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What Does It Take for U.S. to Avoid Stagnation?

A majority of U.S. voters think that life for the next generation of Americans will be worse than it is now. My favorite expert on international finance fears that’s absolutely right.

[IMGCAP(1)]David Smick, a wealthy investor and editor of International Economy magazine who has access to all the world’s movers, shakers and central bankers, sees a future of low U.S. growth and job creation, a possible ruinous global “currency war” and, if policies don’t change, America’s descent to second-class status.

As he did in his best-selling 2008 book, “The World Is Curved,” Smick is calling for an international agreement akin to the 1944 Bretton Woods pact to prevent nations from using currency devaluations to conduct a trade war of the kind that deepened the Great Depression.

For the U.S. economy, he calls for reversing the explosion of the national debt, pro-growth tax reform, “a serious turnaround in our banking system” and care at the Federal Reserve to avoid hyperinflation.

Smick gave a grim speech on the economy last week in Vero Beach, Fla., in which he said that nearly $1 trillion in government spending and the Fed’s slashing interest rates to nearly zero “are simply not working” to reignite growth.

In an interview, he said that, with further spending a political impossibility, the Fed is employing its last weapon — “quantitative easing,” the purchase of bonds with printed cash — in hopes that even lower interest rates will trigger a rise in the stock market that will create a “wealth effect” leading consumers to spend.

QE, by cheapening the dollar, also might stimulate exports. And it could wake up other countries to the danger of worldwide devaluations and impel co-ordination of exchange rates, particularly involving China.

Or it could actually hasten the “currency war” and lead to hyperinflation in the U.S. and a surge in interest rates that balloon the national debt and stifle growth, “creating a vicious cycle of economic despair that would be hard to stop,” he said in Florida.

A Fox News poll released Oct. 14, the day of Smick’s speech to the League of Women Voters and Ivy League alumni, showed that only 27 percent of voters think life will improve for the next generation and 61 percent said it will be worse.

Smick gave a scary forecast: “America faces an unemployment nightmare that is unlikely to end soon,” with impending public layoffs in bankrupt cities and states likely to swell joblessness. Housing prices will continue falling.

Public debt, the highest since World War II, will require borrowing $700 billion a year — more than the defense budget — to pay interest. Half will come from China, a geopolitical rival.

Atop all that, banks still hold toxic assets on their books and are not lending because they can make huge profits borrowing from the Fed at near-zero interest and investing in bonds paying 3 percent to 5 percent.

Smick is a Republican — once chief of staff to the late Rep. Jack Kemp (R-N.Y.) — but he blames both parties for creating conditions that could lead the United States to repeat the example of Japan, lost in two decades of stagnation and pessimism.

“Consider this fact,” he said. “Had Americans not been able to take out cheap home equity loans to engage in hyper-consumption, the U.S. economy for the entire George W. Bush administration would have grown each year by an average of 1 percent.”

Since the economy collapsed in 2008, both Bush’s and Barack Obama’s administrations “caved into big banks’ power” instead of restructuring them, leading them not to lend.

“Is America the next Japan?” Smick asked in Florida. “The answer is that we aren’t yet. Japan was unable to innovate itself out of its economic quagmire. The question is whether America can.

“Here’s the good news. Today there are up to $4 trillion sitting on the sidelines waiting to invest in a new era of American confidence” if the government changes policy and encourages small-business and start-up investment.

“It is time for Washington to wake up,” he said. “It is five minutes to midnight. America doesn’t work any more. In the minds of most Americans, big banks, big unions, big corporations and big government have all gamed the system for their own special interests, and Washington has lacked the courage to fight back for the little guy.”

To restore confidence, America needs “a nonpartisan, problem-solving, no-nonsense leader” who “grabs the country by the shoulders, shakes us and says, ‘We can get out of this mess, but it will take time, and sacrifice and imagination,'” he said.

He told me he does not have a current candidate in mind but that “it would have to be a combination of [New York Mayor] Michael Bloomberg — somebody who understands how markets work — and Ronald Reagan, someone who can communicate and inspire confidence.”

That’s a good combination to look for in 2012 presidential wannabes. If Smick is right, our future depends on it.