Dwight, Joe and Paul
Well I finally got down to think and look for a few references.
I have two links here for you with Fortune articles
by Paul Krugman:
7 habits for investors
pathfinder.com
on Soros
pathfinder.com
I am also pasting Krugman's article on the Asian meltdown which is related to previous postings by Paul and Joe.
--------------------------------------------------------
Paradigms of Panic
Asia goes back to the future.
By Paul Krugman
(posted Thursday, March 12)
There were warning signs
aplenty. Anyone could have told you
about the epic corruption--about
tycoons whose empires depended on
their political connections and about
politicians growing rich in ways best
not discussed. Speculation, often ill
informed, was rampant. Besides, how
could investors hope to know what
they were buying, when few
businesses kept scrupulous accounts?
Yet most brushed off these
well-known vices as incidental to the
real story, which was about economic
growth that was the wonder of the
world. Indeed, many regarded the
cronyism as a virtue rather than a
vice, the signature of an economic
system that was more concerned with
getting results than with the niceties
of the process. And for years, the
faint voices of the skeptics were
drowned out by the roar of an
economic engine fueled by ever
larger infusions of foreign capital.
The crisis began small, with the failure of
a few financial institutions that had bet too
heavily that the boom would continue, and the
bankruptcy of a few corporations that had
taken on too much debt. These failures
frightened investors, whose attempts to pull
their money out led to more bank failures; the
desperate attempts of surviving banks to raise
cash caused both a credit crunch (pushing
many businesses that had seemed financially
sound only months before over the brink) and
plunging stock prices, bankrupting still more
financial houses. Within months, the panic
had reduced thousands of people to sudden
destitution. Moreover, the financial disaster
soon took its toll on the real economy, too: As
industrial production skidded and
unemployment soared, there was a surge in
crime and worker unrest.
ut why am I telling you what happened to
the United States 125 years ago, in the
Panic of 1873?
Anyone who claims to fully understand
the economic disaster that has overtaken Asia
proves, by that very certainty, that he doesn't
know what he is talking about. The truth is
that we have never seen anything quite like
this, and that everyone--from the country
doctors at the International Monetary Fund
and the Treasury Department who must
prescribe economic medicine to those of us
who have the luxury of irresponsibility--is
groping frantically for models and metaphors
to make sense of this thing. The usual round
of academic and quasiacademic conferences
and round tables has turned into a sort of
rolling rap session, in which the usual suspects
meet again and again to trade theories and,
occasionally, accusations. Much of the
discussion has focused on the hidden
weaknesses of the Asian economies and how
they produced fertile ground for a financial
crisis; the role of runaway banks that
exploited political connections to gamble with
other people's money has emerged as the
prime suspect. But amid the tales of rupiah
and ringgit one also hears surprisingly
old-fashioned references--to Charles
Kindleberger's classic 1978 book Manias,
Panics, and Crashes, and even to Walter
Bagehot's Lombard Street (1873). Asia's
debacle, a growing number of us now think, is
at least in part a souped-up modern version of
a traditional, 1873-style financial panic.
The logic of financial panic is fairly well
understood in principle, thanks both to the old
literary classics and to a 1983 mathematical
formalization by Douglas Diamond and Philip
Dybvig. The starting point for panic theory is
the observation that there is a tension between
the desire of individuals for flexibility--the
ability to spend whenever they feel like it--and
the economic payoff to commitment, to
sticking with long-term projects until they are
finished. In a primitive economy there is no
way to avoid this tradeoff--if you want to be
able to leave for the desert on short notice,
you settle for matzo instead of bread, and if
you want ready cash, you keep gold coins
under the mattress. But in a more
sophisticated economy this dilemma can be
finessed. BankBoston is largely in the
business of lending money at long term--say,
30-year mortgages--yet it offers depositors
such as me, who supply that money, the right
to withdraw it any time we like.
hat a financial intermediary (a bank or
something more or less like a bank) does
is pool the money of a large number of people
and put most of that money into long-term
investments that are "illiquid"--that is, hard to
turn quickly into cash. Only a fairly small
reserve is held in cash and other "liquid"
assets. The reason this works is the law of
averages: On any given day, deposits and
withdrawals more or less balance out, and
there is enough cash on hand to take care of
any difference. The individual depositor is
free to pull his money out whenever he wants;
yet that money can be used to finance
projects that require long-term commitment. It
is a sort of magic trick that is fundamental to
making a complex economy work.
Magic, however, has its risks. Normally,
financial intermediation is a wonderful thing;
but now and then, disaster strikes. Suppose
that for some reason--maybe a groundless
rumor--many of a bank's depositors begin to
worry that their money isn't safe. They rush
to pull their money out. But there isn't enough
cash to satisfy all of them, and because the
bank's other assets are illiquid, it cannot sell
them quickly to raise more cash (or can do so
only at fire-sale prices). So the bank goes
bust, and the slowest-moving depositors lose
their money. And those who rushed to pull
their money out are proved right--the bank
wasn't safe, after all. In short, financial
intermediation carries with it the risk of bank
runs, of self-fulfilling panic.
A panic, when it occurs, can do far more
than destroy a single bank. Like the Panic of
1873--or the similar panics of 1893; 1907;
1920; and 1931, that mother of all bank runs
(which, much more than the 1929 stock
crash, caused the Great Depression)--it can
spread to engulf the whole economy. Nor is
strong long-term economic performance any
guarantee against such crises. As the list
suggests, the United States was not only
subject to panics but also unusually
crisis-prone compared with other advanced
countries during the very years that it was
establishing its economic and technological
dominance.
hy, then, did the Asian crisis catch
everyone by surprise? Because there was
a half-century, from the '30s to the '80s,
when they just didn't seem to make panics the
way they used to. In fact, we--by which I
mean economists, politicians, business
leaders, and everyone else I can think of--had
pretty much forgotten what a good
old-fashioned panic was like. Well, now we
remember.
I'm not saying that Asia's economies
were "fundamentally sound," that this was a
completely unnecessary crisis. There are
some smart people--most notably Harvard's
Jeffrey Sachs--who believe that, but my view
is that Asian economies had gone seriously off
the rails well before last summer, and that
some kind of unpleasant comeuppance was
inevitable. That said, it is also true that Asia's
experience is not unique; it follows the quite
similar Latin American "tequila" crisis of
1995, and bears at least some resemblance to
the earlier Latin American debt crisis of the
1980s. In each case there were some serious
policy mistakes made that helped make the
economies vulnerable. Yet governments are
no more stupid or irresponsible now than they
used to be; how come the punishment has
become so much more severe?
art of the answer may be that our financial
system has become dangerously efficient.
In response to the Great Depression, the
United States and just about everyone else
imposed elaborate regulations on their banking
systems. Like most regulatory regimes, this
one ended up working largely for the benefit
of the regulatees--restricting competition and
making ownership of a bank a more or less
guaranteed sinecure. But while the regulations
may have made banks fat and sluggish, it also
made them safe. Nowadays banks are by no
means guaranteed to make money: To turn a
profit they must work hard, innovate--and
take big risks.
Another part of the answer--one that
Kindleberger suggested two decades ago--is
that to introduce global financial markets into
a world of merely national monetary
authorities is, in a very real sense, to walk a
tightrope without a net. As long as finance is a
mainly domestic affair, what people want in a
bank run is local money--and, guess what, the
government is able to print as much as it
wants. But when Indonesians started running
from their banks a few months ago, what they
wanted was dollars--and neither the
Indonesian government nor the IMF can give
them enough of what they want.
I am not one of those people who
believes that the Asian crisis will or even can
cause a world depression. In fact, I think that
the United States is still, despite Asia, more at
risk from inflation than deflation. But what
worries me--aside from the small matter that
Indonesia, with a mere 200 million people,
seems at the time of writing to be sliding
toward the abyss--is the thought that we may
have to get used to such crises. Welcome to
the New World Order. |
