Krugman and the "Liquidity Trap"

One thing I appreciate about Paul Krugman's columns is that he clearly explains the Keynesian paradigm, and does it in short space. One of his favorite themes in his promotion of Keynesianism has been the "liquidity trap." Here is what he says about this term:

In my analysis, you’re in a liquidity trap when conventional open-market operations — purchases of short-term government debt by the central bank — have lost traction, because short-term rates are close to zero.

In other words, interest rates are at about zero (or what he calls the "zero-bound,"), which means that typical monetary policy in which the Federal Reserve System increases bank reserves which then can be lent to businesses for capital expansion is ineffective. When that happens, Keynesians then recommend the government follow "fiscal policy," in which the government borrows (or prints money) and spends it directly in the economy as a "stimulus."

Krugman is quite consistent on this point. He goes by the following syllogism:

• Spending drives the economy, and there must be a certain level of spending to keep the economy afloat;
• Private investors are not borrowing enough even though there are lots of bank reserves, which means the economy is in a "liquidity trap";
• Therefore, to boost spending, government must directly spend by borrowing or getting the Federal Reserve System to purchase government bonds directly, which will "stimulate" the economy and allow us to "spend our way out of the" depression.

In a recent post on his NYT blog, Krugman again claims that the rules are different because much of the world is in a "liquidity trap."

However, there is a different approach, as is laid out by Murray N. Rothbard in his classic America's Great Depression. I include Rothbard's description and criticism of the "liquidity trap" in this link. It is quite long, so I don't include the text in this post. However, it is worth reading if you wish to understand that theoretical basis for the current government policies, and a good antidote to them.

Folly and "Financial Reform," Part II

In Paul Krugman's column on "financial reform," he makes it sound so simple. Just put, smart, "well-meaning" regulators in power, and they will make sure that the financial system will work just fine.

Unfortunately, while Krugman understands the technical jargon about finance, he really does not comprehend the economics behind it. According to Krugman, government regulators can pick "winners" just as well as anyone else can do, and since capital itself, economically speaking, is homogeneous, well it is pretty easy to run an economy. Just let the regulators decide where the loans shall go, and there won't be any risk, and the economy will work like a clock.

This is fantasy. If government regulators really could pick winners, as Krugman seems to think, then people that wise immediately would be hired by investment firms -- at many times their government salaries -- and lead Wall Street firms into investment bliss. In truth, reality is much more complicated.

If the world Krugman still champions were in existence now, I would not be writing this piece, as laptops -- if they existed at all -- would be much more primitive than they are now. Forget about the Internet, since copper wire still would be transporting telephone calls, and the Internet as we know it could not exist under such technology.

Television would continue to be the dreadful fare of a few network stations, Dan Rather still would be on the air (since there would have been no bloggers to expose his dishonest use of forged documents in a diatribe against President George W. Bush), and the only way to be able to read Krugman would be if one purchased a paper edition of the New York Times. That is because the "shadow" system Krugman so despises, was the system that financed most of the high-technology ventures that have become an integral part of our lives.

Someone like Krugman cannot understand this because in his world, economic outcomes depend only upon how much money the government is willing to print. Whether or not the financial system operated under 1930s rules or if investors were free to pursue the new technologies would lead to exactly the same outcomes, at least where what was available to consumers is concerned.

In other words, Krugman has no concept of the Law of Cause and Effect. To him, the effect always is the same, economically speaking. However, to Austrian economists, the Law of Cause and Effect is front-and-center in understanding economic outcomes.

Austrians understand that the banking system Krugman so praises could not and would not have financed what turned out to be a massive economic recovery during the 1980s. That role was left to the "shadow" system.

Now, most of the deregulation initiatives of the 1980s and 1990s really was re-regulation, and the system became increasingly skewed, as politicians sought to maximize political contributions coming from the financial sector. Unwise laws like Sarbanes-Oxley limited possibilities of profit within our borders, so banks and brokerage houses turned to other means to make money.

While it is easy to decry a lack of oversight when the financial system went ga-ga over what turned out to be toxic mortgage securities, in hindsight, we realize that had the politicians not deliberately shackled the productive U.S. economy, perhaps banks and brokerage houses might have pursued more sound "investments" than pyramiding funds atop mortgage securities that turned out to be worthless.

Furthermore, Krugman forgets that the loose credit policies of the Federal Reserve System helped to trigger reckless lending and touched off an unsustainable boom. (Krugman does not believe booms are unsustainable. He just believes that if a boom slows down, government needs to print lots of money to keep the party going.)

Now, I agree with Krugman that the banks and brokerage houses were irresponsible, but one does not forget that people who believe that the government "has their backs" are going to be more reckless than people who understand that if they fail, they have to pick up their own pieces. Krugman never seems to fathom that the moral hazard created by the government backstops ultimately set the stage for this disaster. Nor is he ever going to change his tune; it's his story and he is sticking with it. I'll stick by my account.

Folly and "Financial Reform", Part I

In my review in the Freeman of Paul Krugman's The Return of Depression Economics and the Crisis of 2008 (a book that I am requiring for my MBA students this spring) I noted that he made some insightful observations and comments. However, I continued, he then draws all of the wrong conclusions:

...alas, in the end Krugman resorts to the arguments of the great economic cranks of history, from Silvio Gesell to John Maynard Keynes. He’s like the mechanic who expertly describes a problem with your fuel pump—then insists your car needs more gas. If the tank is full, he tells you to attach an auxiliary tank.

In other words, Krugman is still the one-trick pony featured in the Times. Whatever the problem, his solution is always the same: inflation.

Thus it is today with his column on financial reform.Krugman correctly notes that the financial sector took risks that clearly were out-of-bounds, yet they also understood that the government had their backs. All of us can agree on that point, but the next question is where we part: Now that the financial meltdown has happened, what should we do about it?

Austrian economists like me believe that we need to move entirely away from a financial sector backed up by the printing presses of the U.S. Government and the monetary manipulations of the Federal Reserve System. Such a system always is doomed to failure because the symbiotic relationship between the financial sector and government is inevitable when government agents can descend on that sector and overnight change outcomes.

(The predations of Elliot Spitzer and Rudy Giuliani come to mind. While both men were effusively praised by Krugman's NYT employer, Wall Street got the message and gave both men massive amounts of campaign contributions. Like Willie Sutton, politicians know they can raid Wall Street because "that's where the money is.")

Krugman, on the other hand, approaches financial regulation from this point: Democrats always good, Republicans always bad. Democrats want wise regulation, Republicans want wild speculation. Now, that is something I expect to hear from political hacks or from Keith Olbermann, not to mention the editorial writers and columnists at the NYT.

I don't expect a decorated economist like Krugman to give in to this simplistic hackdom, and that is what he is doing, like it or not. Furthermore, he gives a skewed history of the rise of what he and others call the "shadow banking system."

In Krugman's history, the tightly-regulated banking system was almost impervious to failure because regulators kept it from going after Big Risks. Unfortunately, those bad free-market ideologues both created a shadow system and then bamboozled the Wise Government to deregulate the banking system, ultimately leading to the present crisis. That is a history that plays well to both his audience and the current crop of politicians in power.

As I said before, I expect to hear such nonsense from the Usual Suspects, just as I expect Ann Coulter to claim that Barack Obama is not pursuing Big, Bad Muslims around the globe with enough ferocity (and, thus, adding further to our government's financial bankruptcy). However, as economists have noted for decades, the real story of regulation is much more nuanced and requires for people not to give into partisan diatribes.

What Krugman does not tell us is that by 1980, the small, wonderful banking system was in crisis in no small part because of the regulation Krugman praises. Regulators operate according to a set of incentives in which they receive no credit for "picking winners" but are in hot water if they allow actions that result in failure. Therefore, the default for regulators always will be "no."

Ever hear of MCI? Of Borders Bookstore? Of McCaw (now AT&T) Cellular? Of CNN? Of fiber-optics and a thousand other high-technology initiatives? The reason you have heard of them has been that "shadow banking system" that Krugman condemns. The heavily-regulated banking system would not touch them because these were new ventures that were outside of the usual kinds of things (like government bonds) that banks were permitted to help finance.

Like the entrepreneurs in Elizabethan England who set up shop outside London (because the Queen had granted monopolies in that city to her favored people), something noted by economists Robert Ekelund and Robert Tollison in their book Politicized Economies, the shadow financial system grew precisely because it allowed investors to pursue profitable opportunities that the regulated banking system could not.

Furthermore, the "tightly-regulated" banking system, which really was more of a regulated cartel, was losing capital. Part of the regulatory deal was that government would limit the risk the system could take, but it also would place ceilings on interest rates the banks could offer. At a time when inflation was in double-digits, but banks only could pay depositors something in the range of 6 percent, people flocked to money market accounts being offered by financial entrepreneurs that were relatively safe but also paid higher interest rates.

Like the entrepreneurs who broke down the Mercantilist regulatory system of post-Renaissance England simply by locating elsewhere, the financial entrepreneurs like Michael Milken helped to finance what would be our economic future for two decades. Of course, the established financial firms on Wall Street that were being left out of the action did not like upstarts like Milken, and so Rudy Giuliani did their dirty work, urged on by the NY Times and others.

(By the way, Milken was a liberal Democrat and hardly falls into the category of the "free-market, Republican ideologue" so demonized by Krugman and others. In other words, Milken did not fit the stock profile, but nonetheless was pushed into that false category anyway.)

The background being set, in Part II, I will look at Krugman's current statements and point out why they are wildly untrue and misleading.

Say What? on the Debt

I have read bizarre stuff from Paul Krugman before -- heck, here is a guy who believes prosperity is created by the government printing press -- but I must admit this latest blog post of his comes close to being the most bizarre of all. First, and most important, he declares that the gargantuan public debt really is not much of a big deal.

Second, he wants us to take the word of the Obama administration on the budget numbers up to 2020. Yes, now that the profligate politicians he likes are in power, we are supposed to believe whatever the administration tells us. Right.

However, it gets better. After mentioning that other "independent sources are moderately more pessimistic" (they believe the federal deficit will be five or six percent of GDP instead of the Obama prediction of 3-4 percent), he writes this:

That’s not, in economic terms, a huge number. We could raise taxes that much and still be one of the lowest-tax nations in the advanced world. Or we could save a significant share of that total by not being totally prepared for the day when Soviet tanks sweep across the North German plain.

And it gets better:

The only reason to doubt our ability to get things under control a decade from now is politics: if we’re still deadlocked, if sane Republicans are cowed by the Tea Party, then sure, we can have a fiscal crisis. And longer term, we’ll be in a mess unless we get health care costs under control — which is exactly what we’re trying to do, in the face of cries about death panels.

Yeah, it is those dastardly tea-partiers that are going to cause a fiscal crisis. Why? Well, they oppose "healthcare reform," and everyone knows that a huge combination of new taxes, draconian regulations, mandates and subsidies are going to vastly cut medical costs and help revive the economy.

I will agree that the "War on Terror" has eaten a portion of our nation's production that is equal or greater than any set of costs associated with medical care, and there seems to be no end in sight. What is just as bizarre to me as Krugman's assertion that the Obama numbers are honest is the campaign of the Heritage Foundation, "Four Percent for Freedom," that claims we are not adventurous enough when it comes to military spending and wars abroad.

You see, it never has occurred to the people at Heritage that the financial ruin that has come about in large part because of the "War on Terror" and the vaunted "Ownership Society" initiative of the Bush administration (pushed by Heritage and the Cato Institute) which deteriorated into "let's put everyone into home ownership whether or not they can afford it." Because the Bush administration was profligate, it created a crisis that helped lead to the current political situation, and ultimately to, yes, the real ascension of Krugman to his current "superstar" status. By creating a fiscal crisis, the "conservatives" gave credibility to Krugman, who became well-known in large part because of his public criticism of the Bush administration.

So, we have few voices for fiscal sanity, anymore. On the one hand, Krugman claims that we are supposed to believe Obama's budget numbers as though they came from God, and the "conservatives" want even more war and military spending abroad. Neither side can come to grips with the fact that this government is broke, broke, broke.

Don't kid yourselves. We are on the same path as was Argentina in the mid-20th Century, when a rich and proud nation morphed into poverty and political chaos. Those "advanced" countries of Europe Krugman so praises are headed in the same direction, brought down by the cold hard reality that in order to have a high standard of living, a country must produce something other than paper money. It is unfortunate that the USA is being destroyed by a tag team of the Left and the Right, but here it is.

What About Financial "Reform"?

Once again, we see Paul Krugman promoting the fantasy that our financial system in 1980 was a "robust," productive system done in by the ideology of "deregulation." Well, not exactly.

People who were around then might remember that Krugman's employer, the New York Times, praised the first major deregulation bill, the Depository Institutions Deregulation and Monetary Control Act of 1980. Yeah, you know how those NY Times editorial writers are a bunch of conservative, free-market Republicans.

This time, Krugman claims that as long as regulators are "smart" and "well-intentioned," then they can pull off the whole deal. I think it takes more than that. Krugman, unfortunately, demonstrates his ignorance of finance and of economics (not to mention economic history) in the following missive:

The pre-1980 system was, I’d argue, pretty robust. Bank regulators didn’t have to be all that smart, because the rules were simple — and besides, the large franchise value of banks, the fact that they faced limited competition and were almost guaranteed to be profitable, made bank executives unwilling to take big risks of killing the goose that laid golden eggs.

However, the "golden eggs" of the 1980s were industries in which these bank executives refused to make investments. Ever hear of CNN? What about MCI? McCaw Cellular (now AT&T Cellular) might jog the memory a bit.

These and more all were industries that the banking system -- that "robust" system Krugman praises -- ignored. Krugman really wants us to believe that the high-technology industries, the very industries that are vital to our economic well-being, really just came into being, despite the fact that the banks (regulated by "smart and well-intentioned people") would not make loans to them. Indeed, every one of these firms came about because of the alternative system (specifically, Michael Milken and his "junk" bonds that turned out to be good investments) that Krugman wants to make illegal.

Now, I will be the first to say that if the government is going to backstop the financial system, providing bailouts and other goodies to prop up failure, then the system needs to be regulated. However, keep in mind that this kind of a system is not going to be effective in financing those sectors of the economy we need to lead us out of this recession.

However, none of that matters to Krugman. Here is a guy who really believes that all we need is for a government to have the "courage" to print money, borrow, and spend recklessly.

How DARE Anyone Protest This Bill!

In the days before the vote on the allegedly "historic" Obamacare bill in the House of Representatives, recalcitrant Democrats were receiving threats overt and covert from constituents, unions, and others. A number of them had to deal with obscenity-laden threats from Rahm Emmanuel, courtesy of the Obama White House.

However, such actions were not extremism. No, they were statesmanship, or at least in the Wonderland inhabited by the likes of Paul Krugman.

However, whatever rumors or even lies about the protests of those who were against this monstrosity of a bill are being told, Krugman is there to repeat them, and he does so again in his column today, "Going to Extreme."

Before taking on today's missive, I want to deal with a Big Lie that Krugman was helping to spread. Remember the supposed screaming of the "N-word" at black members of Congress last week? Krugman and all of the others in the media made hay of it. However, it turns out that the account was a fabrication, made up by a reporter from the McClatchy newspaper chain.

(In case you are not familiar with the leftist McClatchy chain, one of its newspapers, the News & Observer of Raleigh, North Carolina, started off the infamous Duke Lacrosse Hoax with a fabricated account written by a female reporter who now works for a Marxist publication. More than any other media outlet, the McClatchy chain was responsible for this patently-false hoax and subsequent attempted frame of three young men by the prosecution and police of Durham. That McClatchy would promote another Big Lie does not surprise me in the least.)

That it turns out that no one -- not one person -- has been able to pick up any of those supposed slurs on the numerous videos made of that moment. This was a fabrication, pure and simple, yet Krugman gleefully jumped on it because it was "proof" that anyone who opposed Obamacare is a racist.

Ironically, Krugman's employer put a correction in his "Fear Strikes Out" column because Krugman had falsely claimed that Newt Gingrich was saying that "civil rights" damaged the Democratic Party. So, Krugman himself is not above promoting fabrications when it suits him. (Of course, Keynesian economics is a fabrication, but that is a discussion for another time and post.)

So, in today's column, we read more of the same:

But back to the main theme. What has been really striking has been the eliminationist rhetoric of the G.O.P., coming not from some radical fringe but from the party’s leaders. John Boehner, the House minority leader, declared that the passage of health reform was “Armageddon.” The Republican National Committee put out a fund-raising appeal that included a picture of Nancy Pelosi, the speaker of the House, surrounded by flames, while the committee’s chairman declared that it was time to put Ms. Pelosi on “the firing line.” And Sarah Palin put out a map literally putting Democratic lawmakers in the cross hairs of a rifle sight.

All of this goes far beyond politics as usual. Democrats had a lot of harsh things to say about former President George W. Bush — but you’ll search in vain for anything comparably menacing, anything that even hinted at an appeal to violence, from members of Congress, let alone senior party officials.

So, we are back to the same partisan vitriol: We Democrats are nice people, those Republicans are a bunch of violent kooks. Now, to me, both parties are full of people who have advocated violence against Americans and much of the rest of the world, and currently are carrying out those threats at home and abroad.

Krugman then makes this astonishing claim:

Mr. Obama seems to have sincerely believed that he would face a different reception. And he made a real try at bipartisanship, nearly losing his chance at health reform by frittering away months in a vain attempt to get a few Republicans on board. At this point, however, it’s clear that any Democratic president will face total opposition from a Republican Party that is completely dominated by right-wing extremists.

For today’s G.O.P. is, fully and finally, the party of Ronald Reagan — not Reagan the pragmatic politician, who could and did strike deals with Democrats, but Reagan the antigovernment fanatic, who warned that Medicare would destroy American freedom. It’s a party that sees modest efforts to improve Americans’ economic and health security not merely as unwise, but as monstrous. It’s a party in which paranoid fantasies about the other side — Obama is a socialist, Democrats have totalitarian ambitions — are mainstream. And, as a result, it’s a party that fundamentally doesn’t accept anyone else’s right to govern.

Please. This is a president who made the hyper-partisan Emmanuel his chief of staff, and who made it clear that he had the votes, and he was going to do whatever he pleased. Obama told Republicans that if they were not going to go along with what he wanted, then it didn't matter, anyway. Furthermore, the Democrats quickly have turned these alleged "threats" of which Krugman speaks into fundraising opportunities, which always makes me a bit suspicious. That Krugman tries to paint a picture of a naive, trusting Obama who was stabbed in the back by those mean, nasty, vicious, racist Republicans is junk that at best is saved for the Daily Kos or Media Matters.

Paul Krugman represents the Eastern, secular, urban Democrat who absolutely cannot understand nor tolerate anything other than the culture in which he lives. Should anyone be different, well, that person really needs at best to pay taxes, and bend over and take whatever the Krugman-approved government gives him or her. Any opposition to his ideas can be motivated only by racism, and whatever "ism" he pulls out of his hat.

Only in Wonderland Will "Healthcare Reform" Reduce the Deficit

Paul Krugman is at it again, trying to convince us that this monstrosity of a bill is going to produce all sorts of financial "savings" for Americans, and he claims to have brought out the heavy intellectual artillery. Krugman pulls out a figure from that great economic soothsayer, Ezra Klein of the Washington Post which "proves" that revenues from this new bill will well-outstrip expenses:

Lest one be a doubter, the Center on Budget and Policy Priorities makes similar claims, and we know that the Left never is wrong on economic policy. However, before we sit back and cheer the good fortune we have before us (you know, "world-class" healthcare and those rich people will pay for all of it), perhaps some wise words from Robert Higgs, an economist whom I respect infinitely more than Krugman or Klein, might be in order:

What has this gargantuan statute wrought? To this question, there can be only one answer: Nobody knows.

I am being quite serious: no single human being knows ― no one can know ― what provisions the statute’s more than 2,000 pages contain. Even if someone had the power to read and remember everything in this massive legislative enactment, he would still harbor a multitude of uncertainties about: how the courts will interpret the law’s general provisions; how the various administrative agencies will flesh out the statute with new regulations; the precise way in which each provision will be implemented; how, when, and in what amounts funds will be made available for carrying out the law’s many stipulated actions; how much resistance the law will meet, both in the courts and among the public, and how these conflicts will be resolved; and countless other matters of critical importance to those directly and indirectly affected by the massive statute ― which is to say, virtually everybody in the United States and a considerable number of people elsewhere, as well.

Already, however, we can say a few things with certainty. One is that this statute, like any other of comparable size, amounts to a Christmas tree for politically favored interests. For months, maybe for years, people will be discovering little provisions tucked into the bill, each of which provides some sort of privilege, protection, subsidy, or other benefit to a particular firm, industry, profession, or other beneficiary. Anyone who has ever toiled through the pages of statutes of comparable length and complexity, as I have for a number of defense authorization and appropriation acts, knows that each such law comprises a host of special-interest provisions.

Higgs makes another point that is well-taken, for Krugman, Klein, and the other cheerleaders for this monstrosity are trying to tell us that a decade from now, no new expenses will be tacked onto this legislation. Right. Higgs says:

We also know that this statute will not be the end of the story of health-care politics in this country. It is, for the current phase, only the end of the beginning. The ink will scarcely be dry in the revised U.S. Code when political factions will undertake to alter or to overturn the provisions just enacted. Thus, within the act’s great expanse, hundreds of little sub-conflicts will rage, as competing interests struggle for control of the state’s coercive power in their area of contention. Politics, in general, is an endless struggle, and the politics of the federal government’s health-care intervention is no exception. Stay tuned.

Finally, because health-care-related economic activity is such a huge part of the overall economy, what happens in this sector will have significant consequences for the operation of other sectors. For example, when Obamacare turns out to be much more costly than the government has claimed it will be, the government’s demand for loanable funds will be greatly increased, with far-reaching effects on interest rates, investment spending, economic growth, and even the U.S. Treasury’s creditworthiness. It is not inconceivable that the burden of supporting this health-care monstrosity will prove to be the (load of) straw that breaks the back of the government camel in the credit markets, where the U.S. Treasury has long been able to borrow the greatest amounts at the lowest rates of interest because its bonds were considered virtually riskless. Indeed, that status as the lowest-risk borrower seems already to be approaching the breaking point, even before the new health-care legislation has taken effect. Implementation of this law can only worsen the Treasury’s plight.

I think that if credibility is an issue, the person with the most in this situation is Professor Higgs.