THE RETURN OF DEPRESSION ECONOMICS

Paul Krugman

Subtitle: and the crisis of 2008: W. W. Norton Co, NY., 2009, 191 pgs., revision of the 1999 edition

This is a well written, clear exposition of the subject matter. Chapters are devoted to specific issues, mostly the several financial crises since the 1980's. The author narrates the surface events well. But he does not discuss the significance of the underlying financial regime of the 20th century - expanding money supply created by increasing exchange of credit for assets which increases the federal debt. This is in keeping with his belief in Keynesian economics, of which he is a principle supporter. His recommendation in the final chapter is to follow Lord Keynes in a 'return of depression economics.
In his introduction he comments that some economists and policy makers believe that the fiscal and monetary mistakes made in 1930-31 are now understood a repeat of the depression won't happen again. He points out that events since the 1990's have shown this to be false. He mentions the 'Asian crisis' the Japanese 'economic trap' as examples authorities should have taken as warning. He states that the book is an 'analytic tract': that it is more about why it happened than about what happened since 1990. But it seems to me to be just the opposite, more about what and not much about the real whys. His ultimate objective, he states, is to develop the theory of the case and figure out how to think about it.

Chapter 1 - 'The Central problem has been solved' -
The quotation is from an address by Robert Lucas in 2003 in which the professor claimed the issues related to the Great Depression have been 'solved'. That is, that depression - prevention was solved. Then Ben Bernanke said much the same thing in 2004. But, Krugman claims, the warning signs were already evident in the 1990's. He then begins to describe the political-economic background with Deng Xiaoping setting China on a new road to 'capitalism'. This was followed by the collapse of the Soviet Union. He focuses on a phenomena that many have noted - the joining of several billion new workers, consumers, producers into the world economy and some form of capitalism.
He writes, "For the first time since 1917, then, we live in a world in which property rights and free markets are viewed as fundamental principles, not grudging expedients; where the unpleasant aspects of a market system - inequality, unemployment, injustice - are accepted as facts of life." Please note the backhanded appraisal of capitalism - plus he exaggerates since there are very many influential opinion leaders who do not accept the fundamental principles of capitalism. He still hopes for a 'plausible alternative'. He then discusses the Great Depression as a phenomena that 'came close to destroying both capitalism and democracy'.

Next he introduces as an example of an economic system a Washington DC baby-sitting organization. He describes its method for issuing credit coupons. He writes that the system failed and judges the cause in a Keynesian manner. But the reader can see that the cause was much different. Anyway, he uses this example to move on to the roll of the FED and central banks in supplying cash. The narrative proceeds through the 1970's and 80's with Alan Greenspan in charge of the FED. And the discussion turns to 'globalization'. This leads to the crisis in Latin America.

Chapter 2 "Warning Ignored: Latin America's Crises" -
This is an excellent chapter focused on the financial - monetary crises in Mexico and Argentina. Debt is mentioned throughout, but without a description of its roll. He correctly comments. "Perhaps most of all, we failed to understand the extent to which both Mexico and Washington simply got lucky".
This is a reference to the way in which the US Treasury secretary (with dubious legality) managed to us the Financial Stabilization Fund (from the 1930's) to provide support to Mexico. He writes that we learned the wrong lessons - true enough - but his 'lessons' are themselves questionable.

Chapter 3 - "Japan's Trap"
Krugman describes the events very well. But he draws the same conclusions so many other economists and commentators draw: that Japan experienced a bursting financial bubble. And this led to a decade long depression. Here he reverts to his baby-sitting group for an explanation. The problem of course is lack of demand and the solution would be increased money supply 'printed' by the monetary authority. He, as so many others, claim there was lack of investment due to lack of consumption due to undermining consumer confidence. His entire description of the causes of the baby-sitting system and his 'solution' is incorrect in many ways, among them to introduce a way to cause 'inflation' of coupons to reduce their value over time. Classic Keynesian theory - destroy the role of money as a store of value.

But throughout and still the Japanese are consuming as much as they want - and are saving large sums against their future needs as they grow very old without a younger generation to pay their bills. There is no shortage of consumption and the saving is necessary for the future. Of course Keynes was all for forgetting about the future and forcing the public to live only for the present by discouraging savings via zero interest rates. Krugman and others always claim Japan is in a 'slump' because it is not 'growing' the way he thinks it should. He notes that the Japanese cut interest rates to zero without solving their 'problem'. He writes, "The classic answer, the one that had been associated with the name of John Maynard Keynes, is that if the private sector won't spend enough to maintain full employment, the public sector must take up the slack.' Exactly, and exactly wrong. For one thing the Japanese are already using great numbers of robot machinery because they need more workers - not due to unemployment. Krugman, notes the Japanese did follow the Keynesian prescription, but. "The trouble was that the programs didn't get enough bang for the yen'. Exactly what his complaint now is about the failures of the Obama 'stimulus' to solve our problems. He describes the results during the 1990's including description of 'liquidity traps'. Sure enough, he solution is 'inflation'. He writes, "Once you take the possibility of a liquidity trap seriously - and the case of Japan makes it clear that we should - it's impossible to escape the conclusion that expected inflation can be a good thing, because it helps you get out of the trap." Bernanke anyone? Further, 'the same conclusion also pops out from application of any of the standard mathematical models that economists conventionally use to discuss monetary policy." Exactly again, when will the fallacy of using mathematical models thinking they have anything to do with the future become evident?
The fundamental flaw in all this is the belief that deflation is bad and inflation good.

Chapter 4 Asia's Crash -
Again, a clear narrative description of the events with the devaluation of the Thailand's currency triggering a financial avalanche. Again, he does not fault the expansion of debt as a component of the total money supply that enabled creation of a bubble and the subsequent impact of debt reduction for its impact on reducing the money supply. Yes, a 'classic currency crisis was in full swing', but why? More and more everyone's assets are someone else's liabilities and people's liabilities are some one else's assets. A shift in the quantity of any small asset or liability will be rapidly compounded due to the huge leverage involved when debt becomes the large component of the money supply. Krugman calls this 'contagion'.

Chapter 5 Policy Perversity -
Krugman begins with a genuflection to his guru, John M. Keynes. at the time of the 1930's depression. He claims the survival of capitalism was on the basic terms that Keynes suggested. But other authors dispute this. He then cites another Keynesian, Paul Samuelson. Krugman terms the resulting economic system the 'Keynesian compact' and claims it is still honored. He then shifts attention to the International Monetary System devised after World War II. He delves into the functioning of the IMF and crises in Brazil and Argentina.

Chapter 6 Masters of the Universe -
This is about hedge funds and speculators. Krugman describes the methods of a master speculator, George Soros. He gives Soros rather more individual credit for the fall of the British pound in 1992 than do other authors, but there apparently is no question Soros had a big hand it is and benefited from it both financially and in public prestige. Krugman continues with discussion of other currency games in Malaysia, Thailand and Hong Kong. Finally comes the collapse of the Long Term Capital management hedge fund in 1998 when Russia defaulted and devalued the ruble. Now Krugman notes the ''brilliant' operators of this fund were Nobel prize winners using mathematical models (no link of course to his previous comment that such use is common as the basis of economic thinking and policy). Recently I read an article in which one of those Nobel guys simply stated their models didn't take significant variables into account. But Krugman's discussion is about the role of the FED in rescuing the world from this disaster.
By coincidence I was in Russia at that time (the very weekend) and made out quite well when over the weekend my dollars bought many more books and other items in Moscow and St. Petersburg.

Chapter 7 - Greenspan's Bubbles -
We are moving closer to the 2008 crisis. In this chapter Krugman deflates the Greenspan personal bubble rather well. Greenspan was lucky at first, owing the initial good times to his predecessor, Paul Volcker, who engineered the huge decline in inflation. The Greenspan era also saw a great increase in information technology that supported economic expansion.

Chapter 8 - Banking in the Shadows -
Krugman gives a very brief overview on the history of banking which is thought to have begun in late middle ages with goldsmiths making loans secured by the gold deposited with them. (But there were banks in ancient Egypt and Rome) The point is to note the possibility of a holder of a valuable such as gold to lend out a multiple of the value counting on the theory that not all of the depositors will want their valuables back at the same time. In other words this is the fundamental concept of holding an asset with a short duration while making a loan at a longer duration. From there he jumps to the Panic of 1907 during which a trust in NYC failed throwing depositors in many other banks into a panic to withdraw their funds. The panic was only stopped when J. P. Morgan arranged with a group of the main bankers to show the public that they would stand behind an unlimited quantity of money.
This is commonly considered the origin of the demand for a central bank that resulted in the formation of the Federal Reserve system in 1913. But there is much, much more to it in terms of what the real agenda was of both the banking industry and the progressive political movement. He then mentions the Glass-Steagall Act from the 1930's. Then Krugman writes, "This new system protected the economy from financial crises for almost seventy years. From this he moves to describe the 'shadow banking system'. He gives a basic description but it is incomplete in terms of what institutions actually now do create money. But he does provide some idea about the complexity of the real financial world. He still does not point out that credit=debt is a huge component of the total money supply. Krugman continues, with discussion of the creation of the 'housing bubble' and its bursting. He does not describe the central role of government in creating the demand for cheap housing to be paid for with dubious mortgages. He blames the expansion of the 'shadow banking' system instead. But we know that the government was demanding that banks lend in dubious locations and mortgage lenders issue mortgages to people who could not afford the houses.

Chapter 9 - The Sum of All Fears -
This chapter gets to the actual financial crisis beginning with July 2007. The surface description of the events as they took place is clear. He believes the FED lost control of the currency. (I believe it lost control of the currency many years ago). He does note the globalization of the real money supply. David Smick in "The World is Curved' has a much more favorable view of globalization but a more negative view of the 'hidden dangers' that are coming, largely through the kind of government intervention that Krugman would desire.

Chapter 10 - The Return of Depression Economics -
Krugman states that he believes the world is not in a depression and won't get into one. But the situation calls for the kind of economic - that means fiscal and monetary - policies that he claims saved the day in the 1930's - of course that means Keynesian nostrums. He defines what 'depression economics' means. Sure enough it is lack of demand. "Essentially it means that for the first time in two generations, failures on the demand side of the economy - insufficient private spending to make use of the available productive capacity - have become the clear and present limitation on prosperity for a large part of the world." Of course 'supply side' economics is 'foolish' - a 'crank doctrine' that appeals to wealthy men. He does note that there are theoretic disputes within the 'economic community'. What one observes from reading the economic literature is that the whole 'discipline' is built on flighty theories. One thinks of the old joke - two economists are discussing a policy - one notes that it is working in practice - the other says, yes, but does it work in theory?
Krugman comes clean, "What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. ... Policy makers around the world need to do two things: get credit flowing again and prop up spending." He means expand credit - that is increase debt 'the obvious solution is to put in more capital". And, "getting the feds temporarily into the business of lending directly to the nonfinancial sector." There is more. Among other things, Krugman wants much more government regulation based on 'relearning the lessons our grandfathers were taught by the Great Depression.' The book was published in 2009, so Krugman can congratulate himself that his fellow Keynesian, Ben Bernanke, has been doing a lot of what Krugman wanted. But to read Krugman's recent newspaper essays it has not been enough. It never is. In this effort he concludes "As readers may have gathered, (we are not blind) I believe not only that we're living in an era of depression economics, but also that John Maynard Keynes - the economist who made sense of the Great Depression - is now more relevant than ever.' This is false on several levels.

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