The Market, not the Central Bankers, Should Decide Interest Rates

Like Paul Krugman, I have little or no pity for the Banksters who are demanding that the rest of us stop saying nasty (and true) things about them. Unlike Paul Krugman, I believe that interest rates should be permitted to rise -- if that is where the market says they should be.

Krugman claims that Banksters believe that low interest rates are "feeding inflation," something he claims is not true. Yes, oil prices are rising, and so are gold and other commodities, but Krugman has an explanation for that: natural volatility and "emerging markets." (He also appeals to the same excuse that the Soviets used to explain decades of bad harvests: bad weather.)

Here is the problem: interest rates should not be decided politically. According to Krugman, any raising of rates will trigger a new bout of unemployment, and at one level he is correct. However, the artificially low interest rates that Krugman endorses are having the perverse effect of preventing the necessary relocations in the economy that will bring about a recovery. Explains Bob Murphy:

...at some point reality rears its ugly head. The central bank hasn't created more resources simply by buying assets and lowering interest rates. It is physically impossible for the economy to continue cranking out the higher volume of consumption goods as well as the increased output of capital goods. Eventually something has to give. The reckoning will come sooner rather than later if rising asset or even consumer prices makes the central bank reverse course and jack up interest rates. But even if the central bank keeps rates permanently down, eventually the physical realities will manifest themselves and the economy will suffer a crash.

During the bust phase, entrepreneurs will reevaluate the situation. If the government and central bank don't interfere, prices will give accurate signals about which enterprises should be salvaged and which should be scrapped. Those workers who are in unsustainable lines will be laid off. It will take time for them to search through the developing opportunities and find a niche that is suitable for their skills and is sustainable in the new economy.

During this period of reevaluation and search, the measured unemployment rate will be unusually high. It's not that workers are "idle," or that their productivity has suddenly dropped to zero; rather, it's that they need to be reallocated, and that takes time in a complex, modern economy. This delay can be due to simple search, where the workers have to look around to find the best spot that is already "out there," or it can be due to the fact that they have to wait on other workers to "get things ready" before the unemployed workers can resume.

Since Krugman holds that factors of production (for analytical purposes) are homogeneous, then raising interest rates makes no sense, as all that needs to happen is for government to stimulate more spending, which then will automatically translate to producers ramping up their productions lines, and all soon will be well. If this were the case -- and it did not matter where capital investments were made -- then Krugman would be correct.

However, if factors from labor to capital ARE heterogeneous, and that the value relationship between those factors matters, then Krugman actually is fighting against the very necessary economic readjustments that are needed to create a meaningful recovery. Furthermore, we forget that this country had an economic recovery -- a substantial recovery -- in the 1980s even though interest rates were substantially higher than they are now. The image below demonstrates my point:

Now, it is true that interest rates fell during the recovery, but they still remained in double-digits through much of the 1980s when the economy was going strong. Unfortunately, because Krugman continues to stick to his "aggregate demand" thesis, all of this to him is white noise.

As I see it, the issue is not whether the government or central bank or anyone else should decide if interest rates rise or fall. I want to know what the market says about rates of interest, and I cannot help but believe that with the Fed trying to flood the world with dollars, that they are going to go up sooner rather than later. But they will rise.

We Have Reached the Goal!

Yes, two days before the campaign on The Point, we have passed the $5,000 threshold. Johanna and I are thankful to God and thankful for all of you who have contributed. (If you still wish to contribute, you can do so.)

This will be used to help with the up-front agency fees and the like.

Best wishes to all of you. Thanks!!

Our "Point" Fundraising Efforts

At the top of this blog, you see the icon for The Point, which is an effort on our part to raise $5,000 by Monday, January 31, in pursuit of our adoption of a girl from Latvia. If we don't reach our goal, then we receive none of what has been pledged.

This is not part of an on-going campaign. We intend to finance most of the $30,000 needed ourselves, mostly by cutting way back on spending and by my picking up extra work on the side. Nonetheless, we are about $2,400 from our goal and hope that anyone who wishes to pledge will do so.

Thanks.

A "War on Demand" or a War on Reason?

In a recent blog post, Paul Krugman is all atwitter over what he perceives to be a "widespread attack on demand-side economics." Not surprisingly, in his defense of Keynesianism, he manages to launch his own misguided attack on anyone who might think that "aggregate demand" is not an economic concept.

He writes:

...we’re seeing a much more widespread attack on demand-side economics. More than that, it’s becoming clear that many people don’t so much disagree with the idea that demand matters as find it abhorrent, incomprehensible, or both. I fairly often get comments to the effect that I can’t possibly believe what I’m saying about monetary or fiscal policy, that no sensible person could believe that printing money or engaging in deficit spending will increase output and employment — never mind that all I’m saying is what Econ 101 textbooks have been saying for the last 62 years.

First, the fact that something might appear in a textbook -- even for 62 years -- does not make it correct. It seems that Krugman is taking a chapter out of the "market test" view of economics that the Chicago School has used in an attempt to discredit the Austrian School.

Krugman, like Keynes, bases his viewpoint on a misstatement of Say's Law, in which he presents a caricature of what J.B. Say wrote in his Chapter XV of Book I in A Treatise on Political Economy. He writes:

First, Keynes was right: Say’s Law — the notion that income must be spent, and hence that supply creates its own demand — really is at the heart of the issue. Many, many people just can’t see how it’s possible for there to be an overall shortfall of demand.

Number one, what Krugman writes is NOT Say's Law, not even close. It is what Krugman and others of his intellectual generation WANT Say's Law to proclaim, yet as one who has read this chapter many times and who published a paper a year ago on it, I can say that what Krugman has written is nonsense.

The chapter in question dealt with the very issues Krugman raises, although it was done more than 130 years before The General Theory was written. In Krugman's caricature, he misinterprets Say's chapter as being written to claim that "aggregate demand" always is sufficient to purchase everything that is produced, as though it is impossible for there to be what Thomas Malthus and others claimed would be a "glut of commodities" that would exist because people would not spend their income.

Say did not deny that there could be a "glut" at times; in fact, he addresses that very issue, beginning with a situation in which there are unsold goods and the economy seems to be in the tank. (This should be a tipoff to the intellectual dishonesty of Krugman's position; Say addresses the very thing that Krugman claims that Say claimed was impossible.)

What Say did argue, and what I have argued in the paper I linked, was that there could be proportional imbalances in the economy, that there would be -- at least temporarily -- "too much" of something produced (Housing bubble, anyone?) and simultaneously, too little of something else.

However, what Say does not do is to lay out the causes of such problems. In his chapter, he only addresses the pre-Keynes/Krugman argument that the problem is due to a lack of "aggregate demand" (they did not use that term in 1803) brought about by a lack of money or a "general overproduction."

The issue Say covered was the source of demand itself: production of goods that could be traded for other goods. Keynes, and later Krugman, would argue that because people are paid in money for producing things, and because they have a tendency to save (and especially the wealthy, which is why Krugman believes that they should be taxed at higher rates -- so government will spend that money), that the market system itself has an internal contradiction that always leads to the problem of overproduction/underconsumption.

Say demolishes that argument in his Chapter XV, and I would invite readers to look at it for themselves, as opposed to taking Krugman's interpretation as gospel. However, Krugman is not satisfied at just attacking that point of view. No, he has to claim that anyone who thinks J.B. Say had a good point is doing so because of irrational moral scruples:

It’s becoming clear to me that a substantial number of writers on economics find the whole idea that the economy can suffer because people are too thrifty, insufficiently willing to spend, deeply repugnant. I’m the sort of person who finds the notion that sometimes virtue is vice and prudence folly interesting; but it’s clear that a number of people find that notion just plain evil. The world shouldn’t be like that — and therefore it isn’t.

And so he continues:

It’s kind of shocking if you think about it. Here we have a huge, hard-won intellectual achievement, one that accounts very well for the world we actually see, and yet it’s being thrown away because it doesn’t go along with ideological preconceptions. Once that sort of thing starts, where does it stop? The next thing you know, the theory of evolution will get the same treatment. Oh, wait.

In other words, this is not an argument about the efficacy of savings versus investment or even the perceived role of "aggregate demand." No, it is an argument between the Smart People (like Krugman) and the Yahoos who are so stupid that they might even believe in Creationism, which every writer at the NY Times knows is a notion that only Really Stupid and Immorally-Ignorant People will embrace.

In other words, in the end, this isn't even an argument about economic theory. No, it is not worthy even of argument. Krugman is saying that those people who disagree with his Keynesian views are so ignorant and so lacking of any regard at all that it would be better for the world if they were not alive. And they certainly deserve not even to be in the presence of Krugman at all, unless, of course, they agree to be treated as people once regarded children: people to be seen but not heard.

Does Anyone Understand the Meaning of "Competitiveness"?

OK, I start this post by agreeing with Paul Krugman this morning that the term "competitiveness" is hackneyed and essentially meaningless. However, as I read Krugman's column today, I think that Krugman has come to believe that all that is needed to make our economy more "competitive" is for the Fed to print more money and the government to spend it.

That's right; we need to be Number One in spending. That will revitalize the U.S. economy, at least according to Krugman, who sees "jobs" in and of themselves as the sign of a truly "competitive" economy:

It’s true that we’d have more jobs if we exported more and imported less. But the same is true of Europe and Japan, which also have depressed economies. And we can’t all export more while importing less, unless we can find another planet to sell to. Yes, we could demand that China shrink its trade surplus — but if confronting China is what Mr. Obama is proposing, he should say that plainly.

Furthermore, while America is running a trade deficit, this deficit is smaller than it was before the Great Recession began. It would help if we could make it smaller still. But ultimately, we’re in a mess because we had a financial crisis, not because American companies have lost their ability to compete with foreign rivals.

This demands a larger question, which Krugman does not ask: Why did we have a financial crisis in the first place? The secondary question is this: What needs to be done in order to bring the economy into a recovery, given we have had a financial crisis?

For Krugman, the answer is simple because his view of an economy is simple: Increase government spending. He writes:

The favorable interpretation (of President Obama's new "competitiveness" initiative), as I said, is that it’s just packaging for an economic strategy centered on public investment, investment that’s actually about creating jobs now while promoting longer-term growth. The unfavorable interpretation is that Mr. Obama and his advisers really believe that the economy is ailing because they’ve been too tough on business, and that what America needs now is corporate tax cuts and across-the-board deregulation.

My guess is that we’re mainly talking about packaging here. And if the president does propose a serious increase in spending on infrastructure and education, I’ll be pleased.

He further adds:

The financial crisis of 2008 was a teachable moment, an object lesson in what can go wrong if you trust a market economy to regulate itself. Nor should we forget that highly regulated economies, like Germany, did a much better job than we did at sustaining employment after the crisis hit. For whatever reason, however, the teachable moment came and went with nothing learned.

In both cases, Krugman employs the non sequitur as his rhetorical device. In the first quote, he assumes that if the government suddenly starts more public works construction jobs and showers new money on government schools, that the economy will regenerate itself (or at least start on the path to regeneration).

In the second quote, he creates the syllogism:

• Germany's economy has more regulation than that of the USA
• German employment losses have not been as great as those in this country
• Therefore, a more heavily-regulated economy creates more prosperity.

This ignores the particular areas of regulation, as it makes a blanket statement about regulation but fails to deal with any specifics. Furthermore, throughout the column, Krugman has only one standard for prosperity: employment.

It reminds me of a television debate that a Marxist "economist" had with a "free-market" economist about 30 years ago. The second economist had just come back from Romania and he was pointing out how poor the people were and how badly things worked there.

The Marxist replied (as though this statement trumped everything else), "But there is no unemployment there." In other words, having an official "job" as named by the government was the ultimate sign of prosperity and "competitiveness," and while Krugman is not claiming (at least I don't think he is claiming) that Romania under Nicolai Ceaucescu's tyrannical government was superior to whatever we had in this country, nonetheless he uses the employment standard as though nothing else matters.

In fact, he contrasts his ideal government policy with private business, writing:

Consider: A corporate leader who increases profits by slashing his work force is thought to be successful. Well, that’s more or less what has happened in America recently: employment is way down, but profits are hitting new records. Who, exactly, considers this economic success?

Again, we are seeing the non sequitur at work. According to this statement, Krugman seems to believe that workers are pure cost, and that the more layoffs a company has, the greater its profitability will be. Thus, he reasons, a "competitive" private economy will have high unemployment AND high profits, which means that a "competitive" private sector actually is BAD for an economy and for human welfare in general.

Krugman demonstrates the typical macroeconomic view of an economy, seen through aggregates and the false belief that all factors of production are homogeneous and that there is no connection between production and consumption. However, no company becomes more profitable simply by having mass layoffs. Layoffs are a response to changes in consumer choices for the final products made by the firm. Labor is a factor of production, a heterogeneous factor; labor is meaningful as it applies to production, and if its discounted marginal revenue product falls to less than its marginal cost, then a company is wise to jettison that factor, just as it jettisons other factors that become cost burdens.

Furthermore, an economy cannot grow unless entrepreneurs find ways to make more final goods while using fewer resources. At the same time, a growing economy finds ways to take the temporarily unused resources and apply them to other productive uses.

Krugman, however, sees no connection between resources and economic growth. For example, he has written that we can "rebuild" our economy via "green energy," yet none of those industries are able to survive without government mandates, special tax breaks, or outright subsidies.

To an economist, there is a fundamental difficulty with a so-called green economy: it cannot stay afloat without cannibalizing the healthy and profitable areas of production. To Krugman, however, it is all just a matter of spending, and if government borrows and taxes and regulates in order to force Americans to purchase products they don't want, then that is good for the economy.

True, I have used a non sequitur, but that is what Krugman seems to be saying. In his view, the only thing that matters is employment. If government spends and hires people to engage in "jobs," then prosperity will follow, as all that matters are aggregates.

That makes no sense, economically speaking. If Krugman is right, and if the primary issue is simply "creating jobs" so that people can have an income, why do we need production at all? Wouldn't it be even better if the Federal Reserve System just printed zillions of dollars and left bags of money with each person? Since "spending" magically leads to everything else, why wouldn't that be a perfect solution to our problems?

To Krugman, an economy is a mass of numbers and nothing else. There are no relative prices and no interrelationships between factors of production. Thus, to him, "competitiveness" is based on the rate of unemployment, which means that there is nothing in his viewpoint that would have refuted the Marxist I heard 30 years ago claim that Romania's economy -- under which most people in that country lived in poverty -- was superior to that of the United States.

Krugman's Nixonian Anti-Chinese Screed

Paul Krugman has gone to great lengths to blame China for the current economic depression that the USA and other nations are suffering. Yes, it those dastardly Chinese saved too much; they hold down the real value of their currency; they don't charge enough for their goods, and on and on and on.

In today's NYT column, Krugman goes on another anti-China screed, although at least he does have some lucid moments. So, let us begin. Krugman writes:

The root cause of China’s muddle is its weak-currency policy, which is feeding an artificially large trade surplus. As I’ve emphasized in the past, this policy hurts the rest of the world, increasing unemployment in many other countries, America included.

However, as Don Boudreaux correctly points out, it seems that Krugman contradicts himself later. Krugman says:

But a policy can be bad for us without being good for China. In fact, Chinese currency policy is a lose-lose proposition, simultaneously depressing employment here and producing an overheated, inflation-prone economy in China itself.

One way to think about what’s happening is that inflation is the market’s way of undoing currency manipulation. China has been using a weak currency to keep its wages and prices low in dollar terms; market forces have responded by pushing those wages and prices up, eroding that artificial competitive advantage. Some estimates I’ve heard suggest that at current rates of inflation, Chinese undervaluation could be gone in two or three years — not soon enough, but sooner than many expected.

China’s leaders are, however, trying to prevent this outcome, not just to protect exporters’ interest, but because inflation is even more unpopular in China than it is elsewhere. One big reason is that China already in effect exploits its citizens through financial repression (other kinds, too, but that’s not relevant here). Interest rates on bank deposits are limited to just 2.75 percent, which is below the official inflation rate — and it’s widely believed that China’s true inflation rate is substantially higher than its government admits.

Rapidly rising prices, even if matched by wage increases, will make this exploitation much worse. It’s no wonder that the Chinese public is angry about inflation, and that China’s leaders want to stop it.

But for whatever reason — the power of export interests, refusal to do anything that looks like giving in to U.S. demands or sheer inability to think clearly — they’re not willing to deal with the root cause and let their currency rise. Instead, they are trying to control inflation by raising interest rates and restricting credit.

Boudreaux counters:

In short, Beijing keeps the value of the yuan too low by buying dollars with newly created yuan – a policy that Mr. Krugman correctly recognizes to be inflationary.

But as we read on to paragraph ten, we find Mr. Krugman singing an altogether different dirge. He there complains that Beijing now is “trying to control inflation by raising interest rates and restricting credit. This is destructive from a global point of view: with much of the world economy still depressed, the last thing we need is major players pursuing tight-money policies.”

If the “root cause” of the low value of the yuan is Beijing’s inflationary monetary policy – and if this policy harms, as Mr. Krugman says, both China and the rest of the world – why does Mr. Krugman scold Beijing for tightening its monetary policy?

That is a good question. Now, in fairness to Krugman, he is claiming that the proper course of action is for China's government to permit the value of the Chinese currency to rise against the U.S. Dollar, which would make Chinese goods more expensive for Americans.

Krugman reasons that such a policy would shrink China's trade surplus with this country, and that is true. For that matter, I believe that such a policy is more harmful to China than it is to the USA because that means the Chinese are holding dollars which are falling in value and the value of U.S. Government debt also is going to decline.

To put it another way, Americans get Chinese goods, and the Chinese get American paper. Krugman believes that is a better deal for China, and a really bad deal for this country.

Why? He claims that such policies reduce "aggregate demand" in the USA and jack up the rate of unemployment. However, if the end of production is consumption, then China's policy means that Americans are not having to pay the full freight for goods they get to use. (The Chinese at the same time are having to pay more for the goods they produce, which means that the government policy is making them poorer.)

Krugman's perspective is that of a Keynesian, and Keynesians get things backward. To a Keynesian, the purpose of production is, well, production. That is why Keynesians will claim that World War II "ended the Great Depression," because they look at GDP and the rate of unemployment and nothing else.

During World War II, Americans experienced high levels of deprivation that were every bit as serious as what they experienced during the Great Depression. Yes, everyone had a job and money in their pockets, but neither meant that much, as goods were rationed or difficult to find.

I don't support what the Chinese government is doing, but as I see it, the greater victims are the Chinese, not the Americans. China is not responsible for our near-10 percent rate of unemployment; U.S. Government policies from both the Bush and Obama administrations are responsible.

When Nixon faced a huge financial crisis in August 1971, his response was not to look inward, but instead to blame the rest of the world. Economically speaking, his administration was a disaster.

While Krugman recognizes that Nixon's policies of imposing price controls was futile, he never does seem to understand that if China imposes such controls on itself, that the Chinese will bear the brunt of the trouble, not Americans. But even here, I must admit to being puzzled. After all, during the California electricity crisis of a decade ago -- a crisis caused primarily by the fact that the state imposed price controls on the same of electricity -- Krugman claimed that price controls would result in more supply and lower prices.

So, if he holds to that same belief today, then I would think he would be applauding the latest actions of the Chinese government. Go figure.

Yes, Paul, Bob Murphy Exists -- and He is a Better Economist than You Are

So, after shunning debate and the like, Paul Krugman finally admits that Robert Murphy exists, although I hardly think that what Murphy wrote constituted as "puerile insults." Yes, this comes from a person who mocks people who disagree with him as "zombies." No immaturity there.

The article to which Krugman refers is this one on capital theory, something that is missing from Krugman's Keynesian analysis as well as from the old Chicago School. (In their view, capital magically appears, as economists simply can assume it into existence. Don't try this at home.)

I think that Krugman and Murphy can argue this on their own without any help from me. Here is Murphy's post on his own blog regarding Krugman's post. Read and enjoy.

(I am back from speaking to the Gulf Coast Economics Club in Pensacola. A great time was had by all, and now it is time to get to work at my day job.)