Krugman: Free Nonsense

There is a reason that Keynesianism is popular with politicians and academic Progressives: Government can step into a crisis with its omniscience and perform magic tricks -- at no cost! Thus, Paul Krugman gives us that theme in a recent column and a blog post.

Government, argues Krugman, should be borrowing even more money because interest rates have been pushed to near-zero and it should use that money to "invest" in propping up public employee unions. No, he didn't say that last part, but the very people he is claiming should be rehired by governments pretty much are represented by unions.

Why the situation exists is because of a mysterious lack of "aggregate demand," or so we are to believe:

So what is going on? The main answer is that this is what happens when you have a “deleveraging shock,” in which everyone is trying to pay down debt at the same time. Household borrowing has plunged; businesses are sitting on cash because there’s no reason to expand capacity when the sales aren’t there; and the result is that investors are all dressed up with nowhere to go, or rather no place to put their money. So they’re buying government debt, even at very low returns, for lack of alternatives. Moreover, by making money available so cheaply, they are in effect begging governments to issue more debt. 

And governments should be granting their wish, not obsessing over short-term deficits. 

Yes, irresponsible Americans are paying debts, which is driving us into depression. If we were willing to stop paying our mortgages, car payments and credit card payments, then we could have prosperity. But since Americans are foolish, the government needs to rescue us by ramping ujp the spending.

No doubt, the message that government spending essentially offers only benefits and no costs is very popular in Washington and at Princeton. Just think; the government by simple declarations can repeal the Law of Opportunity Cost. It's magic, I tell you! Magic!

Robert Higgs notes that the Progressivism to which Krugman subscribes has the following tenets of faith:

1. If a social or economic problem seems to exist, the state should impose regulation to remedy it.

2. If regulation has already been imposed, it should be made more expansive and severe.

3. If an economic recession occurs, the state should adopt “stimulus” programs by actively employing the state’s fiscal and monetary powers.

4. If the recession persists despite the state’s adoption of “stimulus” programs, the state should increase the size of these programs.

5. If long-term economic growth seems to be too slow to satisfy powerful people’s standard of performance, the state should intervene to accelerate the rate of growth by making “investments” in infrastructure, health, education, and technological advance.

6. If the state was already making such “investments,” it should make even more of them.

7. Taxes on “the rich” should be increased during a recession, to reduce the government’s budget deficit.

8. Taxes on “the rich” should also be increased during a business expansion, to ensure that they pay their “fair share” (that is, the great bulk) of total taxes and to reduce the government’s budget deficit.

9. If progressives perceive a “market failure” of any kind, the state should intervene in whatever way promises to create Nirvana.

10. If Nirvana has not resulted from past and current interventions, the state should increase its intervention until Nirvana is reached.

And Paul Krugman is there to give us this road map to Nirvana!

Krugman: We Don't Need No Cause-and-Effect

Why no real recovery? Paul Krugman has the answer. According to his latest bout of economic wisdom, we are still in a depression because not enough people are employed by government. Yes, that has been a constant theme of his lately, and he takes another bite of the apple in a recent column:

Conservatives would have you believe that our disappointing economic performance has somehow been caused by excessive government spending, which crowds out private job creation. But the reality is that private-sector job growth has more or less matched the recoveries from the last two recessions; the big difference this time is an unprecedented fall in public employment, which is now about 1.4 million jobs less than it would be if it had grown as fast as it did under President George W. Bush.

And, if we had those extra jobs, the unemployment rate would be much lower than it is — something like 7.3 percent instead of 8.2 percent. It sure looks as if cutting government when the economy is deeply depressed hurts rather than helps the American people. 

 First, let us get something straight. The "private sector" hardly is thriving. Yes, we are hearing about "record profits" from some businesses, but these are not the best of times for business and a lot of people understand that the foundations are quite shaky.

Second, governments do not generate wealth on their own. Everything that they spend ultimately comes from something that has been produced in the business world. (Sorry, Keynesians. Newly-printed money is not wealth. It is newly-printed money.) Thus, if state and local governments are hurting, they are hurting because businesses and individuals do not have the revenues to support the kind of spending that many states have enjoyed.

This last point is important, because Krugman in effect is declaring that state government spending is the source of wealth for much of the economy. After all, if businesses were doing as well as Krugman and the Democrats are claiming, and if millionaires abound, then there should be no problem in raising the tax revenues necessary for the funding of police, firefighters, and teachers.

Krugman, of course, would claim that the way to generate new funds would be for the federal government to ramp up its borrowing, and then give the money to state governments. Not that this is sustainable, but at least he would have a plan.

However, that still does not solve Krugman's "cause-and-effect" issue. The gathering of tax revenues by state and local governments is what allows these governments to spend, and they only can gain revenues by taxing businesses and individuals. Yet, Krugman wants us to believe that the causal chain runs the other way: state spending generates wealth; in fact, it is the originator of wealth.

Once upon a time, academic economists actually were taught things like cause-and-effect. However, in Macroworld, effect becomes cause.

David Gordon Schools Krugman

David Gordon has a scathing review of Krugman's new book, End This Depression Now!, in which Gordon writes that Krugman has a "cartoon version of Keynesianism." Gordon writes:

Krugman does not so much as mention the pioneering work of Robert Higgs, Depression, War, and Cold War, which decisively challenges the contention that World War II ended the Great Depression. Higgs convincingly shows that prosperity returned only after the war ended. But let us, very much contrary to fact, suppose that Krugman is correct about the effects of government spending in the years after 1940. His defense of Keynes would still be grossly deficient.

What he is in effect saying is this: "Instances that appear to confirm the claim that government spending ends depressions count in favor of Keynes. But cases that go against Keynes do not count, because we cannot rule out the possibility that greater spending would have worked."
What Keynes's friend Piero Sraffa, who cannot be suspected of bias in favor of the Austrian School, wrote in his copy of Keynes's General Theory applies to Krugman as well: "as usual, heads I win, tails you lose."

 I believe that is a fair commentary on how Krugman presents his material, and his method of arguing his point. If you agree, it is because you are good; those who disagree do so because of the evil lurking in their hearts and souls.

Robert Higgs on Krugman's New Book

Robert Higgs, who coined the term "Vulgar Keynesianism," takes on Paul Krugman's new book, End This Depression Now! I especially like Higgs' description of the Keynesian view of output.

Higgs vs. Krugman

I feature a wonderful 2009 piece by Robert Higgs (I had a link to it last year) that I think really shows the differences between the Austrians and what Higgs calls the "Vulgar Keynesians," including Paul Krugman.

Higgs lays out six areas where the Keynesians especially are weak, including:

• Aggregation: Keynesians believe that they can explain an entire economy through aggregate demand, aggregate supply, price levels, and the rate of interest;
• Relative prices: The only thing that means anything regarding prices to Keynesians is the overall "price level. Higgs writes: "If relative prices change, which of course they always do to some extent, even in the most stable periods, these changes are "averaged out" and affect the calculated change, if any, in the aggregate price level only in a shrouded and analytically irrelevant manner."
  
• The rate of interest: Higgs points out that the rate of interest "is a crucial relative price — namely, the price of goods available now relative to goods available in the future." Keynesians, on the other hand, believe it is just a "price of money," so the lower the price, the better;
• Capital and its structure: In the short run, notes Higgs, Keynesians view capital as being homogeneous, with its only real value being the money spent in creating it. Furthermore, Keynesians see capital stock as a "given" and cannot conceive of malinvested capital, believing that capital that is not in use only is "idle," and can be revived with enough spending;
• Malinvestments and money pumping: Because Keynesians don't believe that massive malinvestments have anything to do with an economic downturn, their "solution" of pumping more money into the economy cannot have any other result except success -- provided government pumps enough money. Higgs writes that Keynesians also seem to have an abiding faith in the healing powers of inflation;
• Regime uncertainty: What Krugman calls the "Confidence Fairy," Higgs notes that the political atmosphere does make a difference regarding investment and especially long-term capital investment. He writes: "The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty," a pervasive uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future. This kind of uncertainty especially discourages investors from putting money into long-term projects."

While I am sure that Higgs' points will enrage the Keynesians, nonetheless it is clear that Higgs is writing about economics, not statistical aggregates. There really is a difference.

Keynes was and always will be wrong

Here we go again. Paul Krugman not only attacks the Law of Cause and Effect (substituting Effect for Cause), but also manages to fracture history a bit. However, given that he has claimed that Ronald Reagan was the architect of business and financial deregulation -- thus confusing Reagan with Jimmy Carter and Ted Kennedy -- it is safe to say that Krugman is not a particularly good economic historian.

Apparently, Krugman believes that governments are not running large enough deficits and are not spending enough money, although much of the spending he is demanding comes from accumulation of massive debt (which Krugman believes later can happily be inflated away). In his own words:

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Governments around the world, claims Krugman, could have had us in recovery had they just borrowed and spent enough. Of course, the massive borrowing ONLY could have been financed by central banks, and especially the Federal Reserve System, and the only way such a scheme could have been hatched was the central banks creating "money" from thin air. In other words, Krugman is excoriating governments for not getting their finance arms -- central banks -- to print enough money, as though printing money is the key to economic success.

(If that were true, then the USA should not prosecute counterfeiters but actually encourage them. Maybe Krugman can write a future column on why counterfeiters are an economic blessing and why every household should have its own money printing press.)

Thus, if one is to understand Krugman, the European Central Bank and the Fed should be lending billions of dollars to Greece not so that Greece can use the money to pay its previous debts, but rather to spend itself into prosperity, with the idea that a future Greek economy -- yes, that economy that features bloated government unions and low productivity -- will produce so much wealth that it can pay back the debts or, better still, have the central banks just write off the debt because, after all, it was just funny money in the first place.

However, let us get back to Krugman's Fractured Fairy Tales. According to Krugman, Franklin D. Roosevelt's New Deal government slashed spending after 1936 and THAT was the cause of the recession of 1938 in which the rate of unemployment went to nearly 20 percent, a recession within a depression.

In looking at the numbers from that time, however, I must admit to a very nagging question. Indeed, the federal deficit fell during that time and unemployment rose. However, earlier in that decade, deficits rose and so did unemployment, so to claim that falling deficits would create unemployment is to ignore the earlier record.

It also is true that in that time period, taxes rose and government spending fell, although I remember a year ago Krugman calling for the end of ALL of the "Bush tax cuts," which would have significantly increased the tax bill not only for the wealthiest of American taxpayers, but also for people in lower income groups. Krugman said that if he were president, he would let ALL of the cuts expire and then spend the extra revenue, his words, not mine.

Government spending as a percentage of Gross Domestic Product fell from 10.5 percent in 1936 to 7.7 percent in 1938, and I find it hard to believe that a decrease of less than three percent would be the sole cause of this massive slide back into high unemployment.

You see, Krugman ignores other developments during that time, developments which Robert Higgs chronicled in his paper on the New Deal. Higgs notes that FDR was becoming increasingly shrill in his anti-business rhetoric at this time, and federal legislation aimed at crippling business investment came forth in the latter parts of the 1930s.

Since Krugman seems to believe that federal legislation raising business costs and hostile rhetoric from Congress and the executive branch have nothing to do with business investment (he calls all of this the "Confidence Fairy"), what happened outside of government spending in the late 1930s is completely irrelevant. Yet, as Higgs adptly showed in his paper, that clearly was not the case, and he cites a number of historians to back up his claims.

While I am sure that True Believers would claim the Higgs paper is nonsense, others who actually believe that economic success depends upon wealth that is created, not the amount of money printed, are going to see things differently. Government spending is a very poor substitute for sustainable business investment, and businesses are not going to do long-term investment and capitalization while a hostile government that threatens to confiscate their earnings and dumps trainloads of new and costly regulations on them is in power.

We should not forget that Barack Obama never has had to meet a payroll and never has worked in anything but settings in which at very best, business enterprises existed in order to give campaign contributions to politicians. This is a president who has no idea how an economy works, how entrepreneurs create wealth, and what is needed to bring the economy back from this depression.

Unfortunately, his most influential critic is someone who actually believes that money-printing and government-spending schemes are going to overcome everything else and create prosperity and full employment. Or, to paraphrase the book of I Kings, if Obama wants to bring about economic recovery, he should not chastise us with whips, but rather with scorpions.

Wrong and wrong

Paul Krugman seems to have a need to claiming time and again that he is right and everyone else is wrong, and his "proof" is that interest rates did not go up as predicted by the editorial writers at the Wall Street Journal (thus, giving us the overworked "bond vigilantes" phrase). He also constantly invokes his "confidence fairy" line, but has not given proof of its lack of veracity -- except to use the term with the idea that his constantly saying it "proves" it is true.

His newest pen pal, Bruce Bartlett, seems to have gone over to the Keynesian side, and now he has David Frum to join him. I have linked Frum's mea culpa article for those who wish to read it.

However, there are a number of people who also have been wrong, people that Krugman never will acknowledge because he already has attacked them as being wrong and stupid all of the time: the Austrians. For example, in 2001 -- that's right, 2001 -- Ron Paul on the floor of the U.S. House of Representatives declared that the Fed was in the process of engineering a housing bubble. However, since Rep. Paul subscribes to a theory that Krugman claims is no more credible than the "phlogiston theory of fire," then nothing Ron Paul says should have any veracity at all. (In Krugman's world, only Keynesians are right and everyone else -- even those that are right -- are wrong.)

Keep in mind that Krugman already has declared that the U.S. Government is not "broke," even though borrowing now is now out-of-control. Of course, Krugman's latest "scheme" is for the government to borrow obscene amounts of money, spend it, with the idea that the resulting spending will give the economy "traction" to move on its own. There is no causality other than Krugman's circular belief that spending will begat spending which will begat prosperity. In other words, he actually wants us to believe we can spend ourselves into prosperity.

Let us address his "confidence fairy" phrase for a minute. According to Krugman, business "confidence" is based solely on what business owners and managers perceive to be future spending. If someone will spend, business will build. Robert Higgs, however, notes that not only is Krugman wrong, economically speaking, but he also is contradicting his own guru, John Maynard Keynes:

The humor columnist for the New York Times, Paul Krugman, has recently taken to defending his vulgar Keynesianism against its critics by accusing them of making arguments that rely on the existence of a “confidence fairy.” By this mockery, Krugman seeks to dismiss the critics as unscientific blockheads, in contrast to his own supreme status as a Nobel Prize-winning economic scientist.

The irony in this dismissal, as others, including my friend Donald Boudreaux, have already pointed out, is that Krugman’s own vulgar Keynesianism relies on a much more ethereal explanatory force for its own account of macroeconomic fluctuations–namely, the so-called animal spirits. The master himself wrote in The General Theory: “Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die. . . . [I]ndividual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits. . . .” (p. 162). Because Keynes conceived of his “animal spirits” as “a spontaneous urge to action rather than inaction” (p. 161), he of course had no way to explain their coming and going or to measure or evaluate them in any way. They are as surreal as a ghost–when and why they come and go, no man knows or can know. Such is the force that drives the ups and downs of private investment in Keynesian economic theory, and such theory unfailingly drives Krugman’s commentaries on the recession and on the possibility and effective means of recovery from it.

Since Krugman's "confidence fairy" line is aimed at Higgs' "regime uncertainty" view, I include what Higgs says about it:

Regime uncertainty, however, has a much more grounded basis. In my own research on the topic, I have presented evidence derived from (1) a mass of testimony by investors, businessmen, and other contemporaries, (2) voluminous historical facts on the character of government actions that reasonable people had every reason to interpret as theatening the security of their private property rights, (3) variations in the structure of investment, especially as between short-term and longer-term projects, and (4) specific twists in the term-structure of returns on private corporate bonds, as well as other relevant evidence on the behavior of financial markets.

As against this varied and substantial evidence, what does the proponent of animal sprits have to offer? Well, nothing at all. The idea is purely fanciful, the product of Lord Keynes’s fertile imagination.

So, this is what we have:

• Keynesians are right and Austrians are wrong (because Krugman says so)
• The Keynesians "doctrine" of "animal spirits" also is wrong because it contradicts Krugman's view of business confidence
• But Keynesian doctrine is right, even if it is not right.

So, there you have it. Krugman now is depending upon David Frum, a guy who long ago rejected anything to do with free markets and peaceful relations between people as being desirable, to validate his own Keynesian opinions. You just cannot make up this stuff.

Krugman's Keynesian Cash Con

In the Keynesian system, spending IS demand, and the more spending, the more demand, and the more demand, the more production to meet the demand. There is a nice logic to the system, which is why it has a widespread appeal.

Economics, however, looks under the surface to deal not only with issues of causality, but also to take apart that which seems to be true and to ferret out those things which others taking a superfluous view have missed. For example, the typical "man on the street" believes that the value of, say, gasoline is derived from the value of crude oil and the various aspects of cost of production.

Thus, when the U.S. Government slapped price controls on domestic crude oil in the name of making it less expensive to create gasoline, the typical politician, journalist, and Keynesian economist, as well as the "man on the street," believed that was supposed to be the case. It was as though the Marginalist Revolution of 1871 and the development of Neoclassical Economics had not happened, that Alfred Marshall's "Derived Demand" of the factors as well as Carl Menger's important insights never existed.

I say this for two reasons. First, much of what Krugman writes is in the line of the discredited "Cost of Production" Theory of Value. Here is a guy who along with other "liberal" economists during the California electricity crisis of a decade ago (brought about by price controls levied by California authorities) declared that the way to "solve" the problem was...more price controls. (He even said that price controls would increase the supply of electricity, which even for Krugman is an amazing thing in its repudiation of Neoclassical value theory.)

Second, in recent commentary, Krugman has turned to the situation of so-called "corporate cash" in which banks and corporations are making paper profits, but holding onto large sums of money. Now, I have no problem with the numbers he is using, and I have no doubt that banks are not loaning out a lot of their excess reserves (and Krugman hardly is the only one saying this, given Robert Higgs has written similar things and his perspective of this crisis is 180 degrees opposite of what Krugman is saying).

People can agree on basic data, but the interpretation not only of why banks and corporations are not loaning and investing long-term but also of the reason that we don't have more inflation is where the debates exist. Krugman, not surprisingly, takes the Keynesian view:

So here’s what you should answer to anyone defending big giveaways to corporations: Lack of corporate cash is not the problem facing America. Big business already has the money it needs to expand; what it lacks is a reason to expand with consumers still on the ropes and the government slashing spending.

What our economy needs is direct job creation by the government and mortgage-debt relief for stressed consumers. What it very much does not need is a transfer of billions of dollars to corporations that have no intention of hiring anyone except more lobbyists.

Elsewhere, he writes:

In fact, that idle cash has become a major conservative talking point, with right-wingers claiming that businesses are failing to invest because of political uncertainty. That’s almost surely false: the evidence strongly says that the real reason businesses are sitting on cash is lack of consumer demand. In any case, if corporations already have plenty of cash they’re not using, why would giving them a tax break that adds to this pile of cash do anything to accelerate recovery?

In other words, all that needs to happen is for the government to accelerate spending, either by taking some burdens off consumers or for the government to seize and spend the money itself. That is why Krugman has reversed his view that he told other economists and me in 2004 that 70 percent tax rates "were insane," and now is endorsing higher income and corporate taxes in order for government to confiscate money and spend it.

What I find interesting is his utter dismissal of Higgs' contention that "regime uncertainty" has anything to do with corporate investment. Even if government is to confiscate most corporate profits in the future with high taxes, not to mention the imposition of more regulations, in Krugman's view, the band in "Animal House" will continue to try to march through the wall. As long as there might be "spending" in the future, corporations automatically will engage in capital investment. That is nonsense.

Furthermore, as Higgs pointed out, if banks start making loans wily-nily from their huge monetary base, we WILL see a big rise of inflation. For Krugman, inflation is good; it will "stimulate demand" and repudiate debt, and magically remove us from what he calls a "liquidity trap." Higgs, on the other hand, who is a far wiser person than Krugman ever will be, has much better insights. Uncertainty really does matter, and while Keynesians refuse to read Higgs, the man is right.

Krugman writes that we are forgetting the "lessons of 2008" as though his view were self-explanatory. He refuses to acknowledge that the housing bubble occurred because government guarantees and the infamous "Greenspan/Bernanke Put" in which the Fed promised to backstop whatever foolishness the banks engendered was a major reason that banks and other lenders ran over the cliff.

To Krugman, profits and losses mean nothing, and prices and interest rates don't send any meaningful economic signals. The regulator under the Democratic administration is All-Knowing and All-Wise, while the regulator (usually the same person) under the Republican administration is a devotee of Ayn Rand.

So, Krugman actually wants us to believe that if government confiscates large amounts of corporate cash and spends them on politically-based projects, that corporations automatically will start investing for the future. Apparently, one of those projects must be that proverbial bridge in Brooklyn that Krugman is trying to sell us.

Who is to blame for the coming downturn?

When Barack Obama took office, Paul Krugman urged him to emulate Franklin Roosevelt, and it looks as though Obama might just achieve what FDR did: have a depression within a depression.

As the economy begins another long and sad slide, Krugman is claiming that our government just did not spend enough money the past few years, and that is why we are headed south:

Back when the original 2009 Obama stimulus was enacted, some of us warned that it was both too small and too short-lived. In particular, the effects of the stimulus would start fading out in 2010 — and given the fact that financial crises are usually followed by prolonged slumps, it was unlikely that the economy would have a vigorous self-sustaining recovery under way by then.

Krugman's retrospective is his usual self-aggrandizing nonsense, the idea being that had Obama borrowed and spent an extra trillion, dollars, Krugman then would have argued for two trillion, and had the administration dumped two trillion, Krugman would have demanded four. And so it goes.

What Krugman does not say is that like FDR, Obama went on a regulatory rampage, and on top of that, the government continues to pursue wars abroad and now openly admits to having CIA-sponsored death squads roaming the globe in search of the "bad guys." Obama has openly demonstrated himself to be quite hostile to private enterprise (of the non-subsidized variety), and the government through the Federal Reserve System is showering the world with dollars, yet he wonders why U.S. business firms do not engage in long-range capital planning and expenditures.

As Robert Higgs notes in this excellent essay, the Roosevelt administration created huge amounts of "regime uncertainty," which led to a slowdown of private investment. It seems that Obama, through his rhetoric, his initiatives, and the brazen hostility of Washington toward private investment, we are seeing a repeat.

Krugman, of course, won't mention this point, and why should he? Keynesians believe that all we need to do is to shower an economy with money and everything else follows. Well, it doesn't.

This is Fiscal Responsibility?

Since Paul Krugman's column and blog have become little more than propaganda for the Democratic Party, I thought today that I would feature something written by an economist who actually does real economics: Robert Higgs. But first, let us look at a recent blog post by Krugman.

In critiquing a recent blog post by Tyler Cowen of George Mason University, Krugman notes that Cowen did not zero in on the rise of U.S. Government debt levels during the Reagan administration. He also writes this:

Bear in mind, too, that the signature initiatives of Republican presidents — the Reagan tax cut, the Bush tax cut, the Medicare drug benefit — have all been unfunded deficit-raisers; the signature initiatives of Democratic presidents — the Clinton tax hike, Obamacare — have all been deficit-reducing.

I find his attack on the tax cuts started in 1981, in which the top rates were dropped, including the one from 70 percent to 50 percent. At the Southern Economic Association meetings of 2004 in New Orleans, where Krugman was a featured speaker at a Sunday session, I asked Krugman if he believed that we should go back to the 70 percent rates, since he had been on the attack against Reagan.

His reply? "Oh, no! Those rates were insane!" (He really emphasized the word "insane.") Now, given Krugman's selective memory, I doubt he will recall having said such things, but it was in a room full of economists and I am sure that more than a few of them will remember what Krugman said.

There also is Krugman's claim that ObamaCare is "deficit-reducing." I had to pick myself off the floor at this one. Krugman is saying that the creation of a VAST new entitlement will result in lower levels of government spending, and that simply is a joke, a very bad joke.

Don't forget what ObamaCare has done in its thousands of pages of just the law, not to mention the hundreds of thousands of new regulations that will be kicking in over the years, will make the very thing that we need -- entrepreneurship in the field of medicine (real entrepreneurship, not trying to beat the system) -- will be criminalized. If Krugman really believes that making ALL medical care simply something that falls under government administration is going to reduce the opportunity costs that come with medical care, then he has totally rejected economics for something else.

More than four decades ago, the Democrats under Lyndon Johnson passed a vast array of new laws that created the very entitlements that, along with empire-preserving military spending, are eating the budget. As Professor Higgs notes, these new entitlements never were projected to eat the U.S. economy; instead, they were supposed to be a small appendage funded by our productivity.

Economics deals in the areas of costs and benefits. However, to economists (or at least those economists who are not part of the "elite" system, anyway), costs are opportunity costs. They are not simple administrative numbers.

Yet, when Krugman refers to medical costs, that is exactly what he means. Entrepreneurs over the years have reduced real costs by moving resources from lower-valued to higher-valued uses, as ultimately determined by consumers.

In Krugman's world, however, real cost reduction is nothing more than an edict from the state: You will cut costs. That is not economics, people; that is fantasy.

Krugman Unleashed: Economics as Though the Non Sequitur Means Something

Following with his thematic writing (in following recent blog posts, including this one, along with my response), Paul Krugman continues to insist that if the Obama administration decides to really crank up the borrowing and spending, we, too, can experience a wonderful boom, just as Americans did in the 1940s.

Now, I find interesting that Krugman now has decided that World War II, a time when at least 50 million people met horrible deaths, really was a wonderful time of plenty and happiness, or at least it gave us an "economic boom," and Krugman believes booms are good. Lest anyone think I am exaggerating, read Krugman's own words:

From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 — the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.

But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity. Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.

As I have noted before, Robert Higgs, who actually is an economist who knows something about history (and is not simply a partisan political operative like a famous faculty member from Princeton), lays out the reality of the World War II home front quite well. Furthermore, there is the little problem of Krugman's non sequitur: How in the world can we say that World War II created a "boom" that "laid the foundation for long-run prosperity"?

First, the economy was tuned to war goods, not goods that people actually would want or need in normal life. Much of the capital that was developed during the war was not easily turned toward civilian production.

Second, there is no causality here. Krugman notes that the government went into huge deficit spending during the war, and then "long-run prosperity" just naturally followed. How, I ask, does that follow?

No doubt, Krugman would argue that the economy had "gained traction" during that time, but that is a circular argument at best. In that view, the economy booms because, well, it booms.

Finally, is Krugman demanding that the government expand the way it did during World War II, and that somehow, that will create long-term prosperity? If enough of us get jobs raking leaves and digging holes, and then filling them up again, will that magically make goods appear on the shelves and give us the Horn of Plenty?

Prof. Higgs has a much better handle on the subject. In this paper on "Regime Uncertainty," he not only lays out what happened during the 1930s and the war, but also what happened afterward. The difference is that his paper actually uses believable causal mechanisms, not Krugman's "Hair of the Dog" economic theories.

Is Deflation the Enemy, or Is It Inflation?

Like all Keynesian True Believers, Paul Krugman believes that the worst enemy of the economy is deflation. In his view, deflation causes unemployment and inflation reduces it, and he repeats that canard in this recent column.

Not surprisingly, Krugman claims that unless the Fed under Ben Bernanke engages in massive new money creation (and, of course, spending), the economy is doomed:

Today, Mr. Bernanke is the Fed’s chairman — and his 2002 speech reads like famous last words. We aren’t literally suffering deflation (yet). But inflation is far below the Fed’s preferred rate of 1.7 to 2 percent, and trending steadily lower; it’s a good bet that by some measures we’ll be seeing deflation by sometime next year. Meanwhile, we already have painfully slow growth, very high joblessness, and intractable financial problems. And what is the Fed’s response? It’s debating — with ponderous slowness — whether maybe, possibly, it should consider trying to do something about the situation, one of these days.

The Fed’s fecklessness is, to be sure, not unique. It has been astonishing and infuriating, as the economic crisis has unfolded, to watch America’s political class defining normalcy down. As recently as two years ago, anyone predicting the current state of affairs (not only is unemployment disastrously high, but most forecasts say that it will stay very high for years) would have been dismissed as a crazy alarmist. Now that the nightmare has become reality, however — and yes, it is a nightmare for millions of Americans — Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let’s talk about the evils of budget deficits.

In response, I will include material from Murray N. Rothbard's America's Great Depression, a recent article by Robert Higgs, and something I wrote for the Mises Institute two years ago. First, we look at what Rothbard has to say regarding deflation:

With the supply of money falling, and the demand for money increasing, generally falling prices are a consequent feature of most depressions. A general price fall, however, is caused by the secondary, rather than by the inherent, features of depressions. Almost all economists, even those who see that the depression adjustment process should be permitted to function unhampered, take a very gloomy view of the secondary deflation and price fall, and assert that they unnecessarily aggravate the severity of depressions. This view, however, is incorrect. These processes not only do not aggravate the depression, they have positively beneficial effects.

There is, for example, no warrant whatever for the common hostility toward "hoarding." There is no criterion, first of all, to define "hoarding"; the charge inevitably boils down to mean that A thinks that B is keeping more cash balances than A deems appropriate for B. Certainly there is no objective criterion to decide when an increase in cash balance becomes a "hoard." Second, we have seen that the demand for money increases as a result of certain needs and values of the people; in a depression, fears of business liquidation and expectations of price declines particularly spur this rise. By what standards can these valuations be called "illegitimate"? A general price fall is the way that an increase in the demand for money can be satisfied; for lower prices mean that the same total cash balances have greater effectiveness, greater "real" command over goods and services. In short, the desire for increased real cash balances has now been satisfied.

Furthermore, the demand for money will decline again as soon as the liquidation and adjustment processes are finished. For the completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers' scramble for cash. A rapid unhampered fall in prices, both in general (adjusting to the changed money-relation), and particularly in goods of higher orders (adjusting to the malinvestments of the boom) will speedily end the realignment processes and remove expectations of further declines. Thus, the sooner the various adjustments, primary and secondary, are carried out, the sooner will the demand for money fall once again. This, of course, is just one part of the general economic "return to normal."

In other words, Rothbard says that deflation will help the adjustment process in which the economic fundamentals get back into balance. Given that Krugman operates on the theory that all assets are homogeneous, he is incapable of understanding anything else.

Prof. Higgs notes this about Keynesians and inflation and deflation:

With their great, simple faith in the efficacy of government spending as a macroeconomic balance wheel, vulgar Keynesians disregard malinvestment, past and future, and support government spending in excess of the government’s revenues, the difference being covered by borrowing. Of course, they favor central-bank actions to make such borrowing cheaper for the government. In fact, they chronically prefer “easy money” to more restrictive central-bank policies. As noted previously, they prefer easy money not only because it lowers the cost of financing the government’s deficit spending, but also because it induces individuals to borrow more money and spend it for consumption goods ― such increased consumption spending being viewed as always a good thing, notwithstanding the recent near-zero rate of saving by individuals in the United States. Reflecting on the vulgar Keynesian attitude toward Fed policy, I keep recalling a old country song whose refrain was: “older whiskey, faster horses, younger women, more money.”

Vulgar Keynesians do not spend much time worrying about potential inflation; on the contrary, they are obsessed with an irrational fear of even the slightest hint of deflation. If inflation should become an undeniable problem, we may count on them to support price controls, which, they are convinced on the basis of sketchy knowledge of such controls during World War II, can be made to work well.

In this article, I noted that the current crisis came about because of the Fed's reckless money creation, so it certainly is NOT possible that the Fed can SOLVE the problem with more inflation:

The central issue is that the Fed pushed a policy of inflation, with much of the new money going into the mortgage markets; there is no way to avoid the painful and terrible corrections that must follow such fiscal foolishness. (Now we finally see massive commodity-price increases, which have occurred because there is nowhere for the new money to go but directly into commodities and consumer goods.)

Anyone who believes that the Fed can pretend that heavily damaged mortgage securities are worth more than toilet paper and literally build a $200 billion loan portfolio upon them does not understand finance. Just because Ben Bernanke declares something to be "valuable" does not bestow value upon it.

The simple issue is not lack of liquidity. It is the fact that billions — make that trillions — of dollars were malinvested in markets where the increasing values could not be sustained. To pump near-worthless dollars into this mix does not solve anything; it only ensures that the coming day of reckoning will be even more unpleasant than it would have been otherwise.

So, if the Fed follows Krugman's demands, we can look forward to even more secondary contractions and more malinvestments. The "day of reckoning" won't arrive all at once; it will become a permanent part of our economic landscape.

Krugman, Business Spending, and "Regime Uncertainty"

Paul Krugman has laid down a challenge in his latest blog post, claiming that much of the current joblessness is the result of businesses "sitting on a lot of cash, but not spending it." Indeed, he likens this situation to the extreme cautiousness of Gen. McClellan during the Civil War, which brought about the ire of President Lincoln.

At one level, Krugman claims that the reluctance of businesses to spend is understandable, given what he calls "huge excess capacity." (More on the "capacity" argument later.) He declares:

(Reluctance to spend) then raises the question: how can you believe that, and not also believe that if the U.S. government were to borrow some of the cash corporations aren’t spending, and spend it on, say, public works, this would also create jobs? (Brad DeLong has tried to make this argument repeatedly).

Which brings me to Lincoln and McClellan. General McClellan had raised a powerful army, but seemed disinclined to actually seek battle. So Lincoln sent him a letter: “My dear McClellan: If you don’t want to use the Army I should like to borrow it for a while.” (Yes, there are various versions of the quote).

So shouldn’t that be our response to all that idle corporate cash? We don’t literally have to borrow from the corporations; they’re parking their funds in the money market, and the feds would borrow from that market. But the end result would be to put some of that idle cash to work — and, ultimately, to give the corporations a reason to start investing, too, so that the deficit spending would crowd investment in, not out.

First, the government IS borrowing a lot of cash from businesses and especially from the banks. Second, Krugman is not advocating that businesses seek better deals; no, he is quietly but obviously demanding that government confiscate this "excess cash" if businesses don't increase their spending.

He then throws down the glove: "I have never seen a coherent objection to this line of argument."

My sense is that Krugman has seen "coherent" arguments against this line of thinking, but simply will not acknowledge that anyone else can fashion anything contrary to his own ex cathedra pronouncements. However, in the spirit of Krugman's challenge, I will fashion my own argument, and will lean heavily upon an economist that I really respect, Prof. Robert Higgs.

First, and most important, the "capacity" argument is a red herring that is based upon circular arguments (one of Krugman's favorite tactics). According to Krugman, businesses have large, unused productive capacity that will only become engaged after businesses start spending again. Thus, businesses are causing their own demise, so it is up to the government to break this circular pattern of job destruction and confiscate business cash and spend it wisely.

Once again, we see Krugman claiming that the CAUSE of a recession is less spending, which he also claims in a recent column. Yet, as I see it, this is a violation of what Carl Menger called "The Law of Cause and Effect." Krugman is confusing effect with cause and is missing the larger picture.

He is right that businesses (and many individuals) are putting money in relatively safe places (all of which Krugman would equate to stuffing money in one's mattress), but his circular argument as to why simply fails on its face. However, Robert Higgs has noted many times that "regime uncertainty" on behalf of the Obama administration's actions, which he equates to what happened during the Great Depression.

In 1997, Higgs published a paper in The Independent Review on the Great Depression in which he blamed the "regime uncertainty" promoted by the Roosevelt administration for the lack of long-term investment by businesses. Higgs writes:

Evidence from public opinion polls and corporate bond markets shows that FDR’s policies prevented a robust recovery of long-term private investment by significantly reducing investors’ confidence in the durability of private property rights. Not until the New Deal/war economy ended and resources became available for peacetime production did private investment—and the nation’s economic health—fully recover.

Higgs elaborates on the Great Depression theme in this piece, using a lengthy quote from a member of FDR's "brain trust," noting that FDR's anti-business rhetoric and his punitive policies toward business kept business owners from making longer-term decisions. Higgs in this column equates the current hostility to business by the Obama administration and the equally anti-business Congress to what happened with FDR and points out that we should not be surprised that the present "regime uncertainty" is not going to bring about recovery. He writes:

Speaking to CNBC in Las Vegas recently, Steve Wynn, the billionaire developer and operator of entertainment properties, said: “Washington is unpredictable these days. No one has any idea what’s next . . . the uncertainty of the business climate in America is frightening, frightening to everybody, and it’s delaying recovery.” Wynn complains of “wild, uncontrolled spending” and “unbelievable, unsustainable debt.”

Wynn also has operations in China, and he remarks that he “has no qualms about dealing with the Chinese government. Macau has been steady. The shocking, unexpected government is the one in Washington.” Not very long ago, such a statement would itself have been shocking.

The gambling and real estate magnate expresses concerns about inflation, FHA’s making the same mistakes Fannie and Freddie have made, and the business costs arising from the new health-care law. “We’re on our way to Greece,” he declares, “in the hands of a confused, foolish government.” Exasperated, he mutters, “It’s got to stop. It’s got to stop.”

These observations remind me of similar statements made by investor Lammot du Pont in 1937: “Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate.” Even members of Franklin D. Roosevelt’s cabinet eventually appealed to him to clear the air in which private investors were finding it difficult to breathe, but he refused to do so, preferring to plunge ahead with the New Deal and to publicly blame “economic royalists” for his policies’ failures.

Now, I am sure that Krugman would claim that the above arguments are nonsense and don't provide a "coherent" argument, but nonetheless I believe Higgs has the much stronger argument than Krugman's claim, which is based upon circular logic.

Krugman: F.A. Hayek Wants You to Lose Your Job

One of the reasons I started this blog was to highlight the real differences between Keynesian "economics" and the economics of the Austrian School, and to defend Austrian concepts against the missives coming from Paul Krugman of Princeton University and the New York Times. Thank goodness, mine is not the best or most articulate voice from the Austrian camp, and I have highlighted others, including Robert Higgs, who I believe is infinitely a better economist than Krugman.

Krugman over the years has refused to explain the Austrian viewpoints in anything but outright caricatures and exaggerations. For example, here we get what he calls the "Hangover Theory," which outright misrepresents everything written by Ludwig von Mises, F.A. Hayek, and Murray Rothbard on the subject of business cycle theory.

In this June 14 post on his NYT blog, Krugman once again refuses to take a serious look at what the Austrians claim, deciding, instead, to place them in a false light in order to make them seem as though they are united by one thing: hatred of humanity. He takes the following quote from Hayek as his example of Austrian cruelty:

…still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.The only way permanently to ‘mobilise’ all available resources is, thereforeto leave it to time to effect a permanent cure by the slow process of adapting the structure of production.

If one reads Hayek carefully, he is saying that when governments hold down interest rates to artificially low levels, they actually BLOCK the economic recovery, yet all Krugman can see is "persistent high unemployment." Krugman writes:

These days, relatively few economists are willing to say straight out that they regard persistent high unemployment as a good thing. But they find reasons to oppose any and all suggestions to use government policy — including monetary policy — to alleviate the slump. Same as it ever was.

Notice that Hayek has not said any such thing, but to Krugman, free markets and an economy not steered by government must by definition have "persistent high unemployment," although he does not explain why that would be so. (In fact, Krugman seems to believe that he really is above any such explanation, as his declaration alone should be regarded as ex cathera.)

In claiming that economists like Joseph Schumpeter and Hayek were champions of depression, Krugman (and his partner-in-crime Brad DeLong) violently misrepresent the Austrian viewpoint. The Austrians don't claim that the Great Depression was a "good thing," but rather the Great Depression occurred precisely because governments intervened in the economy to prop up malinvestments and to keep the necessary liquidations from occurring. Because of those policies, the economy got both liquidation AND high unemployment.

Unfortunately, Krugman and DeLong never see that simple point. In the Austrian view, we have EITHER liquidation of malivestments or long-term high unemployment, with any high amounts of unemployment coming from the liquidation process being temporary. Krugman and the Keynesians, on the other hand, believe that once the liquidation process begins, the economy never recovers. Ever.

As Robert Higgs writes about these "vulgar Keynesians":

With their great, simple faith in the efficacy of government spending as a macroeconomic balance wheel, vulgar Keynesians disregard malinvestment, past and future, and support government spending in excess of the government’s revenues, the difference being covered by borrowing. Of course, they favor central-bank actions to make such borrowing cheaper for the government. In fact, they chronically prefer “easy money” to more restrictive central-bank policies. As noted previously, they prefer easy money not only because it lowers the cost of financing the government’s deficit spending, but also because it induces individuals to borrow more money and spend it for consumption goods ― such increased consumption spending being viewed as always a good thing, notwithstanding the recent near-zero rate of saving by individuals in the United States. Reflecting on the vulgar Keynesian attitude toward Fed policy, I keep recalling a old country song whose refrain was: “older whiskey, faster horses, younger women, more money.”

Vulgar Keynesians do not spend much time worrying about potential inflation; on the contrary, they are obsessed with an irrational fear of even the slightest hint of deflation. If inflation should become an undeniable problem, we may count on them to support price controls, which, they are convinced on the basis of sketchy knowledge of such controls during World War II, can be made to work well.

I think that pretty much says it.

Austerity or Reckoning? We Cannot Print Our Way Out of the Crisis

While attending the 2001 ASSA meetings in New Orleans, I was jogging one morning and found myself in the company of a Yale economics professor who taught monetary economics. We had a discussion of approaches, and I explained that I went with the Austrian view, in which one teaches monetary theory from a marginal utility angle. In other words, money is a specialized good used specifically for exchange that is subject to the same laws of economics as any other good.

The Yale prof listened intently and sounded interested. Given that he taught monetary theory from a quantity view of money approach, my viewpoints were foreign to him, but he was not dismissive of what I was saying. Instead, he told me that he was interested and that he had not even thought of looking at money that way. Whether or not I planted a seed of interest, I read today from another Ivy League economics professor, Paul Krugman, that money is so "other worldly" that we really cannot apply economics at all.

Now,Krugman does not give a direct approach of monetary theory in his blog or columns, but it is there in default. Like all Keynesians, he believes that as long as an economy is not running at "capacity," and if interest rates (as set by government monetary authorities) are at or near zero (which Keynesians call a "liquidity trap"), then the only thing that can drive an economy to "full employment" of all resources is "fiscal policy," in which governments borrow and print money in order to push enough spending to those full-employment limits.

This viewpoint also holds that the key to a healthy economy is the rate of unemployment, not just of labor, but of all resources. For example, the "full-employment" of World War II is seen as an economic triumph because anyone who wanted to find work could get a job (provided he or she moved to the population centers where the factories and administrative offices were located). Farmers had huge markets for their crops, and people suddenly had money in their pockets. The fact that the government rationed goods, including food and fuel, is ignored, since people had jobs, and that was the only thing that mattered.

I don't believe that I am misrepresenting Krugman's views here, as they are pretty much standard modern-day Keynesian. The problem, however, as I noted in my post containing Robert Higgs' assessments of Keynesianism, is that this viewpoint has some very unreal assumptions, the most important being that all assets are homogeneous, so it does not matter what is being produced, be they bombs or bagels, as long as labor is being used. Furthermore, the assumptions also rest upon a pure quantity theory of money in which prices themselves are irrelevant, being subservient to a government-calculated "price level."

Another false assumption from this viewpoint is that consumer spending is nothing more than "buying back" the products they created as workers. There is no purposeful behavior here, just a circular motion of production and purchases. As long as consumers have jobs and income, they can continue this circular pattern and the economy will be operating at "full employment." Thus, World War II in this analysis would be a period of "good times."

Professor Higgs, however, takes down even the "war prosperity" myth in this paper. I think a reading of this will change one's viewpoint considerably about the views economists have about World War II.

Unfortunately, this is a very stilted and inaccurate way of looking at the economy, as there really is no plan or purpose on behalf of individuals. Instead, they simply produce, purchase, and consume in a rather mindless fashion, yet that is what Keynesians believe is a "thriving" economy. In Krugman's view, because we are in a "liquidity trap," the only thing that can rescue the economy is government borrowing and spending.

In today's post, Krugman gives what I would call his classic viewpoint of what I have described. Furthermore, in his theoretical world, any spending cutbacks will create needless disaster. After all, if assets are homogeneous, and governments can borrow and print just as long as the economy is operating "below capacity," then it is foolish to stop and engage in "austerity." He writes:

Some thoughts on the fiscal austerity mania now sweeping Europe: is anyone thinking seriously about how this affects the rest of the world, the US included?

We do have a framework for thinking about this issue: the Mundell-Fleming model. And according to that model (does anyone still learn this stuff?), fiscal contraction in one country under floating exchange rates is in fact contractionary for the world as a hole. The reason is that fiscal contraction leads to lower interest rates, which leads to currency depreciation, which improves the trade balance of the contracting country — partly offsetting the fiscal contraction, but also imposing a contraction on the rest of the world. (Rudi Dornbusch’s 1976 Brookings Paper went through all this.)

Now, the situation is complicated by the fact that monetary policy is up against the zero lower bound. Nonetheless, something much like this transmission mechanism seems to be happening right now, with the weakness of the euro turning eurozone fiscal contraction into a global problem.

Folks, this is getting ugly. And the US needs to be thinking about how to insulate itself from European masochism.

However, if assets are heterogeneous, and if money is a good subject to the laws of economics, and if the Europeans must be able to produce real goods in order to pay for their welfare states, then Krugman is uttering foolishness. For the past three years, governments have been boosting their spending to irresponsible levels (at Krugman's urging) and printing money like mad in order to try to "spend" their way back to prosperity, and we are seeing the results: unemployment is at double-digit levels and all of this spending has created zombie financial institutions that on paper are "solvent" but in reality are on the brink.

Furthermore, the wave of government debt creates real liabilities that reflects the perilous situation that exists today. Instead of creating "full employment," these policies have furthered the malinvestments that are at the heart of this downturn. Unfortunately, Krugman refuses to see this point, so he will continue to demand that governments create even more malinvestments, all in the name of "fighting the depression."

At the heart of this matter is the Keynesian myth that money is something extra-economic, and that printing more of it (provided the economy is at less than full employment) will put us back to work and create prosperity. Instead, the current policies of the U.S. and European governments are digging the hole deeper, and Krugman is claiming that the only thing that will work is for us to use bigger shovels.

The Pain Economist

In my Monday column, I looked at some of the work done by Robert Higgs, who takes on the "vulgar Keynesianism" head-on. Today, I look at the chief spokesmen for the "vulgar Keynesians," Paul Krugman, who excoriates modern policymakers for doing what he claims is "inflicting pain" through financial "austerity."

In his May 31 column, Krugman writes the following:

When the financial crisis first struck, most of the world’s policy makers responded appropriately, cutting interest rates and allowing deficits to rise. And by doing the right thing, by applying the lessons learned from the 1930s, they managed to limit the damage: It was terrible, but it wasn’t a second Great Depression.

Now, however, demands that governments switch from supporting their economies to punishing them have been proliferating in op-eds, speeches and reports from international organizations. Indeed, the idea that what depressed economies really need is even more suffering seems to be the new conventional wisdom, which John Kenneth Galbraith famously defined as “the ideas which are esteemed at any time for their acceptability.”

Given that Galbraith was a hardcore socialist, and one who was quick to praise the communist economies, I find it significant that Krugman quotes him, especially when one sees that Krugman has been calling for higher taxes and raising business costs as the means for securing a new "prosperity."

What are these terrible ideas that Galbraith would have criticized? Why, they are very (very) small measures of fiscal responsibility. Krugman declares that policymakers want to let interest rates rise and for governments to begin (and only begin) the process of living within their means. Such "responsible" behavior, Krugman argues, is irresponsible in outcomes:

The best summary I’ve seen of all this (changes of policy direction) comes from Martin Wolf of The Financial Times, who describes the new conventional wisdom as being that “giving the markets what we think they may want in future — even though they show little sign of insisting on it now — should be the ruling idea in policy.”

Put that way, it sounds crazy. And it is. Yet it’s a view that’s spreading. And it’s already having ugly consequences. Last week conservative members of the House, invoking the new deficit fears, scaled back a bill extending aid to the long-term unemployed — and the Senate left town without acting on even the inadequate measures that remained. As a result, many American families are about to lose unemployment benefits, health insurance, or both — and as these families are forced to slash spending, they will endanger the jobs of many more.

And that’s just the beginning. More and more, conventional wisdom says that the responsible thing is to make the unemployed suffer. And while the benefits from inflicting pain are an illusion, the pain itself will be all too real.

In Krugman's view, governments can stop all of the pain -- and bring back prosperity -- simply by printing and borrowing, and any attempt to bring this unsustainable action to a halt is interpreted as a deliberate infliction of "pain" upon vulnerable people. Now, if assets really were homogeneous, and if government borrowing had exactly the same results that business borrowing might have, that would be one thing.

However, assets are NOT homogeneous; they are heterogeneous and as Higgs noted in his articles, an economy is not a blob of homoegeneity: it is a complex organism of assets and production, and the failure to recognize this fact means that we are doomed to repeat the very failures of the 1930s.

Perhaps the greatest irony in the present economic morass is that economists and governments around the world are claiming that they are acting to "avoid the mistakes of the 1930s," yet governments actually are engaging in a repeat of that decade, and we know how it ended: in destruction, death, and war.

Robert Higgs versus Paul Krugman

Because Paul Krugman is the most visible spokesman for the Keynesian economic viewpoint (or, at least what Robert Higgs calls "vulgar Keynesianism"), I tend to deal with his statements from the New York Times, as it is convenient to do so, and Krugman clearly does a good job of stating his viewpoints from there. (I tend to avoid statements by James Galbraith, which are like Krugman's, although Galbraith does not do as well in squeezing the concepts into small spaces.)

One prominent economist who also understands the modern Keynesian orthodoxy is Higgs, who edits the Independent Review and who has been an eloquent voice against what Krugman and others promoting. Today, I examine a couple of articles that Higgs wrote in which he clearly lays out why it is that Krugman's orthodoxy is destructive.

In this article published on Lew Rockwell's page almost a year ago, Higgs goes to the heart of the differences between the Austrians and the Keynesians, writing:

The root problem, I believe, lies in the aggregative character of contemporary thinking about macroeconomic fluctuations. In this view, rising aggregate real output is good, no matter what the composition of the newly produced goods and services. A recession, which most analysts understand as a sustained decline of aggregate real output, is bad, and, in their view, it should be combated by fiscal "stimulus" and by expansionary monetary policy in order to reverse the decline in aggregate demand. They do not worry about – indeed, they rarely even pay much attention to – the makeup of the aggregate output that is added during business expansions, lost during business recessions, or brought into being by the government's compensating fiscal and monetary actions. Output is output; spending is spending. In fact, the whole idea of using government spending to offset reduced spending by investors or consumers turns on this assumption that a dollar spent is a dollar spent, regardless of what it is spent for.

However, that thinking, writes Higgs, is wrong because of its insistence upon the homogeneity of investment and output:

In today's vulgar Keynesian environment, investors and economists do not appreciate how the seeds of macroeconomic busts are sowed by artificially created credit that is employed to finance investments that would not be undertaken if they had to be financed by real savings – investments known in economic theory as malinvestments. When a large volume of malinvestments has been undertaken during a boom (e.g., much of the investment in residential housing and commercial real-estate development between 2002 and 2006), and when for whatever reason the pace of new credit creation slows, causing interest rates to rise, then the unsustainability of these malinvestments becomes increasingly apparent. More and more of them are terminated, often in unfinished condition, and many such projects go bankrupt for want of buyers willing and able to pay for them in the market. (Emphasis Higgs')

A "recovery" created by such means is no recovery at all, as Higgs explains:

If the government and the central bank use their fiscal and monetary policies to prop up these malinvestments, they do not solve the basic problem; they only paper it over for the time being. The vast assistance given recently to financial institutions embarrassed by investments in bad real-estate-related securities, for example, has allowed these institutions to delay the write-offs and other balance-sheet adjustments that would reflect the errors they have made. The bailouts have created a large number of zombie financial institutions, much like the ones that caused the Japanese economy to stagnate during the 1990s and later. Owners and managers of financial firms laden with rotten securities have been holding out for government rescues of various sorts, rather than carrying out the required restructuring, which in many cases must include bankruptcy proceedings.

Just as the malinvestments were made possible in the first place by effusions of artificially created credit and hence artificially depressed interest rates, so now the Treasury and the Fed are keeping the owners of these malinvestments afloat by further effusions of artificially created credit. But so long as these inherently unsustainable projects continue, they constitute a huge legion of the living dead. They may look viable, but their viability hinges entirely on de facto subsidies via the government's various bailout schemes. Such projects will remain unsustainable unless continually propped up at the expense of the general public, who will suffer because of increased ordinary taxes or a mounting inflation tax on their dollar-denominated assets. If the government goes forward in this fashion, it will be sustaining an economy rife with malinvestments kept in operation only by constant transfusions of other people's wealth channeled to the zombie projects by the Treasury and the Fed – a permanent policy of robbing prudent, responsible Peter to pay imprudent, irresponsible Paul. No sound, long-run economic development can be based on such productivity-sapping transfers of wealth into projects that are not worth the expense of keeping them going and which misallocate resources to the overall economy's detriment so long as they continue.

In this article, published in March, 2009, Higgs goes into more detail explaining why the aggregation of economic activity into the Y = C + I + G + (X-M) equation is just plain wrong and ultimately destructive. Writes Higgs:

This way of compressing diverse, economy-wide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy-bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children’s inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62 mm ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. Moreover, when we speak of “economic action,” we are referring to the choices that millions of diverse participants make in selecting one course of action and setting aside a possible alternative. Without choice, constrained by scarcity, no true economic action takes place. Thus, vulgar Keynesianism, which purports to be an economic model or at least a coherent framework of economic analysis, actually excludes the very possibility of genuine economic action, substituting for it a simple, mechanical conception, the intellectual equivalent of a baby toy.

Compare this to what Krugman claims: that all that is needed for the government to "create prosperity" is for the central banks to print money and the government to borrow and spend. Yet, the profession claims that Krugman is the better economist? Somehow, I doubt it.