Liquidity Trap or Malinvestments?

One of the standard Krugman-Keynesian beliefs is that assets are homogeneous, and that the only thing that matters in an economy is spending. (This is separate from real-live purposeful consumption, which is the end of all productive activity.)

In this line of thinking, a "liquidity trap" view of things makes perfect sense, and Krugman is fond of claiming that the U.S. economy, like Japan 20 years ago, suffers from such a condition. In his post on inflation and Japan, he repeats the old canard that deflation is the enemy and that inflation means nothing, at least at the present time.

(I find it interesting that in yesterday's post, he claims that "inflation did have to be brought down," although he does not specify what that was so, given that at the time, the nation's rate of unemployment was unacceptably high. There is no real consistency here, except to throw out partisan political barbs of "Democrats good, Republicans bad," which is acceptable at DNC headquarters, but I do not think is such when coming from a supposed Nobel Prize winner in economics.)

According to Krugman-Keynesian doctrine, an economy is in a "liquidity trap" if interest rates have a lower bound of zero or near-zero, yet businesses are not borrowing at a rate necessary to keep the economy going at the boom rates. That is why Krugman is fond of repeating his contention that current government borrowing only is replacing lost business borrowing, as though all borrowing has its use ONLY in the money spent.

When the economy is in such a "liquidity trap," according to Keynesians, then the only thing that can "stimulate" an economy is more government spending. That is because, according to Keynesians, there is no mechanism within a market economy that will allow economic activity to be generated, as though it were a dead battery that needs to be "jump-started" from the outside.

In a recent post on the Freeman Online, I take issue with the Keynesian approach, pointing out that the real issue we face -- as did Japan two decades ago -- is that government intervention has generated massive amounts of malinvestment. Our current situation is not a "liquidity trap," but rather is one in which the government has kept the malinvestments alive through the intervention via the Federal Reserve System.

For example, the huge amounts of resources poured into propping up the banks and other financial houses, along with keeping General Motors and Chrysler alive, drain the economy of productive capacity. Furthermore, the Obama administration clearly has shown itself to be hostile to real productivity and profitability, labeling profitable firms as being the cause of our problems and calling for higher taxes and other measures to cut the healthy firms down to the level of the unhealthy ones.

The real problem that Japan faced was that its economy had generated malinvestments during its previous boom, and those malinvestments needed to be liquidated, not propped up. Instead, the government tried to keep everything afloat and the result was the "lost decade." Likewise, we are seeing the same thing here.

Krugman, as a True Believer, does not see that. Instead, he really seems to hold that all assets are homogeneous, profits are a drain on the economy, and high taxes and the iron hand of the state will guide us to prosperity. This will not be the case, but I doubt seriously that he will change his tune, given the public worship that intellectuals and the political classes have bestowed upon him.