Thursday, June 25, 2009

Is Immunizing the U.S. Economy Against the Dutch Disease So Bad?

I have written that "Plain Vanilla Banks Must Wax and Wall Street Must Wane." The Wall Street Journal's David Weidner seems to think that is a bad idea, especially to the extent it is a policy goal of the Obama administration. In today's "The Perils of a Smaller Wall Street: Reforms Seek Smaller Pockets of Risk, but Globally, Big Firms Still Dominate," he notes there are now only two U.S. banks in the world's top ten (JPMorgan and Citi) and they are near the bottom.

How bad is it that we are no longer the Masters of the Universe? It is not that long ago that Japan had eight of the ten spots on that list. The result? The next ten years were a lost decade for the Japanese economy. Is this just another example of post hoc, ergo propter hoc (the logical fallacy of "after this, therefore because of this)? Japan had a bubble because of a huge overexpansion in credit, foreign financed after financial deregulation. Inflated capital led to overexpansion of banks and a monster bubble. Bubbles burst. Bubbles distort incentives and misallocate resources. Like inflation, bubbles are bad and are caused by bad policy.

The United States has suffered from a virulent form of the Dutch disease these last twenty years. As Wall Street has sucked in capital from all over the world, manufacturing has been hollowed out. As value added in the financial sector grew, our competitiveness waned.

The White House White Paper is largely ratifying reality. (See below and today's Eagle: "New financial rules explained.") The more prudent banks (JPMorgan, Intrust) will prosper. The others have been shrunk in true capitalist fashion. If the financial sector shrinks, so be it.

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