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Tags: Federal Reserve | economic recovery | barack | obama | fed | reserve | Edward Leamer

The Great Meltdown

By    |   Thursday, 02 June 2011 12:15 PM

We are told that the American economy escaped from its recession in late 2009, at least as measured by seven straight quarters of economic growth since that time. Whatever these numbers seem to indicate, they clearly do not reveal the whole picture and its grim reality.

In early June, CNBC cited a top money expert as saying U.S. economic data was "falling off a cliff." The brutal truth is that regular Americans are hurting and they see no end in sight to their misery.

Meanwhile, our out-of-touch leaders in Washington and the aloof bankers of the Federal Reserve (which controls the nation’s monetary policy by decree) have no clear plan to fully rescue the beleaguered economy.
Federal Reserve, economic recovery, barack, obama, fed, reserve,             Edward Leamer, UCLA Anderson School, prius, Case Shiller Index
Barack Obama

Our ongoing economic crisis began with the collapse of the housing market in the second half of 2008 and since then, the problems have only worsened in that critical sector.

The Wall Street Journal recently reported that if you add up all of the homes that banks have already foreclosed on, homes that banks are holding but not foreclosing out of fear they will flood the market, and new homes set to fall into the hands of banks within the next two years, banks will control some 4 to 5 million homes in total — an outrageously high number.

At the same time, banks themselves remain on artificial life support from the government, indirectly making Uncle Sam the largest property owner in the country. Banks borrow money from the Federal Reserve on a multiple of their own reserves for little or zero interest, but this does little more than keep the banks afloat and prop up the housing sector by sleight of hand.

Rather than lend that money out and create desperately needed economic activity, the banks are largely reinvesting this “free” Fed cash into U.S. government securities at higher interest rates.

The Treasury can then sell its debt, and bank balance sheets balloon as cash from their bond holdings pours in, enabling them to keep without penalty an inventory of millions of non-performing homes and buildings.

It’s a slick arrangement between the Fed and the nation’s banks (we should all be so lucky to have access to such a sweetheart deal), but wholly unhealthy for the economy. Banks are not lending money to the private sector, and it’s easy to see why when they can invest risk free in U.S. Treasuries.

As workable as this scheme has proved in the short term, the Fed has boxed itself into a corner. It can’t raise interest rates because if it does, the proverbial “house of cards” falls apart when banks are forced to unload all those empty homes onto the already saturated market to raise cash.

At the same time, Republicans and Democrats have fallen into their own difficult-to-escape trap. Focused on the nation’s exploding debt, which stands now at $14 trillion, they have forgotten that economic growth is the key to driving us out of this hideous situation.

As one might expect, the GOP is focused solely on significant spending cuts to deal with the debt problem. Democrats, on the other hand, want tax increases for the wealthy to close the deficit.

Interestingly, both sides of the political fence believe that by taking these actions they will boost confidence among investors, corporations and consumers, who, in turn, will start a new boom by a newfound willingness to take on more risk.

Both parties are wrong. No economic recovery since the Great Depression in the United States has ever been ignited by cutting spending or increasing taxes.

Despite this fact, the Obama White House continues to attempt to draw water from a rock that has always been dry. This time the administration says it will work because their plan includes what the financier George Soros calls the “confidence multiplier.”

This approach, even by Soros’s account, is short-lived and will likely fail. The confidence multiplier theory argues that an increase in the value of the stock market will make the investor class feel “wealthier” and induce it to begin investing and spending, thereby setting a recovery in motion.

Since it hit bottom in 2008, the equity markets have risen about 50 percent and to some degree a confidence multiplier from this growth has helped the economy as shown by the positive growth trend in GDP. But this recovery is a hollow, artificially produced expansion and signs of a serious double-dip abound.

I believe there is another way out of our economic hole. Spending cuts are important, but they should be offset by even greater stimulative government actions that pump cash into the economy where it is needed most.

The quickest and most effective way for government to stimulate the economy is through tax cuts, both personal and corporate. Every major tax cut in modern U.S. history has led to an increase in government revenues and spurred economic activity in the overall economy. We did it before, and we can do it again.

Here are the key elements of a plan that could work:

1. Spending cuts. Sensible spending cuts in conjunction with stimulative offsets would generate positive results. The Republicans had promised $100 billion in cuts this year. Out of a $3.7 trillion federal budget, $100 billion in cuts is possible, starting with, let's say, $50 billion in defense spending (we’re spending over $80 billion a year alone in Afghanistan and Iraq).

At the same time, Congress could agree to freeze any new spending increases for the first year, and grow all future spending programs and entitlements slower than the rate of inflation. This will increase investor confidence.

2. Tax cuts. More than anyone else, working Americans are suffering in this economic recession. To help them we could cut the FICA or payroll tax for Social Security and give every worker a one-year holiday from this tax, which currently stands at 6.2 percent (this year the rate is temporarily 4.2 percent).

Corporations, especially small businesses, that have to pay a matching 6.2 percent in tax for their employees, should be given the same yearlong holiday as well, provided they spend the money they gain from it on new hires or capital investments.

In the first year, this tax holiday would give workers and businesses about $650 billion in tax relief. And rather than having this program expire on a hard deadline after one year, the FICA tax should be phased back in gradually over a three-year period.

After the FICA tax holiday, personal and corporate taxes should also be cut modestly across the board. This will, in the short term, increase the deficit; but it will also give a powerful injection of stimulus that will yield greater government revenues down the road.

3. Housing. The Case Shiller Index, which measures trends in home prices across the United States, has been giving off ominous warnings about the future. The latest Shiller numbers in May showed that housing prices had hit an eight-year low and were down by almost 4 percent, year over year.

The government needs to stimulate the housing market, and it can do so using targeted tax credits. Edward Leamer, a renowned economist from the UCLA Anderson School, says that of the $800 billion of the Obama 2009 stimulus only about $10 billion was really effective. It came largely from a homebuyer’s tax credit of up to $8,000 for first-time home purchasers.

With so many homes under government control because of its financial lifeline to the banking system, we need to stabilize and grow the housing market to relieve this burden.

Interestingly, studies have shown that most homeowners who lose their home to foreclosure can actually afford to pay the mortgage. They only walk away because they see they are "underwater" in value and believe it is not worth it to pay the mortgage. We can remove this fear with a tax credit, let's say of $25,000, not just for new home buyers, but any homebuyer.

4. Energy. The energy problem is salt in the nation’s open economic wound as the price of oil keeps rising despite the slower demand (and lower prices) that should logically come during a recession. Even worse, we are shifting trillions of dollars of national wealth out of the United States and putting it in the hands of often hostile powers that control oil resources.

How do we increase economic activity without putting even more upward pressure on oil prices? One way is to cut the demand for oil without cutting activity. For example, the Prius and other hybrid vehicles increase gasoline fuel efficiency by 40 percent.

Unfortunately, many people can’t buy these cars because they are more expensive than comparable all-gasoline vehicles.

The government can close this price gap by offering a tax credit to all Americans who buy a Prius-style hybrid. If, over the next five years, hybrids grew to 30 percent of all automobiles in the United States, oil demand would drop considerably and so would its price, everything else being equal, all without hurting the economy.

5. Immigration. Any economic plan that will spur America forward over the long-term must include a sane immigration policy. The United States has an aging population, and it needs more workers and more creative minds to grow our information-technology economy.

Countries that fail to recognize this, such as Japan, which has failed to tap into the brainpower of the outside world, remain in a permanent economic funk.

A sensible immigration plan would include the following steps:
  • Secure America’s borders, most importantly the U.S.-Mexican border. This is absolutely essential before any other steps take place.
  • Develop a plan to gradually integrate more than 10 million illegal aliens presently in the country, transforming them into taxpaying citizens over a 10-year period.
  • Create a new policy that opens our doors to up to 4 million legal immigrants each year on a “best and brightest” basis so that we can inject their wealth, intellect, and energy into our sluggish economy. The future of America is in building our technological prowess, not in manufacturing and not in low-paying service jobs.
America has endured and grown through great crises — including the founding of the nation, a great Civil War that almost destroyed us, the Great Depression and numerous financial panics, two world wars, and an epic Cold War that kept us on the brink of nuclear catastrophe for decades — and yet, through it all, we came out ahead.

We have always come through because we have always followed our instincts for freedom and empowered individuals in their pursuit of happiness.

We need to renew again our commitment to a bottom-up society energized and incentivized by free markets and supported by wise government policies, which unleash our greatest asset, the American people themselves.

They have been and always will be the basis of our prosperity, and they are the solution to our vexing national problems.

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We are told that the American economy escaped from its recession in late2009, at least as measured by seven straight quarters of economicgrowth since that time.Whatever these numbers seem to indicate, theyclearly do not reveal the whole picture and its grim reality. In...
Federal Reserve,economic recovery,barack,obama,fed,reserve,Edward Leamer,UCLA Anderson School,prius,Case Shiller Index
Thursday, 02 June 2011 12:15 PM
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