Friday, June 18, 2010

That 30's Mistake

Continuing with his theme of "spend, spend, spend," Paul Krugman is determined to claim that the free-spending governments of the West really are engaging in "austerity." Of course, not only does he get the New Deal wrong (and he really gets it wrong), but also is wrong about what happened in 1937.

First, with the U.S. Government running multi-trillion-dollar deficits, the notion that spending is anything but wild and wasteful is a fantasy in itself. For Krugman to claim that the government is involved in an austerity program is ridiculous, but here it is:
Suddenly, creating jobs is out, inflicting pain is in. Condemning deficits and refusing to help a still-struggling economy has become the new fashion everywhere, including the United States, where 52 senators voted against extending aid to the unemployed despite the highest rate of long-term joblessness since the 1930s.

Many economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession.
So, because of a vote regarding a relatively small amount of unemployment compensation funds, suddenly the government is going bare bones. Please.

Second, the depression within a depression in 1937-38 did not come because FDR decided to balance the federal budget. Instead, as Robert Higgs noted in this 1997 paper in the Independent Review, while the Federal Reserve System raised interest rates slightly, nonetheless the real problem came from the White House and its continuing attacks on private capital. Higgs quotes historian Elliot Brownlee, who wrote:
...the tax reform of 1935–37, more than any other
aspect of the New Deal,…stimulated business hostility to Roosevelt.…
[B]usiness opponents of New Deal tax reform charged that Roosevelt’s taxes,
particularly the undistributed profits tax, had caused the recession [of 1937–
38] by discouraging investment....
Furthermore, FDR made it clear after his re-election in 1936 that he was going to tax businesses into oblivion. As Prof. Higgs notes:
Although historians emphasize the president’s defeats with respect to taxation in the late 1930s, contemporary businessmen must have appreciated the reality of increased taxation: in fiscal 1940, with the depression still lingering, the federal government collected 57 percent more total revenue than it had in the prosperous year.
Now, I don't expect Krugman to understand this point, because to him, private capital spending is no different than government spending, and if "capital is on strike" (as FDR declared), then if government makes up the difference through borrowing and printing money, it is just as good. This is something that an economist -- even a Keynesian -- should recognize as being silly.

However, as I read Krugman, I have come to realize that he sees absolutely no difference in government spending and private capital expenditures. Assets really ARE homogeneous, in his view, and there are no real economic fundamentals. Of course, he also wants to demonize anyone who disagrees with him by declaring that anyone who thinks that government spending is out of control is doing ONLY because he or she hates poor people and wants others to suffer. Krugman in his own words:
In America, many self-described deficit hawks are hypocrites, pure and simple: They’re eager to slash benefits for those in need, but their concerns about red ink vanish when it comes to tax breaks for the wealthy. Thus, Senator Ben Nelson, who sanctimoniously declared that we can’t afford $77 billion in aid to the unemployed, was instrumental in passing the first Bush tax cut, which cost a cool $1.3 trillion.
First, "tax breaks for the wealthy" is nothing more than political talking points, and I have an aversion to academic economists acting like political operatives. Second, Krugman assumes that any cuts in tax rates have as their ONLY effect the lessening of revenue. There are no benefits at all, only costs.

This is interesting, as Krugman is saying that any money spent or invested privately, then, carry absolutely no benefits to anyone except the people whose taxes are cut, and that those benefits are completely offset by pain inflicted on others. This is not even economics; it is nothing but political leftism.

I wish that governments actually WOULD go on real programs of slashing spending and reducing its burden. What I find from Krugman, however, is that he views government spending and taxation as a net plus, but private investment and spending is only a cost. So, why should there be any private spending and property at all? If we are to follow Krugman's logic, then the state should take over everything. Then we could be prosperous like the Cubans and the North Koreans!

The government's "mistake" of the 1930s was not balancing its budget. No, its "mistake" was believing that government could control private enterprise, raise taxes, and increase the burdens that governments place upon individuals, and somehow out of that would rise prosperity. Apparently, Krugman continues to perpetuate that myth.


Anonymous said...

Bill - Ironically, M2 has been falling over the last few months. When output and prices predictably fall as a result, PK will claim that that this so-called austerity was the culprit.

Vlad Popovic said...

"And here in Germany, a few scholars see parallels to the policies of Heinrich BrĂ¼ning, the chancellor from 1930 to 1932, whose devotion to financial orthodoxy ended up sealing the doom of the Weimar Republic."

So in Krugman's mind, even the Weimar republic was too austere and their regime collapsed because they did not print enough? Either he is completely insane, or he has a way better sense of humor than anyone at the Times gives him credit for!

Anonymous said...

FDR, as you stated, declared war on private enteprise, and was going to 'tax businesses into oblbivion'. Higher taxes is exactly the kind of fiscal contraction that Krugman is warning about.

"Krugman, however, is that he views government spending and taxation as a net plus"

No where does Krugman nor any Keynsian ever say this. NEVER. In fact, it's the tax increases/austerity in Europe that is most concerning to him and anyone else with common sense that will net lower growth.

You basically prove Krugmans points for him in this post.

Anonymous said...

I would agree that Krugman isn't bashing tax breaks as much as he's badmouthing a balanced budget. The tax break comment is only in reference to the politician who said they couldn't afford the welfare program.

Of course, one can certainly read into that the viewpoint that all money ultimately belongs to the government, but that's another matter.

In this situation, it seems Krugman wants to see low taxes and high spending, with bond issuance to cover the gap. Not sure if he has a plan should people stop buying bonds at any interest rate.

Ultimately, in recession situations it looks like the only functional difference between Austrians and Keynesians is that Austrians see government spending as drawing resources away from productive purposes, while Keynesians see it as a benefit. They both want to lower taxes.

Allen Lewis said...

Krugman knows full well that the massive spending increases, new government regulations, health care entitlements, continued expansion of the wars, etc. are going to cause more pain for the economy. He is simply continuing what he's done for 3 years now - painting a picture of a government that is too tight, not spending enough, not providing enough stimulus, etc. So when the next round of pain comes, it will be blamed not on too much intervention, but on too little.

Paul Krugman is a tool.

Fred said...

Krugman and everyone else needs to just accept we are in a DEPRESSION already.

There is no avoiding a depression. They would call it a recession if it was avoidable.

However this recession is already 2 years old and still no light at the end of the tunnel other than the headlamp of the locomotive.

If you artificially hold things together now you only prolong the old guards reign. They have no motivation to change for the better. They like things just the way they are....otherwise they would not be called "THE OLD GUARD"......duh!

Anonymous said...

Krugman recognizes we are in a depression, which is why he is insisting on increased deficits, not the opposite. Prof. Anderson does not recognize we are in a depression; he thinks we can liquidate our way out of this, except, he doesn't realize when the liquidationists take over, there is no economy left.

And to the poster who said "Krugman wants to see low taxes and high spending, with bond issuance to cover the gap" This is exactly right. Bond issuance is just another means to influence the supply of money in the economy. Krugman recognizes the money supply is shrinking, thus, the need for increased deficits. Why is it 'Austrians' ignore the lessons of Fisher? Do they not believe MV=Py?

William L. Anderson said...

No, I do recognize that we are in a depression, and the bailouts and the attempt to keep the malinvestments from liquidating or being put to other uses is why.

Malinvestments do not comprise the entire economy, so after the liquidation, there is an economy left. Remember the recession of 1982. We did not have "stimulus" then, but we ended up having a strong recovery. According to Krugman's thinking, there could not have been a recovery from that recession.

Anonymous said...

Thomas Sowell has an intersting bit of information on unemployment rates during the depression in his latest column. Thought it worth sharing.

Anonymous said...

"Malinvestments do not comprise the entire economy"

This thinking is wrong during a balance sheet depression, which we are in now. The entire economy has a fragile balance sheet, so a liquidation you desire for would, in fact, impact the entire economy. Again, see Fisher.

And yes, I do remember the recession of 1982. Significant difference from today since overall balance sheets were in fine shape then. In 82, we had rapidly falling interest rates and the death of price inflation thanks to Volcker and the rise of China. I also remember running sizable deficits thanks to tax cuts and defense spending. So your logic doesn't hold: we did have stimulus. Big stimulus relative to what we can do today, since rates and price inflation are already zero. And you can't qualify that recover as 'strong' since all it did was begin the 30 year increase in debt/GDP levels. Check the data.

Steven Handel said...

The U.S. monetary policy has already sown the seeds for an economic collapse. Fiat currencies and loose credit policies spur unsustainable growth. We will be forced to cut costs eventually, whether we are willing to or not.

Anonymous said...

Anonymous, unemployment was not in "double digits in every month throughout the entire remainder of the decade of the 1930s." Sowell and his source must be using the Lebergott numbers, useful only for political polemics rather than economic analysis, rather than the correct Darby numbers for unemployment in the 30s. The Lebergott numbers counted many government workers as unemployed, during the 30s but not the 40s, while the Darby numbers consistently counted them. See wikipedia's New Deal article, table 2 for a comparison.

Bob Roddis said...

Q: Do they not believe MV=Py?

A: Of course we don’t believe MV=PY. Duh!!!

People ACT. All value is subjective. The only path to economic calculation is through market prices. Peter Klein writes:

"To understand Mises’s position in the calculation debate, one must realize that his argument is not exclusively, or even primarily, about socialism. It is about the role of prices for capital goods. Entrepreneurs make decisions about resource allocation based on their expectations about future prices, and the information contained in present prices. To make profits, they need information about all prices, not only the prices of consumer goods but the prices of factors of production. Without markets for capital goods, these goods can have no prices, and hence entrepreneurs cannot make judgments about the relative scarcities of these factors. In short, resources cannot be allocated efficiently. In any environment, then—socialist or not—where a factor of production has no market price, a potential user of that factor will be unable to make rational decisions about its use. Stated this way, Mises’s claim is simply that efficient resource allocation in a market economy requires well-functioning asset markets."

When a central bank creates money out of thin air, those getting the new money first are in effect robbing purchasing power from those holding the existing money. Further, this new money bids up prices for everything (but at different rates) making rational economic calculation virtually impossible. Money dilution tends to encourage investment in lines of higher order production that would not appear profitable without the money dilution and which, in fact, IS NOT SUSTAINABLE. These investments are MALINVESMENTS. Thus, the boom/bust cycle is CAUSED by central bank money dilution/money creation, in other words, by Keynesian policies. The “liquidation” phase should be thought of as merely a re-pricing phase. The new [much lower] prices will simply reflect what people are willing to pay for assets without the corrupt stimulus of funny money. The ultimate solution is to abolish central banks and criminalize fractional reserve banking.

Further, there is no factual, historical or logical basis for the idea that deficits “stimulate” the economy. Tom Woods has an excellent video explaining how the depression of 1920 was ended quickly by doing NOTHING:

Keynesians and Monetarists (who are really just another breed of Keynesians) view the “economy” as a spinning baby toy that won’t spin without the government winding it up. That’s an infantile view of reality, a reality which consists of flesh and blood human beings making their way in the world with limited knowledge. Without free market prices as a guide, they are as blind as the North Koreans. It appears that the main purpose of the Keynesians and Monetarists is to interfere and impede that essential information and discovery process and to cause endless misery and poverty.