Thursday, October 28, 2010

Sinking the QE2 and the False Monetary Policy -- Fiscal Policy Divide

For most of my life, QE has meant Queen Elizabeth. (An early-childhood thrill was being able to board the Queen Elizabeth I while it was docked at a New York harbor and have the opportunity to look around. This also was an age when trans-Atlantic passenger travel often was conducted on the water because flying still was prohibitively expensive.)

Today, QE2 means "Quantitative Easing, the second round," which is another way of saying the Federal Reserve System is supposed to find a way to convert the massive monetary base in banks into lots of new loans. However, as Paul Krugman and many others have pointed out, with interest rates close to "the zero bound," it does the Fed little or no good to use low interest rates to employ "Monetary Policy." (Krugman does favor devaluation of the US Dollar, as it would raise prices and cut real wages, which, according to Keynesians, would accomplish what the so-called Classical economists held: that unemployment occurs when wages are higher than what the labor market is willing to bear.)

As anyone who has taken a typical course in Macroeconomics, the supposed debate is between "Monetary Policy" and "Fiscal Policy" prescriptions for how government should deal with the economy. The debate between followers of John Maynard Keynes (Keynesians) and followers of Milton Friedman (Monetarists) centers around which kind of policy is effective in situations like the one we face today.

Keynesians say that when interest rates are extremely low, then government needs to take up the slack by borrowing and spending in hopes that the "stimulus" will "prime" the economy and get it moving again, the "traction" argument that Krugman often uses. On the Monetarist side, the Friedmanites say that Keynes was wrong in claiming that "money does not matter," and that the Fed really does have tools to get businesses to borrow once again.

Thus, we see the academic arguments spilling to editorial pages and onto the street, with the assumption that the Monetary Policy -- Fiscal Policy prescriptions take up the entire universe of macroeconomic prescriptions. However, what if there were a "third way" of viewing this matter, one that eschews both arguments?

Neither Keynesians nor Monetarists bring factors of production into the mix and specifically capital. Instead, if they do concentrate on prices, it is prices of final or consumer goods, but even there, the only "prices" that matter are those that are part of the "price indices," or the Consumer Price Index. (True, Friedman did speak out against price controls and he certainly had a better understanding of price theory than does Krugman, but nonetheless the macro arguments from both Keynesians and Monetarists ignore the micro-level system of prices.)

Likewise, both groups tend to view the macro economy as having homogeneous factors of production in which production pretty much automatically happens just as long as there is "enough money" by which to make the requisite transactions that will keep the goods moving. As noted before, they differ on the role of money, but also the nature of economic shocks.

The Keynesians hold that a market economy is internally unstable because individuals have a marginal propensity to save that sets off a cycle of under-consumption/overproduction that drags the economy down to a liquidity trap, which can last indefinitely. The Monetarists, on the other hand, hold that the market economy is stable and that the shocks are external, specifically coming when the monetary authorities at the Fed try to push too much money at one time into the economy. Thus, they argue that the Fed should have monetary growth targets. (Friedman even argued for a Constitutional amendment which instructed the Fed to permit the supply of money to grow about two percent annually.)

So, that supposedly is the crux of the Big Debate. However, as noted earlier, neither Keynesians nor Monetarists are willing to concede the Austrian point that during a boom, capital will be malinvested and the crisis occurs when lines of production are no longer sustainable, given the economic bubble has burst. In order for a recovery to occur, the malinvested capital must be liquidated or transferred to uses that can be profitably sustained. In the Austrian view, factors of production (and especially capital) are heterogeneous, not homogeneous, and that simply adding money or new spending to the mix only will further the malinvestments.

Now, in the current debate, I agree with Krugman and the Keynesians that simply easing loan terms will solve nothing, given that businesses are not going to borrow just for the heck of it. Entrepreneurs (who generally are left out of the macro discussions, since it is hard for these "economists" to find proper mathematical variables to depict them) must see the possibilities for economic profit, and in this current age with the White House spouting out anti-business rhetoric and the New York Times editorializing continuously for criminal prosecutions for "economic crimes," entrepreneurs are seeing the handwriting on the wall.

Furthermore, from what I can tell, Keynesians and the "Progressives" who now hold political power see entrepreneurs as being either evil and greedy or as being "socially useful" when they seek to build enterprises that depend upon government funding. To people like Krugman, production of goods is little more than a technological question that is answered by a production function. I doubt seriously that Krugman would even begin to understand the real role of entrepreneurs, given that I never have read any economic commentary from him that even recognized their existence.

So, in a nutshell, it won't do any good to increase bank reserves, but nor will it do any good for government to launch a massive, bond-fed "spending" program. Yes, some people will be employed and temporarily have money in their pockets, but the larger effects cannot and will not be sustainable.

Monday, October 25, 2010

Falling Into Economic Illiteracy

During the fall of 2008, a video made its way around the Internet. Some children of Hollywood producers and Democratic activists were put into a small choir, complete with a leader who directed them to sing about how "Obama's gonna save us." The children sang praises like the choirs of Chinese children four decades earlier who had sung praises to Mao, the Great Leader who was portrayed as the very Sun.

The camera panned on the parents who listened with enraptured hearts, and the expressions on their face were of unalloyed joy. The Very Messiah was here, and he was going to spread freedom, happiness, and plenty. All it would take would be a vast expansion of the State and Obama was the One to do it.

Paul Krugman was not in the audience, but he might as well have been, given the tone of his columns that fall. Indeed, even those who decided upon the Nobel Prize were caught up in the Messiah Fever and awarded its highest honor to Obama's Prophet Krugman.

Two years later, there are no choirs singing praise to the Holy One of Chicago, and the economy is in much worse shape than we could have imagined, and all signs on the horizon are bad. What could Obama have done? Paul Krugman knows, and he shares his Prophetic Vision (Oh, lucky us!) in his column today.

Obama, Krugman writes, did not do enough. He did not spend enough, nor regulate enough, or spread Joy and Peace and Happiness. He should have immediately imposed the very medical system that Canadians would like to change. According to Krugman's fellow NY Times columnist, Frank Rich, Obama apparently did not arrest enough people, either, nor throw enough people into prison, to join with the other two-million plus that already are spending time in government cages.

Yes, the state has neither been a great enough Sugar Daddy, nor has the state killed enough people overseas, nor has it been harsh enough to people who don't meet the approval of the editorial board of the "Newspaper of Record." The same newspaper that decries the state of imprisonment in this country claims that our Real Problem is that we don't have enough people in prison. It has come to that. The children sang of Obama "spreading freedom," but apparently (at least at the NY Times) spreading "freedom" means more incarceration of people who don't meet the newspaper's definition of being politically correct.

So, what does Krugman claim is the reason that unemployment is higher than it was when Obama took office? The government did not pretend that it is wallowing in riches and money, and while it boosted spending and debt, it engaged in Krugman's definition of "austerity."
A few commentators will point out, with much more justice, that Mr. Obama never made a full-throated case for progressive policies, that he consistently stepped on his own message, that he was so worried about making bankers nervous that he ended up ceding populist anger to the right.

But the truth is that if the economic situation were better — if unemployment had fallen substantially over the past year — we wouldn’t be having this discussion. We would, instead, be talking about modest Democratic losses, no more than is usual in midterm elections.

The real story of this election, then, is that of an economic policy that failed to deliver. Why? Because it was greatly inadequate to the task.
Krugman, it seems, was the Keeper of the Secret, and he gives us the Answer For Which We Have Waited:
When Mr. Obama took office, he inherited an economy in dire straits — more dire, it seems, than he or his top economic advisers realized. They knew that America was in the midst of a severe financial crisis. But they don’t seem to have taken on board the lesson of history, which is that major financial crises are normally followed by a protracted period of very high unemployment.

If you look back now at the economic forecast originally used to justify the Obama economic plan, what’s striking is that forecast’s optimism about the economy’s ability to heal itself. Even without their plan, Obama economists predicted, the unemployment rate would peak at 9 percent, then fall rapidly. Fiscal stimulus was needed only to mitigate the worst — as an “insurance package against catastrophic failure,” as Lawrence Summers, later the administration’s top economist, reportedly said in a memo to the president-elect.

But economies that have experienced a severe financial crisis generally don’t heal quickly. From the Panic of 1893, to the Swedish crisis of 1992, to Japan’s lost decade, financial crises have consistently been followed by long periods of economic distress. And that has been true even when, as in the case of Sweden, the government moved quickly and decisively to fix the banking system.

To avoid this fate, America needed a much stronger program than what it actually got — a modest rise in federal spending that was barely enough to offset cutbacks at the state and local level. This isn’t 20-20 hindsight: the inadequacy of the stimulus was obvious from the beginning.
One wonders at the ingratitude of Krugman's words. After all, has not the Obama administration done everything in its power to undermine entrepreneurs all the while giving lip service to them? Oh, the administration has found clever ways to offer low interest rates to those firms who Follow In The Way Of Obama instead of doing real entrepreneurship.

Instead of insightful people finding ways to put resources to use that will enable real economic growth to occur, the Obama administration is dunning taxpayers to continue to finance and to expand the Ethanol fraud. Favored firms from those on Wall Street to GM to the producers of "clean energy," the vast subsidy machine rolls on, pushing us further into depression. Yes, 15 percent Ethanol in our gas tanks "is gonna save us." (Given the performance of this administration, I think that the Ethanol would do better as cheap whiskey, which at least would permit us to better drown our sorrows.)

The fundamental issue here is that not one person in this administration, nor its acolytes like Krugman, has a clue as to what makes an economy grow. They really believe that it is little more than a perpetual motion machine, a mixture of homogeneous stuff into which one throws money to make everything work magically.

So, today, instead of singing praises to His Messiah, Paul Krugman is left to rage that Obama didn't listen to him and borrow, print, and spend even more money, further empower labor unions, jack up the minimum wage to a zillion dollars an hour, or give all government employees a big raise. Thus, we see that those most honored in academic economics really have no idea what economics is, a discipline that is based upon the simple Law of Scarcity.

No, Obama refused to pretend that the Law of Scarcity did not exist. And why not? Two years ago, he was the Chosen One, the Holy One of Chicago, the One Who Would Save Us.

Friday, October 22, 2010

The Austerity Bogey

I do hope that Paul Krugman practices what he preaches, and does not have a savings account and maxes himself on credit cards. If he saves any of his money, then he really is an Enemy of the People.

The guy who recently claimed that the U.S. Government really didn't go on a spending spree now says that the British Government is channeling Andrew Mellon. I think it is important that we understand a couple of things: first, even if Britain or the U.S. Government will not be raising spending as much as Krugman claims they should be doing, nonetheless both countries are characterized by bloated public sectors.

Second, Herbert Hoover did not take Mellon's advice to "liquidate the farmers" and "purge the rottenness out of the system." This is a quote that people like Krugman are fond of laying out, but all Mellon was saying was that the government cannot and should not prop up malinvestments, and needed to let the markets take their courses. Contra Krugman, that is what happened in 1921, and the economy recovered nicely. (Notice that Krugman never speaks of that particular recession because he can't spin a Keynesian tale out of the recovery.)

Given that Krugman generally rewrites history, I find this quote to be amusing. Krugman writes:
The operative word here should, however, be “eventually.” Fiscal austerity will depress the economy further unless it can be offset by a fall in interest rates. Right now, interest rates in Britain, as in America, are already very low, with little room to fall further. The sensible thing, then, is to devise a plan for putting the nation’s fiscal house in order, while waiting until a solid economic recovery is under way before wielding the ax.

But trendy fashion, almost by definition, isn’t sensible — and the British government seems determined to ignore the lessons of history.

Both the new British budget announced on Wednesday and the rhetoric that accompanied the announcement might have come straight from the desk of Andrew Mellon, the Treasury secretary who told President Herbert Hoover to fight the Depression by liquidating the farmers, liquidating the workers, and driving down wages. Or if you prefer more British precedents, it echoes the Snowden budget of 1931, which tried to restore confidence but ended up deepening the economic crisis.

The British government’s plan is bold, say the pundits — and so it is. But it boldly goes in exactly the wrong direction. It would cut government employment by 490,000 workers — the equivalent of almost three million layoffs in the United States — at a time when the private sector is in no position to provide alternative employment. It would slash spending at a time when private demand isn’t at all ready to take up the slack.
From where does the British Government get all of those resources that Krugman claims it should be spending? Well, in Wonderland, governments crank up the printing press and - Voila! - create wealth. Krugman never does seem to grasp the simple fact that when governments spend, they are using real resources that have to come from somewhere; he really does believe that borrowing and printing money is the economic equivalent of serious private investment.

There is one more thing. I never have known politicians not to want to spend, spend, and spend some more. The notion that politicians are stingy with other people's money is laughable, and the notion that the only thing saving us from utter destruction is government's ability to borrow and print is a joke, a sick joke, but a joke, nonetheless.

Thursday, October 21, 2010

Should Paul Krugman and Robert Murphy Debate?

Perhaps the best Paul Krugman critic on the web today is Robert Murphy, who has managed to break down a number of Krugman's arguments and point out the Princeton Prof's errors. Obviously, it is time for these two men to debate!

See more on this proposal at this site. Debate!!!!

Tuesday, October 19, 2010

Robert Murphy Takes On Krugman's "Hangover Theory" Caricature

In recent blog posts, Paul Krugman has been claiming that the Keynesian paradigm has been vindicated by recent employment and financial statistics, but that officials foolishly are listening to the "hangover theory" nonsense.

Since Krugman does have a perch at the NY Times, he is able to control his side of the debate, but he cannot control the facts. Robert Murphy, who in my view is a much better economist than Krugman ever will be (given that Krugman has decided that being a political partisan is much more fun -- and lucrative -- than being an economist), demonstrates that two can play the graph game.

In a recent post on the Mises site, Prof. Murphy takes on Krugman's contention that the breakdown of employment numbers "proves" his points correct. First, he posts a graph used by Krugman that "proves" that the downturn is due to a general fall in "aggregate demand," as opposed to problems within the structures of production (as Austrians maintain). (I post the graph below, including Krugman's explanation):

I tried, in that old piece on hangover theorists, to explain what's wrong with this view in general. Among other things, "this story bears little resemblance to what actually happens in a recession, when every industry — not just the investment sector — normally contracts."

And this is strikingly true this time around. Kocherlakota would have us believe that there's a big problem of mismatch because manufacturing is trying to hire, while construction has slumped. But here's the employment reality:

Manufacturing employment has slumped, not risen — in fact, it has fallen more than construction employment. The problem is lack of overall demand, not worker mismatch.
However, Prof. Murphy does what any good economist should be doing: breaking down the data to see what trends lie in numbers dehomogenized from their aggregates. He writes:
First of all, Austrians can easily explain why there is a general drop in employment after a bubble pops, rather than just drops in (say) capital-goods industries. The problem in the aftermath of a bubble isn't merely that a "given" level of demand switches from one sector to another. On the contrary, people in general are poorer than they thought they were at the height of the boom.

In particular, during the boom, people unwittingly consumed capital. In a simplistic Keynesian model with "no time and no capital," it's not surprising that Krugman finds the Austrian story nonsensical. But as I spelled out in my "sushi article," a distortion in the interlocking capital structure of a modern economy can quite obviously lead to a general rise in unemployment across many sectors, as the mistaken investments are flushed out of the system.
Prof. Murphy then directly takes on the employment issue by noting that a breakdown of employment in construction trades and in durable and non-durable goods does demonstrate -- contra Krugman -- that the kind of employment shifting that Austrians would predict actually has happened. The graph is shown below:

Add Prof. Murphy:
I submit that the above chart is entirely consistent with the Austrian explanation of business slumps following an unsustainable boom period. Contrary to Krugman's misleading chart, in percentage terms the construction sector has taken a larger hit than "manufacturing" in general, and construction has been brutalized compared to the mild downturn in nondurable-goods manufacturing.

Moreover — and this is presumably what motivated Kocherlakota's comments — a naive extrapolation of year-to-date trends suggests that the manufacturing sector has bottomed out and is on the road to recovery. Construction employment, on the other hand, is still falling.

The Austrians can easily interpret the above chart. How does Krugman? If the recession is really just about falling aggregate demand, then why did construction fall so much more than nondurable manufacturing, and why has durable manufacturing risen in 2010 while construction still languishes?
I'm not always enamored with the "my statistics are better than your statistics," but I do think that Prof. Murphy has added some important things to the current debate. Now, I doubt that all the statistical "proof" in the world would dislodge Krugman from his position, but at least I can appreciate someone like Bob Murphy who takes on Krugman at the very points where the Princeton Prof believes he is triumphant.

Monday, October 18, 2010

Captain Ahab Krugman and the Great Yellow Whale

I might be mistaken, but I believe Paul Krugman has a real fetish about China, pursuing the "new Yellow Peril" with the tenacity of Captain Ahab himself. Yes, THAT China, the China where factories turn out vast quantities of goods that make it to the shelves of Wal-Mart. (Krugman doesn't like Wal-Mart, either, so the fact that the company purchases Chinese-made goods makes it complicit with China's apparent dastardly plan to take over the World!)

In today's column, Krugman writes about an incident involving a Chinese trawler colliding with Japanese coast guard vessels, and then turns it into yet another scare story involving trade that I would hope a Nobel Prize winner (for his trade material) would not be writing. We need some reasoned voices, and I would have hoped that Krugman would have been one of those, but apparently we have someone who thinks a trade war would be good for the country. Yes, and Smoot-Hawley brought prosperity to America.

According to Krugman, after the China-Japan incident, China refused for a time to sell rare earth materials to Japanese companies, which highlighted the vulnerability the rest of the world has regarding these materials, given their importance in manufacturing different components. He writes:
On one side, the affair highlights the fecklessness of U.S. policy makers, who did nothing while an unreliable regime acquired a stranglehold on key materials. On the other side, the incident shows a Chinese government that is dangerously trigger-happy, willing to wage economic warfare on the slightest provocation.

Some background: The rare earths are elements whose unique properties play a crucial role in applications ranging from hybrid motors to fiber optics. Until the mid-1980s the United States dominated production, but then China moved in.

“There is oil in the Middle East; there is rare earth in China,” declared Deng Xiaoping, the architect of China’s economic transformation, in 1992. Indeed, China has about a third of the world’s rare earth deposits. This relative abundance, combined with low extraction and processing costs — reflecting both low wages and weak environmental standards — allowed China’s producers to undercut the U.S. industry.
In answer to the obvious question - How did the USA allow its own rare earth industry to falter? - Krugman writes:
You really have to wonder why nobody raised an alarm while this was happening, if only on national security grounds. But policy makers simply stood by as the U.S. rare earth industry shut down. In at least one case, in 2003 — a time when, if you believed the Bush administration, considerations of national security governed every aspect of U.S. policy — the Chinese literally packed up all the equipment in a U.S. production facility and shipped it to China.
Did the Chinese take these materials by force? No, they purchased them because conditions in the United States made it too costly to mine these resources, but instead of dealing with that fact, Krugman makes it sound as though the Chinese were engaging in something nefarious.

The mining of rare earths - like a lot of mining - is dirty and has a lot of environmental issues. American environmental law makes it very difficult to do some mining with any cost-efficiency, so we should not be surprised that the Chinese have managed to undercut what once was a profitable industry in the USA.

While Krugman does not make any real suggestions - other than "punish" China for not valuing its currency as high as Krugman says it should be valued - he is vague about the "solution" to this problem. Do we subsidize rare earth mining in this country? In other words, do we engage in these operations, paying union wages and other environmental costs, and do so by cannibalizing those industries that still are profitable? This is not an idle nor spurious question.

Does Krugman believe we should have tariffs against rare earth materials from China? That would have the same effect as a subsidy, and Krugman then would have to defend his position that tariffs somehow would make us "safer."

Unfortunately, Krugman finishes with some of the most naked hypocrisy that I have read. First, his own words:
So what are the lessons of the rare earth fracas?

First, and most obviously, the world needs to develop non-Chinese sources of these materials. There are extensive rare earth deposits in the United States and elsewhere. However, developing these deposits and the facilities to process the raw materials will take both time and financial support. So will a prominent alternative: “urban mining,” a k a recycling of rare earths and other materials from used electronic devices.

Second, China’s response to the trawler incident is, I’m sorry to say, further evidence that the world’s newest economic superpower isn’t prepared to assume the responsibilities that go with that status.

Major economic powers, realizing that they have an important stake in the international system, are normally very hesitant about resorting to economic warfare, even in the face of severe provocation — witness the way U.S. policy makers have agonized and temporized over what to do about China’s grossly protectionist exchange-rate policy. China, however, showed no hesitation at all about using its trade muscle to get its way in a political dispute, in clear — if denied — violation of international trade law.

Couple the rare earth story with China’s behavior on other fronts — the state subsidies that help firms gain key contracts, the pressure on foreign companies to move production to China and, above all, that exchange-rate policy — and what you have is a portrait of a rogue economic superpower, unwilling to play by the rules. And the question is what the rest of us are going to do about it.
Yes, this is the same Paul Krugman who has written elsewhere that the formulation of an industry based upon state subsidies and rules forcing individuals and businesses to purchase higher-cost "environmental-friendly" items would be good for the economy. Don't think for a second that the U.S. government does not do many of the same things, and this country hardly is a bastion of free trade.

And while I cannot heap praise on China for many of its oppressive domestic policies, nonetheless, the USA, with about a quarter of China's population, incarcerates many more people than does China. Yes, China, a country that had real death camps and gulags and summary executions does not imprison as many people, not to mention anything close to a percentage of its population, as the USA.

Furthermore, for all of the bellicosity that one may see in the trawler incident, China does not have troops scattered about the globe and other than Tibet, does not involve itself in "nation-building." I hate to say it, but China hardly poses a "threat" to the world economy and world peace. I wish I could say the same for my own country.

Friday, October 15, 2010

What About Mortgages?

At the end of class yesterday, a student and I were discussing the housing bubble and the current situation with foreclosures and things that could be done. I remarked that I was puzzled as to why banks were not willing to do more renegotiating to keep foreclosures from happening, since traditional foreclosures are poison for banks as they deal in money, not real estate.

In his October 14 column, Paul Krugman makes some sense, but I can see that he is as puzzled as the rest of us regarding what should be done. Furthermore, I agree with much of what he says here:
Horror stories have been proliferating, like the case of the Florida man whose home was taken even though he had no mortgage. More significantly, certain players have been ignoring the law. Courts have been approving foreclosures without requiring that mortgage servicers produce appropriate documentation; instead, they have relied on affidavits asserting that the papers are in order. And these affidavits were often produced by “robo-signers,” or low-level employees who had no idea whether their assertions were true.

Now an awful truth is becoming apparent: In many cases, the documentation doesn’t exist. In the frenzy of the bubble, much home lending was undertaken by fly-by-night companies trying to generate as much volume as possible. These loans were sold off to mortgage “trusts,” which, in turn, sliced and diced them into mortgage-backed securities. The trusts were legally required to obtain and hold the mortgage notes that specified the borrowers’ obligations. But it’s now apparent that such niceties were frequently neglected. And this means that many of the foreclosures now taking place are, in fact, illegal.

This is very, very bad. For one thing, it’s a near certainty that significant numbers of borrowers are being defrauded — charged fees they don’t actually owe, declared in default when, by the terms of their loan agreements, they aren’t.

Beyond that, if trusts can’t produce proof that they actually own the mortgages against which they have been selling claims, the sponsors of these trusts will face lawsuits from investors who bought these claims — claims that are now, in many cases, worth only a small fraction of their face value.

And who are these sponsors? Major financial institutions — the same institutions supposedly rescued by government programs last year. So the mortgage mess threatens to produce another financial crisis.
Furthermore, I think he is partially correct in this next statement, taking his hyper-partisanship into account:
True to form, the Obama administration’s response has been to oppose any action that might upset the banks, like a temporary moratorium on foreclosures while some of the issues are resolved. Instead, it is asking the banks, very nicely, to behave better and clean up their act. I mean, that’s worked so well in the past, right?

The response from the right is, however, even worse. Republicans in Congress are lying low, but conservative commentators like those at The Wall Street Journal’s editorial page have come out dismissing the lack of proper documents as a triviality. In effect, they’re saying that if a bank says it owns your house, we should just take its word. To me, this evokes the days when noblemen felt free to take whatever they wanted, knowing that peasants had no standing in the courts. But then, I suspect that some people regard those as the good old days.
Lest anyone think that the TARP (which Krugman endorsed) actually solved anything, think again. As much as anything, the TARP and the willingness of so many in Congress to bestow favors to financial institutions that were busy running off the cliff certainly feeds the belief by many that the "banksters" are above the law, and even above the laws of economics.

Krugman makes another point next, and I believe it bears some discussion:
What should be happening? The excesses of the bubble years have created a legal morass, in which property rights are ill defined because nobody has proper documentation. And where no clear property rights exist, it’s the government’s job to create them.

That won’t be easy, but there are good ideas out there. For example, the Center for American Progress has proposed giving mortgage counselors and other public entities the power to modify troubled loans directly, with their judgment standing unless appealed by the mortgage servicer. This would do a lot to clarify matters and help extract us from the morass.
Indeed, Krugman is right when he points out that ill-defined property rights can cause much economic dislocation. (When he endorses socialistic schemes that, in effect, eviscerate property rights, I cannot figure out why he is shocked, SHOCKED when they don't work.)

The securitization of mortgages -- done first by the government entities Fannie and Freddie and then picked up by private Wall Street firms -- has put a huge new wrinkle into this mess. Furthermore, I absolutely agree that if a financial entity cannot establish legal title to a property (and Krugman forgets that the private title companies were the first organizations to sound the alarm on this latest scandal), then it should not be permitted to perform foreclosure.

As for Krugman's statement that it is up to the government to "create" property rights, that makes no sense. What Krugman is saying is that governments de facto own everything, but if we follow some rules given by the state, the government will let us pretend that we own property. At best, government can be a referee in this process, although I believe our government these days is so abusive and so dysfunctional that it is incapable of turning into a trusted referee.

There is one thing he writes, however, that I think absolutely is wrong:
The accounting scandals at Enron and WorldCom dispelled the myth of effective corporate governance.
Enron's demise was not due to an accounting "scandal," nor was it a failure of corporate governance. (As we can presently see, government governance is not exactly going great guns, as the Congressional Budget Office makes the Enron crowd look like A-plus prognosticators.)

The Enron collapse was the collapse of a company that depended heavily upon the stock bubble AND easy credit. When the credit dried up, the heavily-leveraged firm crashed down hard, as one might expect. The accounting measures that Enron did pushed the envelope, but were not illegal.

(I have participated in a project that takes a second look at the Enron case, and I discuss on camera both the legal and economic aspects of what happened at Enron. Now, I absolutely disagreed with the person who put this project together on the role of the short sellers. The late Ken Lay insisted that short sellers caused the demise of Enron; I say that the short sellers exposed Enron. That's a huge difference.)

Wednesday, October 13, 2010

Krugman's Excellent Mine Rescue

While I am doing my day job work, I have decided to post a report from Mike Davis, who is Johnny-on-the-Spot with the latest stimulus idea from Paul Krugman. Take it away, Mike!!
On August 7th, 33 Chilean miners were trapped 2300 feet underground. They were located 17 days later. The problem was – how to get them out? The Chilean Government contacted the Nobel Prize-winning economist Paul Krugman for advice.

“Keynesian theory dictates that you dig a hole in the ground – a big hole - and that you keep on digging.” The Chilean Government took his advice. Finally, on the 12th of October, the trapped workers were reached and the rescue started. On learning the good news, Paul Krugman was ecstatic. “We have been waiting 75 years. Now, finally, we have an unequivocal vindication of Keynesian economic theory.” He added –“as a further bonus, Keynesian Economic Theory predicts a massive stimulus to the economy when the hole is filled in.”

Flushed with the success of this venture, Paul Krugman was asked whether he saw any domestic application. “Actually, I have already been on the phone to the governors of Kentucky and West Virginia to see if we could dig a hole and rescue workers trapped down a coal mine. Obviously, we cannot deliberately trap workers down a coal mine – we would need volunteers. So far The United Mine Workers of America will endorse the idea provided that the workers are paid extra for overtime, night shifts, and weekend in accordance with the Union Contract. They would also require paid time off for all accumulated breaks while the workers were trapped underground.

In West Virginia the governor suggested that the unemployed could volunteer to be trapped underground. “We have a growing problem with unemployment in the state. This would reduce our unemployment numbers – it is hard to claim that you are “actively looking for work” when you are trapped 2000 feet underground.”

However, this plan has run into stiff resistance from the UMWA and Democrat politicians running for re –election. A Union spokesperson said – “this is union work – all the unemployed would need to join the union.” An anonymous Democrat Congressman was quoted as saying – “kick-backs from union dues are a major source of political contributions to democrats – we are desperate – we need this money now – we don’t have much time left – we are behind in the polls – the election is only weeks away.”

Meanwhile, OSHA has been getting involved – they claim that they will need a plan and will need to review and study the plan before they can give their approval, and this will take time.

The Governor of West Virginia is furious – “our State economy is in the tank and we need this stimulus now, not later. I am going to ask President Obama to sign an Executive order to fast-track this project”.

Tuesday, October 12, 2010

On Costs and Public Works Projects

The outright anger and angst shown by Paul Krugman and others regarding Gov. Chris Christie's cancellation of The Tunnel has been pretty predictable, but it also ignores the fact that governments today are spending huge amounts of money for things that were not in the budget back in the days of the Hoover Dam.

While I am not a regular reader of David Brooks' NYT column (given that I am not much into "National Greatness" Neoconservatism), I do believe that he has some important insights into the latest controversy in his column today. Perhaps the most important point he makes is that at the present time, state and local governments have most of their budgets carried away by government employees. He writes:
...nobody seems to be asking is: Why are important projects now unaffordable? Decades ago, when the federal and state governments were much smaller, they had the means to undertake gigantic new projects, like the Interstate Highway System and the space program. But now, when governments are bigger, they don’t.

The answer is what Jonathan Rauch of the National Journal once called demosclerosis. Over the past few decades, governments have become entwined in a series of arrangements that drain money from productive uses and direct it toward unproductive ones.

New Jersey can’t afford to build its tunnel, but benefits packages for the state’s employees are 41 percent more expensive than those offered by the average Fortune 500 company. These benefits costs are rising by 16 percent a year.

New York City has to strain to finance its schools but must support 10,000 former cops who have retired before age 50.

California can’t afford new water projects, but state cops often receive 90 percent of their salaries when they retire at 50. The average corrections officer there makes $70,000 a year in base salary and $100,000 with overtime (California spends more on its prison system than on its schools).

States across the nation will be paralyzed for the rest of our lives because they face unfunded pension obligations that, if counted accurately, amount to $2 trillion — or $87,000 per plan participant.
Unfortunately, the Keynesian version of this seems to be that the more governments pay out to employees in pay and benefits, the more "aggregate demand" is created. As one of the people who regularly comments on this blog wrote: "What Austrians do not understand is wages are not just a cost – they are always income as well."

This is most instructive, for what he is saying is that the higher the rates of pay, the more wealth is created. No, Austrians are not unaware that one's paycheck is one's income, but we hold that the Keynesians have it backward. One's paycheck should reflect the value of the marginal revenue product one has created, and if pay is raised above such a level -- as is often the case with unionized government employees -- then the real wages of others, after the transfers via taxation are completed are diminished to rates below their MRP (or Discounted MVP, to quote Murray Rothbard).

The Keynesians seem to believe that government spending itself creates wealth, so the more that government spends -- no matter how it does so, taxation, borrowing, or printing dollars -- the wealthier we become. Obviously, Keynesians and Austrians are at an impasse at this point, and there really is no bridging of the intellectual gulf.

Brooks is arguing that there really is a "crowding out" effect of government in which the public employee unions make it increasingly costly for state and local governments to afford to carry out many public works projects. Murray Rothbard noted that over time, true monopolies are captured by their employees, and by definition, governments are monopolies. I believe that this version of a "Capture Theory" is correctly applied here.

Monday, October 11, 2010

Krugman Agonistes: We Are In the "Dark Ages" of Economics

While Paul Krugman has a column today alleging that the Obama administration really has not significantly ramped up domestic spending (which is why he says the economy is mired in the doldrums), I want to go back to something he wrote in January 2009, in which he lays out some opposing lines of economic thought (and stays out of partisan politics, for a change).

Furthermore, I find myself agreeing with Krugman that we are in a "Dark Ages" of economic thinking, but for very different reasons. Krugman is alleging that too many economists are accepting Say's Law as being legitimate, when every good Keynesian knows that J.M. Keynes "discredited" Say's Law in the mid-1930s. I disagree wholeheartedly on many fronts.

The difficulties are legion. First, like Keynes, Krugman really gets Say's Law wrong, creating a caricature of what Say wrote in 1803 and then demolishing the straw man he has created. (One has to keep in mind that Say's Law really is a huge obstacle to Krugmanomics, and, like Keynes, Krugman instinctively understands that point.

Second, the argument really goes to the heart of what constitutes what we call an economy. On one side, we see people like J.B. Say and the Austrians write that an economy consists of real things, real assets, and real relationships between goods. On the other side, we see people like Krugman and Alan Blinder and Ben Bernanke insist that governments can create wealth simply by creating money or borrowing and spending. In their view, an economy is little more than a mechanistic entity in which people robotically create goods with the requirement being that they have enough "purchasing power" so consumers can clear the shelves via spending so that the process can repeat itself.

I would urge people to read Krugman's entire blog post to see the perspective from which he is coming. I will include this quote, which I believe is instructive. Calling the perspectives from Eugene Fama and John Cochrane "pure Say's Law," Krugman writes:
There’s no ambiguity in either case: both Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period.

What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship. Yes, savings have to equal investment, but that’s not something that mystically takes place, it’s because any discrepancy between desired savings and desired investment causes something to happen that brings the two in line.
First, and most important, what we call Say's Law is not about accounting identities or even the infamous S=I. Instead, it is about the fact that consumption and production are intricately related, not by a circular patterns, but rather by the simple fact that one's ability to consume MUST arise from the ability of someone to be able to produce something.

I deal with all of this in a paper I published last year on Say's Law in which I take a telling quote from Benjamin Anderson:
The prevailing view among economists, . . . has long been that purchasing power grows out of production. The great producing countries are the great consuming countries. The twentieth-century world consumes vastly more than the eighteenth-century world because it produces vastly more. . . . Supply and demand in the aggregate are thus not merely equal, but they are identical, since every commodity may be looked upon either as supply of its own kind or as demand for other things. But this doctrine is subject to the great qualification that the proportions must be right; that there must be equilibrium.
This view contrasts with the Keynesian/Marxist views that the real problem with a recessionary economy is that there is the problem of overproduction/underconsumption which can be "solved" by the injection of "purchasing power" into the hands of individuals via government intervention. Call it "pump priming," "giving the economy traction," or "enabling workers to buy back the products they created," but nonetheless all three viewpoints operate on the notion that production and consumption are two unequal and unrelated activities, and that the purpose of consumption (or "spending") is to clear the shelves of the goods that workers made so that the workers can be employed making more of them.

Now, the Keynesian argument -- which Krugman repeats -- is that in the real world, savings are greater than investment, especially when the "animal spirits" of investors are quieted. When that is the case, and investment spending is down, it is up to government to fill in the hole by ratcheting up spending. Now, I don't believe I have mischaracterized Krugman's position here, but, nonetheless, I strongly disagree with it.

First, even if I were to give Krugman his point that S>I, nonetheless (and I have not seen this discussed anywhere) the nature of fractional reserve banking would take the existing savings/deposits and loan them out to where the actual new money created would be substantially greater than the savings base. It is true that banks rarely are going to be fully "loaned up," but Krugman ignores the money multiplier that occurs in lending, something that any student who has taken Money and Banking or even a Macro class would understand.

Second, there is something even more fundamental here, and that is the fact that the Krugman position almost seems to be that the Law of Scarcity is abolished when interest rates approach the "zero bound" (in his words). This also is where Krugman and the Austrians really part company, for in Austrian Economics, the Law of Scarcity is not abandoned at the "zero bound" or the presence of unemployed resources.

Instead, Austrians look to reasons as to why the resources are unemployed, as opposed to the Keynesian argument that people and government simply are not spending enough. Instead, we wish to look beyond to why there no longer is demand for certain things, and to the larger issue of how the proportions involving the factors of production have been disturbed or distorted.

As I have said many times, the Keynesian argument depends upon seeing factors of production as being homogeneous and having no particular special relationships. Everything from mine output to making of cotton candy is just one amorphous and homogeneous set of factors. This is not economic theory; it is a theory of convenience to justify the presence of government spending.

Friday, October 8, 2010

Krugman Tunnels Under Economic Logic

I was wondering why all of a sudden Paul Krugman was on a railroad tear, but now I know why: New Jersey Gov. Chris Christie has pulled the plug on yet another high-cost boondoggle that characterizes construction projects in the New York City area.

Yes, Krugman is bewailing the loss of the long-planned rail tunnel under the Hudson River between New Jersey and NYC, a project that promises to have billions of dollars of cost overruns and would burden the state with even more debt. From what I know, I believe Christie did the right thing, and the angst on the editorial pages of the NY Times that has accompanied Christie's decision definitely tells me the guy is correct.

In defending this boondoggle, which has been "planned" for two decades and still lacks the requisite funding, Krugman resorts to the kinds of cheap tricks that should be beneath a Nobel Prize-winning economist. (OK, I'm not really sure that a Keynesian also can be an economist, but nonetheless Krugman did win the Nobel a couple of years ago.)

For example, in a blog post yesterday, Krugman trots out this notion that the economics of public transit is something quite mysterious and that when one factors in all of the "externalities" and implicit costs that accompany people driving into Manhattan, then the mass transit facilities there more than pay for themselves.

(It is interesting that Krugman actually resorts to trying to make an argument by using "opportunity cost," since part of his current economic theme is that economic downturns at best modify and at worst do away with the Law of Scarcity. So, opportunity cost is fine when Krugman thinks it helps make his argument, but when Austrians try to point out the issues of opportunity cost in the analysis of the business cycle, Krugman claims that they are crackpots.)

Furthermore, Krugman does not want to address the cost issue because labor union practices in New York and New Jersey are behind the astronomical cost numbers for mass transit. However, at this point, Krugman then can switch back to his Keynesian mode and claim that all these high costs are just great, because THEY MEAN MORE SPENDING! He writes:
So this was a terrible, shortsighted move from New Jersey’s point of view. But that’s not the whole cost. Canceling the tunnel was also a blow to national hopes of recovery, part of a pattern of penny-pinching that has played a large role in our continuing economic stagnation.

When people ask why the Obama stimulus didn’t accomplish more, one good response is to ask, what stimulus? Leaving aside the cost of financial rescues and safety-net programs like unemployment insurance, federal spending has risen only modestly — and this rise has been largely offset by cutbacks at the state and local level. Many of these cuts were forced by Congress, which has refused to approve adequate aid to the states. But as Mr. Christie is demonstrating, local politicians are also doing their part.

And the ideology that has led Mr. Christie to undermine his state’s future is, of course, the same ideology that has led almost all Republicans and some Democrats to stand in the way of any meaningful action to revive the nation’s economy. Worse yet, next month’s election seems likely to reward Republicans for their obstructionism.

So here’s how you should think about the decision to kill the tunnel: It’s a terrible thing in itself, but, beyond that, it’s a perfect symbol of how America has lost its way. By refusing to pay for essential investment, politicians are both perpetuating unemployment and sacrificing long-run growth.
I have serious doubts that this tunnel, with its costs of $11-15 billion, would "revive" the economy of that area and also provide for long term growth. First, other policies that Krugman has been endorsing are going to sap growth in the future and second, if there is any growth, much if not most of the financial gain will go to paying off the debt incurred to building those projects.

No, what we have is yet another Krugman shot at someone who actually wants to be fiscally responsible. However, being that Krugman is trying to claim that the current regime in power is being "stingy" with its spending, I doubt the man really is capable of comprehending an economic argument.

Wednesday, October 6, 2010

Krugman's Rail Fantasy

Paul Krugman is on another tear. Those Evil Republicans are not supporting what clearly would be an extremely-costly "high-speed rail" boondoggle, which then makes them against ALL railroads. Here is Krugman in his own words:
Jonathan Cohn points out the curious opposition of Republicans to any improvement in our woefully inadequate rail system. As he suggests, this opposition goes beyond issues of cost; there’s something visceral about it.
Notice that Krugman does not say "passenger rail," just "rail," although I guess he is talking about passenger rail travel.

Furthermore, Krugman tries to invoke a questionable economic argument regarding "natural monopoly," as seen here:
It’s not too hard to understand, of course: in real life, as opposed to bad novels, railroads aren’t run by rugged individualists (nor should they be). In fact, passenger rail is generally run by government; even when it’s partially privatized, as in Britain, it’s done so with heavy state intervention to preserve some semblance of competition in a natural monopoly. So rail doesn’t fit the conservative vision of the way things should be.
Hmmm. We have a government monopoly preserving "some semblance of competition in a natural monopoly"? Uh, that does not compute, people. Furthermore, passenger rail was very, very competitive in this country until the automobile became more developed (and was subsidized by the Interstate Highway System) and also after a century of government regulation of railroads.

Furthermore, government subsidies of passenger rail don't exist to "preserve competition," but rather exist to preserve the various rail unions which have helped make the real costs of passenger rail frightfully high. All that is lost to Krugman, of course, who spins his own fantasies.

But, in the end, it really is about people ponying up so Paul can ride the rails for less than the full cost. He writes:
I almost always take trains both to New York and to Washington, and consider the time spent on those trains part of my productive hours — with notebooks and 3G, an Amtrak quiet car is basically a moving office. And I don’t think I’m alone in that.
Gee, I'm surprised Amtrak does not provide him with a heavily-subsidized private car.

As for "high-speed rail," we are speaking of billions and billions of dollars to be spent for which there really won't be any return. To those who don't subscribe to Keynesian "economics," that means that high-speed rail will use far more in resources than it will produce, which means a deficit of wealth. (Yes, Keynesians will claim it would "stimulate" the entire economy because the government is spending lots of money.)

So, any of you who might take economics seriously, don't ride on the same train with Krugman, as he might declare you an "enemy of the people" have have the conductor throw you off to the side!

Daniel Gross: Channeling His Inner Krugman

The New York Times has been a fount of Keynesian revivalism, with not only Paul Krugman's frequent columns and blogs preaching the Gospel of Spending but also other writers as well. Today, I look at a column by Yahoo's economics editor Daniel Gross, in which he claims that the nation's economic recovery depends upon individuals using debt to purchase consumer goods.

Gross claims that the real secret of the past success of the U.S. economy has been the fact that U.S. consumers spend a lot of money. I'm serious. He writes: the economy slowly recovers, there are signs that Americans are rediscovering their free-spending ways. Total consumer credit, which includes non-revolving debt like car loans, has stabilized, and it rose in both June and July. It’s back to where it was in the second quarter of 2009. Collectively, we don’t seem to have run our credit cards through shredders. Mailboxes are again stuffed with credit card solicitations. Newspapers are filled with come-ons from car dealers offering zero-percent financing. The Federal Housing Authority offers mortgages on houses for as little as 3 percent down. You’d be forgiven for thinking that we’ve flown back in time to September 2006.

And, believe it or not, that’s a good thing. The economic expansion that has been going along in fits and starts since June 2009 was initially powered by government stimulus and business investment. But for this recovery to mature, broaden and persist, the greatest economic force known to mankind — the American consumer — has to get back in the game. (Emphasis mine)

In an economy in which consumers account for 70 percent of activity, credit is both a vital lubricant and the indispensable fuel.
Somehow, it does not surprise me that our "elite" thinkers believe this nonsense. (Almost everyone I have known who has been associated with the NYT has considered himself or herself to be intellectually and morally superior to the rest of us mundanes. Over time, these people really do become caricatures of themselves.)

However, if what he is saying is true, then we really should be passing on this Great Secret. Tell the people of Haiti that if they want to have a thriving economy and recover from the recent earthquake, they need start borrowing lots and lots of money so they can buy consumer goods, houses, and the like and spend themselves into prosperity. As for the goods on the shelves, if you spend, they will magically appear.

I would like to contrast Gross's comments with some real economic analysis from Robert Higgs, who recently wrote:
As every student of the business cycle learns early on, the most variable part of aggregate expenditure is private investment. When real gross private domestic investment peaked, in the first quarter of 2006, it was $2,265 billion, or 17.5 percent of GDP. When it hit bottom in the second quarter of 2009, it had fallen by 36 percent to $1,453 billion, or 11.3 percent of GDP. (Deducting investment expenditures aimed at compensating for depreciation of the private capital stock [Table 1.7.6], we find that real net private investment – the part that contributes to economic growth—in the most recent quarter was only one-third as great as it was at its peak in early 2006.) The ups and downs of the business cycle are obviously driven not by consumption spending, but by investment spending.
The difference becomes even more obvious when we compare quotes from Gross and Prof. Higgs. First, I quote Gross:
John Maynard Keynes wrote of the paradox of thrift — if everyone saves, everyone becomes poorer, because demand for goods and services will fall. Here’s another paradox: Running up consumer debt may be a moral failure and a recipe for long-term damnation, but it also contains the roots of our short-term salvation.
Now I quote Prof. Higgs:
Such arguments, however, fail to grasp the true nature of the boom-bust cycle, especially the central role of investment spending in driving it—and, more important, in driving the long-run growth of real output that translates into a rising standard of living for the general public. Politicians, if they truly wish to promote genuine, sustainable recovery and long-run economic growth, need to focus on actions that will contribute to a revival of private investment, not on pumping up consumption. In the most recent quarter, real gross private domestic investment was running at an annual rate more than 20 percent below its previous peak and, as noted, real net private investment was fully two-thirds below its previous peak.

To bring about this essential revival of investment, the government needs to put an end to actions that threaten investors’ returns and create uncertainty that paralyzes their undertaking of new long-term projects. Gigantic measures such as the recently enacted health-care legislation and the financial-reform law, which entail hundreds of new regulations whose specific content, enforcement, and costs are impossible to forecast with confidence, contribute to “regime uncertainty” and thereby encourage investors to hold large cash balances or to park their funds in short-term, low-yield, less risky securities. Such investments cannot support genuine recovery and sustained long-run growth.

In sum, our crying need at present is for a robust revival of private long-term investment. Consumption-oriented government “stimulus” programs, at best, only ensure a protracted period of economic stagnation.
Gross, like Krugman, seems to believe that all that is necessary for our economy to recover and grow is for the government to shower dollars on everyone, who will then take the money and spend it, and borrow to add to whatever they don't have. And if people and businesses are not willing to spend, then it is up to the government to confiscate that money via taxation and inflation and other methods of coercion, if necessary.

Prof. Higgs, on the other hand, says that economies grow when businesses are able to invest for the long term and find ways to produce more using fewer resources over time. Thus, the value of "investment spending" is NOT the spending per se, but rather the fact that the lines of production in which they invest are able to produce goods that satisfy the needs and desires of consumers.

I would add that the Krugman-Gross-NYT approach assumes that spending is mechanistic and exists only to clear the shelves so producers can put more goods on the shelves again. In that view, production and consumption are not intricately related, and entrepreneurship is useful ONLY in the fact that they are able to provide jobs for people so they can spend, clear the shelves, and put more stuff back on them.

This is not an economy; it is a circular pattern, and in that view, production is useful only in the fact that it keeps people busy. It would be just as useful for people to be paid to dig holes and then fill them afterward, and continue the process indefinitely. And this is the best that our "elites" can do?

Tuesday, October 5, 2010

Robert Wenzel and Krugman's "Hangover Theory"

Lew Rockwell recently posted this piece by Robert Wenzel on his page, and it is very much worth reading. (Wenzel wrote it a couple of years ago, but it is quite relevant.)

It deals with Krugman's article that attacked the Austrian Theory of the Business Cycle (ATBC) in 1999, Krugman calling it the "Hangover Theory." Not surprisingly, Krugman not only gets the history of the Great Depression wrong, but he also mangles the theory itself. To further his calumny against the Austrians, he then tries to put the whole thing into a morality play in which he sets the rules and parameters. He also attacks F.A. Hayek and Joseph Schumpeter, two economists whose intellect and life's work dwarfed anything Krugman ever will do.

Krugman's explanation is quite dishonest, but that is the state of modern economics these days.

Monday, October 4, 2010

Are the Keynesians Correct?

Paul Krugman definitely has a sense not only of his own "rightness," but also his own righteousness. While it would be interesting for me to delve into the details of his column today in which he attacks Fox News, when someone goes off the deep end into an outright rant, I let his own words speak for himself.

Although I don't have TV and would not be watching Fox News anyway, nonetheless I do find it interesting that Krugman even wastes time complaining about "news bias." Having followed his employer through the infamous Duke Lacrosse Case, in which the NY Times continued to insist that Mike Nifong was telling the truth and that black was white and that there was a "body of evidence" that should have pushed the whole thing to a trial, I can tell you something about "bias" from a media source. Even today, I marvel at how those "sophisticated" people at the NYT could find a way to believe in an actual "magic towel" that could wipe away all traces of Crystal Mangum's DNA while retaining the DNA of Duke "rapists."

So, when Krugman claims that anyone who disagrees with him either must be on the payroll of the Koch Brothers or the Coors family, I think he has jumped the shark. Could someone say just as easily that people who think like Krugman are on the payroll of George Soros? After all, the famed New Yorker article by Jane Mayer, which claims that the Koch Brothers are the secret force behind the Tea Party, admitted that Soros gives more to leftist causes and organizations in one year than the Kochs have given in their lifetimes.

(For the record, I have published two book reviews and one article in Regulation Magazine, which is published by the Cato Institute, which receives Koch Brothers money. I received $1,000 for each piece that I wrote. That must mean, according to Krugman, that I am on the Koch payroll.)

There is a much more important piece that Krugman wrote on his blog last week that is much more intriguing than his latest anti-Fox rant. In "How the Other Half Thinks," Krugman declares that the Keynesian predictions have been closer to the mark than what he calls the "classical" positions; therefore, Keynesianism must be correct. He writes:
The point is that recent events have actually amounted to a fairly clear test of Keynesian versus classical economics — and Keynesian economics won, hands down.
Now, I am not sure what he means by "classical" here, given that there have been many schools of thought from the past. Does he mean the Monetarists? The Marshallians? The Austrians? (Not a chance there, since Krugman hates the Austrians and when he does describe their positions on things, he deliberately distorts what they say, creating his own "straw man," and then knocking down a false image.)

Like John Maynard Keynes, Krugman creates the "straw man" of "classical" theory and goes from there. If there is a heart to Krugman's point, it is this: So-called laws of economics are turned upside down when economic conditions push interest rates -- or at least interest rates set by the central bank -- to near zero.

When that happens, according to Krugman, then "virtues and vices" and, well, vice versa. Here is the problem I have with his point, and it is fundamental: The Law of Scarcity cannot be repealed by Federal Reserve policies. When one goes to the core of the issue, that is what Krugman is saying.

Krugman's economic thought is really not "economics" at all. It is a mathematical, mechanistic view of an overall economy in which there are no purposeful entities called people. In that view, production and consumption are two separate and unrelated things; the only purpose of "spending" is to clear the shelves so that producers will have something to do.

While the British "classicals" of the 19th Century were way off in their theory of value (and never did fully embrace Marginal Utility, instead creating a hybrid theory in which MU worked in the short run and cost-of-production in the long run), they did hold to Say's Law. (I discuss Say's Law and the Austrian Theory of the Business Cycle in this paper which appeared last year in the Quarterly Journal of Austrian Economics.)

I agree that Krugman has been correct in that we have not seen the hyper-inflation that some have predicted, although when one understands that new money moved into the system via bank loans, it is not surprising at all, since business activity is way down. The real issue, then, is why we are not seeing business activity.

Krugman's answer is that we have to have more spending before businesses are willing to borrow and spend beyond their short-term needs. In that view, spending will lead to spending, and once the system gains what Krugman calls "traction," the economic train can move forward. (My sense is that he dismisses the run-up in gold, silver, and other commodities as being the result of "nut cases" buying the stuff and having no economic meaning, except that Fox News viewers have extra money to spend.)

For lack of time (yes, I do have a day job, and I have to meet with the AACSB re-accreditation team this morning), I cannot go into a full explanation of an alternative view here. However, I do want to make this salient point: Laws of economics are immutable; they cannot change because no one, not Krugman, not the Keynesians, not the Charalists, no one, can repeal the Law of Scarcity.

Krugman really wants us to believe that the Law of Scarcity does not hold when interest rates (set by the Fed) are at a "zero bound." That is the bedrock of the discussion, as I see it. To me, it is like Krugman is saying that the Law of Gravity cannot hold when one is discussing the Theory of Evolution or the Theory of Global Warming. It makes no sense, for it violates the very fundamental tenets of economic theory.

Say what he will, Krugman is trying to argue that Scarcity does not matter. Well, it does matter and it matters greatly.

Friday, October 1, 2010

Paul Krugman's Excellent Protectionist Adventure

Note: Before starting on my post today, I want to share an excellent article, "My Encounter With Paul Krugman," by Murray Sabrin, a professor of finance in the Anisfield School of Business, Ramapo College of New Jersey. Prof. Sabrin lays out the Keynesian nonsense that Krugman gave in his talk and provides an alternative explanation. The article is well-worth reading.

(Murray is a friend of mine and is a regular reader of KIW. Yes, my sympathies to him on both counts!)

One of the things Krugman likes to do is to write a number of columns and blog posts according to a certain theme, and he keeps things varied, although the Keynesian thread runs through them. Thus, he "stays on message" even when moving from one area to another.

In his column, "Taking On China," Krugman repeats a couple of his constant themes: China's refusal to allow its currency to have an official value that meets Krugman's approval is helping to cause this current depression, and protectionism is a legitimate policy when the economy is in the tank. He writes:
Serious people were appalled by Wednesday’s vote in the House of Representatives, where a huge bipartisan majority approved legislation, sponsored by Representative Sander Levin, that would potentially pave the way for sanctions against China over its currency policy. As a substantive matter, the bill was very mild; nonetheless, there were dire warnings of trade war and global economic disruption. Better, said respectable opinion, to pursue quiet diplomacy.

But serious people, who have been wrong about so many things since this crisis began — remember how budget deficits were going to lead to skyrocketing interest rates and soaring inflation? — are wrong on this issue, too. Diplomacy on China’s currency has gone nowhere, and will continue going nowhere unless backed by the threat of retaliation. The hype about trade war is unjustified — and, anyway, there are worse things than trade conflict. In a time of mass unemployment, made worse by China’s predatory currency policy, the possibility of a few new tariffs should be way down on our list of worries.
So, let's see. Because prices are not rising out of control right now when some people predicted that the Federal Reserve System's vast expansion of the monetary base was going on, that means protectionism is a worthy policy. This is a typical fallacy that Krugman uses, the non sequitur.

To further his cause, Krugman resorts to another fallacy, the "Appeal to Authority," by enlisting the late Paul Samuelson (another Nobel Prize winner) who was one of Krugman's mentors when he was in graduate school at MIT. In a recent blog post, Krugman quotes Samuelson:
With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.
Yes! Laws of economics from the Law of Scarcity to the Marginal Utility Theory of Value hold ONLY when times are good! However, if the economy is sluggish, then it is time to trot out "Fable of the Bees" and start all over again.

Krugman lavishes praise upon those in Congress who are pushing this latest round of protectionism. (He calls this latest move "bipartisan," so I guess when Republicans -- who always have been protectionist since their beginnings in the 1850s -- aren't so bad when they do Krugman's bidding, or at least we can say they have taken a holiday from their usual goals of Doing Evil.)

However, as he has done with the "stimulus" and new government spending, Krugman claims that this still is not enough. I only can imagine that his next move would be to trot out Smoot-Hawley II, since it worked so well the first time it was imposed. He writes:
For the truth is that U.S. policy makers have been incredibly, infuriatingly passive in the face of China’s bad behavior — especially because taking on China is one of the few policy options for tackling unemployment available to the Obama administration, given Republican obstructionism on everything else. The Levin bill probably won’t change that passivity. But it will, at least, start to build a fire under policy makers, bringing us closer to the day when, at long last, they are ready to act.
So, it seems that those Evil Republicans have not been channeling enough of their Inner Smoot-Hawley to satisfy Krugman, but maybe, just maybe, we can have a full-blown world-wide trade war, blaming those Dastardly Chinese for their intransigence and for their effrontery in producing goods that Americans want to buy (and for buying U.S. Treasuries by the handful in order to fund our own deficit spending).

No doubt, this will rev up Krugman's base, as his supporters will claim that we can have this wonderful economy based upon a form of autarky. (It is amazing that Krugman actually got his Nobel Prize allegedly for his trade theory, as now he is claiming that unless currencies are matched according to Krugman standards, trade creates poverty.)

Keynesianism is based upon a belief that the laws of economics hold only in special conditions, and when those conditions are not met, then governments need to act as though the Law of Scarcity does not exist. To Austrians like me, the laws of economics are like the Law of Gravity: they are immutable and always apply.

As I see it, Krugman's latest missives contain about as much sound thinking as would be a directive from the MIT graduate that in special conditions, the Law of Gravity does not hold. However, I somehow doubt we would see Krugman then getting ready to take a leap off the Empire State Building, but economically speaking, that is exactly what he is demanding we should do.