The Return of Depression Economics and The Crisis of 2008

A bank, Krugman alerts his readers in the later phases of The Return of Depression Economics, is not just a building with the letters FDIC on the outside. Krugman goes on to patiently explain the component parts of banking institutions so that his non-economically inclined readers can understand the principles of lending and currency control (even if they do a feel bit patronized). Still, it’s light-hearted remarks like this that make this book something that everyone can read, assuming that 191 pages of economic disaster stories do not induce any kind of severe panic reaction.

Krugman happens to be quite adept at describing economic panic, or perhaps more importantly, the government’s refusal to panic that often leads to the demise of an economy. The underlying theme of the book is that economists and policy makers had the hubris to believe they had finally conquered the capitalist beast.

The first chapter of the book is called, “The Central Problem Has Been Solved” and Krugman explains that “by the late 1990s it seemed safe to say that the business cycle, if it had been eliminated, had at least been decisively tamed.” It was that belief that led Alan Greenspan to make the mistakes that he did, and it was that belief that blinded the United States to the lessons that might be learned from crises in other countries.

In fact, the ’90s were a period of tremendous difficulty for many countries world-wide. Krugman tells the stories of each of these countries in order illustrate how the current economic climate came to be.

Primarily, Krugman cites the economic crisis in Mexico and Latin America as situations that should have served as a warning to the United States. Ultimately, the US was able to bail out Mexico, leading to the incorrect assumption that an influx of money was an easy and reliable way to rescue an economy. He argues that although these countries indicated the return of depression era economics, we were unwilling to believe that there would ever be another depression.

Thus, obvious warning signs failed to gel in the minds of our leaders. He goes on to describe the financial crisis in Japan and the big crash in Asia, systematically illustrating what we could have learned, but did not.

After he has fully described the relevant global economies, he elucidates the policies, practices and institutions that inadvertently allowed them to crumble. His book operates on many levels, and thus can be appreciated by anyone with an curiosity about how money works on the big scale, or how the stage was set for the current recession. In particular, the chapter on hedge funds, aptly titled “Masters of the Universe”, is revelatory.

Of course, if you already know what short selling is, you might feel that some of the information is repetitive, but Krugman still shows a side of these funds that it not widely discussed. In fact, the way these funds work legally doesn’t seem that far off from the schemes of Bernie Madoff. They are designed to function with numerous opportunities for loopholes.

And Krugman’s main argument seems to be that everyone thought breaking the rules was acceptable because the capitalist system was basically infallible. Throughout the book, he illustrates the many factors that contributed to this belief, and simultaneously proves what we have learned in the past year: Economists cannot really predict the future than philosophers can.

That said, there seems a benefit to transmitting the knowledge and practices of experts and decision-makers to the lay-people. The book does just that: through simple language and basic analogies, Krugman manages the great feat of explaining how money works in a vacuum, and how it has worked for us in the past 20 years. Not only can he come up with creative explanations such as using a Washington D.C baby-sitting co-op that explains inflation and recession, but he also has a gift for story-telling. He conveys the history of economic with the dramatic tension of a novel.

Perhaps we should be alarmed that there is such a neat and tidy plot arc to our mistakes. One can only hope that as entertaining as his writing is, his observations will lead to greater action. However, is past is prologue, they probably won’t.