Paul Krugman during the past week referenced to a book that wrote in the late 90s on financial crises and which he now apparently is republishing with some added data and another chapter. Considering I'll be taking an economics exam in Berlin relatively soon I figured I should read that book in order to try to find out more about this current crisis and its implications for a Bretton Woods II (whatever that may mean in the end and not matter whether that might be a good analogy or not, it drives across a point).
what does this year's Nobel price winner have to say then? Basically, this obviously being a very much condensed version, a stylistic recounting of a stylistic argument if you want, Krugman shows that financial market crises need not be logical or rational. There is an inherent logic to market behaviour that leads to self-fulfilling speculative attacks (if everyone knows everyone else will sell dollars/euros/whatever else, it is rational for you to join the fray as you will lose money otherwise, even if the good/share/currency concerned might actually have a sound economical value). For him this was especially noticeable in the case of the Asian crisis (crises?) in the 90s, when fundamentally sound markets (like South Korea) were abandoned because of a double standard of markets, an irrational (racist? one could totally do a reading from this point of view, not getting into that here though) benefit of doubt for first world countries (leaving Australia with far less problems than say Malaysia). Obviously, this latter argument would have to be updated some in his new version of this book, simply because we now had (have) a first world financial crisis.
Interesting is the fact that Western governments (mainly the US) forced anti-Keynesian policies on Asian as well as South American countries leading to possibly worse results in regard to their currencies (because their one-time devaluation was not deemed sufficient) at the same time that the following recession was deepened (do recession's deepen?) through the implementation of high interest rates and 'fiscal responsibility'. Why is that interesting? Well, considering the US and Britain the stalwarts of the Western liberal system just (semi-)nationalized their banking sector and are now discussing programs intended to assuage economic problems, there seems to have been a certain amount of hypocrisy in this policy.
Summing up then, Krugman basically claims that a feedback loop, a gigantic financial market failure if you want, can lead to financial crises even if economic data is sound, which leaves us with what? Looking to the government for help? Obviously a solution to this (current) crisis requires some kind of government involvement, but how far and in what way seems very much to be open to debate. After all, it is not like governments have been known to run profitable effective operations in the past.
Super interesting book, read it. I am not sure I can claim I really understand everything and I most definitely have a hard time recounting all the arguments concerning the feedback loop or the liquidity trap that Japan was facing, but I find it shocking how many policies Krugman criticizes are being employed again today, notably by the ECB and its Bundesbank-philosophy of regarding low inflation as the most important aspect of monetary policy. As always, one's lack of knowledge, of a deeper understanding in virtually every subject is quite stunning (and depressing at times), but I guess one just has to continue chugging along (keep on reading that is).