Not long ago I had a chance to talk once again to David Stockman, budget director under Ronald Reagan and author of The Great Deformation: The Corruption of Capitalism in America. Here’s the audio, and here’s a YouTube. A very compelling conversation.

Here’s the full transcript. (For transcripts of all my interviews, click here; for the Tom Woods Show site, click here.)

WOODS: You gave a speech earlier this year on the Federal Reserve and the warfare state, and what I found interesting in it, among many other things, is that you showed that it’s not just the old story that the Fed enables the warfare state — although that’s a story that can’t be told often enough, and most people don’t know anything about it. But it’s also that it was under the conditions of war that the Fed itself grew, the Fed itself developed further what its role in the economy — which was initially a very modest one — was going to be. Now you have all this demand management and everything else going on. This really had roots during wartime. Can you talk a little bit about both angles of that?

STOCKMAN: Sure, I’d be happy to, and I elaborated this more in the longer I article I wrote that appeared on my blog called David Stockman’s Contra Corner. But you have to go back all the way to World War I, to 1913, to the enactment of the Federal Reserve on Christmas Eve that year, practically. And the interesting thing is that the Fed was not authorized in that fundamental change in our monetary system to buy government debt, to be intervening in the bond market or the money markets, to be active in Wall Street in any way. Instead, it was to be a banker’s bank that passively supplied liquidity when country banks, or city banks, or reserve banks came forward with good collateral and were willing to pay a penalty rate of interest on top of what — and this is really important — the free market was setting. So that was the scheme: the banker’s bank, there was no Keynesian macro-management of the economy, no Humphrey-Hawkins or targets for unemployment, or inflation, or housing starts, or anything else. It was to be essentially a market-driven liquidity mechanism.

Now, why did that change? It changed fundamentally because of the accident of World War I and the huge mistake that was made by Woodrow Wilson when he decided that the European war, which was nearing exhaustion in 1917, was something that we needed to jump into. And when we did, there was a massive war finance. Interestingly enough, and I laid this out in my book, Tom, and I just feel like mentioning it again: on the eve of World War I, we had $1 billion of national debt only. It was 4% of GDP. It had not increased since the Battle of Gettysburg, if you can imagine, more than a 50-year period. And suddenly, they had to finance $20 or $25 billion — a 20-fold increase in the national debt. It couldn’t be done overnight, on the spot — another huge part of the mistake Wilson made. And so they drafted the Fed into the service of financing the massive emission of war bonds.

And that’s where it all started. The Fed’s mission fundamentally changed. It got into the bond market. It got into the interest rate setting and impacting business. It got into the fiscal management side of our whole economy, and it took obviously decades and decades for mission creep to go from that start during World War I to what we have today. But, of course, I think there is a continuous thread there, a continuous history, and with each pulse of the warfare state problem we’ve had, then going to World War II, and then the Cold War, and even now with these ridiculous interventionist wars, the Fed has been called into service to finance the government debt on the cheap, and so therefore, people tolerate the wars and the cost of the wars that we don’t need because essentially it’s being financed with free money from the Fed.

WOODS: David, I noted in that speech you even used the word “genocide,” at least borderline genocide, when talking about the U.S. role in the Vietnam War. Now I can’t imagine that using that language would have landed you a position in the Reagan administration. So sometime between then and now you changed your views of the warfare state. When and how did that happen?

STOCKMAN: Well, that’s an interesting question, Tom, but in a sense I didn’t. I started out life as a student at Michigan State University in 1964 to 1968. I became rabidly antiwar. I was an SDSer. [TW note: SDS stands for Students for a Democratic Society.] I fell for the whole sort of radical line, but ironically, they were correct about our intervention in Vietnam. It was a tremendous mistake. I never changed my mind about that, frankly.

WOODS: Wow! Okay.

STOCKMAN: And then I ran for Congress, and I ran as a conservative – because I was: I was a free-marketer from southwestern Michigan. I proved my mettle because I voted against the first Chrysler bailout, not just the second one, the first one. But the opposition candidate I had basically ran against me on the grounds that I had a red file with the Michigan State Police.

Now, I bring this up because in 1980 I was then nominated by President Reagan to be budget director. Some enterprising reporter found out about the red file. They immediately raised the issue and tried to create a crisis, and you know, sort of put me in the penalty box. And he said he did that when he was a young man; I had a lot of crazy ideas, too.

WOODS: (laughs) That’s good.

STOCKMAN: In other words, I have been skeptical all the way through about our interventionist, aggressive foreign policy. It’s been on mistake after another. Vietnam, as I now can clearly see and something that I continue to blog about every day on my blog, David Stockman’s Contra Corner, was just the first step in a multitude and in a long-running history of interventions in places where the true security of the American people was not at issue. And once you got that machine going, and Eisenhower warned us about it, as you well know, in his famous farewell address in 1960 about the military-industrial complex. Once that machinery gets in motion and has the resources that it does — really, I figure the total warfare state today costs nearly a trillion dollars when you count all the debt that’s been used to finance it, $150 billion that the Veterans Administration costs us today because of all the wounded and the harmed veterans that have come back from these unnecessary wars. When you put it all together — foreign assistance, and security aid, and the Pentagon budget per se, and all the spy state apparatus, the intelligence agencies — it’s a trillion dollars, a massive amount of resources, hundreds of thousands of civilian employees, millions in the private sector directly or indirectly benefited, all looking for a mission to keep the thing going. And that’s why I continuously try to say to conservatives and libertarians that the warfare state is every bit as much statist as is the welfare state, and that we have a dual challenge in trying to bring government to heel and get back to some kind of productive and prosperous capitalist system in America. And that is, we have to tame both the welfare state and the warfare state.

Unfortunately, I think we’re losing the battle. I don’t want to be a pessimist, but when you look around and you see the Republican Party has so completely capitulated to the neocons and the warfare state apparatus that it’s no wonder they’re not credible when they say we need to shrink the welfare state. And frankly, Tom, that’s something that I faced day after day in the battle for the budget during the Reagan Administration: we couldn’t persuade even the middle-of-the-road Republicans in the House to do what was necessary to begin to shrink the domestic budget, because they just kept whining about the massive Reagan defense buildup. Which frankly, I lay out in my book The Great Deformation, was a huge mistake, unnecessary and left us with this huge, conventional war machine that has been used to invade all the areas of the world — Iraq, Afghanistan, Somalia, and everywhere else that we shouldn’t have been involved in.

WOODS: I’m always interested in people who move from one worldview to another. So before we move on, I can’t help asking: in your own transition from your SDS days to your days in the Reagan Administration, is there anything in the arguments that reached you that might be useful for us today in trying to make arguments with the Left? What was it that made you say, doggone it, I think I’m wrong on something important here?

STOCKMAN: Yeah, I was really wrong on the mechanics of democracy. I was right on the war and the imperialist foreign policy. I clearly didn’t understand economics. I was a college kid. Although in those days you didn’t get student loans and grants. You had to work 20 or 30 hours a week to keep going at a state college like Michigan State. But where I was wrong was on the mechanics of democracy. The Left insisted that voting didn’t mean anything, that parliamentary democracy was a bourgeois illusion, all of those arguments, and that you had to take the fight directly to the streets. Well, to a point that seemed almost necessary to stop the Vietnam War with the protests, and I went the marches on the Pentagon and a lot of other places.

But where it triggered an inflection point for me was in 1969, when it started to get violent, and you had the Weathermen come along. And I was a student at Harvard Divinity School then, frankly — I don’t mind admitting this — hiding out from the draft, because I got a deferment. I wasn’t going to go to South Vietnam on McNamara’s invitation. Anyway, I lived right near Divinity Hall, and next door was the ROTC building, and the radicals burned down the ROTC building. And that was like a wake-up call. It just sort of struck me: what am I doing here? How can I possibly identify with people who randomly and wantonly decide that this property is going to be destroyed in order to make a statement?

So I began to retract rather dramatically. The violence at the Chicago Democratic Convention in the summer also turned me off, and then I happened to get — and I’ll just throw this in as long as we’re talking about it — a very profound mentor at the time who you wouldn’t recognize today as a conservative; I wouldn’t, either. But it was Daniel Patrick Moynihan. Actually, I was his live-in house man in Cambridge. But he became a great mentor to me, and he was a conservative in the democracy side of it if not in what I would call the economic policy or welfare state side of it. And I learned a lot from him. I learned that you could be an intellectual and you didn’t have to be left.

You asked me for the key point, and that was the thing that Daniel Patrick Moynihan did for me. Until then, I thought people on the right were basically mental midgets, and that if you were a real thinker, and you read a lot of books, and you went deep into history, and you dug into the library, which is what I did in those days, you had to be left because thinkers were left. What I discovered while I was at Harvard Divinity School and under the tutelage of Pat Moynihan — who eventually got me a job on Capitol Hill, and that’s how I started in political life — was that you could be an intellectual, you could be a thinker, you could be steeped in history and in theory, and you didn’t have to be on the left. So I think that’s the real answer to your question.

WOODS: It’s interesting you say that. We have a guest who’s on this program from time to time, Bill Kauffman, who worked for Senator Moynihan for some time, and even though Bill’s not a liberal and he’s not a Democrat, he speaks very fondly of him, so to have two people I respect say that, well, all right, I’m willing to consider there might have been a decent person over in that institution.

I have a couple of things more that I want to make sure I hit with you, and one of them you might think is unfair, and you may want to pass and punt on it, and I would not think the less of you for it. But I feel compelled as a good journalist to ask. You worked in the Reagan Administration, and there is a wide array of testimonies about Reagan the man. You hear people say, he seemed very amiable on TV, but he was of middling intelligence, just a guy who more or less understood the big picture and that was it. Then you get other people who say he was very hands on, he knew all the details, he dominated the meetings. And then you get still others who say: I was at the meetings, and he was shockingly uninformed. Where does your recollection come down in that?

STOCKMAN: Ah, good question. I would sort of come out in a fourth category. I would say he was quite well informed, but his education, particularly on economic matters, was pre-1930. And since I went through the exercise of writing this whole book and digging back into the 1920s, and the real cause of the Great Depression, and what the world used to look like pre-1914, and with the liberal international order – of the real meaning of the word liberal – and the gold standard, I suddenly realized late in life that that was the view that Ronald Reagan had of the world. That’s what he learned in his student days, and he never changed when the Keynesians took over, let’s say, the intellectual brief in Washington, for economic policy anyway, after the 1950s. So a lot of people misunderstood his old world view, old liberal worldview of economics, for lack of information or, or lack of knowledge, or lack of intelligence. I think that was wrong.

But secondly, he was quite passive. He knew a lot. He could defend the position if pushed hard, but he was quite passive in the to and fro inside the administration. And as a result of that, the administration was really run by Deaver, Baker, and Meese. It wasn’t that he didn’t make decisions, but he was the decision-maker of last resort when it got down to two irreconcilable but easily separable choices. But those are about the only choices he made, and I don’t necessarily fault him for that: Jimmy Carter was in all the details, making all the choices, and that was totally unsuccessful.

So generally what I liked about Ronald Reagan was he had a tremendous temperament. He had a willingness to listen to people. He gave people an opportunity to do their job. So there are pluses and minuses, but I think a lot of the conventional stereotypes, negative or positive, really don’t capture the more complex reality that existed.

WOODS: All right, let’s jump ahead to the present day, then. What is your assessment of the economic picture today? That, of course, is what you get asked every time you’re invited on the radio: where are things today? Especially given that we have heard some people say, look, you doom-and-gloomers, things are turning around, and things are turning around under the aegis of Janet Yellen and Barack Obama, so on what ground can you complain? Are things turning around?

STOCKMAN: Well, the point is it’s exactly what they were saying when we had this allegedly Goldilocks economy in 2005, 2006, and 2007. You can go back and replay some old CNBC tapes, and you’ll get the same numbers coming up on the unemployment rate or the number of existing homes that were sold last month. We’re in a serial bubble cycle created by the central banks that seem to last four or five years. They inflate the financial system to a fare-thee-well as Greenspan did during dot-com, as Greenspan did with Bernanke’s help at the end during the housing and credit bubble, and as we’re now doing during the Bernanke, Yellen, what I call wealth effects, or risk asset bubbles. And they take a while to fully unfold. They do allow the economy to get up off the floor after a crash and revive itself. I don’t think all this money printing and zero interest rates have anything to do with the economy inching forward at 1 or 2% a year. That’s just a natural regenerative power of the private, capitalist system, even as hampered and impaired as it is by government policy. But at some point these bubbles become so fantastic — and I think we’re getting close now, if you look at valuations in all the risk-asset markets, and the Russell 2000 trading at 85 times earnings and so forth – that when they crash it creates a sudden crash of confidence, and then economic activity freezes up, and we go into another down cycle.

It shouldn’t happen. There is no reason why we have a monetary central planning agency, a monetary politburo inflating, and reflating, and reflating our financial system with cheap money, and zero interest rates, and massive bond buying. This is all wrong. We really need to go back to the banker’s bank where we started our conversation this afternoon. And I can tell you one thing: if we did, we wouldn’t be going into the seventh year running of zero interest rates effectively in the money markets. They were set there by the Fed, the fed funds rate, which everything else prices off from for short-term interest rates in December of 2008. And here we are mid-2014 entering year six of the so-called recovery, and they are still at zero. In a free market, where savers and borrowers were meeting and finding the requisite price, the market would be clearing at a lot higher levels, and with higher interest rates there would not be nearly as much carry-trade speculation. Zero money market rates are the mother’s milk of gambling and speculation in the financial markets, and the Fed is massively empowering people to speculate. That’s why we get the bubbles. That’s why we get the busts. That’s why we get the destructive cycle that we’re in today.
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