Saturday, April 24, 2010

Too Late for Krugman to Yell "FIRE"?

All across America people are beginning to wake up and realize their country is in serious trouble and heading for even worse. You can hear it every time a notable yells "FIRE."

FIRE is an acronym for "finance/insurance/real estate" which have grown to become a cancer on the economy of the United States. The latest to let out a howl of protest is NYT columnist and Nobel Prize winning economist, Paul Krugman. From The New York Times:

What’s the matter with finance? Start with the fact that the modern financial industry generates huge profits and paychecks, yet delivers few tangible benefits.
Remember the 1987 movie “Wall Street,” in which Gordon Gekko declared: Greed is good? By today’s standards, Gekko was a piker. In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits — about twice its share two decades earlier.

These profits were justified, we were told, because the industry was doing great things for the economy. It was channeling capital to productive uses; it was spreading risk; it was enhancing financial stability. None of those were true. Capital was channeled not to job-creating innovators, but into an unsustainable housing bubble; risk was concentrated, not spread; and when the housing bubble burst, the supposedly stable financial system imploded, with the worst global slump since the Great Depression as collateral damage.

Krugman argues that the financial sector has grown far too large as a segment of America's economy - and it must be shrunk:

...the fact is that we’ve been devoting far too large a share of our wealth, far too much of the nation’s talent, to the business of devising and peddling complex financial schemes — schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?

What Krugman doesn't address is how his country is to fill the vacuum left over by shrinking America's FIRE economy. What do you put in its place and where do you get it? And that, kids, is Wall Street's ace in the hole. The enormous damage they've done is much, much harder to repair than it was for them to cause and they know it.

An article I came across a month or two back in The New Yorker addressed attempts to redevelop America's pre-globalization manufacturing sector. Powerful people were beginning to realize the deep and open wound left in America by the transfer of its manufacturing base to cheap labour countries abroad. Now they wanted to sew that back up, heal their country's economy, restore its manufacturing sector. But it wasn't working. They couldn't make it happen. That little genie was out of the bottle and, arm in arm with Elvis, had long since left the building.

One problem those hoping to re-industrialize America kept running into was the choking grip of the financial sector. Nobody wanted to invest large amounts of capital in factories that promised just a reasonable, albeit modest, return when the financial sector was offering huge returns. And, as Krugman correctly points out, once in the hands of Wall Street, all that capital was then funneled instead into inherently self-destructive economic bubbles.

America also can't restore its industrial economy because it can't compete - on wages, on environmental regulation, on almost anything. The globalized, free market economy means Americans cannot manufacture. The United States cannot manufacture. It cannot compete in its own markets - on the shelves of WalMart - with "cheap" imports. That's what happens when you enter a vast free-trade regime. We're told it's about the free movement of capital but that's a smokescreen. What it's really about, the sine qua non, is the surrender of national sovereignty over access to your markets. That's like giving your teenager the keys to the family car and a twelve-pack.

Republican insider and author Keven Phillips addressed this conundrum in his 2005 book, "American Theocracy." Phillips examined the path of American supremacy and the evolution of its economy from agrarian to industrial to financial and he did that in the context of the rise and fall of the previous Spanish, Dutch and British empires. Each of them grew more powerful, more dominant, more supreme until it decided that it didn't need to make things anymore, it was so rich it could just devote itself to finance and have the stuff manufactured in cheap factories abroad. And that was the end of them.

Phillips, in a very well developed analysis, reveals that what each of these superpowers, by turns, did - and what America itself has done - was to use its national wealth to grow another nation's economy. Where do you find really cheap labour? In agrarian societies, that's where. You take an agrarian society and cheaply transform it into an industrial society only to discover, well after it's too late to change anything, that you've been ousted by the very rival your wealth went into creating. Brilliant.

It's easy to agree with Krugman when he claims America's FIRE economy needs to be suppressed, regulated, cut down to size but it's a lot harder to answer, "okay, then what?" How do you reverse the damage of the three decades that have passed since Reagan ushered in America's "Age of Ruin"?

Is it too late to yell "FIRE"?

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