Depression Economics by Paul Krugman

Paul Krugman is the recipient of the 2008 Nobel Prize in Economics and his updated version of his book entitled "The Return of Depression Economics and the Crisis of 2008" copywritten in 2009 is quite interesting. Here are some paraphrased highlights/statistics I list from this book with my commentary in between:

P.S. #10 is the real issue if you want to "cut to the chase", the rest is mostly historical.

(1) p.15 - 1973 and 1979 were severe energy crisis periods followed by severe recessionary periods
(2) Recessions can be cured by printing money

No one likes the idea of the Fed, the Treasury and the Congress loaning money, spending money and printing money that is happening but economists have learned something over the past 70 years: adding liquidity to the marketplace is an essential ingredient to recovery.

(3) p.43 - The curent account (think trade deficit for one) deficit must be offset by capital account (think U.S. buying assets in foreign companies and real estate, etc.) surpluses.

So when you hear on the news about trade deficits (which of late have actually gotten a little less), please remember that the U.S. is also owning assets in other countries, too. In the long-term, that should be good though short-term tougher.

(4) p. 72 - In 1998, Japan...was projecting a deficit of 10% of GDP and...government debt above 100% of GDP.

In 2009, the U.S. deficit (annual amount) may be pushing 8-9% of GDP and the debt (the total amount owed for all years cumulative) may be pushing 80% of GDP.

Scary numbers! But also remember that after WW II, the U.S. had a debt ratio of 90% of GDP and the 1950's and 1960's had the typical recessions but no major setbacks. We do recover.

(5) p. 144-145 - Interesting price to rent ratio (housing prices divided by the average rent prices) make clear that the housing bubble was extreme and bottomed out in late 2004, early 2005.

(6) p. 143 -144 - Another chart; civilian unemployment rates increased in the 1991 and 2001 recessions and "...the conventional view... was that inflation would start accelerating if the unemployment rate fell below about 5.5 percent..."

The unemployment rate (page 151) rose steeply during the recession but continued to rise in the months that followed. The period of deteriorating employment actually lasted two and half years, not eight months. (which was the official determination of the length of the recession).

So, expect the unemployment rate, unfortunately, to go up, even after the official recession has ended.

But...

Inflation did not happen once the recessions were over but asset bubbles did occur instead.

(7) p. 147 - The real value (return less the excessive inflationary period) of stocks fell about 7 percent a year between 1968 and 1978.

This kept many investor's cautious during this period as Paul Krugman notes but for those who did not bail and waited until the end of this 10-year period and the 1982 recession, stocks never looked back on their old values. In retrospect, it was a great time to buy.

Reminder: market-timing does not work.

(8) p. 156 - The Panic of 1907 began with the demise of the Knickerbocker Trust...credit markets froze...and the stock market fell dramatically...a 4-year recession ensued with production falling 11% and unemployment rising from 3 to 8 percent.

Does this sound at all familiar to today? J.P. Morgan stepped in with money but bank regulations were reformed. J.P. Morgan did not have enough money to stave off the drain on productivity, and not nearly enough to stop runs on the banks in 1929-1932.

Those times, though, are past. We have FDIC insurance and other regulations in place today but you will see from #10 below that they still were not enough.

(9) p.158 - The Savings & Loan crises...in the 1980's...resulted in a government bailout..."which ended up being about 5% of GDP (the equivalent of more than $700 billion now)..."

Now, there is perspective. What happened to the stock market and the economy after the 1980's S&L crises? A drop in 1987 of 22% in one day on the DOW and more losses in the weeks before that fateful day. But the markets recovered from 1987 in about 18 months.

(10) p. 163 - Today's 2008-2009 crisis, ..."for the most part, hasn't involved problems with deregulated institutions that took new risks. Instead, it has involved risks taken by institutions that were never regulated in the first place..."

The crisis today as Paul Krugman so eloquently puts it is not Fannie Mae and Freddie Mac (to this date, I do not believe that they have used any bailout money) or the repeal of Glass-Steagall in 1999 (breaking down the barrier between banks and investment firms) or, this is bantered around alot, the Community Reinvestment Act of 1977 (required lending to sub-prime borrowers kind-of). No, it is auction-rated securities, CDO's and other structured and leveraged products, hedge funds that borrowed to the hilt and investment companies with debt to asset ratios of 30:1 (like Bear Stearns and Merrill Lynch). These mechanisms were not under the scrutiny of the government - maybe they will be to some extent in the future.

But Dr. Bernanke has done a tremendous amount to provide liquidity to these groups anyway through his auction facilities.

The market size of bank investments is approximately $800 billion but the credit market size that is in such disarray today is about $50 trillion in size - or was before this credit freeze began.

As Paul Krugman writes that the solution to our credit crisis is: "...A temporary nationalization of a significant part of the financial system...this isn't a long-term goal...and should be reprivatized as soon as it is safe to do so..."

In addition, "...fiscal stimulus (government spending)...The next one should be much bigger...as much as 4% of GDP (the first stimulus package in 2008 was too small - only 1% of GDP)...and should focus on sustaining and expanding government spending..."

I have to agree reluctantly.

Aid to state and local governments, building roads and bridges, etc. This is what is in the works in the new Obama administration and I don't like the idea but I fully agree that desperate times require desperate measures.

With enough spending and printing of money this era of depression economics may be less severe than without the interventions planned.

Paul Krugman's definition of depression economics, by the way, is thinking about the demand-side (rather than the supply-side) and this thought process has not been considered for a couple of generations (note: not decades) as we have had an economy that mostly worked without it.

In other words, Paul writes, "...insufficient private spending to make use of the available productive capacity..."

Many economists believed we would not have to worry about stagflation or disinflation or deflation again but these concepts have now reared their ugly heads.

I will write more about deflation later.