CNN Impact, November 7, 1997: Interview with Paul Krugman


JOHN STACKS, EXECUTIVE EDITOR, TIME MAGAZINE: It starts in Southeast Asia, where many believe the tigers are performing an economic miracle, but beneath the double digit annual growth rates lurk problems.

PROF. PAUL KRUGMAN: Big trade deficits, a lot of weakness in the financial sector, which is really just a lot of bad lending, speculative bubbles in the real estate market.

STACKS: Economist Paul Krugman writes about those three years ago, but his warnings are ignored.

KRUGMAN: Most people discounted all those problems, because they said Asia is different. There's some kind of Asian miracle which means the usual risks don't apply.

STACKS: But gradually the world's currency traders come to share Krugman's views. Early this year they smelled blood.

DAN KADLEC, TIME STOCKS COLUMNIST: It was triggered by something that the speculators, the hedge fund managers always look for, which is an economy on the brink. In Thailand the banks have loaned more money than they have deposits. You can't sustain that, and when it collapses, it collapses very hard.

STACKS: That happens July 2nd. Thailand devalues its currency after traders attack and the Thai baht eventually falls 40 percent.

KRUGMAN: Once you've discovered that Thailand basically collapses under the pressure, you revise you're estimate of how strong the neighbors are, so they also tend to come under attack.

STACKS: The currencies of Indonesia, Philippines and Malaysia fall like dominoes dropping up to 50 percent.

Meanwhile, the U.S. stock market roars on oblivious.

LEON HARRIS, CNN ANCHOR: Record-setting day on Wall Street as the Dow Jones industrials barreled pass the 8,000 mark.

KADLEC: You can't blame anybody for not even noticing what happened over there, but the fact that our market is so high to begin with means that any little trouble around the world creates at the margin a little bit of earnings pressure, which cannot down the stocks in this country.

STACKS: And that trouble comes in Hong Kong, the government staves off an attack on the Hong Kong dollar, but to do so it raises short-term interest rates more than 200 percent.

EDWARD YARDENI, DEUTSCHE MORGAN GRENFELL: The problem with that, of course, is it annihilated the stock market. It raises tremendous concerns about property values, which got very inflated in Hong Kong.

STACKS: Events in Hong Kong turn a regional crisis international.

ROBERT HORMATS, GOLDMAN SACHS: Well, the Hong Kong crisis became a broader global financial crisis, in part because Hong Kong is an important trading entity, and in part because Hong Kong is a major banking center.

STACKS: Now the roller coaster begins. The Hong Kong index falls 10 percent. Other Asian markets will soon be dropping at risk of being pulled under; banks, realtors and investors. Following the sun around the world, stocks start to fall. London and Paris each drop over 3 percent. By the end of the day in New York the Dow Jones Index of key industrial stocks is Down 186 points. Friday the Dow drops a further 132 points in. In two days it has lost 4 percent.

HORMATS: Over the weekend these apprehensions obviously build as people talk to one another and share their angst. It just was more psychological than anything else.

STACKS: Monday the bottom drops out.

UNIDENTIFIED MAN: Trading was halted not once, but twice after stock prices plummeted in New York. (bell)

STACKS: The Dow records its largest point drop in history, 554 points just over 7 percent of its value. But that's nowhere near the 22 percent the Dow lost almost exactly a decade before during 1987's Black Monday. Nevertheless, on this Monday the worlds' markets combined to lose 1.2 trillion dollars.

KADLEC: If you ever thought your fortunes weren't tied to people halfway around the world, you've got a lesson last week. You can't have a panic in a financial market in Asia or Japan or Latin America or anywhere without it spreading around the globe.

STACKS (on camera): But something else was also at work. The U.S. stock market has doubled in value in just 2 1/2 years, and the Asian crisis presented itself to some investors as the right moment to cash out and take profits. (voice-over): It's the big institutional investors who are dumping. The new global market is in play and the retirement nest eggs of up to half the U.S. population are threatened.

UNIDENTIFIED MAN: This is all the bad blood that's going to come out today.

STACKS: But these small investors who now play a much more important role then they did a decade ago do not panic.

VALERIE WILLIS, INVESTOR: I believe any kind of correction provides buying opportunities. I'm a long-term investor, I'm going to be there ten years from now. I was there ten years ago.

KADLEC: It's really ironic that main street bailed out Wall Street. The mutual fund managers saw the little guy wasn't going to panic, so they started going in and buying because they could see then a buying panic, really.

STACKS: In a wild swing, the largest single point loss is followed by the busiest day in trading in Wall Street history. One point two billion shares changed hands sparking a 337 point gain.

YARDENI: And then when I saw that volume on Tuesday, I said well wait a second is irrational exuberance back already?

STACKS: Exuberance shared by these small investors at this Atlanta investment club who meet Tuesday night.

UNIDENTIFIED WOMAN: My recommendation is that we buy more.

UNIDENTIFIED MAN: There were some stocks, I was really tempted, but I didn't even have time. I mean there was some good buys.

STACKS: Wednesday morning chaos at the Senate Finance Committee. The most powerful financial figure in the world, Federal Reserve Chairman Alan Greenspan testifies. Greenspan says the correction is overdue.

ALAN GREENSPAN, FEDERAL RESERVE CHAIRMAN: It is quite conceivable that a few years hence, we will look back at this episode as we now look back at 1987 crash as a salutary event.

KADLEC: It was the crash that everybody wanted, because it took some of the air out of what was clearly an inflated market.

STACKS: The week closes quietly. The Hong Kong index closes down a total of five percent for the week. New York ends the week a modest 3.5 percent Down. So who were the winners and losers? clearly, Asia lost.

KRUGMAN: The average Asian is pretty badly hit, right? Here we have countries that had been booming and that boom was trickling Down to a lot of people. A lot of people are going to be selling their cell phones.

STACKS: The Asian crisis also leaves Japan vulnerable.

YARDENI: The world's second largest economy, namely Japan, is going to suffer. Japan exports a great deal to all these other Asian countries, and if they fall into recessions, then Japan's economy, which has been faltering as it is, is probably going to sink into another recession.

STACKS: And in the United States, companies with big sales in Asia could take a hit. As for the U.S. economy in general ...

HORMATS: I don't think the impact on the U.S. Economy per se is going to be all that significant.

STACKS: Whatever happens this coming week, there is now another cautionary date to add to the calendar of the world's financial history.

YARDENI: Octobers do have a history of being difficult months for the stock market. They're not always bad, but when they're bad, they can be awfully bad as they were in October of 1929 and more recently, in October of 1987. The one thing I know for certainty is October is over, thank god!

FRAZIER: So, it happened and it can happen again. It might be wise to recall the words of Economist Joseph Schumpeter, unknown to most of us, but famous in academic circles for calling capitalism a gale of creative destruction. The events of the past 10 days prove that right. Bernie's back with a final thought in a moment.


Originally broadcast, 11.7.97