How to Transform the US From a Debt to an Equity Economy

I originally wrote this at the end of 2006, largely because of the need to find a way out of mammoth amount of debt in the US economy. This article and the ideas presented are salient to the recent push to drill in Alaska and offshore. While I have heard a great deal of rhetoric from both candidates, little of it makes economic sense. McCain wants to institute another round of supply-side policies despite the fact that the previous two times these ideas were implemented the US increased its overall debt at a mammoth level (see charts below). While I agree with Obama's overall concept he faces a different problem: he inherits a federal government that is deeply in debt. I explained his basic problem here. The problem with both candidates is no one is accepting the fact the US is in a dire situation at the federal level. Dire situations call for radical solutions.

The US' current economic trajectory is unsustainable in the long run. The domestic economy is dependant on foreign capital to finance consumption beyond our production. The US government has issued over $500 billion dollars in net new debt per year for the last 4 years, indicating the budget deficit is not under control in any meaningful way. The US consumer has taken on an enormous amount of debt to finance the latest economic expansion. In other words, debt saturates every level of the economy to a harmful degree.

What I am about to propose is a radical departure from the overall current economic policy of the United States. Implementing this policy will require an incredibly difficult debate and policy application. The application of this program will hurt many people. Ideally, we should spread the pain out among as many people as possible. However, the pain cannot be avoided. In addition, implementation will take a great deal of time. The method of paying for this plan will be extremely controversial, especially among Democratic circles. Implementation will take consistent effort and sacrifice.

THERE ARE NO EASY ANSWERS TO THE OVERALL PROBLEM. The sooner we accept the reality there will be some pain for everyone, the better off the process will be. As a country, we have lived beyond our means for far too long; it's time to pay the bill. We have a very bitter pill to swallow. The best thing we can do is swallow the pill and move on.

The short version of this plan is simple: The US must move from a debt to an equity economy.

Overview of the Problem

The US international trade deficit has trended to a more negative position over the last 15 years. The following chart is from the St. Louis Federal Reserve:

A trade imbalance indicates a country is consuming more than it produces. The country with the trade deficit must borrow money too fund the difference between consumption and production. At the current level, the US must import roughly $2 billion/day to finance its consumption. At some point, creditors will demand a higher interest rate for the increased risk associated with holding US debt. In addition, it is also possible for the host country's currency to drop in value. Should the currency drop in value, the host country has a greater likelihood of importing inflation. Neither possible scenario -- an increase interest rates caused by increased perception of risk or a devaluation of the host country's currency - is beneficial for the host country.

The federal debt situation is just as dire. The problem started with the implementation of supply-side economics in 1981. While the Reagan administration loved cutting taxes, they did not cut spending. As a result, the Federal government issued a large amount of debt, increasing the debt/GDP ration from roughly 30% in 1980 to over 60% in 1988. Bush 43 implemented the same policies with the exact same result. According to the Bureau of Public Debt, the US has issued over $500 billion in net new debt each year for the last 4 years. (For a complete listing of government and revenue and expenditures, please go the historical budget data (PDF) at the Congressional Budget Office.) As a result of Reagan's and Bush's policies, the US federal government has issued debt to pay for growth. Here is a graphical representation of the situation.

At the household level, we have seen the exact same situation develop over the last 20 or so years. As wages have largely stagnated for a large percentage of the population, households have increased the use of debt to finance their lifestyle. As a result, household debt has continually increased, as the chart below from the St. Louis Federal Reserve indicates.

So, why is all of this debt bad? To quote Dave Ramsey, you're making someone else rich. The person that lent you the money gets some of the benefits of your growth. As the amount of debt increases, the lender receives more benefits in the form of higher interest payments. Eventually, the borrower must pay an amount so large that growth is almost painful. While current payments on US debt are not a large amount of money, we have also been the beneficiary of historically low interest rates. It's only a matter of time before lenders realize the US may not pay its debts and ask for a higher interest rate on their respective debt. This is when we will run into big trouble.

So, we've outlined the problem. That's the easy part. Let's move into how to solve this problem. This is where a great deal of pain comes in, because there are no easy answers. In fact, there are only difficult answers that must be implemented.

Priority 1. Balance the Federal Budget.

Here are the benefits of a balanced budget.

It prevents crowding out. This is a fancy way of saying money that would finance the federal budget deficit is instead invested in private capital. Let me use the current situation as an example. According to the Congressional Budget Office, the US had a $318 billion budget deficit in 2005. That means $318 billion dollars was not invested in the private economy, but instead invested in US government bonds. The larger the deficit, the less money available for private investment.

Psychology and uncertainty. A budget deficit detracts from individual's confidence in the market and the overall economy. As individual's look to the federal deficit, they understand that at some time the government must pay back the money it borrows. That means the government will probably have to either raise taxes (more likely) or decrease spending (far less likely whichever party is in control of the government). Deficits create psychological uncertainty. The larger and more persistent the deficit, the less happy people are and the less prone they are to take economic risks.

One of the primary reasons for the economic expansion of the 1990s was the prevailing sentiment among business leaders that Washington was finally in control of the deficit. This created an environment of confidence which increases economic potential. It's that simple.

So, how do we balance the budget? First, we either let the 2003 tax cuts expire naturally with their built-in sunset provision or we raise them. I would argue against raising taxes immediately because of the current slowing of the overall economy. I would argue we wait until at least the 3rd quarter of the next economic expansion before we consider this. We also need to look at several other options on the tax front, including reforming the estate code, increasing the maximum amount of income subject to social security taxes and certain corporate giveaways. This is all subject to Congressional give-and-take. But, the bottom line is that if we want to balance the budget we first need to increase government revenue.

In addition, spending has to be cut. And honestly,all programs must be on the table. That does not mean all programs will be negatively impacted to the same degree. However, the Federal government spends a lot of money; we have to decrease the rate of spending to a large degree. For the last 6 years, federal spending has increased an inflation adjusted 35%. That level of spending growth is simply unsustainable.

This process of balancing the budget will take awhile. I would guess at least 6 years if not longer. It will take constant concerted effort. And it will mean a lot of people will catch a lot of flack for the consensus decisions reached in the process. This is where political skill comes into play -- the ability to sell this achievement to the electorate in a away that allows Dems to continue the process. It will be a difficult sell -- especially after the Republicans have won elections on easy, something-for-nothing themes. I do not envy any political consultant's job in this task.

OK -- that's the federal side of the deficit. As promised, it is not a pretty picture. However, it is what must be done. Now, how do we deal with the consumer debt?

The first point to make is consumer debt is really a problem of poor wage growth. Save the 1990s, wage growth for most Americans have been stagnant for some time. What has made the "standard of living" bearable is the cost of many things has come down, allowing consumers to feel richer without really being richer. In other words, the central issue is how to create better paying jobs which actually increase wages for most Americans. So, how do we do that?

We take a page from Asian development which has a track record of success. We coordinate three different policies: education, domestic investment, and industrial policy

Priority 2: Education

American manufacturing has undergone a fairly radical transformation over the last 20 years. We have moved from (for lack of a better phrase) a pure brawn model to a brawn and brains model.

But manufacturers, regardless of size, specialty or location, across the USA are reporting a dire shortage of skilled workers: people such as welders, electricians or machinists with a craft that goes beyond pushing buttons or stacking boxes but does not require a degree.

In a survey of 800 manufacturers conducted by the National Association of Manufacturers (NAM) last year, more than 80% said they were experiencing a shortage of skilled workers. In October, manufacturers surveyed by the Federal Reserve Bank of Philadelphia said "finding qualified workers" was their biggest business problem.

The shortage of skilled workers is the result of a number of factors. One of the biggest is that manufacturing in the USA is becoming more high-tech and skill-based as the more repetitive, less-skilled work is moving abroad. Such jobs require greater expertise.

Innovation in the manufacturing sector means that the jobs require greater skills than ever before. According to an analysis by economists Richard Deitz and James Orr at the Federal Reserve Bank of New York, employment in high-skilled manufacturing jobs rose 37%, or by 1.2 million jobs, from 1983 to 2002. At the same time, low-skilled factory jobs dropped 25%, or by approximately 2 million workers.

A paper titled The Changing Nature of Manufacturing in OECD Countries highlights the problem as well. On page 8, the paper notes, "The graph shows that most of the decline in manufacturing employment over the past three decades has occurred in only two activities: textiles and metal products." The bottom line is the developed world is moving to increasingly high-tech manufacturing.

However, as the evidence from the Federal Reserve and NAM indicate, the US workforce is not ready to make this transition. This means, quite simply, that Americans must go back to school. And high school education must be expanded in important areas -- especially math and science. This is what the Asian countries did and still do for the most part. They concentrate education in the primary areas -- the American equivalent of K-12 -- and make the program much more demanding than their American counterparts.

In addition, we need to improve access and the cost structure of trade schools in huge proportions. There are industries which are currently in their end -- stage, at least in the US. Textiles lead the way, as do other more purely brawn-oriented manufacturing. Employees in these industries must be given the benefit to retraining if they are able to make the transition. If they aren't, we must insure their respective pensions are secured so they can live-out their retirement in dignity.

Priority 3: Targeting high-growth industries

This is the final area to discuss, and frankly it won't take long. The bottom line is there are several industrial areas that everybody knows show high-promise as industries of the future. Alternate energy development probably tops the list. The world's energy resources -- particularly oil -- are either at their peak or near their respective peaks. The world market is in desperate need of a true alternative to oil/petroleum as a means of energy. And it's time a country spent the capital necessary to develop one or all of the possible alternatives. I cannot speak to the possibilities. However, I know they are out there.

Two of my personal pet projects are stem cell research and nano-technology. I am sure there are others.

The primary way we target these areas is with money - as in massive amounts of federal dollars going into think tanks, research groups and universities to develop these ideas. Pure research has consistently demonstrated itself to be the mother of most of the greatest inventions. Therefore, funding pure research is the best way to develop these industries.

Paying for all of this.

I mentioned above that this would be the most controversial aspect of this idea. I guarantee I wasn't lying. However, before we get there, let's sum up the basic problem. At a time when the US economy needs a large infusion of cash for investment, it doesn't have it. The Federal government is in debt up to its eyeballs. Foreigners are financing our trade deficit. And consumers have already taken on debt in near-epic proportions.

So where do we get the money?

We open up Alaska and the Coastal reefs for drilling. I realize the controversy this idea will generate in Democratic circles. However, governing is about difficult choices. And we have a ton of them to make. Just as importantly, the US economy stands near a very dangerous precipice. We are completely dependant on foreign investors to finance our way of life. The federal government is facing serious financial problems. The US consumer hasn't seen a meaningful pay raise is some time. In other words, we have very serious problems. Weighing all of these problems against environmental interests is difficult. However, the long-term benefit of this program (as in 50 years from now) outweighs the drawbacks.

However, we do the following. First, we earmark a large amount of the proceeds from this specifically for investment in the above-mentioned programs. We do this through higher royalty fees and a high tax structure on the companies that develop these areas. Secondly, we put in place stringent environmental regulations. Finally, we put in place provisions about using American resources -- as in American manpower resources -- to perform the work.

So - why should we do this? Frankly, we have little economic or financial choice. The US economy must make the transition to the 21st century. We have little national savings to pull on. We have a government issuing debt like a drunken sailor. And, we have a set of resources that can develop the cash flow to allow us to pay for the above ideas. Just as importantly, as we make the transition we create a large amount of high-paying jobs. The bottom line is this solves a lot of problems.

Comments

[olephart]

As much as I agree with your diagnosis, I must disagree with your prescriptions.


“I would argue against raising taxes immediately because of the current slowing of the overall economy.”

An immediate increase in the upper 3% of incomes would have no effect on this consumer based economy. You are correct in looking at other options, I suggest applying the employee portion of the Social Security tax on unearned incomes, with an appropriate exclusion. Waiting for better times for Middle Class reforms (reduction­s/eliminat­ions of deductions) and increasing the gas tax is appropriate.


“This is all subject to Congressional give-and-take.”

This is subject to shoving it down the Republicans throats.


“all programs must be on the table.”

Many essential programs (FDA, INS.....) have been robbed over the past 7 years. Moreover, the “Privatization” of many Departments has drained hundreds of billions from these entities by way of Crony Capitalism. These actions must be reversed and the monies restored by funding the Agencies, not the crony parasites.

NO progress can be made on the deficit until the American people are told that the Islamo Fascist Terrorist Boogeyman is a hoax to relieve them of their money. Our Foreign Policies create the need for Military spending. It is a vicious circle costing one trillion dollars per year. End the War, end Blackwater, cut CIA, Homeland Insecurity and Military spending by 500 billion dollars per year. This in and of itself will balance your budget.

[olephart]

“the developed world is moving to increasingly high-tech manufacturing.”
“the more repetitive, less-skilled work is moving abroad.”
“Employees in these industries must be given the benefit to retraining”

There’s always the left side of the Gaussian Distribution of abilities. These people usually wind up in the lowest quintile of the economy or, as now, President of the United States. Millions of good, hard working Americans are just not going to be working in clean rooms assembling nano tech devices. Millions of low tech workers are here illegally. This drives wages at the bottom lower than they should be (see supply and demand 101 for an explanation). This situation must be remedied without the incorporation of an additional 24 million underpaid hands. The poverty created by the Oligarchs in Mexico and elsewhere should not be exported to the United States. The fight for these peoples well being belongs in their Countries of origin. Wages for Americans at the bottom will improve once employers no longer have a source of cheap slave labor.

[olephart]

“in desperate need of a true alternative to oil”
“stem cell research and nano-technology”
“Pure research has consistently demonstrated itself to be the mother of most of the greatest inventions.”
“So where do we get the money?”

The technologies for alternatives to oil already exists or will debut shortly. The primary hold up is uncertainty about Government Policies and the future price of oil. Once strategic multiyear policies are set forth, private enterprise will step forward. Tax credits/subsidies for solar and wind for individuals and businesses and net metering could double our power production in a few years and create millions of jobs. Plug in Hybrids to run off the new energy sources would cut oil consumption dramatically. A gasoline tax that excludes bio fuels would give them an economic stimulus and a price floor to insure their development. The revenue from the tax would help pay for the credits mentioned above.

Research is cheap, interest on the debt is expensive, B3 bombers are expensive. Cut the last two and there’s your research money.

“We open up Alaska and the Coastal reefs for drilling.”

Don’t need to. There’s no shortage of oil, only the Enron loophole and Government that’s on the same side as the criminals. There’s research now that takes CO2 from coal fired plants and feeds it to living plants that are converted to liquid fuel. Tax CO2 and it becomes economically feasible. Leave the oil in the ground for your great grandchildren.

[jhNY]

And yet, in a larger sense, nearly every proposal you have on view will never have sufficient political support from anybody in either or both parties to actually happen, you know, in what I like to whimsically call "real life".

The biggest economic problem we face is our perpetual war footing, and the resulting massive diversion of capital to blowing shit up. The second biggest problem is nobody wants to pay a decent wage, and nobody wants to pay a fair price for goods. The third biggest problem is nobody is ready to face that we spent our greatness years ago and have been basking in the afterglow by borrowing money we can't and won't pay back in the private and public sectors of our economy.

The American dream has stagnated into recurring nightmare status. The creativity of the citizenry and its stewards has largely been exhausted in the rescheduling and redefining of debt, not in the production of goods or services.

Both parties have encouraged irreponsible lending and purchasing in real estate so that, as long as the value of residences continued to rise, homeowners could borrow additional purchasing power out of their residences. Their wages, being stagnant in constant dollars for a quarter century plus, were not going to get them even a high-interest scrap of the prosperity their leaders had promised them was always right around the corner. It was of course, for them. Not us, who are not 'friends of Angelo'.

[Arkieology]

Dear Mr. Stewart,

When confronted by the banks requests for 25% interest on loans to finance the Civil War, Lincoln bypassed the banks and let the country print its own Money, the Green Backs. If things are as dire as you say, we should look to Lincoln.

A Bill of Indictment
I. The Financiers have Commandeered the Market and They Cheat
II. The Banks are inside Players
III. Money is Created by Private Companies, for Private Interests
IV. The Profession of Accounting is Corrupt and Must Undergo Public Regulation.
V. The Entire System is to Blame
VI. The Tax System is Overly Complex, Unfair, Corrupt and Ineffective.

Begin with a Three day Bank Holiday

Eliminate the Federal Reserve
All Money should be issued by the Treasury
Operations and Lending functions of existing Banks are separated
Bank Operations- Hold all accounts.
Lending done by separate Companies

Strict accounting practices.

On the First day back, $30.000 in Green Backs is deposited into the accounts of everyone the United States. This will put $9,000,000,000,000 into play. The pecking order will be unaffected, it will just be compressed.

Each month thereafter a Citizen’s Dividend will be paid: Packets of 10 new $100 Bills
Tax policy: All taxes to be flat and broad, no exemptions, no exceptions.
2% property, 30% income, 10% sales

Tax expenditure
One half towards the citizen’s dividend
One half to run government
As revenues rise, the amount of money created each month will fall.

This is real reform.

[SCG]

I don't have a chart that says "Amen" but....

[Heidfeld]

Wow, in never ceases to amaze me how short sited some of the people in here can be. People against the drilling... or saying, "good ideas except for the drilling." Well how do you expect to pay for those good ideas?

Look, he clearly states that the drilling is a necessary evil. In the short term it wont be pretty, but in the long term it makes perfect sense. Why can't you people see this? If we drill now, and manage to eliminate the need for oil/drilling in 50 years... than that will have been well worth the sacrifice.

And just some perspective. Alaska is huge, nobody lives there, and drilling isn't akin to toally raping and destroying the land. If that is what it takes to right the US economy, and set us in motion to develop modern and clean energy... than it is well worth it.

Why can't you people see that every not and then a little bit of sacrifice has to be made? You are all wildly over-optimistic. It is no wonder most of you fell for Obama's BS. You don't want to face the harsh reality of the real world sometimes.

[andrew2009]

I disagree with the drilling idea because we won't see returns for 17 years. Plus, the Oil people are sitting un 68 acres of land to drill, and they haven't done anything. Obama's plan is more strategic than McCain's, and I have no doubt that he will be more specific toward explaining what he wants to do in order to turn the economy around.

[NetWeasel]

The Project for a New American Economy has observed that the last time so much of the country's wealth was in the hands of so few was 1914.

"What is needed now is a Titanic type event that will cause the huge accumulations of wealth to be rescattered as happened in the late teens. The difficulty with this is that it will be virtually impossible to have that many of the wealthiest 1% in the same place at the same time. Therefore it will have to be done legislatively, which may be even more difficult, yet slightly more possible."

[RedEyes]

If balancing the budget is the objective, then cutting spending, specifically welfare spending, is really the only reasonable solution. In 2008, welfare spending was 52% of the overall budget. That's a big slice of pie.

The only way to increase revenue is to raise taxes, and that will obviously hurt the economy. Yet, this is what liberalism advocates...the slow progression towards socialism and then communism. Despite being proven as a failed philosophy...the best examples of this being the fall of the Soviet Union and China's embrace of capitalism to prevent their own collapse.

Anyways, i doubt this will ever change until we are truly bankrupt, since the "what's in it for me" outlook in our country creates the atmosphere for pandering on both sides. The Democrats want to spend, and the Republicans want lower taxes, and we end up with a deficit and leave it up to someone in the future to fix the mess.

[zizyphus]

Enjoy your Republican fantasy. This Bush administration is closer to Soviet communism than any other in history. Under Bush most of our civil liberties have been stolen. The only one left is the right to bear arms, but that will go once he declares martial law.

[RedEyes]

I think you're being a little dramatic about our civil liberties being stolen.

And Bush is on his way out, so he won't be declaring martial law. But you're right in a way. Our government may one day take all our rights from us. And that's exactly why we have our 2nd amendment rights, to help protect us from our own government if forced to.

Another reason why we should give our government as little money as possible.

And i'm a Libertarian by the way.

[lbsaltzman]

I am shocked that anybody other than hardcore Republicans can even suggest we drill for oil. We are at the edge of global warming catastrophe. To suggest drilling more oil is the solution to anything is immoral and ignorant beyond imagination. Steward should be ashamed of himself.

[epotruchyeahright]

Loved the analysis, hated the solution.
Drill offshore and in Alaska, which will provide revenue to finance development of alternative energy sources, but will also damage the very environment we're trying to protect by developing alternative energy sources. Brilliant!
A poster also suggested a $200/ton of CO2 tax per vehicle. Revenue neutral? It puts $4,500 back into consumers' pockets, but not before they've spent $750/mo. paying the tax. Brilliant!
No, I think the real solution to creating an equity economy -- which, by the way, means we save more than we spend -- has to start with the consumer. We are trillions in debt because we spend too much, way beyond our means. Tearing up the credit cards and going cash-only is one way, but that will take a long time. To hasten the process along, I was all for taxing consumption. I hate Huckabee, but the Fair Tax Plan, properly managed, would create enough incentive to create smart consumption as opposed to reckless consumption.

[DavidJames]

A 50% flat rebate of a carbon tax revenues(fee for carbon dioxide emission) would be revenue neutral or positive for most people.

For example in a very active household, you might use 30 gallons of gas a week(120 gallons per month) and 700 kilowatt hours of electricity a month. The carbon taxes that you would pay would only be $340 per month. Your monthly household rebate would be $375. Revenue positive by $35.

The numbers are:

120 gallons of gas per month x $2 = $240
700 kilowatts of electricity per month x $0.14 = $100
Total Carbon Taxes per Month = $340
Carbon Rebates per Month = $375

Note this is revenue positive for this relatively active household! If you household is a little more efficient you the carbon tax rebates would be a significant source of income.

[DavidJames]

Note that the point of the $200 per ton carbon dioxide tax is to balance the budget. Balancing the budget is an economic good that shouldn't be underestimated.

Using a flat rebate of 50% of the carbon tax makes the carbon tax revenue positive or neutral for middle class citizens or low income citizens. The rebate makes the carbon tax progressive.

[americaforme]

Bondad, you just stirred everyone up with 2006 enlightenments. You should be at least curtious,to time spent in suffering, from outsourced jobs...These ideas of yours have led to self flagulations, for jobless folks. Just a few people were starting to believe that anyone cared, you laid this half baked ancient assumption on them...guilt, guilt, guilt. Screw guilt.

[bornbubblie]

Great Post Hale!
but What are we Locusts or Human beings? Delete the drilling angle from your blog. Drilling won't change the bottom-line but it will further envisorate our enviornment, wildlife, ourselves. The prices at the pump are real. welcome to the new normal. We're not drilling virgin territory here are we? Alaska, Utah, our country has already drilled these areas before. It seems every 20 years there's a conversation about opening up a reserve to drill on it, and everybody gasps, when in reality, if you look up the history of the reserve - like Spiral Jetty in Utah, for example, you'll find we''ve already taken most of it. Drilling is just another word for Denial. Denial that it's gone and that we must actually THINK and use alternative resources to save ourselves and generations to come.

I agree with a fine many of comments on a variety of issues like Investing towards alternative energy thereby creating jobs for our nation. Assuming the position of Switzerland. Close the embassies around the world bring our troops home and have a government followthrough on it's promise to PAY for troops promised College educations/ medical care/ whatever they need for boldly serving our country. Repair within now as far as CaseyBabes remarks. Legalize Marijuana like Zizphus said and create a nationwide surplus among other things. And "who killed the electronic car"?

[Bladernr1001]

We have been drilling oil for over 150 years now. I would argue that our environment is much better now then back then. It is certainly better now than 50 or 60 years ago when environmental issues were first recognized by the general populace. We have proven time and again that we can drill for oil with minimal impact to the environment.

[blackcat]

When I was a kid my Mom and Dad made us children take work on a farm or in a factory. It was horribly hard work. I learned alot about about why these are undesirable jobs. However, it seems ridiculous to suggest that we shouldn't have ANY of these jobs in the US. I live in NYC and after 9/11 when the roads were closed, our town had very little to supply itself with. I can imagine that an equally precarious situation could easily befall our nation if it goes 'white collar' like my town. Having domestic sources of goods is a necessity- even if it is a duplication of something which can be imported. Perhaps when we educate our youth, we can educate them to respect and honor the hardworking Americans who do manufacturing and farming jobs. And we could also offer these fine people some vocational programs in high schools so they don't have to finance such a worthy occupation.