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Sunday, May 07, 2006

Problems with the Economy & Fixes

Originally Posted: July 31, 2005 -- 9:43 PM
Fool Boards Link: http://boards.fool.com/Message.asp?mid=22823833

This is currently my top recommended post from the Motley Fool.

=================

I'm gonna keep pasting the same thing until I get a good answer from somebody:

Now you're on the clock. Please tell us (1) exactly how the economy is screwed up (other than the deficit, according to you), (2) What you would do to fix it, and (3) *Why* your fixes will work.


====================================

OK, I'll bite.

Here are some of the major problems with the current fundamentals of the US economy.

FOREIGN OWNERSHIP OF US DEBT -- The US isn't just in debt up to its eyeballs, it isn't just in debt up to its eyeballs to future generations of American citizens and voters, it is in debt up to its eyeballs to foreign economies. If those large foreign holders of our debt ever get cold feet about our financial or political situation or decide they can make more money investing directly in their own domestic economies rather than earning interest off US Treasury Bills, our interest rates will SKYROCKET as we try to attract the money we need for our deficit spending and existing debt. We've had the economic pedal to the floor with the low interest rates we've had and have only been able to produce a normal to sluggish recovery. If interest rates return to traditional levels, look out.

RETURN ON THAT DEBT -- When a traditional mortgage is taken out on a home, the borrowing allows a party who HAS a large chunk of money to make a steady, predictable profit by channeling that money to another party who is capable of making steady payments towards retiring the debt while taking ownership of an asset that produces immediate benefits AND creates long term value. There's nothing inherently wrong with government doing the same thing, but what has America obtained with the deficit spending over the past five years?

  • tax incentives to multi-billion dollar corporations intended to increase capital spending and produce jobs when in fact the largest beneficiaries (SBC among them) TOOK the tax breaks, REDUCED capital spending and CUT jobs


  • http://online.wsj.com/article/1,,BT-CO-20040922-005405,00.html?mod=COMPANY

  • lots of tanks, armored personnel carriers and HumVees that wear out in about two years in duty in Iraq

  • public works projects in Iraq to reconstruct infrastructure we blew up toppling Saddam that just return Iraq to barely pre-war conditions

  • income tax cuts intended to stimulate the econony yet barely moved the needle despite unprecended low interest rates and a booming ("bubbling"?) housing market, normally a HUGE driver of job creation through direct construction jobs, durable goods orders, etc.

  • lots of highway pork projects

  • lots of "national security" pork projects that have not demonstrably addressed key security gaps, like containerized shipping security, chemical plant security or information technology improvements to aid better detective work and information sharing between government entities

  • a new "Energy Bill" that provides BILLIONS of tax incentives to oil producers who have failed to build a single oil refinery since 1976 despite making record profits in the past few years


In other words, all that extra debt and little short term value, no long term value and an economy that can barely afford the debt load when every light goes green in our favor. If we hit a few yellow or red lights, market conditions will rapidly turn the opposite direction in a heartbeat.

CONSUMER DEBT -- Unlike all the readers of The Motley Fool (who of course have two years' salary saved in cash, a 401k invested in a diverse range of safe mutual funds, a house that's paid for and a couple of hundred dollars in credit card debt), most Americans have virtually no savings, $8562 dollars in credit card debt at 16-20 percent annual interest, an adjustable rate mprtgage on what may be an overpriced house with virtually zero equity and at least one gas guzzling SUV that swallows $60-70 every time they pass a gas station. If instead, all Americans had adequate savings and little debt, a 6-12 month downturn in the economy would be no problem to ride out without breaking a sweat. In reality, many Americans are no more than three months away from having their credit cards trigger a universal default, losing their house or burning through the savings they have to stay afloat if they lose their job. I'm not just talking people struggling with $30-50k of income and a family, I'm talking people making $1xx,xxx.

Big deal, you say. Someone making $100,000 that would lose their house after only 3 months of unemployment deserves it, right? Well, what if they live next door to you and unload their house for $230,000 instead of $300,000, immediately reducing the value of your home? What if your employer then decides to move and you need to sell your house? YOU are now looking at a $70,000 potential drop in the value of an asset YOU have. That's what happens in an interconnected economy where a lot of other people are getting over their head, getting greedy, or just getting plain stupid.


CHANGING LABOR MARKETS -- As free trade agreements widen and China continues expanding its economy, the US is looking at a TIDAL WAVE of cheap labor that will draw what few manufacturing jobs we have abroad. We'll just focus on service jobs, "professsional" jobs, "knowledge worker" jobs, then, right?

Wrong. Most companies are already eliminating in-house functions for developing payroll systems, ERP systems, etc. to consulting companies who hire programmers in India, etc. at 30% of current US wages for these functions. There are definitely HUGE problems with attempting to offshore this work (language barriers, timezone differences, lack of common business practices, etc.) but that certainly isn't stopping big business from trying off-shoring and driving down white collar wages until they realize it isn't all roses.

At the same time, the US is not doing a very good job in secondary education preparing students for college and the number of students graduating with degrees in physics, chemistry, materials science, mathematics, and general engineering isn't keeping pace with demands. I was perusing the shelves of my local Borders last weekend looking for some books on enterprise Java development techniques, etc. (fascinating stuff, huh?) and happened to overhear a conversation a 12-year old was having with someone else in the aisle talking about how he's been developing his own apps for the past year because the commercial stuff just wasn't meeting his needs, and so on.

For every smart, motivated (albeit somewhat precocious) 12 year-old like that, America has TENS OF THOUSANDS of kids whose expertise about and interest in technology extends no further than knowing which web sites have the codes to unlock the pornographic "extras" in the latest version of Grand Theft Auto or Limp Bizkit ringtones for their cellphone. If the computer doesn't turn on when they press the button, they are CLUELESS. I'm not a technology biggot and wouldn't worry so much if instead we were raising a generation of history majors, linguistic experts or finance and economics wizards. That's clearly not happening either.

Meanwhile, even if only 0.5% of the kids in China or India get selected for special schools in science and engineering, that 0.5% of a BILLION people will soon begin to dominate the jobs that will create the intellectual property and economic growth of the future. Even if none turn out to be "rock stars" in semiconductors or software or biotech, that amount of even mediocre talent will depress salary levels for jobs now paying $70k-90k. There goes what's left of the middle and upper middle class.

Americans aren't entitled to above average salaries and benefits compared to the rest of the world unless we are truly more productive and create actual value (not paper profits in Enron-esque schemes) with our 40-60 hour weeks. We cannot sustain an above-par standard of living in the long term with sub-par education in a global labor market. The competitive pressure on the low end of the wage pyramid is too great.


FIX #1: CLARIFY LIABILITY FOR TERRORIST ACTIONS ON PRIVATE INDUSTRY

Stop spending tax dollars trying to improve public safety involving privately owned assets. If you own a chemical plant, tanker farm, nuclear reactor, or similar "at risk" asset, YOU are responsible for taking reasonable precautions to gaurd the asset against foreseeable sabotage or attack.

What's "reasonable" and "foreseeable"?

I have absolutely no idea. That's exactly the point. The government doesn't either. It's more likely private industry knows the pitfalls of its technology better than the government so that if it is clear no government bailout would be coming if the worst happens, the owner will either take appropriate meausures to protect the asset or exit the business. As things stand now, big business is assuming the government will step in to make them whole if the worst happens so we are systematically under-spending on efforts to harden our infrastructure.


FIX #2: TIGHTEN RESERVE RULES ON BANKS

We have major national banks making mortgage loans without even bothering to check incomes claims of the applicants. "Borrowing less than $100,00? Sure, what the heck..." (see news stories this week). The Fed cannot dictate specific lending policies for mortgages, home equity loans and commercial loans, but it has a much simpler tool. Control of reserve rules for member banks. Increase reserve rules and require banks to have more cash on hand and inject a little sanity back into credit markets. Don't take the punch bowl away in one step, but at least start watering down the vodka with some club soda.


FIX #3: ENACT A REAL ENERGY AND TRANSPORTATION BILL

The Energy Bill just passed by Congress does NOTHING to improve supply of ANY energy sources or reduce consumption. US energy policy (or lack thereof) is one of the biggest single contributers to ALL of our economic and political problems. To cut the volume of cash leaving the country, the government needs to fundamentally alter incentives to individuals and big business.

How about a tax credit to the first American car company that produces a vehicle (or family of vehicles) that gets 50 MPG and sells at least 150,000 vehicles for three consecutive years or 15% of the company's total sales (whichever is larger) over three consecutive years . The tax credit would cover any expense the company incurs on research or design conducted IN THE US or for manufacturing capacity built for the vehicle IN THE US. The tax credit would be structured so:

  • the government isn't trying to dictate the technology (make it a hybrid,
    make it run on hydrogen, make it run on Congressional hot air, just make it hit 50 MPG)

  • the automaker cannot capture the credit by just building a fleet for one year -- the volume is high enough where the marketplace can impose discipline on the process

  • the value of the tax credit would be extended over 10 years AFTER the end of the third year of the qualification period and the 1/10th credit amount would only apply to PROFITS but would not generate tax refunds if the company lost money (prevents the company from swinging for the fences to get the credit but harming the long term
    health of the company)


How about requiring any vehicle selling more than 10,000 units per year to meet passenger safety and fuel economy standards? If you want some interesting reading, look into how a loophole in earlier CAFE requirements that exempted "trucks" from passenger MPG requirements produced the gas guzzling SUV craze in the US.

How about requiring any new Interstate highway projects (new roads or expansion / widening of existing ones) to require the set-aside of easements for rail transport? It may not make sense right away to actually BUILD a rail line in the initial project, but we certainly shouldn't be continuing to dig the hole by cutting swaths for highway expansion without including room for more efficient public transportion on what is clearly a useful route (otherwise, why would the highway be going in there?).


FIX #4: STREAMLINE MEDICAL INSURANCE PROCESSES

Enact legislation requiring the ten largest providers of medical, dental and vision insurance to develop and implement a SINGLE set of electronic forms for

  • applying for insurance coverage

  • submitting claims for benefits

  • processing payroll deductions and payments


within three years. Once implemented, the rest of the insurance industry would have no choice but to follow as the Fortune 500 adopt the standard scheme. Adoption of these methods would allow standard software (open source?) to be developed for use by small business and drastically reduce their costs to even the playing field a bit on the benefits front between large and small business. Streamlining this aspect of insurance coverage will cut costs for all business (including the health care and insurance industries), lighten a MAJOR burden that disproportionately hurts small business (the biggest source of new jobs), and hopefully lead to more portable insurance benefits.


FIX #5: LIMIT CAPITAL INVESTMENT DEDUCTIONS TO DOMESTICALLY STAFFED PROJECTS

If your company is considering a development project that might cost $10 million with domestic labor but only $6.5 million with off-shore labor, feel free to choose the $6.5 million bid. Just don't expect full capital tax benefits on your US taxes (a benefit worth $3.5 million on a $10 million capital expenditure with a 35% marginal tax rate). If the $6.5 million bid turns out just as well as the $10 million bid would have, you're still $3.5 million ahead. However, if off-shoring doesn't really work as well as advertised, you might have been better off choosing the $10 million domestic bid, and getting a $3.5 million tax credit and coming out even on the cash. Even if the company hires a bunch of foreign nationals with green cards to do the work at low wages within the US, at least most of their salary dollars will be spent domestically boosting our economy. Who knows, they might like it here and start another company like Intel here in the US.


WatchingTheHerd

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