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samboct -> RE: Understanding Deflation and our economy woe's finally! (12/28/2008 9:25:07 AM)
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In an offline discussion, we came up with some additional thoughts on the economic pickle we're in. I'm sure this is going to raise the hackles of the people who are convinced that cutting taxes is the cure for everything, but they helped get us into this mess....
Given that the debt is now at what- over $10 trillion and climbing with debt service over $400 billion (that's over $1,250 per head spent on debt service) there are two options for dealing with the problem- (if there are any others, I'm keeping my eyes peeled.)
1) Inflate the currency, wipe out the debt effectively with a flood of cheap money, and issue new currency with an exchange rate of 1000 to 1 or something similar.
2) Increase taxes on the wealthy dramatically. Basically, the $2 trillion floating around in hedge fund debt- we tax the snot out of it and use it to pay down the deficit and fund new infrastructure which is desperately needed. Raise the taxes dramatically on everybody with assets over say $10 million (heck, maybe even $1 million). I think this is what Roosevelt did- although we might need to see an even larger and faster hike. Clearly we could either pay down a chunk of the debt and fund a lot of the new projects if the money in hedge fund debt was thrown into the pot.
As an aside-Do any of the people who are advocating a tax break for 2 months realize that its completely counterproductive? Our creditors are already worrying about defaults- not paying debt service is just going to make any additional borrowing more expensive. And the economic stimulus of tax cuts has been modest to say the least. This just strikes me as insane- something hasn't worked in the past- so let's try it again on a bigger scale. One definition of insanity is a failure to comprehend reality.....
Advantages of 1) Probably easier to do legally. Gets rid of what is relatively small potatoes of a half trillion or so of dollars sitting in the vaults of no goodniks.
Disadvantages- US credit for new capital abroad is shot. As has been pointed out, a lot of US infrastructure such as the railroads were financed with outside capital (in that case, UK). We'll find it much harder to borrow money in the future because all of the people who loaned us money are going to be largely screwed. China will look much more appealing for investment- they've got both the physical plant now with much of our manufacturing base hollowed out, and they've been building a good infrastructure. Hence borrowing money to finance new projects is going to be much more expensive- and money can go anywhere in the globe easily.
Other disadvantages- people with a lot of money now will probably still wind up on top. Even at a 1000 to 1 exchange rate, a billion dollars now will translate to a million dollars- and most people will watch their wages effectively remain frozen or drop. Also- the investor with $100 k will be completely shafted- the modest investment won't be worth anything.
Option 2) Advantages-we don't default on our current debt obligations to the rest of the world, and there is far less disruption in the global economy. Small investors will not be wiped out- our 401ks will still be worth something. The housing market will not get wiped out completely since it was only overvalued by about a 1/3rd or so throughout the country. Another historical aside- much of the cause of the Great Depression was a rapidly inflated housing bubble in the 1920s led by California, Florida, and Long Island. Any of this sound familiar? We may be able to get our economy back on track in a relatively short period of time- like a year- rather than a decade. Borrowing money will remain cheap as other countries will still value US treasuries.
Disadvantages- legal and political nightmare. People that think a tax cut is a cure for everything will be foaming at the mouth and there will runs on rabies vaccines. This will burst one of the balloons of the American dream- that it's possible to start with nothing and amass an unimagineable fortune. People buy lottery tickets as well. (I'd kill lotteries- I think it's a terrible example for our youth and workers- that rather than working for your wealth, you can just win it. Yeah, right. The lure of easy money has always been a pernicious drug....) It's going to be hard to stop the money from leaving the country, and undoubtedly a good chunk will. (People with lots of US dollars will convert to another currency in option 1.) The folks that blather about a free market economy (translate- unregulated) will go berserk.
It will be a tax lawyers wet dream as to do so will require a major revamp of the tax code and probably require passage of emergency bills. People will curse Obama as he goes back on a campaign promise.
Of course, protecting the very rich is something of a Ponzi scheme. We all suffer for these people to amass more money than they know what to do with. And that's not an exaggeration- there's too much money available in private equity for VCs to deal with- they've been turning it down. It's also not been good for real investment- otherwise our infrastructure and manufacturing wouldn't be in such rotten shape.
But there is certainly a psychological disruption of something that's been taken as a staple of the American fabric of life for the last 3 decades will need to get undone. People are going to be faced with hard choices- don't tax the rich (and HARD) or watch their own investments and net worth plummet. Clearly, we've been able to sell people on the idea of lottery tickets- our tax structure is little different. Can we now sell them on the idea that hard work, education, and honesty will enable them to build a better life for themselves- but that being richer than everybody else by orders of magnitude can't happen in a working democracy?
Sam
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