The Return of Depression Economics

So, who should read this book? Firstly, anyone who'd like a deeper insight into what's driven the current financial situation. If you're not an expert in economic theory, and want a better understanding of the crisis, this is a book for you.

Secondly, because of the author's panache as a writer, this book will appeal to anybody who likes a good story, well told – especially those who enjoy dry humor and a clever turn of phrase. This is a great read for people who like to absorb useful information and be entertained at the same time.

So, listen up if you want to find out the role hedge funds played in the current financial crisis, how new technology brought back the romance of capitalism, and what we should have learned from the 'tequila crisis.'

Depression Economics has witty chapter titles and section headings, and is packed with irreverent understatements and asides. With very few exceptions, the book is proudly free from jargon, and the author pokes fun at the 'inscrutable diagrams' often found in other books that attempt to explain finance and economics. He says it's his mission to present ideas in a way that most people will find accessible and understandable.

The book's ten chapters give a chronological history of important financial events. The first chapter, called 'The Central Problem Has Been Solved,' is a general introduction to the topic, and sets the ideological tone of the book and the author's approach. It covers the Great Depression of the nineteen-thirties and its supposed resolution. The subheadings 'Capitalism Triumphant,' 'The Taming of the Business Cycle,' 'Technology as Savior' and 'The Fruits of Globalization' sum up the author's angles on the story.

As we approach the nineteen-nineties, the author shows how technological advances and the information industry brought back the heroic entrepreneur, and the romance of capitalism. He claims this had disappeared with the growth of what he calls faceless and impersonal corporations in the economy. "Who could be enthusiastic about capitalism that seemed more or less like socialism without the justice?" the author jokes.

He adds that the rise of successful individuals through the information industries suddenly made business magazines interesting to read again, as corporate success and wealth had again become admirable, and this favored free market ideas.

The author's opinions and his sense of irony come out most strongly in his discussion of Third World countries, and how he believes that improvements in living standards in some of them were not the result of anyone's good intentions. He makes digs at certain targets, such as what he sees as corrupt governments faking benign policies, entrepreneurs, moralists and humanitarians.

His lead into chapter two pokes fun at those he calls 'sensible observers,' who failed to see the writing on the wall for today's crisis in the events that affected Latin America in the early nineteen nineties.

He calls this chapter 'Warning Ignored. Latin America's Crises.' It starts with the ways economists always used to associate debt, currency crises, bank bailouts and hyperinflation with Latin America. The region's tendency toward what the author calls 'macroeconomic populism' appeared to be cured at the end of the nineteen eighties. This is when free market policies that had succeeded in Chile led to reduced budget deficits, the end of import restrictions, and the privatization of state-owned industries across the region – and especially in Mexico.

But three months after the 'Mexican Miracle' was championed in nineteen ninety four, euphoria plunged and we saw what became known as 'the tequila crisis' – an economic mess-up that the author says has been strangely ignored.

Mexico's government chose to devalue its currency, the peso, to make exports more competitive, and assets more attractive to foreign investors. But he says they botched the job, and the result was panic. The tequila effect, as it became known, spread to Argentina – a country which the author reminds readers is nowhere near Mexico. Argentina's banks started calling in loans, and credit contracted.

Two years later, the economies of both countries were booming, and economists concluded that Mexico, for its unique relationship with the United States, was a law unto itself, and that actually the crisis wasn't relevant to the rest of the world. But this was the wrong conclusion, the author says.

The nineteen ninety-four to nineteen ninety-five Latin American crisis distinctly resembles the current economic situation because Mexico wasn't doing anything considered 'wrong' before it faltered. That is, the world agreed that the Mexican economy was a great success, and then it failed. The author's conclusion is that widely praised and fashionable economic policies can lead a nation into disaster.

Critical readers might be unconvinced about how helpful this conclusion is with regard to the current crisis. But nonetheless, this chapter is completely gripping, as the drama of the story and the author's subtle observations gradually unfold.

The author's sharp wit is a constant, so each chapter will have readers chuckling. He also knows how to build a good storyline out of significant financial events, with the result that this book on economics is a rare page-turner.

In chapter three, 'Japan's Trap,' the author really gets into his stride, with catchy phrases, comparisons and paradoxes, such as Japan's 'growth-recession.' He teases analysts for using amateur sociology to explain why the Japanese were good at producing high-quality goods at low cost, and pokes fun at our weakness for media 'factoids' – like press reports that the land under Tokyo's Imperial Palace was worth more than the whole state of California.

It's in the chapter on Japan that the author explains, in a serious moment, the economic principle of 'moral hazard,' which is taking an immoral advantage of profits that can be gained by insuring against risk. Moral hazard, he says, comes into play whenever borrowed money is at stake, but it ballooned to global epidemic proportions in the nineteen eighties.

The author's political leanings as an economic theorist come out here too, in the section called 'Japan Adrift.' It's clear that Japan's near decade of stagnation fascinates the author as a challenge to widely held economic doctrine. The author's approach has been parodied by his critics as 'Cartoon Keynesianism' – in other words, a simplified, modern version of the theories of British economist John Maynard Keynes.

While the book so far is guaranteed to interest and entertain most readers, it may not hold surprises for those who are well versed in economics and international affairs. However, the next chapter, 'Asia's Crash,' is likely to appeal to anyone interested in learning something new, with its probing analysis of the 'Asian miracle,' focusing on Thailand, Malaysia and Indonesia.

The problem of moral hazard sketched out in the last chapter reappears here in the term 'crony capitalism' – when business success depends on the close relationships between the successful businesspeople and government officials. The chapter then examines the Asian meltdown. He says loss of confidence in this region became contagious, and investors saw troubles in one economy as equivalent to bad news about the others.

The author surprises us by concluding this chapter with Argentina, which he says had another 'Asian-style' crisis, ending in its two thousand and one currency plunge. A recession led to loss of confidence by its foreign investors, fleeing capital, credit crunch and a banking crisis. The final point the chapter makes is about policy: Why were governments so bad at damage management in these cases?

This issue is examined further in chapter five, on 'Policy Perversity.' By this, the author means decisions that troubled governments make to win market confidence, even when those decisions go against their own policy interests.

The chapter begins with a return to economic theory, made digestible and entertaining in the form of a parable. Next, it explains that solid economic policy is no longer enough. The depressing message is that nations now have no option but to play the confidence game and cater to the whims of the market. The author claims this has divorced international economic policy from real economics, and made it dance to the tune of amateur psychology.

Chapter six, called 'Masters of the Universe,' exposes the villains of the plot – and it's hard to put the book down here. The chapter begins with the figure of the evil speculator, in what the author parodies as 'the bad old days before the triumph of capitalism.' Insider trading might happen from time to time as a mere petty crime, but surely – the author says ironically – conspiracy theories no longer have a place in our brave new world of huge markets and national destinies!

This is where the infamous hedge funds come in. In a section called 'The Nature of the Beast,' hedge funds and off-shore operations are explained, while the following section focuses on 'The Legend of George Soros.' It shows the role this Hungarian-American entrepreneur and currency speculator played in the devaluation of the British pound.

Further chapters – called 'The Madness of Prime Minister Mahatir' and 'The Attack on Hong Kong' – continue the story of the unfolding crisis. And then we move to Russia: its difficulties in making the transition from communism to capitalism, and the US pressure on the I.M.F. to lend Russia money because of its nuclear arsenal.

The author deliberately leaves awkward questions unanswered here, to move on to another crisis: 'The Panic of Nineteen Ninety-Eight,' when the hedge funds ran out of steam and the U.S. Federal Reserve bailed one out. Fed chairman Alan Greenspan seemed to save the day on that occasion, but the next chapter soon puts an end to the hero myth surrounding Greenspan and his policies during his eighteen-year tenure in the role.

In chapter seven, called 'Greenspan's Bubbles,' the author points a finger at him for doing nothing to control America's stock and housing bubbles, and then for saying that a decline in house prices was "most unlikely."

Chapter Eight is titled 'Banking in the Shadows,' and continues the drama of our current credit crunch, by explaining why it was so devastating when the US housing bubble burst. This was because the financial system had changed, and different kinds of lending institutions had become major players. They operated as if they were banks – but they weren't regulated as conventional banks were.

The penultimate chapter, on 'The Sum of All Fears,' goes through the decline of housing prices, negative equity, and the ways mortgages were pooled into collateralized debt obligations, and then sold on to investors. The two last sections here, 'The Mother of All Currency Crises' and 'A Global Slump' speak for themselves. But it's the final chapter, which shares the title of the book, that spells out the author's remedy.

After criticizing supply-side economics as a crank doctrine, the author says the way to deal with the current emergency is a rescue operation to inject more capital into markets. He predicts that the urgent need for government control could lead to a temporary nationalization of parts of the U.S. financial system, with re-privatizing coming later.

He makes a few sharp digs at the recent Bush administration, for its 'ideological tilt,' which he says delayed the much needed financial rescue. He believes much bigger fiscal stimuli and increased public spending are crucial to the recovery.

Is the author actually predicting a depression? He says no, but each time he notes this in the book, his comment is followed by a proviso: he wishes he was sure!

In a section called 'Financial Reform,' the author summarizes how we got ourselves into this colossal muddle. He says the main culprit is the unregulated growth of a shadow banking system, which allows bank runs by a click of the mouse. Any type of organization that has to be rescued during a crisis should be regulated when the crisis is over, the author says, and he calls for a return to 'good old fashioned Keynesian economics.'

Another problem is financial globalization, and the author warns we're going to have to 'think hard' about how to deal with this.

The author concludes by saying he believes the "obstacles to world prosperity are the obsolete doctrines that clutter the minds of men." This sounds surprisingly optimistic, perhaps to the extent of being idealistic – at least in the context of all we've learned.

However, readers are left with a good idea of what's behind the current financial crisis, as well as gems of economic information that are bound to be relevant in years to come. Although it doesn't set out to improve our individual abilities to cope with the downturn, Depression Economics offers us highly relevant economic insight and understanding, combined with a stylish and entertaining read.

Part of the author's great appeal as a writer is his awareness of mass media and pop culture. His observations on human quirkiness, market pathologies, national prejudices, and the kinds of silly things we do, say and repeat, help us laugh at ourselves and each other. This makes what could be a depressing topic highly entertaining.

The Return of Depression Economics and the Crisis of 2008 is published in paperback by Penguin books.

That's the end of this episode of Book Insights.