distorted system in which debt is massively underpriced and therefore way too cheap, if you have a stock market which more or less the Fed is committed to propping up and supporting, you create incentives for, you know, corporate decisions and corporate behaviors that are highly inefficient or unproductive. And so therefore, as I've tried to demonstrate in some of my blogs, but also to some degree in the book, there is a massive excess of M&A deals that are not driven by business logic or real synergies or, you know, productive considerations, but happen because the financing is so cheap. Overwhelmingly, these deals are cash based and they're funded through massive junk bond or even investment grade bond issues. You can look at some of the, you know, corporate issues of the last four or five years and see 30, 40, 50 billion dollar issues not to fund one additional piece of equipment or plant or rolling stock or anything else, but to simply finance a merger deal. So I think what we have is a system that is now so distorted that overwhelmingly the cash that's being generated by corporate America plus the massive increase in borrowing that has happened is slowing into financial engineering deals. And ultimately that cash makes its way back to the stock market, to the gambling arena where it drives up prices, further intensifies the mania and, you know, compounds the whole dynamic underway. If you look at real investment in plant and equipment over the last decade, it's less than 1% per year in real terms. If you look at even since the 207 peak, the recovery has been very tepid. And plant and equipment in real terms today is after allowance for the depreciation that we're using up there every year is actually lower than it was in 1999. So therefore you can understand the anomaly that we have today, which is massive corporate debt and borrowing. You see evidence of it every day and virtually non-existent real investment in plant and equipment and productive assets going forward on a sustained basis. And the reason for that disconnect, the reason for that anomaly is the distortions in the financial system are causing a massive flow of cash and borrowing, as they say, into financial engineering, ultimately into the casino where it gets recycled over and over and therefore creates even more dangerous instability and speculative mania that we can see all around us. But isn't this sadness, that's in other words, in a non-crony economy, wouldn't private equity and venture capital play a noble role in allocating resources? Yeah, I think they would. And that's the real sad thing is to use your word and I think it's a good one. These powerful mechanisms of the market and of capitalism are being perverted and you and turned against the system instead of being a source of funding for growth and innovation and invention. They have become the instruments, basically, of unproductive and unstable financial speculation. That is obviously not something that 90 percent of the population can engage in because they don't have the chips to bring to the table in the first place. And so therefore, in this kind of speculative economy, only a very small fraction of the population to play and the windfalls from the falls of pricing and the inflation of financial assets that are systematically driven by the central bank, accrues to the benefit of a very thin slice of the population. They say the one percent actually it's probably one tenth of one percent that have the big asset positions in the hedge funds. They're the private equity world that are being showered with these enormous ill-gotten gains and they're ill-gotten not because of some traditional antipathetic capitalism. They're ill-gotten because they are the fruit of central bank distortion of the financial system. Ladies and gentlemen, we're almost out of time. So I'd like to wrap this up, David, with a final question about your background. Now, I noticed that you went to Michigan State, a public school for your bachelor's degree. So you didn't come out of the Harvard, Wharton, Stanford MBA finance world and that later you attended Harvard Divinity School. So people may not know this. And I'd love to hear about how your education shaped your viewpoint in your career. Well, you know, I came out of a very conservative farm background. I went to Michigan State because I wanted to be a farmer. The next thing I knew, the Vietnam War started. I knew that when I finished undergraduate, I was going to be drafted. I began to read a little bit. I started to go to some teach-ins and protests. I quickly understood that this was a totally misbegotten adventure by Washington, that there was no threat to the security of America coming from the Viet Cong or anyone else in Southeast Asia. I became very anti-war. I became a radical, you know, went to Washington and all the demonstrations in New York, and I understood the dangers of big government at a very early age from the warfare state side. Then I graduated. I got my draft notice. I was not about to join McNamara's army. I had an opportunity to enroll in Harvard Divinity School. I got a deferment as a result of that. And I spent the next two years bidding my time, trying to learn a lot about history, trying to learn a lot about philosophy, even a little economics. I finally got to the point where the draft was ended. I got a high number in the lottery and decided to go to Washington. And I began a career that took me through becoming a member of Congress in the 70s and then the Reagan Budget Office in the 80s and then Wall Street beyond that. But all the way through, there was a common theme, which was a great skepticism about big government and the aggrandizement of the state. And I started on the warfare state side. I got to Washington and worked for a congressman who was middle of the road on many social issues, but on economics, he was very free market oriented. And I began to develop a view on the dangers of the welfare state. And so by the time I became a member of Congress and then entered the Reagan White House, I had a pretty good view of a balanced view of the danger of big government. Now, the problem with the Reagan era was that Reagan was actually very pro-big government on the Pentagon side of the Potomac and anti-big government on the domestic side. The problem is that didn't work. He couldn't put a coalition together on Capitol Hill based on that kind of disconnect. And it's the real reason why very little progress was made. Had the Reagan White House not been taken over by the neocons, had he not been himself, Ronald Reagan, bamboozled by the kind of, you know, extremist view that the Soviet Union was developing the first strike capability and all the rest. None of that was true. The Soviet Union in 1981 was on its last legs because socialism doesn't work. Marxism is a false philosophy. The system was collapsing on its own weight. We had plenty of deterrent force in our Minuteman missile force and the Trident Polaris submarines to deter what was whatever was left of the Soviet Union in its waning years. We did not need this massive buildup. We did not need a big government on the Pentagon side. It was a giant historical mistake. Reagan fell for it. And in the result of that, we had huge deficits and a kind of, you know, discombobulated policy and political coalition that ultimately failed to bring the government to heal. What it did do was create mythology, the mythology that the Reagan era was a roaring success, that deficits don't matter, and that all you have to do is keep cutting taxes and everything will be better. That was a enormously unfortunate and counterproductive or wrong lesson from the Reagan era. And so for the next 30 years, we had two free-launch parties, the Democrats defending all the spending, the Republicans constantly wanting to cut taxes. We now have 18 trillion of debt. The day I went into OMB, we had one trillion. So, you know, 18x, you know, period that I can remember quite well in a period when the economy may be up by four times on a nominal base. So what I'm saying is that that was a historic juncture. It was a time, an enormous opportunity to roll back the status policies of 50 years. And unfortunately, it didn't happen because of the giant mistake that was made when the Republican Party allowed itself to be taken hostage by the neocons and imperialists and warmongers, as I call them, that have ruled the Republican Party ever since. Dave Stockman, thank you so much for your time today. Ladies and gentlemen, have a great weekend.