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The Recipe for a Stable Economy in 2012: Less Debt.

Posted: 01/03/12 12:15 PM ET

The New America Foundation, sponsored by Silicon Valley tycoons such as Eric Schmidt and Steven Jobs' widow Laureen Powell Jobs, published an important and concise prescription to fix the listing world.
"The Way Forward" was written by two academics -- Professors Robert Hockett of Cornell University and Nouriel Roubini of New York University -- and one financial practitioner -- Daniel Alpert, a partner with Westwood Capital. They outline the causes of the current calamity and propose sweeping global policies to repair and renovate the global economy.

The problems are well-known: The U.S. suffers from the double whammy of debt overhang and chronic unemployment, both of which aggravate the other; Europe has a debilitating sovereign and banking crisis; China is slowing down, as are other emerging economies; and the world's poorest nations suffer from currency volatility and lack of assistance as the International Monetary Fund (IMF) and others rescue rich countries.

The conundrum the paper points out is that the world needs strong economic growth but debts make this impossible. As "responsible" governments or individuals save to reduce debt, economic growth contracts and makes debt higher. Some argue inflation may work to wipe out the real value of public and private debts and avoid debt deflation, but it can cause collateral damage and be difficult to engineer.

So if the world cannot grow, save, or inflate, according to the paper's authors "the only solution remaining is debt restricting or its reduction and/or conversion into equity...restructure the [debt] overhang."

Restructuring, by the way, is how businesses are saved by banks or creditors. The authors believe this should be applied to homeowners in the U.S. and PIIGS in the Eurozone.

To implement this, and more, they describe their three-part recovery plan that, in essence, requires spenders to save and savers to spend in order to stimulate economic growth which will keep debts at bay; a global loans forgiveness and restructuring process; and, finally, the Bretton Woods Three system to restructure the world's currencies.

Here are their three pillars that make up the recovery plan needed in the next five to seven years:

Pillar 1 -- Create demand
The U.S. should stimulate the economy by embarking on a $1.2 trillion, five-year infrastructure program.

Pillar 2 -- Address supply
"The resolution of trillions of dollars of impaired debt in the developed world is a problem at least as nettlesome as that of addressing unemployment and inadequate demand. This massive debt overhang must be addressed in order to be able to make sustained progress on lowering unemployment and boosting demand."

Regulations must be relaxed to allow principal reductions on troubled loans -- sovereign, corporate, or individual -- or banks will continue to avoid write downs by hanging onto bad loans until defaults, then foreclosures.

This is, by the way, what Resolution Trust Corporation did to work out the massive savings and loan portfolio mess in the 1990s. In the U.S., 25 per cent of homes are now underwater (worth less than the mortgage) and if nothing is done, or interest rates go up, eight million more homeowners will default and lose their homes, negatively affecting the other 55 million mortgaged homeowners and values generally.

Principal could be reduced or banks could rent these homes to owners with an option to buy, thus stabilizing the market.

Pillar 3 -- Rebalance savers and spenders
The paper states: "A new G20 commitment to currency realignment, domestic demand growth and reduction of current account surpluses, and an IMF and G20 coordinated recycling of East Asian and petro-dollar surpluses to support economic recovery in Europe and the Middle East."

Essentially, the authors are calling for a global redistribution of wealth similar to what developed nations do internally through the income tax system.

The Eurozone, Germany, and other rich countries must reduce surpluses to help and grow their periphery partners.

China has to raise wages, reduce surpluses, and reduce savings. Chinese savings, public and private sector, are 50 per cent of its GDP. Consumption is only 35 per cent, half of Brazil, India, or Russia's. China must increase wage levels to allow developing countries to do so and stop subsidizing its currency and exports.

Finally, they recommended creation of a World Economic Recovery Fund. This would recycle global surpluses, mostly from oil-producing nations, to supplement Europe's efforts and replenish international development and financial assistance resources "bled dry" by the worldwide financial crisis.

"Arab Spring economies, Eastern Europe and African nations need assistance," the authors noted.
If implemented over the next five or so years, this new global economic architecture could repair and renovate the world. This reflects the "unique magnitude and the correspondingly unique urgency of the problems with which the US and global economies are now faced."

This column previously appeared in the Financial Post

 

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