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.

Rhode Island: The Michigan of New England

BOULDER, Colorado -- While Michigan is often cited (including in this blog) as being on the leading edge of America's economic downturn, many people would be surprised to learn that Rhode Island also has one of the country's highest unemployment rates, which hit a whopping 9.3% in November. This ranked second behind Michigan's figure of 9.6%, and the two states have seesawed back and forth for the top spot over the last few months.

There are many reasons for this terrible situation - the collapse of manufacturing, poor job retraining, and low levels of education. Rhode Island ranks well behind every other New England state except Maine in terms of the percentage of the workforce with a college education - Massachusetts and Connecticut rank first and sixth, respectively, nationwide, while Rhode Island sits in 19th place. The Washington Post recently posted this video about the state's economic plight, and the New York Times ran this piece on the subject back in October.



Rhode Island is a very provincial place, and residents are struggling to cope with economic transition. Mason Briggs is reluctant to take a job in Oxford, Massachusetts, a town a mere 40 miles away from Pawtucket. His wife catalogs all the towns she has worked in, but they are all only a few miles apart. I am not blaming these people for their hardships, but there are reasons why the state's economic malaise has been confined within its short borders. I am not callously suggesting that they pick up stakes and move, but some measure of economic relief is just a short communte down I-95.

I have always believed that reviving America's manufacturing base will be a critical component of restoring the country's economic competitiveness and fixing the imbalances and inequalities that currently exist. But it is important not to get too nostalgic about the post-war golden age of the American industrial worker that so many pine for. As Itchy mentions about battery manufacturing, many of these jobs and industries are dirty and unpleasant, and few of us would like a factory like this in our backyard. Manufacturing may have given every American family an icebox and a wireless, but it also gave us the Love Canal.

These industries also had an impact on education. In places like Michigan, and to a lesser extent Rhode Island, the existence of high-paying, low-skill manufacturing jobs actually created huge disincentives for people to pursue an education, when they felt confident that as soon as they graduated high school, they would be able to get lifetime employment at the local plant. As a result, Michigan languishes in 36th place when it comes to educational attainment, when its industries should be a source of innovation and research.

To combat this problem, some communities have adopted innovative plans. Last year the city of Kalamazoo introduced a plan they called "The Kalamazoo Promise," which established a scholarship fund that would pay full tuition to any Michigan state college for any student that graduated from the school district. The program has not only increased school enrollment, but it has boosted property values, and cities across the country are hoping to imitate it.

Of course, there is one growth industry in Rhode Island: incarceration. The immigration detention center in Central Falls has been doing booming business, especially since Rhode Island became the only state to mandate that all state and local law enforcement agencies enforce federal immigration law. This is a story that has been repeated across the country from Flint, Michigan to Susanville, California, when laid-off workers move from the assembly line to the corrections academy. Let's all hope that the next generation of workers is made up of more engineers than prison guards.

Mind the High-Tech Gap

NEW YORK, New York -- Imagine having your iPhone on your wrist. LG unveiled just that -- a watch that functions as a smart phone -- at last week's Consumer Electronics Show in Las Vegas.

For their parts, Sony, Samsung and Panasonic introduced 3-D television sets and Hitachi rolled out a prototype for motion-controlled TVs (like cathode-ray Wiis) at the show. Meanwhile, this week's North American Auto Show in Detroit will see a Chinese battery maker called BYD roll out its electric car (not a typo).


Watch me some 3-D Becks

As the US demands Barack Obama's somewhat-hazily defined "change" and appears set to embark on a massive hunt for ever-larger deficits without knowing what to spend money on, the wonders of these industry conventions could be educational. For all of these products are made by East Asian companies: Sony, Hitachi and Panasonic hail from Japan; Samsung and LG from Korea; and BYD from China.

America, meanwhile, is losing its edge in research and development spending in the private sector, as The Economist recently reported.

There are many caveats to add: the big electronics companies have been Japanese and Korean for years (when did you last buy a TV made by a US firm?); plenty of US companies grabbed headlines at the CES (like Palm, with its Pre smart phone); and the quality of BYD's product is highly, highly suspect (although Warren Buffett has bought a solid stake in the company).

But the trends are alarming. Samsung now has the second-largest number of new US patents, The Economist notes. Its R&D spending outstrips American heavyweight IBM. And while US firms' spending on R&D in computers fell by 33% between 1996 and 2005, Japanese firms' doubled -- to the number that their US competitors used to spend ($13 billion).

Much of the money US firms once spent on innovative technologies now goes to services. So a computer company may invest in servicing office equipment instead of creating better products. This makes business sense to shareholders, since services are more profitable than hardware in a large range of industries.

But when it comes to the long-term viability of a company, cutting investment in what you actually sell to the people you then service could be a disaster. Why would anyone want to buy a Acer computer, for instance, if it was seen to be cutting costs and producing lesser products with a perceptible lag time behind its competitors? And if your business doesn't operate Acers, why would you ever need Acer to service your HP laptops?


Is it really worth it to kill off the nerd jobs for quick profits, Ogre? (Note: This is NOT Carly Fiorina)

Clearly, the US, like any advanced economy, will be in a pinch if it can't come up with new sources of growth and revenues. Current-account deficits have reached staggering levels, and they may ultimately threaten the country's credit ratings, which in turn would impact America's interest rates, appeal for investors as a destination of capital, and ability of citizens to borrow money from banks at reasonable rates.

While Obama's stimulus has become an attention hog as a panacea to the short-term recessionary problems, long term, as Robert Samuelson of the Washington Post has argued, what's needed is export-led growth. That, naturally, is easier done when the leading high-tech companies aren't cutting back on R&D in order to amp up their "services" offerings.

But one of the underlying problems is that too few Americans have opted to become engineers -- the people who dream up, design and build things -- choosing instead to work as bankers and traders in recent years. There are two ways to fix this problem by creating a larger body of engineers likely to invent things, start companies and create an abundant supply of talent to encourage companies to invest more in R&D. The first is to stop sending home all of the foreign students who study engineering in the US. They should all be given a three-year work permit upon graduating and a green card afterward, since they're scientists, not terrorists.


Beware that offer from Morgan Stanley (circa 2005)

The second is for the government to actually fund and prioritize mathematics and science. The Bush administration, which cut and distorted all sorts of science programs, didn't do much of this. The Obama administration has promised to increase funding for scientific research, and I hope it follows through. Additionally, given the shortage of quality math and science teachers (compared with English or history teachers), higher salaries should be offered in public schools to teachers of these subjects.

But with improved science education, what can be produced competitively? Wind turbines and solar panels are often seen as "non-outsourceable" jobs. The enormous space required to store any number of turbines or solar panels large enough to generate serious amounts of electricity helps to explain why this is so.

The automobile industry has long been considered the heart of US manufacturing, and hopefully Detroit's fortunes will turn upward. But even if that does happen in a dramatic way, plenty of old Michigan and Indiana factories will remain unused. Given the utterly undeveloped state of mass transit in the US -- something almost without parallel among other large economies -- a move to embrace trains, subways, light rails and ferries could create large amounts of orders that might be met in retooled auto factories (though increased light rail usage would likely dampen car sales).

And finally, recent weeks have seen a huge uptick in talk about manufacturing lithium-ion batteries for electric cars. Now, I am immediately skeptical when somebody says, "Let's build the economy of the future around making batteries." It makes me think of middle schools (like the Legionnaire's) built on old battery factories, and health hazards. It's the industrial counterpart to Indian grave sites, almost.


Probably not...........................Closer......................................Chrysler?

Nonetheless, as the Detroit Auto Show indicates, car companies are betting heavily on electric cars, though it's unclear if this will just lead to colossal failures down the line. Already, as noted above, Chinese battery maker BYD is moving up a notch into electric cars with the intention of entering the US market -- though its technology looks suspiciously similar to one developed by MIT-based startup A123 (BYD claims it came up with the technology in 1998; though it seems a dubious claim at best that a then-tiny Chinese battery company was looking into making complex electric-car lithium ion batteries at a time when oil was at all-time lows and only a few Jetsons fans and futurists were even thinking about electric cars).

Given the dominance of Asian battery-makers (in China 40+ factories are under construction, and heavyweights Panasonic and others are heavily invested in the industry), US executives are warning that if America continues to lag, a new era of carmaking could trade dependence on Saudi oil for dependence on Chinese batteries. And, as they point out, those battery-makers could potentially provide their own domestic carmakers with the batteries, putting US car companies at a disadvantage. To this end, as the WSJ noted, a consortium of US firms is pooling resources to kick start a domestic battery industry. Since that time, GM has announced plans to open the nation's first lithium-ion battery factory to power its Chevy Volt. Already, the industry seems to be heating up, concentrated around the Detroit show. Given that the US currently spends about $700 billion on gasoline for transportation, batteries could be a huge industry, and as many are beginning to say, controlling battery production could be the key to dominating the auto industry in the future.

Increased spending on R&D and science education are two things Obama can do in the long-term. But regarding the hot battery-making industry, while gaining leadership in this market could well be crucial, let's also make sure we aren't building our homes on any Mohawk cemeteries. You don't need Craig T. Nelson to warn you of the pitfalls of that.