Saturday, March 20, 2010

Peter Schiff on Krugman, the Nobel Prize, and the End Game for the Dollar

Earlier this week, I posted a video in which Peter Schiff takes on Paul Krugman for his recent call to declare what essentially would be a "trade war" against China. In this column, Schiff goes into more detail to explain the problems in Krugman's reasoning.

I think that Schiff really lays out Krugman's thinking in these paragraphs:
According to Krugman, our secret weapon of economic invincibility is the Fed's ability to print dollars endlessly. If China were to foolishly decide to attack us by selling our debt, the Fed could simply step in and buy the excess with newly printed greenbacks. (In other words, Krugman sees no difference between funding the debt and monetizing it. See my latest video blog on the subject.) For Krugman, China would gain little from such an attack, but would lose the ability to export to its best customer and suffer severe losses in the value of its dollar holdings. Krugman's worldview is reassuring – but it has absolutely nothing to do with reality.

There is a huge difference between selling your debt to another and "selling" it to yourself. When China buys our debt, it uses its own savings. In order to purchase a trillion dollars of U.S. Treasuries, the Fed would have to expand our money supply by a corresponding amount. Even Krugman acknowledges that this would cause the dollar to lose value; however, he feels that a weaker dollar is good for America and bad for China.
This is correct. In reading Krugman's columns and blog posts, I find that same theme: printing U.S. Dollars will create prosperity, while having "sound money" leads to depressions. For example, in his book The Return of Depression Economics, Krugman claims that printing money in most economic crisis situations will "solve" the crises.

For that matter, if one thinks Schiff is off-base with his characterization of Krugman's statements, this Krugman post lays out his belief that the dollar is nearly invincible:
There have been many, many papers trying to assess the possibility of an Asian or Argentine-style currency crisis for the United States; all of them run up against the simple fact that large foreign-currency indebtedness was central to these crises, and we just don’t have that problem.
At one level, that is true, but Krugman also wants to have it both ways. On one side, he claims that the USD pretty much is invincible, but then he also claims that at least some of our problems stem from the dollar being too strong, and that it needs to be weakened.

I think that Schiff's point about Krugman's confusion between China buying U.S. debt and the Fed making such purchases is well-taken. On the one side, when China purchases our treasuries, it ultimately sends real goods our way. There is no increase in the number of dollars circulating; Americans simply are borrowing from the Chinese to fuel their own consumption.

However, if the Fed buys treasuries, that is done essentially with newly-printed dollars, which will lower the value of everyone's dollar holdings, from China to the guy on the street with a few dollars in his pocket. As the new money circulates throughout the economy, prices go up, and we experience directly the negative effects of the Fed's actions.

Furthermore, by calling for tariffs and other measures to "punish" China for its currency policy, Krugman is demanding that the U.S. Government make everyone else worse off in the name of "helping the economy." Schiff writes:
Most economists, Krugman included, see cheap money as a panacea for all ills. And while it's true that a falling dollar, by lowering the real value of U.S. wages, would help make U.S. goods more competitive, it would also lead to skyrocketing consumer prices, rapidly rising interest rates, and a collapse in American living standards. Make no mistake: this is the end game of Krugman's "get tough on China" policy.
Now, I do think that Krugman's articles are consistent with what he believes: printing money is a good thing, as it creates inflation, which fuels current spending, which then gives the economy "traction." At some point, he reasons, the economy (which operates in the circular flow like a perpetual-motion machine) simply starts moving again. It just needs a "push," and government spending combined with inflation is what "primes the pump."

This is the typical macroeconomist's view of an economy. All assets are homogeneous, there is no real connect between production and consumption, and unless government intervenes in the economy via new spending and printing money, the economy naturally will implode because of the negative effects of saving (paradox of thrift).

People, this is not economics. It is model-building, and highly-stylized model-building at that. It does not reflect economic reality, and it can lead only to inflation and ruin in the long run. No wonder Schiff makes the following declaration:
In his latest weekly New York Times column, Nobel Prize-winning economist Paul Krugman put forward arguments that were so nonsensical that the award committee should ask for its medal back.
I concur wholeheartedly. What Krugman puts forward is not "economics" in any sense of the word. Instead, it is nothing but state-inspired manipulation of an economy, period.

The USD is not invincible. At the present time, with all of the other fiat currencies floating around, it still is relatively viable, but that situation cannot last forever or even for a few years. Krugman really seems to believe that the Fed endlessly can print dollars, and only good things can come from it. That is not economics, folks, that is madness.


ZombieHero said...

I'm a big fan of Schiff. I really hope he wins in November. We need more Austrians in Congress.

eg said...

Hi William

I am not an economist, nor do I play one on TV. I have, however, been to Frostburg State on several occasions whilst coaching basketball teams in the Alhambra Catholic Invitational. Nice town -- nice people.