Monday, June 28, 2010

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.


Unknown said...

Also while Mises might not have had a Nobel prize, his contempary Hayek did, and specificly for his work on the business cycle...

Then again if Obama can win one for being elected president, it just goes to show how meaningless the award is.....

Anonymous said...

Prof. Anderson, check this out:

The Fed Has Lost It; Publishes Essay Bashing Bloggers, Tells General Public To Broadly Ignore Those Without An Econ PhD

Methinks the Fed doth protest too much.

William L. Anderson said...

Thanks for posting it. I had read it earlier and found it to be the typical "elitist" mentality. It is: "I passed my grad comps and did meaningless mathematical models, so I must be a great economist."

In truth, one does not have to be a mathematician or even a college graduate to understand the fundamentals of economic thinking. Furthermore, if "educated" people are claiming that money is wealth, then perhaps we need to be asking if their graduate program actually taught econ!

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Health Freedom of Choice Blog said...

When you think about it, what better position for a wants-to-be-popular "economist" than to endorse what politicians want to do anyway, namely "spend, spend, spend..." in such a way that no matter how much they spend, when the effort fails (as fail it must) he can always say, "You didn't spend enough..."

Anonymous said...

"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." No, the reason that he and most sane people believe that "spending for the sake of spending" - in the real world people propose spending on reasonable government projects - would get a country out of a recession, is because it is backed up by logical theories and by empirical evidence, dating back to ancient times. "Religious belief" seems more appropriate for "Current spending by government does not create wealth" So building a needed bridge, or financing scientific research does not create wealth? Can anyone really believe such nonsense? Or just intone it as an article of faith?

Anonymous said...

I'm doing my part to improve the economy by breaking windows.

Anonymous said...

In all seriousness, do you ever look at economic data? Do you look at historical data, charts, facts, graphs?

To say the deficits in the early 80's was brought on by a fall in tax revenues due to the recession is utter nonsense. Spending exploded in the early 80's. And every defense company in the country will tell that government spending does create wealth, for them at least.

And, by they way, taxes were cut by $264B in 81, which, of course, helped push tax revenues down during the recession, adding to the deficit. So to say the deficits of the early 80's were brought on only because of a fall in tax revenues due to the recession is 100% false. It was spending AND tax cuts.

And of course, you completely ignore the fact that beginning in 82, US consumers began to lever up, thus beginning the credit bubble that we are dealing with today.

But wait, you said credit creation does not create wealth (of course, common sense will tell you that wealth can not be created with out credit creation, but common sense seems to be missing from this blog).

So what is it: was the recovery of 82 a sham, or did consumer credit creation combined with falling interest rates and government spending generate the amazing recovery of 82 you continuously refer to?

Sorry, but once again, your lack of acknowledging simple facts and data, and childish, snide, comments, lands you in wonderland w/ Krugman.

Bob Roddis said...

The 80s also got started with Democrat Volker raising interest rates to 20% for a substantial period. Those high rates cleaned out a lot of malinvestment. Of course tax cuts and tax rate indexing helped the economy thereafter too.

The fact that there were deficits thereafter does not in any way prove that deficits help the population in general get richer. They got richer despite such excess government spending.

There is no logical, historical or factual basis to support the Keynesian ruse. The 80s sure don't help either.