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Special Economic Report

Part 1: The U.S. Financial Crisis

CEO Q Interview with the Economic Oracle

(First Published in Jan 2,2009)

US Financial Crisis - Economic Recovery - Economic Plan

U.S. Economic Crisis and The Economic Recovery Plan
A Policy White Paper for the Next President

The US Economic Report Sections

CEO Q Interview

CEO Q Magazine Interview

US Economic Outlook 2009 - 2010 - By Med Jones the Expert Who Predicted the Financial Crisis | Economic Crisis | Recession

About Med Jones

Med Jones is the President of International Institute of Management (IIM) - A U.S. based strategy think tank. Jones is recognized as one of the few economic gurus who predicted the U.S. economic crisis. He challenged the U.S. President, Federal Reserve Chairman and the popular opinions of the world economists in January of 2007. Jones is quoted in worldwide media on the topic. He is also known as the Economic Oracle for the accuracy of his predictions. We asked Jones several questions about the root causes of the crisis, the economic outlook for 2009 and 2010 and how best to get out of the crisis.

CEO Q >  How Did We Get Here?
Med Jones >
The U.S. economy got here due to spending money we do not have and not producing enough to pay back the credit. It’s like luxury-living on credit cards, at some point the lenders want their money back. Not to forget that in a new open global economy, the U.S. does not have a competitive monopoly on knowledge, technology, manufacturing, services or marketing anymore. Therefore, the growth rate of U.S. production (cars, airplanes, electronics, IT ...) is not keeping up with the growth rate of the debt. The housing bubble, subprime mortgage defaults, and associated financial crisis are all symptoms of the core problem of too much debt-based spending and over-extended leverage (debt-based investing). We cannot sustain debt-driven economic growth forever.

CEO Q >  How Did the Top American Economic Experts Miss The Crisis?
Med Jones > Experts missed the crisis because of the groupthink mindset, and the lack of information and misinformation in the mainstream media. In such an environment, few have the insight and the courage to tell it as it is, and risk being ridiculed by other industry experts. It is not enough to know the facts, what is needed is the ability to see the big global picture and understand the dynamic interplay of key economic forces.

From a critical thinking perspective, there are two main reasons that caused mainstream economists and financial media to miss the financial crisis of 2008. The first is the NIH (Not Invented Here) bias, which is an organizational phenomenon manifested as an unwillingness to adopt an idea because it originates from unknown outsiders. It is a form of social cognition bias that leads to errors in group judgments such as missing on new opportunities or risks. The second reason is a cognition bias known as the Confirmation Bias which is the tendency to search for, filter in, or interpret information in a way that confirms existing preconceptions. The Confirmation Bias is recognized as an individual cognition bias, but when met with (NIH) bias it appears to develop into a social bias very similar to the Groupthink syndrome. 

CEO Q >  What is the Best Strategy to Rescue the U.S. Economy?
Med Jones > The financial rescue plan or the economic stimulus package in its current version will cost taxpayers more than a trillion dollar over the next 2 years, and there is no guarantee that it will achieve its stated goals. The plan will more likely soften the fall but it will not correct the economy, it will only delay the correction, and therefore, the recovery too. The most cost effective and quickest method to stimulate the U.S. economy is to support job creation through investing in the creation of U.S. small businesses and innovation development. U.S. Census Bureau statistics show that 98 percent of all U.S. firms have less than 100 employees. These 27 million small businesses create over 85 percent of all new jobs and employ over 56 percent of all private sector workers. The main focus of development programs should be innovation development, export and employment support through enterprise creation.

This solution would be much less of a burden to the taxpayers, it can be implemented without too much new legislation, and would have a much faster positive impact on the economy. It can be based on existing federal programs designed to direct federal funds to small businesses. The Small Business Reauthorization Act of 1997 stipulates that a minimum of 23 percent of all federal prime and sub-contracts be awarded to small businesses.

Oversight is critical to the success of the implementation of any rescue program. The effective and efficient program execution is necessary to avoid waste, fraud, and the abuse of loopholes to divert these funds to special interest groups. If the objective of President-elect Obama is to lead the economic recovery through the middle class, then the job creation initiative through small business and innovation development, would be hitting 3 birds with one stone. The birds are sustainable job creation, middle class support, and increasing U.S. businesses competitiveness through innovation development). This initiative would have a significant, and immediate positive impact on the national economy. The European Commission has invested hundreds of billions of dollars in innovation and enterprise creation since 2002. I personally was on the steering board of 3 innovation EU research consortiums from 2002-2006. I saw the impact of these investments first-hand. The result of the EU innovation and small enterprise creation initiatives is that they quantum-leaped U.S. companies in Telecom, Aerospace, and several other industries. The Euro today is almost 50% more valuable than the US dollar, compared to 2002.

CEO Q >  When Do You Think the Economy Will Recover?
Med Jones > The timing of the economic recovery depends on several factors, the most important are the effectiveness of the new economic policies in establishing trust in the U.S. economy (such as reducing budget and trade deficits, etc.), and the performance of corporate America (profits, job creation, etc.) . The markets need at least 2 consecutive quarters of business growth and profits, so that CEOs, investors and consumers will establish the confidence to invest again and reverse the negative cycle. However, we will not see the hugely inflated stocks and real estate prices anytime soon. 

CEO Q > How is the Health of the US Economy?
Med Jones > I do not subscribe to gloom and doom scenarios. We have to do an unemotional assessment of the health. The next 8 years will be the most critical in determining the health of U.S. economy. A healthy economy has no or low debt, a strong base of savers and investors financing GDP growth through investment in production and exports. The government has a budget surplus and uses this surplus to invest in the infrastructure, education and new innovations. The best way to get the picture is to let the numbers speak for themselves.

The U.S. Economy in Numbers:

  • The size of the U.S. economy = $13 trillion. Commonly known as the Gross Domestic Product (GDP) - The 2002-2006 growth has been mostly driven by debt spending, inflated real estate prices and assets valuation (mainly the housing and mortgage/financial bubble)

  • U.S. 2008 deficit is about 1 trillion dollar = 8% of GDP.

  • U.S. National Debt (accumulated) is about $10.5 trillion. Actual numbers are much higher, since U.S. government accounting rules do not meet private business accounting standards.

  • A large national debt is bad. Why? The Government has to pay interest on the debt. As the debt and the interest payment grow, eventually all the Government can afford to do is pay the interest payments, with no money left over for other socioeconomic development investments or even critical expenditures. If uncontrolled, this could lead to states and national bankruptcy and major related socioeconomic crises.

  • During the 2006 fiscal year, the U.S. Government spent $406 Billion of its budget on interest payments to the holders of the national debt. Compare that to Education at $61 Billion, and Department of Transportation at $56 Billion. When interest payments become larger than other critical socioeconomic budgets, this calls for major concern.

  • Consumers are the main engine of any economy, the less money the consumer has to spend or invest, the less is the economic growth. By the end of 2006, the U.S. consumer debt was about $11 trillion.

  • Foreign Debtors hold about 40% of the US National Debt (Mainly China, EU, Japan and Oil producing countries).

  • According to the Commerce Department, the United States paid more to its foreign creditors than it took in from its overseas investments. The gap was about $2.5 billion for the last quarter - the first time that has happened in more than 90 years! (Are you noticing the negative trends in numbers?).

  • According to the Commerce Department, the personal savings rate for 2006 was a negative 1 percent; the worst in 73 years!. This is the lowest level since the Great Depression, which could be a problem for the millions of retiring baby boomers and for the job market.

  • About 45% of American households live “paycheck to paycheck”.

  • In 2007, the median annual income for Americans aged 65 or older is less than $17,000.

  • The average American household has more than $8,500 in credit card debt.

  • 28 million households will need food stamps in 2009.

U.S. health is bad, but it is not terminal. The new administration can enact new policies to reverse the negative trend, but if it does not do that soon, we will be in a critical state.

CEO Q > What About the Real Estate Bubble and Subprime Mortgage Crisis?
Med Jones > The Real Estate Bubble and Subprime mortgage are important components of the current crisis. However, they are not the root cause of the crisis. The crisis resulted from a national culture of spending more than what the nation can produce. There are also other problems following the subprime loans, including other risky loans and inflated assets categories that we will experience in 2009. ARM and other variable loans are expected to reset in 2009/2010, thus resulting in more foreclosures and loan defaults. This will depress the Real Estate and financial markets even further. Adding to this challenge, there are other issues related to the health of the U.S. economy including the falling dollar value, budget and trade deficits, and the diminishing position of the global competitiveness of U.S. industries and that is the real American challenge for the next few decades.

CEO Q > What Do You Think of the "Bad Bank"?
Med Jones > The Bad Bank is a Bad Idea. It will sure help the banks, Wall Street, and the stock market. The market will rally and it will help the credit flowing again. However, beware, it is a psychological trick. It is like making the rabbit disappear with a magic trick (but it is only hidden out of sight) and it will probably work on the public audience during the show. The saying you could fool most of the people for sometime is true here. But you have to remember, it is not a solution to the crisis, it is only transfer of the toxic assets from the banks to the government. In this game, the losers are the government and the tax payers. It is not unlikely we have to pay the price later. Obama's Administration or the next Administration will have to pay the heavy price for the worthless Bad Bank assets, out of control budget deficits, bad dollar, and even a worse economy. On the other hand, my preference would be for a state-owned “Good Bank”. A government-owned bank that will provide liquidity to the market, distressed home owners, and small businesses. The difficulty would be the bureaucracy and efficiency of operating the good bank, but that can be taken care off with private-public partnerships with other healthy banks and investors. The bank can be for profit and will help reduce budget deficit and finance growth. Both public and private investors win.

CEO Q > When Do You Think the Recession Will End?
Med Jones > A modest and slow recovery can start sometime in 2010. The recession will end with a period of stable (flat) economic activities. The timing of the recovery is dependent on the effectiveness of Obama’s policies. All economic predictions are subject to a set of key variables. The two most important variables for the aforementioned timing are:

  1. The competitiveness of the U.S. business environment (investment attraction via lower taxes, improved confidence, lower cost of doing business including healthcare, etc.) and;

  2. The health of the U.S. innovation and entrepreneurship engine. The only hope for reversing the negative cycle is in the creation and development of new innovative and globally competitive industries. The first recovery from the great depression (post-war recovery) was driven mainly by the new auto industry. The second recovery from the 1980s crisis was led by the information and communication technology (ICT) industry, this time it is the same. The U.S. needs to invest in or develop a new industry that will lead the recovery by increasing wealth and creating jobs. The timing of the recovery might be delayed if the U.S. engages in another war or implement more flawed socioeconomic policies.

CEO Q > What Could Hinder the Recovery of The U.S. Economy?
Med Jones > There are several possible scenarios. The complex governmental (and banking) accounting rules hide the fact that the current investment papers are overvalued. This is very dangerous. National and global investors will sooner or later catch up with the fact that their investments are highly inflated and riskier than they thought. If reforms are not taken, the result could be the serious erosion of investors’ confidence. The confidence in the U.S. economic policies is the single most important factor for recovery. The loss of confidence in the U.S. Economy could lead to the significant loss of the dollar value and the migration of capital from the U.S. financial markets to alternative international investment destinations.

CEO Q > What is the Worst Case Scenario and What are the Risks?
Med Jones > There are several risks including, but not limited to:

  • The devaluation of U.S. treasuries and other assets

  • New waves of home foreclosures from variable rate mortgage loans that are set to reset in 2009 & 2010

  • New waves of major consumer and business bankruptcies (especially for large industries) in 2009 and 2010

  • State bankruptcies

  • Double digits unemployment rate

  • Wrong economic policies (uncontrolled spending deficits and higher tax policies)

  • The sharp devaluation of US dollar

  • National political unrest

  • Wrong foreign policies (increased instability and decreased global collaboration)

  • Geopolitical and security risks

The combination of some of the counterproductive policies and bad news, can further damage the investors' confidence, thus sending the economy in downward spiral and resulting in another “great depression” period with ~ 25% unemployment rate. This would be the worst case scenario.

Fortunately, the new administration does have the tools to mitigate those risks and it is not too late to implement the new needed economic reforms.

CEO Q > What is the Best Case Scenario and Positive Forces?
Med Jones >

  • The deregulation and globalization of markets, capital and trade, information technology, better management, lean inventory and production systems will all help in a faster recovery.

  • New markets regulations such as increasing mandatory banking reserves, increasing the power of the shareholders to manage executive compensation, and regulating credit reporting agencies will improve confidence in U.S. investments.

  • The lower dollar will help export increase, thus supporting foreign capital spending and growth.

  • The lower mortgage rates will allow investors and first-time home buyers to get into the market thus reducing the market inventory and improving prices.

  • The proactive monetary and fiscal policies will help absorb the shock and help ease the credit market crunch (assuming the bailout plan is not abused by the banks to reduce their balance sheet losses, rather than loaning money to consumers and businesses).

  • In a global integrated economy , the global investors (including the Chinese, Japanese and the Gulf Arabs), all want the U.S. to recover so that they can recover their investments. We can expect to see a collaboration with various central banks and investors which will help us overcome the crisis. It is unlikely to see these governments taking hostile actions which would cause the collapse of the dollar or the financial system in the US.

  • Oil prices will have dropped, giving U.S. businesses and consumers a break.

  • The government can invest in, and help develop new industries including biotech, alternative fuel, and nanotechnology, thus creating new jobs which will generate enough income to reduce the budget deficit.

CEO Q > When Do You Predict The Next Boom?
Med Jones > There need to be at least 2-3 years of stability before the next economic boom can occur. The next boom cycle is subject to the rise of new industries. That being said, strong innovative research investments and tax policies will help accelerate this cycle. If a new industry evolve, we can expect to see the beginning of a new boom cycle as early as 2012/2013, otherwise we could suffer another crisis by 2015 from the accumulated debt.

CEO Q > How Will Obama’s Economic Policies Impact the Economy and the Financial Markets?
Med Jones > Initially there will a positive impact based on the goodwill from Obama’s positive campaign message and the expertise of his team. However, to sustain the positive psychological momentum, Obama needs to take some major socioeconomic and political reforms. The new Administration has 6-9 months to establish trust in the U.S. economy (nationally and globally). If the administration focuses too much on social welfare, they will miss a huge opportunity for a quick recovery. The Financial and Auto Industry bailouts in their current formats are bad ideas. They increase the budget deficit, and delay the correction, thus prolonging the suffering. The bailout plans reward bad management behavior and poor investment decisions. Not to forget, there will be a lot of waste due to the lack of governance. There will be abuse of funds by the financial industry and the executives of bailed-out banks and financial institutions.

The stated goal is to reduce the intensity of the pain of the fall, but in the process Obama will only prolong the recession. In my opinion, it is better to let the free markets correct themselves. This will allow a faster recovery. Short-term economic pain relief should not be at the expense of long-term economic health. Pain-killers are not the solution. What the patient really needs is surgery. While some social and infrastructure spending will be unavoidable, the best solution is to focus the investments on new enterprise creation and innovative industries that can raise national income and create jobs. All new policies should focus on reducing taxes for new industries in order to attract investments, thus reducing the budget deficit while encouraging investments, growth and exports.
 

CEO Q > What Solutions Would You Recommend?
Med Jones > The U.S. economic problems are multidimensional, therefore the solution should address all the dimensions of the problems, with careful balance between short-term and long-term impact. Economists from different schools and political parties can argue for opposing options. Each option has a benefit and a price to pay. In my opinion, there are several ethical issues for raising taxes on hardworking citizens to pay for the bailout of a group of investors, managers and companies who gambled with their money and made bad decisions. The fallout from subsidizing bad behavior can be serious, but ethics and politics are not the subject of this discussion.

It is not reasonable to try to avoid market correction.
Instead, the policies should focus on making the recovery faster, to enhance the competitiveness of US industries, and to improve the business environment to attract more investments.

In order to succeed, the solution should be pragmatic, not ideological. The solution should not be led by either the liberal or the conservative socioeconomic schools. It is not reasonable to try to avoid market correction. Instead, the policies should focus on making the recovery faster, to enhance the competitiveness of U.S. industries, and to improve the business environment to attract more investments. The following is a partial list of strategies to establish trust and reverse the cycle:

Learn the lessons:

  • Keep state and federal spending in check

  • Regulate to protect investors and consumers, but avoid overregulation or under-regulation

  • Let free markets correct themselves, while at the same time have proactive and rapid response policies. The purpose of intervention should not favor one group over the other or to control the markets. The goal should be to minimize speculation and market shocks, thus maintaining a healthy business and investment environment which supports the global competitiveness of national industries and businesses

Investments:

  • Provide tax holidays for new industries

  • Create tax-free zones for exports and tourism

  • Lower interest rates and tax rates for smaller and new businesses and foreign investments. This is important in order to attract capital, start new companies and create new jobs

Governance:

  • Investment and credit rating agencies should answer to investors, not bankers, like the auditors they should have liabilities for bad performance

  • Increase FDIC cap from $100K to $300K, this will establish trust in the banking systems

  • Raise banks’ mandatory reserves

  • Regulate to limit speculative-gambling investing

  • Reduce the cost of compliance and simplify Sarbanes-Oxley. What is needed is accountability not bureaucracy.

Political Reforms:

  • Reduce government size and expenses drastically.

  • Change the income tax to flat sales tax or value added tax (VAT). This will encourage investments and discourage consumerism

  • Change the way the government does business by creating performance-based job functions linked to business metrics and socioeconomic scorecards similar to the private sector with the focus on effectiveness, efficiency and competitiveness.

  • Public performance reviews of Representatives and Senators. Elections and re-elections should be tied to detailed states and national metrics to minimize wasteful spending and the abuse of national resources by special interest groups.

  • Instituting term limits on the Congress and Senate would reduce the abuse of power and the long-term access of lobbyists to politicians.

  • Reduce healthcare system costs. The high costs of the healthcare system come from 3 areas: labor, insurance and pharmaceuticals. The best way to overcome them is (1) open immigration policies for doctors and nurses to improve the healthcare labor supply/demand ratio, (2) limit compensation caps on lawsuits (3) open the markets by importing medicine from other countries (4) regulate the Insurance Industry.

  • Reduce educational system costs and accreditation bureaucracy, allowing the private sector and online programs to compete more effectively.

  • Audit the Federal Reserve.

For additional recommendations, please refer to Part 2: U.S. Economy Recovery Plan (First Published in Jan 31, 2007)

Who Predicted the Financial Crisis - Economic Crisis - Economic Recovery Policy

Who Predicted the Financial Crisis - Economic Crisis - Economic Recovery Policy

CEO Q Interview

Who Predicted the Financial Crisis - Economic Crisis - Economic Recovery Policy
 

About Med Jones

Med Jones is the president of International Institute of Management. He is recognized as one of the few experts who predicted the US financial and economic crises of 2008. In January 2007, he challenged the US President's State of the Union Address, Federal Reserve Chairman and world economists. His predictions were the most comprehensive and accurate among the experts who warned about the crisis. The original warnings and predictions can be found at:

Jones is a non-partisan technocrat. His predictions are followed by Democrats, Republicans, and Independents. He can be reached at medjones.com



Who Predicted the Financial Crisis - Economic Crisis - Economic Recovery Policy

 

 

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