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How to Fix the Economy

Republicans and Democrats are doing little but screaming at each other. If they’d stop, they’d find the answers to our problems right under their noses.

By Steven Goldberg, Contributing Columnist, Kiplinger.com

July 14, 2010

During the riots sparked by the acquittal of the Los Angeles policemen who were videotaped beating Rodney King, King told news cameras, “People, I just want to say, you know, ‘Can we all get along?’”

I have that same wish for the government and the American people. Partisan politicians, the Internet, talk radio and cable television news seem to have robbed us of the ability to talk rationally about virtually everything.

We face huge problems with the economy and the budget deficit. At the Morningstar investment conference in Chicago in June, charts and graphs showing the federal deficit spiraling out of control in coming years were everywhere. In 15 years of attending Morningstar conferences, I’ve never before witnessed such a focus on the deficit -- nor so much gloom.

The odd thing is that what we must do to rectify our problems is simple. As Ronald Reagan liked to say, “There are simple solutions -- not easy ones.” I’m a Democrat, but Reagan had that right.

The U.S. economic recovery is slowing. Most economists still doubt we’re headed for a double-dip recession, but they’re slashing their estimates for growth in gross domestic product. Slower growth means unemployment could remain in the high single digits for years to come. People without jobs can’t spend much and often can’t pay their mortgages. It’s a vicious cycle.

A new stimulus bill makes sense. We don’t need another $787 billion package. But John Maynard Keynes was right. When the private sector contracts, government must temporarily provide the firepower to jump-start the economy. That the stimulus bill, a mix of spending and tax cuts, didn’t further boost the economy only demonstrates what a deep hole we were in. The best news about last year’s stimulus is that almost half remains to be spent.

What should Congress do? Enacting another $100 billion to $200 billion in new spending and tax cuts makes good sense. That would pay for extension of unemployment benefits, help states and localities prevent layoffs of teachers and other essential employees, as well as finance some tax cuts and other stimulus spending. It would ignite faster growth.

Cutting the budget deficit

But that’s just half the story. Thanks to the strength of the U.S. dollar --which should remain the world’s reserve currency for years to come -- we’re not being forced to enact the immediate budget cuts that much of Europe is under pressure to make. Those cuts will probably cause a double-dip recession in Europe.

But cut the budget we must -- and soon. China and Japan will not buy our Treasuries forever. Like any investor, they’ll insist that we get our financial house in order. The bond market, as we’ve learned, doesn’t always move gradually. It sometimes makes giant moves rapidly. Lead manager of DoubleLine Total Return Bond fund (DLTNX), Jeffrey Gundlach -- who compiled a terrific record at TCW before launching DoubleLine -- uses the apt phrase “tape bomb” to describe how abruptly bond and currency traders will turn on U.S. Treasuries. (See How to Play Treasuries for more from Gundlach.)

When will the tape bomb explode? We probably have a few years, but no one really knows. One thing is sure: If we continue our profligate ways, a tape bomb will explode -- and make the current recession look like a gnat bite. If we put our budget on a glide path towards a sustainable budget, we can defuse the tape bomb. As Ross Perot used to say, “It’s just that simple.”

Contrary to popular belief, the budget deficit can’t be brought down mainly by eliminating waste, fraud and abuse, and cutting welfare and foreign aid. More than 70% of the budget goes for defense, interest on the federal debt, Social Security, Medicare and Medicaid (most Medicaid spending nowadays pays nursing-home costs for formerly middle-class senior citizens who have depleted their assets.)

We need to slow the growth of Social Security. When 65 was chosen as the retirement age in the 1930s, life expectancy was about 62 years. Today it’s more than 80 years and rising. We need to move the full retirement age from 67 (for those born after 1959) to about 70, and slide up the early-retirement age for collecting Social Security benefits from 62 to 63. These are hardly dramatic changes.

Health-care costs are the main engine of our future debt. We need panels of physicians and other medical experts to decide which fancy treatments make good medical sense -- and which don’t. These are not death boards. They are common sense. If you still want the latest unproven treatment, you’ll have to pay for it out of your own pocket. Ditto if you’re dying from heart disease and want a liver transplant.

Much more is required. The entire medical culture has to change. Doctor pay isn’t the main driver of medical costs; doctor decisions are.

The baby boomers are aging. The U.S. faces a demographic time bomb. That and increasing medical costs are the chief causes of the budget crisis.

State and local governments need to tighten their belts, too. They can no longer afford the generous pensions and retiree health-care benefits provided to so many public employees.

Spending cuts alone won’t solve our problems. We need higher taxes. Federal taxes currently stand at 15% of GDP -- the lowest they’ve been since 1950. Increasing taxes only on the wealthy won’t cut it, either. The middle class will have to pony up, too.

We can no longer pretend that deficits don’t matter. They matter enormously. And if we don’t work together to defuse the debt bomb, the U.S. faces ruin. Can we all get along?

Steven T. Goldberg (bio) is an investment adviser.

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