We Can All Do Better (5 page)

To those worried that inflation will result because of the Fed's large-scale money creation and the entitlement spending increases on the horizon, I'd say simply that we're unlikely to experience inflation if consumers and businesses are not spending. And I'd remind those who fear a return of the “stagflation” of the 1970s that even as the economy back then was doing poorly, wages and consumer credit were rising.

Along with the short-term actions related to job subsidies and housing, we need a mid-term approach that will create jobs over the next five to seven years and allow some time, as the New America Foundation study has pointed out, for mortgage holders to work down their debt, U.S. companies to strengthen their positions in international trade, Europe to resolve its sovereign debt and banking issues, China to orient its economy more toward consumption and less toward exports, and the world economy to reduce its excess supply of capital, labor, and productive capacity.

What most people remember about President Franklin Roosevelt's response to the Great Depression are the Works Progress Administration, the Public Works Administration, and the Civilian Conservation Corps, which created jobs for Americans in building schools, parks, roads, dams, bridges. In the small town in Missouri where I grew up, the high school was a PWA project built in 1939. Today, over
seventy years later, it stands as testimony to far-sighted government leadership. We need new public investment in public goods that will last another seventy years. To get America back to work, strengthen our national security, and stimulate economic growth, the President should propose a massive nationwide infrastructure-investment program. The New America Foundation study estimates that a $1.2 trillion investment in much-needed infrastructure over a five-year period would generate 5.52 million jobs in each year of the program. There is no other stimulus that could create so many jobs and leave behind a seventy-year foundation for economic growth. Given low interest rates, there will never be a cheaper time to float thirty-year reconstruction bonds. Government-subsidized personal consumption (i.e., tax cuts) in the current climate of debt de-leveraging cannot work; public investment that directly creates jobs can.

Without high-speed rail lines in key U.S. corridors of 750 miles or less—such as Boston to Washington on the Eastern seaboard and San Francisco to San Diego along the Pacific seaboard; the Texas triangle comprising Houston, San Antonio, and Dallas; the Orlando/Tampa/Miami corridor; and the Milwaukee/Chicago/Detroit route—we will become even more dependent than we are now on insecure sources of foreign oil, because people have no convenient mode of transportation except for their cars. Indeed, transportation now accounts for nearly 75 percent of U.S. oil consumption.
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Without investment in seaports and airports, our points of entry will become increasingly clogged, expensive, inefficient, and even dangerous. Without investment in highways and bridges, we will be less productive and more inconvenienced. These investments interact positively with each other. If high-speed rail connects cities, then airlines can concentrate on longer distances and highways will be less jammed. If airports trade in their old traffic-control technology of the 1960s for what is possible today, delays will fall and productivity will rise.

Just as it did in the nineteenth century, infrastructure investment can lay the foundation for the next wave of economic growth, even as it employs more hardworking Americans. It will also demonstrate to the American people that their tax dollars are being spent on behalf of all of us. In 1987, Ronald Reagan vetoed a transportation bill because it had a hundred earmarked projects. In 2005, George W. Bush, without uttering a word, signed a transportation bill with 6,229 earmarks. Such profligacy may be a good re-election strategy, and it might even employ a few more lobbyists, but it is not a transportation policy. There should be a limited number (under fifty) of projects, and they should be projects of national significance. Each should be costed out rigorously. Individual earmarks must cease; otherwise we'll be wasting dollars with no real national benefit. A 2011 report from the Carnegie Endowment for International Peace by a committee on transportation solvency called for a Transportation Trust Fund that pays for highways, transit and passenger rail programs, and a National Infrastructure Bank—all fully funded, as in most other countries, by revenues from transportation.
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Specifically, it concluded that to fund infrastructure improvements, we need an oil-import fee that, as oil prices dropped, would morph into a gasoline tax, thus holding the price of gasoline stable.
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The price of gasoline would rise as the import fee is passed through to the consumer. When the market turns, the consumer will continue paying the former price with gasoline taxes making up the difference, thereby establishing a predictable floor and sending automobile companies the price signal to build more fuel-efficient vehicles. To add urgency to the program, all contractors should be offered completion incentives and asked to put up bonds backing the quality of their work.

Meanwhile, of course, we need to finance our federal debt. Without foreign lenders, that will be difficult to accomplish. Our largest creditor
is China, which holds $1.426 trillion in U.S. debt. Many argue that China would never precipitate a financial crisis by selling U.S. Treasury bonds, because such action would mean a drop in the value of the dollar and thus of their remaining dollar investments. They argue also that panic selling of U.S. Treasury debt would hurt the U.S. economy, which in turn would mean reduced exports from China to the United States and thus increased unemployment in China. And then there is the question of where China would put its $3.2 trillion in foreign currency reserves. It seems unlikely that they would buy more yen and give the currency of Japan, their Asian rival, the status of a major reserve currency. The euro is also an unlikely repository. Who knows whether, ten years from now, it will even exist? Currencies such as the Swiss franc or the Singapore dollar or the Norwegian krone don't have enough circulation to be a meaningful alternative for the Chinese. But nations aren't always rational. Our vulnerability is real.

It's wise to remember that those who control the purse strings often control much more. An example: In 1956, the British, French, and Israelis invaded Egypt in an attempt to take over the Suez Canal. At the time, the United States was the world's dominant economy. President Eisenhower was outraged and ordered the U.S. Treasury to start selling the British pound short, thereby putting unbearable downward pressure on that already sinking currency. His administration also prevented the British from drawing down their quota from the International Monetary Fund, further fueling speculation in the pound. Britain got the message and announced its withdrawal within a month.
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The prospect that China will exert similar pressure on us is not a probability, but it is a possibility. By threatening to sell off our debt or excluding our companies from its market, they might try to influence our actions with regard to Japan, Taiwan, or the South China Sea. Whatever the precipitating event, the faster China's economy grows and the more dollar reserves it accumulates, the more powerful
could be such coercive action. Clearly, China is fed up with our failure to deal with our long-term fiscal imbalances. It fears inflation down the road and a depreciating dollar. These concerns make it highly unlikely that China will be at the front of the line to purchase much of the $3.5 trillion in maturing Treasury debt that we have to refinance over the next two years. In January 2011, the Chinese Central Bank ceased to require Chinese companies that earn dollars to return those dollars to the central bank in exchange for yuan; they can now use their dollar earnings any way they want. With fewer dollars at the central bank, the Chinese will be able to say, when we ask them to buy a lot more Treasury bonds, “Sorry, we don't have the dollars to buy more than we already are buying. They're in the coffers of Chinese companies, which, as is the case in your country, we don't control.”

Whereas it might be more difficult to count on the Chinese for our government-debt financing, Chinese capital could lay the groundwork for America's next wave of economic growth. If we can control our long-term structural budget deficit, we will need less Chinese investment in Treasury bonds. The Chinese will continue to amass dollars as Americans continue to buy Chinese exports. They could use these surpluses to buy the reconstruction bonds issued by the U.S. government to fund the entire $1.2 trillion in infrastructure investment so critical to the recovery of the U.S. economy. Such action would be a tremendous vote of confidence in our bilateral relationship. We could then use the transportation trust fund for the less high-priority but needed infrastructure improvements. Persuading China not only to fund major infrastructure projects in the United States but also to bring more Chinese companies here to hire Americans (as opposed to simply purchasing American companies) should be another national priority. Japanese investments in the United States since the 1980s have led to the current employment of nearly seven hundred thousand Americans at U.S. affiliates of Japanese
companies.
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More Chinese investment that creates new jobs could provide a win/win way out of our current capital imbalance with China. The British made major investments in the United States in the nineteenth century; it was a good deal for them and a good deal for us. There is no reason, once we act with fiscal prudence, for China not to follow suit in the twenty-first.

Since 1944, when the Bretton Woods monetary system was established, the dollar has been the world's principal reserve currency, which means that many governments hold it as part of their foreign-exchange reserves. Indeed, the dollar represents over 60 percent of the world's foreign-exchange reserves, with the euro next, at 26 percent. For us, the advantage is that the United States can execute international transactions in dollars rather than having to pay the transaction costs of going from one currency to another. With the world's governments holding dollars, it is also easier for the United States to finance its budget deficit. Trillions of dollars need to go someplace. Given the flexibility and perceived advantage the United States has because of its reserve-currency status, China, Russia, and the Gulf Cooperation Council want to replace the dollar with a new reserve system, such as a basket of currencies or special drawing rights issued by the IMF. As a step in that direction, China, Russia, South Africa, Brazil, and India have established lines of credit among themselves in their local currencies. These countries represent a combined GDP approaching that of the United States and more than one third larger in real terms—that is, adjusted for our higher cost of living. Moreover, most of them have a higher growth rate than ours, so they will only become more important over time.

If more countries use dollars only to trade with the United States, gradually the dollar will play less of a role in world commerce. It won't happen tomorrow, but it could happen sooner than you expect. Our economy will reel from the effects of losing our reserve
currency status. The government will have to pay higher interest rates to attract the necessary capital for its bonds—or higher taxes to reduce the deficit and therefore our borrowing and exchange-rate costs. There will be less demand for dollars, and the dollar's value will drop. Our imports will then be more expensive. Shortages could develop, as the United States could no longer pay for imports of goods and services with its own paper currency. And we will be unable to replace the imports with domestic production, because we have sent our manufacturing jobs offshore. We'll be just like any other country that consumes more than it produces and borrows more than it saves: We will have to accept a lower standard of living.

The state of our economy is similar to a turnaround situation in the private sector. When a company is in distress, the CEO decides what to cut, what to consolidate, what to do about pricing, how much additional capital to request, and what to set as the executive team's priorities going forward. He tells all participants that for two years all employees, including himself, will have to tighten their belts and make sure that any expenditure promotes future growth. He lays out a plan and executes it. Today a similar program has to take place in the public sector.

Projecting budget deficits beyond a year or two is difficult. They are subject to assumptions about economic growth and interest rates. Manipulate those assumptions and a deficit projection can be practically anything you'd like it to be. For example, a growth rate 1 percent lower than the projected rate will increase the budget deficit by $40 billion per year, because of lower tax revenues and higher unemployment outlays.
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In a
Wall Street Journal
opinion piece in June 2011, former Federal Reserve governor Lawrence B. Lindsey warned that if
interest rates on government debt return to their levels of the last two decades (5.7 percent per annum, on average), they will add $420 billion in interest costs in 2014 alone. These two unknowns—growth rate and interest rates—make predicting precise budget deficits similar to shooting blindfolded at a moving target. If you try—because Congress now formulates a ten-year budget—to project growth and interest rates a decade out, you enter the realm of fantasy. Inaccurate projections often lead to government policy that exacerbates either inflation by spending too much or recession by spending too little.

Politics will determine whether our long-term structural deficit can be successfully addressed. The structural deficit is the trajectory of spending over current revenues with no changes in law, and it differs from the cyclical deficit, which comes from higher unemployment with its mushrooming unemployment benefits and lower tax revenues. The structural deficit hangs over our future prospects like a dark cloud over the Kansas prairie. Medicare is the starkest example of a federal program with a large structural deficit. That's why actions need to be taken today that will have an effect beginning three to five years from now, when the economy will presumably have recovered. If interest rates remain lower than inflation, the deficit could be reduced over time; the cost of borrowing would be less, and we could repay our loans with the increased taxes arising from inflation. But negative interest rates take a long time to have a substantial effect. Then there are the people who argue for “a little inflation” as the way out of our debt problem, but if the Federal Reserve miscalculates, “a little inflation” becomes much more and the American people pay the cruelest tax of all.