Special Report

How to Save the Global Economy: Buy More Yachts

Recessions that follow severe financial crises are stubborn. Consumers won't lead a recovery because they're still paying down debt and worried about losing their jobs. Nor will businesses invest, because they already have more than enough capacity to produce what people want to buy. Government is the only actor with both the motive and the ability to boost spending enough to restore full employment in the short run -- but as long as entrenched political leaders insist on austerity, they won't.

Fortunately, there is another tool available. It isn't the best tool, but it is one that can work in spite of U.S. and European governments' newfound commitment to austerity. We could enact a steeply progressive surtax on the annual consumption of the wealthiest households, while making sure it's scheduled for gradual phase-in only after the economy has returned to full employment. A household would report its income to tax authorities as before, and would also report its annual savings, as many already do with tax-exempt retirement accounts. The difference -- income minus savings -- is the household's annual consumption. The surtax would begin once annual consumption exceeded a high threshold -- say, $500,000 -- and rates would rise with consumption beyond that threshold.

Taking this step would create an ensured future revenue stream to balance government budgets. More importantly, it would spur a massive burst of private spending as wealthy families rushed to buy bigger yachts and completed planned additions to their mansions before the surtax took effect. It would, in effect, be a second stimulus -- one bankrolled not by Uncle Sam but by Uncle Pennybags.

It's an idea with a long history -- even the sainted free marketeer Milton Friedman once proposed something similar. A progressive consumption surtax would have other benefits in the long run too. Its gradual phase-in would shift resources over time from consumption toward investment. Total spending, and hence total employment, would remain the same, but productivity and income would grow more rapidly.

The tax would also give us a much more potent tool to help address future economic downturns. The most widely used current remedy is a temporary income tax cut; this tends to be ineffective because in times of economic uncertainty most people are likely to put the extra money into savings. By contrast, the only way consumers could take advantage of a temporary consumption surtax cut would be by spending more right away.

Let's not forget that a far better approach would be large-scale spending on productive public investments, such as infrastructure and education. In this austerity-crazed age, though, that isn't going to happen anytime soon. In the meantime, any port in a storm!

Ilya Pitalev/Bloomberg via Getty Images

Special Report

How to Save the Global Economy: Tame the World's Crazy Currency System

Despite mind-boggling amounts of fiscal and monetary stimulus since 2008, the world economy has grown at only a 1.2 percent annual rate. Global public and private debt has mushroomed to an incredible 300 percent of GDP. And with the eurozone's financial system imploding, this picture will turn even darker: The world is at risk of an ugly collapse in asset prices.

Sadly, no magic pill -- no clever tax credit or new government spending initiative -- is likely to relieve us. Governments and central banks may have kept us out of a depression, but full recovery will only come after a long, hard slog.

During this global deleveraging, the major risk is that a currency and trade war might erupt as governments face public anger resulting from declining incomes and rising joblessness. A currency war is not as far-fetched as it sounds. Large parts of the world have become dangerously dependent on exports at a time of rising global overcapacity, particularly in manufacturing. Currency devaluation -- making exports cheaper -- is increasingly seen as a tool for prosperity.

And China is hardly the world's only "currency manipulator." Large parts of the globe are gaming the foreign exchange system. More and more, countries are making up their own rules. Such freelancing may have been acceptable during past periods of brisk global growth, when the U.S. economy and the dollar dominated the world. With American dominance fading, however, today's currency system has become a dangerous, mercantilist tripwire for misunderstanding, resentment, and potentially destructive reactions.

Every country, it seems, wants a relatively weak currency. In 2011, for example, as the eurozone's sovereign debt crisis was building, the Swiss franc began to soar. Fearful investors saw a safe haven in the Swiss currency. The swiftly rising franc was threatening to hollow out Switzerland's export sector, though, so the Swiss pegged their currency to the euro for trade purposes -- just as the Chinese regularly peg the yuan to the dollar to gain trade advantage.

Or consider the Japanese, who are masters at using their foreign exchange reserves, through central bank intervention, to keep the yen from strengthening too much. Lately, however, officials in Tokyo have been struggling to keep pace with a deliberate tidal wave of yen-buying by Chinese government-directed funds. Economist Tadashi Nakamae argues that the Chinese, who compete directly with Japan in the export of capital goods (high-speed rail systems, for example), have been ruthless in their efforts to engineer a yen rise and thus make Japanese goods less competitive.

At the same time, European policymakers are in the fight of their lives to save their monetary union. Because of the uncertain outcome, the eurozone is flirting with recession in 2012, but you'd never know that given the relative strength of Europe's currency. Why hasn't the euro weakened significantly? One reason is that the crisis has forced European banks to bring a great deal of their overseas capital back home. But another important reason, again, is China. The eurozone is China's largest export market, and a weaker euro would make Chinese goods less competitive. Thus, the Chinese have been buying the debt of countries such as Greece, Portugal, and Spain in part as a means of keeping the euro from weakening.

Nothing about today's foreign exchange system is fixed in concrete. Last April, the IMF reversed a position it had held for decades. It now deems capital controls (which allow governments, not the market, to set the level of exchange rates) as appropriate in some cases for developing economies. Immediately, the Germans announced that they too would retain the right to institute capital controls. This means that in the event the eurozone breaks up, Germany will likely try to make it more difficult for weaker countries to devalue their currencies for competitive advantage. If Germany leaves the eurozone, it will take steps in the currency markets to make sure its export industry is not put at risk.

In short, nearly everyone now wants to game the system. The result? Dangerous uncertainty for financial markets. A more rational system, one involving a transparent, negotiated agreement on currency intervention, and structural changes including capital controls, is essential if the world is to achieve a sustained recovery -- and avoid another crisis. Global trade operates under negotiated, fixed rules, creating a climate of certainty for all. It's time our currency system did the same.