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 spiralling 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.

Read More:

Should the Government Bail Out the Big Three U.S. Automakers? HuffPost Bloggers Weigh In

Comments

[glitzqueen]

Above all, we need to do what should have been done all along: Cancel the shadow economy that's sucking the real economy dry. All these hundreds of billions are going to pay off stupid, overleveraged derivative side bets that never served any useful purpose. Had those contracts simply been nullified, there'd be only small probls -- but we're still allowing more of them to be created every day. Letting the world fall into a recession, perhaps a depression, for the profit of a few high-stakes gamblers is madness.

[JBS]

Any increase in gasoline taxes should be accompanied by massive increases in taxes on oil company profits. Restore the corporate income tax. Corporations claim the rights of "persons"; make 'em pay.

Abolish limits on corporate liability. Make corporate officers individually liable, civil and criminal, for the actions corporations take while under their charge.

And bring back the PROGRESSIVE income tax. Tax ALL income; making no distinction between capitol gains, stock options, deferred compensaton and wages.

[letsbepeaceful]

Comparing the USA to China is not valid since China is still mostly rural, and its energy use is increasing exponentially.

Most economists agree that deregulation of the credit markets led directly to the market idiocy. There's too much leverage.

We must increase interest rates on simple savings accounts and cds to get the general population to increase savings. People put money in riskier investments (if they were saving at all) because even a basic mutual fund returned more than a bank account .

Long-term economic stability cannot depend on consumers buying new cars, TV's, washing machines, etc. We cannot wastefully turn over these items every 2-3 years just because there's a new model.

It's not possible to just raise taxes on gas in the US to be equivalent to the 'rest of the world' - first, we are a much bigger country and have very different needs than Europe. I would like to see very high registration taxes ($500-800 annually) on large vehilcles, etc. not being used for business. Tax the vehicle rather than the fuel. That would immediately encourage people to buy more fuel-efficient cars, which would increase the demand and would push the Big Three to make more fuel-efficient cars!

Use the money from the inefficiency tax for infrastructure, creating more jobs.....

Restricing credit card interest rates to 15-18% would immediately help struggling families. Credit companies also should refrain from automatically increasing credit limits - we should have to ask for such increases.

[JBS]

Restrict credit card interest rates to less than 12%? Or tie them to the CPI-U core inflation rate; core inflation as reported by the department of labor + 6%.

[sposton]

"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!"

And whose fault is that? Are the American people guilty of this? This did not happen overnight without any economic or ideological framework! Sir, it is your profession that is largely responsible for this outcome. And it was not the Chinese people who have saved these surpluses but the Chinese state! Our government could have done the equivalent if it wanted to but it followed the interests of the banksters instead of its people. And let us please put everything in a proper perceptive. Chinese per capita income is equal to Albania's! While I agree with some of what you say I strongly disagree with your apparent deflection of who is truly responsible for this mess. Without properly investigating the true causes and culprits of this meltdown we cannot properly fix our problem.

[ObjectiveRealist]

[
Airlines have demonstrated repeatedly that the bankruptcy mechanism rarely grounds planes permanently.
]

... in normal credit markets. Restructuring under Chapter 11 Bankruptcy requires significant amounts of cash on credit during the restructuring period. That does not seem to be viable right now, and would lead quickly and certainly to Chapter 7, liquidation.

[Chavez08]

Great point!

...and Airlines don't have the Washington-subsidized competition to deal with either (Toyota, Nissan...)

[joebaggadonuts]

I agree with your premise, Paul, but I think you need to leave the solutions to the clean-up team.

http://www.ft.com/cms/s/0/4309f7d4-b737-11dd-8e01-0000779fd18c.html?nclick_check=1

Bad outcomes are not inevitable and the difference between them and a bright future will be the choices our new leadership makes.

[ObjectiveRealist]

Interesting, but I'm not convinced that bankruptcy is a real option, right now. As I understand it, "restructuring" is part of the plan in Chapter 11 bankruptcy, and it *depends* on the availability of credit. But the unavailability of credit is the exact reason that all three are unable to pay their operating expenses, simultaneously.

I think Congress is disingenuous to ask the execs for a written "plan" for their business. What we should be doing is asking Ford, GM and Chrysler's previous creditors, who did extend them operating cash until very recently, "Have you withdrawn their lines of credit because of their creditworthiness, or because you're broke." If the latter, that's Congress' fault.

[texastrixie]

As to this whole article, comparing the US to other countries is a faulty premise. All of Europe has demographic patterns based on walking, cycling, and ox-cart for that matter. Yes, people don't have cars, and the country is set up for that.

Here, people live in suburbs. If we tax gasoline to match Europe, we are going to destroy the economy. Most people who live in the suburbs are not rich. If we were, we'd live in town. Making gasoline vastly more expensive will make housing in the city only more expensive. And can we really expect a 50 year old white collar worker to bike 20 miles everyday into the city? In a suit? And if not, where is he/she supposed to shower before starting work?

And China! China uses no oil because they only have like 3 cars per thousand people. And a large majority of those people still live on farms, have almost no income, and little (except for electronics) to distinguish life from what it was 40 years ago. Their corporations feed their babies poison! On purpose! People are considered a disposable resource. This is the country we should strive to emulate?

Yes, we need to make major changes. But I am tired of people holding up other countries as these pristine ideals; especially China.

[Sundialsvc4]

Paul, I know you're a finance guy, but I think you glossed over one of the most important points in your excellent piece. To me, "it ALL comes back to 'making things.'"

When you have an economy that is centered around production, not consumption, you find that for every factory you have two dozen smaller factories who spring up to supply it. And for each smaller factory, another two dozen spring up to supply them and so-on. This multiplier effect puts money into tens of thousands of pockets ... within a small geographic region. Flows of money are seen to be circling in tight, close loops.

A typical financial picture, as I understand it (and cheerfully bowing to your greater expertise), either does not consider what happens outside of a single balance-sheet, or treats it as "price alone." But the physical proximity of sources is, I believe, quite important. We have neglected it. China's growth has been to some degree at our own expense. Had we emphasized "make it HERE," their growth might have been smaller but the situation today would be "beneficial to ALL concerned." As things stand now, lots of people are holding bags of straw.

[ktthecarguy]

About #1: you can't compare apples to oranges like USA to Europe. Their population density and dispersal is quite different from ours - more concentrated, which makes mass transit more ecomical. Their whole culture is geared around this as well. to them, travelling to the next city to, say, go shopping is a BIG DEAL! Planned for weeks or months before undertaking. Here, it's not even a second thought. An incremental increase in gas taxes to modestly achieve those goals might work, but anything drastic will have enormous backlash.

[joebaggadonuts]

Their population is more concentrated BECAUSE they have good mass transit. It's called a virtuous circle. Get a clue.

[Mildmannered]

the reason the economy is so terrible is because the economy is reacting to what it sees as an anti-economy, anti-growth policy of Obama -- or at least that is what Hannity says -- in other words, the present financial meltdown occurring a number of months before Obama even takes office is really Obama's fault -- or sometimes the rightwing talk show kooks blame it on Barney Frank --- how about blaming it on the Secr of the Treasury, the head of the Fed Reserve and the SEC chair -- the people in charge, the people on whose watch this meltdown occurred. Let's assume that they couldn't stop it, couldn't they see it coming a year or two ago and warn all of us?!?!

[letsbepeaceful]

I think they did see it coming - they were certainly warned by many, including Obama, at least a year ago, and conveniently ignored reality

[nogimmicks]

Judging from his previous steps, Obama will not do it. He will just do cosmetic changes, will fiercely delegate to the wrong people, and will keep the status quo. Same people running committees, same lobbyists, same flow of taxpayer money to the military-industrial complex and the financial sector, preserving health insurance company profits. I hope I am wrong, though, but it looks bad.

Of course he will get a free benefit from the fact that the crisis conveniently happened before his presidency.

[Sundialsvc4]

Why don't we give the new CEO a few months in the job and see for ourselves?

And is anyone pointing a baleful eye at where the true Federal decision-making authority within this country actually lies ... the ONE AND ONLY place ... the Congress?

Is anyone also looking to the second decision-making authority, the "several States?"

The job of the Chief Executive is a lonely one. You're going to be blamed and vilified for anything that goes wrong, and glorified for anything that goes right, and you'd better remember at all times "which one of the two lasts longer." So many hopes and expectations have been pinned on Mr. Obama that he is being damned even before he takes Office. But you have to know to expect that.

[richardmcnoggin]

Obama and the Democrats should not do anything to help the economy that way it will be easier to institude their socialist agenda .

[BillZBubb]

While I totally agree President Obama needs to lower expectations, he also needs to explain exactly what caused the mess we are in: Republican economic philosophy. The public only learned that lesson for a short time after the Great Depression, and since buying the snake again from Reagan we are on the same path now.

Maybe this time people will wise up for the long term.

[Erdgeist]

We could balance imports to exports by using a tariff on imported goods, including oil, while strengthening, at the same time, our manufacturing base (at one time we made half the world's goods).

[Sundialsvc4]

I would think that tariffs might be useful, but before we look at that I think we need to rein-in this process of "fiat financing." We can easily count how many trillions of "United States Dollars" are supposedly out there, but there are many times more of them than there is actual economic activity world-wide. (In other words, we have all been swindled.)

The so-called "solutions" that are being thrown about now are all "finance" solutions. Everyone in the country is running up to Uncle Sugar asking for a cup o' "mo' money." But to those of us who remember when the big abandoned factory in our little town was humming, and there were bustling businesses where the (struggling!) pawn-shops now are... we remember what we used to have and we remember how we had it.

"Make things. Here." Well, you can't just swish your magic-wand and make that happen. You can't do ANYTHING and expect it to happen in six weeks or six months, maybe six years. But you CAN adjust the picture to alter where a businessman sees new opportunity.

After all, "of COURSE there would be advantages if I could ship raw-materials 30 miles instead of 10,000... and call my suppliers in my own time-zone."

[tomas0808]

I think this is the best post I have ever read here. I've been droning on about a gas tax for years. The benefits will be many, the ones you listed and we could use it for universal healthcare and free education. I think the American people would go for it, even 10 bucks a gallon, if we could get healthcare and education.

If anyone can do it, Obama can. The only problem is getting it past the people who have been running this country the last forty years, the corporations aka, the enemy of the people. If this happens I would consider not leaving this country for Norway, land of my ancestors. If things don't change I think you're gonna see a lot of reverse immigration, people whose parents and grandparents moved here looking for greener pastures will move back looking for greener pastures, and how ironic would that be?

[texastrixie]

I know of almost no one who could afford to go to work if gas were $10 a gallon. We live 20 minutes from my husband's job, and rarely leave home on weekends except to go to the grocery store (5 minutes away). But if gas was $10 a gallon, I don't think we could even afford to eat, use air conditioning, or buy anything PERMANENTLY.

Who could afford to go to the doctor at $10 a gallon?

What school districts could bus children to school at $10 a gallon? Many school districts were just about to go bust when gas was $4 a gallon.

Yes, we should implement a higher gas tax, but $10 a gallon would destroy this country.