Booms and "Trickle-Down" Spending

One of the real differences between Austrian Economics and what is taught in mainstream Neoclassical thought is the view of the individual. Austrians see individuals as acting with a purpose while many Neoclassicals see people as acting in a more mechanistic fashion. What comes out of this is the viewpoint by Neoclassicals that what might be good for individuals runs at cross purposes to what supposedly is "good" for society as a whole.

I don't mean violent or coercive behavior in which one steals from someone else and makes himself better off while making someone else simultaneously worse off. Instead, I am referring to peaceful, private, and mutually-agreed-upon economic exchange or decisions involving my person or my family, which is at the heart of Austrian thinking. Mises wrote that individuals will act in order to make themselves better off, and when that action comes about via mutually-beneficial exchange with others, the action can have positive social benefits.

For example, when I make an exchange at the grocery store, I am purchasing food that I believe will make me better off in the future, both relieving me of hunger and also providing healthy personal benefits. Likewise, the people within the store who are recipients of my money are able to use that to accomplish their own individual purposes. This is not "mindless" behavior, as many Marxist critics of capitalism like to claim; it is purposeful and not based upon coercion.

Now, I agree that this is pretty much Exchange 101 found in many economics texts, including the mainstream ones, but Austrians and the mainstream part ways when it comes to a broader social viewpoint. To put it another way, Austrians believe that individual freedom to trade one's possessions, be they accumulated wealth in the form of money or goods, or one's labor or talents will have positive social and economic effects across an economy, provided that individuals are free to do these things without coercion. It is the non-aggression principle at work.

Keynesians such as Krugman see things differently. What is good for an individual often is not good for the economy at large. In his recent column, Krugman writes:

...an economy is not like a household. A family can decide to spend less and try to earn more. But in the economy as a whole, spending and earning go together: my spending is your income; your spending is my income. If everyone tries to slash spending at the same time, incomes will fall — and unemployment will soar.

 This is something that intuitively sounds right, but is based upon a principle founded upon a belief that mutually-agreeable exchange and individual action that can be harmful economy-wide, and that if a lot of people decide, for example, to save more money, that is what creates unemployment. The Keynesian-Krugman point has been made on many occasions, and I don't believe I am being controversial when I state it.

At one level, if a lot of people suddenly decide to stop spending all of their income and decide to withhold some present income so that they may consume more later, that obviously will have certain effects upon some part of the economy, as there will be less demand for certain kinds of goods and services. That is obvious and non-controversial.

There is, however, a larger issue Krugman and Keynesians ignore, and that is why this change of behavior has occurred. In the Keynesian view, just as Malthus once held, this change is not a rational response to a set of changing economic conditions; instead, it is irrational, "animal spirits" behavior. It just happens. People just stop spending and start saving, and then the whole Fallacy of Composition kicks in and kicks down the economy.

 Austrians note that when booms run their course -- as they invariably do -- and that the current level of activity in certain sectors cannot be sustained through normal exchange, then people are going to adjust their behavior. Furthermore, Austrians are going to point out that booms over time (1) result in wasted or malinvested resources, (2) are financed via borrowed money that sooner or later must be paid back, and (3) create conditions in which there must be a "correction" within the economy as the booms run aground.

Moreover, Austrians also believe that if the government does not interfere with the creation and application of directing resources, then entrepreneurs will look for and find those lines of production that are compatible with current economic conditions. It is those lines of production, then, that will lead a recovery.

Even Krugman will admit that the Housing Bubble could not be sustained, although he is not going to claim resources were "malinvested" if for no other reason than to do so would hand Austrians an important intellectual victory, and that is not something Krugman can countenance. Still, what is a "bubble" if it is not malinvestment or based upon malinvestment? Krugman is not going to claim that the Housing Bubble was infinitely sustainable, and if a set of investments cannot be sustained when other normal market factors expose that fact, then we are dealing with malinvested resources, period, even if he refuses to cite the M-word.

However, we now come to the response to what should be done when the markets have exposed the malinvestments. (I note here that Krugman believes that unless government agents are all over those participating in peaceful, private exchange, markets will run blindly over a cliff, dragging everyone else with them. Yet, it was the markets that exposed the Housing Bubble just as the markets exposed Bernie Madeoff's fraud, not government regulators.)

Krugman's answer is for government to create yet more bubbles and create more malinvestments. Yes, we have the infamous Krugman quote from about a decade ago on the need for Alan Greenspan to create a housing bubble, but I am not talking about that. Instead, Krugman believes that governments should borrow and print and spend in order to fill a "hole" of spending, since money and exchange no longer will be directed toward the part of the economy that collapsed, i.e. housing in this case.

(For example, Krugman has strongly endorsed boondoggles like wind power and mass-subsidized electric cars, yet the fact that these entities continually need subsidies to stay alive speaks volumes for their economic sustainability. These are malinvestments pure and simple, yet Krugman and President Obama wish for us to believe that this economy can fashion an economy recovery from them.)

The Keynesians argue that if there are "unemployed or idle resources," then malinvestments are not possible, since the economy can absorb a lot more spending without overall prices rising. Such reasoning ignores the question of why those resources are "idle" in the first place. Krugman would claim that they are "idle" because people are not spending money, and so government must take the place of everyone else and spend in order to pump up the economy again, creating the "trickle-down" effects that supposedly would boost the economy.

Yet, these resources are idle because earlier investments in them could not be sustained. The markets are telling us something, but Keynesians ignore the obvious, instead demanding that these sectors receive extra injections of government spending.

In effect, Krugman and the Keynesians are claiming that the Law of Scarcity is suspended during severe economic downturns, but unless government starts borrowing and spending in huge amounts, then everyone else will be severely limited by scarcity. Likewise, households are bound by scarcity, but governments are not.

Lest anyone claim that I am misrepresenting Krugman, here he is in his own words:

So what can be done? A smaller financial shock, like the dot-com bust at the end of the 1990s, can be met by cutting interest rates. But the crisis of 2008 was far bigger, and even cutting rates all the way to zero wasn’t nearly enough.

At that point governments needed to step in, spending to support their economies while the private sector regained its balance. And to some extent that did happen: revenue dropped sharply in the slump, but spending actually rose as programs like unemployment insurance expanded and temporary economic stimulus went into effect. Budget deficits rose, but this was actually a good thing, probably the most important reason we didn’t have a full replay of the Great Depression.

But why should the the private sector "regain" its balance? If mutually-beneficial exchange over an economy has harmful effects, and if the natural tendency of a market economy is to implode as people increase their savings, then why should we expect any kind of recovery at all, and why should governments stop their massive spending?

If one sees individual spending as being mechanistic instead of purposeful, then the Keynesian viewpoint might make sense. An economy, in this view, is little more than a perpetual motion machine kept running by spending that moves in a circular flow, with resources being homogeneous.

There is one more point I believe that needs to be made. Krugman claims that our recovery is weaker than it should be because the federal government is not taxing, printing, and borrowing enough, and that if the government were to bolster its spending habits even more -- like preparing for the imaginary invasion of "space aliens" -- then all would be right with the world and we would see a wondrous recovery.

As I see it, we lack a real recovery for a number of reasons, including the government's insistence upon forcing resources from higher-valued to lower-valued uses. ("Green energy" investments are a case in point.) The federal government, and especially the Obama administration, demonstrate hostility toward entrepreneurs who are not connected to the political classes, and the Fed's slashing of interest rates to near-zero not only take away incentives for people to save, but also sends false price signals to the markets, making it harder for entrepreneurs to find truly profitable and sustainable lines of production.

Krugman believes that all that is necessary for recovery is for government to shower money upon politically-favored enterprises, with the spending having a huge "trickle-down" effect on the rest of us. Yes, if resources are purely homogeneous and if individuals do not act purposefully, then Krugman has a point, but if that is not the case, then he is demanding that the government continue the behavior that has put us in a depression in the first place.

Maybe the Stimulus-Bearing Space Aliens will have iPhones

I believe I owe Paul Krugman an apology, for I have written in the past that Keynesians do not have a theory of capital. I was wrong; Keynesians do have a capital theory: it is called More Spending.

Now, this is not a theory of capital like that developed by the Austrian School, beginning with Carl Menger. Instead, it is a theory that says that the construction and addition of capital to the economy is useful mainly in the amount of short-term spending that it brings. Thus, the actual performance of new capital takes a back seat to the fact that when business enterprises purchase the capital, they spend money, and it is that short-term spending that is significant.

For those who might argue differently, Krugman lays out his view in his column that claims the new iPhone will provide "stimulus" to the U.S. economy. True, it seems that others also have drunk the Kool-Aide, and others seem to be even more enthusiastic about this latest rendition of the "Broken Windows Fallacy" than even Krugman (although he does seem to buy into the concept):

A recent research note from JPMorgan argued that the new iPhone might add between a quarter- and a half-percentage point to G.D.P. growth in the last quarter of 2012. How so? First, the report argued that Apple was likely to sell a lot of phones in a short period of time. Second, it noted that although iPhones are manufactured overseas, most of the price you pay when you buy one is domestic value-added — retailing and wholesaling, advertising and profits — all of which counts as part of G.D.P. Finally, it took some plausible guesses about the price of each phone and the number of phones sold, and used those guesses to make an estimate of the impact on G.D.P.

It’s all pretty straightforward. But the implications are wider than most people realize.

The crucial thing to understand here is that these likely short-run benefits from the new phone have almost nothing to do with how good it is — with how much it improves the quality of buyers’ lives or their productivity. Such effects will kick in only over the longer run. Instead, the reason JPMorgan believes that the iPhone 5 will boost the economy right away is simply that it will induce people to spend more.

 Once again, we see the most important element of economic thinking go missing: opportunity cost. The money that people will spend for new iPhones is money that will not be directed in the purchase of other goods. We do not have new "spending" arising from nothing; what we will have is a redirection of how people spend their incomes.

Not surprisingly, Krugman does not end at that point. If you believe in the "iPhone stimulus," he crows, then you believe that more government spending will boost the economy. But, hey, why even stop there?

Why not go whole hog and hope that the invasion of the space aliens comes complete with the Little Green Men stopping at the Apple Stores and elsewhere to buy the iPhones before they set out to destroy the earth. However, if that is their plan, then we should not resist the invasion because doing so would invoke "weaponized Keynesianism," and Mitt Romney supports that, so it must be bad. (Actually, it is bad, but not because Mitt likes it. Yes, Paul, there is more to life than partisan political thinking.)

No, we should not resist because after the Little Green Men With iPhones destroy the earth, we then will have the Ultimate Keynesian Stimulus of rebuilding just about everything. As Krugman writes:

Yet depressions do end, eventually, even without government policies to get the economy out of this trap. Why? Long ago, John Maynard Keynes suggested that the answer was “use, decay, and obsolescence”: even in a depressed economy, at some point businesses will start replacing equipment, either because the stuff they have has worn out, or because much better stuff has come along; and, once they start doing that, the economy perks up. Sure enough, that’s what Apple is doing. It’s bringing on the obsolescence. Good.

The Little Green Men With iPhones could accelerate that process, all to the better. In fact, I will slightly change Krugman's next paragraph to demonstrate exactly what I mean:

But why suffer through years of depressed output and high unemployment while waiting for enough obsolescence to accumulate? Why not have the government Little Green Men With iPhones step in and spend more, say on education and infrastructure, to help the economy through its rough patch? Don’t say that the government Little Green Men With iPhones can’t add to total spending, or that government spending can’t create jobs. If you believe that the iPhone 5 can give the economy a lift, you’ve already conceded both that the total amount of spending in the economy isn’t a fixed number and that more spending is what we need. And there’s no reason this spending has to be private.

So, all it takes for us to experience new stimulus is for E.T. to phone home. If he does it with an iPhone, all the better.

Krugman's Great Illusion

Paul Krugman is in Spain this week, most likely telling the Spaniards what they want to hear: The European Central Bank can end the country's unemployment miseries painlessly by buying near-unlimited amounts of Spain's government bonds and then floating massive amounts of new euros around the world. Yes, for the umpteenth time, Krugman insists that if Europeans print money and spend it as though they are rich -- they can become rich!

Once upon a time, Krugman would have been classified as a "crank," someone who believes that wealth is cranked up on printing presses. Today, he is seen as a prophet, a "lonely voice" crying in the wilderness with the message that economic salvation is easy. Repent and be baptized in a flood of inflation, and all will be well.

He uses the analogy of Norman Angell's 1910 book, The Great Illusion, in which Angell claimed that because of the economic advances that had been made up to then, nations plundering nations via wars no longer seemed necessary:

Trade and industry, he pointed out, not the exploitation of subject peoples, were the keys to national wealth, so there was nothing to be gained from the vast costs of military conquest.

Moreover, he argued that mankind was beginning to appreciate this reality, that the “passions of patriotism” were rapidly declining. He didn’t actually say that there would be no more major wars, but he did give that impression. 

We all know what came next. 

Krugman then claims he knows the REAL lessons to be garnered in modern times. (No, it is not the lesson that wars are utterly destructive. After all, "Military Keynesianism" makes us rich, right?) It is that government hubris keeps governments from borrowing and spending as though they had the resources to do it:

The point is that the prospect of disaster, no matter how obvious, is no guarantee that nations will do what it takes to avoid that disaster. And this is especially true when pride and prejudice make leaders unwilling to see what should be obvious.

 And what is that "obvious" lesson?

It comes as something of a shock, even for those of us who have been following the story all along, to realize that more than two years have passed since European leaders committed themselves to their current economic strategy — a strategy based on the notion that fiscal austerity and “internal devaluation” (basically, wage cuts) would solve the problems of debtor nations. In all that time the strategy has produced no success stories; the best the defenders of orthodoxy can do is point to a couple of small Baltic nations that have seen partial recoveries from Depression-level slumps, but are still far poorer than they were before the crisis.

Meanwhile the euro’s crisis has metastasized, spreading from Greece to the far larger economies of Spain and Italy, and Europe as a whole is clearly sliding back into recession. Yet the policy prescriptions coming out of Berlin and Frankfurt have hardly changed at all.

One would think from that statement that European governments had massively cut back spending and allowed entrepreneurs to pursue profitable lines of production without the kind of government interference for which European governments have been famous. Think again.

No, the past four years have been characterized by governments expanding their regulatory and tax reaches, along with the massive implementations of "security" measures and other mechanisms of state power. The "austerity" programs also have brought huge tax increases and efforts by governments to stop the free flow of capital and trade. In other words, governments have used the financial crises to increase the power of governments.

To read Krugman over the past few years, one would think that the U.S. and European governments have embarked on a large-scale experiment in free markets, free trade, and measures to lesson the impact and burden of the Warfare-Welfare State, and have been the epitome of fiscal and monetary restraint. That hardly is the case.

What is needed? Once again, Dr. Krugman offers his advice to governments: pretend that you are rich and borrow and spend as though there is no tomorrow.

What would it really take to save Europe’s single currency? The answer, almost surely, would have to involve both large purchases of government bonds by the central bank, and a declared willingness by that central bank to accept a somewhat higher rate of inflation. Even with these policies, much of Europe would face the prospect of years of very high unemployment. But at least there would be a visible route to recovery.

Yes, another Krugman howler. We are supposed to believe that governments need to suck up the "courage" to borrow, print, tax, and spend on a level never seen before outside world wars. This brings the obvious question to mind: Since when did governments ever have to employ "courage" in order to do these things?

No, governments do them as a matter of course. The euro was supposed to impose a certain amount of fiscal discipline of the governments of the member states, just as the U.S. Dollar is supposed to have similar effects upon state governments. Yet, what have we seen over the last decade? I can tell you that "fiscal discipline" has not exactly been the watchword of the U.S. Government, the U.S. states, and European states.

Being that he is a good Keynesian, fiscal "discipline" is the last thing that Paul Krugman ever would want to see in government. Anyone who claims that the USA still is in depression because state governments are not spending enough money is not someone who has a handle on the reality of the current situation.

Governments -- and central banks -- do not create wealth on their own. They confiscate the wealth produced by individuals and then transfer it to others. Yes, I admit that roads and bridges can help create wealth, provided they are located in places other than the furthest reaches of "Nowhere," but the funding for those projects still must be garnered via confiscation of wealth created by others. 

(Keynesians can claim "social contract" or anything else, but taxes are a confiscation of wealth. One can argue whether or not they are "proper" confiscations, but nonetheless they are taken from people via threats. That is, unless one actually believes that the IRS never uses coercion and implied threats along with outright brutality to take money.)

I'm sure that Krugman's message will be well-received in Spain, and I am sure that he will not mention how Spain's very strict employment laws (it pretty much is impossible to fire workers, no matter how unproductive they might be) contribute mightily to that country's high-unemployment rate. Instead, he will claim that the only thing that is needed is for the other European states -- and especially Germany -- to understand that the economic version of "Hair of the Dog" is the True Pathway to Recovery.

To be sure, Krugman's scheme will not create new wealth, nor will it help economies move toward those structures of production that are sustainable. After all, Krugman is a graduate of MIT, a program made famous by Paul Samuelson and his belief that a doctrine of "Schmoo Capital" really would be appropriate for setting up working models to describe the economy.

What Krugman really is endorsing, however, is not creation of wealth or allowing entrepreneurs to move resources from lower-valued to higher-valued uses. No, what he is saying is that the Germans, the Dutch, and others in the European Union should be forced to transfer massive amounts of resources from their countries to Spain, which then will use those resources in a way that will frustrate the creation of new wealth, with the whole scheme masked by central bank borrowing and essentially the printing of money.

That this scheme actually will result in widespread prosperity is a huge illusion, but in desperate times, people especially buy into that kind of mental deception. However, it is Krugman who is delusional, for he really wants us to believe that the answer to our economic needs is for governments to spend recklessly, borrow, and print, something that governments have done as long as governments have been in existence.

Krugman wants us to believe that preparation for an imagined invasion of "space aliens" would bring back prosperity. One only can wonder if he can sell the Europeans on the same kind of scheme. Maybe there really is enough illusion to go around, after all.

The Aliens are Coming! We MUST Build High-Speed Rail!

We now know what it will take to end the current depression: A few lies from American scientists (taking a break from claiming the seas are going to rise 20 feet) to get us ready to prepare for the vaunted invasion of "space aliens" and...high-speed rail.

Yes, in that world known as Wonderland, boondoggles will make us rich!

Said The Great One on a recent appearance with his soulmate, Bill Maher:

This is hard to get people to do, much better, obviously, to build bridges and roads and healthcare clinics and schools. But my proposed, I actually have a serious proposal which is that we have to get a bunch of scientists to tell us that we're facing a threatened alien invasion, and in order to be prepared for that alien invasion we have to do things like build high-speed rail. And the, once we've recovered, we can say, “Look, there were no aliens.”

But look, I mean, whatever it takes because right now we need somebody to spend, and that somebody has to be the U.S. government.

Actually, this is Keynesianism in its purest form, for only in that world can one base a recovery on real-live boondoggles such as high-speed rail and claim to be speaking wisdom. No doubt, Maher was applauding every word.