The Charlie Rose Show, October 23, 2008

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CHARLIE ROSE, HOST: Welcome to the broadcast. Tonight Princeton economics professor, "New York Times" columnist and 2008 Nobel Prize winner, all one person, his name is Paul Krugman. And he is here.

PAUL KRUGMAN, 2008 NOBEL PRIZE WINNER IN ECONOMICS: Ordinarily, we like thrift, but we`re in a St. Augustine economy, "oh, lord."

CHARLIE ROSE: We conclude with David Smick. His new book is called "The World is Curved." It`s been praised by, among others, David Brooks in his "New York Times" column.

DAVID SMICK, AUTHOR, "THE WORLD IS CURVED": When I look at the world of finance, which is the world I know, the world is curved, in the sense you can`t see the dangers over the horizon. So I decided to write these dangers, and it turned out my title, "The World is Curved: The Hidden Dangers of the Global Economy" -- people keep reminding me they`re not hidden anymore. So maybe I should change the title.

CHARLIE ROSE: Krugman and Smick next.

ANNOUNCER: From our studios in New York City, this is Charlie Rose.

CHARLIE ROSE: Paul Krugman is here. He is a Princeton professor, a "New York Times" columnist, and this year`s Nobel Prize recipient in economics. He gets a prestigious award for his study of international trade and the effects of globalization. It is a great time to welcome Paul Krugman back to this table. Welcome.


CHARLIE ROSE: And congratulations.

PAUL KRUGMAN: Thank you.

CHARLIE ROSE: Was this is a surprise?

PAUL KRUGMAN: Yeah, it was. Absolutely. They caught me just about to step into the shower.

CHARLIE ROSE: Is that when they called? I`ve done this before, but tell me how it went.

PAUL KRUGMAN: Well, this guy called me. I said hello.

CHARLIE ROSE: Is this Professor Krugman?

PAUL KRUGMAN: Yes. And my immediate thought was that is an obviously fake Swedish accent. This is a practical joke. I didn`t believe it until it was on their web site...

CHARLIE ROSE: Did you have a notion someone might be doing it?

PAUL KRUGMAN: All kinds, I mean, people -- there could be easy ways, various people might have done it. So anyway, I was actually out of town. They got me on my cell phone. My wife was out of town at a different place. I got her on the phone. I said, this might be a practical joke, but somebody called me and said this. She said oh, my God. Pause. We don`t have time for this.

CHARLIE ROSE: We can`t be bothered.

PAUL KRUGMAN: It was completely out of the blue. No hint whatsoever.

CHARLIE ROSE: But most people know building up. I`ve had people say that at some point this person is going to get a Nobel Prize because often the work is not they work they did yesterday. It`s work they did over the years.

PAUL KRUGMAN: I`d been mentioned people had told me. In fact, there had been other years in which the university made sure they knew where I was on the day it was announced, but not this year it turns out.

CHARLIE ROSE: So you thought all hope is lost. They don`t care where I am.

PAUL KRUGMAN: Also there was apparently a panic at Princeton. Luckily, it turns out, somebody, a personal friend who happened to be Swedish, had given the committee my cell phone. Otherwise nobody would have been able to find me.

CHARLIE ROSE: What was it that so impressed the Nobel committee that they decided to give you the economics` prize, which is a big one?

PAUL KRUGMAN: Economists talk about international trade for a couple centuries. And for about 180 of those 200 years, there was a basic view, which was that countries trade because they`re different. This country is tropical so it exports bananas. This country`s got lots of land so it exports wheat. There was this kind of building discontent because a lot of world trade is between countries that don`t look very different. It`s difficult to come up with some fundamental reason why the united states should be making jet aircraft and not some European country, and why the Japanese should be ahead of us in the car industry or they used to be, and not in something else. There were some stories about it, but it hadn`t been rally pulled together. I and a few other people put together this thing, the new trade theory, which talked about how very small, almost accidental advantages get built into larger advantages that then persist over time. So it can be almost some story -- we have our favorite story of -- all the carpet production in the United States used to be located around Dalton, Georgia. It traces back to some teenage girl who made a tufted bedspread as a wedding gift in 1895. And then one thing led to another. So that kind of thing -- and this built into a theory of international trade. It was really important to have the nice little mathematical models because that`s how you clarify your thoughts. Then you can start to talk in plain English. Then the location of production within countries, that was sort of the second string to this. It was -- a lot of it sounds obvious now, but it was completely new. Nobody could think about these things clearly until that point.

CHARLIE ROSE: That reminds me, the furniture business is in High Pointe, North Carolina, sort of the center of the global furniture business in part. I have no idea why it`s true.

PAUL KRUGMAN: Costume jewelry is in and near Providence and that`s because some guy invented filled gold in the 1790s. There are all these stories. There was a great story about the detachable collar and cuff industry of Troy, New York, which unfortunately is no longer with us.

CHARLIE ROSE: And are trading patterns changing significantly now because of the obvious reason, China is building up a manufacturing base and it can manufacture things that the rest of the world has wanted and sell them at an effective price.

PAUL KRUGMAN: There is actually a funny story about that because I was doing a lot of work in 1980s or when the -- world trade has kind of shifted from the north, south. European countries trading with their colonies to north, north cradle of these advanced countries trading with each other. No sooner did we have this new theory about why there is so much north-north trade that north-south trade started growing again. Now we have a big shift. In some way the old trade theory is more relevant now than when I was writing. The latest wrinkle in a theory is not necessarily the latest thing in the world.

CHARLIE ROSE: But is the most dramatic change taking place because of these emerging markets that have both economic power as well -- and both in terms of demand and...

PAUL KRUGMAN: Oh, yes, it`s transformational. When I was in grad school, the developing countries didn`t count economically. They were just too small. If you knew what was happening in the G7, you knew what was happening in the world economy. Now we`re in a world economy where China isn`t yet the world`s biggest economy but it will be. We`ve just had a big shift of the center of gravity towards these new powers.

CHARLIE ROSE: When you say it will be the biggest economy, what`s the measurement, gross domestic product? Is that the measurement?

PAUL KRUGMAN: Yes, gross domestic product. And basically because there are a lot more of them than there are of us, and they`re just as smart as we are, so eventually they will pull ahead of us just on that basis.

CHARLIE ROSE: But as we talk, their rate of growth has declined to single digits.

PAUL KRUGMAN: We`re having a global crisis, which is -- I mean, this is -- that doesn`t say much about the long run. America had the Great Depression and we were still the world`s greatest industrial power. But we are seeing this global crisis, and, you know, decoupling was the story six months ago.

CHARLIE ROSE: No longer.

PAUL KRUGMAN: No longer. But we are coupled with a vengeance.

CHARLIE ROSE: With a vengeance. So tell me where you think it`s going, this global economic crisis that has engulfed the world.

PAUL KRUGMAN: I`m actually more hopeful than I was a couple weeks ago because a couple weeks ago we seemed to be completely floundering in the response. And now at least there`s a response to the immediate financial crisis that makes sense. We do have all the major governments pumping capital into the financial system, all of them essentially buying shares in the banks and bank-like institutions, and putting capital in guarantees.

CHARLIE ROSE: And that`s a good thing? An essential thing?

PAUL KRUGMAN: It`s an essential thing. Better if we didn`t have to do it. But given where we are, that`s what we ought to be doing. The fundamental thing that`s happened is that we had these initial losses, so there is an initial problem, which is the housing bubble bursts, and people start defaulting on mortgages and you lose a lot of value there. But then that depletes the capital of banks and other financial institutions, leaving them unable to do business, forcing them into fire sales of assets, reducing their capital even further. We had like a building in an earthquake where the floors start pancaking down. So now we`ve got somebody rushing in to basically throw in supports to keep that from happening. And that`s good. It doesn`t solve -- you know, we also have one heck of a recession probably already baked in. Even if we get this financial thing...

CHARLIE ROSE: To last through when, the end of 2009 or longer?

PAUL KRUGMAN: What`s baked in is probably through to the end of 2009. It could easily go much longer than that. I`ve been looking -- the last recession didn`t end when it ended. You know, officially it ended in, I guess, November of 2001, but the job markets didn`t start improving until the summer of 2003. And there is ever reason to think that what`s coming now will last at least that long. So we`re looking at probably a long siege.

CHARLIE ROSE: I hear you though saying that the government had no choice, the treasury secretary, whether they made some bad decisions, but they came to -- and the treasury secretary, who was just here. He essentially argued the following point: Look, we couldn`t have done what we did most recently, which is won more approval, which Gordon Brown had done in Britain because, A, the Congress wasn`t ready to do it, and, B, we had to get there by thinking that each of these things that we were trying might be enough.

PAUL KRUGMAN: Well, you know, there`s -- basically all hell broke loose. Can I say that? All hell broke loose after...

CHARLIE ROSE: Yes. You`re a Nobel Laureate. You can say whatever you want to.

PAUL KRUGMAN: ... after the treasury made a bad mistake, which was not to rescue Lehman Brothers. It turned out they were too connected to fail. And so...

CHARLIE ROSE: It was a mistake not to do it because the consequences in failing, rather than measuring them by the same measurement, because they make the argument, as you well, know better than I do.


CHARLIE ROSE: They make the argument that there was no buyer for Lehman Brothers and there was a buyer for Bear Stearns, and that was different.

PAUL KRUGMAN: Right, but it turns out that they could have found a way. In fact, just about all of us expected that they would and they decided, no, we can let this one go. The system can handle it.

CHARLIE ROSE: And it`s a moral hazard thing we got into.

PAUL KRUGMAN: Whatever. And it turned out to be, you know...

CHARLIE ROSE: It turned out to be a mistake because of the consequences and it sort of signaled to everybody around the world...

PAUL KRUGMAN: That nothing was safe. Basically it turned out that the idea that, well, you know, the fundamental strategic institutions, while the stockholders might get wiped out, the counter-parties would not, that your claims on them would be secure. When Lehman was allowed to fail, people said, oh, that`s not right. Then all confidence disappeared from the system. Within three days the whole market had frozen. That was a big mistake. But it also created the political conditions for more comprehensive solutions.

CHARLIE ROSE: That`s his point, Paulson`s point.

PAUL KRUGMAN: That`s right.

CHARLIE ROSE: It created the political conditions so they could go to Congress and say, give us $700 billion and all the authority in the world.

PAUL KRUGMAN: Right. And the question we don`t know is could they have done this with a series of case-by-case rescues instead. Because we talk about they`ve now in effect partially nationalized the banking system. They almost fully nationalized AIG a few weeks ago. They had in effect quasi-nationalized several other -- they nationalized Fannie and Freddie. So maybe we could have done this with a series of stages. Maybe this big plan wasn`t necessary. This we can`t answer. In any case they finally came around to doing what people like myself had been saying for some time was the right answer, after first coming up with the wrong answer.

CHARLIE ROSE: Fair enough. You`ve been saying the right answer was, what, recapitalizing the banking system? And you knew that because?

PAUL KRUGMAN: Recapitalize the system. Mostly conceptual, mostly thinking it through. How does this -- why are we getting this cascade of failure? Why are these things going downhill? You start to say, it`s about the balance sheets. What`s happening is, each one of these institutions that goes down or is threatened to go down, is having to do a fire sale which is driving the price down further. And the fundamental problem is the destruction of $500 or $700 billion or a trillion worth of capital in the mortgage, but this is leading to this secondary, these domino effects. And so what you do with that is you say, OK, you can let the system collapse and wait for ten years while the Warren Buffett`s of the world rebuild a new financial system. Or we can put capital in to prop it up right now. And that`s -- so the conclusion a lot of us reached was, you know, recapitalization. You know, previous experiences. What do we do with the SNLs? Essentially, we recapitalize them. What did the Japanese do in the end?

CHARLIE ROSE: But that was easier because there was property attached to them.

PAUL KRUGMAN: That`s right. It was easier to do because it was more transparent, but -- what the Swedes did in the early `90s, they recapitalized their banks. What the Japanese did in `96 and `98 to deal with their own banking problem was they bought preferred shares in the banks. More or less, exactly what Paulson is doing now. So there was precedent and logic behind it. That seemed to be the natural solution.

CHARLIE ROSE: Could the private sector have done more here? Could we have had more Buffett kind off confidence building because he used preferred stock, as you know?

PAUL KRUGMAN: Yes. It would have been -- you know, the hope was that it might happen. Again, it`s one of those things. You can say until September 18th or so, you might have been able to believe that possibly that would occur, but there wasn`t time. There wasn`t -- as things broke, there just wasn`t time to see, well, maybe there`s a private sector work out here because you don`t play games with what could be a second Great Depression.

CHARLIE ROSE: Tell us what that means. I mean, everyone uses words like the system will collapse, an economic collapse. And we know a bit about the depression, the Great Depression because we know about the soup lines and bank failures and banks being closed and we know people couldn`t -- people were in a very, very painful place.


CHARLIE ROSE: Were we close to that? Had we turned the corner in your judgment because of recapitalization and all the other factors at play?

PAUL KRUGMAN: I am not at all sure that we`ve turned the corner, but I`m slightly hopeful. You look at these various financial stress indicators, TED-spread and A2B2-spread -- never mind, right? You get all of these. And they all look better than they did a week ago. They`ve been improving for the lastfew days. But they`re all at levels that historically would have been crazy. So it looks like -- we had a 107- degree fever and now it`s 105. And we`re hopeful but we don`t know that the patient is going to be OK.

CHARLIE ROSE: But do we have any other errors in our quiver, so to speak?

PAUL KRUGMAN: Well, there are lots more. You can go and do a lot more of nationalization. That`s where it goes in the end. We move further into the business of intervening, having essentially the taxpayers stand behind the functioning of the system. You do need to do whatever is needed because what happens is credit starts becoming unavailable. It`s already started to happen. Corporations can`t float bonds. Small businesses can`t create...

CHARLIE ROSE: So the government had to come in and buy commercial paper?

PAUL KRUGMAN: Right. There are scattered stories of crazy stuff happening. Freighters full of wheat that can`t get unloaded because of the guy who was supposed to take the wheat off had his credit line cut off. In Britain, stories about bodies going unburied because funeral homes can`t get the money. So far it`s just anecdotes. But it`s the kind of thing that can take what`s already going to be a nasty recession -- like I said, that`s baked in -- and turn into something much worse. And every economist says there was this recession that began in `29, maybe in `28. It was a nasty recession. But it would have stopped there if you hadn`t had the bank runs and the bank failures of `31 and `32. So that`s what you don`t want to see happen again.

CHARLIE ROSE: What`s been missing from this? Everyone talks about confidence building. They`re no FDR.

PAUL KRUGMAN: Yes, well, certain...

CHARLIE ROSE: But would an FDR been able to get us out of this because of his power to, in a different time to communicate some hope and...

PAUL KRUGMAN: What FDR did was a lot more than communicating hope. There was a lot of real money behind it, too. If we had a U.S. government that was more proactive -- although I will give -- I`m not too fond of Henry Paulson`s handling of this. But I will say it`s probably true that the political consensus would not have been there for an all-out effort until really mid-September when all hell breaks loose. So there were limits on what could be done. But what we need now is we definitely need an FDR now. We need leadership. And it`s not just soothing words. We need money. We need a demonstration that people are in charge and, in a fair number of cases, actual taxpayer money hopefully not lost, but taxpayer money put on the line to make this system work.

CHARLIE ROSE: Speak to Paulson because he had an hour here to talk about why he did what he did.

PAUL KRUGMAN: Yeah. I actually was more or less approving of what was done until Lehman.


PAUL KRUGMAN: There were places where I would have done more, but Lehman -- I wasn`t 100 percent sure it needed to be rescued but I felt very nervous about it. I wrote about it at the time that he was playing financial Russian roulette.

CHARLIE ROSE: Right, you did.

PAUL KRUGMAN: There two big missteps, Lehman and then the initial version, the TARP. We`ve got to get a better name for this thing.

CHARLIE ROSE: Yes, I agree with that. I totally agree.

PAUL KRUGMAN: My colleague Alan Blinder ...

CHARLIE ROSE: Wall Street Bailout was not the right definition either.


CHARLIE ROSE: Alan Blinder?

PAUL KRUGMAN: Alan Blinder, based on Fannie Mae and all that suggested calling it hanky-panky. Any way, the initial version of this...

CHARLIE ROSE: They also said this, too, didn`t they?

PAUL KRUGMAN: Oh, dear, yes. Oh, my. But the initial version of the TARP did not make sense.

CHARLIE ROSE: Basically, your complaint about Paulson, secretary of the treasury, and Bernanke, they made these decisions together my impression is, and Geithner. Is it Lehman Brothers primarily or Lehman Brothers, plus asking for too much authority to rescue toxic securities?

PAUL KRUGMAN: It`s not just too much authority. It`s Lehman Brothers, plus not just too much authority but a wrong-headed program. The initial version of the TARP was we`re going to buy the toxic waste off these guys. They never made a good case why that was going to help. You buy the stuff off for what it`s really worth. Then the capital position of these guys isn`t helped, right?

CHARLIE ROSE: They said in the "New York Times" -- I`ll never forget this -- or the "Washington Post." It was some great Sunday story. The last line was, "nobody has a better idea," at that time.

PAUL KRUGMAN: But the fact of the matter is a lot of people did. And a lot of people -- a lot of people...

CHARLIE ROSE: A columnist for "The New York Times." PAUL KRUGMAN: Well, yes, and the whole sort of econo-blogosphere, whatever. All of those guys said, wait, in a situation like this, what you`re supposed to be doing is injecting capital and buy preferred shares. Why what are you doing buying toxic asset. In the end, they came around to that. But three weeks were wasted, and three weeks is an eternity in the stocks. CHARLIE ROSE: What was the opportunity lost because they wasted three weeks? PAUL KRUGMAN: A lot of further damage was done to confidence. You really got a situation where a lot more fear and loathing was put into the markets. I`m not sure there was that much actual destruction of institutions. Luckily, nothing big failed except AIG, which was essentially nationalized. But I think it does set you a pretty hard path now to getting us back even to the level of confidence that prevailed three days before Lehman. So it`s a little squishy. If I say were there a bunch of banks that failed, thankfully not, but there was a long time during which we just had this great pall of uncertainty.

CHARLIE ROSE: My sense of history would only have liked to have all the people that were raising this, you included, saying -- and knowing that in the deliberations -- if memory serves, Ben Bernanke came from Princeton?

PAUL KRUGMAN: We don`t know what actually happened in there. And there are reports that the Fed -- they haven`t said specifically Ben, but they said the Fed actually wanted preferred share purchases.

CHARLIE ROSE: Oh. Bernanke authored that because of what he understood about previous depressions or what?

PAUL KRUGMAN: Or the Fed has a superb staff and maybe the people there said, look, we know what happened in Japan. This is what we ought to do. Here is this advanced, sophisticated country that looks a lot of us, from an economist`s point of view, and they were having something that looked like a low-key version of the Great Depression. That`s not supposed to happen. That`s like having a tribe of nomads living in central New Jersey. This isn`t supposed to happen in a modern society. So there were saying there has to be some lessons for us here and trying to figure out how to not have it happen here. But the thought it is could. And it`s been scary because Ben Bernanke is the ideal person to have in that position. He knows more than anyone about what the Japanese did wrong. He`s been trying not to repeat it. And we`re still looking kind of Japanese.

CHARLIE ROSE: But I`m asking, what are the lessons from the Japanese`s experience as you were part of the Japan obsessives.

PAUL KRUGMAN: It is, first of all, hit the thing hard early, fiscal stimulus, monetary policy.

CHARLIE ROSE: Kind of a Powell military strategy?

PAUL KRUGMAN: Yes, overwhelming force. Hit it with capital injections to the banks is one of the things we learned. Don`t worry too much about inflation. Worry about that later. Inflation is not your problem right now. Better still, don`t have too low an inflation rate even to begin with because that higher inflation rate gives you more wiggle room when these things hit. The Fed actually did studies. They know models and all these things. They said if the Japanese had done X, Y, Z, they wouldn`t have that lost decade. They ran it through their models. So the Fed went and did X, Y, and Z, and it`s not quite working yet. So this is what`s scary.

CHARLIE ROSE: How do you assess his performance then?

PAUL KRUGMAN: I think Bernanke has done everything -- well, up to Lehman, I think he was doing fine. I think he did what you would expect. It wasn`t working as well as we would have hoped, but he did pretty much the same checklist of things I would have done. Does that make it the right thing? He did what I would have done. Then when -- he was -- whatever his private views may have been, he certainly did not publicly offer any counter-weight to Paulson`s initial, I think, misguided strategy on the bailout. And he ended up sounding like Paulson`s yes-boss supporter at a time when we really need someone to say, look, we need more than this.

CHARLIE ROSE: But my impression is that`s not the dynamic of the relationship, but I may be wrong, yes, boss.

PAUL KRUGMAN: No, it wasn`t yes, boss, but it was -- there was no hint in the public experiences, in those few days after the Paulson plan was initially announced, that there were any support from the Fed for things that were coming. You know, Chris Dodd came out quite quickly came...

CHARLIE ROSE: Chairman of the Senate Banking Committee.

PAUL KRUGMAN: Exactly. Came out with a proposal for essentially, let`s turn this into a capital injection. There was actually Bernanke saying, no, we don`t need to do that. And that was unfortunate. So not a great episode.

CHARLIE ROSE: So what I hear you saying and others have said, they came to the right idea late in the game, and suffered not only economic loss but some things made the situation, in terms of confidence-building, much more difficult?

PAUL KRUGMAN: That`s right. And they did the right thing only after all the alternatives were exhausted. That`s not entirely fair, but it`s...

CHARLIE ROSE: Some people talk about they ought to change this -- and I don`t know the right term -- but the amount of the leverage ratio for banks so that...

PAUL KRUGMAN: It`s looking forward. It`s not so much banks. Depository institution, big marble buildings, traditional banks, they`ve already got capital requirements. Their leverage is already limited. We have all these other institutions now that are...

CHARLIE ROSE: Capital requirements, you have to have so much capital to lend so much money?

PAUL KRUGMAN: That`s right. And that`s the inverse of a leverage ratio. But basically, you know, anything that has to be rescued like a bank ought to be regulated like a bank in terms of anybody who borrows short and lends long.

CHARLIE ROSE: But don`t you think that will be the end result of all this?

PAUL KRUGMAN: I hope some. I fear a little bit that the skies will clear and people will say, oh, let`s go back to business as usual. But it has to be. What we really need to have is -- this is, we hope, a much lower key, but this is a replay of the early 1930s. And we need to relearn our grandfather`s lessons. We need to say, OK, the banking system, which is now much bigger than just the commercial banks, needs to have capital requirements, needs to have some government guarantees. It needs to be regulated so that it doesn`t destroy the world when it runs amuck.

CHARLIE ROSE: Whether it be war or economics, we don`t listen to history, do we?

PAUL KRUGMAN: No, and we are doomed to repeat it.

CHARLIE ROSE: And we did. So George (inaudible) was right.

PAUL KRUGMAN: Yes, exactly.

CHARLIE ROSE: So have the presidential candidates, in your judgment - - you clearly have been among the most articulate of critics of President Bush.


CHARLIE ROSE: Has Senator Obama, for example, in your judgment, been out there showing a command of the situation, even though he could deserve a lot of credit because he`s consulting with all of the wise people of the Democratic Party?

PAUL KRUGMAN: Look, Obama clearly understands the basics of the financial situation. He talks about it in a way -- and even off script he talks about it in a way that makes it clear he understands it. He`s been a little cautious. He hasn`t taken a leadership role.

CHARLIE ROSE: Mistake or wise?

PAUL KRUGMAN: I think in some ways wise. Look, this stuff is technical. It is difficult. It is actually very difficult to formulate a plan without the resources of the Treasury Department behind you. It`s true that Chris Dodd and Barney Frank have come in and done it, but in some ways that -- they don`t run the same risks of seeming to be out of control that a presidential candidate does. So it`s OK. I might have been happier if that Dodd version of the TARP that came out right away had actually came from the Obama campaign. But I`m not crushed that it wasn`t. It`s all right. And we do know that people who know or are making a lot of sense do have the candidate`s ear.

CHARLIE ROSE: Based about what you know what, do you think a President Obama would do about all this? And where are his inclinations? And where is his ideology? And where is his...

PAUL KRUGMAN: He`s a moderately liberal Democrat. He`s not...

CHARLIE ROSE: Moderately liberal?

PAUL KRUGMAN: Moderately. He`s not -- he`s certainly not a Socialist as the McCain people tag him. But even then it puts...

CHARLIE ROSE: Is he any more liberal -- less liberal than Barney Frank?

PAUL KRUGMAN: I would think so, probably by instinct although it...

CHARLIE ROSE: By instinct he`s more liberal or less?


CHARLIE ROSE: Less liberal.

PAUL KRUGMAN: Put it this way. I think by his...

CHARLIE ROSE: Barney gets high marks for this, does he not, or no?

PAUL KRUGMAN: Very good. Of course, people go after him, but he has been very -- he was on this way in advance. And he was -- and I think I`m actually stealing his line, "Anything that needs to be rescued like a bank has to be regulated like a bank." I think that`s a Barney Frankism.

CHARLIE ROSE: That`s a good one. He does have talent for phrase making.

PAUL KRUGMAN: And Obama is a little more -- he`s more conservative and cautious, put it this way, than I am on these issues. His instincts go a little slowly, early on, when the sub-prime crisis was going on, his adviser, Austin Goolsby, who was my student, by the way.


PAUL KRUGMAN: So we`re all incestuous. But put out an article saying we don`t want to crush the ability of homeownership to spread. So there was a kind of carefulness about it. But that`s not such a bad thing. And in practice, clearly with this very broad consensus now that we need expanded regulation -- and Obama was early on saying that. He actually was ahead of the curve on that. So good stuff. I think we can expect something reasonable if he wins.

CHARLIE ROSE: Stimulus program, should we have one and should we have one now? And what should be in it? And what are they sort of building on what Bernanke said yesterday?

PAUL KRUGMAN: Yeah, we should have one, because even if the financial rescue is -- that`s sort of like battlefield medicine to stop the guy from bleeding to death immediately.

CHARLIE ROSE: That`s a metaphor that`s been overused. But it`s the best one.

PAUL KRUGMAN: Really. But meanwhile, there`s a lot of -- there`s -- as I say, there is a recession baked in. There is a tremendous amount of downward momentum. Retail sales are plunging. Industrial production is plunging. Consumer confidence is plunging. All of these things are heading us downhill. We need something to get us out of that. We should have a stimulus. My guess is we`re going to have two. We`re going to have a bipartisan stimulus, sort of November 5th or shortly afterwards.


PAUL KRUGMAN: And then we`ll probably need another and probably bigger one early...

CHARLIE ROSE: January 22nd, 23rd?

PAUL KRUGMAN: Yes, something like that. Now I have a view on this, which is that tax cuts and tax rebates should not be the core of this. In fact, they really -- because there is - - the last time around, the early 2008 stimulus package, because it had to go through the Bush White House, was essentially had to consistent of entirely things they could call tax cuts because Bush wouldn`t sign anything else. Those were only -- it`s hard to know exactly how effective it was. But the problem is a lot of people didn`t spend the money they got. Now we need the money spent.


CHARLIE ROSE: Why didn`t they spend it? Because they paid off their credit cards or they....

PAUL KRUGMAN: Credit cards, put it in their bank account.

CHARLIE ROSE: So they didn`t run out and buy a TV is the point.

PAUL KRUGMAN: Right. And this is -- ordinarily we like thrift, but we`re in a St. Augustine economy, "Oh, lord, make me chaste and continent, but not yet."


PAUL KRUGMAN: So what do we do now? There are some things you can do fast that we wanted, like expanded unemployment benefits extended. Those are the people who really are going to spend it because they desperately need the money. But now is the time to actually talk about spending programs, to talk about...

CHARLIE ROSE: Building infrastructure?

PAUL KRUGMAN: Building infrastructure. First of all, actually aid to state and local government because they`re cancelling infrastructure projects as we speak. I think the argument against infrastructure projects is always, well, they take time.

CHARLIE ROSE: Exactly. Right.

PAUL KRUGMAN: And you know, by the time they come online, the recession is over. This is not a concern right now. This looks like not just deep but long. Now...

CHARLIE ROSE: What does deep and long?

PAUL KRUGMAN: Depression is measured I believe by the unemployment rate, which I think is -- if it goes to 8, then it`s the worst recession since `82.

CHARLIE ROSE: So the growth rate right now is about 2 point something.

PAUL KRUGMAN: Whatever. I`m not...

CHARLIE ROSE: It goes to...

PAUL KRUGMAN: It goes to minus two.


PAUL KRUGMAN: Long, well, you know, my -- the last recession, although officially it was only eight months long, in fact, the unemployment rate -- the labor market didn`t start to improve for two and a half years. It wasn`t until the summer of 2003. If you look at the White House fact sheets on the economy, they always talk about jobs gained since August 2003. I seem to remember Bush being inaugurated in 2001. But the point was things got worse for two and a half years before they started to turn better. And there`s no reason to think -- there are some -- I can go into the economic logic. We used to have recessions because there was inflation and the Fed raised interest rates and housing crashed. And then when they let the interest rates come down again, housing perked up again. We have these V-shaped recessions. But recently, that`s not what happens. What we have is the private sector has irrational exuberance and then the bubble bursts. It`s very hard to get the economy restarted after that. And so these slumps go on for a long time. So it was two and a half years this last time. Easy to tell a story where it becomes three, four -- if we don`t have a strong fiscal program, it could be a Japanese-style lost decade, so long.

CHARLIE ROSE: What happens to commodity prices if that`s true?

PAUL KRUGMAN: They come down and stay low.

CHARLIE ROSE: So it all goes down to 30?

PAUL KRUGMAN: Hard to say. It partly demands on whether OPEC countries do start to cut back and all that. The story six months ago, nine months ago was that the world demand is growing because the Chinese are growing.

CHARLIE ROSE: And India is growing.

PAUL KRUGMAN: Well, it turns out the Chinese are joining us in this downward plunge. And so all of your stories about growing demand have got to be put on the shelf for some years. And that`s not good for oil prices.

CHARLIE ROSE: Exactly. Now here`s the question about all that for me is does that put some kind of hit on what the government is likely to do or might do about alternative sources of energy and all kinds of -- because as long as oil is at $148 a barrel, then alternative sources in terms of price point look very good.

PAUL KRUGMAN: Yes, it is a problem. We are seeing a lot of private - - well, a lot of private -- well, a lot of incentives for things that we`re going to have to do in the long run. In the long run, for limited resources, plus climate change reasons we`re going to have to use less of these fossil fuels. But that`s going to be a hard argument. The private incentives have suddenly evaporated. All of a sudden gas is cheap again. And the public sector, it`s a hard case for people. I`m getting a lot of people bending my ears saying that we need to -- the infrastructure spending has to include a lot of green investment. And I haven`t done the homework to figure out how much of that can be productively done, but it is a problem.

CHARLIE ROSE: They`re saying that to me, too. I hear that all the time. How do you factor in, in terms of whatever money you`re going to do to stimulate infrastructure, to make that green and make that part of sort of that energy spending ought to be crucial to whatever stimulus this economy needs.

PAUL KRUGMAN: But there is still a -- and there is a tension because, although I`ve said there`s plenty of times, you still don`t want projects that will take five or seven years to get going. You want stuff you can do in a year or so.

CHARLIE ROSE: And other than a direct investment to state and local governments, what`s the best alternative for that as a stimulus program?

PAUL KRUGMAN: I think there are lots of -- there are lots of actual infrastructure projects where people know what is to be done. They actually have, more or less, have the design on the books. I was at a meeting with Governor Corzine not too long ago where people were talking about can we accelerate the plans for the second tunnel under the Hudson, that sort of thing.

CHARLIE ROSE: All these questions are being raised about capitalism.

PAUL KRUGMAN: Right. Look, we had something which we called capitalism from the 1930s until 1980 which was a fairly tame, somewhat regulated system where banks were heavily regulated, where taxes on the rich were pretty high. It was still a market economy. Then we went into the age of Reagan, which is the age of deregulation; government is never this solution, it`s always the problem; Wild West capitalism. We`re probably going back to something more like the capitalism I grew up in, which was still capitalism, but not quite as free wheeling.

CHARLIE ROSE: Either scrutinized or regulated?

PAUL KRUGMAN: Right. And that`s not such a terrible thing. We are not going to move Labor Day back to May 1st.

CHARLIE ROSE: But did we lose anything because of it. Let`s assume you are weighing the pluses and the minuses. And among the pluses would be you avoid the kind of catastrophe we`re having now because of lack of regulation or whatever other aspect of capitalism that was. Do we lose something on the other side because of what`s going on in terms of creativity, in terms of restraint on whatever?

PAUL KRUGMAN: You know, that`s a hard question to answer. I mean, the trouble is there`s certainly been a lot of financial innovation. The trouble is many of those financial innovations were actually destructive.

CHARLIE ROSE: Like derivatives?

PAUL KRUGMAN: Yes, in many cases there were actually ways of not so much creating a new product that people wanted, as a way of doing end run around the regulations. So now we might lose some stuff. On the other hand, you know, the postwar generation, which was a heavily regulated, heavily taxed economy, was also the best economic growth America`s ever had. So it`s not clear to me that there`s a whole lot that we`re standing to lose.

CHARLIE ROSE: What do you hope if it`s -- if Senator Obama wins the election what do you hope he says in his inaugural address?

PAUL KRUGMAN: The only thing we have to fear is fear itself, something like that. No, I mean, I`d hope he`d...

CHARLIE ROSE: That`s been used.

PAUL KRUGMAN: Yes. But I do hope that he calls for something like -- whatever words he uses, I want him to call for something like a new New Deal saying, look, we`ve gone off the rails. Not everything has been bad these past couple decades, but we lost sight of having a society that works for everybody. We lost sight of a society that provides some basic security. We lost sight of a society that provides some basic insurance against chaos in the financial markets. And we need to recapture some of those values that have made us successful.

CHARLIE ROSE: It`s great to have you here.

PAUL KRUGMAN: Thank you.

CHARLIE ROSE: One more time, congratulation.

PAUL KRUGMAN: Thanks so much.

CHARLIE ROSE: Back in a moment. Stay with us.

CHARLIE ROSE: David Smick is here. He is the founder and chairman of the investment and strategic consulting firm Johnson Smick International. He is also the founder and editor and publisher of the finance quarterly, "The International Economy." His new book is called "The World is Curved: The Hidden Dangers to the Global Economy." "New York Times" columnist David Brooks recently called it an astonishingly prescient book given the current financial crisis. I am pleased to have David here at this table for the first time. Welcome.

DAVID SMICK: Great to be here.

Originally broadcast, 10.23.08