From economist Tom Keen, the following chart showing private debt as a percentage of GDP, and public dept as a percentage of GDP.

A big portion of private debt is household debt including mortgages.  Which is why the ongoing problem with mortgages will continue to be a big drag on the economy.  This mortgage overhang will continue forcing household deleveraging.  It would be better to reduce the mortgage debt outright and there are many proposals on how to do so.  The one I like the most is where the mortgage principal is reduced but the mortgage owner gets an equity piece of the home which it will capture at sale.  The other lesson is that public obsession with the much smaller public debt is mis-directed.  The bigger problem is how to delever the private sector.  Or more accurately how to delever the private debt without just shifting it onto the public ledger (which is the primary reason why the lower public debt turns up as the much higher private debt turns down, private debt was purchased by taxpayers).  Of course the single best way to reduce private debt, particularly household debt, is to employ millions of the unemployed in re-building America’s infrastructure.  The resulting work and good paying jobs creates income flows that will help the debt be repaid more quickly.

Wall Street may own the GOP, but Wall Street investors REALLY pay attention to politics when it comes to what effect politics will have on economic activity.

Investors know that if the government stops spending right now economic activity will slow down.  That’s bad for equity prices in particular, and commodity prices too if the slowdown looks severe enough.   So failure to reach some ‘grand bargain’ where spending is severely curtailed is not a bad thing from an investor standpoint. 

Europe, on the other hand, bothers investors a great deal.  Why?  Because Europe is the world’s largest economy taken as a whole.  And the biggest customer for US products.  If Europe sinks back into recession it will hurt US companies, irrespective of whatever negative effects weakened European banks might produce.  

Domestically, the Feds need to keep spending and if that spending directly hires unemployed people the domestic economy is guaranteed to strengthen more quickly.  Obama is touring the country beating the drum for his latest stimulus, one that directly hires and is guaranteed to put people back to work.  If he is successful, the country will benefit.

And so too will equities benefit.  Austerity, on the other hand, will sink the economy and equity prices too.

The fundamental question is what dynamic or dynamics will arise to lure massive inert savings into productive investment in America?

For 11 years now we’ve cut taxes time and again hoping this would do the trick.  At the same time that we were cutting taxes we relaxed regulatory oversight, particularly in the financial markets, again in the hope that savings might be applied to productive investment.  We pursued pro-international trade policies in hopes we could reduce foreign trade barriers and that would spur domestic job and income growth.  We used these laissez faire policies because we were told they would stimulate innovation which would create jobs and boost incomes for everyone–even for government.

The results?  For the most part the tax cuts weren’t invested in productive activity.  For the lower incomes, they were spent on consumption.  For the top incomes they went into savings type of securities like Treasuries, certificate of deposits, municipal bonds and, regrettably, mortgage backed securities that were sold as ‘safe.’  

The ‘forbearance’ of regulators allowed wild leverage in the financial markets which magnified a housing bubble that burst into a global recession, most severely in the United States and Europe.

The international trade push grew jobs and income in the Far East rather than in America.  Other than multi-national corporate profits, the only things that rose at home were the national trade deficit and the national debt.

Lassez faire turned out to be laissez fairy.

The truth is the private markets show little inclination to invest in America, other than to buy the nation’s debt at incredibly low rates.  The question of what dynamics might arise to boost domestic innovation remains unanswered.

Republicans counsel that we stay patient.  The laissez fairy will arrive, just you wait.  In the meantime we need to cut government spending dramatically (conveniently forgetting government revenue didn’t rise as promised), and cut taxes some more as well.  We need to ‘double down’ on the policies, say Republicans.

It’s past time to try things differently.  Shrinking government from top to bottom isn’t going to help pay down debt and reduce deficits when real unemployment is in the mid teens.  Reducing the number of young people who can go to college isn’t going to make the future better in any analysis.  Allowing financial markets to remain casinos isn’t going to turn water into wine.  Cutting taxes further isn’t going to boost investment nor will it increase government revenues.  Instead it will increase deficits and add to the debt.

It’s time to be effective.  We need good paying jobs and until the private markets can find the laissez fairy and bring her home, we collectively through our government need to create those jobs.  Fortunately, there’s identified infrastructure projects that would employ millions of Americans. 

For fifty years America’s infrastructure spending has declined as a percentage of Gross Domestic Product.  Our roads and bridges need repairing.  We have levees that are in need of repair.  Our urban train systems need updating and expansion.  Energy transmission systems are inefficient.  Airports  need modernization.    These projects would make America more competitive and would put a dagger into the heart of unemployment.    

How to pay for these projects?  Cutting taxes won’t pay for them.  Tax increases are required.  Simply rolling back the Bush tax cuts would put $4 trillion into government funding the next 10 years.   Issuing project specific bonds, such as is done in the municipal bond markets for states and municipalities, would transform inert savings into these badly needed productive capital investments. 

This is a dynamic large enough to produce momentum throughout the moribund private American economy.  This is a dynamic large enough to  reverse deficits and allow the debt to be repaid on schedule.   This is a growth dynamic that would restore America’s confidence and the world’s confidence in America.

Let’s see what needs doing.

• Create jobs.  Right now we’ve got about 16 million people willing to work fulltime but can’t find a job.  A good portion of these people, maybe 10 million, are receiving government unemployment checks.   So if we’re paying them anyway we might as well give them something productive to do.  Everyone knows we’ve got a $2.2 trillion backlog in various infrastructure projects.  We can can employ about 10 million people there, it is reasonably estimated.   Problem solved for the better part of the decade.
• Bring down deficits, reduce overall debt.  Creating jobs solves the short term deficits because employed people pay taxes and don’t require unemployment insurance.  If unemployment levels stay low, this creates more consistent demand which increases sales, which increases everyone’s income, including  government income.  Rationalize health care spending by implementing reforms already passed in the health care reform bill.  Maybe raise the Medicare tax up from the current 2.9% on payroll.  Raise the Social Security ‘cap’ to $180,000 from the current $106,000.    Go back to the Clinton era tax tables (see surplus).
• Diversify energy sources with a long term aim of erecting a sustainable, cleaner system.   Short term, extract more domestic petroleum and natural gas.  Use these relatively plentiful sources while subsidizing building to scale alternative sources such as wind, solar, geothermal, nuclear.  In the efficiency department, improve and build out train systems, most particularly urban subway systems.  Raise CAFE standards for autos and trucks too.  Get more with less is the basic theme.  And make it as clean as possible.
• Reduce ocean acidification.  Even if we are not responsible for climate change (most scientists think we are) no one argues about the really bad effect of the rise in ocean CO2 levels we’re experiencing.   This acidification is attacking the bottom of our ocean food chain, which covers  2/3 of our planet and supplies the major source of protein for a billion people.  High acid levels destroy coral and shellfish thus disrupting the existing food system in the ocean.   The most effective way of reducing CO2 in the atmosphere is to have more plants growing in more fertile soil.  Plants basically clean CO2 from the atmosphere.  Regenerative agriculture methods that enrich soil, such as greater use of natural compost, more advanced tilling techniques, and crop rotations that increase plant diversity and avoids leaving soil fallow, could vacuum as much as 30% of the atomosphere’s CO2.  Get rid of the $8 billion corn/ethanol subsidy which is effectively destroying soil and plant diversity in America, not to mention poisoning wide areas of the Gulf of Mexico while tying the price of oil to the price of food:  A front runner for the world’s stupidest legislation prize.
• Make our military/industrial complex more efficient.  Estimates are that we could trim $200 billion per year in the federal budget without compromising our military effectiveness.  Some argue we can’t afford to be the world’s policeman.  That’s a pipe dream because we have private assets spread around the world.  Everytime some region experiences political upset, America gets involved because American businesses have facilities there.  Being a global commercial power is expensive for many reasons, one of them being the cost of military strength to protect those commercial investments.   Efforts to build effective diplomatic alliances are far cheaper than war making.

Beezer here.  Feel welcome to add  to this list.

America isn’t ‘broke.’  America is just confused.

Somewhere along the journey of the past 30 years or so, America forgot how to do business and build productive capacity.  This forgetfulness didn’t happen in America’s boardrooms, it happened in Washington DC.

Two distinctly naive concepts gained wide acceptance in DC and as a consequence among the population at large.  One was that because America was so rich and powerful, it could turn it’s productive capacity on at will.  No, it’s even worse than that.  America began to believe it would happen without America even being consciously involved.  The ‘invisible hand’ took care of this issue for America.  This magical ‘tooth fairy’ would deliver.

The reality is that competitive markets are the best engine for economic growth and these markets more resemble a mixed martial arts contest than the classroom markets imagined by economists.  If the ‘tooth fairy’ existed at all, she would be eaten for lunch in these markets.  Counting on the ‘invisible hand’ to deliver is like going into a boxing match and forgetting the opponent has two hands not just one.

The second naive belief was that the government could not help America grow.  In the 1980s President Reagan ridiculed his own government, and by association the people it represents, by asserting the government was the source of economic problems and, ergo, not an institution that could help.  An incredibly naive pronouncement, but it took hold nevertheless among the public at large.

Large multinational companies knew better.  They co-opted government to receive special tax breaks and subsidies.  They knew the government could directly help their endeavors.

They also knew they could grow overseas and in order to do so they negotiated with foreign countries for access.  In China this normally meant the American company had to build productive capacity in China, hire local talent, sell half the production outside of China and take on a Chinese partner thus assuring that intellectual property was transferred.  So much for the ‘tooth fairy’ in China.  She apparently doesn’t speak Mandarin.

The results?  According to the Wall Street Journal, via an edited version in economist’s view:

U.S. multinational corporations, the big brand-name companies that employ a fifth of all American workers, have been hiring abroad while cutting back at home, sharpening the debate over globalization’s effect on the U.S. economy.

The companies cut their work forces in the U.S. by 2.9 million during the 2000s while increasing employment overseas by 2.4 million, new data from the U.S. Commerce Department show. That’s a big switch from the 1990s, when they added jobs everywhere…

The data … underscore the vulnerability of the U.S. economy, particularly at a time when unemployment is high and wages aren’t rising. Jobs at multinationals tend to pay above-average wages and, for decades, sustained the American middle class. …

While small, young companies are vital to U.S. economic growth, big multinationals remain a major force. A report by McKinsey Global Institute … estimates that multinationals account for 23% of the nation’s private-sector output and 48% of its exports of goods.

So does America negotiate similar concessions from those who wish to gain access to the still rich by comparison American market?  That would be a ‘No.’  Why should we?  The ‘tooth fairy’ is taking care of America.  There are a few exceptions, but America only acts when a private organization forces the issue.  One example is where the Steelworkers Union filed suit with the World Trade Organization against Chinese dumping of steel pipe in America.  The union won and stiff import tariffs were levied on these steel imports.  The result?  China spent $1 billion building a steel pipe plant Texas that employs 600 full-time steel union workers.  Just try and get the ‘tooth fairy’ to do that.

Of course if we were really serious we would have required the Chinese company to take on a US partner, source most of the product domestically, and sell half the product overseas.

As debilitating as the ‘tooth fairy’ concept is, the idea that our own government can’t help us grow is just as bad.

There is absolutely no debate over the valuable role modern infrastructures play in enabling robust economies.  None.  The American Society of Civil Engineers estimates that the country needs to spend $2.2 trillion over the next five years just to maintain our existing infrastructure, never mind upgrade things.  The University of Massachusetts Political Economy Research Institute estimates as many as 18,000 jobs could be created for every $1 billion spent on infrastructure.  Even if that estimate is off by 8,000 jobs, investing $1 trillion creates 10 million jobs–more jobs than were officialy ‘lost’ in the Great Recession.

There are other important means government can apply to grow the economy and create jobs.  One is to provide cheap capital to industry, reducing the cost of expansion.  Former Intel CEO Andy Grove explains a problem government can definitely help overcome.

“The underlying problem isn’t simply lower Asian costs. It’s our own misplaced faith in the power of start-ups to create U.S. jobs. Americans love the idea of the guys in the garage inventing something that changes the world. New York Times columnist Thomas L. Friedmanrecently encapsulated this view in a piece called “Start-Ups, Not Bailouts.” His argument: Let tired old companies that do commodity manufacturing die if they have to. If Washington really wants to create jobs, he wrote, it should back startups.

Mythical Moment

Friedman is wrong. Start-ups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordable, build factories, and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

The scaling process is no longer happening in the U.S. And as long as that’s the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.”

Grove uses a personal experience of this, when he decided to use alternative energy in his own home.

“The job-machine breakdown isn’t just in computers. Consider alternative energy, an emerging industry where there is plenty of innovation. Photovoltaics, for example, are a U.S. invention. Their use in home-energy applications was also pioneered by the U.S.

Last year, I decided to do my bit for energy conservation and set out to equip my house with solar power. My wife and I talked with four local solar firms. As part of our due diligence, I checked where they get their photovoltaic panels — the key part of the system. All the panels they use come from China. A Silicon Valley company sells equipment used to manufacture photo-active films. They ship close to 10 times more machines to China than to manufacturers in the U.S., and this gap is growing. Not surprisingly, U.S. employment in the making of photovoltaic films and panels is perhaps 10,000 — just a few percent of estimated worldwide employment.”

But wait, there’s more.  Remember when we stopped making consumer electronic products because the companies that used to make them domestically started making them in Asia in order to get cheaper labor?

Here’s Grove on what happens because of that movement.

“There’s more at stake than exported jobs. With some technologies, both scaling and innovation take place overseas. Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass- produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny.

That’s a problem. A new industry needs an effective ecosystem in which technology know-how accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer-electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies didn’t participate in the first phase and consequently weren’t in the running for all that followed. I doubt they will ever catch up.”

These problems aren’t really being created by the average American, who still knows how to show up and work.   They are being created by a political class that does believe in the ‘tooth fairy’ and does believe the government can’t help grow our economy.   The Republican Party is comprised almost entirely by members of this class, but too many Democrats have been influenced as well.  It’s this political class which has damaged our economy and to this day hinders its recovery.

One can only hope that, at some point, a leader comes forward who can  sweep aside the cobwebs and simply say: ‘Let’s do this.  Let’s get back to building productive capacity.  Building new, modern infrastructures.  Creating jobs that pay.  Forget the naysayers who claim we can’t afford to succeed.  No one, no ‘ Tooth Fairy’ is going to do this for us.  We must do this ourselves.  And we must do it now.’

Came across this word in a post from the blog Worthwhile Canadian Initiative, as cited by Brad Delong’s Grasping Reality blog.  It means moving forward in time an expenditure that was going to be made anyway.

It’s application in the discussion is the idea of building infrastructure now that most likely would need to be built anyway sometime.  If you build it during a recession then it puts to work slack labor in a recession, and probably uses materials that are cheaper for the same recessionary reasons.   If you build it later, and the economy is out of recession, then it uses labor that would otherwise be used in the private economy for other purposes. 

From the canadian blog.

“If the economy has unemployed resources due to deficient demand, both this year and next, then there is no real benefit from preponing the government spending by one year. We get higher demand, output and employment this year, and lower demand, output and employment next year. Adding the two years together the multiplier is zero.

But if the economy has unemployed resources due to deficient demand this year, but not next year, there are benefits…. We get an extra bridge (or whatever) almost for free. The resources that would have been used to build this bridge next year are now freed up to build something else instead. Like a second bridge. And the resources used to build the bridge this year weren’t doing much anyway….

If we prepone the bridge, government expenditure will be lower next year. That means private consumption will be higher next year. (Because government spending crowds out private spending under “full employment”). Assume people know this. The Euler equation for intertemporal optimisation tells us that an increase in expected future consumption will cause an increase in desired current consumption. So preponing the bridge also increases current consumption…”

Beezer here.  I’m skeptical of a lot of economic theories because they seem to rely a lot on ignoring variables and just assume the variables will remain stable or predictable.  Anyway, building infrastructure now would have one predictable result:  It would employ lots of people now who are unemployed.  Millions of people, in fact.  If at the same time the economy continues moving into recovery, then under the argument that ‘preponing’ infrastructure that’s going to be built anyway, the infrastructure work will boost consumption now, will cost virtually nothing, and will free future labor up for private market jobs.  So I like this particular economic theory.