Anti-Depressant - Review

The Return of Depression Economics, by Paul Krugman (Norton, 176 pp., $23.95)

The world economy has been looking up since this book went to press. Asia shows signs of bouncing back. The U.S. somehow keeps chugging along. So this might not seem the most promising moment to launch a tome called The Return of Depression Economics, even a tome as blessedly concise and breezy as this one. But what the heck? Paul Krugman is not predicting another depression, just the revival of a school of thought dealing with the question of how to prevent another depression.

To oversimplify, the recurrent problem of the past 30 years has been too much money chasing too few goods. Some observers would blame government deficit spending and consumers eager to live it up on credit. Some would also blame tax disincentives and regulatory policies that discourage production. In any case, the overall tendency was toward inflation and stagnation-culminating in the "stagflation" of the late 1970s.

Krugman raises the question of whether the problem today is just the opposite: too much supply and not enough demand. If so, this carries a risk.

Though Krugman does not dwell on the word "deflation," that's what he's talking about. In the 1930s, bank failures, unemployment, and "fear itself" undermined the willingness of consumers and businesses to spend. In our more closely interlinked world, a mild version of "fear itself" seems to have laid hold of the Japanese, who have refused since the 1990s to soak up their share of the world's goods and services. They are aging; they may simply be nervous about the future; whatever the reason, the Japanese reluctance to spend was causing trouble for the smaller Asian economies even before the meltdown of the last two years.

Then in mid 1997 things got much worse. Fast-growing countries like Thailand, Indonesia, and Malaysia were hit by a modern version of that Depression-era curse, the bank run. Foreign investors suddenly pulled out their money and went home. Currencies plummeted. Banks failed. Businesses went belly up because they no longer could pay back their foreign loans.

Why did this happen? Corruption and cronyism have been popular villains in the Western press, but Krugman isn't buying: "There were real failings in these economies," he writes, "but the main failing was a vulnerability to self-fulfilling panic."

So now we have large numbers of Asian consumers dropping out of the global bazaar. The only thing keeping the world economy afloat has been U.S. and European consumers. What might cause Western publics suddenly to ratchet back their spending too, inviting the danger of global depression?

How about the sort of financial meltdown nearly set off by the collapse last year of Long Term Capital Management, the big New York hedge fund that was gambling with $100 billion in borrowed money? Had the Federal Reserve not organized a bailout, a panic liquidation of the hedge fund's huge bond portfolio might have crashed the world's markets, toppled banks, and killed the confidence of consumers to keep spending.

Because of the "stagflation" of the 1970s, we have all the wrong instincts in place to deal with such potential problems, Krugman writes. We've become too enamored of monetary discipline, of central bankers who refuse to print money to paper over fundamental economic problems. In Japan, exactly what's needed today is a bit of monetary indiscipline: a deliberate, advertised policy of inflation. Then the Japanese would face the choice of spending their savings or seeing them eaten up by rising prices. If the U.S. or Western Europe were faced with a financial panic presaging a similar slump in consumer demand, we would be well advised to adopt the same policy: Damn the inflation torpedoes, flood the banks with liquidity (central banks do this by "creating" money and using it to buy bonds from the public).

In making out these prescriptions, Krugman is hardly the radical he seems to think he is. Pundits he would consider ideological Neanderthals have been arguing for years that Japan needs to run the printing presses to get out of its slump. Likewise, when the U.S. stock market crashed in 1987, Fed chairman Alan Greenspan made plenty of credit available to keep the banks alive and stop the ripples from reaching the larger economy.

Meanwhile, when it comes to the problem most bedeviling policymakers who worry about a world depression-what to do about developing countries whose "main failing was a vulnerability to self-fulfilling panic"- Krugman admits to holding the same muddled views as do most economists. If countries are going to devalue their currencies, they shouldn't botch the job. If they are going to place limits on foreign investors, they should do it with a light hand.

But Krugman overlooks the crucial question of whether such nations are getting their domestic politics right. Investors in the Asian countries may finally have bolted out of panic. But China and Indonesia were facing monumental and uncertain political transitions. The Japanese had dumped their one-party state after 40 years but had stalled on the way to something else. Malaysia was becoming more autocratic by the day. Thailand's rowdy democracy had devolved into a bidding war between shifting factions of cronies.