Commentary on Current Bond Rates

A number of people making comments on this blog have agreed with Paul Krugman that the relatively low bond rates right now "prove" that new monetary creation and an explosion of government spending bring no inflationary pressure. Thus, they claim, the concerns of people that the current "stimulus" efforts will lead to inflation are unwarranted.

I have asked a number of friends who are economists to comment. As I receive them, I will include them in this post.

Guido Hülsmann
Professeur des Universités
Faculté de Droit, d'Économie et de Gestion
Université d'Angers
France

If I understand this point correctly, higher deficits need not be monetized (or not much) because of the current drop of T-bill rates. Therefore, the danger of inflation is limited. Well, this argument presupposes that it is always possible for political institutions such as the Fed to stabilize TB rates at the current low levels, or even decrease them. But this is wishful thinking. In the past 20 months, the US Treasury, along with the German treasury and a few others, have benefited from the fact that investors have been losing confidence in all other market participants. Therefore, their TB rates have declined while the rates of all others have increased, or are starting to increase. However, this group of beneficiaries shrinks by the day.

Pressure is mounting for rates to go up, for three reasons: (1) there are more and more countries that have to pay higher rates, which will create pressure on T-bills and bonds precisely if and when the general situation seems to stabilize; (2) the supply of T-bills and bonds could dramatically increase if and when the general situation deteriorates, because the US and the German governments have started to act as financial problem-solvers of last resort; and (3) the return on investments in the "natural monies" gold and silver is outpacing the meager return offered by T-bills, and this at much lower risk. These facts are so glaringly obvious that even mainstream banks such as the Landesbank of Baden-Württemberg in Germany, Société Générale in France, or UBS in Switzerland are now hammering this point, to the benefit of their clients. See the latest installment of this wave of financial enlightenment.

As soon as the rates of US T-bills and of bonds start increasing to a moderate crisis level of, say, 10 percent, all government budgets will be belly-up. Then the only remaining alternative will be between (I) US and German government default, entailing a deflationary meltdown of world financial markets, and (II) monetizing T-bills and bonds, which will very quickly bring us on the road of world hyperinflation.

Krugman and the Keynesian "Stones into Bread" Fallacy

The more I read Paul Krugman's columns and papers, the more I realize just how great the gulf is between Austrian and Keynesian thought. It is impossible to sum up all of the differences between the two camps, but I do think that perhaps the disparities can be summed up in the Austrian rejection of Keynes' famous 1943 statement that expansion of credit by the central bank will create a “miracle . . . of turning a stone into bread.”

In his column today, Krugman in a roundabout fashion repeats this notion, as he excoriates the governments of the world for not borrowing, printing, and spending at a rate that he believes will keep the world economy from slipping into depression. At the heart of Krugman's exhortation is his belief that credit expansion is the same thing as creating wealth. I don't think so.

Krugman has almost a religious belief that borrowing and printing money and policies of spending for the sake of spending will pull the country out of a recession. He writes of the current mess:

...this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

Krugman ignores the recoveries after the 1921 recession and the 1982 recession, both of which occurred in the absence of inflation and and the presence of higher interest rates. Furthermore, while the U.S. Government in both instances ran deficits, they were deficits brought on by the fall in tax revenues due to the recession, not as matters of "deficit-based stimulus" policies.

But, there is a larger issue here, and it is this: Current spending by government does not create wealth, and it is the creation of wealth that will bring us out of the depression. Borrowing from future generations (or repudiating the debt through inflation) is nothing more than making a claim on future wealth. Furthermore, Krugman's recommendations do nothing to address the current set of malinvestments which plague the economy, not to mention the huge added burden of government-imposed costs which make production of wealth more difficult.

Lest we think that Krugman is saying something new, the great Ludwig von Mises more than 60 years ago exposed this faulty thinking. He wrote:

The stock-in-trade of all Socialist authors is the idea that there is potential plenty and that the substitution of socialism for capitalism would make it possible to give to everybody “according to his needs.” Other authors want to bring about this paradise by a reform of the monetary and credit system. As they see it, all that is lacking is more money and credit. They consider that the rate of interest is a phenomenon artificially created by the man-made scarcity of the “means of payment.”

In hundreds, even thousands, of books and pamphlets they passionately blame the “orthodox” economists for their reluctance to admit that inflationist and expansionist doctrines are sound. All evils, they repeat again and again, are caused by the erroneous teachings of the “dismal science” of economics and the “credit monopoly” of the bankers and usurers. To unchain money from the fetters of “restrictionism,” to create free money (Freigeld, in the terminology of Silvio Gesell) and to grant cheap or even gratuitous credit, is the main plank in their political platform.

Indeed, it was as though Professor Mises was anticipating Krugman's arguments. No doubt, Krugman would think Mises was a fool and a charlatan, but the joke is on Krugman. True, Mises did not have a Nobel Prize; but Mises had wisdom, and that makes all the difference.

Krugman: In the Long Run, We Screw Future Generations

Years ago, I taught an Intermediate Macroeconomics college class in which the required text was written by Keynesian disciple Wallace Peterson. In short, the book quoted the General Theory as though it were Scripture, and repeated the numerous economic fallacies that make up the structure of Keynes' book.

(I countered Peterson with Henry Hazlitt's The Failure of the New Economics, which I featured yesterday.)

So, in his post today, he repeats Keynes' silly phrase, "In the long run we are all dead," as though it had great economic value. Now, perhaps certain self-absorbed people might think that when they pass, there are no more generations, but in the real world, the present generation will hand off its economy to the generations of the future -- and in THAT long run, they will very much be alive.

Krugman uses this line to insist that we really cannot afford at the present time to get our financial house in order. We need to borrow, spend, inflate, all to give that perpetual motion machine called an "economy" enough "traction" to where it can move on its own without government spending.

Now, I would love to know what plant Professor Krugman occupies, for on that planet, spending exists to bolster production for its own sake. Indeed, spending replaces consumption, for in the Austrian paradigm, people acquire goods they believe will meet their needs by purchasing them in the marketplace. "Spending," in that view, is a purposeful activity done by individuals who wish to satisfy their needs.

However, on Planet Krugman, spending is an activity that is done for the sole purpose of keeping people "employed." It does not matter what is produced just as long as the government (or someone else) purchases it. If one steps back and takes a hard look at this paradigm, one can see that it is not "economics" at all, but rather something that turns production and exchange upside down.

Now, I can appreciate Krugman's point regarding the long and short runs. He is saying that if governments do not try to borrow and spend us into prosperity, then in the "long run," there will be no opportunity at all to bring prosperity, since the economy will be in permanent doldrums. He writes:

I mean, why shouldn’t we be focused on the business cycle? We’ve suffered the worst cyclical downturn since the Great Depression; in terms of unemployment and output gaps, we have recovered almost none of the lost ground. Millions of willing workers are idle because of lack of demand; let them stay idle, and we can turn this into a long-term structural problem, but right now it is precisely a short-term, cyclical problem.

When Krugman uses "demand," he means "aggregate demand," which economically speaking is a nonsensical term. There is no such thing as "aggregate demand;" Furthermore, people are trying to build up their savings precisely because they want to have some cushion for the future. If they are abstaining from some present spending, it is because of the current recession/depression.

In other words, personal cutbacks in spending are occurring because the economy is in recession; to say otherwise is to violate what Carl Menger calls The Law of Cause and Effect. Yet, Krugman and his followers continue to believe that the recession came about because people stopped spending, period.

I will go further. If governments cut back on present spending and start to get their financial houses in order, then the long run actually will hold much more promise than what will be the case if governments continue their suicidal attempts to spend resources that, frankly, we no longer have.

What "Expansionary" Policies?

OK, Paul Krugman is a True Believer. No matter what, according to the Nobel laureate, the government needs to spend and spend and spend because the economies of the world are in a giant "liquidity trap." However, in a recent blog post, he claims that any deviation from such policies of borrowing, printing, and spending simply is "horrifying." Horrifying?

Not surprisingly, Krugman turns back to Keynes for inspiration:

The case for expansionary policies in the face of a slump is intellectually difficult; Keynes described the writing of the General Theory as a painful process of discovery, and so it is. The natural instinct of almost everyone is to think that tough times require tough measures, and that if the economy is suffering, the government should tighten its own belt. It would take a clear consensus from economists to overcome that natural bias.

And that consensus has, of course, been lacking — largely because a significant proportion of the economics profession has spent the last three decades systematically destroying the hard-won knowledge of macroeconomics. It’s truly a new Dark Age, in which famous professors are reinventing errors refuted 70 years ago, and calling them insights.

This is nuts. Keynes refuted NO errors 70 years ago. His so-called refutation of Say's Law was a joke. First, he created a straw man and then, second, refuted something no one believed.

If anyone did any refutations, it was Henry Hazlitt in 1959 when he made mincemeat of The General Theory in his own book, The Failure of the New Economics. Hazlitt went through Keyne's "masterpiece" line by line, demonstrating how it was nothing but a tissue of fallacies.

There was no "hard-won" knowledge of macro, unless one believes that an economy is nothing but a bunch of aggregates, that prices are just numbers to go into an index, and that government creates wealth by printing money. Don't forget that this "hard-won" knowledge by 1980 was giving us double-digit inflation, high unemployment, and an economy in tatters.

So, Krugman wants us to believe that all we need is borrowing, spending, and lots of printing money. Oh, and costs are nothing but administrative numbers. This is not economics, folks, it is pure bureaucracy.

Paul Krugman Endorses Bernie Madoff!

In his post today, Paul Krugman unwittingly gives an endorsement of the disgraced Bernie Madoff, the Ponzi king who will die in prison, unable to spend the millions that he stole through fraudulent means. Yes, yes, I know that Krugman has not actually mentioned Madoff by name, but he does throw his considerable influence behind the financing of Social Security, which actually is the greatest Ponzi scheme in world history.

Now, before the defenders of Krugman go ballistic, I would love to ask Krugman and his followers this question: If Social Security is a legitimate funding scheme, then why is Bernie Madoff in prison? Let me further explain.

Krugman writes the following:

We went through all this at length back in 2005, but let me do this yet again.

Social Security is a government program funded by a dedicated tax. There are two ways to look at this. First, you can simply view the program as part of the general federal budget, with the the dedicated tax bit just a formality. And there’s a lot to be said for that point of view; if you take it, benefits are a federal cost, payroll taxes a source of revenue, and they don’t really have anything to do with each other.

Alternatively, you can look at Social Security on its own. And as a practical matter, this has considerable significance too; as long as Social Security still has funds in its trust fund, it doesn’t need new legislation to keep paying promised benefits.

OK, so two views, both of some use. But here’s what you can’t do: you can’t have it both ways. You can’t say that for the last 25 years, when Social Security ran surpluses, well, that didn’t mean anything, because it’s just part of the federal government — but when payroll taxes fall short of benefits, even though there’s lots of money in the trust fund, Social Security is broke.

And bear in mind what happens when payroll receipts fall short of benefits: NOTHING. No new action is required; the checks just keep going out.

Well, not exactly. The current "surpluses" from SS are borrowed by the U.S. Government to fund part of its deficit spending. Thus, the government owes the government money. While there are surpluses, the whole thing looks sound, but when there are deficits, the money needs to come from somewhere, and that will be the printing press or the Fed's application of its powers to create "money" from thin air.

If this sounds somewhat like Madoff's scheme, that is because it is Madoff with its own twist. When Bernie ran "surpluses," he paid benefits to people who already had given money to his "fund." However, at some point, the Madoff stash began to run deficits and everything went to hell after that.

Madoff, of course, could not print money, nor could he borrow from the central bank indefinitely. THAT is the only difference between SS and Madoff, period.

So, Krugman says that those who raise questions about the future of SS are "lying." No, they are not lying. They are those old-fashioned people who think that printing money is not the same thing as creating real wealth. So, who is not telling the truth here?

Spend Now and Save Later? Right

In the world of Keynesian economics, there really is no individual behavior that is purposeful. People don't "spend" because they believe that the purchase of a specific good or service will make them better off, but because they are "buying back the product" they have produced as workers.

This is what one might call circular logic, and it reminds me of the imaginary exchange that Professor Israel Kirzner used to explain the circular flow of Keynesianism:

FIRST PERSON to SECOND PERSON: Why do you eat breakfast?

SECOND PERSON: So I can go to work.

FIRST PERSON: Why do you go to work?

SECOND PERSON: So I can eat breakfast.

As I read Krugman's column this morning, I get that same sense of circularity, as he claims that we should be spending now to get the economy out of depression. Saving, he argues, can come in the future: "The responsible thing, then, is to spend now, while planning to save later."

Of course, when he speaks of "saving," he means government budget balancing, as though government were the only legitimate economic entity. In Krugman's view, government spending is a net plus; there is no real opportunity cost to borrowing and printing money. Instead, it is what Keynes called, "Turning stones into bread."

Furthermore, whatever the Congressional Budget Office presents (since Congress is controlled by Democrats) is taken as Gospel Truth:

At the moment, as you may have noticed, the U.S. government is running a large budget deficit. Much of this deficit, however, is the result of the ongoing economic crisis, which has depressed revenues and required extraordinary expenditures to rescue the financial system. As the crisis abates, things will improve. The Congressional Budget Office, in its analysis of President Obama’s budget proposals, predicts that economic recovery will reduce the annual budget deficit from about 10 percent of G.D.P. this year to about 4 percent of G.D.P. in 2014.

Unfortunately, that’s not enough. Even if the government’s annual borrowing were to stabilize at 4 percent of G.D.P., its total debt would continue to grow faster than its revenues. Furthermore, the budget office predicts that after bottoming out in 2014, the deficit will start rising again, largely because of rising health care costs.

This whole thing is predicated upon the Keynesian "solution" of massive borrowing and printing of money actually bringing about a recovery. However, what if this continues to make things worse?

He gives healthcare costs as a future problem, but what is his solution? Give the state more power:

So America has a long-run budget problem. Dealing with this problem will require, first and foremost, a real effort to bring health costs under control — without that, nothing will work. It will also require finding additional revenues and/or spending cuts. As an economic matter, this shouldn’t be hard — in particular, a modest value-added tax, say at a 5 percent rate, would go a long way toward closing the gap, while leaving overall U.S. taxes among the lowest in the advanced world.

Again, he speaks of lowering costs as being an administrative issue, as though government can simply order "costs" to be lower. That is nonsense. Costs are opportunity costs, but Krugman treats them as simply numbers that government can order to be lower, and that's that. Once again, he sees an economy simply as an administrative entity that can be controlled by fiat.

It is true that while he calls for a five percent Value Added Tax, he does hold to his Keynesian roots in saying that this is not the time for new tax increases. Yet, I have seen him writing NOTHING critical about current attempts by Congress and state governments to raise taxes, and he even has hinted that perhaps we should go back to the old rates that existed before 1981. (He told a public gathering at the Southern Economic Association meetings in 2004 -- in response to my question -- that the old rates were "insane," but he seems to have been backtracking some since then.)

So, while Krugman is being somewhat consistent with Keynesian thinking, he has not dealt with the problem of massive malinvestments in the economy, made worse by government policies. To Krugman, of course, there is only spending, so there can be no malinvestments -- by definition. There is only the administrative, fiat economy.

That 30's Mistake

Continuing with his theme of "spend, spend, spend," Paul Krugman is determined to claim that the free-spending governments of the West really are engaging in "austerity." Of course, not only does he get the New Deal wrong (and he really gets it wrong), but also is wrong about what happened in 1937.

First, with the U.S. Government running multi-trillion-dollar deficits, the notion that spending is anything but wild and wasteful is a fantasy in itself. For Krugman to claim that the government is involved in an austerity program is ridiculous, but here it is:

Suddenly, creating jobs is out, inflicting pain is in. Condemning deficits and refusing to help a still-struggling economy has become the new fashion everywhere, including the United States, where 52 senators voted against extending aid to the unemployed despite the highest rate of long-term joblessness since the 1930s.

Many economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession.

So, because of a vote regarding a relatively small amount of unemployment compensation funds, suddenly the government is going bare bones. Please.

Second, the depression within a depression in 1937-38 did not come because FDR decided to balance the federal budget. Instead, as Robert Higgs noted in this 1997 paper in the Independent Review, while the Federal Reserve System raised interest rates slightly, nonetheless the real problem came from the White House and its continuing attacks on private capital. Higgs quotes historian Elliot Brownlee, who wrote:

...the tax reform of 1935–37, more than any other
aspect of the New Deal,…stimulated business hostility to Roosevelt.…
[B]usiness opponents of New Deal tax reform charged that Roosevelt’s taxes,
particularly the undistributed profits tax, had caused the recession [of 1937–
38] by discouraging investment....

Furthermore, FDR made it clear after his re-election in 1936 that he was going to tax businesses into oblivion. As Prof. Higgs notes:

Although historians emphasize the president’s defeats with respect to taxation in the late 1930s, contemporary businessmen must have appreciated the reality of increased taxation: in fiscal 1940, with the depression still lingering, the federal government collected 57 percent more total revenue than it had in the prosperous year.

Now, I don't expect Krugman to understand this point, because to him, private capital spending is no different than government spending, and if "capital is on strike" (as FDR declared), then if government makes up the difference through borrowing and printing money, it is just as good. This is something that an economist -- even a Keynesian -- should recognize as being silly.

However, as I read Krugman, I have come to realize that he sees absolutely no difference in government spending and private capital expenditures. Assets really ARE homogeneous, in his view, and there are no real economic fundamentals. Of course, he also wants to demonize anyone who disagrees with him by declaring that anyone who thinks that government spending is out of control is doing ONLY because he or she hates poor people and wants others to suffer. Krugman in his own words:

In America, many self-described deficit hawks are hypocrites, pure and simple: They’re eager to slash benefits for those in need, but their concerns about red ink vanish when it comes to tax breaks for the wealthy. Thus, Senator Ben Nelson, who sanctimoniously declared that we can’t afford $77 billion in aid to the unemployed, was instrumental in passing the first Bush tax cut, which cost a cool $1.3 trillion.

First, "tax breaks for the wealthy" is nothing more than political talking points, and I have an aversion to academic economists acting like political operatives. Second, Krugman assumes that any cuts in tax rates have as their ONLY effect the lessening of revenue. There are no benefits at all, only costs.

This is interesting, as Krugman is saying that any money spent or invested privately, then, carry absolutely no benefits to anyone except the people whose taxes are cut, and that those benefits are completely offset by pain inflicted on others. This is not even economics; it is nothing but political leftism.

I wish that governments actually WOULD go on real programs of slashing spending and reducing its burden. What I find from Krugman, however, is that he views government spending and taxation as a net plus, but private investment and spending is only a cost. So, why should there be any private spending and property at all? If we are to follow Krugman's logic, then the state should take over everything. Then we could be prosperous like the Cubans and the North Koreans!

The government's "mistake" of the 1930s was not balancing its budget. No, its "mistake" was believing that government could control private enterprise, raise taxes, and increase the burdens that governments place upon individuals, and somehow out of that would rise prosperity. Apparently, Krugman continues to perpetuate that myth.