Rule by inflation

When John Maynard Keynes called for the "euthanasia of the rentier," he meant that the government's monetary authorities should hold the rate of interest low enough to where people who earn money from lending no longer would be willing to lend. Thus, the "rentier" would disappear from the scene.

Paul Krugman is repeating that call, and now claims that it is that evil "rentier" that is dragging down the economy. If only the authorities were willing to listen to him and have more inflation; if and only then would people be able to find jobs and the economy would hum along nicely:

While the ostensible reasons for inflicting pain keep changing, however, the policy prescriptions of the Pain Caucus all have one thing in common: They protect the interests of creditors, no matter the cost. Deficit spending could put the unemployed to work — but it might hurt the interests of existing bondholders. More aggressive action by the Fed could help boost us out of this slump — in fact, even Republican economists have argued that a bit of inflation might be exactly what the doctor ordered — but deflation, not inflation, serves the interests of creditors. And, of course, there’s fierce opposition to anything smacking of debt relief.

Looking at the Fed's balance sheet post TARP, one hardly can say that the Fed has not been "aggressive" in trying to spread more dollars throughout the world. However, I suspect that when Krugman calls for the Fed to be "more aggressive," he means the Fed finding a way to purchase short-term Treasuries directly, as opposed to buying them on the secondary market. (The original Federal Reserve Act prohibits the Fed from such direct purchases, although given that Washington no longer has to abide by the same laws that govern the rest of us, I am sure Ben Bernanke can find a way around such pesky requirements.)

Krugman's call for more inflation is based upon his belief that inflation benefits low-income people and hurts the wealthy. Thus, the reason that inflation is not higher is due to unwarranted lobbying by the rich, who are benefiting at the expense of the rest of us.

Now, when the main financial crisis hit in 2008, I argued (contra Krugman) that not only would bailouts retard any recovery, as they would prevent or postpone liquidation of bad assets, but also would increase the political strength of the very people who had driven the economy over the cliff. Krugman now thinks that the people on Wall Street have too much political influence, but he fails to see the connection between the bailouts and their political strength.

I will go even further. Krugman is absolutely wrong on inflation, in that the people most hurt by it are NOT the rich, but rather the small savers and people on fixed incomes. (Krugman claims that people on SS and other fixed incomes would not be hurt because SS is indexed to inflation.)

Here is the problem, and it demonstrates that Keynesians (once again) really have no concept of money and see it only as a "quantity variable." Yet, what actually happens with a burst of inflation?

As Henry Hazlitt points out in his excellent Economics in One Lesson, inflation creates a "mirage" of prosperity at the beginning, but in the end is like the "Dead Sea fruit that turns to dust and ashes in its mouth." A new bout of inflation does not raise all prices and incomes at the same time. Instead, those who receive the new money first receive the benefits, while those at the back of the line (small savers and, yes, people on fixed incomes, even those incomes indexed to inflation) bear the costs. Murray Rothbard writes:

Inflation, then, confers no general social benefit; instead, it redistributes the wealth in favor of the first-comers and at the expense of the laggards in the race. And inflation is, in effect, a race--to see who can get the new money earliest. The latecomers--the ones stuck with the loss--are often called the "fixed income groups." Ministers, teachers, people on salaries, lag notoriously behind other groups in acquiring the new money. Particular sufferers will be those depending on fixed money contracts--contracts made in the days before the inflationary rise in prices. Life insurance beneficiaries and annuitants, retired persons living off pensions, landlords with long term leases, bondholders and other creditors, those holding cash, all will bear the brunt of the inflation. They will be the ones who are "taxed."

He continues:

Inflation has other disastrous effects. It distorts that keystone of our economy: business calculation. Since prices do not all change uniformly and at the same speed, it becomes very difficult for business to separate the lasting from the transitional, and gauge truly the demands of consumers or the cost of their operations. For example, accounting practice enters the "cost" of an asset at the amount the business has paid for it. But if inflation intervenes, the cost of replacing the asset when it wears out will be far greater than that recorded on the books. As a result, business accounting will seriously overstate their profits during inflation--and may even consume capital while presumably increasing their investments.

In Krugman's Keynesian world, however, none of that matters. If anything, businesses are parasites and government, by creating "new money," also creates wealth. That really is the "New Economics" in a single sentence.

OK, Krugman really is a mercantilist

One of the supposed great triumphs in economics was the development of an intellectual argument for free trade and against the "mercantilist" doctrines of the day which emphasized the belief that wealth consisted of the money in the government's treasuries. Unfortunately, mercantilist beliefs never quite died, and we see Paul Krugman resurrecting them in his recent column on "making things."

Krugman touts the recent rise in manufacturing employment to the falling dollar and Obama's industrial bailouts, and he may be right. After all, if the government forces Americans to pour resources into certain economic sectors, we should not be surprised when those sectors, at least on paper, are doing better. However, the economic analysis should not be aimed at output, per se, or even employment. No, we in economics, we look at the opportunity cost of the policies that are spurring manufacturing growth to see if they are making us poorer.

Henry Hazlitt, in his classic "Economics in One Lesson," noted that the difference between "good" and "bad" economics was the following:

"The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economsit sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups."

Indeed, one of the constant themes in Krugman's columns has been that only the short-term effects matter. I never have seen him even ask the larger question of whether or not certain policies move resources from lower-valued uses to higher-valued uses, or if we see the opposite occurring.

From what I can read in this column, Krugman really believes that a government can bring an economy into prosperity through financial tricks such as money debasement and industrial subsidies. He writes:

...one potential disaster has been avoided: the U.S. auto industry, which many people were writing off just two years ago, has weathered the storm. In particular, General Motors has now had five consecutive profitable quarters.

America’s industrial heartland is now leading the economic recovery. In August 2009, Michigan had an unemployment rate of 14.1 percent, the highest in the nation. Today, that rate is down to 10.3 percent, still above the national average, but nonetheless a huge improvement.

I don’t want to suggest that everything is wonderful about U.S. manufacturing. So far, the job gains are modest, and many new manufacturing jobs don’t offer good pay or benefits. The manufacturing revival isn’t going to make health reform unnecessary or obviate the need for a strong social safety net.

Furthermore, the GM and Chrysler bailouts, he claims, gave us "net" benefits:

...there’s the matter of the auto industry, which probably would have imploded if President Obama hadn’t stepped in to rescue General Motors and Chrysler. For those companies would almost surely have gone into liquidation, closing all their factories. And this liquidation would have undermined the rest of America’s auto industry, as essential suppliers went under, too. Hundreds of thousands of jobs were at stake.

Yet Mr. Obama was fiercely denounced for taking action. One Republican congressman declared the auto rescue part of the administration’s “war on capitalism.” Another insisted that when government gets involved in a company, “the disaster that follows is predictable.” Not so much, it turns out.

Not surprisingly, Krugman is taking a very narrow approach: the bailouts helped the unions, and with government help, GM is making a comeback, so the move by the government must have been a net benefit to the economy. The problem is that there is a much larger picture that we need to understand.

At the time of bankruptcy, GM and Chrysler were hopelessly in the red. In economic terms, consumers saw them as moving resources from higher-valued to lower-valued uses. Just because the Obama administration declared that GM was to be viable again did not make the consumers' judgment wrong; it just forced consumers and taxpayers to put resources into GM that they would not have made voluntarily.

No doubt, the shuttering of GM and Chrysler would have caused hardships in Michigan, Indiana, and Ohio, but those also are the states (especially Michigan) that have shown themselves to be hostile to capital investment and reasonable business practices. Like New York, Michigan's government actively has driven firms out of the state or tried to regulate them to death, and when the results of their actions become apparent, those same governments then demand that taxpayers from elsewhere bail them out.

We also see manufacturing "growth" in subsidized "alternative or green" energy sectors, yet all of the firms in those sectors basically are wards of the state. The excuse to subsidize them has been that we must keep them alive while they "innovate" and experiment with new capital and ways to deliver their products, yet historically subsidized industries generally have lagged behind those that did not need or seek government largess.

Then there is the situation with the dollar, a currency that Krugman claims must be further debased. He writes:

First, what’s driving the turnaround in our manufacturing trade? The main answer is that the U.S. dollar has fallen against other currencies, helping give U.S.-based manufacturing a cost advantage. A weaker dollar, it turns out, was just what U.S. industry needed.

Yet the Federal Reserve finds itself under intense pressure from the right to make the dollar stronger, not weaker. A few months ago, Paul Ryan, the chairman of the House Budget Committee, berated Ben Bernanke for failing to tighten monetary policy, declaring: “There is nothing more insidious that a country can do to its citizens than debase its currency.” If Mr. Bernanke had given in to that kind of pressure, manufacturing would have continued its relentless decline.

This falls into the Keynesian prescription that government through the monetary authorities can inflate us into prosperity. Now, I have no doubt that Krugman partially is correct; debasing the dollar does make American exports more attractive while raising the costs of imports. I'm even willing to give him the argument that if the Federal Reserve System actually were to end its current policy of deliberate inflation, American manufacturing exports might even fall.

Yet, that is not the larger issue. The larger issue is whether or not entrepreneurs will be able to have the freedom to invest and direct resources from lower-valued to higher-valued resources, and seek investment projects that are economically sustainable.

Subsidies require that government cannibalize healthy sectors in order to prop up unhealthy sectors. That is the bottom line in economic analysis here, yet Krugman continues to insist that if the unhealthiest of manufacturers like GM and Chrysler are kept afloat by government intervention, that the overall effect MUST be good. After all, Michigan's rate of unemployment is falling.

In Krugman's world, there is no such thing as opportunity cost, especially if the economy is in what he calls a "liquidity trap." Yet, economic laws are immutable, and they apply to a world of scarcity, and not even the august Princeton University economics faculty can change that simple fact.

I'm sure that more than two centuries ago, Krugman would have been welcomed by the mercantilists and monetary cranks. Today, it seems that the economic faculties of our most prestigious universities once again are open to those very things Adam Smith and others debunked. I guess that is why these faculty members often refer to themselves as "Progressives."

Krugman joins the "Broken Window Fallacy" crowd

I am in New York for a conference, but I will share this gem from Paul Krugman's recent blog post in which he claims that the tragedy and recovery in Japan likely will be "expansionary." Yes, we see yet another "economist" become a caricature of the people who claimed that the hoodlum who broke the baker's window described in Henry Hazlitt's classic Economics in One Lesson.

As Hazlitt explains in the first chapter, the "Broken Window Fallacy" is the central fallacy that we see in one form or another, and from what I see, Krugman is the biggest advocate of this fallacy. Hey, I know. We're in a "liquidity trap," so the world is turned upside down. Right?

What "Expansionary" Policies?

OK, Paul Krugman is a True Believer. No matter what, according to the Nobel laureate, the government needs to spend and spend and spend because the economies of the world are in a giant "liquidity trap." However, in a recent blog post, he claims that any deviation from such policies of borrowing, printing, and spending simply is "horrifying." Horrifying?

Not surprisingly, Krugman turns back to Keynes for inspiration:

The case for expansionary policies in the face of a slump is intellectually difficult; Keynes described the writing of the General Theory as a painful process of discovery, and so it is. The natural instinct of almost everyone is to think that tough times require tough measures, and that if the economy is suffering, the government should tighten its own belt. It would take a clear consensus from economists to overcome that natural bias.

And that consensus has, of course, been lacking — largely because a significant proportion of the economics profession has spent the last three decades systematically destroying the hard-won knowledge of macroeconomics. It’s truly a new Dark Age, in which famous professors are reinventing errors refuted 70 years ago, and calling them insights.

This is nuts. Keynes refuted NO errors 70 years ago. His so-called refutation of Say's Law was a joke. First, he created a straw man and then, second, refuted something no one believed.

If anyone did any refutations, it was Henry Hazlitt in 1959 when he made mincemeat of The General Theory in his own book, The Failure of the New Economics. Hazlitt went through Keyne's "masterpiece" line by line, demonstrating how it was nothing but a tissue of fallacies.

There was no "hard-won" knowledge of macro, unless one believes that an economy is nothing but a bunch of aggregates, that prices are just numbers to go into an index, and that government creates wealth by printing money. Don't forget that this "hard-won" knowledge by 1980 was giving us double-digit inflation, high unemployment, and an economy in tatters.

So, Krugman wants us to believe that all we need is borrowing, spending, and lots of printing money. Oh, and costs are nothing but administrative numbers. This is not economics, folks, it is pure bureaucracy.

Krugman: In Despair Because Governments Are Reluctant to Inflate Even More?

In his post, "Reasons to Despair," Paul Krugman declares that the prospects for economic recovery are "grim." I happen to agree with him, but our reasons are quite the opposite. For Krugman, his despair is based upon his belief that governments are not inflating enough, while I believe governments are inflating way too much. Obviously, there is no way for our ideas to intersect.

Krugman writes:

Here’s where we are: growing GDP, but mass unemployment still the law of the land, with only tiny progress so far. What can be done?

Well, we could have more fiscal stimulus — but Congress is balking even at the idea of extending aid for the ever-growing ranks of the long-term unemployed. Fiscal responsibility, you see — hey, and let’s make sure estate taxes stay low!

We could get tough with China, which continues its currency manipulation and, in the face of a world of grossly inadequate demand, is actually tightening monetary policy to avoid an overheating economy — when basic textbook economics says that it should be appreciating its currency instead, which would not only rebalance China’s economy but help the rest of the world. So given China’s outrageous behavior, Geithner went to China, got nothing .. and pronounced himself very pleased.

We could do more through monetary policy. Macro theory suggests that the theoretically right answer, if you can do it, is to get central banks to commit to a higher inflation target. But the Fed and the Bank of Japan say no, because … well, that’s not what central bankers do.

It’s depressing: shibboleths and conventional wisdom are blocking all routes out of this slump. And I worry that policy makers will just sit there, for years and years, all the while congratulating themselves on the soundness of their policies.

So, Krugman despairs because the governments won't print enough money and won't confiscate enough wealth from others. Now, he does not explain how destruction of the currency and confiscation of wealth will lead to a "recovery," but I am sure that the answers can be found in his columns.

And China is being "outrageous"? As a commenter pointed out, if China is trying to tighten its output of currency, that alone will result in "appreciation" of its money. (What Krugman claims is that China is overvaluing the US Dollar in relationship to its own currency, which actually makes its own people poorer, yet Krugman actually wants us to believe that this is good for China and bad for us.)

There is a larger problem here, and that is the Krugman-Keynesian view of the economy. In Krugman's view, consumption is irrelevant and unrelated to production. Instead of being purposeful, consumption is little more than "buying back the products made," as though the real purpose of consumption is to get goods off the shelves. In Keynesian doctrine, the purpose of an economy is production for its own sake.

Perhaps this is why Keynesians really wanted us to believe that the economies of the Soviet Union and the old Eastern Bloc were "growing" because the GDP numbers that their bureaucracies spit out were becoming larger every year. The Keynesians were fascinated with the "output" figures, but never once took a hard look at what was being produced, from autos to consumer goods, with much of it being outright junk.

So now, all that is needed is yet another "stimulus" outburst, higher taxes, and even more inflation, and that is going to bring prosperity? And, to launch what effectively would be a protectionist trade war with China? Right.

Should readers wish to get a more sound view of economics, read Henry Hazlitt's classic Economics in One Lesson. Although the first edition came out before Krugman even was born, nonetheless it really is a line-by-line refutation of the nonsense that the 2008 Nobel winner in economics puts out.