Review: The Great Deformation, by David Stockman

The Great Deformation: The Corruption of Capitalism in America, by David Stockman. Philadelphia: Perseus Books Group, 2013. 768 pp. $25.24 (hardcover).

deformationWhen the U.S. economy collapsed in 2008, most economists, policy analysts, and government advisers were caught flat-footed. For more than a decade, the experts had assured Americans that such a catastrophic economic event had become impossible.

In 2004, Ben Bernanke (now chairman of the Federal Reserve), declared a “Great Moderation,” beginning in the mid-1980s, during which “improvements in monetary policy” at the Federal Reserve had led to “a substantial decline in macroeconomic volatility” (Fed-speak for a taming of the business cycle).1 Robert Lucas gave a presidential address to the American Economic Association in 2003, declaring that the “central problem . . . of macroeconomics”—maintaining recession-free growth without runaway price inflation—“has been solved, for all practical purposes.”2

Yet the seeds of the so-called Great Recession, David Stockman argues, were already there for anyone to see.

The Great Deformation is Stockman’s attempt to explain and diagnose the economic crash, connect it to historical trends, and warn against policies that will bring worse economic disasters in the future. Stockman presents a compelling case, based on economic theory and exhaustive research. His warnings for the economic future are chilling but powerfully argued.

The “Great Deformation” named in Stockman’s title is the distortion of the economy brought about by the Federal Reserve’s credit expansion since 1971, when Richard Nixon ended the last vestiges of the gold standard.

Stockman reviews several major financial developments of the 20th century. Prior to Nixon’s move, he recounts, the developed world was governed by the Bretton Woods Agreement, signed in 1944. Although not a full-fledged gold standard, Bretton Woods kept the world economy tethered to gold. All major currencies were pegged to the U.S. dollar, which in turn was redeemable in gold at $35 per ounce.

Bretton Woods limited any country’s ability to inflate. For America, it meant that any inflation by the U.S. government—creation of money to cover government debt—led investors to trade value-losing dollars for value-retaining gold. Thus, the effects of creating new money would show up immediately and painfully in the banking system.

Chafing under this fiscal restraint, on August 15, 1971, Richard Nixon unilaterally reneged on the agreement, ended the convertibility of U.S. dollars to gold, and laid the groundwork for an unprecedented series of financial crises.

Nixon’s move had an immediate, dramatic effect, Stockman writes: skyrocketing prices for oil and other commodities in the 1970s. In four years, the price of oil increased from $1.40 to $13 per barrel. A ton of scrap steel went from $40 to $140, and even such a humble commodity as coffee went from 42 cents to $3.20 per pound.

Abandonment of the gold standard enabled unfettered deficit spending without immediate consequences in the capital markets, Stockman writes. . . .

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