DeLong on East Asian Crisis & European Feedback Cycle of Doom

DeLong seems to be partly reacting to Baker's criticism of Summers and the Clinton administration's handling of the East Asian Financial Crisis. At least it is the same subject.

The Long and Large Shadows Cast by Financial Crises: The Future of the European Periphery in the Mirror of the Asian Pacific Rim 1997-98 by DeLong

And yet that is not what happened. On the Asian Pacific Rim in 1997-8, the fact that so much of the region’s debt was denominated in dollars meant that bouncing the value of the currency and thus of domestic production down far enough raised universal and valid fears of bankruptcy, and sharply raised risk premia: the Asian Pacific Rim thus had to, to a certain extent at least, defend its currency. And in Europe’s periphery nations are tied by treaty, by the deep and close technical integration of the financial system, and by hopes for a united and peaceful European future into the euro zone. Thus when the crisis comes both regions must generate rapid adjustment of the current account: a sudden stop.

The problem is general. There are lots of reasons why the natural market’s bounce-the-value-of-the-currency-down adjustment mechanism will not work. Overwhelming reasons to maintain a fixed parity. High levels of harder-currency debt. A tight coupling of import prices to domestic inflation and a belief that the costs of accepting domestic inflation are unacceptable–cough cough, why we all today feel sorry for Raghu Rajan. In any of these cases, when the crisis comes you must generate a rapid adjustment in your current account, and the easiest and the most straightforward way to do this are via domestic investment collapse. This is the first failure of the veil of the financial system to be merely a veil–the first coupling of financial distress to destructive real economic consequences.