Roots of the Crisis Revealed: Krugman Jumps on the Wagon

NEW YORK, New York -- It looks like it's that time of the month again. No, not that time. It's time for the monthly article that seriously looks at the roots of the global economic collapse.

Any serious individual (i.e., anyone not in Congress) can tell you that "greed," which may be one of the Seven Deadly Sins, a state described by psychologist Erik Erikson, or an omnipresent emotion basic enough to be in Aesop's repertoire, cannot actually be blamed for the economic mess. Nor was it $35,000 toilets, corporate jets or suburban sprawl.

The real root of the crisis is America's willingness to become utterly dependent on imports. In recent years, as China became America's dominant trade succubus, the Chinese government's Central Bank, which takes $0.50 on every dollar entering China, built up huge reserves. Because sitting on foreign currency reserves mean they'll lose their value to inflation, it invested them back in the US. But because US companies were so busy shutting production in America and moving it to China, there were no factories for China to directly invest money in (this is called Foreign Direct Investment).

So it bought securities and derivatives based on US consumer and mortgage debt. That had the effect of keeping the dollar strong, which meant the US could keep interest rates lower than usual without fearing depreciation of the dollar that low interest rates normally cause. Low interest rates = cheap credit = debt-based bubbles. China was happy because all that US consumer debt meant its products had a market, its factories could keep humming, and employed workers weren't about to rise up in protest of their rights. The US was happy because we got cheap credit and cheap Chinese goods.

The Walter Duranty Report and NYT talked about this 2 months ago. The Economist picked up the torch a month ago. Paul Krugman talks about it today.

So what's the solution? The thick of it is that the US needs to export more and import less so that we can tackle the source of the savings glut at its head, which is the Chinese goods-addicted US consumer. Given the relative strength of the dollar right now, it'll be tough to increase exports to any place but a China with a free-floating yuan.

What we can do, then, given the difficulty of increasing exports, is make a concerted choice to support not only the US economy but the stability of the global economy by producing more in the US and buying US goods. If that sounds a bit too jingoist, compare it to the sacrifices we made in past generations by keeping "victory gardens" and buying US war bonds, e.g. Only by buying fewer Chinese goods can we get out of this -- and that will require a concerted effort as long as China offers exporters WTO-violating tax rebates, subsidizes factories, and keeps the yuan devalued.

More leverage and borrowing won't get us out of this. Only a re-industrialization of America will help re-balance the severely out-of-whack world trade equilibrium that has led to the savings glut, the debting of America, and the collapse of the whole system.