The Return of Depression Economics and The Crisis of 2008 - Essay Example

The book draws parallel between the great depression and 2008 financial crisis and it explores depression economics through lenses of the Japan’s Lost Decade and 1997 Asian financial crisis (Krugman, 45). In the book, he analyzes the history of market crashes, like the panic of 1907 and the Tequila Crash in the mid-1990s; through demonstrating how banks exposed themselves too much risk, hence resulting to loss of confidence thereby causing capital fight and panic. In The Return of Depression Economics and the Crisis of 2008; Krugman warns that, just like a disease can become resistant to a vaccine, the economic difficulties that lead to great depression have made a comeback in the global economy.

He argues that the 2008 financial crisis is because of the failure to properly regulate the financial sector thereby turning around the world economy hence deep recession. Through this book readers can understand the history of financial crisis, its effects and possible resolutions the current financial problems. There were major financial crisis prior to 2008 financial crises. These include: the 1907 panic, the Great Depression, the Latin American Crisis of mid 1990s. The Savings and loans problems of the 80s, the Japan’s lost Decade and the Asian flu of the late 90s. . Loss of confidence played a big role in fueling these financial crises.

To get the economy moving especially during economic booms, the economic agents have a great deal of confidence, so much that large bets are placed on the prediction of continued success during the economic expansion. But a financial crisis starts with a minor change that reduces the level of confidence, hence leading to economic panics. The power of speculators can be felt in all aspects of the economy especially when there has been a collapse in confidence. Krugman demonstrates that speculators always hedge funds; however they rarely do much in the way of equivocation.

Their main focus is to make profit and they are willing to do so whenever such opportunity presents itself even if it means sacrificing the welfare of the entire community. They leveraged their positions up to 100 to 1 with an aim of devaluing the country’s currency for their own benefit. Their basic strategy is to exploit markets by shorting safer assets and then buying the riskier assets. However, when the market faces a financial crisis, these hedgers and speculators will create trades that will alter the stability of a nation’s financial markets with the local currency being the targeted element.

The devaluation of the currency will cause great pain and hardship to the citizens but this social cost is not relevant to the speculators. According to Krugman, the hedge funds are in most situations unregulated and the speculators take the necessary actions to stay away from the regulators (Krugman, 108). The shadow banking system also parallels the speculators in fueling the financial crisis. In both cases, the profit maximization was the motivator. Leverage was used at mind boggling levels each