Economist’s inexact models exactly defective 11
(Nobel Prize Hijacked 4, P Krugman 2)
Understanding reasons behind the Global Economy Meltdown
Nobel Prizes - Economics & Physics - More SCIENCE-FICTION which does not comply to Alfred Nobel’s Terms-of-Will.
Multiple-layers of abstract mathematics falsely guised as ‘fact’
Nobel Foundation long penetrated & corrupted by global Finance-Powers => ‘Illuminati’?????
Nobel Foundation increasingly desperate to find Economics ‘science’ works to award Nobel Prize.
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It is recommended that you read the previous papers in this series – click on ‘view now’ Historical Archives (lhs panel).
This series highlights the gross defectiveness of Economic Scientists’ models that are causing gross injustices & instabilities throughout the world. The previous papers concern:-
1. Milton Friedman, Lucas, Aumann
2. John Nash (portrayed in Beautiful Mind by Russell Crowe)
3 & 4. Edmund Phelps
5 Robert Mundell
6 Nobel Prize Hijacked
7 R Myerson, E Maskin, L Hurwicz 1
8 R Myerson, E Maskin, L Hurwicz 2
9 Nobel Prize Hijacked 2
10 Nobel Prize Hijacked 3, P Krugman.
(Please Note: This website is about the pioneering of ENGINEERING into the SEBFL environments, it is about seeking truths; it is NOT about journalism, English grammar or prose, or quick-sell – it is down-to-earth engineering & pioneering requiring extensive & intensive THINKING.
SEBFL = social/economy/business/finance/legal environments.
Explaining transmission mechanisms & pre-empting catastrophic failures is NOT doom-prophecy, it is explaining probabilistic reality.)
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INDEX:
Introduction
2008 Economics ‘Nobel’ Prize – P Krugman
- The Return of Depression Economics and the Crisis of 2008
- 2008 Nobel Economics Lecture:
2008 Nobel Physics Prize.
Illuminati???
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INTRODUCTION:
The World is in chaos because academic institutions & foundations have long been penetrated & corrupted by global Finance-Powers; science models have been purposefully distorted to give false respectability to organised-crime frauds that have undermined the global pensions/investments & financial structures.
Despite numerous proofs to the Nobel Foundation the NF continue to award Nobel Prizes for grossly defective & massively destructive economic ‘science’ models. The 2008 Physics Nobel Prize also falls into this category.
The Nobel Foundation is also becoming increasingly desperate to find economics models to award prizes – the inadequate models by Paul Krugman clearly show this to be so.
Merit is not rewarded in academic institutions or by governments, hence grossly defective & massively destructive science models prevail, and ‘scientists’ are misleading governments.
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oOo 2008 Economics ‘Nobel’ Prize – P Krugman
Subsequent to the announcement of Krugman’s NP prize, Krugman saw fit to publish an article/book on the meltdown & on how to solve it – simple application of rational thinking shows that Krugman does not understand systems & controls.
It is not necessary to show all flaws within Krugman’s works, just some of the critical Fatal Flaws, one Fatal Flaw is sufficient.
- The Return of Depression Economics and the Crisis of 2008 – by Paul Krugman, published by Penguin.
(Edited extraction in the UK Guardian - Sat Dec 6, 2008 – Weekend magazine (see copy annexed)
- entitled: ‘We all go together when we go’.
- And subtitled: ‘The first great financial crisis of the 21st Century has begun. Nobel prize-winning economist Paul Krugman explains how it happened, and how it can be cured’.)
The problem with Krugman’s article is that it does not explain how the crisis happened, nor does not, in any shape of form, explain how to cure it.
The most profound statement that Krugman makes is his closing one: ‘The true scarcity in Keynes' world and ours - was therefore not of resources, or even of virtue, but of understanding.’
Krugman has no understanding of economy systems & controls, as they should be constructed, he has a basic understanding of a Heath-Robinson style mess that is mistaken as a dynamic capitalist system – it is mistaken as a dynamic capitalist system BECAUSE defective mathematics models, not science models, are being wrongly honoured.
Economists are not recognizing the very destructive nature of the prevailing systems & controls to which their research has progressively contributed.
Communications to King Carl Gustaf of Sweden, via his Personal Secretary, to rectify the hi-jacking of the Nobel Foundation has not produced responses.
The easiest way of visualizing the fundamental error within the intangible environments of Krugman’s arguments is to compare to a tangible problem: e.g. consider a motor manufacturer producing a batch of defective cars, with defective brakes. Eventually cars begin to crash. The extent of the crash damage will vary from one car to the next and is dependent upon the terrain, conditions & the manner in which the car is being driven.
For example: and elderly granny on a slow Sunday drive may experience brake failure at low speed resulting in limited damage. However Lewis Hamilton driving at max speed, on a wet road, through a sharp bend, would experience a catastrophic collision resulting in a mangled wreck.
The two scenarios are from the same cause but with completely different outcomes.
Enter now, an unqualified ‘scientist’. In failing to understand the vehicle the ‘scientist’ wrongly assumes that because the two scenarios have completely differing results that the causes are thus completely different.
The ‘scientist’ would (for example) recommend developing better road surface & tyres to prevent the car breaking from road surface, and/or beefing up the car – all of which increases costs, drives inflation, shifts government spending from social-growth to supporting financial-growth – i.e. the ‘scientist’ fails to uncover the cause (defective brakes) and squanders money unnecessarily on over-specifying (c.f. over-regulating) the environment.
It is now easy to see how the unqualified ‘scientist’ develops multiple layers of defective analysis & takes us further & further away from the causal problem as increasingly defective ‘solutions’ are attempted over time.
In Economy terms this is how Krugman, & economists in general, have skewed economy development, which skews into all spheres of social/economy/business/finance/legal (SEBFL) environments.
In a similar way, the downs of the markets over the past decades have been differing crashes but from essentially the same causal problems. (Undermined economy foundations, saturated Money Supply, defective & destructive Interest-Rate control, spirals, pyramids & hosts of other frauds, etc.)
(As an aside: Prof Niall Ferguson makes the same errors in his latest book & documentary ‘Ascent of Money’. Whilst the historical sequencing & overview are interesting the technical analyses have the same basic flaws – incorrect deductions of the various & numerous economy crashes that have occurred over the centuries.)
BUT, economists are not recognizing that the root problem is their lack of skills & engineering insight and that their consequent defective models are the cause of defective economy models used by governments to develop defective legislation/regulations, which are increasingly worsening.
The crashes are the SYMPTOMS of the problem – they are not the problem.
Over time the increasingly defective models have brought about a complete mess – which is what we are seeing & experiencing right now – and governments are failing to recognize this, they continue to believe (wrongly) that because Royal Swedish Academy of Sciences academics & Nobel Foundation dish out Nobel Prizes amongst wadges of Pomp & Ceremony that these defective models must be right.
Hence governments continue with grossly defective policies – which is what we see with Prime Minister Brown, & other European leaders; and now Barack Obama, recently inaugurated, also fails to engage, honestly & transparently, with pioneered engineering - to date his comms system is one-way deaf – which means only one thing, his policies will also fail.
Obama’s deafness means that he is not listening to constructive engineering.
A key reason for Krugman’s errors rests with his statement (false) that the financial systems had been engineered. Krugman is not qualified in engineering, he has only a limited fast & easy ticket into inexact ‘science’, with no formal training & no practical experience, yet he, like other past Nobel Prize winners in Economics, bestow upon themselves the unqualified abilities of engineering.
In short:
- Krugman fails to recognise that symptoms of the Global Economy Meltdown are not the Causal Problems.
- Krugman fails to recognize that the financial/economic/business environments are devoid of any sound engineering
- Krugman fails to recognise that the entire global economy foundation has been undermined through defrauded pensions/investments
- Krugman fails to recognise the Money Supply saturation that is created by false double-accounting of defrauded pensions/investments
- Krugman fails to recognise the structural deficiencies with spiral, pyramid & other fraudulent mechanisms, and their contribution to further Money Supply saturation.
- Krugman fails to recognise that sub-prime is merely a cover-up of an ECONOMY IMPLOSION so as to hide the eroded foundation, sub-prime was NOT the cause of the collapse.
- Krugman fails to recognise that securitisation of mortgages was not the cause of collapse.
- Krugman fails to recognise the massively destructive nature of the prevailing unitary-model interest rate economy control-device.
- Krugman fails to recognise that economies, globally, are overinflated, undermined, unsound and require engineering to stabilise them
Krugman’s recommended solution is to rescue the credit system & to prop up spending & to increase regulation.
As with a seriously bleeding patient, transfusions are critical – but the blood must be pumped into the right places AND the bleeding must also be stopped; AND surgery must be performed.
Engineering is to economies & machines what surgery/medicine is to humans.
Qualified doctors carry out surgery on humans, but unqualified ‘scientists’ are carrying out engineering onto economies – engineering, historically, has been entirely absent (until pioneering by CDADD).
(Why not simply give the Economics Nobel Laureates another Nobel Prize in medicine for, say, advancing brain surgery and have them fix humans?)
Krugman freely throws out the argument of closer ‘regulation’ – but he cannot articulate what regulation; nor does Krugman recognise that one cannot develop regulation if one hasn’t got a sound engineered system & controls. And one cannot develop sound engineered systems & controls unless one understands the environments and has appropriate engineering expertise; which Krugman does not.
QED!
– 2008 Nobel Economics Lecture:
(NOTE: Krugman, like other NP Prize winners, does not have the courage to openly engage with CDADD.)
Krugman’s Nobel Lecture is notable, unlike past lectures, for its full-attendance. Either the credit-crunch has cautioned people into being seen to minimise their own retrenchment-risk or the Nobel Foundation & RSAS had to press-gang the audience, for which the first option is a powerful persuader.
Recall:- Krugman has essentially an MA background (mathematics it appears), and he then, like many Economics ‘Nobel’ Prize winners, took a fast & easy ticket to becoming an inexact ‘scientist’ with no formal science training or practical experience - BUT for over 10 years he has been out of the ‘science’ arena and working as a journalist.
Krugman’s Nobel lecture is pure waffle. Krugman structured his lecture around 4 key (‘safe’) points but in practice he himself ignores all four.
1 Listen to the gentiles (Krugman ignores this, he does not have the courage to engage with CDADD)
2 Questioning the question (Krugman fails to recognise that one must first attempt to answer the question, then question both question & answer in iterative cycles)
3 Daring to be silly (Krugman dares not be open, let alone silly)
4 Simplify, simplify (Krugman’s equation for which he ‘won’ the Nobel Prize is far from simple – it is defective, complex & duplicitous)
Krugman displayed a ‘Manufacturing cities’ map – which, he argued, supports his theories for modern economies migrating to cities – Krugman doesn’t ‘question the question’, or his ‘answer’ and fails to recognise that his map shows the evidence of defective economic policies destroying rural employment (which previously were micro-economies) thus causing/forcing people to shift to cities & mass chaos.
Nor does Krugman see that the defective economy policies that caused the migration to cities has made the USA, as a Nation, vulnerable to attack – externally & internally – which early evidence rests in the Twin Towers, Global Economy Meltdown, etc., etc.
The Global Economy Meltdown is partly attributable to Krugman’s models.
oOo 2008 Nobel Physics Prize.
The three recipients’ works did not comply with Alfred Nobel’s Terms-of-Will, nor did their impossible theories achieve benefit for mankind, as they are theories not proven facts (in fact CDADD’s work disproves their theories).
In short: Quantum Physics was a concept that originated, some 80 years ago, through the mathematical brilliance of a number of scientists, but as we can now see (in papers series Captain’s Log Stardate xx) the much of this concept is not realistic, it is not physically possible, it is not science fact, but science fiction.
Despite the Nobel Foundation & Royal Swedish Academy of Sciences being presented with these proofs they continue to wrongly award Nobel Prizes for abstract mathematics, and not for Physics.
Admissions by 2008 NP recipient Yoichiro Nambu:
- that Nambu’s models were theories only – which does not comply with Nobel’s Terms-of-Will in that it must bring most benefit to mankind, clearly defective theories do not do this, nor do any theories - only proved principles (established laws) do this.
- his models rely upon Einstein’s Gravity equation (which we now know is incorrect) – Einstein’s brilliant mathematics has caused scientists to deviate from reality for decades. Gravity is an internal force, a static electric force, whereas magnetic forces are external (see series Captain’s Log Stardate xx).
- there is an implied reliance upon Einstein’s energy equation – but, as shown by CDADD, light particles, or any particles, do NOT travel at speed-of-light, or anywhere near it.
All three 2008 recipients rely upon abstract principles directly or indirectly stemming from defective Quantum Physics ideas and confused with increasingly complex mathematics.
Consequently the Nobel Physics Prizes were awarded for defective works & works that did not comply with the Terms-of-Will.
[CERN still do not acknowledge that their accelerator experiments - accelerating particles to speed c - are impossible.
Who is behind the CERN project? and what is happening to the science research? The probability is that Israel (Virtual & Real) is siphoning the research & purposefully feeding in defective theories to weaken the West’s technology position both commercially & militarily.]
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oOo Illuminati????
About 6 years ago when engineering by CDADD brought about the realisation that global financial frauds were behind Financial Institutions it was proposed:-
‘Who then are these immensely powerful people within these Financial Institutions who intellectualise & manipulate these deviant schemes to defraud society as a whole. They are not faceless & nameless people. They have faces and they have names! Who are these people????????’
(See paper ‘Annuities in Retirement’).
Over the ensuing years continuing research & development by CDADD brought more & more faces & names to light (Government Ministers, Constitutional, Supreme & High Court Judges, countless corporate executives, and so on) – BUT, it has always seemed that these people are bit-players – they would not have done what they did, and are still doing, if there were not some other key-players providing the motivation.
Twin Towers, pyramids, spirals, Global Economy Meltdown, undermined Financial Foundations, disabled national security systems, grossly defective works awarded Nobel Prizes, are just some of the key issues that have occurred – they could NOT have happened without some central force, a central key-players mindset.
Who then are these central key-players?
It is not suggested that full revelation has come about, BUT the light on the dark evil is becoming clearer & brighter as we progress further into the perimeters of what can be loosely described as an ‘Illuminati’.
We have seen, for example, that Donald Gordon (Liberty Life Founder & global fraudster) pioneered the Gordon Institute of Business Science to entrench defective social/economy/business/economic/finance/legal (SEBFL) models behind which he could give false credibility to his massive fraud scams. We have seen recently how the CERN Large Hadron Collider is providing a front for defective research (light particles CANNOT travel at speed c) – so it begs the question: who is behind the manipulations? What is happening with CERN research? Who is power-scheming with latest technology that can defeat western nations commercially & militarily?
We have seen that the Nobel Foundation & Royal Swedish academy of Sciences have been awarding Nobel Prizes for grossly defective works, and fraudulently so – see other papers in this series (John Nash is the only one to have made a retraction – limited though it was).
The question is: who is behind this?
The name Wallenberg pops up.
Jacob Wallenberg is a Member of the Nobel Foundation – this is a relatively obscure position for a person that heads up the Wallenberg family in Sweden, which family ‘… is one of the most influential and wealthy families in Sweden, renowned as bankers and industrialists. They are considered to be the wealthiest family in Sweden. In 1990, it was estimated that the family indirectly controlled one-third of the Swedish Gross National Product.’ (this from Wikipedia website. NOTE: Wikipedia is unreliable but nevertheless Wallenberg has had ample opportunity to refute these statements)
Wallenberg is supposed to bring Governance integrity to the Nobel Foundation but it is clear that he is buying-off the Foundation & coercing grossly defective science models behind which global frauds & scams can be perpetrated. The Wallenberg’s wealth is derived through this kind of organised-crime fraud.
Compare this to Donald Gordon’s Gordon Institute of Business Science in South Africa which is funded from defrauded pensions/investments monies – Gordon influenced research so as to hide his fraud scams behind false credibility. SA & UK justice systems protect him from prosecution because he has bought-off the judges; ditto, Richard Branson, Raymond Ackermann, Roy Anderson, etc. etc.
Wallenberg doesn’t have the ‘balls’ to communicate directly with the writer, he hides behind his secretary’s skirt.
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Enestam, Marianne <This email address is being protected from spambots. You need JavaScript enabled to view it.;
Please delete from your mailing list: This email address is being protected from spambots. You need JavaScript enabled to view it.
Hence - it is entirely reasonable to argue that a ‘loose’ network of organised-crime Finance-Powers are in operation, an ‘Illuminati’, acting in common interests.
Wallenberg is one of the ‘faces & names’ behind the mastermindings of massive global frauds – which have caused the Global Economy Meltdown.
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Chris Addington Pr.Eng.
(Under enforced exile from South Africa due to ANC government’s oppressive XDR-nazi system and oppressive economic isolation by corporate & academic world’s.)
XDR = Extreme Democracy Resistant.
Paul Krugman’s text from Guardian website:
We all go together when we go
The first great financial crisis of the 21st century has begun. Nobel prize-winning economist Paul Krugman explains how it happened, and how it can be cured
Paul Krugman
The Guardian, Saturday December 6 2008
I'm tempted to say that the crisis is like nothing we've ever seen before, but it might be more accurate to say that it's like everything we've seen before, all at once: a bursting real estate bubble comparable to what happened in Japan at the end of the 80s; a wave of bank runs comparable to those of the early 30s; a liquidity trap in the US, again reminiscent of Japan; and, most recently, a disruption of international capital flows and a wave of currency crises all too reminiscent of what happened to Asia in the late 90s.
Let's tell the tale.
The great US housing boom began to deflate in the autumn of 2005. As prices rose to the point where buying a home became out of reach for many Americans, sales began to slacken off. There was a hissing sound as air began to leak out of the bubble.
Yet house prices kept rising for a while. After an extended period during which prices had been rising sharply each year, sellers expected the trend to continue, so asking prices actually continued to rise even as sales dropped. By late spring 2006, however, the weakness of the market was starting to sink in. Prices began dropping, slowly at first, then with growing speed.
Even the gradual initial decline in house prices, however, undermined the assumptions on which the boom in subprime lending was based. Remember, the key rationale for this lending was the belief that it didn't really matter, from the lender's point of view, whether the borrower could actually make the mortgage payments: as long as home prices kept rising, troubled borrowers could always either refinance or pay off their mortgage by selling the house. As soon as prices started falling instead of rising, and houses became hard to sell, default rates began rising. And at that point another ugly truth became apparent: foreclosure isn't just a tragedy for the homeowners, it's a lousy deal for the lender. Between the time it takes to get a foreclosed home back on the market, the legal expenses, the degradation that tends to happen in vacant homes, and so on, creditors seizing a house from the borrower typically get back only part, say half, of the original value of the loan.
In that case, you might ask, why not make a deal with the current homeowner to reduce payments and avoid the costs of foreclosure? Well, for one thing, that also costs money, and it requires staff. And subprime loans were not, for the most part, made by banks that held on to the loans; they were made by loan originators, who quickly sold the loans to financial institutions, which, in turn, sliced and diced pools of mortgages into collateralised debt obligations (CDOs) sold to investors. The actual management of the loans was left to loan servicers, who had neither the resources nor, for the most part, the incentive to engage in loan restructuring. And one more thing: the complexity of the financial engineering that supported subprime lending, which left ownership of mortgages dispersed among many investors with claims of varying seniority, created formidable legal obstacles to any kind of debt forgiveness.
So restructuring was mostly out, leading to costly foreclosures. And this meant that securities backed by subprime mortgages turned into very bad investments as soon as the housing boom began to falter. By February 2007, the realisation sank in that the junior shares in CDOs were probably going to take serious losses, and prices of those shares plunged. By the end of the year, it became clear that nothing related to housing was safe - not senior shares, not even loans made to borrowers with good credit ratings who made substantial downpayments.
Why? Because of the sheer scale of the US housing bubble. Nationally, housing was probably overvalued by more than 50% by the summer of 2006, which meant that to eliminate the overvaluation, prices would have to fall by a third, and in some metropolitan areas by 50% or more.
This meant that practically anyone who bought a house during the peak bubble years, even if he or she put 20% down, was going to end up with negative equity. And homeowners with negative equity are prime candidates for default and foreclosure, no matter what their background. Job loss, unexpected medical expenses, divorce - all of these can leave a homeowner unable to make mortgage payments. And if the house is worth less than the mortgage, there is no way to make the lender whole.
As the severity of the housing bust sank in, it became clear that lenders would lose a lot of money, and so would the investors who bought mortgage-backed securities. But why should we cry for these people, as opposed to the homeowners themselves? After all, the end of the housing bubble will probably, when the final reckoning is made, have wiped out about $8 trillion of wealth. Of that, around $7 trillion will have been losses to homeowners and only about $1 trillion losses to investors. Why obsess about that $1 trillion? The answer is, because it has triggered the collapse of the shadow banking system.
The shadow banking system is formed by financial institutions that aren't banks from a regulatory point of view but nonetheless perform banking functions. The system includes innovative financial products such as CDOs and hedge funds. Often these products offered better returns than those of the conventional banks. Investors were paid higher interest rates than they would have received on bank deposits, while borrowers paid lower interest rates than they would have done on long-term bank loans. There's no such thing as a free lunch, Milton Friedman told us, yet these deals seemed to offer just that. How did they do that?
Well, the answer seems obvious, at least in retrospect: banks are highly regulated; they are required to hold liquid reserves, maintain substantial capital and pay into the deposit insurance system. In the shadow banking system, borrowers could bypass these regulations and their expense. But that also meant they weren't protected by the banking safety net: if they ran out of funds, they couldn't turn to the US Federal Reserve to bail them out.
As we've seen, there were some serious financial tremors in the first half of 2007, but as late as early August, the official view was that the problems posed by the housing slump and subprime loans were contained - and the strength of the stock market suggested that markets agreed with the official position. Then, not to put too fine a point on it, all hell broke loose. What happened?
It began with subprime-related losses, which undermined confidence in the shadow banking system. And this led to a vicious cycle of de-leveraging, as those who had borrowed heavily sought to repay their debts by selling assets as banks withdrew credit. Trouble was, bonds based on poor-quality mortgages had been sold widely, infecting the whole system. The result was, in effect, a massive bank run that caused the shadow banking system to shrivel up, much as the conventional banking system had in the early 30s. Trillions of dollars in credit disappeared. Two of the five major US investment banks failed and another merged with a conventional bank. And so on down the line.
Consumer credit was the last to go, but by October 2008 there was growing evidence that credit cards were also on the chopping block, with credit limits cut, more applicants turned down and the ability of consumers to charge things undermined.
All across the economy, some businesses and individuals were losing access to credit, while others found themselves paying higher interest rates even as the Fed was trying to push rates down. The Fed is set up to do two main things: manage interest rates and, when necessary, provide cash to banks. And it has used these tools aggressively since the crisis began - with little effect: businesses without a top credit rating continue to pay higher interest rates for short-term credit now than they did before the crisis, even though the interest rates the Fed controls have fallen by more than four percentage points.
What about all the loans the Federal Reserve made to the banks? They have probably helped, but not as much as one might have expected, because conventional banks aren't at the heart of the crisis. As the shadow banking system went down, no amount of Fed loans to Citibank or Bank of America could do anything to halt the process.
In effect, then, the Fed found itself presiding over a liquidity trap, in which conventional monetary policy had lost all traction over the real economy. What else could the Fed do? Instead of making loans only to conventional banks, it could make loans to other players: investment banks, money-market funds, maybe even non-financial businesses - in effect doing the lending that the private financial system wouldn't or couldn't do. It remains possible that these schemes will eventually bear fruit. What one has to say, however, is that their effects so far have been disappointing. Why? When the Fed acts to increase the quantity of bank reserves, its actions tend to be large relative to the scale of the assets involved, since the monetary base is "only" $800bn. When the Fed tries to support the credit market more broadly, it's trying to move a much bigger beast, the $50 trillion or so credit market.
The Fed has also suffered from the problem of being, again and again, behind the curve. The financial crisis keeps developing new dimensions, which few people see coming. And that brings me to the international dimension of the crisis.
After the financial crises of 1997 and 1998, the governments of the affected countries tried to protect themselves against a repeat performance. They avoided the foreign borrowing that had made them vulnerable to a cut-off of overseas funding. They built up huge war chests of dollars and euros, which were supposed to protect them in the event of any future emergency. And the conventional wisdom was that the "emerging markets" - Brazil, Russia, India, China and a host of smaller economies, including the victims of the 1997 crisis - were now "decoupled" from the US, able to keep growing despite the mess in America. "Decoupling is no myth," the Economist assured readers back in March. "Indeed, it may yet save the world economy."
Unfortunately, that doesn't seem likely. On the contrary, says Stephen Jen, chief currency strategist at Morgan Stanley, the "hard landing" in emerging markets may become the "second epicentre" of the global crisis.
What happened? Alongside the growth of the shadow banking system, there was another transformation in the character of the financial system over the past 15 years - namely, the rise of financial globalisation, with investors in each country holding large stakes in other countries. Like much of what has happened to the financial system over the past decade or two, this change was supposed to reduce risk: because US investors held much of their wealth abroad, they were less exposed to a slump in America, and because foreign investors held much of their wealth in the US, they were less exposed to a slump overseas. But a large part of the increase in financial globalisation actually came from the investments of highly leveraged financial institutions, which were making various sorts of risky, cross-border bets. And when things went wrong in the US, these cross-border investments acted as what economists call a "transmission mechanism", allowing a crisis that started with the US housing market to drive fresh rounds of crises overseas.
The failure of hedge funds associated with a French bank is generally considered to have marked the beginning of the crisis; by the autumn of 2008, the troubles of housing loans in places such as Florida had destroyed the banking system of Iceland.
In the case of the emerging markets, there was a special point of vulnerability, the so-called carry trade. This trade involves borrowing in countries with low interest rates, especially but not only Japan, and lending in places with high interest rates, such as Brazil and Russia. It was a highly profitable trade as long as nothing went wrong; but eventually something did.
The triggering event seems to have been the fall of Lehman Brothers, the investment bank, on September 15 2008. When Bear Stearns, another of the original five major US investment banks, got in trouble in March 2008, the Fed and the Treasury moved in - not to rescue the firm, which disappeared, but to protect its "counterparties", those to whom it owed money or with whom it had made financial deals. There was widespread expectation that Lehman would receive the same treatment, but the Treasury decided that the consequences of a Lehman failure would not be too severe, and let it go under without any protection for its counterparties.
Within days it was clear that this had been a disastrous move: confidence plunged further, asset prices fell off another cliff and the few remaining working channels of credit dried up. The effective nationalisation of AIG, the giant US insurer, a few days later failed to stem the panic.
And one of the casualties of the latest round of panic was the carry trade. The conduit of funds from Japan and other low-interest nations was cut off, leading to a round of self-reinforcing effects. Because capital was no longer flowing out of Japan, the value of the yen soared; because capital was no longer flowing into emerging markets, the value of emerging-market currencies plunged. This led to large capital losses for whoever had borrowed in one currency and lent in another. In some cases, that meant hedge funds - and the hedge fund industry, which had held up better than expected until the demise of Lehman Brothers, began shrinking rapidly. In other cases, it meant firms in emerging markets, which had borrowed cheaply abroad, suddenly faced big losses.
For it turned out that the efforts of emerging market governments to protect themselves against another crisis had been undone by the private sector's obliviousness to risk. In Russia, for example, banks and corporations rushed to borrow abroad because foreign interest rates were lower than rouble rates. So while the Russian government was accumulating an impressive $560bn hoard of foreign exchange, Russian corporations and banks were running up an almost equally impressive $460bn foreign debt. Then, suddenly, these corporations and banks found their credit lines cut off and the rouble value of their debts surging. This, truly, is the mother of all currency crises, and it represents a fresh disaster for the world's financial system.
So what does all this portend for the "real economy", the economy of jobs, wages and production? Nothing good.
The US, Britain, Spain and several other countries probably would have suffered recessions when their housing bubbles burst even if the financial system hadn't broken down. But the financial collapse seems certain to turn what might have been a run-of-the-mill recession into something much, much worse. The intensification of the credit crisis after the fall of Lehman Brothers, the sudden crisis in emerging markets, a collapse in consumer confidence as the scale of the financial mess hit the headlines, all point to the worst recession in the world as a whole since the early 80s. And many economists will be relieved if it's only that bad.
What's really worrying is the loss of policy traction: the economy is stalling despite repeated efforts by policy-makers to get it going again. This policy helplessness is reminiscent of the 30s.
The world economy is not in depression; it probably won't fall into depression, despite the magnitude of the current crisis (although I wish I was completely sure about that). But while depression itself has not returned, depression economics - the kinds of problems that characterised much of the world economy in the 30s - has staged a stunning comeback. Fifteen years ago, hardly anybody thought that modern nations would be forced to endure bone-crushing recessions for fear of currency speculators, and that major advanced nations would find themselves persistently unable to generate enough spending to keep their workers and factories employed.
For the first time in two generations, failures on the demand side of the economy - insufficient private spending to make use of the available productive capacity - have become the clear and present limitation on prosperity for a large part of the world. The global credit system is in a state of paralysis, and a global slump is building momentum. What we need right now is a rescue operation. Policy-makers around the world need to do two things: get credit flowing again and prop up spending.
The first task is the harder of the two, but it must be done, and soon. Hardly a day goes by without news of some further disaster wreaked by the freezing up of credit. What lies behind the credit squeeze is the combination of reduced trust in and decimated capital at financial institutions. People and institutions, including the financial institutions, don't want to deal with anyone unless they have substantial capital to back up their promises, yet the crisis has depleted capital across the board.
The obvious solution is to put in more capital. In fact, that's a standard regulatory response in financial crises. In 1933, the Roosevelt administration used the Reconstruction Finance Corporation to recapitalise banks by buying preferred stock - stock that had seniority over common stock in terms of its claims on profits. When Sweden experienced a financial crisis in the early 90s, the government stepped in and, in return for a partial ownership, provided the banks with additional capital equal to 4% of the country's GDP - the equivalent of about $600bn for the US today. When Japan moved to rescue its banks in 1998, it bought more than $500bn in preferred stock, the equivalent relative to GDP of around a $2 trillion capital injection in the US. In each case, the provision of capital helped restore the ability of banks to lend and unfroze the credit markets.
A financial rescue along similar lines is now under way in the United States and other advanced economies, although it was late in coming, thanks in part to the ideological tilt of the Bush administration. At first, after the fall of Lehman Brothers, the US Treasury proposed buying up $700bn in troubled assets from banks and other financial institutions. Yet it was never clear how this was supposed to help the situation. (If the Treasury paid market value, it would do little to help the banks' capital position, while if it paid above-market value, it would stand accused of throwing taxpayers' money away.) Never mind: after dithering for three weeks, the US followed the lead already set first by Britain and then by continental European countries, and turned the plan into a recapitalisation scheme.
It seems doubtful, however, that this will be enough to turn things around, for at least three reasons. First, even if the full $700bn is used for recapitalisation (so far only a fraction has been committed), it will still be small, relative to GDP. Second, it's still not clear how much of the bail-out will reach the shadow banking system, the core of the problem. Third, it's not clear whether banks will be willing to lend out the funds, as opposed to sitting on them (a problem encountered 75 years ago by the New Deal).
My guess is that the recapitalisation will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control - in effect, it will come closer to a full temporary nationalisation of a significant part of the financial system.
All these actions should be coordinated with other advanced countries. Part of the payoff to US rescues of the financial system is that they help loosen up access to credit in Europe; part of the payoff to European rescue efforts is that they loosen up credit in the US. So everyone should be doing more or less the same thing; we're all in this together.
And one more thing: the spread of the financial crisis to emerging markets makes a global rescue for developing countries part of the solution to the crisis as well. As with recapitalisation, efforts so far look as if they're in the right direction, but too small, so more will be needed.
Even if the rescue of the financial system starts to bring credit markets back to life, we'll still face a global slump that's gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus.
Now, the US tried a fiscal stimulus in early 2008; both the Bush administration and congressional Democrats touted it as a plan to "jump-start" the economy. The actual results were, however, disappointing for two reasons. First, the stimulus was too small, accounting for only about 1% of GDP. The next one should be much bigger, say, as much as 4% of GDP. And second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The next plan should focus on government spending on roads, bridges and other forms of infrastructure.
The usual objection to public spending as a form of economic stimulus is that it takes too long to get going - that by the time the boost to demand arrives, the slump is over. That doesn't seem to be a major worry now, however: it is very hard to see any quick economic recovery, unless some unexpected new bubble arises to replace the housing bubble. (A headline in the satirical newspaper the Onion captured the problem perfectly: Recession-Plagued Nation Demands New Bubble to Invest In.) As long as public spending is pushed along with reasonable speed, it should arrive in plenty of time to help - and it has two great advantages over tax breaks. On one side, the money would actually be spent; on the other, something of value (eg, bridges that don't fall down) would be created.
And once the recovery effort is well under way, it will be time to turn to prophylactic measures - reforming the system so that the crisis doesn't happen again.
At the start of the Great Depression, John Maynard Keynes said: "We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand." How did this second great colossal muddle arise? In the aftermath of the Great Depression, we redesigned the machine so that we did understand it - or, at any rate, well enough to avoid big disasters. Banks, the piece of the system that malfunctioned so badly in the 30s, were placed under tight regulation and supported by a strong safety net. Meanwhile, international movements of capital, which played a disruptive role in the 30s, were also limited. The financial system became a little boring but much safer.
Then things got interesting and dangerous again. Growing international capital flows set the stage for devastating currency crises in the 90s and for a globalised financial crisis in 2008. The growth of the shadow banking system, without any corresponding extension of regulation, set the stage for latter-day bank runs on a massive scale. These runs involved frantic mouse clicks rather than frantic mobs outside locked bank doors, but they were no less devastating.
What we're going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won't try to lay out the details of a new regulatory regime, but the basic principle should be clear - anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn't a crisis so that it doesn't take excessive risks. Since the 30s, commercial banks have been required to have adequate capital, hold reserves of liquid assets that can be quickly converted into cash and limit the types of investments they make, all in return for federal guarantees when things go wrong. Now that we've seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.
We're also going to have to think hard about how to deal with financial globalisation. In the aftermath of the Asian crisis of the 90s, there were some calls for long-term restrictions on international capital flows. For the most part, these calls were rejected in favour of a strategy of building up large foreign exchange reserves that were supposed to stave off future crises. Now it seems that this strategy didn't work.
In this new era, John Maynard Keynes - the economist who made sense of the Great Depression - is now more relevant than ever. Keynes concluded his masterwork, The General Theory Of Employment, Interest And Money, with a famous disquisition on the importance of economic ideas: "Soon or late, it is ideas, not vested interests, which are dangerous for good or evil."
We can argue about whether that's always true, but in times such as these, it definitely is. The quintessential economic sentence is supposed to be "There is no free lunch"; it says that there are limited resources, that to have more of one thing, you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes' world - and ours - was therefore not of resources, or even of virtue, but of understanding.
© Paul Krugman, 2008
• This is an edited extract from The Return Of Depression Economics And The Crisis Of 2008, by Paul Krugman, published next week by Penguin