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« Previous Entry | Main | Next Entry » Does the current financial meltdown prove that our economy is based more on just smoke and mirrors and not on true productivity? Name:
Mike
Question/Comment: Paul: Does the current financial meltdown prove that our economy is based more on just smoke and mirrors (risky investments) and not on true productivity (ie. goods and services)? And what will be necessary for our economy to truly grow so my children have a chance at a decent standard of living. Thank you Paul Solman: Risky investments aren't smoke and mirrors. The Ford Motor Company was once a risky investment. (Come to think of it, it is again these days.) How about eBay or Google? I think you mean something like "pure speculation": credit default swaps, for instance. But even these aren't necessarily smoke or mirrors. They're ways of transferring risk, and that can be productive. (See our Enron farmer piece) The problem is that the financial sector of the economy seemed to become the most profitable, thus attracting the brightest college grads, the most capital. It got bigger and bigger, more and more competitive. Its ways of "transferring risk" became ever more complex and thus more difficult to understand. But the same thing could conceivably have happened in a sector of the economy that MADE things. Suppose the same portion of the U.S .economy devoted to finance had instead invested its capital, its best and brightest minds, in Time Travel Machines -- because of supposedly new discoveries in string theory or something. (Bear with me here; I'm just trying to make a point.) And then someone discovered, after gobs of jobs and zillions of dollars, that time travel isn't actually possible. We might well have the same kind of economic crisis we've got now. With hunks of junk (machines) instead of junk securities. Fancy finance may be more vulnerable to excess than mundane manufacturing (though the auto industry might suggest otherwise), but I'd focus more on the excess than the industry. As to our children (and grandchildren), they'll probably have somewhat more than we do. Maybe they'll even build time machines. But even if they don't, compared to the past, they'll probably have a pretty good deal. -- Posted September 19, 2008 | Comments (4) | Permalink
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Paul~
I appreciated your breakdown on Newshour w/JL.
I take issue with your time machine analogy. While time machine investment has a goal--even a noble goal, at that--the inscrutable financial system you describe seems devoid of any nobility and instead is infused with greed.
How many times do we have to hear that "new financial instruments and complex transactions are too complicated for the average investor to understand," before we regulate them into something we can understand?
Only two people on a British war ship knew how to navigate -- that kept the crew from ever thinking of mutiny.
I partially disagree with your analysis.
The financial instruments in question, present no value, except credibility. Many don't even even value as recyclable paper. They are virtual.
The time machine scenario presents an example of the underlying fundamentals of an economy that is capable of recovery. There would be losses, certainly. But the factories can be retooled for a "better" product. The machines can be used for other purposes, at least for scrap.
But in the end, there cannot be any comparison between those two scenarios. The commercial and investment banking system is part of the infrastructure that makes any sector of the country run. The time machine sector is, albeit large, only a segment of the manufacturing base that may affect regions of the country, but will never halt the economy in its tracks for years.
A big portion of the economy was productive. The 'smoke and mirrors' portion grew over the last generation. Financial guarantees were issued without funding capital. The entire financial system became a stack of cards and should have been allowed to collapse. Our economy would possibly have been setback 50 years or so, but we would have recovered. I would have preferred to weather the storm all at once then suffer indefinitely before perhaps ending up a the bottom anyway. The current bailout money should have been saved for ordinary citizens that invested their life savings rather than failed financial institutions.