Sunday, January 3, 2010

Strategy for the 10s: Add Value to America

The Aughts were for naught. During the first decade of the 21st Century, after adjusting for inflation, home values fell about 3% and the stock market fell over 30%. Unemployment stands at 10%. According to today's New York Times, 1 of every 8 Americans is on food stamps. One of every 50 lives in a household whose only income consists of food stamps. Now is a good time to reassess.

The signal events of the Aughts' financial history were the tech bubble that burst in 2000 and the real estate and credit bubbles that burst in 2007-08. Both bubbles lasted longer and pushed prices higher than anyone would have imagined. The illusion of wealth created by these bubbles encouraged consumption, and borrowing for the purposes of even more consumption. That would have worked out more or less okay if people had liquidated their stocks and sold their homes in time to capture their capital gains. But the bubble mentality dictated that they buy and hold their ever appreciating assets in order to finance more consumption.

Thus, Americans frontloaded their consumption before they had the money in hand to pay for it. Many stopped saving and counted on asset gains to finance their retirements. Others spent their asset gains along with all their earnings. Amidst the frenzied pursuit of upper middle class lifestyles for all, the most basic principle of financial planning--that each of us has a finite lifetime income--was forgotten. But lifetime income is finite, even when one counts not only earnings like wages and salaries, but also interest, dividends, capital gains, pensions, inheritances, gifts, Social Security and other government assistance, and all other sources of income. No one has unlimited income and if you borrow for the purposes of current consumption, you will simply consume more now, and less later, when you have to repay your debts. This dynamic becomes all the more stark if the unrealized capital gains you count on evaporate in collapsing asset bubbles. The Aughts were the time when many consumed more. The 2010s will be a time when they, of necessity if not by choice, consume less.

America did the same thing on a national scale. Those self-proclaimed guardians of fiscal restraint, the Republican Party, recklessly embarked on a program of sizeable tax cuts while whipping out the federal checkbook early and often. Meanwhile, the Republican controlled Federal Reserve never saw an interest rate cut it didn't like, and became almost a service organization providing low cost of funds to the big Wall Street banks that were making profits hand over fist from asset bubbles they helped to foster. The national welfare became a national bloat.

Japan, China, Europe and other foreign purchasers of U.S. Treasury securities were facilitators of the American bloat. If the federal government had been forced to fund its profligacy solely from domestic sources, interest rates would have risen quickly and imposed discipline. But the willingness of foreigners to transfer their wealth to the Treasury Department allowed the gravy train to keep running from sea to shining sea. American consumption served the needs of their export-driven economies, and American bloat made them better off. China could never have achieved its 10% plus growth rate during the Aughts without the American consumption frenzy. There were no angels on the road to Lake Wobegon.

But it turned out that Lake Wobegon is fictional. Now, everyone is scrambling for cover. Banks stopped lending. Consumers became savers. Foreigners are quietly slipping away from the dollar. Even as the stock market rose this past year, the relatively light trading volume betrayed the fact that much and probably most of the trading consisted of market pros tossing stocks back and forth between each other. The individual investor, busy packing a homemade lunch before carpooling to work, has largely stayed on the sidelines. The laid off hope that unemployment compensation and food stamps will be enough to get them through the month. Formerly upper middle class professionals pretend that peanut butter is Thai peanut sauce without the spices.

What the decline in the stock and real estate markets reveal is that America lost value over the Aughts. The decade was financed with borrowed money and illusory asset values. The government's current strategies for recovery--borrowing and printing money to save banks and stimulate consumption--have all the qualities of methadone. They ease the pain and allow the patient to stabilize. But true recovery requires increasing America's value.

Economic value emanates from the ability to produce things that other people will pay for. No nation has attained prosperity by borrowing or printing money. America can no longer compete with other nations by producing clothing, furniture, or a lot of other consumer goods. It must focus on its advantages--creativity, innovation, complexity, knowledge, skill, and risk taking. Industries that reflect these advantages include, among others, high tech, entertainment, agriculture, aircraft manufacturing, medical technology, machine tools and, indeed, automobile manufacturing. Granted, the American nameplate auto companies haven't exactly demonstrated much prowess recently. But millions of cars bearing foreign nameplates are made in America, and hundreds of thousands of Americans work in the plants where these cars are made. In actuality, Americans are skilled at auto manufacturing; just not always for companies headquartered in Michigan.

Another way to add value to America is to allow more foreign students to attend American universities. America has the largest and most comprehensive university system in the world. The economic downturn has put a lot of strain in schools and students. Increasing the numbers of foreign students, who would pay full freight (and out of state tuition, in the case of state universities), would enhance university revenues while enriching the educational process. A certain number of foreign students would stay, thereby bolstering America's intellectual capital. There are security concerns with allowing in greater numbers of foreign students. But the recent Detroit airline bomber was entering the U.S. on a tourist visa. Restricting the inflow of students won't stop a determined terrorist.

More federal assistance to small business and business startups is also desirable. Small businesses are crucial to job growth, and also innovation. Many and probably most of the biggest innovations in high tech were created in suburban garages or college dorm rooms by obsessed kids having low fiber diets. These kids may improbably be crucial to America's future.

There's no single policy or program that will accomplish the goal of adding value to America. Republican knee jerk demands for tax cuts ring hollow when one remembers their utter lack of fiscal responsibility during the W years. At this juncture, there's no way to reduce the government's role in the economy without reducing the size of the economy. Not many Americans favor shrinking the economy. International trade agreements prevent the government from providing direct subsidies to favored industries. But measures such as trade financing, intellectual property protection, visas for skilled workers and students, small business lending, protection of American goods from foreign trade barriers, and more federal support for basic research and development would all be helpful.

Saving should be encouraged. America is way too dependent on foreign capital. Domestic savings could provide a cheaper source of capital--American investors wouldn't demand a premium to cover the risk of currency fluctuations. Indeed, domestic savings would make the federal deficit easier to finance (one reason the Japanese government, which has a debt load much larger than the U.S. government, hasn't imploded is that the Japanese people themselves are financing their government's debt and they aren't inclined to transfer the bulk of their savings offshore). The government's obsession with stimulating current consumption keeps smashing against the rock of individual determination to save. Maybe the government should help the citizens have their way, and then enjoy the benefits.

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