Reagan Admin official: This is the economy’s biggest threat

Reagan Admin official: This is the economy's biggest threat

Few people on earth understand US macroeconomic policy quite like David Stockman. As Director of the Office of Management and Budget during the first years of the Reagan Administration, Stockman was a key figure in creating the modern tax code that sparked America's economic turnaround in the early 1980s.

Even though the markets are at record highs and interest rates at three-month lows, Stockman sees one giant threat ahead for the US economy. Stockman spoke with Talking Numbers about the Fed and what he thinks it's doing wrong.

(To see this interview watch the video above or read the transcript below)

Amanda Drury, Talking Numbers: "Can we ever exit our QE (quantitative easing) program smoothly? And, if we can't achieve that, at what point will it really matter to the market?"

David Stockman: "I think [the Fed is] in a dead end. They've painted themselves into a corner. Zero interest rates now have been in place since December 2008. We're headed towards seven years if we take them at face value that they're not going to raise interest rates until 2015. So, this is sort of a made-up doctrine by the seat of their pants. Ten years ago, no one would have thought this was remotely rational not withstanding some of the weaknesses we've had in the economy. But, after all, the GDP is now higher, we're five years from the crisis, and yet somehow, we seem to be addicted to stimulus in just a crazy way. So, I think they're trapped and I think it's a very great danger to the economy because at some point, they're going to have to shift. And, when they do, there's going to be a day of reckoning of pretty serious magnitude."

Drury: "You're clearly very critical of the Fed's programs. But, just to play the devil's advocate, since we've enacted QE, the stock market is up – we're sitting around record highs again – the unemployment rate down. Why is it so bad?"

Stockman: "It's so bad because, essentially, the zero interest rate and the massive bond purchasing have very little to do with the slow recovery that we've had in the economy. I think that was just a natural recovery after we had the big liquidation of labor and inventory at the time of the crisis in the fall of 2008. Nevertheless, we barely crept forward at 2% real GDP growth for more than four years – weakest recovery we've had in the post-War period after the deepest recession. The fact is most of the money that they're printing never gets out of the canyons of Wall Street. It goes into speculation. It goes into financial engineering and leverage, stock buybacks, and everything else. That drives the indices higher but it's really not doing much that's constructive for Main Street and it's only hooking the economy on ultra-low interest rates that aren't sustainable."

Drury: "So, if you were at the Fed right now, what would you be doing? How would you be doing it differently?"

Stockman: "Well, I think that it's long past the time that they stop the 'quantitative easing'. When you buy $85 billion of bonds a month, you are distorting the market. They haven't repealed the law of supply and demand. So, therefore, long-term interest rates on the Treasury and everything that prices off of them – which is most of the fixed income world – is artificially set today by the Fed's intervention. And, therefore, the market is being misled as to the true cost of borrowing and it creates enormous distortions."

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