Can the US avoid creating the next bubble?

I know it may sound like we're getting a bit ahead of ourselves, but . . . as we implement policies to stabilize the financial system and end the recession, one thing policy makers need to consider is the structure of the recovery ahead. And one important question is, how do we avoid creating the next bubble?

The issue is hardly academic. The United States has experienced a series of bubbles -- dot-com, commodity, private equity and housing -- and each one has been more devastating than the last, resulting in economic dislocation, devastating increases in unemployment, a disproportionate number of bankruptcies and foreclosures and, with the bursting of the last one, a debilitating credit crunch.

U.S. leads the league in bubbles

The United States is the reigning bubble champion and one economist says we may have used up our allotment. "The United States cannot afford any more bubbles, particularly on the heels of the devastation caused by the bursting of the leveraging bubble," economist Richard Felson tells DailyFinance. "Bubbles create economic distortions, result in the incorrect deployment of resources and represent pseudo wealth. They are everything you would not want to see take place in a modern economy."

DailyFinance's Peter Cohan has written extensively and incisively on bubbles in the modern era, and Cohan lays much of the blame at the feet of the U.S. economy's over-reliance on debt -- which he argues has driven up prices, most noticeably in the housing sector. It's a theory Felson agrees with.

"There is no question that as financing becomes more available for an asset, upward pressure is placed on the price of that asset. It's classic supply and demand economics," Felson says. "Amortized over 30 years, an asset becomes affordable to more people, increasing demand for that product, which pushes up its price. It's happened in cars, even in leveraged buyouts, and we know what it did to the housing market."

What really caused the housing bubble?

However, while cheap, easy credit is responsible for the bulk of housing's boom and bust, Felson says the solution is not as simple as raising mortgage loan approval requirements. First, he says, unless the U.S. bans mortgages outright, "mortgage lending will eventually revert to the mean." Second, even in constrained markets, home buyers and others will seek credit from alternate sources. The key then, in Felson's interpretation, to is not restricting lending, but eliminating the reason people sought so many problematic loans in the first place.

"Much of the housing asset bubble-and-bust was driven by refinancings and by home equity lines of credit. Which begs the obvious question, 'Why were people doing these things in the first place?' " Felson says. "Why would so many homeowners succumb to using their home as a sort of bank ATM or piggy bank?"

Felson argues the reason is due to more than just clever marketing by banks or an American public addicted to consumption. The main reason Americans over-borrowed is wage stagnation, he says.

"We know that several job segments, including many blue-collar positions, experienced wage stagnation during the past decade. If median wages had increased at normal, historical rates, would many of these Americans even have considered refinancing or taking out a home equity loan? Probably not," Felson says. "But the reality of the past decade has been that, for many job segments, wages were flat, or negative after adjusting for inflation, and it was that income shortfall that prompted many to succumb to counterproductive refinancings and home equity lines of credit."

The key then to the United States avoiding the next bubble, Felson says, is wage gains driven by strong job growth. This will not be an easy task, he adds. The United States must identify multiple engines of growth -- literally create new horizons of discovery, accomplishment and wealth. This will most certainly involve technology and other growth-oriented sectors, as well as involve transforming existing ways of doing business in the energy and health care fields. Education investment and government support will be critical, Felson says, which is why he generally supports the Obama Administration's 10-year proposed budget.

If the United States does the above, it will have a balanced economy capable of sustainable growth in the 21st century -- one that creates sufficient jobs and where median incomes rise across society, Felson says. He adds that the United States should have as its goal 250,000 new jobs per month at the start of the next economic expansion, and 200,000 new jobs per month as the expansion matures, after the third year.

Fiscal Policy Analysis: The view from here thoroughly supports economist Felson's job growth goals. Getting both private investment and public policy aligned for the mission will be a Herculean task, but the economy must be restructured: Some manufacturing jobs will return, but many won't, which is why the U.S. must identify and create new sectors of growth in energy and renewable energy, health care and of course technology. (Further, no legitimate source of jobs can be ignored. One example: tourism. Almost 82 million people visited France in 2007, a very profitable revenue stream for the nation. About 56 million visited the U.S. during the same year.) Another key is innovation: The U.S. must corner the market in doing things better, whether it's the best windmill, solar panel or most-reliable electric or hydrogen-fuel-cell car.

If all of the above become key features of the U.S. economy in the decade ahead, we will meet Felson's job growth requirements and build a stronger, prosperous economy, with rising corporate earnings and median incomes.

Financial Editor Joseph Lazzaro is based in New York.

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