Economic Policy: Don’t Fight The Next War With The Last War’s Tactics

The NY Times business section had several articles yesterday on the effort by the Bush administration and congress to address the financial problems facing the US economy. I read them all on the plane out to LA.

The Bush administration is looking to push through policies that they used in 2001 to address the last economic downturn. Treasury Secretary Hank Paulson says, “The research I’ve seen indicates that the programs in 2001 clearly worked.” Those programs include a tax rebate of $300 to $600 per household and a tax incentive for businesses to invest in plant and equipment.

Those measures may have worked in 2001, but I am not sure they will work this time. When treating a patient, doctors focus on the problems a patient is currently facing, not what they were facing seven years ago.

In late 2001/early 2002, the economy was suffering from the triple whammy of a stock market downturn including a full-blown meltdown in the NASDAQ, the shock induced by 9/11, and uncertainty around our government’s response (which was resolved by the invasion of Iraq). Businesses were holding back from hiring and investing and the consumer was holding off from spending. So it makes total sense to me that a tax rebate and business incentives were the proper stimulus.

This time around, we are facing very different issues. The primary problem our economy faces is a financial system that is badly damaged by the implosion of the housing bubble. In addition, consumers have lost a lot of paper wealth in their homes. This paper wealth was a large source of funds for the consumer in the past five years via home equity loans and other forms of mortgages. The banking system is in a risk adverse phase and it is unlikely that consumers will be able to tap other forms of debt like credit cards to make up for the loss of home equity finance. We have a credit crunch on our hands.

The large financial institutions have gone overseas to fix their balance sheets, tapping the growing pools of capital in the middle east and asia. But just because they have shorn up their balance sheets doesn’t mean they will start lending again.

Meanwhile the US government is also in a bit of a pickle. We have large budget deficits that we have also been funding with debt bought by foreign investors and governments. The US dollar has been falling for six years against most of the major currencies and US government debt is worth less and less every day because it is dollar denominated. I suspect the US government is also facing its own credit crunch.

We can try the economic stimulus that worked in 2001/2002. Maybe it will make consumers feel better and they’ll start spending again. Maybe that’s all it will take to get the housing market to bottom and banks and other financial institutions will start lending again.

But I think we need to focus on measures that will address the credit crunch for consumers and our government. And they are different problems that require different solutions. We need a very easy monetary policy right now. We need to make it so that banks and other financial institutions can make a lot of money lending right now. Only then will they re-open their balance sheets and start lending.

I think using fiscal policy to address the economic problems we face is a mistake. We should not go deeper into debt as a country. First and foremost, we need to restore confidence in the US economy and government credit. We need to balance our budget and stop living beyond our means (as a nation and as individuals).

Back in the late 80s and early 90s, the Soviet Union essentially went bankrupt because it could no longer afford to keep pace with the United States militarily and economically. Many point to the Afghanistan war as the straw that broke the camel’s back.

The US is in a similar position with our war in Iraq. We are burning through billions of dollars fighting a largely unilateral war in Iraq that we can no longer afford. We must leave Iraq as soon as possible as a first step in getting our financial house in order.

We must also tax our citizens at a rate that is necessary to cover our expenses. We can reduce our government expenses if we have the political willpower to do that. But if we don’t then we need to tax our citizens to cover our bills. Since the early 80s (with a short and successful departure in the Clinton/Rubin era), our government has taken the approach of reducing taxes in advance of reducing spending. We’ve never gotten the corresponding reduction in spending and instead have borrowed trillions from overseas. That must stop.

And we must have economic policies that incent our citizens to save instead of spend. I think its time for rethinking our entire federal tax system. What if we eliminated the income tax for taxpayers who make less than $250,000 per year (indexed with inflation)? What if we replaced the lost income with a broad based sales tax? And what if we stopped taxing income from investments of less than $250,000 per year per taxpayer (again indexed with inflation). Want to think radically? What if we stopped allowing taxpayers to deduct any form of debt including home mortgages?

I am not saying we should do any of these things. All of them will cause huge market dislocations and it’s certainly not time to make homes less valuable by removing the mortgage deduction. But we are a debtor nation. We have a balance sheet problem as a country and as citizens. We need to wake up and realize that and do something about it.

These are difficult choices that I am certain we do not have the political will to implement without serious pain. So instead we’ll put a bandaid on. And it might work in the short term. But it won’t work in the long term. I think we are headed toward bankruptcy in this country, on a governmental level and on a consumer level, unless we change our stripes.


Comments (Archived):

  1. Elia Freedman

    I grew up poor and have run a start-up. When I have had to adjust my spending I always make it in terms of the revenue I can produce. Can’t afford cable? Good bye. Spending too much on dining out? We clip coupons and force ourselves to cook more.Our government — and each of us, of course — has to make the same decision. Where will we spend our money? We currently are running $300B over budget. Do we cut Medicare? Social security? Military spending? Discretionary spending? Something will need to be cut — or someone will need to be taxed more. It really is that simple. It’s the implementation that’s hard.So the question comes down to who will have the guts to do it? Who will be the next George H.W. Bush, willing to raise taxes when he knows it is political suicide, but whose action will set off the next decade of positive economic activity?If this is the real issue facing America then we should be voting for the person who would best solve this problem, not the one who looks prettiest on TV or says the right things to appeal to one group or another.Eliap.s. Suggested reading: check out Matt Miller’s “2% Solution” if you haven’t already.

    1. jedc_mercury

      It’s been a while since I read it, but I thought “The 2% Solution” was quite an interesting and thought-provoking book. I would also recommend it.

  2. Jeff Marks

    Thx for the very thoughtful post!

  3. Dan Cornish

    How about a more paranoid idea? Donald Rumsfeld the former defense secretary had a saying “if you can’t solve a problem, make it bigger.” Almost everyone is against the war in Iraq. Yet the government is now preparing for war against Iran in a big way. Few if any people are for a war with Iran, which would be far larger than the war in Iraq.Much like the war on terrorism started with finding Osma bin Laden in Afghanistan, since we could not solve that problem, we made it much bigger with the war in Iraq. I am a big believer in patterns and I do see a clear pattern here.

  4. Michael J.

    Fred, maybe after Union Square wraps up its work you’ll consider a senior appointment in the government? I am serious – we need more clear thinking like this. I’m sure it’s the last thing you’d really want to do, but we’d be better off for it.

  5. Paul

    The issue is a short term stimulus package and you’re talking about a major restructuring of the tax system. There is no way we could pull that off in time to have much of an effect, which I am sure you are well aware of. Unless, of course, the goal is to make a bunch of noise and distraction such that we endup doing nothing causing the economy worsens and we ensuring a Democrat gets elected in the fall. How diabolical of you Fred. 🙂

    1. fredwilson

      all i am really saying with respect to the short term is do it via monetary policy, not fiscal policy. cut rates, not taxes.

      1. Andy Swan

        Agreed with Fred here. The problem isn’t that people aren’t spending, it’s that their interest rates on the houses they spent too much on are killing them. Long-term, I think Fred is right. We should be taxing SPENDING, not productivity. Make as much as you want and keep it all….but when you spend it, you pay.

  6. Paul

    Sorry for the poor grammar of the previous post – did not proofreed it after making some changes.

  7. S.t

    Fred wrote ‘…war in Iraq that we can no longer afford. We must leave Iraq as soon as possible as a first step in getting our financial house in order…’Or, we could make Iraq a state.Face it, we’ve built the largest emabassy in the world (I think I read that it’s bigger that The Vatican), so WE ARE NEVER LEAVING IRAQ.If Iraq becomes a state, we won’t have to call it ‘foreign oil’ anymore. Iraq has 115-Billion barrels proven oil reserves. But I think that the last time the reserves were measured was 1979. And I’m pretty sure that only 2,000 wells have ever been drilled in Iraq — as opposed to, say, Texas, where they’ve drilled over 500,000.Let’s see, multiply 115-Billion by $100/barrel….carry the one…11.5-Trillion reasons to stay in Iraq.Let’s let the Iraqi’s vote on that proposal: Would you like to become Americans?

  8. Nick Molnar

    If you haven’t already, I’d highly reccomend reading Daniel Shaviro’s book “Do Deficit’s Matter”. You can find it on Google Books thankfully, and just the introduction and conclusion are probably enough to help reframe this debate.

  9. Bob Warfield

    Fred, there’s no evidence whatsoever that our current economic woes have anything to do with the deficit. That’s a total Red Herring to tack on here. If anything, the economic situation improves the deficit by devaluing the debt. I’m all for reducing government spending, but to wring our hands and say if we can’t do that we must raise taxes is ridiculous. Eliminate the waste that goes on and on with our government and leave taxes alone, especially in a time like we face now. People don’t have it to give, and it would be a disaster raising taxes.As far as monetary policy goes, yes, we do need to cut rates, but making it easy for banks to make a lot of money lending is contradictory to your view that we have to quit borrowing so much. There need to be some regulatory changes on lending to go along with rate cuts to prevent more untenable mortgages from being issued.At the very least, limiting the amount of a house’s value that can be borrowed would be a start. 100% financing was never a good idea. 80% is more prudent.Best,BW

  10. nick davis

    Fred, the idea of a national sales tax, as you conjure it, is similar to that of the “fair tax” currently favored by Huckabee. And to that, I would ask a simple question:If the goal is to tax consumption, what of the trillions of dopllars that already exist that have had taxes paid on it? In order to switch to this system, you would have to give people a tax credit based on what they had already saved or invested. So, tell me where that trilion dollars comes from? And how will that help out our problem?I wrote a post back in August about the coming credit crunch:…People forget that the market crash did not cause the depression (the market had almost recovered by the time the Great Depression began), rather the debt deflation and resulting credit crunch. I link to a quote by Minsky, who is perhaps the preeminant expert in all of this.We need some sensible policy, but what we need most is to take the hit. At some point, we have to take our medicine.

  11. Roman

    actually the deficit as a percentage of GDP has been steadily declining the last couple years and is relatively low compared to earlier high points in the last 30 years. Look it up for yourself, the deficit is about 1.5% of GDP, whereas the norm since the 1970’s has been around 2.3%. The deficit might be large in magnitude, but far from the alarming problem some people make it out to be.

    1. fredwilson

      That’s like saying its ok for a company to be operating at a loss because its losses are lower as a percentage of revenueLosses are losses and losses over a long period erode the balance sheet and weaken the company or the countryFred

      1. Nate

        People and companies can’t make bad economic decisions indefinitely otherwise they’ll go bankrupt and fail. Too bad the government can’t fail. Instead government uses its power to raise taxes, or it devalues its currency, or it borrows and passes the debt to posterity.Of course nobody wants the government to fail, but what if we could create incentives that worked like failure? Something like, if the government is in the hole for more than 2 years in a row all members of the legislature and the President are ejected and barred from ever holding a government job again.

      2. Roman

        Actually its nothing like saying that because the government is not a company–that’s the whole point. Wall Street demands that companies increase profits indefinitely, while citizens make no such demands of the government. At the extreme, the government needs to operate at “break even,” to use you company analogy. As long as the government is reasonably close to break-even, there will be stability, and no reason to believe that the country is eroding.Given that there is stability, if the losses are being used as an investment to improve living standards through government programs and/or lower taxes to stimulate the economy, most people will take this trade off. In the last 15 years or so, the national debt has increased by 6 percent while GDP has grown by 35 percent. It’s hard to say that a marginal deficit is weakening the country long term.

        1. fredwilson

          I don’t buy part of that argumentI agree that a government should not try to run a surplus and should not tryto grow that surplusBut I don’t buy that governments can run defecits forever.An entity (whether it be a company or a government) that runs defecitsforever will go bankruptfred

        2. Andy Swan

          Exactly right. The national debt and deficit are paltry, non-issues when compared to GDP. Ya, they are big numbers, but come on….look at the market for your answer.Do we really think that people, nations, and corporations would be lending the US government money at a paltry 5% interest rate if the debt and deficit were actually big problems? Now….that isn’t to say that there isn’t a limit…(just like with people borrowing money)….but it should be tied to GDP or some other ratios (like people’s credit worthiness).

          1. fredwilson

            AndyThe market is telling us somethingLook at the yeild curve and the dollarIts going to get worseGwb and his cronies are bankrupting this country and everyone knows itFred

          2. Andy Swan

  …That’s the 10 year bond. The interest rate was 15% back in the early 80’s prior to the huge run-up in spending, debt, tax cuts and economic booms.The fact of the matter is that everyone is still willing to loan the US government money for under 4%. This does NOT tell me that the markets believe that the US is headed for bankruptcy….or anything less than stellar economic growth into the future.Yes, Bush is a disaster…..and the market is going to crash tomorrow and everything is getting worse near-term. I agree with all of that…..but there is no way someone can tell me that an organization or government is on its way to “bankruptcy” when the entire world is willing to loan it money at 3.64% for 10 years.

          3. fredwilson

            Banks and the market were loaning subprime at rates not that different not so long agoThe market is not nearly as wise as we all give it credit for beingFred

  12. Andy Swan

    A few quick points.The falling dollar devaluing our debt is a good thing. If you owed someone 100,000 clams, and suddenly the value (price) of clams dropped 40%, wouldn’t you be in a better financial position? Of course there are major downsides to a weak currency, but when it comes to debt…you can’t beat it!You are exactly right that spending is the problem. Both individually (guilty) and as a government. The government is NOT here to make everyone equal, healthy and happy!Your argument about tax increases is based on a false premise. You are assuming that decreased taxes lead to decreased revenues for the government. In fact, if you look back at the data, the JFK, Reagan and Bush tax cuts were all followed by RECORD levels of government revenues (which we are enjoying now), precisely because they served to reduce the friction in the economy and allow it to expand.In summary: The size of the pie is NOT static!!!! Do what it takes to GROW THE PIE (get the hell out of the way) and stop worrying so damn much about how to slice it!

  13. charlie crystle

    Fred–Check out this chart. Then consider what to cut. Also, folks, remember that we could eliminate quite a few social and medical programs if we paid a living wage and adopted a single-payer, universal healthcare system, AND reduce healthcare coverage costs.…worth publishing that chart.

    1. Andy Swan

      Nonsense. That chart just so happens to leave out about three-fifths of the federal budget covers expenses that are written into law, including Social Security Administration (larger than defense), Treasury Department (debt interest—slightly lower than defense), Health and Human Services, (much higher than defense)….while including the ONLY ONE that is actually written into the Constitution as a responsibility of the Federal Government…the defense of its borders and citizens.So what you are looking at is a chart of how 36% of the entire US budget is allocated, because when anti-military folks put up a pie chart of the entire 100%, it’s not near as effective because it’s actually quite reasonable.Your comments about price-fixing the cost of labor and switching to a healthcare system that discourages entrepreneurship, innovation and R&D spending are equally scary.

      1. nick davis

        Wow, Andy. What I find most amazing is not that you hold such a strong opinion, it’s that you’re absolutely convinced that you are correct.1) The Constitution was designed as a living document. Any argument that claims something is invalid because it wasn’t originally contained in the Constitution is a farce. Either make a real argument or stay out of the debate.2) You said in an earlier post:>>Your argument about tax increases is based on a false premise. You are assuming that decreased taxes lead to decreased revenues for the government. >>In fact, if you look back at the data, the JFK, Reagan and Bush tax cuts were all followed by RECORD levels of government revenues (which we are enjoying >>now), precisely because they served to reduce the friction in the economy and allow it to expand.And you think there’s not equal evidence that your’s is a false premise? Really? I tend to believe that any untestable statement (and yours definitely does not have controlled experiments surrounding it) is at best opinion. So let’s cut the bull and state that your opinion is that the Laffer curve, Reaganomics, Trickle-Down, etc is proven fact. Oh, I’m sure you can find lots of facts to back you up, but I can do the same in the opposite direction (probably more so). Again, your hypothesis is untestable. We can’t go back in time, take the opposite track, and record the outcome. And you’re citing the Bush Tax cuts? Really? That’s your supporting evidence?>>Do what it takes to GROW THE PIE (get the hell out of the way) and stop worrying so damn much about how to slice it!Yes, let’s grow the pie. But the division of the slices can not be separated from the method to grow it. Would you make the same statement if there were no taxes on income under $100k, and a 80% tax rate on incomes over $10,000,000 and the pie were growing?

        1. Andy Freeman

          I’m willing to stipulate that all Andy’s are bad people.However, it’s still true that Nick’s chart omits govt programs that cost more than defense.And, if you want to change the constitution, amend it. What? You don’t trust Congress and the states? They are elected – what is your claim to power?

        2. Andy Swan

          Nick, yes…I am convinced that I am correct on the following point:”So what you are looking at is a chart of how 36% of the entire US budget is allocated, because when anti-military folks put up a pie chart of the entire 100%, it’s not near as effective because it’s actually quite reasonable.”I don’t know why you are attacking my stance on the Constitution. No where did I say that the spending efforts in other “living document” areas were “invalid”. Quite the opposite. I was pointing out that the ‘important’ chart posted by Charlie was a farce precisely because it included ONLY “living document” spending programs….with one exception….the “constitutionally mandated” program, which (gasp!) is the biggest piece of his selective pie.The answer to your last question is “yes”….IF it worked at growing the full pie. Do I think that would actually work? Well, no, because I’d guess a LOT of people would be making $9.9 million/year and not be willing to take the risks necessary to make an additional million that they only get to take home $200k of.Oh….and the concept of an extremely high marginal tax-rate is nothing new….we tried it…and guess what…..slashing it had no effect on overall tax revenues:

          1. Charlie Crystle

            You’ve got to be kidding–the Heritage Foundation? You trust the Heritage Foundation for numbers? Scaife’s shill think tank? Man, you’ve really taken a big swig of the KoolAid.

          2. Andy Swan

            Charlie….just show me where the facts or numbers are wrong and save the Kool-aid cutdowns. I’d love to see you show me that the top-marginal tax rate in the graph is incorrect, or the tax revenues as % of GDP is incorrect.Or perhaps you’d prefer it from a different source:… showing increased tax payments from the top earners after the DRAMATIC bi-partisan cuts in top tax rate in the 1980’s.Nope….just cut me down because of the source of the image.

          3. Charlie Crystle

            Sorry–I just don’t trust that source. Gov source, sure. Independent news org, sure. But not Heritage, ever.

          4. David B.

            How about the New York Times, Andy, to explain why those numbers are not worth the web site they’re printed on:…Cash Accounting says that if I make $100 a year, owe nothing this year, but owe a million dollars next year, debt is 0% of GDP. It’s the most inane thing I’ve ever heard.Try this too:…There’s nothing that gets my goat worse than a good company being mismanaged into the ground, and that’s exactly what’s happening with America.

      2. Charlie Crystle

        Seems you want to continue to subsidize corporations through food stamps and other programs that plug the economic gaps at the bottom of the workforce–screw the people if you can make a buck on it. Sorry, but I don’t subscrive to that cynical view of business.As for healthcare, the current system is broken, and can’t be fixed and get helpful results, it needs to be scrapped. It’s an economic drag on the country and its businesses, and it’s killing people. A single-payer national healthcare plan would be great for entrepreneurism and innovation–hell, we could have used it hwen we started, and now we would save over 50k a year that could be put into R&D or marketing, not to mention have a safer nation. But no, not for Andy Swann, who is happy to prop up a lousy system designed not for the benefit of the country but for the profits of a few at the expense of the many.Finally, the chart shows discretionary spending, and that page is up front about non-discretionary spending. Social Security isn’t an expense, it’s a funded obligation, a trust. And wipe out Medicaid and Medicare and suddenlly 200 million people are without health coverage, but I suppose that’s ok for free marketeers who believe health is a market and not a necessity, but no, Andy, it doesn’t sit well with me or most of the rest of the country.I’m happy to keep scaring you if it means standing up to the economic injustices of your view of the world.

        1. Andy Swan

          Charlie… point is that defense spending is NOT discretionary.Show me one industry where the government is more efficient and puts out a higher quality product than its private-sector, free market counterpart? Schools? Post Office? Transportation?Oh, and thanks for painting me with the “he cares about no one but the fat cats (whom I don’t know)” label…..Nope, no chance that I actually believe that that free-markets actually improve the quality of care for everyone. No chance I think that profit-incentives are the best way to progress and prosperity. No chance that I actually believe that the reason 90% of the world’s health-care innovation and breakthroughs occur here is precisely because of the profit-incentives that fund failing study after failing study.Nope…I’m just an uncaring SOB only out to line his own pockets at the expense of anyone in my way. Nice.

          1. Charlie Crystle

            Defense is in fact discretionary. The size of the force, the amount and nature of equipment, the amount and nature of ships, warplanes, the outsourcing to mercenaries, the replenishment of bombs, bullets, and other “replenishables”. Those are choices, and it is part of the discretionary budget. And billions are not accounted for, and that’s before you look at the Iraq debacle.When your company has to build part of a road, let me know how it goes. I agree that profit incentive is great for inspiring entrepreneurs, I just think profiteering is bad for health, and healthcare is so fundamental both to economic health and personal well being. As far as your claim about 90% of innovation: where do you get your numbers? And what about the Gov subsidies for research? plenty. Penicillen worked out pretty well–that was government funded. A whole host of things. The market doesn’t offer research into unprofitable diseases and conditions. Because it’s not in the business of healthcare, it’s in the business of business.Scientists and researchers–I’ll make a generalization and say that most don’t innovate because of a payoff. They research and innovate to solve a problem. It’s about discovery. It’s the entrepreneurs like you and I who love to exploit good ideas for profit. But there’s more to life than profit, and more to business than profit.

  14. Andy Freeman

    The single payer folks “forget” to mention that govt currently covers about half of american healthcare at about the same cost of private healthcare covers the other half.If govt heathcare is going to be significantly less expensive, why isn’t it?As to the predicted savings, let’s look at some numbers.We’re currently spending about 15% of gdp on healthcare. Let’s say that govt’s current share is 7% (which is low) to cover about half of the population. If we’re going to pay only 10% to cover everyone, that means that we have to cover the half of the population that is currently getting private healthcare with 3% of GDP. Since govt currently needs 7% to cover half, some details would be nice, and they better include why govt healthcare isn’t as cost efficient now as it it is promised to be later.

    1. Andy Swan

      Exactly. It’ll be a disaster just like government-run (anything). The good doctors and pharms will go private, so that the most productive 5% pay for over half of everyone else’s medical care, plus their own somewhere it’s more expensive but better…..just like everyone with the means does with government-run schools.I have NO IDEA what public schools, DMVs, post-offices, VA hospitals or court systems these people are going to that they are so enthused about the concept of letting government run their healthcare system.

      1. Charlie Crystle

        I imagine the things about which we have no idea would fill volumes. But I went to both public and private schools, am running my 4th company (all successful), and grew up in a medical family, and can tell you single-payer is better for business. It’s not government run, it’s publicly financed.We currently have rationed healthcare. I ration it for my employees, then the insurance companies ration it more. I choose what we can afford to pay, I choose how much deductible they have to pay, I choose what drugs are covered, I choose what doctors they can see. And then when they go to the next job, the next Exec chooses the same thing all over again, and brilliant if you’re lucky enough to get as good a deal as you get with me (90% for families, 100% for individuals, 1k deductible).This system sucks. You’re young. You believe in markets. You have young partners/employees. Get out there a bit and learn what really happens–to the insured, underinsured, and uninsured. It’s tragic, and it’s not about personal responsibility. The health system is a deadly leech on our profits, our lives, our economy.

      2. fredwilson

        The public schools in parts of this country are great and they are run by the govtBloomberg and joel klein are in the middle of an amazing turnaround in the public schools in nycGov’t can run things well if the people in gov’t think act like the private sector a bitFred

  15. Sanjay

    risk averse, not risk adverse

    1. fredwilson


      1. charlie crystle

        well that was a hell of a discussion…

        1. fredwilson

          I was dizzy following it

          1. Steven Kane

            Fred, can we puhlease stop blaming everything on George W. Bush? The economy went into the toilet within weeks of GWB’s first inauguration. Was that President Clinton’s fault? The bottom line is, recessions happen periodically. Always happen and always will. Managing economies is a constant attempt at achieving equilibrium. The Bush administration’s handling of the conomy has been pretty darned good, all things considered. The current market swoons do not reflect administration poklicy as much as wall street greed — nobody forced all the banks to create and sell all those rotten CDOs. And last time I looked, much of the uppermost wall street crowd is soldily democratic, and anti-Bush (just ask Charley Rangel and Charles Schumer!)The media has turned a small crisis into a HUGE CRISIS. We had nothing to fear but fear itself and now we’re in the shit. Heck, the economy is still growing — albeit much more slowly than before. Recession is when two consecutive quarters shrink! Unemployment rates are still within historical means and norms. Even the much hyped mortgage default rate is low by historical standards! (It seems high because it was a-historically low, near zero, the last several years.We have problems for sure. But if you’re going to sling venom, I suggest you aim it at the titans of Wall Street — its the meltdown of the big banks balance sheets that has everyone freaked, not Bush policies. And that meltdown is happening because a lot of seeming superstars turned out to be charlatans — radically enriching themselves and their cronies at the expense of, well, everyone, foisting bogus products and bogus numbers with gleeful abandon.

          2. fredwilson

            SteveThe point of my post and my comment is that cutting taxes and not cutting spending at the same time is the reason our economy and our country is in such a pickleI lay the blame sqaurely on bush and his repubican predecessorsThe republicans are the party of defecits not financial conservatismAnd I for one am sick of itFred

  16. David B.

    Fred, not only does Warren Buffet agree with you, but he has a novel and brilliant strategy on how to achieve those reforms. Here’s the article:Why I’m not buying the U.S. dollarAmerica’s growing trade deficit is selling the nation out from under us. Here’s a way to fix the problem — and we need to do it now.By Warren E. Buffett, FORTUNE…I’m about to deliver a warning regarding the U.S. trade deficit and also suggest a remedy for the problem. But first I need to mention two reasons you might want to be skeptical about what I say. To begin, my forecasting record with respect to macroeconomics is far from inspiring. For example, over the past two decades I was excessively fearful of inflation. More to the point at hand, I started way back in 1987 to publicly worry about our mounting trade deficits — and, as you know, we’ve not only survived but also thrived. So on the trade front, score at least one “wolf” for me. Nevertheless, I am crying wolf again and this time backing it with Berkshire Hathaway’s money. Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in — and today holds — several currencies. I won’t give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar.But as head of Berkshire Hathaway, I am in charge of investing its money in ways that make sense. And my reason for finally putting my money where my mouth has been so long is that our trade deficit has greatly worsened, to the point that our country’s “net worth,” so to speak, is now being transferred abroad at an alarming rate.A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that’s how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there’s a quid pro quo — but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off — or simply service — the debt they’re piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat — they have nothing left to trade — but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are — in economist talk — some pretty dramatic “intergenerational inequities.”Let’s think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies — that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island’s fiscal pain.That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island’s government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.So what does all this island hopping have to do with the U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment — that is, our holdings of foreign assets less foreign holdings of U.S. assets — increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country’s “net worth,” viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world.Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.In the late 1970s the trade situation reversed, producing deficits that initially ran about 1 percent of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4 percent of GDP. Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5 trillion is invested in claim checks — U.S. bonds, both governmental and private — and some in such assets as property and equity securities.In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce — that’s the trade deficit — we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what’s already been transferred abroad is meaningful — in the area, for example, of 5 percent of our national wealth.More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding — goodbye pleasure, hello pain.We were taught in Economics 101 that countries could not for long sustain large, ever-growing trade deficits. At a point, so it was claimed, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders. And that’s the way it has indeed worked for the rest of the world, as we can see by the abrupt shutoffs of credit that many profligate nations have suffered in recent decades.The U.S., however, enjoys special status. In effect, we can behave today as we wish because our past financial behavior was so exemplary — and because we are so rich. Neither our capacity nor our intention to pay is questioned, and we continue to have a mountain of desirable assets to trade for consumables. In other words, our national credit card allows us to charge truly breathtaking amounts. But that card’s credit line is not limitless.The time to halt this trading of assets for consumables is now, and I have a plan to suggest for getting it done. My remedy may sound gimmicky, and in truth it is a tariff called by another name. But this is a tariff that retains most free-market virtues, neither protecting specific industries nor punishing specific countries nor encouraging trade wars. This plan would increase our exports and might well lead to increased overall world trade. And it would balance our books without there being a significant decline in the value of the dollar, which I believe is otherwise almost certain to occur.We would achieve this balance by issuing what I will call Import Certificates (ICs) to all U.S. exporters in an amount equal to the dollar value of their exports. Each exporter would, in turn, sell the ICs to parties — either exporters abroad or importers here — wanting to get goods into the U.S. To import $1 million of goods, for example, an importer would need ICs that were the byproduct of $1 million of exports. The inevitable result: trade balance.Because our exports total about $80 billion a month, ICs would be issued in huge, equivalent quantities — that is, 80 billion certificates a month — and would surely trade in an exceptionally liquid market. Competition would then determine who among those parties wanting to sell to us would buy the certificates and how much they would pay. (I visualize that the certificates would be issued with a short life, possibly of six months, so that speculators would be discouraged from accumulating them.)For illustrative purposes, let’s postulate that each IC would sell for 10 cents — that is, 10 cents per dollar of exports behind them. Other things being equal, this amount would mean a U.S. producer could realize 10 percent more by selling his goods in the export market than by selling them domestically, with the extra 10 percent coming from his sales of ICs.In my opinion, many exporters would view this as a reduction in cost, one that would let them cut the prices of their products in international markets. Commodity-type products would particularly encourage this kind of behavior. If aluminum, for example, was selling for 66 cents per pound domestically and ICs were worth 10 percent, domestic aluminum producers could sell for about 60 cents per pound (plus transportation costs) in foreign markets and still earn normal margins. In this scenario, the output of the U.S. would become significantly more competitive and exports would expand. Along the way, the number of jobs would grow.Foreigners selling to us, of course, would face tougher economics. But that’s a problem they’re up against no matter what trade “solution” is adopted — and make no mistake, a solution must come. (As Herb Stein said, “If something cannot go on forever, it will stop.”) In one way the IC approach would give countries selling to us great flexibility, since the plan does not penalize any specific industry or product. In the end, the free market would determine what would be sold in the U.S. and who would sell it. The ICs would determine only the aggregate dollar volume of what was sold.To see what would happen to imports, let’s look at a car now entering the U.S. at a cost to the importer of $20,000. Under the new plan and the assumption that ICs sell for 10 percent, the importer’s cost would rise to $22,000. If demand for the car was exceptionally strong, the importer might manage to pass all of this on to the American consumer. In the usual case, however, competitive forces would take hold, requiring the foreign manufacturer to absorb some, if not all, of the $2,000 IC cost.There is no free lunch in the IC plan: It would have certain serious negative consequences for U.S. citizens. Prices of most imported products would increase, and so would the prices of certain competitive products manufactured domestically. The cost of the ICs, either in whole or in part, would therefore typically act as a tax on consumers.That is a serious drawback. But there would be drawbacks also to the dollar continuing to lose value or to our increasing tariffs on specific products or instituting quotas on them — courses of action that in my opinion offer a smaller chance of success. Above all, the pain of higher prices on goods imported today dims beside the pain we will eventually suffer if we drift along and trade away ever larger portions of our country’s net worth.I believe that ICs would produce, rather promptly, a U.S. trade equilibrium well above present export levels but below present import levels. The certificates would moderately aid all our industries in world competition, even as the free market determined which of them ultimately met the test of “comparative advantage.”This plan would not be copied by nations that are net exporters, because their ICs would be valueless. Would major exporting countries retaliate in other ways? Would this start another Smoot-Hawley tariff war? Hardly. At the time of Smoot-Hawley we ran an unreasonable trade surplus that we wished to maintain. We now run a damaging deficit that the whole world knows we must correct.For decades the world has struggled with a shifting maze of punitive tariffs, export subsidies, quotas, dollar-locked currencies, and the like. Many of these import-inhibiting and export-encouraging devices have long been employed by major exporting countries trying to amass ever larger surpluses — yet significant trade wars have not erupted. Surely one will not be precipitated by a proposal that simply aims at balancing the books of the world’s largest trade debtor. Major exporting countries have behaved quite rationally in the past and they will continue to do so — though, as always, it may be in their interest to attempt to convince us that they will behave otherwise.The likely outcome of an IC plan is that the exporting nations — after some initial posturing — will turn their ingenuity to encouraging imports from us. Take the position of China, which today sells us about $140 billion of goods and services annually while purchasing only $25 billion. Were ICs to exist, one course for China would be simply to fill the gap by buying 115 billion certificates annually. But it could alternatively reduce its need for ICs by cutting its exports to the U.S. or by increasing its purchases from us. This last choice would probably be the most palatable for China, and we should wish it to be so.If our exports were to increase and the supply of ICs were therefore to be enlarged, their market price would be driven down. Indeed, if our exports expanded sufficiently, ICs would be rendered valueless and the entire plan made moot. Presented with the power to make this happen, important exporting countries might quickly eliminate the mechanisms they now use to inhibit exports from us.Were we to install an IC plan, we might opt for some transition years in which we deliberately ran a relatively small deficit, a step that would enable the world to adjust as we gradually got where we need to be. Carrying this plan out, our government could either auction “bonus” ICs every month or simply give them, say, to less-developed countries needing to increase their exports. The latter course would deliver a form of foreign aid likely to be particularly effective and appreciated.I will close by reminding you again that I cried wolf once before. In general, the batting average of doomsayers in the U.S. is terrible. Our country has consistently made fools of those who were skeptical about either our economic potential or our resiliency. Many pessimistic seers simply underestimated the dynamism that has allowed us to overcome problems that once seemed ominous. We still have a truly remarkable country and economy.But I believe that in the trade deficit we also have a problem that is going to test all of our abilities to find a solution. A gently declining dollar will not provide the answer. True, it would reduce our trade deficit to a degree, but not by enough to halt the outflow of our country’s net worth and the resulting growth in our investment-income deficit.Perhaps there are other solutions that make more sense than mine. However, wishful thinking — and its usual companion, thumb sucking — is not among them. From what I now see, action to halt the rapid outflow of our national wealth is called for, and ICs seem the least painful and most certain way to get the job done. Just keep remembering that this is not a small problem: For example, at the rate at which the rest of the world is now making net investments in the U.S., it could annually buy and sock away nearly 4 percent of our publicly traded stocks.In evaluating business options at Berkshire, my partner, Charles Munger, suggests that we pay close attention to his jocular wish: “All I want to know is where I’m going to die, so I’ll never go there.” Framers of our trade policy should heed this caution — and steer clear of Squanderville.FORTUNE editor at large Carol Loomis, who is a Berkshire Hathaway shareholder, worked with Warren Buffett on this article.