Do economic conditions make opportunity cost disappear?

With the flavor-of-the-week being blaming China for the economic depression this country caused, Paul Krugman is at it again. At least the theme is constant: a "liquidity trap" changes all the "rules" of economics.

This is a nice way of saying that if Paul Krugman believes the economy is in that "liquidity trap," then he gets to say what the "new rules" of economics are, and the first thing to go is that oppressive Law of Opportunity Cost. He writes:

Now, some people will ask, didn’t I used to be a free-trader? Yes, and under normal circumstances I still mostly am. But these are not normal circumstances! In an economy that isn’t in a liquidity trap, one can reasonably assume that jobs lost due to Chinese exports will be offset by jobs gained elsewhere, although that may be small comfort to the workers affected. Under current conditions, however, there is absolutely no reason to believe that there are offsetting gains — on the contrary, the losses to import competition are magnified through multiplier effects.

Like everything in economics, support for free trade should be based on analysis, not slogans. And if you’re in a situation where the analysis says normal rules don’t apply, then they don’t apply.

The idea of "free trade" is nothing more than a rendition of opportunity cost. One's production decisions are based upon the opportunity costs involved, period.

What Krugman is saying is that our situation today repeals the Law of Opportunity Cost and with it the Law of Scarcity. Thus, we are left with the head-scratching notion that goods no longer are scarce, even as people are being deprived.

(I am sure I will have a host of angry readers claiming I am putting words into Krugman's mouth. All I can say is that by debunking the Law of Comparative Advantage, which is based upon the Law of Scarcity and the Law of Opportunity Cost, Krugman is doing away with those things. There is no way around it, even if Krugman's fans don't like it.)

Krugman: Blame China for our economic ills

Paul Krugman received his Nobel Prize three years ago ostensibly for his contributions to theories of international trade. (He actually received it at the time because he was writing anti-Bush columns, and the Swedes were in the anyone-but-Bush mode. A year later, President Barack Obama would receive the Nobel Peace Prize, and we see what he has done with it: employ international death squads.)

Krugman writes:

...Senate leaders will...take up legislation that would threaten sanctions against China and other currency manipulators.

Respectable opinion is aghast. But respectable opinion has been consistently wrong lately, and the currency issue is no exception.

Why such drastic steps? Krugman spells out what he sees as the problem:

Ask yourself: Why is it so hard to restore full employment? It’s true that the housing bubble has popped, and consumers are saving more than they did a few years ago. But once upon a time America was able to achieve full employment without a housing bubble and with savings rates even higher than we have now. What changed?

The answer is that we used to run much smaller trade deficits. A return to economic health would look much more achievable if we weren’t spending $500 billion more each year on imported goods and services than foreigners spent on our exports.

There is much more in his column defending countries manipulating their currencies in order to make them weaker internationally, including a demand that the U.S. Government do the same. However, since China is "manipulating" its currency to do what Krugman demands we do, China must be the cause of the depression in the USA.

Krugman uses an interesting set of logical steps to reach this conclusion. (1) The government has tried to "stimulate" the economy, (2) the economy still is in a depression; (3) therefore, China must be at fault.

When the Indonesian economy collapsed in the late 1990s, mobs murdered ethnic Chinese merchants. I guess I am grateful that Krugman is not calling for the murder of others, but nonetheless when a Nobel Prize winning economist calls for trade barriers as a way to pull the USA out of a depression, he no longer is practicing economics.

If you ask where Krugman is calling for trade barriers, I think the following quote from his column provides ample proof of that:

In the last few days a new objection to action on the China issue has surfaced: right-wing pressure groups, notably the influential Club for Growth, oppose tariffs on Chinese goods because, you guessed it, they’re a form of taxation — and we must never, ever raise taxes under any circumstances. All I can say is that Democrats should welcome this demonstration that antitax fanaticism has reached the point where it trumps standing up for our national interests.

In other words, opposition to a new tariff on Chinese goods is said to be bad because it is "right-wing" to be against "new taxes." No matter that this would be exactly the kind of measure that would make things worse; no, opposition to a new tariff is bad because Krugman thinks it is a way to score points against "right-wingers."

Before Herbert Hoover signed Smoot-Hawley in 1930, a letter signed by 1,000 academic economists urged the president not to do it. Hoover did it anyway, and the results were tragic.

Today, America's best-known economist is demanding that the Obama administration erect new trade barriers in the wrong-headed belief that restricting trade will create new prosperity. This is beyond economics; it is madness, and it also is very sad, because if Congress carries out the policy that Krugman is demanding, we are going to see the economy quickly go downhill.

Krugman's Nixonian Anti-Chinese Screed

Paul Krugman has gone to great lengths to blame China for the current economic depression that the USA and other nations are suffering. Yes, it those dastardly Chinese saved too much; they hold down the real value of their currency; they don't charge enough for their goods, and on and on and on.

In today's NYT column, Krugman goes on another anti-China screed, although at least he does have some lucid moments. So, let us begin. Krugman writes:

The root cause of China’s muddle is its weak-currency policy, which is feeding an artificially large trade surplus. As I’ve emphasized in the past, this policy hurts the rest of the world, increasing unemployment in many other countries, America included.

However, as Don Boudreaux correctly points out, it seems that Krugman contradicts himself later. Krugman says:

But a policy can be bad for us without being good for China. In fact, Chinese currency policy is a lose-lose proposition, simultaneously depressing employment here and producing an overheated, inflation-prone economy in China itself.

One way to think about what’s happening is that inflation is the market’s way of undoing currency manipulation. China has been using a weak currency to keep its wages and prices low in dollar terms; market forces have responded by pushing those wages and prices up, eroding that artificial competitive advantage. Some estimates I’ve heard suggest that at current rates of inflation, Chinese undervaluation could be gone in two or three years — not soon enough, but sooner than many expected.

China’s leaders are, however, trying to prevent this outcome, not just to protect exporters’ interest, but because inflation is even more unpopular in China than it is elsewhere. One big reason is that China already in effect exploits its citizens through financial repression (other kinds, too, but that’s not relevant here). Interest rates on bank deposits are limited to just 2.75 percent, which is below the official inflation rate — and it’s widely believed that China’s true inflation rate is substantially higher than its government admits.

Rapidly rising prices, even if matched by wage increases, will make this exploitation much worse. It’s no wonder that the Chinese public is angry about inflation, and that China’s leaders want to stop it.

But for whatever reason — the power of export interests, refusal to do anything that looks like giving in to U.S. demands or sheer inability to think clearly — they’re not willing to deal with the root cause and let their currency rise. Instead, they are trying to control inflation by raising interest rates and restricting credit.

Boudreaux counters:

In short, Beijing keeps the value of the yuan too low by buying dollars with newly created yuan – a policy that Mr. Krugman correctly recognizes to be inflationary.

But as we read on to paragraph ten, we find Mr. Krugman singing an altogether different dirge. He there complains that Beijing now is “trying to control inflation by raising interest rates and restricting credit. This is destructive from a global point of view: with much of the world economy still depressed, the last thing we need is major players pursuing tight-money policies.”

If the “root cause” of the low value of the yuan is Beijing’s inflationary monetary policy – and if this policy harms, as Mr. Krugman says, both China and the rest of the world – why does Mr. Krugman scold Beijing for tightening its monetary policy?

That is a good question. Now, in fairness to Krugman, he is claiming that the proper course of action is for China's government to permit the value of the Chinese currency to rise against the U.S. Dollar, which would make Chinese goods more expensive for Americans.

Krugman reasons that such a policy would shrink China's trade surplus with this country, and that is true. For that matter, I believe that such a policy is more harmful to China than it is to the USA because that means the Chinese are holding dollars which are falling in value and the value of U.S. Government debt also is going to decline.

To put it another way, Americans get Chinese goods, and the Chinese get American paper. Krugman believes that is a better deal for China, and a really bad deal for this country.

Why? He claims that such policies reduce "aggregate demand" in the USA and jack up the rate of unemployment. However, if the end of production is consumption, then China's policy means that Americans are not having to pay the full freight for goods they get to use. (The Chinese at the same time are having to pay more for the goods they produce, which means that the government policy is making them poorer.)

Krugman's perspective is that of a Keynesian, and Keynesians get things backward. To a Keynesian, the purpose of production is, well, production. That is why Keynesians will claim that World War II "ended the Great Depression," because they look at GDP and the rate of unemployment and nothing else.

During World War II, Americans experienced high levels of deprivation that were every bit as serious as what they experienced during the Great Depression. Yes, everyone had a job and money in their pockets, but neither meant that much, as goods were rationed or difficult to find.

I don't support what the Chinese government is doing, but as I see it, the greater victims are the Chinese, not the Americans. China is not responsible for our near-10 percent rate of unemployment; U.S. Government policies from both the Bush and Obama administrations are responsible.

When Nixon faced a huge financial crisis in August 1971, his response was not to look inward, but instead to blame the rest of the world. Economically speaking, his administration was a disaster.

While Krugman recognizes that Nixon's policies of imposing price controls was futile, he never does seem to understand that if China imposes such controls on itself, that the Chinese will bear the brunt of the trouble, not Americans. But even here, I must admit to being puzzled. After all, during the California electricity crisis of a decade ago -- a crisis caused primarily by the fact that the state imposed price controls on the same of electricity -- Krugman claimed that price controls would result in more supply and lower prices.

So, if he holds to that same belief today, then I would think he would be applauding the latest actions of the Chinese government. Go figure.

Krugman's Phony "Painless" Solutions

I have no idea if Paul Krugman reads the Bible or any other religious material, but being that I am in the midst of reading through the section of the various major and minor prophets of Israel, I can see how Krugman fancies himself to be an Isaiah or Ezekiel. Here is Krugman giving prophecies of woe -- but also presenting what he claims to be are "solution" to the current ills.

Unfortunately, he believes, no decision makers in the government are listening. Instead, from President Obama to Ben Bernanke, these people are listening to the "Pain Caucus" (as he calls people who note that the economy cannot expand with malinvested capital), the "inflationistas," and those lyin' furriners (the Chinese and Germans) who are more responsible than anyone else for our present condition.

For example, he writes of the Chinese and Germans:

After all, you have China, which is engaged in currency manipulation on a scale unprecedented in world history — and hurting the rest of the world by doing so — attacking America for trying to put its own house in order. You have Germany, whose economy is kept afloat by a huge trade surplus, criticizing America for running trade deficits — then lashing out at a policy that might, by weakening the dollar, actually do something to reduce those deficits.

So, there you have it; these countries, which actually make goods that people want to buy, are partially at fault for our predicament. Obviously, we need a good trade war to accompany our failed "war on terror." That will bring prosperity for sure.

Here is the ultimate irony, however. Krugman believes that the government is choosing the "hard way" when, in fact, fixing the current problem is quite easy. As he wrote in his book The Return of Depression Economics, most economic crises (according to him) can be "fixed" simply by the printing of money. In other words, Ben Bernanke really can print some of it, go into his helicopter, and dump it out upon grateful people who then will go and spend it, giving the economy "traction," and leading us into prosperity.

Now, this makes Krugman a most interesting prophet. Most prophets of the Bible excoriated Israelites for seeking a life of ease, for following after false gods, and "oppressing the poor" by getting them to work, and then not paying them, or having crooked judges rule in their favor when the poor brought their cases before the courts of those days.

Krugman, on the other hand, claims that the real solution to the current situation is the easier path. Those that say that we no longer can continue the boom through loose credit and wild deficit spending and who must get the "house in order" really are the villains, for they lead us down the path of pain.

In his famous "Hangover Theory" article in Slate, Krugman (after mangling the Austrian Theory of the Business Cycle) declares:

Powerful as these seductions (ATBC) may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less.

See? The "solution" really is quite easy. When the value of malinvested assets fall and the follies of a boom are exposed, we then pretend that we are prosperous. Is the income that flowed from the money borrowed to finance these malinvestments drying up? No problem! Let the government either try to prop up these malinvestments by getting the Fed to purchase government bonds, or sell the bonds to a central bank in Upper Slobovia and use those dollars to fund the politicians' latest projects (like rail tunnels). And, if the projects run way over budget, THAT IS EVEN BETTER BECAUSE IT MEANS WE ARE SPENDING MORE MONEY!

Usually, prophets tell people that they must choose the more difficult path, but the Prophet Krugman differs. If I may use an analogy from the New Testament, it would be like Jesus telling his disciples that they should enter "through the wide gate," as "the narrow gate is too painful."

I sense a real anger in Krugman's words. Here is a Nobel Prize winner telling people that the way out of this depression is easy: just borrow, print, and spend (and spend and spend). Yet, somehow, the Bad People are winning the day, falsely convincing people that we cannot borrow and spend our way to prosperity. They are not moved by Krugman's prophecies that the road to ease is for us to start a trade war with China, tell the Germans "Zum Teufel mit Ihnen," and spend, spend, and spend some more.

Is something wrong with this picture?

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.

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.

Those Chinese Commies, er, Capitalists, Finally Got Us!

When I was a young person, America was taught to fear the communists. The U.S.S.R. had missiles pointed at us, Castro's Cuba was 90 miles from Key West and the Cubans were set to invade any day, and China's Maoist commies were helping the North Vietnamese in our war in Vietnam. (I remember the Cuban Missile Crisis when I was in fourth grade.) As a girl I used to date told me when I questioned whether or not we should be in Vietnam, if we let the commies win there, then they would take over country after country until they got to us.

Well, history has a funny way of working out things. The U.S.S.R. and its satellites went out of business (complete with a going-out-of-business sale in which I bought some Really Neat Stuff). Vietnam is liberalizing its economy and its society, and the Mao Suits that American Limousine Leftists loved to wear have long been replaced by real clothes, just as China has become a productive country, as it throws of the shackles of communism.

However, where once we saw a Chinese commie hiding behind every bush and tree, Paul Krugman (who usually sees a Republican hiding behind every bush and tree) now sees a Chinese Currency Manipulator hiding behind every bush and tree. Oh, the humanity! Will we ever be free from the Present Dangers from those nations of the East?

Krugman's fear is based upon one of his usual themes: China's government is deliberately underpricing its currency, the renminbi, which makes Chinese goods cheaper relative to goods that are dollar-denominated. Krugman writes:

The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.

And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.

In other words, Krugman asserts that China is engaging in a "beggar-thy-neighbor" policy, but Americans (unlike the heroic Japanese) are too timid to challenge China as it supposedly becomes wealthy at our expense. Now, in case you don't recognize the logic here, Krugman is making the arguments that were put forth by the Mercantilists four centuries ago, with many of their arguments successfully refuted by Adam Smith in 1776.

Yet, bad ideas continue to stay around. While Krugman makes his claims on the basis of Keynesianism, in truth, that "economic theology" had its roots in Mercantilism and John Maynard Keynes even praised that group in his book, The General Theory.

Now, I do realize that simply screaming "Mercantilist!" does not win any real arguments, although this brief space is not appropriate for laying out every wrongheaded notion of the Mercantilist doctrines. However, I need to point out that when Krugman declares that somehow China is at least partially responsible for our current economic downturn because of its currency policies, he conveniently forgets that the U.S. Government under the Bush administration pushed the housing bubble, and then the Obama administration proceeded to try to prop up failed banks, the housing market, and producers (Government Motors being Exhibit A) as a sop to Wall Street contributors and American labor unions. By forcing the diversion of trillions of dollars of resources to those firms and sectors that cannot stand up on their own, President Obama and his minions are aggressively and deliberately blocking the recovery.

Of course, it is more fun to blame the Chinese commies capitalists. After all, aren't they the ones who caused the housing bubble in the first place by saving lots and lots of money, which somehow made its way here and was foolishly diverted into the U.S. housing market? (Oh, that's another conspiracy theory by the Usual Suspects. Yeah, those commies finally got us. Mao himself must have hatched the plot and is laughing from Hell.)

As for blaming any subsidies that China has for its "clean energy" programs for our current situation, I must admit that such an accusation is quite rich. Doesn't the U.S. Government provide huge subsidies to "clean energy" and has not Krugman called for the government to do so in the mistaken belief that we can spend and subsidize ourselves into prosperity? I mean, from where do the subsidies come? They MUST come from the remaining healthy (or less-ill) portions of the economy. Despite the Krugman-Keynesian-Chartalist beliefs that wealth is generated by the Federal Reserve System, transfer payments ultimately must come from REAL assets, not paper ones.

One must remember that for Krugman, the end of production is, well, production. If World War II created "prosperity," then China is creating its own version of prosperity by making it more difficult for the Chinese consumers to purchase those goods that they have been making. Instead of acknowledging the basic economic truth that the end of production is consumption, Krugman is claiming that the way for us to have a recovery is to subsidize our own industries, manipulate our currency (or place economic sanctions on China, which can be interpreted as an act of war), and then we will be fat and happy.

I doubt it. We are dealing with basic economics here. Creating what clearly would be a trade war would be yet one more step in destroying not only our economy (or, what is left of our economy), but also creating havoc in the rest of the world. Yeah, punish the Chinese; that will make us all rich.

Is China the New "Predator"?

From about 1980 until the mid-1990s, Japan was the Great Peril to the United States, at least from what the politicians, the unions, and their supporters were telling us. Today, the Great Bogeyman is China which, according to Paul Krugman, is engaging in "predatory trade policy."

Why does he say predatory? Krugman explains:

Right now, China is following a policy that is, in effect, one of imposing high tariffs and providing large export subsidies — because that’s what an undervalued currency does. That should be a violation of trade rules; it might in fact be a violation, but the language of the law is vague on the subject. But leave aside the fine print of the law for a moment: what China is doing amounts to a seriously predatory trade policy, the kind of thing that is supposed to be prevented by the threat of sanctions.

I have no intention of debating Krugman on what China might be doing, and that would include "undervaluing" its currency. It seems to me that China is doing what the old Mercantilists advocated hundreds of years ago.

Furthermore, I don't doubt that producers around the world resent the Chinese trade strategy. Nonetheless, from an economic point of view, China is not making itself wealthier by pursuing these policies. If there are victims, they are the Chinese people themselves.

It is one thing to say that such a policy can be disruptive to world trade and certainly make life more difficult for manufacturers in other countries, but it is quite another to claim that the Chinese policies will make China better off any more than export subsidies given by the U.S. Government are good for the U.S. economy. In fact, the actual effect is to make U.S. consumers better off, but at the expense of Chinese workers.

Peter Schiff, in this speech given in 2009, laid out this point, noting that right now, the Chinese are working, but we Americans get the goods, paying for them with green pieces of paper. Obviously, this is not a relationship that will continue, and sooner or later, as Schiff notes, the Chinese are going to be able to "keep their stuff."

When I think of predatory actions, I think of one group of people taking something from others, and not paying for it. Think of the U.S. invasion of oil-rich Iraq or the police in this country committing literal highway robbery in the name of "asset forfeiture." Now, THOSE actions are predatory in every sense of the word.

However, China is not invading our country (sending goods here that we purchase voluntarily is NOT an "invasion"), nor is it engaging in anything close to acts of war, yet Krugman calls for economic sanctions against China. That is ridiculous. While I don't support what the Chinese Government is doing, I believe that its Mercantialism actually is more harmful to China than it is to other countries.

Jeremy Warner Gets It Right On Krugman

Paul Krugman makes light of the recent article by Jeremy Warner in The Telegraph, but I think Warner is spot on. Here is Warner in his own words:

When the self-proclaimed "conscience of liberal America" and a one-time free trader to boot starts arguing for protectionism, you know that things have come to a pretty pass. But that's what's happened over the past week.

Paul Krugman, a Nobel Prize-winning economist, has taken to advocating a 25 per cent "surcharge" – he refuses to use the more descriptive term of "import tariff" – on goods from China as a way of bringing the Chinese leadership to heel over currency reform. So potentially dangerous and out of character is this idea that when I first read it, I assumed he was being ironic. But sometimes the cleverest of people can also be the most stupid, and he's now said it so often that you have to believe he's serious.

What he's advocating is trade retaliation so extreme that it would make the 1930s look like a stroll in the park. Contrary to Professor Krugman's naïve assumption that the Chinese would soon cave in and allow their currency to float if confronted by such hard-ball tactics, I am certain that nothing is more guaranteed to produce the opposite response.

Professor Krugman's suggestion mines a rich seam of populist US thinking and rhetoric which grows ever more vocal and worrying as the recession persists. What makes Krugman and other highly regarded economists who toe the same line so dangerous is that they give intellectual respectability to a fundamentally disreputable idea.

Unlike Krugman, who already has given us a fantasy version of what would happen if the USA were to retaliate against China for officially undervaluing its currency against the dollar. To be honest, I think Peter Schiff's recent comments were far more astute.

Warner makes some important and insightful comments here:

An outbreak of protectionism is just what the still-fragile economic recovery doesn't need. China makes an easy scapegoat for America's ills, but it is not the cause, nor would making it revalue its currency provide the solution. The debate is echoed in Europe, where Germany – an exporter second only to China – finds itself blamed for the eurozone crisis. If only Germany would make itself less competitive, if only Germany would save, invest and export less, then everybody else would be fine. The virtuous find themselves depicted as the villainous. If the argument were not so perverse, it would be laughable.

Let us briefly consider what would happen if Professor Krugman got his way and there was either a 25 per cent devaluation of the dollar against the renminbi or 25 per cent import duties. Almost overnight China would sink into a deep recession as exporters already operating on wafer-thin margins were plunged into insolvency.

American business, which relies heavily on China as the assembly plant of choice (guess where iPods are made), would also find itself deep in the mire. Even in the long term, the revaluation would scarcely be more helpful. Over time, Chinese wages would merely deflate relative to US ones to make exports competitive again.

For all of his "credentials," let us not forget that Krugman is a Keynesian who has no clue whatsoever what happens in a real economy. His world is the imaginary world of aggregates, GDP numbers, crude graphs, and no real people and certainly no real production. There is no such thing as consumption, only spending. And all good Keynesians know that no one has to produce anything, just print a bunch of money, and we'll all be rich!

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

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

I think that Schiff really lays out Krugman's thinking in these paragraphs:

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

There is a huge difference between selling your debt to another and "selling" it to yourself. When China buys our debt, it uses its own savings. In order to purchase a trillion dollars of U.S. Treasuries, the Fed would have to expand our money supply by a corresponding amount. Even Krugman acknowledges that this would cause the dollar to lose value; however, he feels that a weaker dollar is good for America and bad for China.

This is correct. In reading Krugman's columns and blog posts, I find that same theme: printing U.S. Dollars will create prosperity, while having "sound money" leads to depressions. For example, in his book The Return of Depression Economics, Krugman claims that printing money in most economic crisis situations will "solve" the crises.

For that matter, if one thinks Schiff is off-base with his characterization of Krugman's statements, this Krugman post lays out his belief that the dollar is nearly invincible:

There have been many, many papers trying to assess the possibility of an Asian or Argentine-style currency crisis for the United States; all of them run up against the simple fact that large foreign-currency indebtedness was central to these crises, and we just don’t have that problem.

At one level, that is true, but Krugman also wants to have it both ways. On one side, he claims that the USD pretty much is invincible, but then he also claims that at least some of our problems stem from the dollar being too strong, and that it needs to be weakened.

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

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

Furthermore, by calling for tariffs and other measures to "punish" China for its currency policy, Krugman is demanding that the U.S. Government make everyone else worse off in the name of "helping the economy." Schiff writes:

Most economists, Krugman included, see cheap money as a panacea for all ills. And while it's true that a falling dollar, by lowering the real value of U.S. wages, would help make U.S. goods more competitive, it would also lead to skyrocketing consumer prices, rapidly rising interest rates, and a collapse in American living standards. Make no mistake: this is the end game of Krugman's "get tough on China" policy.

Now, I do think that Krugman's articles are consistent with what he believes: printing money is a good thing, as it creates inflation, which fuels current spending, which then gives the economy "traction." At some point, he reasons, the economy (which operates in the circular flow like a perpetual-motion machine) simply starts moving again. It just needs a "push," and government spending combined with inflation is what "primes the pump."

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

People, this is not economics. It is model-building, and highly-stylized model-building at that. It does not reflect economic reality, and it can lead only to inflation and ruin in the long run. No wonder Schiff makes the following declaration:

In his latest weekly New York Times column, Nobel Prize-winning economist Paul Krugman put forward arguments that were so nonsensical that the award committee should ask for its medal back.

I concur wholeheartedly. What Krugman puts forward is not "economics" in any sense of the word. Instead, it is nothing but state-inspired manipulation of an economy, period.

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

A Krugman in Wolf's Clothing

Paul Krugman's jihad against China continues and he now enlists the help of Martin Wolf, who claims that China and Germany are "uniting" in their nefarious plan to "impose deflation." Yes, Krugman has decided to continue his theme that "Mercantilism" is the proper path to prosperity, which means that wealth really is created when governments manipulate the system.

Today, he insists that not only are his views correct, but that they fall within the very scope of the laws of supply and demand. For a guy who insists that the laws of economics are turned upside down during depressions and that "none of what you learned in Econ 101 applies," I find it curious that suddenly these laws really matter. (Well, they matter when Krugman says they matter and their application is seen to be to his advantage.)

I think a larger view is in order here. Krugman has claimed elsewhere that the real culprit in the bubble was Chinese savings, and now the dastardly Chinese are giving us the one-two punch with its pegged exchange rates. Furthermore, by doing so, China supposedly is preventing our government from properly engaging in policies of inflation! What's a Nobel Laureate to do?!?

Furthermore, he likens the Chinese currency policies to the policies pushed by Latin American countries in the 1950s. In his own words:

As I read this debate, one thing that’s truly amazing is the way China defenders are recapitulating some old fallacies from, of all places, Latin America. Back in the 50s it was common for Latin economists to insist that getting realistic exchange rates wouldn’t solve their persistent balance of payments problems because imbalances were “structural” — now we’re hearing the same thing about China, with the only difference being that this time it’s a surplus, not a deficit, that is supposedly immune from the usual rules of supply and demand.

Hmmm. As I recall, the Latins were overvaluing their currencies relative to the U.S. Dollar, creating what were called "dirty rates." (Indeed, that has been a staple of Third World countries, not to mention the old Communist Bloc during the Cold War.)

I also remember that Americans accused Japan of undervaluing the yen during the 1980s, and that was the reason for the huge trade surpluses in Japan's balance of payments accounts. In the end, the Japanese spent their surpluses on U.S. real estate. (I remember the hysteria fueled by the politicians and the media when Japanese investors purchased the Rockefeller Center, as though the Japanese were going to tow those buildings back to Japan.) That little venture, as one might recall, turned out badly for the Japanese, as real estate prices plummeted, along with the value of Japan's stock market. (Can someone spell "m-a-l-i-n-v-e-s-t-m-e-n-t-s"?)

For all of the Mercantilist fallacies pushed by Krugman, we have to remember that to Krugman and Keynesians in general, production is done for its own sake. Lawrence Reed noted this fallacy in his wonderful article in the April 1981 Freeman, "7 Fallacies of Economics." The fourth fallacy, "production for its own sake," has this gem, which I think perfectly applies to Krugman:

A bad economist who falls prey to this ancient fallacy is like the fabled pharaoh who thought pyramid-building was healthy in and of itself; or the politician who promotes leaf-raking where there are no leaves to be raked, just to keep people “busy.”

When Reed wrote those words, few people had heard of Paul Krugman. However, if one wishes to better understand Krugman's economic worldview, read "7 Fallacies of Economics," and you will find that nearly everything the Nobel Laureate writes falls into one of the categories listed in that piece.

I hate to say it, but the Chinese are not the source of our problems, no matter what Krugman, Martin Wolf, the New York Times, and our politicians might be saying. The problem has been the massive malinvestments that defined the economies of the USA and Europe, malinvestments that Krugman and our government insist need to be kept going.

However, the more we try to prop up the unhealthy portions of the economy at the expense of those portions that are healthy, the worse things will become. The Austrians understand this in spades, but the "wise" Keynesians are clueless. So, like Wolf and Krugman, they look elsewhere for blame instead of looking in the mirror.

Fable of the Krugman

While Paul Krugman likes to present himself as being a Keynesian, in reality, his intellectual roots run back a few centuries to the Mercantilists. If you wish to see the Krugman of 300 years ago, read Bernard Mandeville's "The Fable of the Bees," first published in 1705, to see all of the same economic (and logical) fallacies that haunt Keynesianism and Krugman's columns.

Do you want the "paradox of thrift"? You can find it there. There is "underconsumption" and the emphasis upon spending that has not changed in three centuries, at least when one reads Krugman's columns.

In his column, "Taking on China," Krugman takes his Mercantilist arguments to a new high (or low, which might be more appropriate), blaming, yes, China for the continuing economic depression in the rest of the world. It seems that China has been undervaluing its currency, the renminbi, and that forces the rest of the world into that infamous "liquidity trap." Here is Krugman in his own words:

...it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.

To understand Krugman's logic, first you must turn economic logic upside down. By undervaluing its currency, China is following a policy of exports first, and in the process is amassing a lot of foreign reserves in the process. This, by the way, was the very kind of practice that Adam Smith and other Classical economists railed against, as they successfully argued that such artificial trade restrictions made their own people poorer.

Furthermore, China has been building a huge surplus denominated in fiat currencies from abroad, mostly the U.S. Dollar. However, Ben Bernanke and soon-to-be-his-partner-in-crime Janet Yellen are willing to turn the dollar into worthless paper that cannot compete with the infamous German Mark of 1923, not to mention the fading Euro and Lord knows what else. Maybe we can throw some Bolivian money in the mix and some Argentine Pesos from the Age of Juan Peron.

By pursuing this action, Chinese producers indeed are able to sell their goods more cheaply abroad than are Americans. This much is true. Conversely, this also means that China is willing to ship real wealth overseas and accept our worthless green pieces of paper in return. Yes, we have the situation in which the poorer Chinese are playing the role of philanthropist to the wealthy Americans and European. Hmmm, exploitation, anyone? This is a better deal than Colonialism.

Now, if one has a Keynesian, er, Mandevillian, view of the world, this is terrible. In the Keynesian view of things, spending, not consumption, is the end of economic activity. There IS a difference. Under the Keynesian view of things, consumption and production are two unrelated things. People make products and then hope-to-goodness that they can "buy back" what they have just produced.

In this view of things, producers just "make things," and then the real reason for spending is just to empty the inventories. That way, producers can make more things and then they are cleared off the shelves, and the process begins anew.

This is not an economy; this is a cat chasing its tail. The only purpose I can see here is keeping people occupied. The purpose of "consumption" here only is to "buy back" what has been made; it does not and cannot go any farther.

No wonder that Keynesians emphasize the "circular flow" of the economy, as it fits within their circular logic. Israel Kirzner once parodied this whole set of nonsense with the following dialogue: "Why do you eat breakfast? So I can go to work. Why do you go to work? So I can eat breakfast."

Lest one thinks I am exaggerating or trying to present a caricature of Keynesianism as fact, take the following quote from Krugman, in which he praises Richard Nixon's 1971 action in which he cut ties to gold, devalued the dollar (or, in real-live terms, engaged in a default), and wrote a vital chapter in what would be a disastrous economic decade:

In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies.

Now, as a hardcore partisan Democrat, Krugman cannot utter the N-word, except in derision, yet he is praising what Austrians see as a dishonest approach to the real problem of runaway government spending, fiat currencies, and a mountain of government debt. To Krugman, all of the things I have mentioned are virtues, just as Mandeville praised profligacy as being virtuous and thrift as a vice.

I would pose a different scenario. Indeed, China should end its pegging of the renminbi to the U.S. Dollar, but for different reasons. Chinese workers have toiled in factories, yet government policies are overpricing those goods at home. This is similar to what Japan did in the 1980s and we see how well that worked for the Japanese.

Yes, Wal-Mart is full of Chinese consumer goods that are artificially cheap for us, and as long as we can keep this arrangement going, who is to complain? Krugman does not like it for all of the wrong reasons. To him, when he sees Americans buying something at Wal-Mart (well, let's face it, I'm sure Krugman never lowers himself to step into a Wal-Mart and mingle with the Great Unwashed), he sees trade imbalances. I see American consumption made possible by the philanthropic Chinese government acting to the detriment of the Chinese consumer.

Granted, one must understand Keynesian and Mandevillian logic. Domestic consumption, according to this "logic," is "buying back the product," but the real goal of American production should be to let someone in another country consume what Americans have produced. If that does not make sense to you, don't worry. It means you are thinking clearly.

As for the Krugman "solution," he advises the Nixon strategy of raising tariffs (Krugman calls for a 25 percent import surcharge) and telling the Chinese that while they amassed those dollars, the heck with them if they wish to spend them at least here. Who would have thought that Mr. Democrat would be channeling the policies promoted by the Republican that Democrats Love to Hate, Richard Milhous Nixon?

Of course, this would work wonders at home. Americans, who are struggling to make ends meet, would discover that prices were shooting up and their dollars would purchase less than before. There would be international tensions and the dollar would become the worthless paper in a scenario that the Austrians have been predicting for a while.

Yes, this is the Mercantilist world of Paul Krugman. Peaceful private exchange is an act of aggression, and aggression will bring us from an imaginary "liquidity trap." Indeed, War is Peace, Slavery is Freedom, and Ignorance is Strength.

Should We Blame the Chinese for the Recession?

When the economies of Singapore, Indonesia, and other Southeast Asian countries crashed more than a decade ago, mobs of people rampaged in the streets, seeking out ethnic Chinese merchants and workers and beating and killing them. Why? Well the Chinese were convenient scapegoats.

Today, Paul Krugman, while not advocating mayhem and murder against Chinese (thank you for being civilized, Paul), nonetheless is trying once again to blame China for at least some of our current troubles. China, he declares, is using a "beggar-thy-neighbor" policy against us.

China's "crime," it seems, is undervaluing the Renminbi relative to the U.S. Dollar, having an official exchange rate that values its currency lower than it could get in the market. This makes Chinese exports cheaper relative to U.S. goods, which is one reason that American consumers can purchase inexpensive Chinese products.

However, such a policy encourages China to send its goods abroad, and it also means that such goods are more expensive at home than they would be in a free market. Thus, if anyone is being "beggared," it is Chinese consumers, who are being fleeced in order to permit Americans to consume more goods from China.

Obviously, this is a situation of poorer people subsidizing those who are wealthier. It is welfare in reverse, philanthropy from the poor to the rich.

American consumers are not the ones complaining. U.S. producers are not happy, and for all of the talk in Washington of protecting consumers, it is the producers who tend to be politically connected. Furthermore, if we are going to speak of real-live victimization, then perhaps the fact that the Chinese central bank has been purchasing boatloads of near-worthless U.S. Treasuries is the real scam.

Let's be honest, folks. For years, we have sent dollars to China, dollars that, frankly, are overvalued. The Chinese people have sent us goods, such as cell phones and computers, and in return the government has taken the money and purchased U.S. paper that depreciates daily. Who is getting the good deal, and who is being cheated?

I think that is a legitimate question, one that Krugman does not want to answer.