Home > The Merk Perspective > Merk Insights > February 2nd 2004

The Price of Loyalty: a Commentary

Axel Merk, February 2nd 2004
This article was written by Merk Investments before the Merk Hard Currency Fund was launched.

Former US Treasury Secretary Paul O'Neill's inside perspective to the current Bush administration as portrayed in Ron Suskind's book The Price of Loyalty received significant public attention, among others because of his acute criticism of President Bush's lack of economic understanding. We provide our analysis focusing on O'Neill's and Greenspan's failures to promote fiscal discipline; we also offer our input as to how the US economy could allocate its resources more effectively to promote a healthier US job market.

Last week, we wrote a letter to the author that we reprint below, subject to minor editing for clarity:

Dear Mr Suskind,


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thank you for your comprehensive coverage of Secretary O'Neill's insights to the George W. Bush administration. It provides a rare and most valuable complement to the information available from the media.

Below are some of my thoughts and comments as I read through your book. Maybe I can provide some insight that may be of interest to you and Secretary O'Neill.

First, let me start out saying that I most appreciate Mr O'Neill's focus on what he calls a "broken process". Unfortunately, too many believe that if one disagrees with a politician's, or even a president's actions, one must favor "the other" party. Mr O'Neill demonstrates, among others, that one can very well be a Republican but not agree to a blind application of supply side economics. In discussions with friends, I have the feeling that anyone in favor of spending money to boost the economy must be a Republican, and anyone else a Democrat. Where have we come? It used to be that Democrats used to have tremendous spending plans (social security, Medicare...), and that calling for fiscal prudence was a Republican domain. And Clinton has become the god of fiscal management, although much of his achievements were due to the fact that he couldn't get his spending plans through Congress.

And that's partially where the biggest problem of the current administration lies. Bush ran as a "uniter", and he is more successful at it than anyone would have dared to assume. As soon as Bush is in office, he declares that the "economy is in serious trouble" - and Mr O'Neill agreed that "alarm in some quarters [..] could justify swift action" (p55). By creating the sense of urgency, it was easier to pass the tax cuts. In my assessment, Bush was a little too good at it and contributed to the economic slowdown by 'talking down' the economy. Similarly, the events of 9/11 caused such a shock that Bush was able to get the Patriot Act passed in record time. Without commenting on the details of the merits of these and related proposals, the process of pushing through legislation with fear ('economy in serious trouble', patriotism) is risky. The risk being that you have undesired side-effects, notably the scaring away of the all important entrepreneurial spirit that makes this country so attractive.

Secretary O'Neill talks extensively about the secret pact with Chairman Greenspan, how the two agreed that fiscal discipline must be preserved. Mr O'Neill was overrun by President Bush's style, and unable to fulfill his pact. He also overestimated the drive Alan Greenspan would have to help push for a fiscally prudent agenda. It is my assessment that Mr Greenspan has survived for such a long time in Washington that he at times is too accommodating - not because of ill intentions, but because he seems to be seeing his role more as a support role to whatever fiscal policy is decided upon, rather than as a policy setter. As you write, Greenspan warned that if he endorsed the tax cut, he would "throw fiscal responsibility out of the windows" (p61) - Greenspan did suggest limitations, but he, too, seems ill-prepared to stand up against an administration that is steaming ahead full steam, picking and choosing those aspects of legislation that make tactical sense only. Greenspan was content to play an Adviser's role, but 'knew better' than stand in the way of policy makers.

As you point out, President Bush seems most interested in tactics, not analytics (p117). There are positive aspects when top managers do not get bogged down with details, but as you suggest, there are serious problems with "not negotiating with oneself" -- I cannot help but get the feeling that to Mr Bush, running this country as if it were a mission to complete campaign promises (e.g. p153), and to keep an apparatus around that makes it appear as if the entire administration is working together - the thank you notes (p248) mentioned (and unprecedented media management in general) show that choreography is all important . Because politicians have such widely differing views on economic policy, any policy must be ok, and if it is according to Bush's ideology, then that's the one to be pursued. The lack of in-depth understanding of the potentially devastating effects of the wrong policies are ignored (because they are not understood) for the sake of pursuing tactical goals.

As was pointed out in your book, "a dollar invested is multiplied by its return on investment, bringing more stimulus on balance, than a dollar consumed" (p112, quote by Hubbard). If we combine this with the fact that the consumer was not slowing down his (or her) spending, then what the country seems to have needed was more a corporate investment stimulus than a consumer stimulus. The stimulus theme came up again after 9/11, when a group around O'Neill cautioned that the facts may not call for "enormous additional tax cuts" (p194).
In my assessment, this stimulus turns irresponsible if one considers the escalating consumer debt. A few months ago, I had discussions with some Fed economists who had redefined the household debt service payment ratios, http://www.federalreserve.gov/releases/housedebt/default.htm . What shocked me at the time was how the economists praised the new methodology to encompass the increased "sophistication" and "efficiency" consumers have by finding ever more ways to buy goods and services on margin rather than purchasing them outright. The obvious risk, of course, is that this super-efficient consumer is ever more sensitive to interest rates. Mr Greenspan not only does not seem to have tough words for the government, but he is complacent about the consumer, too. The obvious answer is that with US GDP ever more dependent on the consumer, it is simply politically not wise to force the consumer to become more financially prudent. While I see the risks of reigning in the consumer, recessions until the early nineties were part of the normal cycle, and only recently have recessions become an evil to be avoided at all cost. A lot more can be done to strengthen the consumer's long term health than strangling him or her: in the UK, the FSA is very aggressively going public about the lack of understanding consumers there have about the risks of rising interest rates in a high-debt society. Lots could be done, but the issue is not addressed at all, likely causing much more severe problems down the road.
Mr Greenspan seems to think (p63) that debt, even high debt, is preferable to cash for a government, as it takes the politics out of government: if you can't afford programs, you will have to stick to your debt.

Let me mention a policy initiative that I do not see covered, either in your book, or by either political party, although it seems all too obvious and would be "all American". Very simplified, the main issue we are facing is that we have a huge stimulus through tax cuts, military spending, foreign purchases of US Treasuries, but this stimulus has been unable to generate significant job growth. This economy needs consumer spending, but the consumer is exhausted (*), and with rising input prices, corporations have to squeeze costs further and will be very hesitant to hire workers.
Why don't we invest some money to generate local jobs that cannot easily be relocated abroad? The class of jobs that is difficult to outsource abroad is the small business owner. Small business owners are inherently local, and money small business owners earn flows directly into the economy. While many people who have lost their jobs have started their own business, this is very different from the entrepreneurial drive the late nineties saw. A friend of mine, a long time independent IT consultant, recently interviewed for a job at Cisco, and noticed an outright hostile and suspicious attitude. Similarly, badmouthing the economy as happened in early 2001, or the terror talks after 9/11 discourage risk taking and entrepreneurialism. These attitudes have to change again if entrepreneurship is to blossom.
On the trend that the US economy is on right now, retirement is a long way off for many. As Americans cannot retire because of a lack of savings, this economy will turn ever more "efficient" as the elderly will be in the work force. In a few years, it will be as natural for a seventy year old to work, just as it is now for mothers with kids at home. We can argue about the socio-economic desirability of these trends, but given that they are likely to become reality, we should provide the environment that is supportive for it.
As Mr O'Neill points out, tax cuts alone won't cause smart people to change strategy. However, just as Bush tries to rally the US around a Mars mission, it would be much wiser, to rally people around getting small businesses started. Currently, the government does not even have statistics on how many people are starting their own business. Not that I want to encourage red tape and require small business owners to register; on the contrary: a great hindrance to start your own business is regulation. Regulation serves established companies well as they have the resources to cope with it, but create insurmountable barriers of entry for the newcomer.
Your book points out (p41) that while taxation of corporations has declined in the past decades, taxation on individuals (social security taxes) have risen - many small business owners fall into the later tax category. Don't take me wrong, I believe we need to keep our corporations competitive, but we should seriously look at the balance of fostering those firms that take jobs abroad while punishing those who would create local jobs.

The beauty of this is that the concept is simple and popular enough so that Bush could get the message. It also doesn't favor a particular industry and wouldn't be money directed at a particular special interest group. But Bush's policy making has been driven by negative motivation, by threats, all of which are destructive to an entrepreneurial spirit. Bush's policy (the dividend tax cut in particular) is very heavily influenced by Lawrence Kudlow, whose friendship with Dick Cheney you have pointed out (p275); it is sad when CNBC commentators have greater influence on the President than his own Treasury Secretary.

As a closing note, has Mr O'Neill considered to become an advisor to Governor Schwarzenegger? As you point out (p106 among others), Mr O'Neill likes getting people together with opposing views. Mr Schwarzenegger seems to embrace this approach, and needs highly talented and dedicated people who like to discuss issues with both friend and foe.

Again, thank you Mr Suskind for writing this book. I would also most appreciate if you shared these comments with Mr O'Neill.


Axel Merk
Merk Investments

(*) The US consumer reminds me of the economy under LB Johnson when a stimulus was provided

although the economy was running just fine - in this case, the consumer has been stimulated although a recession would have been in order. It took all of the 1970s to correct the excesses of the late 1960s.

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