Coronavirus and the Federal Reserve's Political Policy

It's when times are tough that you see what's really going on.  Last week, the stock market fell 11% because of fears over the economic impact of the coronavirus epidemic, dropping into a correction in a matter of days.  President Trump called loudly for a Fed interest rate cut.  Always ready for another government handout, Wall Streeters also chimed in for a rate cut.  Yesterday, rumors that the Fed and other central banks would act together pushed the Dow Jones Industrial Average up over 1200 points.

Early this morning, the Fed indicated it was considering accommodative action, but signaled that nothing was imminent.  https://www.cnn.com/2020/03/03/economy/federal-reserve-rate-cut/index.html.  However, a few hours later, the Fed announced a surprise 0.5% cut in short term interest rates.  The Dow, instead of responding positively, promptly fell almost 800 points.

What gives?  It's hard not to think the Fed gave in to political pressure.  A rate cut won't cure coronavirus.  Nor will it vaccinate humans against the disease.  It won't quarantine the virus or establish barriers to its spread.  People who are avoiding traveling, large gatherings, restaurants, concerts, sporting events, and other potential infection venues won't start spending and exposing themselves to the illness just because of a rate cut.  Even if stocks had risen, people wouldn't have started to engage in risky behavior.  Of course, things were only made worse because the market fell after the rate cut.  The market wanted a bigger welfare check.  The President, perhaps too lazy to do the work needed for a fiscal stimulus, promptly called for another immediate Fed rate cut.

But another immediate cut would only tell us that the epidemic is far worse than we thought, and that we'd best hunker down and isolate ourselves for a long time.  No travel, no restaurant meals, no public gatherings, no socializing, no contact with anyone we don't know and trust.  Romance would halt abruptly, as who'd want to meet new people in a time of epidemic?  Dating websites would collapse and singles bars would shutter. The President would be much better off committing billions of federal dollars to emergency medical research.  But he seems to have a problem with science, like he doesn't believe in it because it sometimes contradicts his political views.  So maybe the Fed will be bullied into another rate cut that will only instill even more alarm and panic.

There are powerful reasons for the historic independence of the Federal Reserve.  Most important among them is that an independent Fed can serve the public interest, not the short term scheming of politicians.  This means, among other things, that the long term vigor of the stock market is served by a rigorously independent Fed (see the story of Paul Volcker's career for further information).  Today's surprise rate cut gave the market and us discouraging news:  that the coronavirus crisis is much worse than we thought, that the Fed is becoming the sous chef of monetary policy, and that instead of focusing on medicine, the White House is focused on the political aspects of the coronavirus epidemic.  Now that the Fed is politicized, expect more poor policy and national distress.

How to Stimulate the Economy

With current economic indicators mostly signaling a slowdown in the economy--and perhaps a recession--a lot of attention is focused on stimulating the economy. The dialogue revolves around central bank accommodation (via lowering interest rates and bond purchases in the form of quantitative easing) and fiscal policy (i.e., deficit spending).  Fiscal measures are essentially impossible because of political gridlock.  And central banks, having devoted the past decade to accommodation, have only limited ammo left.  So what can stave off recession and renew economic growth?

There's no simple answer.  But one important factor is the availability of inexpensive energy.  Modern life is dependent on vast amounts of cheap energy.  The Industrial Revolution that created our high tech lives was the result of the development of inexpensive ways to harness and utilize large amounts of energy.

Let's begin in A.D. 1700.  Living standards in A.D. 1700 worldwide were about the same as they were in A.D. 700 and 300 B.C.  In other words, things had hardly improved over thousands of years.  But within the 150 years following 1700, people had developed the steam engine and learned how to harness electricity for commercial use.  These developments were followed by new ways to extract large amounts of fossil fuels that could be sold inexpensively.  Then, after 200 years (i.e., by 1900), people had developed the internal combustion engine.  The internal combustion engine could be used widely in transportation, manufacturing and many other ways.  Large scale generation and distribution of electricity became feasible, and the widespread availability of electric motors greatly enhanced living standards.  Economic growth and improvement of living standards accelerated at an exponential pace.  In essence, access to inexpensive energy sources (carbon based fuels and electricity) triggered a monumental amount of economic growth and a phenomenal rise in living standards in a historically short amount of time.  Of course, we now have pollution and other byproducts of the Industrial Revolution to contend with.  But the simple truth is the astounding economic growth of the past 300 years resulted to a large degree from ever increasing access to cheap energy.  Cheap energy and the technology developed to exploit it made modern life possible.   

Why is energy so important to economic growth?  Because energy is a key input into all economic activity.  From manufacturing to transportation to farming to fast food to government offices to hair salons to slimy corporate lawyers peddling excuses for their greedy clients to sordid lobbyists plotting to kill health insurance coverage for all to the performances of rock stars in large arenas, energy is an input into essentially all economic activity.  If the cost of energy is lowered, all economic activity gets a boost and economic growth in all sectors of the economy is facilitated.  

It's no accident that America's economy grew briskly in recent years concurrently with a drop in the price of natural gas, solar and wind energy, and to some degree, oil.  The proliferation of fracking not only has capped the price of oil, but also created demand for a lot of drilling equipment, trucks of various kinds, and so on.  So it boosted the manufacturing and transportation sectors. 

We use enormous amounts of energy stored in the past to make our current lives more comfortable and enjoyable.  We now understand we can't keep relying so much on energy from fossil fuels.  We have to develop more sustainable lifestyles.  However, in order to maintain and improve our lives, we need to continue our access to cheap energy in better ways.  After decades of frustration, solar and wind energy have actually become cheaper than fossil fuels.  That is a very positive development.  More technological advance is needed. 

The policies needed continue the availability of cheap energy would be varied and sometimes controversial.  Increased federal funding of basic research is an obvious one, although the GOP has done much to cut this from the federal budget.  Republicans seem fear science.  But ignorance will not spur economic growth.

Building more gas pipelines is obviously controversial to the NIMBY crowd.  But we do need better distribution systems for gas--and electricity as well.  All the windmills and solar farms in the Plains states won't do much good without power lines to transport the electricity to the big cities that need the power.  These power lines entail a huge NIMBY problem.  But this will have to be dealt with somehow, because distribution systems have to be enhanced if there is to be growth.  We need not bow to big, bullying energy and power companies and give them everything they want.  But we should acknowledge the need for better distribution systems.

Fostering greater fuel efficiency also helps to lower energy costs.  It may not lower the stated price per unit, but it reduces the number of units people have to buy.  So it would help to pursue efficiency as well as reduce unit costs.  One hidden cost of efficiency, though, is people consume more energy when it effectively becomes cheaper--many ordinary cars and SUVs today have engines that are as powerful as those in the muscle cars of the 1960's, since engine technology has improved so much, and people drive more miles per year.  So greater efficiency isn't an improvement if it doesn't reduce the use of fossil fuels.

There are many other factors besides energy that affect economic growth.  But a lot aren't controllable by any branch of the government.  Energy policy, though, can be implemented through government.

In the 1940's, 50's and 60's, the U.S. had ultra-high marginal tax rates, not that much deficit spending (the government focused on reducing the deficit, not increasing it), a rather inactive Fed, relatively high wages that provided for a comparatively equitable distribution of wealth and income--and an era of brisk economic growth and low unemployment.  This is an era still remembered as a golden age in America.  Why?  Because oil was damn cheap.  What happened after the first OPEC oil embargo in 1973?  A decade of economic stagnation followed by decades of economic uncertainty.  When we had cheap energy, we had lots of prosperity.  When energy rose sharply in price, prosperity as we had enjoyed it went away and still hasn't returned.  We don't need to sell our souls to the fossil fuels companies.  But we need to recognize that our standard of living and future improvements to our standard of living are dependent on access to cheap energy.  And we need to find responsible and sustainable ways to keep that gravy train rolling.

To Increase Inflation, Increase Incomes

The Federal Reserve Board is desperate to increase inflation to 2% per year.  It believes that a 2% level of inflation will promote economic growth by giving businesses greater pricing power and the ability to repay debt with less valuable dollars.  Right now, inflation as measured in the way the Fed prefers, runs about 1.6% per year, and remains stubbornly below 2%.

There's no economic research that definitively shows anything magical about 2% inflation being the key to the Goldilocks economy (i.e., not too hot and not too cold).  The figure is just a guess.  But if we were to accept that 2% has miraculous powers, then why has inflation persisted in staying lower?  With unemployment levels running at historic lows of about 3.6%, one would expect inflation to be moving up briskly.

Economists believe consumer expectations have a large role in determining the rate of inflation.  If people expect inflation, then there will be inflation.  If people don't expect inflation, they will resist price increases and inflation will be hard to come by.  Right now, inflation expectation are low.

Why would people today have such low expectations for price increases?  Perhaps the most obvious reason would be because they don't have the money to pay increased prices.  Wages, adjusted for the mild inflation we've had, have stagnated for decades.  The middle class, who are key consumers in the national economy, just aren't bringing in any more.  So they not surprisingly feel that they can't pay more and would resist price increases.  If the Fed wants to pump up inflation, it should hope that people get paid more.

With unemployment reaching an astonishingly low 3.6% level, one might think employers would pay more to get new hires and keep existing employees.  But that's not happening much.  Here and there, pay is jumping up.  But on the whole, incomes are mostly in a rut.  There pretty much is nothing the Fed can do to increase worker pay.  But it shouldn't hold its breath waiting for inflation to boost the economy. 

A Brief History of Asylum in America

In 1620, a small group of religious refugees from England, called Pilgrims, landed on Cape Cod in Massachusetts.  Facing persecution, imprisonment, fines and even execution in their native land, they had fled to the New World to find a better life.  Their early years were hard, but they persisted and eventually prospered.

The Pilgrims were soon joined by other refugees from England--the Puritans--who had also fled persecution in order to improve their lives.  The Puritans established the Massachusetts Bay Colony, a beacon of liberty from whence the American Revolution sprang.  Many of the colonial men who assembled in the early hours of April 19, 1775 at Lexington and Concord to await the British Redcoats descended from the Pilgrims and Puritans.  The refusal of these offspring of 17th Century refugees to submit to tyranny remains the foundation of American liberty today.

Other religious refugees from England and elsewhere in Europe found asylum in America.  Rhode Island, Pennsylvania and Maryland all provided asylum to the persecuted and endangered.  They, too, prospered.

In the 1840's and 1850's, a flood of refugees from Germany and other parts of Europe arrived in America, fleeing the Revolutions of 1848, a largely failed group of democratic uprisings. These refugees found in America the freedom that they had been denied in Europe.  Many of the German refugees were instrumental in establishing heavy industry in America, particularly a robust machine tool industry that powered America's victory in World War II.   During the war, America produced some 295,000 aircraft, 88,000 tanks and other armored vehicles, and some 6,000 ships.  Refugees helped to make America the Arsenal of Democracy.  Even to this day, America has substantial manufacturing prowess, employing over 12 million people and producing over $2 trillion worth of goods.

During the first half of the 1860's, a large number of refugees of African descent fled bondage in the Confederate States of America and found asylum from the blue-coated Union Army.  Some 200,000  African-Americans enlisted in the Union Army and bolstered the ranks of the Army of the Potomac that Ulysses S. Grant led to victory over Robert E. Lee.  These refugees, too, fought and sometimes died for the liberty we now enjoy.

In the late 19th and early 20th Centuries, many Jewish inhabitants of Eastern Europe and the Russian Empire fled pogroms--persecutions that featured mass murders, pillaging and destruction of property.  Many and perhaps most were penniless and not well educated when they arrived.   But they and their offspring prospered in the warmth of American freedom and can now be counted among the most successful of Americans.

In 1949, a small group of Chinese college and graduate students studying at American universities, around 3,000, were stranded by the Communist victory in China.  These students were largely from well-educated and well-to-do backgrounds, which made them enemies of the people from the Communist perspective.  Many of their family members remaining in China were treated harshly by the Communists, up to the point of execution in some cases, and suffered the loss of their jobs and property.  These students faced the same if they returned to China.  But they were given asylum in America.  Many found jobs in the high tech industries, and played important roles in developing modern electronics, including the integrated circuits that are at the heart of modern computers. 

When we look at photographs of those seeking asylum today, we should see not just what they are at the moment, but the potential they offer.  Refugees have powerful reasons to work and succeed, more so than those who ensconced in comfortable suburbs or upscale urban neighborhoods.  Providing asylum is an act of compassion and mercy (witness the sanctuary offered by Christian churches since ancient times).  It also brings social and economic benefits that have powered America to its status as the world's sole superpower.  The energy and motivation of asylum seekers and other immigrants can bolster America's safety nets--Social Security, Medicare and Medicaid--with the employment taxes they will pay at a time when native-born Americans have falling birth rates, lower employment force participation, and aging demographics.  Countries in Europe and Asia face the same and more severe demographic problems. But their tightfisted attitudes toward immigration and asylum will force them gradually to cut back on social safety nets, which will likely lead to ugly political maelstroms. America is vibrant and flexible enough to avoid that outcome. 

So, when you hear the cry of an asylum seeking child, think about what asylum has done for America.  Those who know history may sometimes want to repeat it.

Does the Internet Hamper Economic Growth?

The sharing economy--Uber, Airbnb, Zipcar, bike sharing and so on--makes more efficient use of resources.  Cars that might sit around are instead used more often.  Living space that might remain empty provides accommodation.  People don't have to buy a bike any more.  They can just rent the short term use of one. 

But does all this sharing hinder economic growth?  If people use cars, bikes, homes and other things more efficiently, fewer of these items need to be produced and sold.  Manufacturers may see decreased demand.  Jobs may be lost.  Growth could slacken.  The country's tax base might stagnate, just at a time when increased government funding is sought for everything from national defense and security to infrastructure repair and expansion to Social Security and Medicare.

Gig-based employment could have similar implications.  People who work short term gigs tend to earn less than full-time employees, reducing their ability to contribute to the consumer demand that comprises 70% of America's economy.  Employers have little or no incentive to improve the abilities and productivity of gig employees, so improvements in worker productivity could be hampered.  Without productivity growth, we won't have long term gains in employee compensation or national wealth.  Gig employees may be unable to save significantly for retirement, which would place more of the burden of their golden years on public funding.  These increased tax burdens could further impair growth.  As gig-based employment grows, so would these problems. 

The Internet greatly enhances globalization.  Customer support centers in Third World countries can inexpensively serve the needs of corporations in the industrialized world.  All manner of services, from manufacturing to radiology to routine legal work, can be cheaply coordinated and/or delivered from distant, low wage places over the Internet.  Workers in America who provided those services are out of luck.

The Internet provides the communications process that allows the sharing economy, gig-based employment, and globalization of services, to operate.  But greater micro-economic efficiencies such as these may have negative macro-economic implications.  One of the great mysteries of modern economics is why the economy is growing so slowly.  Increased efficiency creates losers as well as winners.  Those losses will have aggregate impact eventually, when they grow large enough. 

The Internet is an astonishingly effective conveyor of information.  But, as regards the sharing economy, gig-based employment, and globalization, owners of assets, holders of capital, and employers benefit more than employees--except employees willing to work for lower wages  The Internet may have enhanced total global economic growth.  But the distribution of that increased growth may well favor low wage countries, leaving industrialized nations with dimmer futures.   

It's impossible to stop the march of technological advance.  But the Internet is almost too effective in cutting costs and creating efficiencies.  When artificial intelligence and robots have driven millions of people out of the labor force, leaving them penniless, economic stagnation may be more likely than prosperity.  We had damn well better come up with a way to maintain social equilibrium in such a circumstance, or the political insurgencies of today will seem like gentle summer breezes.

Ask Not What Your Country Can Spend For You

Ask what you can spend for your country.  At least, some folks might like it if you did.  The Federal Reserve is in trouble.  The economy is meandering.  Unemployment levels have reached full employment, but labor force participation levels are low.  The Fed accentuates the negative and projects gloom about employment.  Wages stagnate, and, net of inflation, are lower than a generation ago.  The dollar is strong, which encourages imports while discouraging inflation. The Consumer Price Index is dropping, leading some to conclude that we have deflation.  This conclusion is a classic example of how statistics mislead.  Prices are higher if you take out energy costs.  If the price of everything except energy is going up, and energy is dropping a lot, do we really have deflation?  Or a misleading statistic?

But we digress. The Fed has greatly reduced its quantitative easing measures, since they didn't seem to be doing much good any more.  It's holding short term interest rates lower than a snake's belly.  But it can't do more.  The Fed is now low on ammo and can't expend what it has left; it has to hold something in reserve in case the economy belly flops.

There's no possibility of fiscal stimulus.  The federal government tied its budget into knots with the sequestration law, which requires automatic spending cuts each year through 2021.  Congress and the White House can get around the cuts by passing specific legislation providing for something other than sequestration.  But, given how the daily love fest between Congress and the White House consists of brickbats, but not bouquets, the chance for fiscal stimulus is lower than short term interest rates.

That leaves you, dear consumer.  The U.S. economy is about 70% consumption, and if consumers don't consume, the economy reaches for one of those little airline bags.  So spend, spend, spend.

Right?  Come on, right?

Or maybe not.  Consumers learned the hard way after the 2008 financial crisis that lavish spending and debt accumulation are shortcuts to financial ruin, and that saving improves the quality of your sleep.  Just because the Fed made it cheap to borrow doesn't mean borrowing is a good idea--soda is inexpensive but drinking a lot of it is a very bad idea.  If the Fed can't move short term interest rates above a complete goose egg, you have to suspect that maybe the Fed knows that the economy is a complete goose egg.  In which case, the last thing you want to do is spend freely.

We live with a contradiction:  our individual financial health requires acting in a way that is unhelpful to near term economic growth.  But those who are prudent can get through hard economic times, and it makes sense to put self and family first.  This leaves policy makers with controversial choices--negative interest rates, easing immigration restrictions to bring in educated, ambitious foreigners, and even more hotly debated measures (can you say Ex-Im Bank?).  How likely are these?

The truth is government policy is largely played out.  The economy will have to rise or fall based mostly on its own.  The next surge of growth, whenever that is, will probably come in a rush of technological innovation that may be hard to foresee.  Until then, the economy will likely meander.  If you're building up your savings and preparing for a tough slog, you'll probably be okay.  Ask not what you can spend for your country.  Ask what you can save for yourself and your family.

The Student Debt Dilemma

Some predict that student debt will be the next asset bubble that will make the financial markets crash.  That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system.  The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG.  These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt).  The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government.  Which means that taxpayers will bear a lot of the burden, along with private investors.  But it will be a diffuse, albeit large, burden rolling out over years and decades.  There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction).  The burden of defaults and other nonpayment will also grow.  It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on).  Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming.  Young people can't afford to buy things, so they purchase the use of things for short periods of time.  This may be good for the environment, but it hinders economic growth.  If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy.  It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch.  Otherwise, taxpayers could be asked to give free college educations to vast numbers of people.  And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default.  Of course, their credit scores are knocked down.  That seems fair enough, but that's also where the kidney punches start.  Many employers won't hire a person with credit problems.  If you are laid off and then default on your student loans, you may not be able to get a new job to repay them.  Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan.  Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay.  So, if you have significant student debt, here's what you have to do:  (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default.  Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters.  The exact scope and terms of the relief aren't easily predicted.  But it will happen.  Why?  Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers.  Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way.  Sooner or later, that will find expression in the ballot box.  When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself.  When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy.  Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so.  As one might expect, the use of debtors prisons wasn't always fruitful.  A debtor in prison couldn't work or otherwise do much to repay.  But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start.  Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations.  Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith.  But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers.  As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system.  In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy.  Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change.  Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result.  Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults.  And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students.  These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector. 

The current student loan crisis is yet another illustration of the problems of easy credit.  Easy credit at first seems like a bargain, and everyone loves it.  But there's no free lunch, and the costs of easy credit will eventually emerge.  When the problem becomes so severe that it cannot continue in the present form, then it will change.

Is Financial Inequality Constraining Economic Growth?

Businesses are having trouble raising prices.  (See http://online.wsj.com/news/articles/SB10001424052702303743604579354693061491748.)  Consumers resist price increases and look for cheaper alternatives.  The stagnation of middle class incomes surely plays a large role in keeping downward pressure on prices.  With people becoming wary of debt, the decline in the real incomes of the middle class leaves folks with no choice except not to spend money they don't have.

It's become an article of faith among central bankers that a little inflation--in the 2.0 to 2.5% range--promotes economic growth.  And they strive for such a Goldilocks level of inflation.  Whether or not this actually will work isn't clear.  Inflation isn't like the flow of water from a faucet, which can be kept at a desired level while economic growth blossoms.  A slithering rattlesnake, sometimes moving slowly and sometimes moving quickly but always potentially dangerous, is a better analogy for inflation. 

Nevertheless, let's posit for the sake of discussion that Goldilocks inflation can be maintained continuously for long periods of time and that it does indeed give the economy a lively fillip.  The ongoing hollowing out of the middle class stands as a major impediment to the central banks' use of inflation as a stimulus for economic growth.  As income and wealth inequality increases, the middle class--and indeed much of the 99%--will obstinately resist price increases.  Inflation will remain muted and not contribute to growth.

There are plenty of reasons to be concerned about increasing financial inequality--reduced social mobility, decreased social cohesiveness, rising extremism (especially noticeable in Europe), and so on.  We can add to the list that an increasingly plutocratic society may constrain the economy's ability to grow.  And that's not good for anyone.

A World of Foreign Policy Gambles

It is almost axiomatic that when a political leader faces domestic problems, he or she will turn to foreign relations as a way to divert disgruntled constituents from their daily travails.  Appeals to national pride easily tap into the often reflexive patriotism that many people have.  Folks tend to rally 'round the flag whenever there's a dustup with some bunch of dang foreigners.  Since foreign relations tend to be largely in the domain of Presidents, Prime Ministers and other national executives, legislative interference is less of a problem and credit for success can be hoarded.

With essentially all of the world's major economies unimpressive, sluggish or even tending toward torpid, it's hardly a surprise that some world leaders are indulging in cross-border shenani . . . , well, activities.  China has a slowing economy, with a real estate bubble, a debt bubble, increased competition from lower wage nations around the world, growing unemployment, a lack of high-value innovation, and a demographic demon of too many elderly and way too few young workers that's far, far worse than America's social security issues.  So what does China do?  Make noise about territorial claims in the East China Sea and South China Sea.  America responds by flying B-52s into an area claimed by the Chinese.  The Japanese, with a sludgy economy and a recently elected Prime Minister, Shinzo Abe, who appears to be of a nationalistic bent, contest the Chinese claims with their military aircraft, sabre-rattling as good as they've been rattled at.  Japan and China are quietly drifting into an arms race, while the U.S. military is expanding its presence in Asia.  And of course, there's North Korea, an economic dead zone, which engages in virtually nonstop sabre-rattling to legitimize its autocracy. 

Meanwhile, in the Middle East, a newly elected Iranian leadership faced with a sanctions-hammered economy that's circling the drain, are suddenly open-minded about a deal to slow down their nuclear program.  An American President, crippled by the virtual non-launch of his showcase domestic health insurance program, decides it's okay to let Iran continue to enrich uranium up to the 5% level, even though this isn't exactly a complete freeze of Iran's nuclear program.  (Even though Iran says it wants to have 5% uranium to develop nuclear power, since when does a country with gobs of petroleum reserves need to develop nuclear power?)  This deal could be seen as an effort by the U.S. to reduce its presence in the Middle East (so it can increase its presence in Asia).  Does that make war in the Middle East less likely?  Or will the increasingly nervous Israelis act on their own, as they have in the past?  And if they do, will America be militarily dragged into the consequences?

Over the past century and a half, foreign policy adventurism has tended to end badly.  Sometimes, very badly, with 20 million dead in World War I and 60 million dead in World War II.  This isn't to suggest that America and other nations should become isolationist.  The world is interconnected and some degree of international engagement is necessary.  But citizens should be skeptical of their leaders, who often have much to gain by stepping up their rhetoric and actions.  The recent popular outcries against American and British military action in Syria over its use of poisonous gas is an example of how the levelheadedness of the citizenry can cool the jets of a handful of very powerful people who may spend too much time talking to each other.  If a nation's leader seems to have a gambling problem in the foreign policy arena, citizens should stage an intervention.

How Is GDP Financed?

It may seem strange to ask how GDP is financed.  GDP simply measures the total market value of final goods and services that an economy produces.  It is a way to measure national income, not a measure of assets on a national balance sheet. 

But the way GDP is paid for does matter.  If large quantities of borrowed money finance GDP, then GDP in future years may be less sustainable than GDP produced by organic growth (i.e., GDP derived from people and companies spending their earnings, rather than borrowings).  The pauper nations of the EU, mostly located on the southern rim, are good examples.  They borrowed heavily (or their banks borrowed heavily) to finance consumption.  For a while, their GDPs grew.  But debt, unfortunately, has to be repaid.  A nation's whose GDP is heavily dependent on borrowed money will eventually have to pay the piper.  If those payments are burdensome enough, the nation's GDP bubble will burst, and recession will follow.  That isn't hypothetical; look at Greece, Ireland, Cyprus and Spain.  Indeed, look at the EU as a whole, which is sinking into recession even as we blog.

In America, the picture ain't pretty.  Even though GDP is nominally growing, in the first quarter of this year at an annual rate of 2.5%, the question of sustainability looms.  The federal government is constraining its borrowing (partly because of sequestration and partly because of Social Security and income tax increases).  Thus, the federal budget wouldn't be a source of GDP growth. 

But the Federal Reserve's quantitative easing program is.  The Fed is pumping $85 billion a month into the economy through purchases of financial assets.  Over a full year, the QE program would pump $1 trillion into the economy.  That's equivalent to about 6% of America's $16 trillion GDP.  It wouldn't be accurate to say that $1 trillion spent on QE results in $1 trillion of GDP.  Much of the money printed by the Fed for QE is recycled back to the Federal Reserve System in the form of member bank deposits at Federal Reserve banks.  This process is a near wash (except that it gives the depositor-banks riskless profits).  But QE is boosting the economy.  Our stock market--bizarrely exuberant in the face of a tepid economy--needs its regular fix of QE to maintain and increase its high.  The real estate markets seem to be getting a boost from the Fed's purchases of mortgage-backed securities.  Increases in asset values such as these appear to be creating a wealth effect that boosts spending (mostly by the top 10%).  That is probably a primary source of GDP growth today. 

But QE is similar to borrowed money.  At some point, the Fed will start selling down its more than $3 trillion balance sheet.  This akin to debt repayment.  It will remove money from the economy.  When there is less money to spend, there may well be less economic growth.  The Fed is hoping that the economy will be organically growing briskly by the time it goes into QT (i.e., quantitative tightening).  But there's no way to know for sure that will be the case.  The Fed may have to shift to QT because of a rise in inflation, whether or not growth has revived.  Whatever the reason for QT, it will constrain growth.  In some circumstances, it could produce a recession. 

Like toothpaste and genies, QE on the loose isn't easily put back into the place where it came from.  There's no riskless way to execute QT.  It's possible that continuation of the Fed's QE program could stimulate the economy to resume vigorous growth.  But that's far from certain.  And every additional month of QE heightens the risks that our economy is becoming overleveraged.

Reducing the Deficit: Should the Fed Monetize the Federal Debt?

Desperate times call for desperate measures.  We've seen yet another dysfunctional mess from the political process, and have to think expansively.

The recent fiscal cliff deal was largely a failure.  It raised taxes on most Americans, while doing virtually nothing to reduce federal spending.  While income taxes were not increased for the middle class, Social Security taxes were increased for all workers at all income levels.  The well-off (the $400,000 plus crowd) face a higher income tax rate of 39.6% (20% on qualified dividends and capital gains) and wealthy dead people now pay a 40% tax rate (instead of 35%) on the portions of their estates exceeding $5 million ($10 million for married couples).  The automatic spending cuts required by the cliff were deferred for two months (except for $24 billion in cuts that do go into effect), so spending largely continues apace.  Presumably, there will be a second face off over spending cuts when the President asks Congress to increase the debt ceiling in the next few weeks (even though the White House insists it won't negotiate over the debt ceiling).

One thing to take away from the cliff deal is that spending cuts are really hard to agree on--so hard that the Dems and Republicans simply kicked the can down the road.  But they will be even harder to agree on two months from now.  The Republicans have lost significant leverage by agreeing to tax increases now.  The tax side of the fiscal cliff has been resolved, more or less favorably to the Democrats (although some liberal Dems are still unhappy).  What incentive do the Dems, who control the Senate, now have to agree to spending cuts?  Of course, the Dems would agree to some spending cuts (the defense budget would be their target number one).  But Republicans are focused on hurting core constituencies of the Democratic Party through Social Security, Medicare and Medicaid cuts.  With the Dems having largely won on the tax issues, they have little reason to make concessions on the social safety net.  Even if the President is willing to give the Republicans some of what they want (which he seems to be), he may have a problem in the Senate, where Social Security, Medicare and Medicaid were stoutly ring-fenced and defended during the fiscal cliff talks.

Realistically speaking, we shouldn't expect our dysfunctional elected government to find grand solutions to the fiscal deficits.  Due to a variety of bad and intractable political dynamics, that simply won't happen.  We have to look elsewhere for solutions.

The next logical candidate to get the hot potato would be the Fed.  The central bank has played a central role in combating the Great Recession, not without some success.  In the course of its massive quantitative easing programs, it's accumulated a balance sheet of close to $3 trillion.  This total is likely to grow as the Fed continues to purchase debt on the open markets.  Slightly over half of the balance sheet consists of U.S. Treasury securities.  Total federal debt is about $16 trillion.  Thus, the Fed holds about 10% of all federal debt.

Why not have the Fed simply forgive some or even all of the U.S. Treasury debt it holds?  In other words, it would declare that the Treasury wouldn't be required to pay the debt.  That, by definition, would reduce the federal deficit by reducing the amount of federal debt outstanding.  And it's what happens anyway.  When the Fed receives debt payments from the Treasury (usually consisting of interest payments), it simply remits those funds back to the Treasury Dept. (except for a small amount retained to finance the Fed's budget).  Debt forgiveness by the Fed would simply expand on what happens in the ordinary course.   

Of course, such debt forgiveness would be tantamount to monetizing the debt, and has the potential to be inflationary.  But precisely what the heck do we think is going on now?  When the Fed launches repeated quantitative easing programs, with ever more asset purchases but not the tiniest hint of when, if ever, it would unwind its Brontosaurian balance sheet, it has functionally monetized the debt.  With the economy expected to be a sick puppy for years, reality is the Fed may hold a lot of its current inventory of U.S. Treasury securities until they mature.  When they mature, it will remit the principal payment it receives from the Treasury back to the Treasury (or use the funds to make more open market purchases of Treasury securities).  The federal debt has been monetized, even though no one on the government's payroll is going to admit it. 

Such debt forgiveness wouldn't fully resolve all the deficit problems.  But it could reduce the scope of the crisis, and would amount to little more than accurately accounting for what is actually going on.  If inflation flared, the Fed could suspend debt forgiveness and raise short term interest rates, combating inflation as it traditionally would.  But as long as inflation is subdued, debt forgiveness could contribute to resolving a problem that politicians clearly won't be able to solve, at least not comprehensively.

Ultimately, the best solution to the deficit problem is to boost economic growth.  Greater growth means higher employment levels and more income and corporate profits to be taxed.  If the economy were growing briskly and unemployment were around 5%, we probably wouldn't feel we have a deficit crisis.  Housing seems to be stabilizing, although its long term prospects remain clouded.  So we can't count on housing to be the engine for growth.  Measures the government could take include:  (a) rebuilding infrastructure--this is something the government has historically done well, and should do more of given the crumbling state of our infrastructure; (b) loosen up immigration restrictions for well-educated people and people who can invest substantial capital in America to create jobs--we need more innovators and entrepreneurs; (c) improve education, not by handing out loans to anyone who has a pulse and a signature (there's way too much student debt already, and it will be the next big debt bubble), but with measures to make education more efficient and inexpensive, like expanding Internet-based educational programs.  Achieving greater economic growth will take time, but it's a lot easier than trying to use the political process to agree on budget cuts. 

All That Noise, All Those Robocalls, and Nothing Changed

We had the elections, and nothing changed.  Barack Obama was re-elected President.  The Democrats kept control of the Senate.  The Republicans kept control of the House.  After all the accusations, attack ads, junk mail, robocalls, soaring campaign rhetoric, and lies, we can look forward to . . . more gridlock.

This election was the comeuppance of all the money bag men who nonymously or anonymously tried to buy their way into political power.  Hiding behind secretive nonprofits, monied interests barraged users of every type of media with relentless harangues and unending fear mongering.  While Democratic war chests were very large, Republican funding was Brobdingnagian.  But all that spending, and counter-spending, produced very little change.

That's a great result.  It shows that the American voter isn't a dumbo who can be cynically manipulated by unnamed puppet masters with zillions to spend behind the scenes to instill subliminal fears.  Politicians and political parties must, however difficult it may be, offer something that is in the public interest.  They need to demonstrate that they have something positive to say and do.  The political process remains a means for societal concerns to be debated and resolved.  The rich may not get richer.  The poor may not get poorer. 

Many problems lay ahead.  The fiscal cliff approaches anon.  The economy remains in first gear, and unemployment levels feel like the real bad hangover that comes from drinking the worm as well as the tequila.  The federal deficit must be dealt with.  As difficult as these problems may seem, the defeat of the monied interests is a sign of hope--hope that politicians may try doing something constructive for a change, rather than cater to those that offer to hand over the biggest checks.

The Great Anxiety

The Great Recession has morphed into the Great Anxiety.  Economic growth is tepid, enough so that it inspires little confidence.  Unemployment, still high, is falling, but so slowly that consumers' animal spirits remain tame.  Individual investors, confronted by three year highs in the stock market, celebrate by fleeing.  The members of Congress devote their energies to calling each other finks, rat finks, double rat finks, and triple rat finks, while the nation veers toward a fiscal vortex.  Both candidates for the Presidency, although individually quite intelligent and accomplished, swap lies about how the other is lying and inspire little more than resigned sighs from their supporters.  The Federal Reserve is operating the only show in town, and its program consists of printing money, printing money while riding a bicycle sitting backwards, printing money while juggling eight balls and printing money while doing double somersaults on a trapeze.  But the Fed can't do much to resolve the problems in Europe, which is now sliding into recession even as the sovereign debt crisis gets kicked farther down the road.

If the Federal Reserve Board is correct in believing that public confidence is crucial to economic growth, then we are a long way from healthy, sustainable growth.  By all current indications, whichever candidate for President wins won't inspire much confidence.  Congress appears likely to remain divided between a Republican House and a Democratic Senate.  Gridlock isn't that big a problem when the economy is strong.  But it is deadly when the economy is moribund.  For better or for worse, a somnolent economy needs a decisive government, and we probably won't have one. Can kicking isn't a sound federal economic policy.  Both Japan, and more recently, the European Union, have vigorously kicked the can numerous times.  The problem, though, is that business people and consumers all know that the can is still there, and can bite them in the butt big time.  So they don't make big commitments; they don't go exuberant.  Can kicking virtually guarantees stagnation.  Yet can kicking has been the order of the day in Washington.

In a time when lukewarm coffee is all that you can hope for, invest cautiously.  It's not a bad idea to hold some risk assets.  But limit your exposure, and avoid the riskiest.  Hold a good dollop of stable assets, and don't stretch for yield.  One important way to give your net worth a boost is to save more.  Remember that the thriftiest squirrels have the best chance of surviving winter--and the coming winter could be cold indeed.

Ignore the Election. Try a Little Science.

As far as economic growth goes, forget about the Presidential election. Neither party is focused on what really matters: basic scientific research. All great surges in economic growth have resulted from scientific advancement. When humans acquired enough scientific knowledge to engage in agriculture, they were able to grow large surpluses of food. These surpluses were used to support the development of settled societies, with cities, specialized workers, the centralization of knowledge through educational institutions, and control over resources like rivers and their floods. Human populations increased exponentially, as did human wealth.

The leap from a largely agricultural world to an industrialized world began with the development of the steam engine at the end of the 18th Century. The steam engine allowed humans to harness very large quantities of power derived by burning wood, and later fossil fuels. The vast increase in power offered by the steam engine led the way to the railroad, steam ships, giant factories that provided economies of scale, and even a few early cars.

In the 19th Century, the harnessing of electricity led to the telegraph, telephone, small and large scale lights and lighting systems, and all manner of machinery and equipment. New technologies for extracting and utilizing fossil fuels like coal, oil and natural gas vastly increased the amount of power available to humans, especially through the use of the internal combustion engine that powers almost all motor vehicles today. With that great increase in power came an enormous improvement in living standards.

In the 20th Century, advances in knowledge of electromagnetic radiation gave rise to the radio, television, cell phones and the wireless computers used today (variously called smart phones, tablets, etc.). Advances in agriculture have eliminated a great deal of the hunger that plagued much of the world before World War II. Developments in material sciences led to the semiconductor revolution, which is the foundation of all modern computers. The Internet, invented by [fill in the name of your favorite politician], has revolutionized communication.

In short, the big score comes when humans make major scientific advances and find ways to exploit them. Money printing and interest rate manipulation by the Fed, supply side tax cutting, deficit spending, scorched earth treatment for Medicare and Medicaid, and just about all the other hooey that politicians can't stop talking about don't amount to jack compared to the effectiveness of scientific advance in fostering economic growth. Much and perhaps most of today's political debate revolves around how to split up a seemingly inadequate pie. But the supposed conflicts between the 1% vs. the 99%, older folks vs. younger ones, taxpayers vs. beneficiaries of the social safety net, and so on all become less consequential if the pie expands at a faster rate.

Don't expect private financing sources to support basic scientific research. Private capital wants to reap its profit within a few years, and concentrates on applied science. But applied science doesn't provide lasting prosperity (ask the Japanese, masters of applied science, about this point). Support for basic scientific research is essential to long term prosperity. If there's one item in the federal budget that should be boosted, this is it.

Distribution of Income and Wealth is the Issue

As much as many politicians--mostly on the right--try to deny it, today's politics are all about the distribution of wealth and income. Democrats, with President Obama at the forefront, have made financial inequality a crucial element of their 2012 platform. Republicans argue against new taxes, and for the long term reduction of taxes and the shrinkage of the federal deficit. That, too, affects the distribution of financial resources, mostly in directions unfavorable to middle class and modest income households. Long term cuts, to be effective, would have to come to a large degree from Medicare and Medicaid, which verge on insolvency in the relatively near future. Social Security benefits may well shrink over time, although the cuts aren't likely to be apocalyptic. The 1% won't have to trim their sails much if the Republicans have their way. Most of the rest of us will notice the increased costs we would bear.

The Euro crisis is all about the distribution of economic resources. As a whole, Europe has more than enough money to resolve the sovereign debt crisis. But a lot of the money that would have to be paid out to bond vigilantes would come from the good burghers of northern Europe, and they have no appetite to cover chits signed by spendthrift members of the EU. Reality is the Europe isn't a whole, and its continental wealth isn't available to cover the debts of profligate nations. The thrifty don't want to distribute their wealth to the prodigal.

In China and India, even as substantial middle classes emerge with the turn toward capitalism, hundreds of millions remain mired in poverty. The governments of both nations, in different ways, grapple with difficult problems of distributing the fruits of growth. China also confronts a demographic problem far worse than America's; its principal solution to date has been to slash the safety net once provided by the iron rice bowl. Both nations equivocate when asked to commit large sums to bailing out Europe. How can they explain to their citizens why they should save much wealthier Europeans from themselves?

In times of brisk economic growth, the expanding size of the pie makes sharing easier. Stagnation, however, brings out harpies. Increasing growth is the obvious solution. But that, for sure, falls into the category of more easily said than done (for elaboration on this point, call Ben Bernanke, Fed Chairman and Tim Geithner, Treasury Secretary).

Since the times when humans clung together in small groups of hunter-gatherers, distributional questions have existed. Hunting is a hit or miss process (pun intended), and the lucky hunter bringing down a deer would expect to share it with the entire group, just as the next day, another lucky hunter would share.

In a modern free enterprise system, protection of private property rights is important to provide incentives to work, save and invest. But market forces, alone, do not always produce distributions of financial rewards that comport with societal needs and norms. The demands of market-based economies altered social structures. Extended families disappeared as children reaching adulthood move hundreds and even thousands of miles away to find suitable jobs. Family-based safety nets evaporated as families splintered. But market forces make no provision for those injured on the job, the sick, the disabled, the laid-off or other unfortunates; and most certainly not for the elderly who no longer wish to or can work. Government programs were necessary to fill the gap.

There are no easy answers to distributional questions. But it's important to debate and decide them, because they are among the most crucial issues of the day. Trying to silence President Obama by accusing him of class warfare is tantamount to avoiding the central point in today's political dialogue. Whichever side you take on the question of the size of federal deficits, or the allocation of tax burdens, you're talking about the distribution of financial resources. A nation that faces up to the responsibility of dealing with this problem has a chance to reach the accommodations that lead to social harmony. A nation that ducks the issue and indulges in political mudslinging will face a grim future.

Rising Oil Prices: Has the Fed Been Too Clever By Half?

In eviscerating interest rates and quantitatively tranquillizing (we're way past easing), the Fed has sought to push investors into risk assets. Investors have responded. Stocks have risen sharply over the past six months. More disturbingly, oil and gasoline prices have bounced up, too.

The standard explanation for rising oil prices--demand from emerging markets like China and India--seems less plausible now that these economies are slowing down. The threat of Iran going off the deep end points toward higher prices. But Saudi Arabia's expressed intention to keep prices stable can't be taken lightly either.

However, the flood of liquidity that has come out of the Fed surely is a factor in rising petroleum prices, as all this cash has to find a home somewhere in the financial system. Rising oil prices create jobs in some parts of the country, but discourage consumers in all parts. While oil consumption won't fall much in the short term (because demand for gasoline is relatively inelastic, as economists would put it), consumption of clothes, food, vacations, and other things will suffer as gas bills snarf up the monthly budget. Recently improving economic statistics may reverse their trend.

The distribution of income enters the picture. Owners and sellers of risk assets benefit handsomely from the Fed's easing, while consumers (most of whom are middle class and hold little or no risk assets) are shortchanged. This matters in America, where consumption is 70% of the economy. One can see why QE 1, 2 and perhaps soon to be announced 3 haven't and won't boost economic growth that much. With the QEs, the Fed giveth, and it taketh away. The net gain to the economy is unclear.

Will America Ever Produce Another Steve Jobs?

It hardly needs to be said that Steve Jobs was a transformational figure, doing as much or more than anyone to create the personal computer, and decades later, the products that will gradually replace the personal computer. Jobs took the lead in adopting the mouse and graphical interfaces, critical features that made computers user friendly to non-geeks. He was a talented marketer, offering tech products that actually looked attractive and felt sleek. The massive personal computer market spawned by Jobs and a small group of like-minded geeks made possible the Internet as it exists today: a global forum for the largest informational and intellectual exchange in history. The creators of portals, search engines and social networks are singles hitters compared to Jobs' standing as the high tech world's Babe Ruth.

A rather scary question is whether America will ever again produce a figure such as Jobs. When Jobs went to high school and college, America was evolving from the rigidity and conformity of the 1940s and 1950s into a more open-minded place where being different was tolerated and, in Jobs' case, ultimately rewarded. Jobs briefly attended college. Then, he dropped out but hung out around campus, exploring what interested him, growing spiritually as well as technically. Steve Jobs was simply different, and that's why he achieved such far-ranging, innovative success. His varied interests in the arts, music, religion, and high tech were ultimately reflected in the products he created. It wouldn't have been obvious to 99% of personal computer makers that they should create a product that promotes music, like the iPod. But Steve Jobs by all indications saw the iPod, iPad, iPhone and other expansions of the digital world as just part of the same continuum.

His particular vision is gone. He leaves behind a company that employs about 50,000 people, with suppliers that probably employ tens of thousands more (and let's not forget Pixar, Jobs' other corporate creation that's now a Disney subsidiary). Entrepreneurial success like this is crucial to economic growth. Comparable figures from the past, like Edison and Ford, had similar impact on the economy. Today's contentiousness over economic, monetary and tax policies, social safety nets, and so on can't do much to solve our problems. That debate is about the allocation of costs and burdens, and does little or nothing to make the economy grow.

The way to solve our problems is to foster more rapid economic growth. As history shows, a small number of original thinking entrepreneurs can have a disproportionate impact on growth. They envision and then foster disruptive change, sweeping aside conventional assumptions and recreating the world as they see it. They produce products almost no one else could have imagined, and convince millions of other people to like and buy those products. They are strong-willed and singularly determined. Blessed with exceptional intelligence, they tend to be impatient with those less capable, whom they may micromanage and over-supervise. Highly sensitive to criticism and any imperfection in their worlds, they often don't play well with others. They're difficult to be around and their employees have to be well-compensated to put up with them. When they succeed, they become exceedingly wealthy, as do their employees and the nations that host their companies.

There is reason to doubt America's ability to produce another Steve Jobs. Our educational system posits that all holes are round--as in well-rounded--and tries to peg all kids into them. To be regarded as highly successful, kids need to get A's in all subjects, excel at taking standardized tests, and be superb athletes, musically gifted, charitably and community minded, well-traveled, immersed in at least two foreign languages, pleasant, mannerly, well-groomed, well-spoken and generally pleasing to adults. A kid who is brilliant in one or two areas, such as high tech or math, but is otherwise diffident, reticent, indifferently groomed, and unexceptional in other ways, is viewed as weird, strange, unbalanced, geeky, nerdy and not competitive for most of the best colleges. A 17-year old Steve Jobs today would probably have a tougher row to hoe than Steve Jobs had in the 1970s. There was once a time, decades ago, when America's educators understood that it was more important to cultivate a student's strengths than to turn all kids into carbon copies of the student body president. That allowed many gifted, but not well-rounded kids to grow into great successes in their individual fields.

America's obsession with well-rounded students who excel at taking standardized tests means that we are turning out legions of future administrators, bureaucrats, consultants, corporate lawyers, and mid-level executives. Those in this group who earn MBAs may accumulate small fortunes in business or finance. Very few or none will have any macro impact on the economy.

Those poorly rounded, but disproportionately talented kids who have the potential to change the world must struggle against stereotyping, unfavorable social expectations and schools that don't value them. It's important to remember that advanced economies require people who are highly specialized and that innovation comes from those that don't fit in and aren't readily accepted. America today has reverted to a troubling conformism that may hinder the full development of our children's potential. This nation remains a haven for tinkerers, inventors and garage-based business start-ups. Our best chance for future prosperity rests in their hands, not in the hands of the idiots on Capitol Hill who can barely agree on a continuing resolution. Let's try to give the nerds a better chance at the brass ring.