Krugman and the Keynesian "Stones into Bread" Fallacy

The more I read Paul Krugman's columns and papers, the more I realize just how great the gulf is between Austrian and Keynesian thought. It is impossible to sum up all of the differences between the two camps, but I do think that perhaps the disparities can be summed up in the Austrian rejection of Keynes' famous 1943 statement that expansion of credit by the central bank will create a “miracle . . . of turning a stone into bread.”

In his column today, Krugman in a roundabout fashion repeats this notion, as he excoriates the governments of the world for not borrowing, printing, and spending at a rate that he believes will keep the world economy from slipping into depression. At the heart of Krugman's exhortation is his belief that credit expansion is the same thing as creating wealth. I don't think so.

Krugman has almost a religious belief that borrowing and printing money and policies of spending for the sake of spending will pull the country out of a recession. He writes of the current mess:

...this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

Krugman ignores the recoveries after the 1921 recession and the 1982 recession, both of which occurred in the absence of inflation and and the presence of higher interest rates. Furthermore, while the U.S. Government in both instances ran deficits, they were deficits brought on by the fall in tax revenues due to the recession, not as matters of "deficit-based stimulus" policies.

But, there is a larger issue here, and it is this: Current spending by government does not create wealth, and it is the creation of wealth that will bring us out of the depression. Borrowing from future generations (or repudiating the debt through inflation) is nothing more than making a claim on future wealth. Furthermore, Krugman's recommendations do nothing to address the current set of malinvestments which plague the economy, not to mention the huge added burden of government-imposed costs which make production of wealth more difficult.

Lest we think that Krugman is saying something new, the great Ludwig von Mises more than 60 years ago exposed this faulty thinking. He wrote:

The stock-in-trade of all Socialist authors is the idea that there is potential plenty and that the substitution of socialism for capitalism would make it possible to give to everybody “according to his needs.” Other authors want to bring about this paradise by a reform of the monetary and credit system. As they see it, all that is lacking is more money and credit. They consider that the rate of interest is a phenomenon artificially created by the man-made scarcity of the “means of payment.”

In hundreds, even thousands, of books and pamphlets they passionately blame the “orthodox” economists for their reluctance to admit that inflationist and expansionist doctrines are sound. All evils, they repeat again and again, are caused by the erroneous teachings of the “dismal science” of economics and the “credit monopoly” of the bankers and usurers. To unchain money from the fetters of “restrictionism,” to create free money (Freigeld, in the terminology of Silvio Gesell) and to grant cheap or even gratuitous credit, is the main plank in their political platform.

Indeed, it was as though Professor Mises was anticipating Krugman's arguments. No doubt, Krugman would think Mises was a fool and a charlatan, but the joke is on Krugman. True, Mises did not have a Nobel Prize; but Mises had wisdom, and that makes all the difference.

Krugman and the Hoover Fallacies

One of the economic myths that Paul Krugman, along with most politicians, journalists, and academics, promotes is the outright lie that Herbert Hoover organized his presidency to promote free market economics. Furthermore, he tells us (ad nauseum) that during the last three years of his presidency, Hoover did nothing to stop the Great Depression, leaving it up to Franklin Roosevelt and his New Deal to mitigate the effects of the downturn.

Thus, when Krugman refers to someone as a "Herbert Hoover," he is saying that he or she is not embracing the Keynesian paradigm and, instead, claims that we must "be responsible" in not spending beyond our means. Yes, Krugman believes that such "responsible" behavior actually is irresponsible, at least during a depression.

Thus, in his recent blog post, "Fifty-One Herbert Hoovers," Krugman claims that spending cuts by state and local governments are dragging down the economy:

...I think it’s fair to say that state and local cuts largely offset federal stimulus.

And David Broder thinks this is a good thing, that Washington should be more like the states.

What amazes me is that Broder doesn’t even seem to be aware that there’s an argument on the other side, let alone that most economists are dismayed by the effects of fiscal austerity. If Broder is a guide to Beltway conventional wisdom — which he usually is — we’ve got a big problem. (Emphasis mine)

Krugman even has a graph that "proves" his point:



First, Krugman is more correct than he realizes, if he claims that the states are emulating Hoover. Murray N. Rothbard (a much better economist than Krugman could claim to be) laid out Hoover's many government interventions in his classic, America's Great Depression. However, I don't think that is what Krugman wants us to believe.

Second, Krugman seems to be living in Wonderland if he believes that state and local governments can spend money they don't have. (This is why he is demanding that the federal government print a lot of money and give it to the states.) Third, if one looks at the graph, one can see that the economy recovered after the 2001 recession when state spending was down. (No doubt, Krugman will claim that state and federal spending, which increased during the recession of 2001, was the reason for the recovery.)

Now, the "recovery" after 2001 turned out to be a faux recovery, or what I called a "boomlet," which I predicted would end in a worse downturn. However, to Krugman, boom conditions can last forever, just as long as government provides enough "free" money to keep the punchbowl filled. Unfortunately, that is not the case.

There is another point as well. One of the reasons that we are not seeing a real recovery (and only one of the many reasons) is that state governments have become hostages of public employee unions. (Steven Greenhut has written a great book on this subject, appropriately called Plunder.)

State spending has become extremely voracious, and states are raising taxes left and right to fund their generous pensions and pay that unions extracted when the economy seemed to be in better shape. The notion that states raise even more taxes to continue spending at a drunken rate is irresponsible, and the notion that most economists believe that such actions would be good for the economy is pretty pathetic. If most economists believe this nonsense, then the academic profession is in worse shape than I had thought.

Note: I am blogging from the Austrian Scholars Conference at the Ludwig von Mises Institute in Auburn, Alabama.

Krugman Agonistes, Part II

The great soul search is over. Paul Krugman has, albeit reluctantly, recommended that Ben Bernanke be reappointed as the chairman of the Federal Reserve System. Now, this hardly is the Great Moment For Which I Have Been Waiting, but I do find his reasoning to be interesting.

On the con side, Krugman states:

• The Fed did not recognize the Greenspan-Bernanke housing bubble;
• Bernanke has failed to admit publicly that he blew it on the subprime mortgages;
• He failed to support the creation of a Consumer Protection Agency (and old Ralph Nader demand in which a government agency full of activists who hate private enterprise will decide pretty much everything economic);
• He is not aggressively pushing policies that will quickly bring down inflation and create millions of new jobs;
• He thinks too much like a banker.
  

On the pro side, he writes:

• While there are good Keynesian replacements, a confirmation battle would be bruising, so it is better to go with the safe choice;
• Bernanke has engaged in "unorthodox" but necessary actions to "save the economy from depression;
• Another appointee might listen to the "inflation hawks" (people who think inflation is bad), which would make things even worse.

Let me translate: Bernanke has "fought" this recession by using the Fed's unlimited pocketbook to buy trillions of dollars of worthless assets and help banks and other entities artificially balance their ledgers, and he should be rewarded for it. Second, any worries about inflation are overblown and the real enemy is deflation and unemployment.

As much as anything, Krugman's words today expose the Keynesian mentality as well as anything I have read. To a Keynesian, there is the Eternal Struggle Between Inflation and Unemployment because, after all, a market economy is prone to internal destruction because ultimately, consumers cannot spend enough money on their own to keep the economic perpetual motion machine running.

In this view, all assets, factors of production, and capital are homogeneous entities that pretty much respond equally to new money being thrown into the pot. New money, or should I say, newly-created (printed) money always greases the wheels of the machinery and leads to more economic activity, and more activity will lower unemployment.

As you know, I have a totally different view of things, and from the Austrian perspective, inflation does not grease the wheels of commerce over time, but rather destroys them, because assets and the like are NOT homogeneous. They are heterogeneous, and their values reflect the valuation that consumers give them through their own choices.

Lest anyone think that "aggressive" policies of money creation will bring back an economy, read this superb piece by Doug French, given in Houston last Saturday in which he takes a look at the experience in Japan. (The Japanese central bank followed Krugman's advice, so if you want to see Krugmanism in action, read Doug's account.)

As for me, I don't want to see Bernanke reappointed. I want to see the Fed closed down. Get rid of this engine of inflation and economic destruction. Now.

Welcome to Krugman-in-Wonderland!

I would like to welcome readers to my new blog, Krugman-in-Wonderland, dedicated, of course, to Paul Krugman and the Keynesian and politically-partisan missives he sends almost daily from his perch at the New York Times and elsewhere. In this blog, I will have my own comments plus links to some of Krugman's critics, and especially the criticisms of the Austrians. (The best of the Austrian critics is NOT yours truly, but rather Robert Murphy, who often takes Krugman apart on the Mises Daily page.)

It will take a few days to get this blog up and running, as I do have a day job. However, I do hope you will enjoy some good economic sense as I try to provide an antidote to the Keynesian mishmash from Krugman that masquerades as "good economics."

Of course, there will be the obvious question: Why is a nobody like me taking on a Nobel Laureate, a Princeton University faculty member, no less? True, the odds are not exactly in my favor. Krugman is one of the foremost public intellectuals in the country and I, well, am not. Krugman has his doctorate from MIT and has a Nobel Prize. I have my doctorate from Auburn University and have no prizes.

Nonetheless, over the years I have found that it is not as hard to answer Krugman as one might think. First, he is a True Blue Keynesian, and plenty of people before me have taken the Keynesian paradigm apart. Second, Krugman has this way of trying to rewrite recent history, and he stubbornly does not let the facts get in the way. Thus, he makes himself to be a pretty easy target.

To quote "The Godfather," this is business, not personal. I have met Krugman only once and he seemed to be pleasant enough. My beef with him is professional; he writes bad economics, and I want to set the record straight.