Krugman rewrites history (again)

One of the most famous lines said by anyone in the Herbert Hoover administration was what Secretary of the Treasury Andrew Mellon supposedly told his boss: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Oh, and he said one other thing: "Purge the rottenness out of the system."

In his column today, Paul Krugman takes that quote and decides to rewrite history. True, Krugman is famous for that, as he gives us several howlers per week, but this one is important because not only does Krugman give us a false accounting of history then, he makes an equally-spurious claim for today.

The first and most important thing to remember (and something Krugman always seems to leave out -- not surprisingly) is that Hoover brags that he rejected Mellon's advice. This is important, because Krugman always presents that quote as an official policy of the Hoover administration when, as Hoover notes in his memoirs, he not only refused to follow Mellon's suggestion but he also tried actively to keep the liquidation from happening.

My sense is that Krugman ignores that fact because it does not fit into his chain of events, and because he wants to claim that the Republicans, who apparently want to cut all of $61 billion from a $3.5 TRILLION federal budget are trying to engage in what he calls Mellon-style austerity:

But never mind the lessons of history, or events unfolding across the Atlantic: Republicans are now fully committed to the doctrine that we must destroy employment in order to save it.

And Democrats are offering little pushback. The White House, in particular, has effectively surrendered in the war of ideas; it no longer even tries to make the case against sharp spending cuts in the face of high unemployment.

So that’s the state of policy debate in the world’s greatest nation: one party has embraced 80-year-old economic fallacies, while the other has lost the will to fight. And American families will pay the price.

Now, I am not sure how a tiny proposed cut in spending translates to "austerity," but like Blutarsky in "Animal House" who asked his frat brothers if the Americans quit "when the Germans bombed Pearl Harbor," Krugman is on a roll.

However, I think for all his botching of history, Krugman does perform a useful function here, and that is to ask the question (in his own, nasty way, of course) as to the larger issue underlying debate about boom and bust. Are we dealing with simple idle resources that need to be jump-started via an infusion of government spending, or are we dealing with malinvested resources that need either to be liquidated or transferred to other uses?

This is not an idle question, for I believe it is at the heart of all of Krugman's anti-"austerity" diatribes. Krugman clearly believes that the problem is that of idle resources; people stopped spending, and the only way to get the economy moving again is to bring in wads of new government spending that will give the economy "traction" and continue the circular process.

To Krugman, a boom is just that: a boom. It can and should be continued by all means possible, including policies of massive borrowing, spending, and, yes, creation of new money. (As Krugman claims in The Return of Depression Economics, many economic problems can be solved simply by printing money, and that printing money creates what he calls "a free lunch.")

In that world, all factors of production, economically speaking, are homogeneous. It does not matter from what direction the spending comes, as everything moves in the same way. If a boom is touched off by something like the housing bubble, it creates the very kind of mix of capital and labor that a huge infusion of government spending would produce.

Should that be the actual situation, then Krugman is correct and the way to long-term prosperity is for government to print and spend. Money in that view would be nothing more than a tool used by government to manipulate events, and as long as the "correct" people are in political power, such policies will create a second-best nirvana.

The Austrian position, however, is much different. Austrians hold that factors of production are heterogeneous, and that the mix of capital created during a credit-fed boom cannot be sustained, even if the government throws in new spending measures after new measures. In fact, Austrians believe that the very wave of spending that Krugman demands government do only exacerbates the situation, as it only deepens the unsustainable capital structures and creates even more malinvestments. That is the heart of the Austrian Theory of the Business Cycle (ATBC).

I'm not about to claim that the "austerity" measures of what Krugman speaks are based upon the ATBC or that finance ministers across the globe suddenly have embraced Austrian Economics. Nonetheless, I will say that until the economy can deal with the very real malinvestments that piled up during the last 20 years, we are doomed to have a low-growth economy with high unemployment.

This is the Austrian critique in a nutshell. As for Krugman's claims that the Republicans suddenly have become the Second Coming of Andrew Mellon, I believe that is, to put it mildly, a bit of hyperbole. But, Krugman never would engage in that kind of rhetorical fallacy, would he?