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.

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

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

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

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

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

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

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

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

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

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

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

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

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

Writing on the Tonya Craft Trial At My Other Blog

I have not made as many posts as usual here at KIW because I have been intensely following the trial of Tonya Craft at my other blog. She is being tried for allegedly molesting three young girls, including her daughter.

However, as I follow the trial and how it came about, it has become utterly obvious to me that this is a sham. The "investigators" who supposedly interviewed these children were absolutely unqualified and in most states would not be permitted to testify as expert witnesses at all. Furthermore, if one remembers the infamous child molestation hoaxes that swept this country about 20 years ago, causing untold human destruction, as well as the Duke Lacrosse hoax of four years ago, you will then understand the dynamics of this particular trial.

I have been writing on this case for a couple of weeks, and I will admit that it is taking huge blocks of time, not to mention emotion and about everything else. Yet, I believe it is important, because what we are seeing is state-sponsored judicial terrorism at work. The State of Georgia has been suborning perjury, prosecution witnesses on the stand SUDDENLY REMEMBER all sorts of damaging things that they conveniently had "forgotten" to tell investigators before the trial began.

This memory "recovery" has happened time and again and it occurs because the judge, Brian House, and the prosecutors, Chris Arnt and Len Gregor, have encouraged it. What people are witnessing is a crooked trial, and it is happening in real time.

So, while it is going on, I won't be making as many posts here at KIW, even though I know Paul Krugman will be saying outrageous things that should be answered. Nonetheless, I hope all of you will bear with me. Thanks.

And make sure you read the blog.

Yes, Paul, I Agree! (Sort Of)

In today's post, Paul Krugman writes that we should not cry for the bankers, and I agree. Would that he had written that two years ago when Washington was airmailing billions of dollars to Wall Street to buy up the "toxic assets" (yes, an oxymoron) and "save" the system.

It always is frustrating in reading a Krugman column which begins with promise, as I don't want to be opposing the guy just to oppose him. Rather, I wish to oppose his arguments. For example, a few years ago, he was (appropriately) knocking down the so-called lump-of-labor fallacy that holds there are only a finite number of jobs in any economy, so they have to be spread out. (Union work rules arise from this theory, which is why we often see some ridiculous work arrangements in union contracts.)

As I was reading the column, I was agreeing wholeheartedly. Unfortunately, he ended with his usual non sequitur. He claimed that by not "fully funding" the Homeland Security Department(!), the Bush administration was falling to the "lump-of-labor" nonsense, leaving me with a "Huh?" response.

Likewise, today he begins by saying the following:

On Thursday, President Obama went to Manhattan, where he urged an audience drawn largely from Wall Street to back financial reform. “I believe,” he declared, “that these reforms are, in the end, not only in the best interest of our country, but in the best interest of the financial sector.”

Well, I wish he hadn’t said that — and not just because he really needs, as a political matter, to take a populist stance, to put some public distance between himself and the bankers. The fact is that Mr. Obama should be trying to do what’s right for the country — full stop. If doing so hurts the bankers, that’s O.K.

More than that, reform actually should hurt the bankers. A growing body of analysis suggests that an oversized financial industry is hurting the broader economy. Shrinking that oversized industry won’t make Wall Street happy, but what’s bad for Wall Street would be good for America.

At one level, he is correct. Wall Street DOES need reform, and it cannot be business as usual for the Usual Suspects. That being said, however, we need to remember that two years ago, the market was saying the following in no uncertain terms: "You bankers have had a wonderful run, with your bonuses and your big houses in Connecticut. It is time to say goodbye to all of that and live in the real world again."

However, being that Krugman believes the market always is bad, he called for bailouts and then demanded "reform." And, once again, we see that Krugman recognizes the disease, but then calls for a "cure" similar to bloodletting or pouring arsenic down the patient's throat.

There are two ways to travel here. The first way is what Krugman and others are demanding: Have essentially a state-run financial system in which the SEC controls ALL of the investment sectors, with the supposed "brilliant" regulators knowing exactly what investments to choose. Yes, I guess Krugman means people like this, which apparently populate that august regulatory agency known as the SEC:

As the country was sinking into its worst financial crisis in more than 70 years, Security and Exchange Commission employees and contractors cruised porn sites and viewed sexually explicit pictures using government computers, according to an agency report obtained by CNN.

"During the past five years, the SEC OIG (Office of Inspector General) substantiated that 33 SEC employees and or contractors violated Commission rules and policies, as well as the government-wide Standards of Ethical Conduct, by viewing pornographic, sexually explicit or sexually suggestive images using government computer resources and official time," said a summary of the investigation by the inspector general's office.

More than half of the workers made between $99,000 and $223,000. All the cases took place over the past five years.

My guess is that Krugman would claim that these people did not "believe in government."

There is another way, and that is to make these firms accountable to the market for their actions. Yes, there is moral hazard created in the markets and, yes, people scratch each others' backs, but that also goes on in government, and I would defy Krugman to create a government agency that ultimately does not become yet another example of how "Capture Theory" works.

As Peter Schiff noted in this speech (yes, I repeat stuff from an earlier post), the market would have caught onto Bernie Madoff long before the SEC had figured out the scam, but because the SEC was putting its bill of approval on Madoff's secret Ponzi operation, he went undetected until the whole thing fell down.

Are we going to have that kind of Wall Street, a financial system in which individuals actually are accountable to their errors? Not at all. The irony, however, is that Krugman believes that by creating a Bigger Financial Cartel, he is going to get the moral hazard out of the system. Right.

Of course, Krugman also believes that the Federal Reserve System has "saved" our economy when, in fact, it is making it even more unstable and vulnerable to future meltdowns. Unfortunately, a nanny-state liberal like Krugman simply cannot bring himself to believe that government run by People Who Think Like Him actually can run an economy -- instead of running it into the ground.

Was Paul Samuelson a Great Economist?

When I was in graduate school, one of my professors told me that he believed that Ludwig von Mises was a "first-rate mind," and that Paul Samuelson had a "second-rate mind," but that Samuelson had captivated the mainstream. Certainly, Paul Krugman's near-worshipful tribute to Samuelson confirms that even though Keynesian "economics" is a fraud, the fact that Samuelson helped establish it in U.S. academe makes him an icon.

Here is what another economist, a man who not only has been prominent in economic circles but is, in my view, a much better economist than Krugman ever could be, has to say about Samuelson and Krugman's remarks:

Samuelson 1948 still the standard we need today. Pathetic.

Krugman thinks Samuelson's merely playing with ideas, as opposed to seeking the (closest attainable approximation of the) truth, was a virtue. To me it was a fatal flaw. He was very, very clever, in the way that a really bright boy can solve all sorts of mathematical puzzles without knowing anything at all about how the real world works.

What if Bailouts ARE Inevitable?

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

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

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

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

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

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

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

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

Yes, It's a Republican Plot

Most of the economists I have known have been associated loosely with the Republican Party or maybe the Libertarians. (Mark Thornton and John Sophocleus, two of my favorite economists and writers, both ran for statewide offices in Alabama as Libertarians, and both did better than most other Libertarian candidates have done. Neither are kind to the Republican Party.)

That being said, I never have dealt with any economists that were hyper-partisan Republicans, and at most economic events dominated by my friends, I heard more criticism of Republicans than I heard praise. Then there is Paul Krugman.

Even though the Republicans are nearly endangered species in this Congress, Krugman still insists that they are like Goldstein, falsely convincing us that we are at war with Eurasia when, in reality, we are at war with East Asia. For example, as I have pointed out many times before, he continues to claim that it was Reagan and the Republicans that gave us financial deregulation when the most important deregulation bill, DIDMCA, was passed in 1980 when Jimmy Carter was president and Democrats had the same majority in the Senate and an even bigger one in the House.

So, I hardly am surprised when Krugman insists that Goldstein, er, the Republicans, might kill the present "financial reform" bill. Now, if this is anything like the "reform" that gave us Sarbanes-Oxley or the Patriot Act that "reformed" how the government conspires against its citizens, then I am not sure I am in the market for such an act and would cheer on anyone willing to filibuster it.

Krugman writes:

I have a theory about the problem here. My understanding is that Obama officials have looked at the polls, which show that the public overwhelmingly favors cracking down on Wall Street; so they assumed that the GOP wouldn’t dare stand in the way. But they seem not to have learned, even now, that the right has an awesome ability to create its own reality: that Mitch McConnell et al would stand in the way of reform while claiming to be taking a stand against Wall Street.

that is a most interesting theory, actually. Now, what does he mean by "cracking down" on Wall Street? What he means is that Wall Street becomes the repository for buying government bonds (after the Chinese decide they don't want any more of that junk).

Furthermore, what he wants is to create what essentially would be a large financial cartel held together by the wise regulators from the SEC (who, on application, would have to pledge that they, like Krugman, "believe in government"). I doubt Krugman will use the "C"-word, but that is what he wants, and he forgets that the last SEC-run financial cartel fell apart about 1980, whether or not he wants to believe it. Furthermore, if he believes that giving the Federal Reserve System even more power than it has now is "reform," well, Lucy van Pelt has a football she wants you to kick.

Of course, he could not resist hinting that not falling into line with his view of "reform" is racist. In his own words:

And let’s be clear: there’s a sort of tribal thing going on (and I don’t necessarily mean race, although that’s part of it). The hard right has managed to convince a large number of Americans that it consists of people like them, whereas progressives are alien and untrustworthy; in the face of that, rational arguments don’t make much of a dent.

That the "Progressives" are our friends reminds me of the scene in "The Unbearable Lightness of Being" in which dissidents are being interrogated after the Soviet crushing of the Prague Spring, with the interrogator shouting, "Don't you know that we love you?!?