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The Return of Depression Economics

From the many economy-related books available I read The Return of Depression Economics by Paul Krugman.  This book was written during the Asian financial crisis of the late 1990’s.  Many say that Krugman wrote this book much too quickly to be fully correct on every issue that he wrote about in this book.  Krugman mainly focuses on financial crises of the 1990’s and mostly on the Asian financial crisis.  This book was very interesting to read even though I did not fully understand every issue he covered.  In this book Krugman laid out the basic fundamentals of global economy and the choices we had to get ourselves out of the Asian financial crisis.  With the Asian financial crisis done and over with, many of Krugman’s thoughts and choices are now out-of-date.  Even though there were an option at the time but now dated, they were interesting and I agreed on many of his points.  Krugman believes that Mexico’s crisis was a three-act play with Mexico as act one, Asia as number two and us finishing off as act three.

During the 1990’s there have been many currency crises around the world.  For example, Britain and Sweden in 1992 to Mexico and Argentina in 1995 to East Asia’s rim in 1997 to Brazil in 1998-1999.  These crises are better known as financial “panics”.  There are many different things that can trigger a financial crisis but I will explain Krugman’s classic example of the “panic”.  International investors in New York, Frankfurt, London, and Tokyo are known as main investors.  These main investors invest their huge amounts of money in countries that they think are doing well.  From this “hunch” they flood their billions of dollars, about $70 billion into Asia, into a country’s economy.  If they feel that they have made a poor financial investment they quickly pull their money out of the market at huge losses.  These main investors cause a stampede of smaller investors to also pull their money out of the economy at sale prices.

This causes a panic and seems to have a snowball effect.  So in effect the country that once was flooded with billions of dollars is left off worse and soon is facing economic troubles.  This panic has a tendency to effect surrounding countries.  In the Asian crisis, it all started with Japan and quickly spread the whole Eastern part of Asia.  Another way to think of the financial panic is to think about it as a sudden fall in demand for a country’s products.  Investors will search for other companies in other countries for the same type of product.  When this happens the companies that were left behind should offer the investors incentives.  They should cut their prices to attract the investors again.  This will help prevent another panic in the country’s product and economy.
The main part of the book talked about the other financial crises of the 1990’s.  I explained the classic “panic” situation that tends to always lead up to a financial crisis.  Krugman uses the analogy, cattle herd, for the large investors that tend to flood the market and leave so quickly.  Now that we know what causes this panic, why can’t we prevent it from happening?  Why do we allow these panics to have such a huge destructive effects on global economies?  Krugman suggests that we use capital controls.

But capital controls tend to make those who have money keep it to them and not spend it for economic growth.  This makes way for the policy of free international flows of capital.  It allows those who need money to borrow it from other countries.  This is a wonderful policy that helps countries recover from economic hardships much faster.  This policy no only benefits the borrower but also the lender and in turn the whole global economy.  But this free flow of financial capital is also giving us one major international financial crisis every two years.  Though impossible to prevent financial crises from happening again, Economists are studying on how to recover from a crisis much faster.  And so far the free flows of financial capital is the best way to go.

In the early 1990’s Japan’s economy was booming.  Then their products were becoming superior and technology was on the rise.  But as the years went by in the 1990’s, Japan felt that their economy was getting slower and slower.  By 1995, Japan felt the full effect of the collapse of the financial bubble of the 1980’s. This depressed consumption and investment spending.  Japan knew that they were going to be in trouble; they felt a huge inflation coming on.  At the point, Japan’s economy had little economic growth and was in stagnation.  Once the investment panic hit, it was all over.  There was nothing that Japan’s advisors could do.  They tried lowering interest rates, at one point the interest rate was at zero, and still no success.  The whole country was under the impression that their economy was hopeless.

With the short-term interest rates around zero, Krugman suggested that it was time for the engineering of inflation to extract Japan from what economists call the “liquidity trap.”  Krugman explained Japan’s present period of stagnation very clearly and presented it in a very amusing way.

With the Asian crisis over with, many countries have quickly recovered from the whole mess but many others are not as fortunate.  Japan will still have many rough years ahead before they get that bitter taste out of their mouth.  The “MIT” economies (Malaysia, Indonesia, Thailand) all had similar outcomes from the crisis and that may be due to the fact that all three countries are exporting similar products.  But Indonesia is taking a bigger hit than the other two because of political turmoil.  Financial analysts are to be blamed for the Asian crisis.  Once again they tend to look at the long-run effects of economy instead of the short-run.  The Asian crisis is a prime example of this point.  Instead of looking what happened years ago, what’s been done is done, we should focus on the short-run and into the future.  To ensure our own economic stability, we should put our efforts and knowledge into the effects that economic policies will have on the short-run side.  But can it happen again?  Sure it can happen again.  Krugman asks the question, why now?  Why are the ghosts of the 1930’s visiting us again?  Krugman believes that,
“…some nations are paying for their failure to obey the necessary dictates of free markets.  Asian economies, in particular, are being punished for the sins of crony
Though true, this is not the exact reason why the Asian crisis happened.  They got hit so hard because Asian economies have weaknesses in their policies and institution.

After completing this book, the whole Asian panic has taught me that small events can cause huge disasters.  We should employ our “beta” economic policies on smaller scale economies.  Governments should educate their citizens to prevent a panic.  Large investors should advise the countries that they are investing in to prevent any harm if they make bad financial decisions.  Reading this book was fairly difficult but it gave me insight to the complexity of global economics.

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