Obama’s One-Time Opportunity: to Restructure the American Economy

With worldwide equity markets down by 40 – 50%, it seems virtually certain that we are already falling into a depression. Hopefully it will be far smaller than the Great Depression of the 1930’s where the economic contraction was 40%. But a 10% or a 20% contraction of GDP is a realistic scenario in this dire situation. Already in March the Gallup Poll found 60% of Americans said a Depression is likely; today I suspect most Americans would admit we are already there.

President Obama is right to offer hope for the long term and to show compassion to those most injured by this storm. However, unless he tells Americans soon how terrible the economy is already, he will certainly get blamed for the inevitable continuing catastrophe. The American people can handle a candid assessment and will sacrifice to make the changes needed for an eventual recovery. But minimizing the challenge now will soon shift the blame to Obama, who didn’t create this regrettable state of affairs.

It is customary for a new CEO when taking over the management of a company in distress to clean house and to lower short-term expectations. This involves examining the books and disclosing hidden losses. It allows a more realistic set of goals to be pursued without useless baggage from the past, which should be thrown overboard.

The plunging financial markets have signaled severe economic deficiencies. Some people naively believe that our main challenge is how to restore the stock market and the housing market back to their former levels. But the precipitous stock market decline is due to a very sick American economy, not just an isolated problem in the financial sector.

What we are witnessing is not only the failure of some of the largest American banks and corporations, but also the financial disintegration of the government. Conventional wisdom says that the government must use every fiscal and monetary measure available to restore confidence and to increase consumer spending to help avoid world recession. But I see it differently.

Let me explain why. My international banking career has trained me in credit assessment of both corporations and of national governments. What has become abundantly clear to me throughout my 35 year financial career is that size alone is insufficient to protect any bank, any corporation, or even an entire nation from financial collapse.

So restoring economic growth alone will not restore our fortunes. In fact, too rapid growth – in house construction, in stock prices and in energy consumption – has caused the present problem. The US (and world) economy is entering into a time of intense contraction. This is a necessary antidote to the haphazard growth.

By every normal measurement, the US government’s financial health is poor and deteriorating rapidly. Let me put some numbers to this by comparing the United States and China, which are respectively the most profligate and most disciplined major economies in our world.

Although China’s economy is half our size, it has been growing 6 times faster. That rapid growth comes from having a three times higher national investment and savings rate.

China consumes 6.93 million barrels of oil per day, compared to America’s 20.8 million barrels of oil per day, despite having a four times greater population. That is the main reason that China enjoys a $300 billion trade surplus compared to our $900 billion trade deficit. It is also the reason we are the largest debtor nation and they are our largest creditor.

Consequently, our national debt is $14 trillion, 34 times as great as China’s debt. What is more, China’s treasury holds $1.5 trillion in gold and foreign currencies, while we have only $71 billion. Our financial cupboard is bare!

Putting the United States on a path to recovery of its financial health is an immense undertaking, but let me sketch out the top priorities.

• Guard the federal treasury against quick depletion. The titanic struggle to regain economic health will take years, if not a full decade. Every dollar of government resources is precious and should be used frugally. The government doesn’t have an endless well of financial resources.
  
  
  
• Reduce energy consumption drastically
  
  
  
• Balance imports and exports
  
  
  
• Reduce foreign borrowing
  
  
  
• Increase domestic savings and investment
  
  
  
• Discourage debt-based consumer spending
  
  
  
• Reduce military spending
  
  

These priorities would help restore America to an economic superpower once again. Here are a few specific suggestions:

1) Introduce gas tax measures to reduce energy consumption by half. While we should improve domestic oil production and develop new energy sources, these alone will never offset enormous energy imports. Why not follow Europe and most of the world by taxing energy much more? Their energy conservation plan has been proven highly effective for decades. Japan consumes 38% less oil per capita and Germany uses 53% less than Americans. That gives them an enormous economic advantage.

I suggest raising retail gasoline prices to the level of the rest of the world. Higher taxes should also apply to industrial energy consumption. This is a bitter pill, but the only alternative is continuous financial decline until this oil-import haemorrhage stops. The lessening oil consumption will do immense good for the environment. The tax revenue from this program could fund further tax cuts or new social programs.

2) Avoid huge bailouts to GM and other bankrupt companies. GM (together with GMAC LLC) has total liabilities of over $200 billion against $5 billion of operating cash flow during its best recent year, before the massive losses began. Even if GM recovered miraculously to its previous earnings in 2005, it has $150 billion more in debt than its cash flow could ever service. GM needs rescue, but after it goes though the bankruptcy courts. Why should the Federal Treasury shoulder an unnecessary further $200 billion for GM alone, which will only result in extraordinary gains for shareholders and creditors?

The current request by the three large automakers is disingenuous, to say the least. GM alone is losing $5 billion per month. Once the government steps in, the market will expect a continuous financial lifeline, which is in fact an implicit government guarantee. This would ultimately cost several hundreds of billions in the long term, like with Freddie Mac and Fannie Mae.

Airlines have demonstrated repeatedly that the bankruptcy mechanism rarely grounds planes permanently. They provide for an orderly restructuring. GM and the other car companies should be drastically restructured before tax payers help out. The priority of keeping a vigorous American car industry is worthwhile, but not at such a high cost.

3) Reduce consumer debt costs, particularly among the poorest citizens. Historically, American states restricted interest rates to 6%, 10% or 12%, but gradually this was raised to over 30%, and now there is no limit whatsoever on consumer interest rates and other excessive fees for debt. Why not limit consumer interest rates to 15% or 20% by federal law? This would discourage the spiraling growth of credit card debt and other consumer debt, which cripples low wage earners.

4) Provide much larger incentives for saving & investment. The United States has had the lowest personal savings rate among major nations for decades. Recently the savings rate has been about zero, when personal borrowing is netted against savings. Most of the leading economies apart from the USA have had high savings rates: Japan, China, Germany, and most of Europe. This is what pays for industrial investment.