One extremely basic thing I have difficulty understanding is how the world as a whole can "borrow prosperity from the future," and end up in a global depression. It is easy to understand how a single individual or nation could borrow, end up with massive debt, and suffer a depressed economic future. But how can this happen to the world as a whole? The world is a closed economic system, and the resources and workers which support "living large" remain relatively fixed over short timescales. How is a global depression possible?

An increase in transaction costs relative to everything else.

Caused by what?

The sudden withdrawal of liquidity, like in 1929. Today we're seeing the implosion of credit markets worldwide, a variation on the same theme.

Metric,

Resources consumed now cannot be invested in expanding, or even maintaining, the capital stock, which undermines future productivity, which undermines future consumption, i.e. future standard of living.

I.e. partying now leaves you poorer after the party is over.

So tribe A on one side of an island catches fish, and tribe B on the other side of the island picks oranges. Tribe A likes oranges, and tribe B likes fish, so they trade. Times are really, really good for a while. Tribe A builds more fishing boats, and tribe B plants more orange trees. Then all of a sudden no one in tribe A thinks it's profitable to fish any more, and no one in tribe B thinks it's profitable to pick oranges any more, there is massive unemployment, and then no one can afford to buy fish or oranges, even though actual demand really hasn't changed at all, and there are plenty of resources available to generate supply, and plenty of willing workers... I still don't understand how this can happen. It seems I am leaving out something of fundamental importance.

Is it fantastically wrong to assume that everything I'm consuming now was also produced recently?

I have asked the same question in my head a couple times so this might be the answer you are looking for.

Imagine that we have your island. And the island has a bank and uses Fractional Reserve System. By using the fractional reserve system, money is basically created out of thin air. I may have a $1,000 in the bank but $800 of it is being given out as a loan to my neighbor. He in turn uses it to make more money put it in the bank, loan it out to friends or pay other people who in turn put it in the bank and borrow from the bank. When this cycle breaks, all of a sudden money starts flowing. The money people thought they had isn't really there and everybody panics. They go to their bank and want to take out their money to find out it isn't there.

Sort of. Everything you are consuming now was probably produced recently at the end of a long and roundabout production process that goes back years (think of the tools and equipment used in the production of the things you are consuming; and then think of the fact that they too had to be produced, etc).

And the only way to make those punks stop partying is to get them involved in something serious... something like global warfare.

At least that's what it took to straighten out all those punks from the "Roaring Twenties."

Which is why we need to go to war with Iran immediately LDO.

I suspect that the key point is lying around very close by. But there is still something blocking this from seeming obvious and natural to me.

At the level of individual businesses, it seems obvious that a computer maker (or whoever) would recognize the need for up-to-date machinery to build computers into the future. I would imagine a continuous and very strong incentive to build faster, better, cheaper.

At the level of many competing businesses, it seems obvious that makers of **** nobody wants go out of business much faster than makers of stuff everyone wants. So even if the Fed (or whoever) artificially makes investment in ****-making companies more attractive, it seems intuitive that only some fractional slowdown should result, rather than a dramatic shift from prosperity to depression. Or perhaps is it the fact that interest rates can not be lowered below 0 that causes some kind of phase change? Still confused...

Can this really be it? Just a periodic panic phase where people realize that the banks don't have enough money to cover everyone? Doesn't there have to be something more fundamental at work?

Such an outcome would be puzzling indeed, given that set of conditions. A scenario paralleling the actual one needs another factor in addition to fish and oranges: a third, intermediating commodity used in exchanges between the other two. If, one fine day, a Sylvester McMonkey McBean were to show up and con the tribes into denominating all trade among themselves in his inherently worthless mass-produceable tokens over which he retains control of supply, the result would be a more realistic, and tragically unstable, situation.

I think it is more that people realize the future isn't nearly as bright as they thought.

The thing that disturbs me about this line of thought is that if downward shifts in emotions are the underlying reason for a global depression, then we could create a depression-proof economy just by passing a law that investors have to do a bunch of hyper enthusiasm building drugs before considering any investment.

Direction of causality.

It isn't that the realization makes it not as bright. Finding out your wife left you didn't cause her to leave.

I think what happens is someone has $2 million in the bank. They think $1 million is plenty, so I will have a relaly good time and blow through a million. After they realize "wow, inflation is more than I thought and might be going up, I need $5 million to buy what I was plannig to buy with that $1 million" so they have to buy less. I think this leads people wanting to hold onto what they have rather than trading it causing factors of production to idle. Note: I haven't given any real thought to macro issues beyond what was taught in required courses.

This is a great question - I don't think most people realize how troublesome the idea of a global recession from an equilibrium standpoint. As Krugman points out in http://www.slate.com/id/9593 this idea that we spent too much in the past, so we're gonna spend less *and* work less makes no sense.

Theres a difference between working less and producing less. We work a lot less than we did 100 years ago and we produce way more than we did 100 years ago.

This may be true, but I'm not sure where you're going with it. During a recession, people do work less. This isn't the slightest bit controversial.

Everyone might have to forgive me if I look like an ass. I'm new to a lot of this **** so will try to answer your question while at the same time clarifying my own thoughts on the subject.

I think he's saying that we will just produce less in the way of consumption goods. We will have to "work" towards rebuilding our neglected capital supply. By shifting effort to this, we will have to produce less materials that we directly consume.

Let's posit a scenario.... If you are a farmer and neglect your harvest machinery because you spend all your excess revenue on your own personal consumption, soon you will find that you can no longer harvest.

One option is that you find another revenue stream and save as much as you can until you can afford to fix or replace your harvester. If all you can find is a part time job, you are working less, and certainly producing less.

Another option is that you borrow the money to fix or replace your harvester, but now you have less excess revenue because part of it has to go to paying your interest on they borrowed funds. This is the "borrowing from the future" in a very real way.

Now that's a micro example. Lets move that same behavior to a more macro scale. This is what many are arguing has happened in the US for some time. With a rapidly expanding money supply, option two is much less painful than option one. This leads to questionable long term business practices and higher inflation, IMO.

Still on a macro scale, with a more fixed money supply (gold backed), option 2 becomes more difficult. With everyone neglecting the maintenance (or planning for replacement) of their capital goods, everyone has to compete for the investment funds that a few smart people have saved during this time. This will mean much higher interest rates.

Option one is now more likely to happen than with an expanding money supply. Since now people are looking for other revenue streams to save to reinvest in their own businesses, we are definitely going to be producing less and working less.

Ya?

Sorry I wrote that like 2 minutes before I had to go to an exam. So I'll clarify a bit.

I'm not sure what part of the article you are talking about so I'm going address this paragraph

People werent spending less on investment goods, they were incentivized to spend more on consumption goods at the expense of investment goods. We did get a consumption boom because of the very keynsian policies Krugman advocates.

Eventually the investment capital runs out because people werent saving and the artificial boom has to liquidate. The unemployment is temporary because eventually the capital is released back into the economy and can be put to real productive uses. So people do spend less as they move their consumption back to savings and people work less because of the temporary unemployment.

Not only that but Krugman has the entire Austrian theory backwards but the "problem" with the austrian theory is actually the criticism the austrians have with the keynsians. To muddle the theory up this much is very revealing, regardless of his credentials.

Also what witeknite said

But this is a special kind of "work" that requires a lot of people to be out of work?

But the farmer isn't a closed system, like "the world." By spending his excess revenue on consumption, he's making the work of other producers more profitable, and incentivizing productivity elsewhere. And if he eventually goes bankrupt because he can't farm anymore, some other producer with a better plan should buy his fields, right?

But couldn't he let someone else with a harvester farm his fields (for a fee) until he earns enough to fix his own harvester? So really all that happened here is that he temporarily traded his own good job (farming) for a bad one (crappy part time job), and the same amount of total work still gets done.

But this is really no different than the farmer fixing his harvester with money that he wisely set aside, only then he gets drunk one night and goes on a crazy wild party binge, paying for it all with credit. He parties and goes into debt, suffering a depressed economic future (but he remains equally productive), meanwhile someone else profits and expands their own business/productivity at his expense. So it looks, at first glance anyway, like there's a conservation of wealth and no "global depression" in this sort of game.

What I'd really like to see is some kind of simple game like this played in a closed system, like the island example that I tried to construct (but was apparently too simplistic).

I'm sorry if I'm being really dense, here, btw... I feel like this whole issue is something that should be sort of obvious after a few minutes of thinking, but I must be getting stuck in some kind of "thought rut" or something.