America's twin financial woes and how to solve them

The current financial crisis in the USA boils down to two problems: subprime mortgage, and inflation. I have argued in my previous post that the more devastating one of the two is inflation. Subprime problem affects largely the Wall Street financial institutions, while inflation affects every single consumer, particularly those in the lower economic ladders.

To solve the financial crisis, we have to address these two problems. My argument is that: if we address the inflation problem first and head-on, other problems will be resolved easily as a result.

So how to solve the inflation problem? First we have to look at the root cause of inflation.

1) Inflation is caused by excessive printing of the dollar
As the great economist Milton Friedman stated: "inflations are always the result of increases in the supply of credit money: it is easy to print paper, and governments that have begun issuing paper money have always eventually fallen to the temptation of just printing and spending new money."

The root cause of inflation is the excessive money creation by the Federal Reserve. As the world's reserve currency, US dollar affects inflation not only in the US, but around the world.

2) Printing money was necessitated by increased government spending

Why did the Fed print so much money to begin with? To finance the run-away US government spending. After Bush took over the White House, he immediately reduced personal and corporate taxes across the board, fulfilling his campaign promise. Then the US entered two wars, against Afghanistan and Iraq. Government entitlement was also expanded during this period (Medicare prescription drug benefits for the seniors, or the Part D Program), plus all those pork barrel spending the congress likes to lavish on their own home states.

Now the common sense dictates that if you increase spending, you have to have the income to pay for it. Not in this case, because the government tax income was greatly reduced by tax cuts. Now what do you do? You print money, that is the only way out.

That is why US dollar has been steadily declining in value since 2001, which led to accelerating pace of inflation.

To stem the inflation, I have the following remedies. But I doubt any politician would have the courage to adopt them:
1) Pull out of Iraq
We went in for the wrong reason, we have to get out, before the war bankrupts USA. I am not suggesting pull-out immediately, but a measured and definitive time table of military draw-down seems to be the only way to get us out of there.
2) Increase taxes on the wealthy
The widening wealth gap in the US is alarming. In this time of war, some personal sacrifices are needed. The poor have sent their sons and daughters to Iraq. It is only fair that the rich need to pay their duties. We have to roll back the Bush tax give-aways to the wealthiest of the wealthy.
3) Adopt a long-term strategic energy policy to reduce reliance on fossil fuel
If it was not because of the oil, we would not have gone to the war with Iraq. That is undeniable truth. Let's not fake it. Imagine how much the US has to spend each year on military to protect the oil trade. The amount is staggering. We have to produce reliable source of renewable energy domestically (such as wind, solar, and bio-fuel). And we also have to conserve energy consumption. Currently the US is consuming 25% of the world's oil production, while the US population is only 4% of the world total.
4) The Federal Reserve has the reverse the excessive money printing process.
How can it do that? By raising the interest rate. I bet if the Fed starts to raise interest rate, US dollar will rise in value and commodities prices will start to fall. That will be a huge shot in the arm for consumer confidence and business confidence. Once confidence is restored, I think subprime problem will be eased as well. Part of the subprime issue is the lack of confidence of investors in the value of those mortgages. Restoring confidence will help the market to clear out all the liquidity excesses and mislocations.