America 2050: Economic Action Plan

Preamble:
From the current discourse in Washington, DC it is important to identify the key components that are required to ensure a timely deleveraging of liabilities while ensuring that the federal, state and local governments continue to prosper. The United States of America was founded on the values of Thomas Jefferson and our Founding Fathers: life, liberty and the pursuit of happiness. To ensure these values and the free market ideals that they espouse continue in the 21st century, the United States Congress is requested to act on the following Provisions of the America 2050: Economic Action Plan.

i) Reconstruct the Federal Tax Code:
Federal income levels commensurate to tax rate:
<$30,000 - 5%
$30,001-45000 - 10%
$45,001-58,000 - 13.5%
$58,001-75,000 - 15%
$75,001-150,000 - 20%
$150,001-250,000 - 25%
>$250,000 - 35%
Family (joint income) rate reduction of 2.5%, with children 5%.
Mortgage interest deduction: Up to $5000/year reduction in taxable earnings.

Federal business income:
20%
Capital expense carry-forward tax credit of up to 10 years.
New hire carry-forward tax credit of up to 2 years.
R&D carry-forward tax credit of up to 5 years.

ii) Educate America 2035
Convert 40% of US public schools to charter schools by 2025.

Teach America program to retrain teachers and educators to: update skills in maths, sciences and technology; learn modern classroom management skills.

Limit school size to 1500 by 2020 through new construction and modernization efforts.

Provide $100 billion for state-level post-secondary education.

Require successful completion of course for eligibility of government student loans.

iii) Train America 2030

Create New Millenium Skills Program for adults 25 and older to enroll in government run computer skills, word processing, Internet and smartphone courses.

Provide $15 billion in direct funding for results-based student loans for courses/programs at accredited post-secondary institutions.

iv) Reform Welfare and Supplemental Nutrition Assistance Program (SNAP)

Limit receipt of welfare to 2 years before requiring skills training or public service.

SNAP available to individuals with income <$24,000 or families <$29,000

v) Medicaid eligibility

Individuals w/ income <$24,000 or families <$29,000

vi) Social Security

Means test benefits for individuals with eligible income >$65,000, and couples >$80,000 for Citizens younger than 55 (2012).

The World in 2014

The world in 2014 will be a more volatile and dangerous place. 
Following the 2007-2008 financial crisis in the United States, the global economy has suffered a lingering credit crisis. The impact of the destruction of trillions of dollars in global wealth has shaken financial institutions and governments. The cascade from the financial crisis on European economies was immediate, but not realized until 2010 when European banks began to struggle under the weight of their own property investment excesses. Unfortunately, their banks were too big to fail, and also too big to bailout, especially in the Eurozone periphery. The weight of the failing banks is destroying the public finances of these countries as the investment excesses of a few are effectively nationalized under undemocratic anti-progressive terms.
This essentially takes us to today, June 2012. The Eurozone is fracturing as debt-burdened periphery countries (Ireland, Greece, Portugal, Spain) are relying more and more on the core (Germany, France) to keep their banks and governments afloat. Greece has already accepted a government bailout under the most draconian of terms, Spain required €100 billion to keep its banks capitalized and will likely need a national bailout as well. Nouriel Roubini's "slow motion train wreck".
The Euro Crisis is extremely dangerous to the world economy as Europe is a lynchpin in global credit markets. Eventually "too big to bailout" will mean something and the ripples through the EU, and the global economy would likely perpetuate a recession worse than 2008-2009.
The EU is easily China's largest trading partner. Chinese exports to the EU were $356 billion ($324 billion to the US) in 2011. Imports from the EU at $211 billion almost double the US. This means that EU troubles are Chinese troubles and Chinese troubles affect global commodity prices and have spill over to Japan, Indonesia, South Korea, Brazil and Australia. This will also create conditions for a likely US recession.
All of this financial turbulence will lead to greater instability around the world. As the primary exporter of natural gas to Europe, Russia will face a dangerous situation of lower medium-term commodity prices. Already facing political challenges, Vladimir Putin, Russia's president/prime minister, will likely see that challenge increase as state coffers struggle to keep job growth. Similar political challenges might face Saudi Arabia, which already had to grant $150 billion in social programs to skirt out out of the Arab Spring. Saudi Arabia will likely survive politically, as they have $500+ billion in currency reserves available to appease the population. Countries like Nigeria, Argentina, Peru and Venezuela all face similar political problems in a low-price energy environment. All of this means greater uncertainty in the world economy that had so much promise at the turn of the new millenium.
In 2014, we are likely to see a world that become more fractured. While the neo-liberal agenda of free trade and globalization will continue, the benefits will be harder to see. City-states like Singapore and Hong Kong are likely to benefit as safe harbors. Fiscal pressures will continue to mount for developed economies as negligible growth will hurt tax revenues and aging populations will increase the burdens on the state. Massive pension and health care funding shortfalls exist in all developed countries and this will exacerbate an already precarious situation. This might even create political tension in the United States as Congress becomes forced to address fiscal challenges in 2013-2014. Although likely to become a beneficiary of a flight to quality, the US cannot continue to run trillion dollar deficits forever, even at 0.5% interest rates. All of this culminates in a very precarious world in 2014 which will likely continue until the end of the decade.

A tale of two Europes

Taking the EU debt crisis back to the Carolingian Renaissance in the late 8th century might be a bit of a stretch, but it is the beginning of France and the Holy Roman Empire, that would (a millenium later) become modern Germany. Throughout the centuries, this European division has been associated with a class of cultures as northern Europe struggled to take up the mantle from the Roman Empire.

Today's crisis harkens back to this era, but more noticeably to the Protestant Reformation and the development of an Anglo-Saxon model of economics. The Catholic countries of Europe (France, Spain, Portugal, Italy, Ireland), have always favored more state control in their daily lives. Much of this comes from the consecration of kings by the Vicar of Rome, ad the familial nature of the Catholic faith.

It is argued that Protestants, beginning with Martin Luther had reconceptualised worldly work as a duty which benefits both the individual and society as a whole. Thus, the Catholic idea of good works was transformed into an obligation to work diligently as a sign of grace. Whereas Catholicism teaches that good works are required of Catholics to be saved (viewing salvation as a future event), the Reformers taught that good works were only a consequence of an already-received salvation.

This Schism in faith continues to be articulated in modern Europe today. The Protestant work ethic is evident in Germany, whereas the Catholic nations of the south continue to have expectations that the state will be there to bail them out. In Portugal, Spain and Italy, their modern economies are vastly underdeveloped. They lag their economic peers by almost two decades in terms of labor efficiencies, tax policy and economic creativity. This is leaving an economy like Spain operating at almost 20% below nominal GDP. Because the government has controls on competition and over regulates industries to favor guilds and unions (many of which date back centuries). Southern European consumers are vastly underprivileged in terms of service supplied. An example would be a pharmacy, where compared to 24hr drug stores in the US and UK, France and Italy have a heavily regulated industry where even during business hours it can be difficult to get a prescription filled.

What does this mean for Europe and the Euro?

Germany is going to be the engine of Europe for the foreseeable future, and it is developing an neo-mercantilist relationship with its EU neighbors as low-value add processes take place in the periphery, whereas high value add jobs are done in Germany. This is the difference between bottling olive oil versus machining a precision tool for robotics. One economy is stuck in the 14th century, whereas Germany is competing directly with Japan, the US for command of the 21st (China will join that list in the 2030s).

The world should favor the Euro because it has created an economic union that rivals the US and China in size (the EU is already the largest economy). The challenges are now political, but PIGS needs to recognize, that it is better to be a vassal state of Germany's economic empire than to go it alone in a globalized world.

Macroeconomic Policy in the Age of the Individual

In the Age of the Individual it is even more important for government to lay effective policy to allow for private sector innovation. In the wake of the Great Recession, global governments have taken a number of approaches to address slow GDP growth, which is still, 4 years later, not back to pre-recession highs. The European model is the austerity model. While fiscal discipline is important, and will pay dividends in the next decade, it wasn't the amount of spending that was problematic, it was the type of spending. The American model is steady as she goes (with bonuses), but here the issue is not the spending, but on what. Both models are not addressing the correct issue.

The myth of the Welfare State and its economic benefits
In politics, it is often stated that direct government handouts to the poorest of society is the best way to stimulate growth. These handouts come in the form of targeted tax cuts, food stamps, welfare and unlimited unemployment insurance. The pro-welfare argument is that people with the least are most likely to spend the money, thus a $100 gets spent and creates economic growth as that works through the system. The challenge is that low-end foods and goods are very low-margin products that are likely made overseas. The people who stimulate economic growth are "aspirational buyers" from the middle class. The mom who wants a Coach bag, or the suburban teenager who "needs" an iPhone. These are high margin goods that create jobs in the markets they are purchased (Coach has a big sales/marketing organization and iPhones run on cellular networks that are services (forever business)). That same $100 may create 10X the economic activity because of the add-on services that come with it.

This comes back to the issue of the Welfare State, Obama's Recovery and Re-investment Act paid to keep unproductive people in their jobs and extend UI to 99 weeks (basically 2 years!), only about 10% went into infrastructure that would pay dividends in the future. The same in Europe, where Britain and France already pay people NOT to work almost in perpetuity. Reductions in benefits to people who have lived off the state for so long is a recipe for revolt.

Both the US and Europe need economic stimulus, and both have epic infrastructure deficits. If money was being poured into new roads, bridges, government buildings and community buildings the economic accelerators would magnify. It would also provide companies (construction, architecture, MRO, support, software) with a multi-year sales pipeline that would buffet the decline in other business.

Considering government has spent $5 trillion on stimulus in the last 4 years, they haven't bought much other than junk food and cheap Chinese goods. Time to change the policy.

How the 1% do it

One aspect of bank reform that is being missed is bankers' ability to make money from deposits. The traditional bankingsystem has for example,depositors making 3% returns on their cash, the bank lending money at 5% and taking a 2% spread. The challenge we are seeing today is that most bank accounts have fees and do not pay any interest (even if you meet the minimum deposit it is still 0.5%). What this is doing is giving banks free access to all of our deposits to use at their will (until the Volker rule comes in 2014).
The wealth disparity between the 99% and the top 1% is partially a result of the way banks operate, and how the Fed funds rate encourages it. Since 1992, the Fed funds rate has never been above 7%. This has made debt an easier choice for individuals and created a "mortgaged society". 70% of Americans have credit cards with an average balance of $16,000. This "easy money" is not free and the average interest rate is 12%. The FHA (through Congress) and the Fed also pushed credit on homebuyers, giving away "low APR" mortgages to anyone in a process that inflated the bubble in housing and has now left even more bad debt in the system.
Banks, Congress and the Fed have ostensibly encouraged lending to consumers to boost an economy that is: not adding jobs, running a $706 billion/yr trade deficit, seeing small business being marginalized due to subsidies to big business and not fostering an investment climate.
Debt is Slavery
This was a sign from Occupy Wall Street and it conveys the message: The 1% maintain their control is through debt. $16,000 at 12% APR is $1200/year the average consumer is paying to the banks for things they have already bought. A mortgage is different because it is an investment that historically appreciated at 3%, so even through you lose money on your housing investment (through taxes, interest, maintenance, etc.) - it is still better long-term than renting and can be classified as an investment.
The government needs to do two things:
1) Encourage consumer debt repayment and legislate the banks to pass on the Fed's low interest rates.
2) Fix the mortgage mess once and for all and dismember the zombie banks. i) Congress legislates principle right-downs for underwater mortgages. ii) The Treasury buys up written down assets into a bad bank. iii) Congress recapitalizes the banks, and the Treasury sells the debt to the Fed. iv) The Fed prints money to buy the debt, creating a structured round on quantitative easing. v) Inflation rises, but the economy begins to work again and the mortgage debt overhang is removed.
The total value of residential properties in the U.S. fell to $19.1 trillion by the end of 2008, down from $21.5 trillion a year earlier, so the losses are already being worked through at the expense of the average American. $4.17 trillion are underwater mortgages. Ceteris parabus that underwater mortgages are 30% underwater - that is $1.4 trillion that needs to be worked out of the system. Will $20 trillion of outstanding US dollars this would amount to 5% inflation that could be controlled through increasing interest rates.
This would achieve two policy goals as well: make imported goods more expensive/make exports less expensive; increase price of imported oil reducing consumption and encouraging conservation/domestic sources.
The alternative is to "muddle through" until house prices bottom (2015-16) and we work through 2 trillion in consumer debt overhang (roughly 14% of US GDP). Assuming a 10 year timeline, that is 1.4 percentage points off of GDP for a decade to come.

European Financial Crisis - The Good Parts

While the world is watching European governments and banks, policy makers and pundits are failing to recognize the good things about the crisis.

#1 - The free market is strong. European government debt, which has lost confidence in recent years due to the thresholds being reached that indicated it could never be paid back, is being priced according to RISK. This is a fundamental function of the free market - so business and markets have a say in the governance of the countries. With the internationalisation of risk and power, markets are responding faster and nations are competing through economic means. This is a good sign for the future of the species.

#2 - Europe is taking its medicine BEFORE its too late. The post-WWII baby boom has affected demographics across the developed world, and because of the earlier retirement age, Europe is an example of the burdens baby boomers will be on the system. The good thing is that the situation is not dire and austerity, while difficult and traumatic to many is the best way forward. The neo-socialist sentiment that the government can pay everyone to do nothing is dwindling in the face of vivid economic proof to the contrary. The free market needs to be more FREE and the Internet is paving that way.

#3 - Europe will recommit to the EU and the Eurozone - the crisis will bind Europe closer together. This is an important step because the Great Powers of today have massive populations and if Europe is not united, they will lose their economies of scale and eventually reduce their global influence. If they can sort out their issues - most notably the competition gap that creates fiscal differences - they will end up in better shape in the future.

Age of the Individual (and it's consequences)

We live in the Age of the Individual. Despite claims of expanding communities through computers and social networks, we are becoming a more selfish, self-absorbed society that cares less for the collective good than the good of the individual.

This has severe societal and economic impacts. In 2007-2008 the world watched as the greed of a select group plunged millions of people into unemployment and sent-off economic shockwaves around the world. These shockwaves manifested themselves on the doorsteps of "working class" people through government layoffs of teachers, companies laying off thousands of workers for short-term cost-savings and societal redistribution in Greece. The crisis and the aftermath are both the result of short-term thinking by individuals - both in government and corporations.

The forestry industry is a great parable to modern economics. In the 1970-1980s the forestry industry was clear-cutting itself into extinction. Through government and social pressure, the industry was put on a more sustainable path. This is a lesson the oil industry needs to learn, but also the financial industry.

In 2005-2007 when the mortgage bubble was being inflated by the demand for mortgage-backed securities (MBS), individuals made the decision to set aside their reservations and make money. Mortgage brokers attest to the fact that they processed paperwork they didn't feel comfortable submitting, but it was approved. Why? The mortgage broker wanted the commission, and if it was approved, it no longer was their problem, so why not be greedy? Who was doing the approvals? The person who was going to sell the mortgages to Wall Street for a nice commission, so why not be greedy?

We exist in a world where society is so far removed from our lives. Everything and everyone is so disconnected, the decisions we make are in our individual best interests, not the best interest of our community. Even "community" is transitory. If you move from the west end to the east end of Toronto everything looks and feels the same, but the people are different - but it doesn't matter. You still keep in touch with friends online.

As we move to greater short-term goals, we are more willing to do things that aren't in our own best interest. A salesman might close a deal he knows will be shutdown, only to be paid the commission this month rather than next month. The consensus is "money now is better than money later".

Three decades of failed leadership and the loss of national competition (vs. USSR) has created a political caste that is also completely self-interested. Their goal is not to accomplish something big, it is to accomplish enough to get re-elected. It is our politicians who are most to blame for failures of modern society and we need to look at ways to start over the political system.

Modern American economics is failing and without changes, the whole political system will collapse - what may follow it is unclear.