The Forgotten "Millions" (and Billions and Trillions) of Government Spending

Yes, millions of people are out of work, and Paul Krugman takes note. Anyone who has lost a job is in the position of losing income, and if a head of household loses a job, the income losses can be a crisis.

In advocating for a new "jobs program," Krugman first gives his pat answer for funding the whole affair:

(D)espite years of warnings from the usual suspects about the dangers of deficits and debt, our government can borrow at incredibly low interest rates — interest rates on inflation-protected U.S. bonds are actually negative, so investors are paying our government to make use of their money. And don’t tell me that markets may suddenly turn on us. Remember, the U.S. government can’t run out of cash (it prints the stuff), so the worst that could happen would be a fall in the dollar, which wouldn’t be a terrible thing and might actually help the economy. 

 In other words, we should not worry about it, as the government can inflate away the debt, and that is a good thing. But there is another issue that Krugman ignores, and that is why there would be the need for a "job" at all. (In other words, just borrow the money and give it directly to anyone who is unemployed.) Hear me out on this.

Krugman writes:

(L)ong-term unemployment remains at levels not seen since the Great Depression: as of October, 4.9 million Americans had been unemployed for more than six months, and 3.6 million had been out of work for more than a year.

When you see numbers like those, bear in mind that we’re looking at millions of human tragedies: at individuals and families whose lives are falling apart because they can’t find work, at savings consumed, homes lost and dreams destroyed. And the longer this goes on, the bigger the tragedy.

There are also huge dollars-and-cents costs to our unmet jobs crisis. When willing workers endure forced idleness society as a whole suffers from the waste of their efforts and talents. The Congressional Budget Office estimates that what we are actually producing falls short of what we could and should be producing by around 6 percent of G.D.P., or $900 billion a year.

He is correct in his assessment of the human tragedy, but simple spending with government "creating new jobs" is pretty meaningless. First and most important, to a Keynesian, a "job" is important because it is a source of income. People work in order to earn money so that they can consume. Yet, in the real world, a job is a mechanism through which someone produces something that meets the needs of others, and for which that person is compensated.

Keynesian theory separates production and consumption, as though they were two separate and unrelated things. Goods are randomly produced and then one only can hope there is enough money floating around to allow people to purchase those goods and clear the shelves so the circular process can continue. There is nothing purposeful about it; this is just a description of a big production/consumption circle with the chief end of consumption being the creation of an opportunity for more production (so that people can earn incomes and buy more goods so they can support their jobs).

Second, a real economy (as opposed to what Peter Schiff calls our "phony economy") creates employment opportunities out of the natural progression of economic growth. People in a real economy do not have to implore politicians to borrow a few hundred billion dollars to employ people in a new bureaucracy and call it "job creation" or "putting America back to work."

If Krugman is going to write about the "forgotten millions," perhaps he needs to recall those millions of tax-and-borrowed dollars that were spent yesterday to employ people for a while so that the president could be seen as enabling a fake recovery. For that matter, the mirage of recovery continues. At the present time, the government is borrowing 46 cents of every dollar spent (according to the Congressional  Budget Office), and the upshot has been a huge increase in...government jobs.

What Krugman apparently wants is for that rate of borrowing to increase so that we can turn more and more Americans into bureaucrats. Not that bureaucrats produce anything, but I guess they can spend and spend. So, if this is going to be our "employment" future, why not just print a bunch of money, load it into helicopters and dump it. The effect on the economy would be about the same as "creating" fake government occupations.

Are the Austrians Wrong?

Paul Krugman is at it again with the Austrians, creating straw men and then shooting down the arguments that they never made in the first place. Today, he goes after Peter Schiff, who actually did a very good job warning people about the housing bubble. Of course, in the process of supposedly discrediting Schiff, he discredits himself, too.

Krugman writes:

Now, the thing about Schiff and all the other Austrians predicting runaway inflation is that they were right to make this prediction given their model. If you believe that a recession is caused by a failure on the production side of the economy, the result of past malinvestment or something, you should also believe that any attempt to correct this decline by expanding credit will simply result in too much money chasing too few goods, and hence a lot of inflation.

By the same token, the failure of high inflation to materialize amounts to a decisive rejection of that model. (And no, it’s not because the numbers are fudged; independent estimates don’t differ significantly from official inflation.)

First, I agree that since the increase in the monetary base has come about by expanding bank reserves, the only way the new money will move into the economy will be through a huge expansion of loans, which has not happened. Yes, much of that new money has gone into government bonds, but we have to remember that much of what is raised through government bond auctions is used to pay off previous bonds. (This is something the ancients once called "robbing Peter to pay Paul.") Even Austrians know that the new money has to circulate before it affects asset prices.

However, Krugman misses something that is obvious: The Austrians, including Schiff, recognized the housing bubble for what it was, a huge set of malinvestments. After all, if there are no malinvestments, there is no bubble. So, how could a theory that actually predicted the meltdown also be a bad theory, if we are to use Krugman's criteria for determining if a theory has validity or not.

Second, while we have seen significant price increases in food and fuel, and these increases come in part because of the continual debasing of the dollar. What we have not seen has been hyperinflation and I agree with Krugman that this is because the economy is depressed. No one in the Austrian camp would deny this.

Third, the very fact that we have had massive malinvestments that cannot be supported by the market certainly is going to bring a downward effect on the economy and on prices. Furthermore, with government moving vast amounts of money to prop up the failing housing market, not to mention subsidizing "green energy" and banks, why should we be surprised that there is a huge lack of economic growth?

However, understand that Krugman also has called for government measures that would vastly expand the rate of inflation, that being his call for the Federal Reserve System to be the primary buyer of U.S. short-term securities, something that for now is prohibited by law. (Krugman claimed that a "clever lawyer" could find a way to re-interpret the law, and I am sure he is right, given how the government has re-interpreted other laws to fit the interests of politicians.)

If that were to take place, then there is no doubt we would see massive inflation as the bond sales would be financed almost entirely by new money, which then would be spent by the government. Krugman pretty much said the same thing in his Monday column, claiming that government can just print its way out of this morass without any real consequences, since inflation would "be good for the economy."

There is one thing that troubles me whenever Krugman claims that Austrians are willfully blind because they have not bowed to Krugman's demands that they declare the Austrian Theory of the Business Cycle to be invalid, and it is this: If real increases in government spending, massive Fed purchases of both private and public securities, and vast subsidies given to "green" industries, along with a huge auto industry bailout have not produced a robust recovery, then should not Krugman also take a hard look at his model?

(Yes, yes, I know. Krugman says that the problem is we have not had enough government spending, enough taxation, enough printing, enough borrowing, and, of course, enough inflation. After all, Krugman is a strong believer in the post hoc ergo propter hoc fallacy of inflation and economic growth, and despite historical evidence to the contrary, Krugman is not going to abandon what seems to be his real religion.)

Yes, Paul, I Agree: The Rating Agencies ARE Corrupt

In his column today, Paul Krugman takes on the Rating Agencies, such as Moody's, that were giving AAA marks to sub-prime debt that turned toxic. His comments here are on the mark:

Let’s hear it for the Senate’s Permanent Subcommittee on Investigations. Its work on the financial crisis is increasingly looking like the 21st-century version of the Pecora hearings, which helped usher in New Deal-era financial regulation. In the past few days scandalous Wall Street e-mail messages released by the subcommittee have made headlines.

That’s the good news. The bad news is that most of the headlines were about the wrong e-mails. When Goldman Sachs employees bragged about the money they had made by shorting the housing market, it was ugly, but that didn’t amount to wrongdoing.

No, the e-mail messages you should be focusing on are the ones from employees at the credit rating agencies, which bestowed AAA ratings on hundreds of billions of dollars’ worth of dubious assets, nearly all of which have since turned out to be toxic waste. And no, that’s not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.

What those e-mails reveal is a deeply corrupt system. And it’s a system that financial reform, as currently proposed, wouldn’t fix.

He is right about the out-and-out whoredom of the agencies and I also agree that Financial Reform as is being touted right now would not solve the problem.

The issue, however, is why the once-staid and sober Moody's and Standard & Poors turned into a bunch of financial drunkards in a relatively short period of time. That is where Krugman and I differ.

As an economist, when I see something perverse like what happened, I look for the underlying reasons, and especially the structure of incentives that helped bring about this whole regime change in how the agencies went about their business. While I am sure Krugman gives lip service to incentives, he prefers the Keynesian line about "deregulation," which tends to be the ideological umbrella under which he works.

A friend of mine who is a first-rate accountant said that mortgage bankers told her that what seemed absolutely silly and reckless after the bust made perfect sense when the easy money regime was ruling. This is vital to understanding the boom-and-bust, as Austrian Economists point to the actions of the Federal Reserve System holding down interest rates and flooding the markets with credit.

Now, Krugman at the end does give lip service to incentives, but he still misses the bigger picture. Had the Fed not been reckless with interest rates and dumping credit everywhere, the incentives for the ratings industries would have been different, period. As Peter Schiff said last year, "The whole country was drunk." The real question, he asks, is who brought the booze.

This is where Krugman and the Austrians differ. We believe that if the Fed is not playing the credit sugar daddy, the incentives that run with an easy money financial regime will not be there. (This is not excusing Moody's and S&P for not doing their jobs, but rather giving a reason as to why they took flight from sound finance.)

Krugman, on the other hand, believes that the Fed should continue providing the liquor, but the regulators will tell Wall Street when, where, and how much to drink. This is a recipe for later problems that will be worse than what we are facing now.

What if Bailouts ARE Inevitable?

In an earlier post, I wrote that Paul Krugman is basing a lot of his policy analysis upon the belief that future Wall Street bailouts are inevitable. Given what has transpired in the past few decades, I would say that he very well might have a point.

Thus, by beginning with the assumption that there will be bailouts, Krugman then mentally reconstructs a financial system that will never need to be bailed out, or where bailouts where be rare. How would such a system be organized, and what would it do?

While Krugman has not put out a hugely-detailed plan, some things clearly are in view. First, all of the financial organizations, including banks and the financial houses such a Goldman-Sachs, would be strictly regulated by the SEC. (However, the SEC currently regulates these institutions, so my guess is that what he proposes is that the SEC be given more power than it currently has, the idea being that more regulation will keep meltdowns from occurring.)

On the other hand, as noted in earlier posts, Krugman also favors the Fed aggressively lowering interest rates to below-market levels, which not only would be inflationary but would discourage savings. (Of course, Krugman, being a good Keynesian, attacks savings as lowering "aggregate demand.") So, we have the prospect of the Fed opening the money spigots and the SEC trying to route it to "safe" investments.

In a speech last year, Peter Schiff pointed out that depending upon the SEC to vet all firms actually creates larger problems because market participants are not as careful about their choices. He gave the example of con artist Bernie Madoff, noting that had people not been fooled by the lack of SEC oversight, the market would have flushed out Madoff long before his empire fell.

I think Schiff is on to something here. Krugman seems to believe that since bailouts are inevitable, we need a very strict SEC to vet everything, and a Fed to turn up the crank, and somehow that will give us prosperity -- and will keep bailouts from ever being reality. All that is needed, he claims, is for regulators to be "smart" and "believe in government."

What Krugman does not say is that having the federal bureaucracy determine the direction of investing will be disastrous. Do we really want the risk-averse, bureaucratic culture to run our economy, because THAT is what would happen.

I have a better idea. Require banks to hold 100 percent reserves and tell all financial firms that if they fail, they fail on their own. Unfortunately, our current political culture favors bailouts, and if that culture continues, we are going to find that "finance" will mean nothing more than borrowing and paying off government debt.

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.

Peter Schiff Takes On Paul Krugman

Even though Peter Schiff is not a Nobel Laureate in economics or has a doctorate in economics from MIT, it is clear he knows economics in a way that Paul Krugman never could. In this video, he refutes Krugman point by point.



(Hat tip to Michael Rozeff and an emailer named Mike)