It's Not the Euro, Paul

When I went to Baylor School in Chattanooga (when it was an all-boys' military school), one of our traditions was to have senior write-ups in the yearbook, along with a quote that would characterize the particular senior. (Perhaps my favorite quote was that given to Mike Aiken of our Class of 1971, which read, "Life is one damn thing after another." If you know Mike, you know that one is perfect.)

For another friend who was graduated several years before me, there was this: "The problem with the world is wine, women, and song. We must stop singing." Obviously, that line is meant to be humorous, but when someone actually tries to apply something similar to economic analysis, well, the joke ceases to be funny.

One of the reoccurring themes in Paul Krugman's blog posts has been his dissatisfaction with the results of European countries adopting the Euro as a single currency. In a recent post, he writes:

As readers may have guessed, I’ve been working on a euro-related project; more about that one of these days. But for now, I thought it might be worth explaining a bit more about how I see the political economy.

Some readers have chimed in that the euro is essentially a political rather than economic project. Well, it’s both; that has been the European strategy ever since the Schuman declaration. The point is to deliver a series of economic integration plans that do double duty: they’re economically productive, but they also create “de facto solidarity”, moving Europe closer to political union.

For 60 years, this strategy has been highly successful. Europe is one of the great, inspiring stories of the modern world, maybe of all time: peace, prosperity, and democracy flourishing where once there were minefields and barbed wire.

But: the strategy depends on each move toward economic integration being both a political symbol and a good economic idea. That was clearly true of coal and steel, the common market, the eurosausage, and so on. It is, however, by no means clear that the euro passes that test. Europe’s limited labor mobility (although there’s more than there used to be) and, crucially, lack of fiscal integration makes a common currency a dubious proposition at best.

In this and in other posts and columns in which he blames the Euro for much of the turmoil on the Continent, Krugman confuses cause with effect. As I have noted in other posts dealing with Krugman's Euro fetish, Krugman seems to believe that the "solution" for Europe is yet another round of inflation, a "hair of the dog" monetary and fiscal strategy.

At the center of this problem is the fact that the huge European welfare apparatus, along with the power of government employee unions such as those in Greece, Spain, and Frace, only can be supported if the economies of those nations produce enough wealth to enable governments to spread it around. Furthermore, the taxation and regulation policies of those nations must be such that it is possible for private firms to create enough wealth in the first place.

Unfortunately, one of the things that happens in economic downturns is that tax revenues fall and it becomes obvious that the lavish government benefits given to government employees cannot be supported by that country's economic activity. Now, as Krugman has noted, in the past, when each of these government controlled its own fiat currency, one "solution" was devaluation, which in reality is nothing more than a government's admission of trying to paper over its losses by engaging in a glorified printing of new money.

This, economically speaking, is not a solution at all. It simply masks the underlying problems and creates new problems in the process. Not only does this strategy continue the charade of "giving" people something that is illusory, but it also undermines an economic recovery.

However, when a country does not control its fiat currency, as is the case of the Euro, then the problems become much more front-and-center. Greece, for example, is in trouble because it no longer can afford to give government employees pay and benefits that they are not earning, and the Greek government employees have responded by going on a rampage of rioting, murder, and destruction of property.

The Euro is not the cause of this trouble; instead, it is the messenger, the entity that bears the bad tidings. What is Krugman's response? It is shoot the messenger. In Krugman's view, there is nothing wrong with runaway government benefits; in fact, he argues, such spending helps the economy by "stimulating" it.

While there often is much not to like about "austerity" moves, nonetheless for the most part they are little more than policies that reflect the economic reality of the present time. (My problem with "austerity" is that it often emphasizes the implementation of new taxes without cutting enough spending; I'm all for the reality of "pay as you go," but we have to understand that we cannot kill the Golden Goose in the process.)

Krugman really seems to believe that we can pretend we are creating wealth simply by borrowing, spending, and creating new money. Yet, these actions don't create wealth; they destroy it. Krugman may call such a statement the product of "zombie economics," but to claim that government spending by itself "creates wealth" is the real "zombie" position.

Krugman: "Save" the Euro by Creating Another Unsustainable Boom

In his latest column, Paul Krugman explains why he believes that the euro has been crashing, and in part, I agree. Europe, he says, is not like the United States which actually is a unified country which also has a federal government that spreads its own spending programs throughout those states. (This is not in praise of those programs, but rather an admission that there is more tying the USA together than what we see in the European Union.)

Furthermore, I agree with Krugman that the housing boom especially covered the underlying flaws of the EU and its currency. Krugman writes:

Why did the euro seem to work for its first eight or so years? Because the structure’s flaws were papered over by a boom in southern Europe. The creation of the euro convinced investors that it was safe to lend to countries like Greece and Spain that had previously been considered risky, so money poured into these countries — mainly, by the way, to finance private rather than public borrowing, with Greece the exception.

And for a while everyone was happy. In southern Europe, huge housing bubbles led to a surge in construction employment, even as manufacturing became increasingly uncompetitive. Meanwhile, the German economy, which had been languishing, perked up thanks to rapidly rising exports to those bubble economies in the south. The euro, it seemed, was working.

I even agree with Krugman's next statement:

Then the bubbles burst. The construction jobs vanished, and unemployment in the south soared; it’s now well above 20 percent in both Spain and Greece. At the same time, revenues plunged; for the most part, big budget deficits are a result, not a cause, of the crisis. Nonetheless, investors took flight, driving up borrowing costs. In an attempt to soothe the financial markets, the afflicted countries imposed harsh austerity measures that deepened their slumps. And the euro as a whole is looking dangerously shaky.

At that point, however, the agreement stops, as Krugman then decides that the best way to "fix" the crisis is essentially to engage in an economic version of "hair of the dog." He writes:

What could turn this dangerous situation around? The answer is fairly clear: policy makers would have to (a) do something to bring southern Europe’s borrowing costs down and (b) give Europe’s debtors the same kind of opportunity to export their way out of trouble that Germany received during the good years — that is, create a boom in Germany that mirrors the boom in southern Europe between 1999 and 2007. (And yes, that would mean a temporary rise in German inflation.) The trouble is that Europe’s policy makers seem reluctant to do (a) and completely unwilling to do (b).

I must admit that even though I have read Krugman for many years, something like this shocks me. The European and U.S. economies have been suffering in the aftermath of the collapse of the housing bubble, and the response of governments and central banks has been to try to recreate boom conditions somewhere else via easy credit and monetary expansion. We see how well that has worked.

So now Krugman claims that Europe and the euro will be saved if the EU Central Bank can do in Germany pretty much what it did in Greece, Ireland, Spain, and Portugal. And what happens when that boom/bubble in Germany collapses, as it inevitably would?

That's easy. Krugman will demand that the authorities create a bubble somewhere else. Maybe he wasn't joking in 2003 when he called for the creation of a housing bubble in the USA. And when the bubble crashes, then he can blame private enterprise.

Can we "save" the euro through inflation and outright financial fraud? Good luck!

It has come to this: all we need is a bit more time to sort out the financial mess that now engulfs Europe (and, by proxy, the United States). In the meantime, the Federal Reserve System, the European Central Bank, as well as four other banks, will resort to the usual "fixes" of inflation and the everlasting game of "Let's pretend that the worthless securities they purchase really are valuable."

The latest reprieve, for all its ballyhoo, is nothing but a stay of execution for the euro and (next) the dollar, but for the moment the central bankers -- and especially Ben Bernanke -- can share the spotlight and have the Usual Suspects praising them for their Great Wisdom and Foresight:

In Europe and the United States, where the announcement broke well ahead of stock market openings, the prospect of more cheap money to ease banks’ operations sent stock indexes soaring. A broad index of German stocks, the DAX, jumped almost 5 percent Wednesday, while the broad measure of American stocks, the Standard & Poor’s 500-stock index, climbed more than 4 percent. Short-term borrowing costs also declined modestly for some European governments and banks.

But policy makers and analysts were quick to caution that the Fed’s action did not address the fundamental financial problems threatening the survival of the European currency union. At best, they said, efforts by central banks to ease financial conditions could allow the 17 European Union countries that use the euro sufficient time to agree on a plan for its preservation.

In other words, the head has been temporarily moved from the chopping block, and that is cause for a party. Keep in mind, however, that the very people who celebrated in the stock and bond exchanges sooner or later will return with very different looks on their faces, as they realize that this lurching from crisis to crisis -- with the "solution" being more "liquidity" (read that, inflation) -- is unsustainable. The debt is unmanageable, period, and these economies are incapable at the present time of generating enough income to pay back these loans, especially given that the current set of "bailout" loans coming from the Fed and elsewhere are nothing more than loans to enable these countries to pay their current debt service.

Now, according to Paul Krugman, there really is a way out for the euro and the dollar. Yes, in response to the Greek crisis and others that follow in its wake, the European and U.S. government must follow policies that resemble...Greece. No, I'm not kidding.

Read for yourself:

I hope, for our sake as well as theirs, that the Europeans will change course before it’s too late. But, to be honest, I don’t believe they will. In fact, what’s much more likely is that we will follow them down the path to ruin.

For in America, as in Europe, the economy is being dragged down by troubled debtors — in our case, mainly homeowners. And here, too, we desperately need expansionary fiscal and monetary policies to support the economy as these debtors struggle back to financial health. Yet, as in Europe, public discourse is dominated by deficit scolds and inflation obsessives.

Yes, what is needed is inflation and more borrowing, the very things that put us in this untenable position in the first place. The U.S. economy is not producing enough to give the tax revenues needed for this burst of spending in the last four years, so borrowing and, essentially, monetizing U.S. debt are the only ways even to continue this spree.

There is another way out, one that is painful but at least will not have the long-term destructive effects of the kind of massive inflation that seems to be on the horizon: default. Yes, default.

First, a real default versus what Krugman is demanding -- default via inflation -- will not have the same distorting economic effects that inflation (and especially if it reaches double-digits...and beyond) would have, and second, a default would provide a much more realistic picture of what the situation really is, as opposed to what happens when inflation undercuts the price system. Yes, there will be a sharp downturn when this happens, but afterward, there will be the real prospect of an economic recovery, something that simply is not going to happen if this borrowing and printing madness continues.

When Krugman calls for "expansionary fiscal and monetary policies," he is not talking about policies that actually will expand the real economy. No, he is talking about more financial trickery, more central bank "pulling rabbits out of hats," more "stimulus" money given to politically-connected groups that are tied to the Obama administration, and so on.

Trickery and inflation won't save the euro. The irony as I see it is that the euro has a lot better chance of surviving if some honesty is permitted to enter the discussion. At the present time, unfortunately, the loudest voices are those that call for further debasement of the euro (and the dollar) and even more borrowing to cover the payments for the last set of loans. Neither option is sustainable, but for now, that is all the Keynesians seem to be offering.

Krugman's Cyprus Solution: Seize Property and Print Money

In answer to the "What would you do about Cyprus if you were dictator?" question, Paul Krugman has shared his Nobel-level of economic intelligence with the rest of us, and it comes down to two actions: the Cyprus government should seize as much private property as it can, go off the euro and print its own currency, lots of it. Krugman writes:

...Cyprus should leave the euro. Now.

The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.

He continues:

If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP.

What’s the path forward? Cyprus needs to have a tourist boom, plus a rapid growth of other exports — my guess would be agriculture as a driver, although I don’t know much about it. The obvious way to get there is through a large devaluation; yes, in the end this probably does come down to cheap deals that attract lots of British package tours.

Getting to the same point by cutting nominal wages would take much longer and inflict much more human and economic damage.

At one point he is correct in that the boom that Cyprus enjoyed by playing the role of bankster is over, kaput. (The biggest offender of banksterism, the government-owned bank Laiki, does seem to contradict Krugman's belief that government usually is a responsible entity and only private enterprise is reckless.) But the party is over, truly over, although Krugman seems to want us to believe that Cyprus can avoid consequences by engaging in yet more financial tricks and that a Cyprus with its own government-issued scrip will be just fine.

By the way, Krugman (as a true Keynesian) believes that no one will notice that by getting out of the euro and printing its own money (and converting the deposits in its banks into Cyprus-scrip) that Cyprus has gone bankrupt. In reality, everyone there still will be getting a major head-shaving. We are talking about a currency that would be as popular in world markets as the Zimbabwe dollar at the height of that country's hyperinflation. Imports would fall to near-zero, to be paid only by the euros and other currencies in the seized bank accounts.

In other words, we are not looking for a happy ending. On one side, Cyprus and its people could face the truth, take the up-front medicine, and then try to create a real economy producing things people actually might want to purchase. On the Krugman side, Cyprus goes on with its "let's pretend" game of slashing real wages through inflation and continuing the Big Lie that the only problem there is a currency problem.

My sense is that Krugman's easy solution might be less attractive than what he might predict. First, given the proclivity of the government there to seize the property of others, I doubt seriously that the government would offer a true market exchange rate when those hordes of British tourists invade Cyprus looking for the Good Deal. Instead, we will see the infamous Third World "dirty rates" that are notorious elsewhere.

Second, people who are the victims of outright theft -- and that is what Krugman has been advocating -- are not going to take their situations lightly. Tourists are not going to want to come to a place where mobs are pillaging and burning -- and robbing tourists. (Well, completing the robbery process that would start when the government cheated on the exchange rates.)

The best way to avoid a crisis is not to create one in the first place. Booms created through monetary tricks and inflation have a way of blowing up, and starting a second boom to replace the first is not as easy as Krugman thinks it is.

Robert Murphy notes that Krugman's "solution" is to "ignite a boom" in place of the boom that has crashed. Of course, Krugman does not come clean and tell us what will happen when that boom inevitably crashes. No doubt, his "solution" is to create yet another boom, but in reality, financial trickery has a way of being exposed and at some point, not only is the party over, but people who have been fed a diet of inflation become so addicted to it that they cannot and will not do what is necessary to fix their economies.

In the end, Keynesianism is not about long-term solutions. It is about monetary manipulation in hopes that something -- Anything! -- can hide the fact that inflation is destroying the economic fundamentals. But to the homogeneous-factors Keynesians, there are no fundamentals, just the printing press and government, lots of government. Krugman's Inflation Fairy turns out to be a wicked witch after all.

Krugman: A Central Government Solves All Economic Problems. Yeah, Right

I am thankful for Paul Krugman, if for no other reason he has helped me keep my thinking diversified even as the Tonya Craft sham of a trial goes on and takes most of my attention. As the "Greek tragedy" unfolds and Krugman makes his commentaries, once again we see the difference between the Keynesian approaches and the Austrian ones.

Today (Friday, May 7), Krugman once again gives the standard Keynesian theme: A central government can save the day because it can print money. If you think I jest, read on:

The problem, as obvious in prospect as it is now, is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.

Now, how would a strong central government be able to rescue Greece from its current crisis? Krugman explains:

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation (emphasis mine); this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third, Berlin could become to Athens what Washington is to Sacramento — that is, fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

So, the idea would be for all of Europe to have more inflation via action from the central bank, and thus all of the Europeans could damage their economies simultaneously, creating new crises that Krugman conveniently fails to mention. (Inflation has a way of doing that.)

But, Krugman is not finished, as he also lays out another scenario: Greece leaves the Euro and goes back to the Drachma. In his own words:

What remains seems unthinkable: Greece leaving the euro. But when you’ve ruled out everything else, that’s what’s left.

If it happens, it will play something like Argentina in 2001, which had a supposedly permanent, unbreakable peg to the dollar. Ending that peg was considered unthinkable for the same reasons leaving the euro seems impossible: even suggesting the possibility would risk crippling bank runs. But the bank runs happened anyway, and the Argentine government imposed emergency restrictions on withdrawals. This left the door open for devaluation, and Argentina eventually walked through that door.

If something like that happens in Greece, it will send shock waves through Europe, possibly triggering crises in other countries. But unless European leaders are able and willing to act far more boldly than anything we’ve seen so far, that’s where this is heading.

Here is the problem that Krugman forgets: if Greece leaves the Euro, its currency will be considered "soft" on the world markets, like the currencies of Third World nations or of the old communist bloc. Combined with the big increase in inflation as Greece tries to print its way out of the crisis will be the fact that the Greeks will find the costs of imported goods skyrocketing, and they will be reduced quickly to poverty.

Krugman does not understand that deflation and recession would be the BEST things to happen to Greece, as while there might be default, the Greeks once again would be able to get their fiscal house in order. Yes, there would be a quick drop in their standard of living, but they not only would get past that quickly as the economy recovers, but they also would have a brighter future.

The Krugman "solution," however, only extends the problem into the healthier economies of Europe and with inflation, the "good" effects come first, and the "bad" effects are felt later. With deflation, it is the other way around. The Greeks will have troubles up front, but things will get better.

What Krugman does not understand is that the inflation "solution" only will distort the Greek economy even more without solving ANY of the underlying problems. Look, the Greeks are headed for very rough times no matter what they do. However, it would make sense for them at least to be able be doing something that would give them a decent economic future.

Instead, Krugman insists that printing money will solve all problems. I don't think so.

Will inflation save the European economy?

In his latest column, Paul Krugman believes that he has the answer to saving the European economy from disaster. The solution? In a word, inflation. Yes, if the European Central Bank will show the "courage" to print more money, everything will be fine.

I admit that at one level, Krugman is correct when he writes:

So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.

More specifically, the creation of the euro fostered a false sense of security among private investors, unleashing huge, unsustainable flows of capital into nations all around Europe’s periphery. As a consequence of these inflows, costs and prices rose, manufacturing became uncompetitive, and nations that had roughly balanced trade in 1999 began running large trade deficits instead. Then the music stopped.

Note that Krugman does not think that countries like Greece have been irresponsible, or at least he indicates such in this column. Instead, he seems to believe that another round of inflation would pretty much solve everything.

Krugman is correct when he says that the single currency of the euro did impose some requirements, although like a typical Keynesian, he believes that any fiscal discipline really is a bad thing, given that all wealth creation begins with government spending. When Europe went to the euro, it meant that when governments like that of Greece borrowed from European banks, they would have to generate the revenues via taxation to pay back the loans.

Obviously, that would restrict the Greek government's behavior, given that it could not print euros, and borrowing would have to be done at a sustainable rate. Unfortunately, given the fact that Greece, like many other small European countries, has a bloated public sector that is controlled by militant labor unions, it was inevitable that the Greeks sooner or later would borrow well beyond any threshold to pay back the loans, given that fiscal discipline does not exist with the Greek government.

Unfortunately, Krugman believes that fiscal discipline is bad, bad, bad, and that inflation is a much better "solution" to any problem that the Law of Opportunity Cost might pose when governments spend themselves into a corner. (Don't forget that in his book, The Return of Depression Economics, Krugman declares that literally printing money creates a "free lunch" -- his words.) He writes:

If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation. Their debt crises are mainly a byproduct of this sad prospect, because depressed economies lead to budget deficits and deflation magnifies the burden of debt.

That might be true, although Krugman forgets that if Greece still were on the drachma, then the banks might have been more reluctant to lend to that government -- although the prospect of being backstopped by the European Central Bank might have been enough to encourage the banks to lend even when they figured being paid back in euros was a stretch. Even so, if the loans had been in euros and Greece were on the drachma, then Greece still would have had the same issues, given that the banks would not have been willing to accept drachmas in repayment.

By being on the euro and with the liberal lending policies by banks, the Greeks were getting a free ride, and they knew it and believed that they were entitled to it. This is something Krugman never addresses because (1) the inevitable outcome would fall into the Opportunity Cost category, and all good Keynesians know that printing money trumps laws of economics, and (2) government spending CREATES wealth and the more government spends, the better off we are.

Likewise, when Krugman has called for the U.S. Government to borrow money and then give it to state governments, he claims that such actions would "stimulate" the economy and foster economic recovery. When California's government employee unions take an ever-growing bite of the Golden State's revenues and overall economy, Krugman refuses to see this situation as the unions plundering everyone else. Instead, he seems to believe that the unions are the responsible actors, and anyone who thinks otherwise is evil.

Keynesian theory literally turns economics on its head. Spending and printing money create wealth; wealth creation through saving, capital formation, and judicious choices by consumers and investors creates depressions and should be stopped by government, which should use force, if necessary, to keep people from acting responsibly.

Krugman on Flexible Labor Markets

In a recent blog post, Paul Krugman makes what I believe to be an insightful comment on the flexibility of labor markets, and there is no reason to disagree with him as far as the statement goes. The disagreement, of course, is about what to do regarding this situation.

He writes:

Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro. With a unified currency, adjustment to differential shocks requires adjustments in relative wages — and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Let me repeat that:

WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY.

For many years, government employee unions in countries like Greece and Spain have been able to extract attractive pay packages and because the employees were being paid in euros, they found themselves enjoying a very high standard of living. However, this is not because they were earning such a standard, but rather because they had the political power to extract such standards from other people who were poorer -- and who had to do real productive work.

Unfortunately, Krugman, as a True-Believing Keynesian, does not see this relationship at work. Instead, he relies on the Keynesian belief -- based upon what I believe are accurate empirical observations -- that labor markets are less-flexible than markets for commodities. He notes:

How hard will it be to achieve this? Look at Latvia, which has pursued incredibly draconian austerity. Unemployment has risen from 6 percent before the crisis to 22.3 percent now — and wages are, indeed, falling. But even in Latvia labor costs have fallen only 5.4 percent from their peak; so it will take years of suffering to restore competitiveness.

The official answer is that this just shows the need for more flexible labor markets. But this was a subject we all batted back and forth in the initial debate about the euro, circa 1990: nobody has labor markets that flexible. If the euro isn’t workable without highly flexible nominal wages, well, it isn’t workable. (Emphasis his)

Thus, the Keynesian "solution" to this problem: inflation. In The General Theory, Keynes recognized the problem of labor costs being out-of-kilter and the difficulty in bringing them back into line, with the result being that labor would be priced out of the market and would result in high rates of unemployment.

I don't think anyone disagrees with that point, for it is pure classical economic theory at work. However, Keynes' "solution" was for government to give workers a wage cut through inflation, and he wrote that since he believed that workers only were concerned about their nominal (not real) wages, this "trick" would work time and again.

Indeed, since Krugman says that letting wages adjust by falling is not "workable," then he has the solution: inflation. Where Keynesians and Austrians differ, however, is that Keynesians see labor and factor markets as being somewhat homogeneous, while Austrians recognize that there are imbalances in these markets that are made worse by inflation. In the Austrian view, inflation is not a "solution" at all; it only exacerbates the problem, creating more malinvestments and leading to future crises.

Krugman: "Save" the euro by inflating it to death

Like most Keynesians, in the end, Paul Krugman is a one-trick pony who always recommends inflation as the answer to economic problems. (After all, he DID say in The Return of Depression Economics that inflation could provide a "free lunch" during economic downturns. In other words, the printing press negates the Law of Opportunity Cost.)

So, I see that Krugman now is giving the "Vietnam Strategy" to the Europeans: in order to "save" the euro, you must destroy it -- via inflation. Furthermore, we are supposed to think that had the German government in 1930 embarked on a policy of inflation, that it would have "saved" the country. Somehow, I doubt it.

How should the Europeans do it? Krugman already has set out a strategy that marks the way in which the European Central Bank would purchase the short-term debt of countries like Ireland, Portugal, Spain and Greece and hope that in the future, these countries will get their fiscal house in order. (Even Krugman knows that Greece cannot and won't do it, given Greek policies and its bloated government sector. Nonetheless, he believes that maybe the European Central Bank can inflate Greece's problems away, too.)

However, Krugman does not even contemplate any realistic outcomes of his strategy. If the ECB simply acts as the Big Sugar Daddy for countries by purchasing government bonds wily-nily, what is to keep everyone else from joining the Free Lunch? Sure, the European Parliament can enact policies that supposedly will limit this foolishness, but it is doubtful that once the shower of goodies starts, that anyone will hold to fiscal discipline.

In the end, this is a strategy that would inflate the euro out of existence. Now, that might be "good" for the dollar, given that investors around the world holding money are looking for safe havens. But the dollar sucks, too, thanks to the money-pumping strategy of the Obama administration.

So, in the end we are left with blizzards of paper money. But never fear, says Krugman. After all, everyone from Princeton and Washington knows that paper is more valuable than gold because paper is managed by Really Smart People Who Know More Than Everyone Else.

The Inflation Prisoner

About 30 years ago, I read a book by Irwin Schiff (yes, THAT Irwin Schiff) called The Biggest Con in which he exposed Keynesian economics and declaring that the only "arrow in the quiver" of Keynesianism was inflation. As I read Paul Krugman's column today on Spain and its problems, I can see that if Krugman is the most public spokesman today for Keynesian thinking, then Schiff was correct. Let me begin.

In The General Theory, John Maynard Keynes argues that the standard supply-demand wage theory holds only if there is full employment of labor. However, if there is widespread unemployment, the way to get labor back to full-employment levels is to sneak in a general wage cut via inflation. Keynes writes:

...it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, inasmuch as they resist reductions of money-wages, which are seldom or never of an all-round character, even though the existing real equivalent of these wages exceeds the marginal disutility of the existing employment; whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment. Every trade union will put up some resistance to a cut in money-wages, however small. But since no trade union would dream of striking on every occasion of a rise in the cost of living, they do not raise the obstacle to any increase in aggregate employment which is attributed to them by the classical school. (Emphasis mine)

I believe that the concepts shown in this paragraph really are at the heart of Krugman's column today in which he says that Spain easily could get out of its present situation if it had its own currency and could engage in a devaluation which, in his view, would establish something close to full employment and boost Spanish exports. He writes:

Now what? If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.

And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems.

What all this means for Spain is very poor economic prospects over the next few years. America’s recovery has been disappointing, especially in terms of jobs — but at least we’ve seen some growth, with real G.D.P. more or less back to its pre-crisis peak, and we can reasonably expect future growth to help bring our deficit under control. Spain, on the other hand, hasn’t recovered at all. And the lack of recovery translates into fears about Spain’s fiscal future.

Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”

The concept is strikingly similar to what Keynes wrote, although Krugman also exposes his own biases of aggregation in this column. After all, what happens when a government devaluates the currency? There is a cut in real wages, and while the goods denominated in that currency become cheaper relative to goods made elsewhere, nonetheless people at home do suffer a fall in their standard of living.

Like Keynes, Krugman argues that what he calls an "internal devaluation" is bad because real wages are cut and people can see firsthand that they are making less, and in countries like Spain that are dominated by labor unions, that spells trouble. However, an inflation-led "wage cut" tends to be less visible or less clear, even if the same thing, relatively speaking, is accomplished.

However, all of this assumes that the effects of inflation are exactly the same as a cut in wages and government spending. (Actually, Krugman believes that inflation is superior because, in his view, people spend more in the short term, which he claims gives an economy "traction," enabling it to move forward on its own.) According to Krugman, or at least what I ascertain through his columns, inflation does not distort the structures of production nor cause any internal dislocations.

This last point is important, because one can have such a view ONLY if factors of production are homogeneous. However, if there are malinvestments that come about through inflation, and these malinvestments over time become unsustainable, then there is a problem.

In a nutshell, that is a huge difference between Austrians and Keynesians. While the devaluation of which Krugman speaks might have some "good effects" at first, nonetheless, this "solution" only exacerbates the long-term problem. For example, within an economy, the wages that tend to be out-of-kilter with the rest of the economy often are centered in unionized industries, and when inflation hits, those sectors tend to be able to force employers (and the government, since these countries have powerful public sector unions) to give raises that better keep up with inflation than workers who either are not unionized or have weak or non-existent political connections.

Thus, the internal distortions are likely to grow. In countries like Spain, Greece, and Portugal, the very sectors that are bloated and are gobbling up resources are the government sectors. A bout of inflation in the long run then would further empower those very employment groups that are most responsible for the current trouble.

To a Keynesian like Krugman, none of this matters, as all sectors are homogeneous and there is no such thing as economic distortion. The only thing that matters are aggregate numbers, as economics to him is nothing more than charts, numbers, and aggregations. To "cure" an economy, give it a bout of inflation, and when the inevitable problem arise, deal with them via another bout of inflation.

When things deteriorate -- as they surely will -- then one blames the "greedy" corporations which, in the view of someone like Krugman, need to be reined in by activist government. All that is needed is to find the "Goldstein," demonize, rage on, and then inflate some more. In the end, THAT is the "Krugman solution."

My Big, Fat Greek Disaster

The old saying, "Beware of Greeks bearing gifts," might now be changed to, "Beware of Greeks bearing debt." Indeed, after yesterday's murderous riots, people also need to beware of Greeks bearing Molotov Cocktails, as Greek government employees, after living high on financial bubbles, do not believe they should have to face financial reality.

In a blog post, Paul Krugman acknowledges that the "Greek end game" is going to be disastrous no matter what, as no one there is willing to face the truth: Greece was living in a bubble economy, and when the bubble bursts, there is nowhere to hide. Unfortunately, as a true Keynesian, Krugman believes that the Very Worst Thing that can happen Greece is deflation.

But even Krugman admits that the Greeks need to get their economy into some kind of balance, and that is amazing, given that Keynesians believe that all factors of production, for purpose of economic analysis, are homogeneous, and the way to get costs of factors (especially labor) and prices of goods into "balance" is through inflation. Yet, even that bit of wisdom is tempered with Keynesian foolishness. He writes:

The only thing that could reduce that need for austerity would be something that helped the economy expand, or at least not contract as much. This would reduce the economic pain; it would also increase revenues, reducing the needed amount of fiscal austerity.

But the only route to economic expansion is higher exports — which can only be achieved if Greek costs and prices fall sharply relative to the rest of Europe.

He admits, however, that Greece is not a cohesive society, so the most likely scenario is for Greece to "leave the Euro" and go to printing Drachmas again. That, Krugman admits, will be disastrous, triggering bank runs and worse.

Yet, Krugman does not realize that the problem of leaving the Euro would create even more problems for Greece than bank runs. Should Greece leave the Euro and go back to the Drachma, the currency markets will treat the Drachma as "soft money" and give it the same status as money from Zimbabwe, which does not trade on any currency markets.

To put it another way, Greece will become essentially a Third World country. How did this happen? It happened because central banks around the world engaged in Keynesian "expansion" by creating Dollars, Euros, you name it. Keynesians believe that such action can go on forever without creating any consequences. As you can see, that simply is not true.

Greece is living the consequences. They either can get their house in order and suffer the short-term consequences, or they can go on living in the inflationist fantasy that is Keynesian "economics."

Yes, Yes, Inflation Solves All Economic Problems

If inflation really could save the world, then we would be looking to Zimbabwe as our savior, given that its government over the past few years has been producing some memorable moments in the history of crankdom. Alas, inflation is a scourge, not an economic solution.

Unfortunately, Paul Krugman does not seem to get it. In his latest column, "Making of a Euromess," he blames the economic crisis in Spain on...the Euro. Now, I am no more fond of the Euro than I am of the 1923 German Mark, but Krugman's reasoning is something to behold. In his own words:

And there’s not much that Spain’s government can do to make things better. The nation’s core economic problem is that costs and prices have gotten out of line with those in the rest of Europe. If Spain still had its old currency, the peseta, it could remedy that problem quickly through devaluation — by, say, reducing the value of a peseta by 20 percent against other European currencies. But Spain no longer has its own money, which means that it can regain competitiveness only through a slow, grinding process of deflation.

Notice that he is saying that Spain really is in trouble because it cannot engage in inflation, since it does not control the Euro, unlike its former fiat currency, the peseta. However, devaluation really does nothing but put off the Day of Reckoning for a while, but that day will arrive.

On the other hand, perhaps the best thing that Spain needs is the "grinding process of deflation," as that simply means that the prices paid for overvalued Spanish factors of production (and especially labor) are going to have to fall into line with economic reality. Most people, and especially the heavily-unionized Spanish workforce, don't want to hear that "option," as they would like to continue the charade that economic recovery is not going to require some short-term painful medicine.

However, if the Spanish were willing to take the medicine, they would be hurting now, but their economy would recover and become a beacon in Europe. Inflation, while delivering the "good effects" in the short-run, runs the economy off the rails as bout after bout of money devaluation takes its toll.

Not surprisingly, Krugman advocates inflation and denounces deflation. Yet, the only hope for Spain is deflation. The European Union is not going to bail out Spain, and that is a good thing. No, Spain needs to get its house in order. Likewise, on this side of the Pond, perhaps the USA needs to get its own house in order and stop preaching the Gospel of Inflation.

Spain, Unemployment, and Recession

One of the great weaknesses of Keynesian analysis is its lack of any coherent theory of causality. John Maynard Keynes laid the "problem" of volatile investment spending (which he claimed was the cause of sudden downward shifts in "aggregate demand") to the "animal spirits" of investors.

Now, I hate to break it to people, but the manifestation of "animal spirits" within the investment community does not count as a causal mechanism in the turn of the business cycle. It is mere gibberish.

In his recent blog post on the rising unemployment and recession in Spain, while Krugman does not resort to "animal spirits," nonetheless he gives no sense of causality as to why there is high unemployment in that country. He writes:

...Spain’s troubles are not, despite what you may have read, the result of fiscal irresponsibility. Instead, they reflect “asymmetric shocks” within the eurozone, which were always known to be a problem, but have turned out to be an even worse problem than the euroskeptics feared.

After explaining how the real estate bubble also hit Spain (not surprisingly, contributing to the boom there), he then says:

But then the bubble burst, leaving Spain with much reduced domestic demand — and highly uncompetitive within the euro area thanks to the rise in its prices and labor costs. If Spain had had its own currency, that currency might have appreciated during the real estate boom, then depreciated when the boom was over. Since it didn’t and doesn’t, however, Spain now seems doomed to suffer years of grinding deflation and high unemployment.

Here is the problem: Spain's troubles ultimately are not due to the Euro or its lack of a currency it can manipulate (as though currency manipulation is an economic solution at all). The troubles are due to the fact that the government there is hostile to productive people. Spain's policies of forcing up wages and having draconian anti-employer labor laws are the major reason that Spain is not well-positioned for a recovery.

While I don't think that so-called economic freedom indices are perfect, nonetheless I think this recent rating by the Heritage Foundation has some merit. Notice, especially, the very low rating on "labor freedom" in which Spain falls into the "repressed" category. Guess what? In a downturn, strict and inflexible labor policies are going to translate into mass unemployment. Look for Spain to have numbers well above 20 percent in the coming months and years.

Unfortunately, you will not see Krugman deal with that central issue. Instead, he will call for general debasement of the Euro as a "solution" when inflation is no solution at all.

Paul Krugman: We Need Inflation, and Lots of It

As I have said before, I appreciate Paul Krugman's openness in explaining his Keynesian views. True, he gives a few platitudes toward fiscal responsibility, but basically he recommends that government spend lots and lots of borrowed and printed money, and by doing so, will bring about economic recovery and prosperity.

The problem is not Krugman's saying such things; it's a semi-free country, after all. No, the problem is that when government follows these recommendations, disaster follows, even while Krugman and others are denying it or blaming the free market and sound money for economic evils. In today's column, he gives us more of the same.

As everyone knows, the government of Greece is in deep trouble. It overspent, went into deep debt, and now cannot pay back the debts. Even Krugman recognizes that fact, but then (as usual) draws the false conclusion that the way to deal with financial irresponsibility is, well, to be even more irresponsible:

Yes, Greece is paying the price for past fiscal irresponsibility. Yet that’s by no means the whole story. The Greek tragedy also illustrates the extreme danger posed by a deflationary monetary policy. And that’s a lesson one hopes American policy makers will take to heart.

Now, to say that any country now has a "deflationary monetary policy" is to be hallucinating. No one, I repeat, no one is engaging in deflation. Would be that were the case.

Here is Krugman in his own words about the crisis:

The key thing to understand about Greece’s predicament is that it’s not just a matter of excessive debt. Greece’s public debt, at 113 percent of G.D.P., is indeed high, but other countries have dealt with similar levels of debt without crisis. For example, in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed. And debt as a percentage of G.D.P. continued to fall in the decades that followed, hitting a low of 33 percent in 1981.

So how did the U.S. government manage to pay off its wartime debt? Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation, with both real G.D.P. and the overall level of prices rising about 40 percent from 1946 to 1956.

Unfortunately, Greece can’t expect a similar performance. Why? Because of the euro.

Until recently, being a member of the euro zone seemed like a good thing for Greece, bringing with it cheap loans and large inflows of capital. But those capital inflows also led to inflation — and when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies. Over time, Greek prices will have to come back down. And that means that unlike postwar America, which inflated away part of its debt, Greece will see its debt burden worsened by deflation.

Once again, Krugman gets it wrong. The USA followed pro-growth policies after World War II, unlike Greece (you know, where people actually are allowed to produce real goods without the government trying to put them out of business). However, Krugman, while admitting that Greece is not going to be so fortunate, then blames the semblance of sound money.

Like most Keynesians, Krugman believes a boom can last forever, just as long as government provides lots and lots of money, even if it leads to, well, double-digit (and worse) inflation. According to Krugman, the worst thing that can happen is deflation, and the real lesson here is that we need to debase the currency even more. Read on:

But what are the lessons for America? Of course, we should be fiscally responsible. What that means, however, is taking on the big long-term issues, above all health costs — not grandstanding and penny-pinching over short-term spending to help a distressed economy.

Equally important, however, we need to steer clear of deflation, or even excessively low inflation (Emphasis mine).

While Krugman does not define "excessively low inflation," nonetheless his point is clear. We need lots and lots of inflation, and anything else will be a disaster.

This is foolish advice, and it does not surprise me to read such nonsense from a Keynesian. After all, Keynesians believe that money is nothing more than a quantity variable that is to be manipulated to make aggregate models "work better." Is there unemployment? No problem; just add inflation, which will increase "aggregate demand" (because the demand for money falls as it loses value and velocity increases) and result in "full employment."

You see, to a Keynesian, this trick can be repeated time and again, as there are no real consequences from higher inflation except that prices go up. However, as Austrians point out, when inflation continues, malinvestments distort the structure of production, changing relative values of assets and ultimately leading to a crisis.

For example, contra Krugman, the housing boom could not continue because ultimately the factor prices in housing relative to everything else became too distorted to continue the charade. When the whole market depends upon being able to cram family incomes of $50K into paying a mortgage for a $500K house, the system cannot be sustained no matter how much new money government throws into the mix. Even Krugman recognizes that the housing market went bad, but then he reasons that it came about because of a lack of regulation, not because government was holding down interest rates and trying to direct that new money into housing. As I wrote in this post, such notions make no sense at all.

As I have stated many times before, the central problem is that Krugman and the Keynesians work from models in which all capital and all other assets are homogeneous. There can be no distortions in the structure of production, which always responds negatively to deflation and positively to inflation. This is a methodology that appeals to politicians and the modern, mainstream media, but it is not economics; it is Harry Potter Science.

Furthermore, we need deflation. That's right, far from avoiding it, we need to experience it. Yes, the initial results will be very painful (as though we are not experiencing pain now), but soon enough the factors of production will become balanced again, relative prices will make sense, and then the economy can find new lines of production that actually can be sustained.

However, because the initial stages of deflation are painful, Krugman says me must avoid it at all costs, even to the cost of destroying our money via inflation. Now, Krugman also believes that deflation will lead to a permanent downward spiral in which the economy ultimately becomes stuck at low production and high unemployment.

That is not true, not by a long shot. If Krugman were right, then the economy never would have recovered in 1982, when President Ronald Reagan and Fed Chairman Paul Volcker (who is the real hero here) permitted interest rates to rise, yet we had a real recovery in 1983 and beyond. While Krugman tries to claim that the recovery came about because of Keynesian-inspired deficit spending, the real results of that recovery contradict his story.

Had it been a "Keynesian recovery" (which in Austrian terms is an oxymoron), we would have seen growth in the usual sectors of manufacturing instead of seeing the growth centered on high-technology and telecommunications. Furthermore, Keynesians hold that one cannot have a recovery and have high interest rates, yet that is exactly what happened in the mid-1980s.

I agree with Krugman that the fact that Greece is on the Euro means that the government cannot inflate its way out of this mess -- and create a bigger mess. Yes, that means some real pain in the short run, but, contrary to what Krugman is claiming, in the long run it actually presents the Greeks with the opportunity to get things right.

Yes, there is a lesson from the fall of Greece. It is this: get your house in order and keep it in order. Don't keep printing money and claiming you are "saving the economy." Inflation is like heroin. It might feel good at the beginning stages, but in the end it destroys everything.

Krugman and the "Magic" of Inflation

I remember reading a book 30 years ago in which the author said that in the end, Keynesians have one arrow and only one in their quiver: inflation. While they might deny that to be true (Hey! We have FISCAL policy!! We borrow a lot of money that is created by the Fed!)

But Paul Krugman certainly seems anxious to prove the author's point, as once again he calls for the "solution" of printing money as salvation for Europe. For that matter, he has long advocated the same "salvation" for this country, continuing that fallacy that our economy is exactly like the so-called babysitting co-op in Washington.

Today's column is pretty typical of Krugman. While I agree that the bank-imposed "austerity" measures put on the regimes of Greece and Spain are not helpful to economic growth, my differences with Krugman are substantial. To Krugman, the entire thing is spending; the more a government spends, the richer everyone becomes, end of discussion. And if the government does not have enough to spend in tax revenues, then print money or borrow, but spend, spend, spend.

As I see it, restructuring any economy in order to place its debt service at the top (which means high tax rates) is likely to be counterproductive in the short run AND long run. Like it or not, governments usually are an impediment to economic growth and certainly not an engine of the same.

For Krugman, financial bubbles ARE the soul of capitalism, period. In his view, investors are a bunch of lemmings that always run over the cliff unless wise government agents steer them otherwise. As Austrians see it, the culprit is going to be the central bank or government in one form or another.

(For those people who claim that the housing bubble was SOLELY the result of private investment, they ignore the role of the Federal Reserve System, Freddie and Fannie, and a government that demanded that more people be put into home ownership, damn the consequences.)

So, what is Krugman's "solution"? He provides it here:

Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect of emerging from austerity and depression. Realistically, the only way to provide such an environment would be for the central bank to drop its obsession with price stability, to accept and indeed encourage several years of 3 percent or 4 percent inflation in Europe (and more than that in Germany).

Both the central bankers and the Germans hate this idea, but it’s the only plausible way the euro might be saved. For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time. Now time has run out.

So will Europe finally rise to the occasion? Let’s hope so — and not just because a euro breakup would have negative ripple effects throughout the world. For the biggest costs of European policy failure would probably be political. 

Yes, salvation through inflation, as though a central bank can "manage" rates of inflation over time. Krugman's love affair with inflation totally ignores the underside of such a policy, and ignores the fact that over time, the corrosive effects of inflation grow and any "positive" effects (i.e. "deleveraging") tend to diminish.

You see, Krugman truly seems to believe that the only "bad" effects of inflation would be higher prices, although those higher prices would be offset by higher incomes. Inflation, at least in Wonderland, has no effect upon investors' choices, it does not direct money into lines of production that are unsustainable, and it has no destructive effects at all unless it gets out of hand, and even then, the results are not very bad.

Like the Bourbons who, in the words of Tallyrand, "learned nothing and forgot nothing," the Keynesians never learn from inflation, and in the end always reach for that last arrow. Like Krugman, who apparently believes that the Obama administration can subsidize the economy into recovery (see "green energy" and other such nonsense), Keynesians truly believe that all assets are homogeneous, and that an economy is a mixture into which one stirs money and if one stirs in enough money and forces everyone to spend, out of it comes prosperity.

That is a Wonderland view of economics, but apparently that is what our economic and political elites are trying to claim is the truth. So print and spend yourselves into prosperity, Europeans! It must be so, it must be so!

Krugman: Greece Could "Solve" Its Problems if it Could Print More Money

In his best-seller, The Return of Depression Economics (which I am having my MBA students read this spring), Paul Krugman declared that most economic problems can be "solved" rather easily: the government prints more money. I am not making up that declaration, nor am I embellishing it or putting it out of context. That is what he said, and, like Sgt. Friday, just the facts, ma'am.

Today, he looks once again at the crisis in Greece, which has spread to Spain and where Austrians see fiscal folly and wages and work policies that are totally out of line with the structures of production in those country, a situation that must be put back into balance to end the crisis, Krugman sees the lack of inflation being at fault. Don't take my word for it. Read on:

The fact is that three years ago none of the countries now in or near crisis seemed to be in deep fiscal trouble. Even Greece’s 2007 budget deficit was no higher, as a share of G.D.P., than the deficits the United States ran in the mid-1980s (morning in America!), while Spain actually ran a surplus. And all of the countries were attracting large inflows of foreign capital, largely because markets believed that membership in the euro zone made Greek, Portuguese and Spanish bonds safe investments.

Then came the global financial crisis. Those inflows of capital dried up; revenues plunged and deficits soared; and membership in the euro, which had encouraged markets to love the crisis countries not wisely but too well, turned into a trap.

What’s the nature of the trap? During the years of easy money, wages and prices in the crisis countries rose much faster than in the rest of Europe. Now that the money is no longer rolling in, those countries need to get costs back in line.

But that’s a much harder thing to do now than it was when each European nation had its own currency. Back then, costs could be brought in line by adjusting exchange rates — e.g., Greece could cut its wages relative to German wages simply by reducing the value of the drachma in terms of Deutsche marks. Now that Greece and Germany share the same currency, however, the only way to reduce Greek relative costs is through some combination of German inflation and Greek deflation. And since Germany won’t accept inflation, deflation it is.

Krugman, of course, supports Germany having a round of inflation. We have been down this road before, people, and it ends in disaster. In the late 1920s, Great Britain did not want to devalue the Pound, which at that time should have been trading at about $3.50 instead of the $4.86 "official" rate.

To keep the $4.86 rate intact, Benjamin Strong, who then was the chairman of the New York Federal Reserve Bank, cut a deal with Montagu Norman, Britain's equivalent of the Secretary of the Treasury, to inflate the U.S. Dollar. This led to the infamous stock market bubble that burst in October, 1929, and President Hoover's response to that crash (to try to prop up failing firms, as well as prop up high prices and wages) led to the Great Depression.

The Germans have their own history with inflation (1923 anyone?) and are not about to go the Benjamin Strong route, as to do so would create a series of troubles down the road. Unfortunately, inflation ultimately distorts an economy's structure of production, leads to unsustainable booms, and then to disaster. However, Keynesians like Krugman hold that the Very Worst Thing that can happen to an economy is deflation, and that prosperity is possible only through inflation.

Here is the problem with Krugman's prescription (Germany inflate, Greece continue as is): It does nothing to get the Greek fundamentals back into order and it distorts the economic fundamentals in Germany. In other words, it does nothing to solve the real, underlying problems in Greece, but it lays the foundation for a future crisis in Germany, as inflation will create its own problems.

If you wish to see an important difference between Austrians and Keynesians, here it is. Keynesians really don't see economic fundamentals, nor do they see any issues with factors of production. Instead, in their view, the economy is a homogeneous mix that works when government throws lots of money into the recipe. If there are imbalances (and the theory does not allow for that to happen, although Krugman himself recognizes that imbalances could be an issue), then inflation can solve everything. Unfortunately, what happens when governments engage in policies of inflation is that the seeming good effects come first, but then when the factor prices get out of balance with what is being produced, the economy moves toward an inevitable bust, and any attempts to "fix" things through another round of inflation only make things worse.

Austrians, on the other hand, look first at the factors of production for the distortions in the entire structure of the economy. Deflation, far from being the enemy of the economy, allows those factors to get back into balance with the overall structure of production, and direct production to consumer desires. It is the opposite of inflation: the bad effects come first (unemployment and initial dislocation), but the "good" effects come later (a recovery).

There is no way to bridge the gap between Keynesians and Austrians. Today, it is the Keynesians that rule, and it is economy that ultimately will suffer because their "theories" ultimately lead to disaster.

No, Greece cannot "solve" anything by going back to the Drachma and printing out the wazoo. Instead, it is up to that country to get its house back in order by letting the factors, including labor, get back into balance. That means, in the initial stages, that Greeks will find their wages being cut and their standard of living will fall. Yet, that initial stage is absolutely necessary if, in the long run, Greeks want to enjoy a higher standard of living in the future with an economy that is sustainable.

[Note]: It is good to be posting here again. I have been following the Tonya Craft trial in Ringgold, Georgia, and it is a fiasco. The prosecutors are running the show, and they are acting like typical high school bullies. It is a tragedy and a train wreck in progress.

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.

"Deficit Hawk Down," Financial Delusion Up

Yes, readers, I do agree with Paul Krugman when he says that the federal budget deficit is not the central fiscal issue that the U.S. Government and the U.S. economy face today. However (and you KNEW there would be a "however" coming), we disagree for opposing reasons.

In his latest column, Krugman attacks what he calls the "deficit hawks" (thus, the clever title for the column) who he says have always been wrong on the real effects of federal budget deficits:

Mr. Obama’s clearly deliberate neglect of Washington’s favorite obsession was just the latest sign that the self-styled deficit hawks — better described as deficit scolds — are losing their hold over political discourse. And that’s a very good thing. Why have the deficit scolds lost their grip? I’d suggest four interrelated reasons.

His reasons are as follows:

• A true Greece-style meltdown has not happened; therefore, it cannot happen here;
• Deficit spending as a share of GDP supposedly has started to decline, and the "deficit hawks" had predicted a reverse secular trend, i.e. recent deficits have become slightly smaller than previous years;
• Advocates of government "austerity" are wrong because "austerity" did not immediately bring about full economic recovery where it was practiced;
• The anti-deficit agenda really was a not-so-secret attempt by Evil Republicans to impose an unrelated evil political agenda.

 There is what I would call a "fifth reason" that Krugman says is a reason why the deficit hawks should not worry: the deficit is a good thing, not bad:

...it was, in fact, a good thing that the deficit was allowed to rise as the economy slumped. With private spending plunging as the housing bubble popped and cash-strapped families cut back, the willingness of the government to keep spending was one of the main reasons we didn’t experience a full replay of the Great Depression.

Whether or not one believes that the government's bank bailouts and subsequent "stimulus" spending prevented a return to 1933 is not answerable because one would have to prove a negative. What we are supposed to believe, however, is that "trickle-down" economics works when the government is in charge.

What happens? The government gives money or financial credits to politically-connected financial institutions and everyone pretends that the market values of the assets of those institutions are higher than what everyone understands is the case. (If you try to do this in private, the government will charge you with "fraud." However, if it is done by the government, it is called "saving the economy.")

Under outright stimulus, the government directly issues funds to politically-favored groups and the individuals then spend the money with the idea being that the good effects will "trickle down" to the rest of us who do not have the same political connections. Somehow, after we spend what money is left over, the effects will be such that the economy will magically have "traction" and it will move forth on its own.

Moreover, as Krugman argues, since the Fed has managed to push interest rates for U.S. securities to near-zero, then there is almost no opportunity cost for borrowing (and more borrowing). As he declared in a blog post a while back, it is "free money." Because the Fed and the Social Security Administration own the largest single blocs of U.S. debt, we "owe it to ourselves" which apparently means that there are no problems associated with the high debt of the U.S. Government.

What puts the USA in the "catbird's seat" (as opposed to other countries like Greece) is that this country has its own currency, which means that the government essentially can pay its bills with printed money, and since the U.S. Dollar effectively has been the "world currency" for a long time, we can get away with it, while countries like Zimbabwe could not. Unlike Greece, which is on the euro, we can print and devalue forever, and the rest of the world simply has to take it.

The federal deficit is not the problem in and of itself; instead, it is a symptom of a much larger fiscal problem, and that is that the U.S. Government is spending at rates that impose huge burdens on everyone else. In Krugman's Wonderland, government spending always is a net plus, especially when the economy is down.

(Yes, I know that Krugman calls for "austerity" during a boom, but in reality, politicians spend even more if they think the funds are available. Furthermore, I don't recall hearing Krugman call for massive cuts in government spending during the last few years of the Clinton Stock Bubble or during the Bush Housing Bubble.)

Furthermore, in Wonderland, those who are productive are the real "takers," entrepreneurs are irrelevant to a growing economy, the most desired industries are those that receive massive subsidies, and it is the people receiving direct government benefits that are most likely to take the entrepreneurial risks that our economy needs to grow. (Face it, that was the gist of Barack Obama's "Progressive" inauguration speech, and Krugman himself declared that there was "a lot for progressives to like" in that speech.

So, if the government spends enough money, if enough people can receive new benefits that they will spend quickly, if the spending "trickles down" to those not receiving the direct benefits, if the government continues to massively subsidize politically-favored "green energy" firms and "green" research, if the Fed continues to keep interest rates low, if the government continues to print money, if the "Inflation Fairy" does its magic, and if everyone just believes in the Greatness of Barack Obama, we someday will have real prosperity. That is the financial delusion that apparently rules in "elite" academic and political economics these days.

Krugman: Actually PRODUCING a High Standard of Living is a "Zombie" Idea

Like most Keynesians, Paul Krugman has no idea of how societies prosper. In his view, governments borrow, print, and then spend money and out of that comes, like magic, a prosperous economy. If times are hard, then spend even more and, like the Great Pumpkin, prosperity will rise out of the pumpkin patch.

Take his view of what should be done in Europe, for example, and especially for Greece and Spain. As he has written on numerous occasions, instead of facing the fact that the economies of those two nations cannot produce enough wealth in order to support their bloated unionized government workforces and sustain their ridiculous work rules for private employers. Greece and Spain are in trouble not because they are on the euro, but rather because they used the financial and monetary arrangements of the European Union in a way that was not sustainable.

Now, I agree that most "austerity" packages are wrongheaded because the state swallows much of the GDP of the affected nation and then directs that money to the banks (or, as some libertarians call them, "banksters") that foolishly lent money to those nations for things that ultimately went bust, or to pay for simple operating expenses of the various governments. However, there is another aspect of economics and economies that Krugman not only refuses to admit, but belittles it at every turn: societies that consume much also produce much, and that production is the source of their consumption.

To Paul Krugman, such a notion -- that an economy actually has to produce a standard of living -- is a "zombie idea." Every good Keynesian knows that consumption actually creates production, that one consumes first and then produces later. And, no, Keynesian "demand" is NOT the same kind of demand which entrepreneurs anticipate as they try to move resources from lower-valued to higher-valued uses. Keynesian "demand" is nothing more than new money or wealth transfers being directed to politically-connected people who ostensibly will "spend" that money, and out of which is supposed to come general prosperity. Anything to the contrary is nothing more than "Say's Law," which everyone knows has been discredited. (I mean, people really believe that we can have consumption without production? Get real!)

And so, he demands that Congress, the president, and governments at state and local levels ratchet up their spending, and if the economy is not producing enough wealth to pay the taxes necessary to support this blizzard of spending, no worry. Why? The government can manipulate the Federal Reserve Act of 1913 to permit the Fed to purchase U.S. treasuries in the primary market, so if need be, there would be no barriers at all to vast new amounts of spending and if the shower of new money creates an inflationary environment, all the better! Inflation, as Krugman has written, is a great tool for "deleveraging," which in his view would transfer wealth from rich to the poor.

(For those who insist that Krugman is not an apostle of inflation, note that he strongly endorses the views of Mark Thoma, who is a hardcore inflationist. Like so many other Keynesians, Thoma believes that all it takes is for government to inject new money, which will solve problems painlessly and put the economy back on track. The only problem, people like Thoma and Krugman claim, is that governments are too reluctant to aggressively debase their currencies. The "Inflation Fairy" is hard at work.)

So, yes, do you believe that government wealth transfers are a cost and not a boon to the economy? Do you believe that over time, a nation cannot consume more than it produces? Then you, too, are a "zombie." Wear that moniker proudly.

Krugman Tell a Lie? Oh, Surely Not!

In a blog post following the first presidential debate, Paul Krugman insisted that while Obama did rather poorly, he spoke only the truth while Mitt Romney spoke only lies. Given that I cannot imagine the president or his main challenger telling the truth, I would say that Krugman was guilty of speaking only half a lie, but nonetheless, by insisting that Obama tells only the truth, that half was a whopper.

Krugman, being the political operative that he is, insisted in his latest column that the economy is not in any kind of crisis. In a recent speech in Europe, however, Krugman told a different story, warning of impending collapses if Europe continues its present course of what Krugman calls "austerity." What I find most interesting about his speech, however, is his insistence that the European Central Bank engage in what would be nothing more than a pure print-the-euro scheme, as though the "Zimbabwe Solution" would be sustainable. He declared that Europe must

...contain immediately the financial threat to troubled countries and stabilize yields on their borrowing, which in the end requires the ECB to be ready to be the lender of last resort and buy sovereign bonds.

Understand what he is saying. In effect, he is recommending that the European authorities create what would be an inflation crisis -- and that is what pure money printing schemes like this always create -- in order to solve the fiscal crisis. So, I guess that if Europeans are drowning in euros, they will forget that their economies are grinding to a halt. The Krugman "solution," or what we call the "Inflation Fairy."

"The Great Abdication" -- Of What?

Perhaps the most constant theme in Paul Krugman's recent columns has been his unwavering belief that the only way out of this depression is for governments to borrow and spend, and for central banks to inflate, and he repeats this theme again in his latest column. The way out, he believes, is easy and painless: borrow, spend, and inflate:

So what should European leaders — who have an overwhelming interest in containing the Spanish crisis — do? It seems obvious that European creditor nations need, one way or another, to assume some of the financial risks facing Spanish banks. No, Germany won’t like it — but with the very survival of the euro at stake, a bit of financial risk should be a small consideration. 

But no. Europe’s “solution” was to lend money to the Spanish government, and tell that government to bail out its own banks. It took financial markets no time at all to figure out that this solved nothing, that it just put Spain’s government more deeply in debt. And the European crisis is now deeper than ever. 

Yet let’s not ridicule the Europeans, since many of our own policy makers are acting just as irresponsibly. And I’m not just talking about Congressional Republicans, who often seem as if they are deliberately trying to sabotage the economy. 

Let’s talk instead about the Federal Reserve. The Fed has a so-called dual mandate: it’s supposed to seek both price stability and full employment. And last week the Fed released its latest set of economic projections, showing that it expects to fail on both parts of its mandate, with inflation below target and unemployment far above target for years to come. 

This is a terrible prospect, and the Fed knows it. Ben Bernanke, the Fed’s chairman, has warned in particular about the damage being done to America by the unprecedented level of long-term unemployment. 

So what does the Fed propose doing about the situation? Almost nothing. True, last week the Fed announced some actions that would supposedly boost the economy. But I think it’s fair to say that everyone at all familiar with the situation regards these actions as pathetically inadequate — the bare minimum the Fed could do to deflect accusations that it is doing nothing at all.

 And why are governments (and especially the Federal Reserve System) "abdicating" their responsibility to borrow, spend, and inflate? In a word, Goldstein:

Why won’t the Fed act? My guess is that it’s intimidated by those Congressional Republicans, that it’s afraid to do anything that might be seen as providing political aid to President Obama, that is, anything that might help the economy. Maybe there’s some other explanation, but the fact is that the Fed, like the European Central Bank, like the U.S. Congress, like the government of Germany, has decided that avoiding economic disaster is somebody else’s responsibility. 

None of this should be happening. As in 1931, Western nations have the resources they need to avoid catastrophe, and indeed to restore prosperity — and we have the added advantage of knowing much more than our great-grandparents did about how depressions happen and how to end them. But knowledge and resources do no good if those who possess them refuse to use them. 

And that’s what seems to be happening. The fundamentals of the world economy aren’t, in themselves, all that scary; it’s the almost universal abdication of responsibility that fills me, and many other economists, with a growing sense of dread. 

 To be honest, I am filled with dread, too, but it is not because governments have not been spending enough. Central Banks have been piling new reserves into banks, purchasing government securities, mortgage securities, and other assets and pretending that they actually have real value (as opposed to the paper value of "governments always can print money to pay for these 'assets'"). At home, federal borrowing accounts for 40 cents of every dollar the government spends, yet Krugman claims that this is not enough. 

If governments are abdicating anything, it is responsibility and understanding of the basic creation of wealth. Keynesians have this view that if government increases spending, the new money will trickle down to all of the various factors of production in perfectly proportional amounts so that those factors that are unemployed or underemployed will get a boost, and the factors running at higher rates of employment will not be negatively affected. Not even the University of Chicago financial economists ever came up with a Perfect Market Hypothesis to match this one!

(Krugman now is championing a new cause for the current downturn: not enough spending by state governments. His point is that the projected "job growth" of state employees is not where it is "supposed" to be right now, so the federal government must borrow more and give to the state governments, while taxes in the states need to be raised so that there can be more state spending. You see, there is no such thing as opportunity cost when governments borrow, tax, and spend.)

To buttress Krugman's points, I found another blog which worships FDR and also professes the same kind of thinking that Krugman gives us: government spending is the SOURCE of all wealth. The blog declares:

If I were the head of the US government, the first thing I would do would be to introduce a Job Guarantee program and set about restoring jobs and a living income to those who are without either. This would immediately boost aggregate demand and give business firms a reason to start investing and producing. You can’t do this by “internally deflating” your economy a la Ireland or Estonia.

Franklin Delano Roosevelt understood this better than any of our current leaders. He knew that workers’ wages are not just a cost but a source of INCOME. The mainstream economics profession continues to ignore the income side of the wage deal. Supply and demand are not independent variables, just as fiscal policy cannot be viewed outside the broader construct of the economy as a whole. Mass unemployment occurs when there are not enough jobs and hours of work being generated by the economy to fully employ the willing labor force. This is because there is insufficient aggregate spending. Government spending is the one obvious remedy.

 Notice that the writer does acknowledge that workers wages really are a "cost," but then ignores that fact when he goes into the rest of his spiel. As for causality, that is, why this situation occurs in the first place, fuhgeddaboudit. All of a sudden, people stop spending enough money to keep the Perpetual Motion Machine known as the "circular flow economy" going at "full employment," so government must step in and fill the hole.

Murray Rothbard understood these arguments quite well when he wrote in 1969:

The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: that these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention.

 Unfortunately, we have learned nothing. In the past decade, both the spending and regulatory burdens -- yes, burdens -- of the state have multiplied immensely. Entrepreneurs are finding it more and more difficult to negotiate the legal steps in cities across this country to simply start businesses. In an experiment, John Stossel looked at what it would take for a kid to legally open a lemonade stand in New York City, and he found it would take about 65 days, not to mention the opportunity cost of going through all of the legal procedures.

This is the situation across the country, yet we hear from people like Krugman is that (1) there is not enough regulation of business, (2) increasing the financial and regulatory burdens of government will help create prosperity, and (3) government spending will fill all of the holes and overcome the vast numbers of barriers that governments place in front of entrepreneurs. In fact, if I read Krugman correctly, entrepreneurs are predators, while government regulators protect us, and the income that we are taxed to pay these regulators contributes to prosperity.

The cart truly is before the horse, but Keynesians always will be in denial. Instead, they claim that if government borrows and prints new money in massive amounts, somehow all of this will translate into prosperity. I don't see how that is possible, but I guess everything is possible in Wonderland.