AND IT'S NOT JUST THE "SURPRISING" ECONOMIC COMEBACK...:

An Economy You Can Bank On (CASEY B. MULLIGAN, 10/10/08, NY Times)

The non-financial sectors of our economy will not suffer much from even a prolonged banking crisis, because the general economic importance of banks has been highly exaggerated.

Although banks perform an essential economic function — bringing together investors and savers — they are not the only institutions that can do this. Pension funds, university endowments, venture capitalists and corporations all bring money to new investment projects without banks playing any essential role. The average corporation gets about a quarter of its investment funds from the profits it has after paying dividends — and could double or even triple that amount by cutting its dividend, if necessary.

What’s more, it’s not as if banking services are about to vanish. When a bank or a group of banks go under, the economywide demand for their services creates a strong profit motive for new banks to enter the marketplace and for existing banks to expand their operations. (Bank of America and J. P. Morgan Chase are already doing this.)

It’s important to keep in mind, too, that the financial sector has had a long history of fluctuating without any correlated fluctuations in the rest of the economy. The stock market crashed in 1987 — in 1929 proportions — but there was no decade-long Depression that followed. Economic research has repeatedly demonstrated that financial-sector gyrations like these are hardly connected to non-financial sector performance. Studies have shown that economic growth cannot be forecast by the expected rates of return on government bonds, stocks or savings deposits.

It turns out that John McCain, who was widely mocked for saying that “the fundamentals of our economy are strong,” was actually right. We’re in a financial crisis, not an economic crisis. We’re not entering a second Great Depression.

How do we know? Well, the economy outside the financial sector is healthier than it seems.

One important indicator is the profitability of non-financial capital, what economists call the marginal product of capital. It’s a measure of how much profit that each dollar of capital invested in the economy is producing during, say, a year. Some investments earn more than others, of course, but the marginal product of capital is a composite of all of them — a macroeconomic version of the price-to-earnings ratio followed in the financial markets.

When the profit per dollar of capital invested in the economy is higher than average, future rates of economic growth also tend to be above average. The same cannot be said about rates of return on the S.& P. 500, or any another measurement that commands attention on Wall Street.

...that will make the next president look good but the peace dividend as well--whoever wins can cut Defense spending by at least a half as a percentage of GDP. It's that Bill Clinton sweet spot from '93.

Posted by Orrin Judd at October 13, 2008 8:03 AM