Tuesday, October 7, 2008

Krugman, the crisis, and the late 1990s

During the late 1990s - the halcyon days of the Clinton administration and the tech boom - were disastrous for many middling economies: Mexico, South Korea, Japan, Russia, Brazil, Indonesia, Thailand, etc. Throughout this second tier of global economic powers, currencies failed, governments defaulted on their debts, and bank runs on the order of our Great Depression occured. A lot of people missed it because of how well the U.S. was doing - but it was a milestone event in international finance that directly threatened the prospects of economic globalization.

Part of the reason for this was the irresponsibility of central banks in these countries. That's why it wasn't just businesses that failed - currencies and national treasuries failed.

Krugman points out that right now the Federal Reserve board is doing one of the irresponsible things that these second tier economies were criticized for back in the late 1990s - putting a lot of corporate securities on their balance sheet. This is happening at a time when the U.S. government is already leveraged to the hilt - trillions of dollars in debt to international investors. This is a very very dangerous situation to be in. This is how a violent rebalancing of international financial imbalances happens.

I agree with Krugman - we needed to do something and the bailout bill as it stands is better than nothing. But we can't stop their and we cannot throw responsibility out the window at the Federal Reserve to stabilize things in the short-run.

The scariest thing is we're in uncharted territory. When has a superpower's currency crashed and defaulted on it's debt? I don't know of an occassion personally (although I don't know much about macroeconomic history). I know of superpowers being surpassed, but not crashing (USSR doesn't count... I consider them a faux-superpower because their power was based on nuclear weapons and perception - not solid strength). So is this all likely? I have no freaking clue... but I really don't like our central bankers taking a page out of the 1996 playbook of central bankers in Russia, South Korea, or Indonesia.

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