jmkeynes

It's Only the End of the Beginning

The main economic problems Americans need to are address are: the current banking crisis, the energy/environment crisis, and the trade deficit.

As for the banking crisis, as I see it there are three options for dealing with institutions that are thought to be too big to fail:

1) a free market approach that lets failing banks fail,

2) a socialism for the rich approach that bails banks out but then lets them go back to their high risk behavior, which leads to future bailouts, and

3) a plain old socialism approach that nationalizes institutions that are deemed to be too big to fail and turns them into highly regulated government agencies.

The Resolution Trust Approach is a variant on option (2).

Most business journalists argue about whether option (1) or (2) is better, but they don’t give option (3) any coverage.

The critical long term issue is whether you want the CEO’s (and other high ranking executives) of these firms to be high paid, high rollers who earn their eight digit paychecks by taking big risks.

If so, then the taxpayers will rebel when they’re left holding the bag on bad investments.

Alternatively, do you want bank managers to be competent (but rather boring) functionaries who simply follow the script set forth in regulation. If this is what you want, then the taxpayers should be more willing to fund bank bailouts. But, don’t expect much innovative behavior from banks if this is the way we want them to operate.

You can’t really have it both ways.

So, if a majority of Americans really want an innovative, high risk banking system, then we need to be willing to let banks fail and suffer the consequences.

On the other hand, if the majority of Americans want a safe, reliable, but unexciting banking system, if we think banks are inherently too to fail, then I say we move banking to the public sector.

In any event, if we look at the current crisis as "merely" a problem of socializing a few hundred billion dollars worth of bad debts, then we’re missing the forest for the trees.

Those who obsess over the credit crisis generally make three faulty assumptions:

(1) they assume that since US economy is consumer driven it has to be that way going forward,

(2) they think the only way to prop up consumer demand is to re-inflate the housing bubble, and

(3) they conclude from (1) and (2) that to avoid another Great Depression the US has to bail out the banks.

We need to examine how these three faulty assumptions are part of a larger story.

To see the larger picture one needs to understand the link between America’s energy policy, its chronic trade deficit, and asset bubbles induced both by the Fed’s easy money policy and America’s need to borrow from abroad to finance its trade deficit.

America’s energy policy has been entangled with our military policy for many years. Even Alan Greenspan admits that the war in Iraq was and is largely about oil.

Unfortunately, those opposed to the war have not insisted that Americans must at least pay for the war by imposing a tax on oil consumption. Since the cost of the war is not included in the price of oil, America is subsidizing its consumption of oil.

Taxing oil would help bring down the trade deficit and it would encourage investments in alternative energy. But, instead, America borrows money from abroad to pay for the war.

The Chinese, Japanese, Germans, Saudis, and others have been all too willing to loan American money to help stimulate their own trade surpluses. In fact, their surpluses are so large, and America’s deficit is so big, that America is allowed to borrow still more to pay for “investments” in housing - hence the housing bubble.

If America could redirect investment spending away from housing and toward alternative energy we might be able to make a dent in our trade deficit.

According to T. Boone Pickens, America needs to invest around one trillion dollars in windmills and another 200 billion dollars in an expanded electricity grid to bring power to the coastal states.

In short, we need to make massive investments in alternative energy. Given the need for massive investment spending, a slowdown in consumer demand may actually be a blessing in disguise.

But politicians cannot get elected by telling voters the country needs to take some bad tasting medicine to regain its economic health.

Instead, politicians tell voters what they want to hear. Both the Republicans and Democrats push for cutting oil taxes and income tax rebates to encourage consumption spending even though both policies will exacerbate the trade deficit.

Of course, in an economic downturn it does make sense to borrow money (from abroad if need be) to stimulate aggregate demand. But, the government can and should stimulate demand by investing in alternative energy infrastructure.

Windmills help bring down the trade deficit, but more consumer spending simply drives up imports.

Finally, to top it all off, politicians seek to capture the home owner vote by insisting that their party has the best plan to re-inflate the housing bubble.

Unfortunately, politicians, voters, and some economic journalists have come to believe that the US economy must continue to depend on consumer spending.

What is worse, “free market” economists argue that government shouldn’t make (or even try to promote) investments in alternative energy because this would be industrial policy. And, according to free market buffs, industrial policy is yet another futile attempt by government to “pick winners.”

Oddly, these same “free market” economists don’t see the war in Iraq (a war Greenspan admits is largely about oil) as energy policy or industrial policy. They see war as “military policy” so therefore picking winners in this instance is OK according to the Ayn Rand and Milton Friedman guidebook on what governments should and should not do.

So, America borrows money from abroad and lets the Fed run the printing presses to send out tax rebates, bailout banks, and jack up home prices.

These policies may be “good tasting” but they’re not good medicine, they’re poison.

The medicine America needs to take won’t taste good, but there may still be time to save the patient.

America needs to nationalized the banking system. We need to work off our trade deficit. And, we need to kick both our oil and our house-as-investment habits.