Anatomy of a Crisis

I'm reading "The Return of Depression Economics" by Paul Krugman. A very enlightening book for a coffee table economist like me. He traverses the history of meltdowns across the world from Latin America to South East Asia. A very interesting journey indeed. This journey triggered a thought in my mind. If its brought out later in the book, I'm not aware. Its not there in the first 100 pages and given my ageing memory I thought it best to write it down before I forget it. So here goes.

Size of Economies
All these crisis economies (Mexico, Argentina, Thailand) etc. are essentially small, unlike US or Japan. The businesses within the country do not have much power to move the indexes too much for their lack of resources. The outside players such as US and Europe pump in money or pull it out as they feel. Though the money they pump in or pull out is small change to these countries, they are substantial sum when compared to size of these economies.

I've read somewhere that speculators add liquidity and depth to the market. In financial markets of these countries when sentiments change, the first world speculators collectively move to one end of the spectrum (buy or sell), lets say 10 funds. Even if there are 100 other operators within the country that wanted to buy at lets say 10% less than current price, they can't buy all the load thats coming their way. This reduces the prices beyond their natural bottom(bottom it would have settled if external and internal operators had about equal buying powers).

The sheer size of their economies makes these countries more susceptible to crisis. That's how I could explain the Contagion effect.

Currencies
Another point. When these countries face crisis, the currencies get hammered because the pulls out the money. However, when a Crisis hits the biggies, the currencies appreciate. For example, before the 2008 crisis hit US, Rupee was trading at 43 per dollar. The moment Crisis hit us in September, rupee dropped to 50 and beyond, more than 15%. India is not much of an export driven economy compared to lets say South Korea(25% of GDP vs 40% of GDP. They have comparable GDPs). I also checked Australian Dollar vs USD The AUD dropped from 1.2 in Sep-08 to 1.5 Dec-08. Why did this happen?

America and Europe have huge hordes of money. Though most of that money is invested in US and Europe, a significant part is also invested in other parts of the world. So when a credit crisis happened in the US, all this money across the world flooded in to the rescue bolstering liquidity cushioning the fall. Same with Yen. The Japanese had the 12% contraction in GDP (Q4 2008) vs 6% in US. Their currency actually appreciated against the USD (112 in the end of 2007 vs 90 at the end of 2008).

In effect, the anatomy of crisis in Big and Rich countries is a little different. They are better protected against the crisis just because they could call upon investments in other countries to cushion the blow.

Punishment to a small country for their economic sins is far harsher compared to the rich. Didn't I just prove the social aspect of crime and punishment in economic terms. Ha!