Chicken Little

Economics, like politics, has its apostles of hope and its apostles of worry. There are those who pursue policies meant to benefit the commonweal and those who believe only in the sanctity of credit itself and the paper that gets backed by it. The former believe that easy credit creation benefits most people and should be pursued. The latter fret that too much easy money could create inflation and, ultimately, a debasement of private capital. At times the camps take on a fiery Populist versus cool elitist cast, with the first contingent seeming irresponsible and the latter appearing heartless. Both would claim to be doing the right thing at all times for the economy they want to preserve, promote and protect. Both have chapters of history on their sides.

The two viewpoints have always had their champions. In the latter portion of the 20th century, amazingly, they appeared in downtown Manhattan, literally diagonally across the street from each other, at Salomon Brothers and Goldman Sachs, at one time the twin pinnacles of Wall Street. The antagonists couldn’t have been more different. At Salomon Brothers, Henry Kaufman represented the public face of the multitrillion-dollar bond market. He was the voice of doom constantly expounding on the hazards of growth and deficit funding. He would preach certain disaster if strict, conservative rules of credit were not adhered to. While his firm profited mightily from his forecasts, he held fast to his predictions because he had seen the hazards of what too much debt could mean to a country or a people. In his memoir, “On Money and Markets,” we learn how his boyhood vision of Germany, wracked by debt, succumbed first to inflation and then to Hitler’s tyranny. That object lesson is the central theme of this memoir, with Kaufman spending the rest of his life fearing that another apocalypse could be born of excessive debt and credit creation. As we watch Kaufman rising from credit clerk to credit seer, we learn that he has always seen the hazards of growth as far outweighing its gains.

Across the Street, at Goldman Sachs, stood Robert Rubin, who, as head of the most powerful firm in finance, quietly urged growth, intelligent growth within means but, ultimately, growth to benefit the greater society. He knew it would encompass risks, in both domestic and foreign markets. He knew that unbridled growth would lead to reckless borrowing and ultimately collapse, but he thought that it could be managed and that it was worth the risk to try to put the United States on a path of growth without triggering inflation.

For much of the 1980s, Kaufman’s view, however credible it may have been, was largely ignored. Everybody from the government to private industry took on too much debt. It was Kaufman’s nightmare. Ironically, it was the key to Salomon’s profitability, as the firm benefited tremendously from the profits generated by trading and issuing bonds.

In the 1990s, Rubin went to Washington, first as economic policy director for President Clinton and then as his Treasury secretary. He did not pontificate about the economics of worry; he simply and quietly, through his own strength and knowledge, formed a consensus to wipe out the United States’ debt and return the credit markets to the private companies that needed the capital. He knew from his years of profiting from the trading of the U.S. government that the nation would never have full employment or a prosperous inflation-free economy as long as those leftover Reagan administration budget deficits remained sky-high.

Rubin engineered a strategy of growth without inflation, something that Kaufman would not have thought possible without its triggering some sort of Weimar epidemic such as the one he lived through as a boy. Rubin executed a plan that can only be described as the economics of optimism: If you eliminate the government as a significant borrower, you take out the most profligate debtor, and that will lower interest rates dramatically and let real growth bloom.

That chain of events, the elimination of the federal budget deficit through higher taxes and a decline in government spending and better management of the debt issuance of the United States, led to an unprecedented boom in jobs, the bull market and the increase in the gross domestic product. Once the Treasury stopped disrupting the bond market with its mammoth financing needs--Rubin sought to finance much more of the debt short term while he used deficit reduction to lower interest rates long term--the Federal Reserve was free allow short-term interest rates to fall and spur a stock market that would finance a technology boom that we all plainly see the results of and can enjoy.

Ironically, the changes ended the bountiful profits of the government bond portion of the fixed-income departments of both Salomon and Goldman Sachs as the government no longer needed overpaid agents to merchandise large tranches of debt.

Somehow this miraculous transformation, one that ended the most reckless financial practice in our nation’s history, the overwhelming of America’s capital markets by the federal government’s incessant need for deficit financing, didn’t make it into Kaufman’s new book. This dry tome, devoid of any of the tension between these two camps, has a terrible scolding quality to it. It focuses on the dark and harrowing part, the giant federal deficits, without ever mentioning the successful denouement. Kaufman repeatedly points out that the system will collapse if restraint is not shown in the credit markets, and he systematically ignores the entire point of the last 10 years: Growth without inflation in this country is not only a possibility, it is an empirical reality. But Kaufman refuses to acknowledge it even as a possibility.

Kaufman begins by giving a brief and sterile overview of how he came to earn his hard-line saturnine stripes. He traces his history from small-time credit officer to Federal Reserve gnome to young hotshot at Salomon Brothers to ultimately a bond guru who could move markets with the faintest utterance. How fascinating this book could have been had Kaufman been willing to talk about the behind-the-scenes of these big calls. Did Salomon short the bond market before his grave prognostications? Did the firm buy bonds ahead of his call that bonds would rally? Did it profit from his brilliant calls, which are often linked with the beginning of the 1982 bull market? He doesn’t tell us, unfortunately, and is bloodless in his description of those heady days when he could move markets with his mildest musings.

I am not asking for “Liar’s Poker” here, the entertaining Michael Lewis book about his brief stint in bonds at Salomon, but if you are going to call something a memoir, give us something worth remembering. Alas, we get no insights into the inner sanctums of finance during that bond heyday. Kaufman desultorily delves into the politics that led to his 1988 resignation from Salomon Brothers, at the time a shocking development that roiled Wall Street. Along the way he drops a weird charge that had Maurice Greenberg from the giant reinsurer American International Group been able to purchase a stake in Salomon Brothers instead of Warren Buffett, things would not have ended so nastily. As if poor Buffett needs to hear such a charge after the rough ride his company’s been having lately.

And then Kaufman returns again and again to the charge that we will all have to pay for whatever bountiful financial times we may be having now with a lean or putrid harvest some time in the future. He suggests the collapse that awaits us would be similar to the Asian collapse of 1997. He cites the Long-Term Capital Management debacle of 1998, in which the firm borrowed more than $100 for each dollar under management, allegedly to make risk-free bets, and ended up holding the free world of capitalism hostage before a major bailout was required. Kaufman hints that this financial nightmare was the outgrowth of arrogance nurtured in the participants during their time at Salomon Brothers and could be dwarfed by coming tragedies if we don’t somehow instill financial discipline.

Lurking always as a heavy motif in “On Money and Markets” is the threat of another Germany of the 1930s. If Kaufman can somehow keep alerting us to the possibilities of such a catastrophe, it seems, he will have fulfilled his destiny. One would think that we are just a heartbeat away from men in ragged suits selling apples from pushcarts, if not from the Brown Shirts overturning those pushcarts on the way to seizing the government.

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Unfortunately, such a view misses the reality of the weakness of the debt boogeyman when pitted against the strength of our dynamic capitalist system. Put simply, had Kaufman not been so focused on the negatives, he would have seen that the system survived the horrid budget deficits, the savings and loan debacle, the Asian and Latin American meltdowns and the collapse of Long Term Capital. Prosperity is not chimerical. The growth of America is not a false or fleeting possibility, it is a reality that has produced 10 million jobs during a period when all of Europe produced 500,000 jobs. It produced great investable wealth and an actual decline in the deficit and lower rates than Kaufman could have imagined, but all this goes unrecognized in this dismal scientist’s take on the greatest wealth creator that has ever existed in history.

Ultimately, Kaufman’s legacy will be that of the prophet of doom during a period when doom just didn’t come. It, and “On Money and Markets,” just can’t be reconciled with what truly happened to the United States in the final portion of the 20th century. Certainly some day, some financial calamity will occur, but then again, as another economist of a different period intoned: In the long run we are all dead. In the meantime, let’s give this economy its due. The times are simply better than Kaufman can even imagine, let alone see.