The New Grand Bargain

February 2, 2013

It’s time to speak about a potential new Grand Bargain – not the side show we just witnessed in Washington DC – but how unlocking the US$3.5 trillion of capital sitting in Beijing could be transformational to the growth of the world economy. One economic relationship – not only because of its size but because of its ability to shift the psychological momentum – can change everything. If we can find a way to unravel the economic stalemate between China and the US, and create a flow of capital free of political constraints, we can change the economic trajectory of the world economy for the next decade. This is where our energy should be focused.

The elections we just had in the US were very consequential in this regard. We still have a very divided electorate and divided government, but in arguably the weakest economic environment since the Great Depression, the opposition party was unable to win. This has led to more soul searching about the nature of the opposition party’s message then has occurred in the last 30 years. In the lingo of the entrepreneur, the Republican Party is coming to terms with the fact that it has a ‘product development’ problem, not just a “marketing” problem. This in turn, I believe will set the stage for a new grand bargain.

The economic narrative that launched Ronald Reagan to the presidency, a narrative that celebrated the stimulative effects of cutting taxes and reducing the role of Government, still dominates Republican thinking, but it has proven unsuccessful in a year that was its to lose. That has created a huge opening for new thinking, one that could have enormous consequences for the “convergence of interests” between Democrats and Republicans, and ultimately between the US and China.

Throughout the presidential campaign, Americans were peddled the false choice between raising taxes on the rich (who are the ones who can invest) and draconian cuts to social services to the less fortunate (who are already badly off).

This same bad choice played out on a state by state basis to varying results. In the state of California, the issue was framed between the rich paying a little more and public education suffering. Framed that way, it actually sounds like a simple choice except when you consider that the top 1% already pay 50% of the taxes in California, are highly mobile, and have access to accountants that can maneuver around our highly complicated tax code.

The bottom line is that neither solution, taken in isolation, works well in a fragile economy. One needs look no further than Spain and the UK to see the depressing effects of purely contractionary fiscal policy. So each party developed an approach to address this.

The Republicans would lower tax rates to counter the dampening effects of cutting spending, and the Democrats advocate investing in infrastructure in order to offset the negative impact of tax increases. That then leads to a new round of arguments.

Republicans, while agreeing that infrastructure investment is vital for reviving growth, counter that we need to find a way to pay for it, that this so called “investment” is just spending by another name that will further inflate the deficit. The Democrats say tax cuts will do the same thing. Neither party gives credit to the other party’s auxiliary fiscal plank for creating growth which would reduce the deficit.

This is why we have a stalemate in the US and why the economy is paralyzed. But there is a way out of the box, a political and financial solution that starts at the state level and that provides the necessary knowledge and the means to move out of the present financial trajectory. This new economic narrative, which is tailor-made to become the new economic platform of the Republican party, starts by looking at how to make the trillions of dollars of state public assets more efficient. They have been completely overlooked in the fiscal debate, and they represent the biggest piece of wiggle room that exists to restart the US economy today.

Instead of only looking at annual budgets and liabilities, we must go deeper and thoroughly examine the asset side of the balance sheet. A full balance sheet is the first step to reassessing what can actually be done on a state by state basis. Incredibly, this has never been done- not even in a state the size of California, despite its massive problems.

When you look at the balance sheet, you see a very different picture state by state of the US economy. You start to see a much bigger pie, and with that comes more room to maneuver. All of a sudden a scenario exists where you can avoid the most draconian cuts, avoid further taxes on the rich, and invest to kick start the US economy while deleveraging it. None of this obviates the need for serious entitlement reform, but it’s a lot easier, with this new information, to see how we can create a solution to the partisan divide.

Most people think that California is bankrupt. I maintain that it’s actually rich, and probably getting richer with the shale energy revolution. We feel it when we walk the streets, when we look at our forests, our cities, our parks, our incredible beaches, and the creativity of our people. We are home to the best and most innovative companies in the world – Apple, Facebook, Google – brands that are larger than many states. We are home to the one place producing dreams and imagination for the whole world – Hollywood.

Once we tally all this up, and finally know what the state really has, things start to change immediately, just like they would for a person with a debt of $1,000 who discovers his assets are worth $1 million. In the case of California, there are estimates that put the value of public assets at over one trillion dollars, dwarfing even the worst case estimate of total liabilities for the state. When the financial markets see that California is not bankrupt, that its assets are worth more than its liabilities, the state’s interest payments, contributing to the deficit, will go down immediately.

Other benefits will accrue over time. Once we have the balance sheet, a logical next step would be to create a “California enterprise fund” and accept investments in it. This is where China comes in, with its huge reserve of dollar denominated “soft assets”. These assets are potentially at risk of being eroded by future US inflation. China has made it clear it would like to convert these into hard, inflation protected assets. It has two problems in that regard.

One is the sheer volume of money that needs to be moved. It will be difficult to find enough large assets. But public assets are sufficiently large to solve that problem. Second, there has been political resistance to even relatively small acquisitions because of the fear of outsourcing jobs. That problem is also solved by public assets because the jobs associated with them are immobile and can’t be outsourced.

Of course, no state will give up control over its assets, nor should they. But even selling a non-controlling 20-30% stake could yield hundreds of billions of new capital in a state like California, capital that could be earmarked for paying off debt (and likely would be through investor covenants), investing in dilapidated infrastructure, and providing a bridge that makes unnecessary the false choice proposed in this last election.

Once the transfusion of capital is in, Democrats get money to rebuild infrastructure and avoid the worst cuts to social services. Republicans avoid the worst of the tax increases that dampen investment and hurt the economy, and they get to ride the improvements in infrastructure without increasing the debt. They also get, and this is critical, the discipline of outside investment in public assets, a “public private” partnership that leads to more efficiency.

This is a new, improved way to harness big government which allows Republicans to stay true to their conservative principles. China gets to structure their US holdings in a safer and potentially more prosperous way, and avoid the political backlash of other types of investments in the US. And America gets to recapitalize itself and kickstart its growth engine.

This grand bargain represents an initial convergence of interests between the two main political parties, and could set the stage for a real deal on entitlements. It also represents a significant convergence of economic interest between the United States and China, and that will make it much easier to solve our other differences. As presidents like to say “Elections have consequences”, and this one perhaps more than most people think.

(This is adapted from a speech delivered on December 11, 2012 in Beijing at The Third Forum on Global Entrepreneurial Economy.)

Bill Mundell is a Californian entrepreneur who has advanced market-based solutions to economic and policy issues in the Wall Street Journal, the New York Times and the Financial Times. He is spearheading a citizens’ campaign to attack gerrymandering in American politics.


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