The Scandal of Money: Why Wall Street Recovers but the Economy Never Does - George Gilder (2016)

Prologue. Winning the Debate

Humans don’t decide what to build by making choices from some cosmic catalog of options given in advance; instead, by creating new technologies, we rewrite the plan of the world.

—Peter Thiel, Zero to One (2014)

Will conservatives win the coming economic debate? The nation depends on it. We deserve to win, after all. We have the best economic ideas, so we say, aligned with constitutional liberty and the American Dream. The economy is in trouble, and after two terms of President Barack Obama the Democrats are mostly to blame.

After a crash like the 2008 financial debacle, the U.S. economy typically takes off on a seven-year boom. “Seven fat years” was the harvest of President Ronald Reagan, who entered office in the face of Cold War setbacks and sky-high interest rates, inflation, “malaise,” unemployment, and poverty.1 Pursuing similar policies in faint rhetorical disguise and correcting Reagan’s second-term hike in capital gains tax rates, Bill Clinton delivered a seven-year echo boom of his own.

The Democrats now must answer the question: Why have Americans suffered seven years (and counting) of a famine of growth—the slowest recovery from recession in a hundred years? Why are jobs increasing more slowly than the job force is shrinking, with lower growth in wages and larger gaps in income and wealth than we have seen since the Great Depression? Why are productivity growth numbers at sixty-five-year lows, down to less than a quarter of the postwar average, and business starts actually in decline?

Above all, if the Democrats have governed well, why are our young people demoralized as perhaps no previous American generation has been? Why is the real youth unemployment rate at 25 to 35 percent, even after shrinking the hours for a “full-time job” to thirty? Why do fewer young people than ever look forward to an entrepreneurial future, starting their own businesses and careers?2

The crisis we face in 2016 is a fundamental challenge to capitalism and freedom. Will seven years of failure tip America into more of what failed? Or will a vigorous case for a new economics emerge that persuades the average American to renew his faith in freedom? Winning the election requires winning this debate. Why, after seven years of the Obama economy, is the average American worker facing a declining standard of living?

To Democrats, the answers are simple. The global financial crisis arose under a Republican administration and was inherited by President Obama. It plunged the nation into a “Great Recession” marked by an oppressively skewed distribution of wealth, with an estimated $5 trillion in bonuses for bankers over seven years and unemployment soaring above 10 percent in the face of a shrinking percentage of adults in the workforce.3

Like most financial crises in history, they argue, this one required active governmental interventions, such as extended unemployment benefits and financial stimuli. But an $800 billion stimulus over three years represented less than 2 percent of the economy. As usual when there are widespread bank runs and financial turmoil, the Federal Reserve had to step in as “lender of last resort,” necessarily expanding governmental debts. Needed also was renewed regulation of systemic risks. But our debt levels remained under control compared with those of other countries and in the context of America’s world-leading gross domestic product (GDP). Under Obama, a record-breaking stock market and a thriving dollar confirmed other indications of able economic management.

Republicans respond to such claims with baffled incredulity. Yet the Democratic claims are mostly true. To the extent that the economic debate revolves around the usual indices of GDP growth and financial market revival compared with other countries and markets, the Democrats can hold their own. They argue that a more balanced economy fueled by redistributive tax and spending policy can close the growing gap between rich and poor. It can redress simmering middle-class anxieties and lower-class stagnation.

For Republicans to succeed, they first must win the debate. Today they are floundering. Many try to shirk the economic challenge. Intimidated by the media and the academy, they shrink from confronting the most devastating threats to our future. Though Republicans have more accomplished and articulate spokesmen than perhaps ever before, they have fallen into a rut of clichés and forlorn incantations that have not been fresh since the Reagan era. Although they offer inspirational anecdotes, they miss the larger picture.

Republicans have been running on tax-cut proposals since the era of Harding and Coolidge. Tax-rate reductions and simplifications are urgently needed. But again, there is no mention of the key problems of a global economy in decline—of the acceptance by economic elites of inevitable and irremediable stagnation. We have not faced the fact that the Federal Reserve’s capacity to command growth is a god that has failed.


In mid-July 2015, for example, FreedomFest, the annual libertarian gathering in Las Vegas, hosted a long-awaited “great debate” pitting Paul Krugman, paladin of liberal economics and the most popular New York Times columnist, against Steve Moore, chief economist at the Heritage Foundation and once the most popular Wall Street Journal writer.

The debate had everything. The New York Times versus the Wall Street Journal, the Ivy League and mainstream media versus Fox News and the Heritage Foundation, academic liberalism versus supply-side think-tank activism, the most prestigious voice of liberal economics versus the tribune of the Koch brothers’ libertarianism—all before an avid crowd of several thousand, pumped up by scores of speakers, just off the Vegas strip.

The topic of the debate was “How can we restore the American Dream . . . for all?”—a question central to the election of 2016. But for many of the attendees, the immediate thrill was to witness the humiliation of Krugman, famous advocate of spending, taxes, debt, and regulations, and Moore promised to be up to the challenge. In nine years and perhaps a dozen debates at FreedomFest, on a wide range of economic topics, the flamboyant supply-sider had never lost. A master on stage, pirouetting deftly in argument, juggling numbers with aplomb, dramatically unveiling stark and colorful charts, climaxing with eloquent perorations to the crowd, he was a FreedomFest inspiration. By contrast, Krugman was dour and low-key.

Moore did indeed win the votes of an audience overwhelmingly favorable to his cause. But FreedomFest impresario and economist Mark Skousen boldly conducted a further vote to determine which speaker had changed the most minds. By that measure, Krugman won. If conservatives cannot clearly win economic debates at FreedomFest, how can we win them in the all-important November 2016 plebiscite on the economy?

Moore, seeming perplexed and chastened, discussed the debate at a breakfast meeting the next morning. He had a series of further charts he wanted to show, but he had little to add to his arguments from the day before. Given the enormous ongoing stagnation of the economy, why do conservatives and libertarians currently have so much trouble winning debates with liberals on economics?

The FreedomFest audience seemed startled by the strength of Krugman’s arguments. While Moore compared the dismal sluggishness of the current U.S. recovery with the brisk three-year turnaround of the Reagan years, Krugman pointed to larger trends around the world. All countries historically have been slow to recover from severe financial crises, particularly when they cannot lower interest rates, already nearly zero when Obama assumed office.4 Reagan benefited from Paul Volcker’s high interest rates, which broke the inflation trend and provided a powerful lever to promote growth. Obama followed George Bush, who entered office resolved to enact the conservative agenda, lowering tax rates, disciplining government spending outside the military, and appointing many regulators with deregulatory goals. But after a few years of faltering growth marked by a rush of investment into real estate and banking bubbles, the result was a devastating crash in 2007.

Government spending, said Krugman, was not to be feared. In his vivid chart, countries escaped from the recession after 2008 more or less in proportion to their increases in government spending. Second only to dirigiste China, the United States under Obama was one of the best-performing economies in the world. But even China was now in a slump. Comparing economic growth rates under recent American presidents, Krugman showed that the supposed tax-hiker Bill Clinton was the runaway winner, Reagan second, and Obama third, ahead of both Bushes. Krugman conceded that tax policy alone did not explain the comparative data. But perhaps activist government is not the main enemy of the American Dream after all.

According to Krugman, a key test came in the predictions of conservatives and libertarians after the 2008 crash. As he pointed out, nearly all expected the huge increases in government spending and debt to foster runaway inflation and interest-rate spikes that would crash the dollar and bring down the U.S. economy. Many expected the Chinese to bolt from the American currency. These predictions still echoed at FreedomFest 2015 and across the floor of exhibits. Everywhere doom was predicted for the dollar.

As Krugman mildly pointed out, after more than six years of Obama, all these predictions were proving wrong. The dollar was actually surging in value, the stock market was near all-time highs, and interest rates remained near historic lows.

At the post-debate breakfast, the consensus seemed to be that with another half hour, Moore would have conclusively prevailed at last. He had more charts to show and a devastating statement by Krugman in 2003 calling for Federal Reserve Chairman Ben Bernanke to engineer a “real estate bubble” (be careful what you ask for). He would have liked to hear Krugman answer that one. Perhaps all is well with conservative economics after all. Or perhaps something fundamental that is missing can be added.


The most important question that both sides miss is why the Fed’s allegedly fearsome economic tools are failing to address the demoralization of Main Street, the debauch of Wall Street, and the doldrums of transformative innovation in Silicon Valley. When capital runs with deep knowledge into effective channels of enterprise, the opportunities of Main Street and the average family multiply. A closed loop of Washington, the Wall Street elite, and Silicon Valley’s increasingly political rock stars may enrich the One Percent but does little for America.

Addressing a summit of Republican and libertarian critics of the Fed at Jackson Hole in 2015, Steve Moore calculated that an economic revival comparable to Reagan’s “seven fat years” would have increased today’s GDP by some $4.5 trillion and raised today’s average personal incomes—seven years after the crash of 2008—by some $15,000. With an extra $4.5 trillion a year, Moore asserted, we could satisfy any reasonable needs for safety nets and social niceties.

Many Democratic intellectuals, to be sure, see such growth as an unjust burden on the planet, skewing the climate, bloating the incomes of the “rich,” offering a paltry “trickle down” of benefits to the poor, and glutting the nation with unworthy trinkets and addictions.

Behind this clash of cultures, however, demand-side Keynesians and fist-clenched socialists share with conservatives four fundamental beliefs: (1) the economy is chiefly a system of incentives that motivate work, savings, and investment; (2) economic and monetary policy has the power to define the incentives and guide the growth; (3) consumption spending is “70 percent of the economy” and the driving force of economic expansion; and (4) at the center of the system is the human being as a rational respondent to his incentives, a Homo economicus reacting to carrots and sticks, responding to stimuli, robotically pursuing pleasure like a psyche in a Skinner Box.

It makes little difference whether you exalt this economic agent as a heroic Randian individual or pity him as a dehumanized cog in the capitalist machine, whether you aggregate him into a Marxian class or agglomerate him into a “grotesque consumer culture.” Whether you approach him from the left or the right, you’re treating the human being as a passive tool of his environment rather than as an active creator in the image of his creator.

On both sides, the prevailing model of the economy is false. Driving America’s jobs and wealth, progress and productivity today are not appetites for consumption or social programs or highway infrastructure or educational subsidies or pavilions of Trump Towers, but a half-century efflorescence of creativity in information technology: computers, microchips, software, communications, and Internet applications. Pervading all segments of the economy, from agriculture to healthcare to government, and dropping in price by at least a third with each doubling of sales, these innovations account for 60 percent of stock market capitalization.

Information technology makes Apple and Google the world’s most valuable companies with the largest market capitalization. It is directly responsible for some 17 percent of all jobs and indirectly raises the pay for most of the rest. It shapes such industries as healthcare, energy, retailing, finance, entertainment, and defense. It provides the efficiency to compensate for the mostly rigged or rising prices of an expanding array of government-regulated goods and services, from education and healthcare to banking and bandwidth, housing and social services.

Yet the prevailing economic theory has nothing to say about this creative upsurge in innovation. In the ventriloquist models of politicians, growth evolves from expanding population, incremental investment, material resources, government infrastructure, and education, all spurred by that “grotesque and insatiable culture of consumption”—aggregate demand. Declining prices are not evidence of a learning curve that creates new wealth but a sign of dreaded “deflation.” Innovation and creativity are exogenous, coming from outside the economy, mostly from government programs and governmentally dependent universities.

At the heart of these ideas you will find that venerable but imaginary creature Homo economicus—“economic man,” the rational pleasure-seeker responding to his environment. A better name might be Homo sumptuarius, man the hedonic consumer, whose economic choices express his self-interest and appetite for pleasure. Economic theorists caricature as greed any human drive, ambition, and entrepreneurial energy beyond what is necessary for bare subsistence. Since Homo economicus or Homo sumptuarius could never build that new computer architecture, find that biotech peptide, or design that wireless network, we tell the entrepreneur who did that in fact he “didn’t build that.”

Surprisingly, Homo economicus is not a notion of the Left. Many conservatives sport Adam Smith neckties as emblems of their reverence for the founder of the science of economics. Yet Adam Smith was the source of the idea—inspired by the Industrial Revolution’s steam engines, pin factories, and other mechanical apparatus—that the economy is itself a “great machine.” Every cog and gear, he said, is precisely adapted to its role and purpose. A cog or gear is even less creative or informative than the rational pleasure-seeking economic man. Keynesian economists translate the great machine into an interaction of massive aggregates of demand, supply, and money.

Most alert to the problem, the Austrian school of economics, led by Friedrich Hayek and Ludwig von Mises, laboriously makes room for human creativity and entrepreneurship, “opportunity scouts” and arbitrageurs.5 Then they explain it all away as a function of “spontaneous order,” apparently restricting human beings to finding price differences and “assembling or reassembling chemical elements” in an effort to restore “equilibrium.” We are back again to the great machine purring away as deterministically as the stars and planets of Newton’s galaxy.

In recent years, some pioneers of what is called behavioral economics—led by the psychologists Daniel Kahneman and Amos Tversky—have caused a stir by challenging our faith in Homo economicus.6 Kahneman won a Nobel Prize. But astonishingly enough, the behavioralists question the concept only to diminish it further, by denying the rationality that makes the machine operational and its outcomes just.

The putatively rational economic agents—who’da thunk it?—turn out to harbor “biases” and habitual modes of thought, “anchoring” on previous inputs and prices, over-projecting from past experience into the future, overreacting to losses, succumbing to misleading contextual cues. (Did no one know this before?) All these behaviors cause economic players to make bad decisions, undermining their utility for the great machine. The biases, fixations, overreactions, and manias skew markets and perpetuate perilous disequilibria. The great machine sputters, the invisible hand jitters spastically, and recessions, crashes, panics, and depressions ensue. In such markets, justice and growth together fail. Justice, therefore, must be enforced by outside experts, popes, and professors, who much of the time reduce it to a matter of equal distribution determined by envy.

None of these theories has anything very useful to say about technological innovation. To explain the integrated circuit, the laser, the wireless spectrum, the geosynchronous satellite, the Internet software stack, the fiber optic line, the polymerase chain reaction (PCR), the ATM, the carbon nanotube, the defibrillator, or the smartphone teleputer, you must make an imaginative leap into a hierarchical universe, carrying the theory far beyond any deterministic great machine, behavioral skew, or interactive interplay of supply and demand.

Democratic politicians are deeply vulnerable on these issues because they treat innovation chiefly as an issue of justice. They take pains to deny credit to its protagonists: “You didn’t build that,” snarl Barack Obama and Elizabeth Warren. They and Bill Clinton’s labor secretary Robert Reich and most university faculty members insist that today’s technological innovation is little more than the fruit of some obscure 1950s research program at the Defense Advanced Research Projects Agency or the National Interstate and Defense Highways Act. Bernie Sanders wants to quadruple tax rates on investment, taking 90 percent of the yields of innovation. Hillary Clinton wants to double the capital gains tax.

Most Democrats see robotics and other advancing computer technologies as job killers rather than job creators, as if more workers would be employed if they were less productive. They see energy production as chiefly a source of pollution, to be suppressed by the Environmental Protection Agency (EPA). They are transforming the Internet into a sterile and litigious public utility regulated by the Federal Communications Commission. They are making the banks into a protectorate of the Federal Reserve Board, which they are turning into a fourth branch of government. All these Democratic extensions of government thwart entrepreneurial job creation. They are the chief threats to the middle-class family’s economic well-being.

To prosper, Silicon Valley, Main Street, and Wall Street need to work together. But our misplaced faith in the power of the Federal Reserve to order growth into being by manipulating its monopoly money has led to the capture of Wall Street by Washington and the consequent starvation of Main Street and decay of Silicon Valley. Understanding the real sources of our economic crisis requires surrendering our faith that the Fed has the answers. This is the key not just to political victory but to restoring the American Dream.