August 31, 2013
The Unsaved World
by Paul Krugman (09-29-13)
The rupiah is falling! Head for the hills! On second thought, keep calm and carry on.
In case you’re wondering, the rupiah is the national currency of Indonesia, and, like many other emerging-market currencies, it has fallen a lot over the past few months. The thing is, the last big rupiah plunge was in 1997-98, when Indonesia was the epicenter of an Asian financial crisis.
In retrospect, that crisis was a sort of dress rehearsal for the much bigger crisis that engulfed the advanced world a decade later. So should we be terrified about Asia all over again?
I don’t think so, for reasons I’ll explain in a minute. But current events do bring back memories — and they are, in particular, a reminder of how little we learned from that crisis 16 years ago. We didn’t reform the financial industry — on the contrary, deregulation went full speed ahead. Nor did we learn the right lessons about how to respond when crisis strikes. In fact, not only have we been making many of the same mistakes this time around, in important ways we’re actually doing much worse now than we did then.
Some background: The run-up to the Asian crisis bore a close family resemblance to the run-up to the crisis now afflicting Greece, Spain and other European countries. In both cases, the origins of the crisis lay in excessive private-sector optimism, with huge inflows of foreign lending going mainly to the private sector. In both cases, optimism turned to pessimism with startling speed, precipitating crisis.
Unlike Greece et al., however, the crisis countries of 1997 had their own currencies, which proceeded to drop sharply against the dollar. At first, these currency declines caused acute economic distress. In Indonesia, for example, many businesses had large dollar debts, so when the rupiah plunged against the dollar, those debts ballooned relative to assets and income. The result was a severe economic contraction, on a scale not seen since the Great Depression.
Fortunately, the bad times didn’t last all that long. The very weakness of these countries’ currencies made their exports highly competitive, and soon all of them — even Indonesia, which was hit worst — were experiencing strong export-led recoveries.
Still, the crisis should have been seen as an object lesson in the instability of a deregulated financial system. Instead, Asia’s recovery led to an excessive showing of self-congratulation on the part of Western officials, exemplified by the famous 1999 Time magazine cover — showing Alan Greenspan, then the Fed chairman; Robert Rubin, then the Treasury secretary; and Lawrence Summers, then the deputy Treasury secretary — with the headline “The Committee to Save the World.” The message was, don’t worry, we’ve got these things under control. Eight years later, we learned just how misplaced that confidence was.
Indeed, as I mentioned, we’re actually doing much worse this time around. Consider, for example, the worst-case nation during each crisis: Indonesia then, Greece now.
Indonesia’s slump, which saw the economy contract 13 percent in 1998, was a terrible thing. But a solid recovery was under way by 2000. By 2003, Indonesia’s economy had passed its precrisis peak; as of last year, it was 72 percent larger than it was in 1997.
Now compare this with Greece, where output is down more than 20 percent since 2007 and is still falling fast. Nobody knows when recovery will begin, and my guess is that few observers expect to see the Greek economy recover to precrisis levels this decade.
Why are things so much worse this time? One answer is that Indonesia had its own currency, and the slide in the rupiah was, eventually, a very good thing. Meanwhile, Greece is trapped in the euro. In addition, however, policy makers were more flexible in the ’90s than they are today.
The International Monetary Fund initially demanded tough austerity policies in Asia, but it soon reversed course. This time, the demands placed on Greece and other debtors have been relentlessly harsh, and the more austerity fails, the more bloodletting is demanded.
So, is Asia next? Probably not. Indonesia has a much lower level of foreign debt relative to income now than it did in the 1990s. India, which also has a sliding currency that worries many observers, has even lower debt. So a repetition of the ’90s crisis, let alone a Greek-style never-ending crisis, seems unlikely.
What about China? Well, as I recently explained, I’m very worried, but for entirely different reasons, mostly unrelated to events in the rest of the world.
But let’s be clear: Even if we are spared the spectacle of yet another region plunged into depression, the fact remains that the people who congratulated themselves for saving the world in 1999 were actually setting the world up for a far worse crisis, just a few years later.
A version of this op-ed appears in print on August 30, 2013, on page A19 of the New York edition with the headline: The Unsaved World.