“The Fed is out of control,” exclaims David Stockman – perhaps best known for architecting Reagan’s economic turnaround known as ‘Morning in America’ – adding that “people don’t want to hear the reality and the truth that we’re facing.” The following discussion, with Harry Dent, outlines their perspectives on the looming collapse of free market prosperity and the desctruction of American wealth as policymakers “take our economy in a direction that is dangerous, that is not sustainable, and is likely to fully undermine everything that’s been built up and created by the American people over decades and decades.” The Fed, Stockman concludes, “is a rogue institution,” and their actions have led us to “one of the scariest moments in our history… it’s a festering time-bomb and we’re not sure when it will explode.”

Full Discussion:

David Stockman: People don’t want to hear the reality and the truth that we’re facing. But I think there is an enormous appetite out in the country to get a different perspective than what you have from the media day in and day out, so I say the fed is out of control. Its balance sheet is exploded. It’s printing money like never before.

Zero interest rates for 70 months have basically destroyed the pricing function in the financial markets. I said that as a result of this, Wall Street has become a huge casino which basically rewards gamblers, but it is not functioning as a capital raising, capital allocating instrument, which really is what the financial markets should do in a free market system. I warned about the size of the federal debt. I’m an old budget director from the Reagan days. We had a trillion dollar national debt, a 3 trillion economy when I started. Today, it’s 18 trillion. Eighteen fold gain in the last 35 years versus maybe a fourfold gain in the economy. So all of these trends are taking our economy in a direction that is dangerous, that is not sustainable, and is likely to fully undermine everything that’s been built up and created by the American people over decades and decades.

So people don’t want to hear the warning. They don’t want to hear the truth in the establishment, in Wall Street, in Washington, but I think out in the country they must.

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David Stockman: Well it’s obvious that Wall Street is addicted to cheap money and unlimited flow of new liquidity into the markets. Traders can then borrow money on an overnight basis for five basis points, which is nothing. Buy anything with a yield like a ten-year or five-year bond or speculate in stocks that they think might be going up or even get fancier and go into derivatives or commodity futures or whatever. And then capture the profit or the spread between the cheap money that the fed is putting into the overnight market and the yield or profit they’re making on the asset, and they’re leveraging way up.

You know, 90 percent, 95 percent in many cases. So obviously, the whole financial market is dependent on this, but it comes at a cost. It is destroying savers in America. If you worked a lifetime and saved $100,000.00, you’re making $400.00 a year in interest from a lifetime of savings. I think there will be a revolt sooner or later of the American public against this disastrous crushing of the saver in order to essentially accommodate Wall Street’s appetite for liquidity.

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David Stockman: Well you know, the problem is the fed, I’ve described, is a rogue institution. It’s operating beyond any of the legislative intent or statutory authority that’s been given to them over the years. They have essentially become a national monetary planning agency that has decided they can drive the daily, weekly, monthly movement of the economy by manipulating interest rates and the yield curve by putting a put under the stock prices by essentially trying to drive the entire 18 trillion or 17 trillion US economy from Wall Street. That is fundamentally at variance with the requisites of a healthy capitalist economy. You need an honest financial market. Not a manipulated one.

You need price discovery by people that have their money at risk, not the central bank.

Harry Dent: Actually, it’s a centrally planned economy, isn’t it?

David Stockman: Right, exactly.

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David Stockman: Well I would like to think so, and they talk a good game, but unfortunately when push comes to shove, they’re in the consensus with everyone else in the beltway in Washington and are unwilling to take on the hard issues. We are borrowing still $600 billion in the last year, six years after allegedly the great recession ended, and we are setting ourselves up for trillion dollar deficits again, the next time the economy stumbles or we have a recession or some other dislocation. The fact is the fed is not abolished the business cycle. The fed has not made the world completely safe from these kinds of dislocations. So therefore, we need to look at what’s driving this huge deficit, and the answer is big entitlements and big defense spending, and the republicans are unwilling to take on the Pentagon. They want more, and they’re afraid to take on Social Security and the entitlements because they believe that is going to be problematic politically.

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David Stockman: Well, it’s one of the scariest moments I think in our history, but also we need to recognize we’re in uncharted waters. No central bank has ever printed this much money this long, kept interest rates at zero, fueled so much speculation. Not just here, but worldwide. Not just in the normal stocks and bonds, but the whole shale boom, for instance, in the United States was massively funded by cheap debt based on oil prices that weren’t sustainable, and now that’s all coming unwound. We have never had deficits of ten percent of GDP back to back, or even still four or five percent four or five years into a recovery.

We have a runaway budget where the population is getting older and older, 10,000 people are retiring every day. Nothing is being done about Social Security. It’s a festering time bomb, and we’re not sure how it will explode, but we know it isn’t sustainable. We have a Wall Street that is more addicted to pure overnight gambling and trading and speculation for the ultra short run that is driven by robo traders, the so-called HFT money, like never before. It’s unstable. That’s why we see things happen like the overnight 40 percent gain with the Swiss Franc when the Swiss National Bank pulled the pay.

Forty percent overnight – not overnight, but in a couple of minutes or seconds when there were hundreds of billions of short positions in the Swiss Franc. All of these things have never existed simultaneously, not only in the United States, but worldwide. All the central banks are doing it. We’re reaching the point where it’s unsustainable, things are going to give and break, but the good thing is it’s going to be more a disaster in the financial markets in my view, less some kind of Great Depression impact on Main Street. It will be difficult on Main Street, but Wall Street is in the gun sites of this disaster coming.

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David Stockman: I agree. In the long run, we have to get off this debt addiction. We need to get back to sound finance both in government and households, but beginning between here and there is going to cause enormous pain for millions of households who have been herded into risky investments, junk bond funds, stock market funds, high flying biotech stocks and on and on because they were told it’s the only place to be.If you put your money in a CD, you get no return. If you put your money in a safe bond, you get almost no return. Now when the big reset, as Harry calls it, happens, and the stock market drops by large magnitudes, 50 percent, more, those people who were herded into these risky investments late in life – Because remember, we have the baby boom, you know, heading towards their retirement homes, are going to be badly hurt at a time that they can’t recover, and it will be a massive injustice that is being done by Washington and the fed to this current generation of middle class Americans. That will produce, in my view, a political reaction, a political revolt that will begin to say, “What’s wrong here? Who believed that printing money out of thin air can make a society wealthier? Why did we do that? Who believed that we can actually create jobs and new economic output on Main Street simply by having the fed press a button and create another billion dollars?”

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David Stockman: Yeah, I agree with that, and the point to remember is that massive money printing by central banks on a worldwide basis is inherently deflationary for two reasons. One, it fuels massive financial speculation. When we talk about speculation, we’re talking about professional gamblers who borrow 95 cents and use that borrowed money that they pay practically nothing for to buy stocks or bonds or commodities or derivatives or biotech stocks and so forth as I indicated. All of that buying power is artificial. That is not coming from production today, real effort in the economy. That’s coming from newly minted credit.

So it takes asset prices to unreasonable, unsustainable levels. They crash, and that creates a negative economic cycle. Secondly, massive money printing makes capital and debt too cheap to the real sector of the economy. So therefore, massive capital investments are made on the basis of cheap cost of capital, not on the basis of the likely return or sustainable return over time.

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David Stockman: Yeah, a famous American economist once said anything that’s unsustainable tends to stop. My argument is that we’re at the stop point. The fed has been printing money like there’s no tomorrow really for 25 years since Greenspan took over in 1987. They are now at the point where their balance sheet has become so bloated, so enormous that even the people running the fed are confused about what to do. They’ve painted themselves into a corner, and they’re playing it by the day, and they’re going to make a huge mistake. So the money printing thing is near an end.

Secondly, our political system has become totally non-functional. We have a lame duck president who can accomplish nothing, a congress that is totally paralyzed, meaning that before 2017 at the earliest, nothing will be done about our fiscal and entitlement explosion. Finally, the American people have believed falsely that all of this is going to work out. It’s not going to. When they find out that the adults so called in Washington had no clue what they were doing, there is going to be a collapse of confidence, and that will flow into the system as well.

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So it seems like this bubble bursting is inevitable. How much time do we have? Is it years, months? How will we know? Are there some clues we can look into to make sure that we’re prepared?

David Stockman: There’s really no magic numbers here, but it’s remarkable that these central bank driven bubbles tend to peak after about six years. The dot com bubble started really in mid-1994 with the famous Netscape IPO. It crashed in March 2000, six years. The housing bubble roughly started in 2002. It totally crashed in 2008. Six years. The meltdown on Wall Street bottomed in March 2009. Add six years. 2015. I think we’re at the end of this bubble simply based on the fact that they can’t expand forever. They reach an asymptotic peak, and then confidence is lost, a catalyst occurs, a black swan appears, the selling begins, and there’s nothing under this market. There is no safety net under this market.

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Is there anything that can save us?

David Stockman: Yes, there are, and in the short run, that will be painful. There will be great dislocations, both in the financial markets and the real economy. But in the long run, that’s a good thing. We have become so dependent on government, we have come to believe that the Federal Reserve drives the economy hour by hour, day by day. None of that is historically true. Real wealth, real prosperity comes from the sweat and from the enterprise and from the invention of people on Main Street, not the politicians on Wall Street who are on the central bank. So I think the big inflection point that we’re facing is when the big crash comes, on the other side, maybe we can get back to the private enterprise system and the kind of family self-reliance and thrift and prudence that our prosperity was built on 40 years ago.

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David Stockman: Well in The Great Deformation, I said, “We’re heading towards a day of reckoning. This isn’t sustainable.” It’s happening in real time, and in the updates, what I try to do is focus on the catalyst events, the catalyzing forces that will warn us when we’re really getting to the edge of the cliff.

That is the central banks. Japan’s central bank is out of control. I watch that. It’s important to know what happens there because if the great money printing debt experience in Japan finally fails, it’s going to be noted in markets all around the world. I watch the ECB, European Central Bank. It is divided between Germans who want to try to maintain some semblance of some money and the rest of Europe that would like to print and drown themselves in debt as far as the eye can see. It’s important to watch China, which is a giant house of cards, that’s on the verge of collapse, and that will ricochet around the world in terms of the countries that supply it. Australia, Korea, the so-called emerging markets, and what it’ll do to the theory, which I think is false that China is the engine of growth in the world, it is not. It is the biggest speculative disaster in human history.

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David Stockman: Well, the crisis is unfolding by the day. It is not too late to start preparing right noW. Now is the time to begin to save if you can and minimize your outlays for unnecessary luxuries. This is going to be a devastating crisis, and people will be happy down the road if they take the steps to prepare today.