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.


Wow - it's been over a week since I last posted. And this one will have to be concerned with a few media updates.

First, the crisis is spreading despite the eventual passage of the bailout bill. Would it have helped if the Treasury could have got the ball rolling last Monday instead of last Friday? Since most of the global markets tanked this weekend, it probably would have... but we'll never really know.

More disconcerting is that it's starting to move into the "real economy" - losses aren't cropping up just on paper anymore - they're affecting auto sales. It makes sense that this is next - cars are the next biggest consumer product purchased on credit after houses (which are already doing crappy as everyone already knows). This move into the "real economy" is bad. People have been talking about how this crisis is nothing like the Great Depression because "the fundamentals" - unemployment, GDP growth, etc. - are still strong. Here's the problem with that logic: people have this idea that the bottom fell out in the recession all at once in 1929. It didn't! The stock market crashed in 1929, but GDP growth didn't reach it's low point and unemployment didn't reach it's high point until several years later, in the early 1930s. The fact that the crisis so far has been restricted to the housing market and the money market is no proof that "the rest of us are safe". This drop in auto sales is likely an opening salvo in a war on the "real economy" - and we're probably going to start to see other bad numbers trickle in.

The biggest recent news is that the crisis is spreading to Europe and Asia. This is also bad news in terms of the possibility of a broader recession. The only thing buoying us in the last year or so has been - ironically - our exports. If aggregate demand contracts in Europe and Asia, you can bet that component of GDP is going to drop and suddenly we're going to be looking at negative GDP growth - recession territory. Paul Krugman has a good, albeit brief post on the global nature of the crisis this morning. He specifically compares out situation to that of Brazil, Thailand, Indonesia, Russia, and South Korea - who crashed in 1997-1998, in part because of their high exposure international financial flows. These have increased in the U.S. dramatically since 1995 or so. Which begs the question - what is the end game here? I see two things that could potentially happen - first, we could close up and insulate ourselves from the world economy. It could also be a Bretton Woods moment - since we know that all this international connectivity exposes us to substantially more financial risk than in the past, it may be appropriate not just to reregulate our own financiers - but to establish a new international regulation of financial markets on the ruins of Bretton Woods. Not that we've been hearing any clamoring for this... and besides - who could possibly stand in for Keynes?

In election news... well, Obama is giving McCain a whooping for the most part. A few concerns - Palin is performing better than she has been (could she really be performing worse???), and McCain is on a smear hyper-campaign right now. I think it will make him look childish - but you never know. But overall I think it looks good. Michigan is a lock - Ohio, Pennsylvania, and Virginia are leaning Obama. Florida still sounds tough, but if Obama really gets all those swing states perhaps we could do without. I hear McCain and Obama are now heating up the war over Nebraska!... NEBRASKA! McCain is on the defensive in traditional red states. Not only does this not bode well for him in the red states, it means it's that much less resources he's going to spend in the blue states and the swing states - which is going to make keeping Michigan, Ohio, Pennsylvania, Virginia, etc. that much easier for Obama. Good news all around.

And... as I've been updating for months... Gilmore is a lost cause. Go Warner!!!