Bahtulism

The search for better economic policy.
Aug. 15 1997 3:30 AM

Bahtulism

Who poisoned Asia's currency markets?

I often run into people who assert confidently that massive speculative attacks on currencies like the ones on the British pound in 1992, the Mexican peso in 1994-1995, and the Thai baht in 1997, prove that we are in a new world in which computerized trading, satellite hookups, and all that mean that old economic rules, and conventional economic theory, no longer apply. (One physicist insisted that the economy has "gone nonlinear," and is now governed by chaos theory.) But the truth is that currency crises are old hat. The travails of the French franc in the '20s were thoroughly modern, and the speculative attacks that brought down the Bretton Woods system of exchange rates in the early '70s were almost as big, compared with the size of the economies involved, as the biggest recent blowouts. Currency crises have been a favorite topic of international financial economists ever since the 1970s. In fact, they are among my favorite topics--after all, I helped found the field.

The standard economic model of currency crises had its genesis in a brilliant mid-'70s analysis of the gold market by Dale Henderson and Steve Salant, two economists at the Federal Reserve. They showed that abrupt speculative attacks, which would almost instantly wipe out the government's stockpile, were a natural consequence of typical price-stabilization schemes. In 1977 I was an intern at the Fed, and realized that Henderson and Salant's story could, with some reinterpretation, be applied to currency crises that suddenly wipe out the government's foreign exchange reserves. A bit later Robert Flood, now at the International Monetary Fund, and Peter Garber, of Brown, produced the canonical version of that conventional story.

The key lesson from that conventional model is that abrupt runs on a currency, which move billions of dollars in a very short time, are not necessarily the result of either irrational investor stampedes or evil financial manipulation. On the contrary, they are the normal result when rational investors contemplate the implications of unsustainable policies.

Some economists, however--notably Berkeley's Maurice Obstfeld and Barry Eichengreen--argue that the standard model is too mechanical in its representation of government policy, and that the more complex motives of actual governments make speculation a more uncertain and perhaps more pernicious affair. Self-fulfilling crises, in which a currency that could have survived is nonetheless brought down, are a hot topic these days. But everyone agrees that a sufficiently credible currency will never be attacked, and a sufficiently incredible one will always come under fire.

Paul Krugman is a professor of economics at MIT whose books include The Age of Diminished Expectations and Peddling Prosperity. His home page contains links to many of his other articles and essays.

TODAY IN SLATE

Sports Nut

Grandmaster Clash

One of the most amazing feats in chess history just happened, and no one noticed.

The Extraordinary Amicus Brief That Attempts to Explain the Wu-Tang Clan to the Supreme Court Justices

Amazon Is Officially a Gadget Company. Here Are Its Six New Devices.

Uh-Oh. The World’s Oceans Have Broken Their All-Time Heat Record.

The NFL Explains How It Sees “the Role of the Female”

Future Tense

How to Keep Apple From Sharing Your iPhone Data With the Police

Food

How to Order Chinese Food

First, stop thinking of it as “Chinese food.”

A Simple Way to Keep Apple From Sharing Your iPhone Data With the Police

The Country Where Women Aren’t Allowed to Work Once They’re 36 Weeks’ Pregnant

The XX Factor
Sept. 18 2014 11:40 AM The Country Where Women Aren’t Allowed to Work Once They’re 36 Weeks’ Pregnant
  News & Politics
Weigel
Sept. 18 2014 8:20 PM A Clever Attempt at Explaining Away a Vote Against the Farm Bill
  Business
Moneybox
Sept. 18 2014 6:02 PM A Chinese Company Just Announced the Biggest IPO in U.S. History
  Life
Outward
Sept. 18 2014 4:15 PM Reactions to a Sketch of Chelsea Manning Reveal Transmisogyny
  Double X
Doublex
Sept. 18 2014 8:07 PM Crying Rape False rape accusations exist, and they are a serious problem.
  Slate Plus
Behind the Scenes
Sept. 18 2014 1:23 PM “It’s Not Every Day That You Can Beat the World Champion” An exclusive interview with chess grandmaster Fabiano Caruana.
  Arts
Brow Beat
Sept. 18 2014 4:33 PM The Top 5 Dadsplaining Moments From The Cosby Show
  Technology
Future Tense
Sept. 18 2014 6:48 PM By 2100 the World's Population Could Be 11 Billion
  Health & Science
Science
Sept. 18 2014 3:35 PM Do People Still Die of Rabies? And how do you know if an animal is rabid?
  Sports
Sports Nut
Sept. 18 2014 11:42 AM Grandmaster Clash One of the most amazing feats in chess history just happened, and no one noticed.