Thursday, January 3, 2013

No, Paul, Wealth Transfers are NOT a "Free Lunch"

One of the first principles that supposedly is taught in formal economic study is the Law of Opportunity Cost, with the simple acronym being TANSTAFL: "There ain't no such thing as a free lunch." From that hallowed halls of Princeton University, the Land of Privilege, the view is different.

At Princeton University, economists (and probably people in all of the other departments) teach that government is magic, and that financial trickery is the same thing as creating wealth and bringing about legitimate economic growth. Or, to put it another way, Paul Krugman claims that at certain times (when the "lower bound" of interest rates is zero -- the Keynesian "Liquidity Trap"), that financial tricks can create the "free lunch." (Those are his words, not mine.)

In a recent blog post, Krugman once again claims that tricks can create the "free lunch," which matches what he claims in his book, The Return of Depression Economics. (Once assigned the book as reading for my MBA students, and even many of them were able to see the holes in Krugman's arguments. But, then, The Great One is not known for arguing, preferring the insult and the appeal to academic privilege instead.)

He lays out some scenarios, such as outright printing money or having the Treasury mint a three-trillion-dollar platinum coin and deposit it at the Federal Reserve System, but says they are not feasible? Why? There is a legal debt ceiling set by Congress, which I gather from this post is the only thing keeping these schemes from being realistic. He writes:
In reality, to pursue the thought further, the coin really would be as much a Federal debt as the T-bills the Fed owns, since eventually Treasury would want to buy it back. So this is all a gimmick — but since the debt ceiling itself is crazy, allowing Congress to tell the president to spend money then tell him that he can’t raise the money he’s supposed to spend, there’s a pretty good case for using whatever gimmicks come to hand.
Krugman's next comment is even more puzzling, given what he has written in the past:
It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.
But why should that matter, given Krugman's earlier statements that (1) the Fed should be permitted to purchase short-term Treasury paper in the primary market, thus monetizing the federal debt directly, and (2) that public debt is not much of a problem, since "we owe it to ourselves."

He goes on:
We are living in weird economic times, where many of the usual rules don’t apply and there are big free lunches to be had. But not everything is a free lunch, even now.
 'Tis true, we are in weird times. But those times are better explained by the Austrian Business Cycle Theory than the contradictory madness that comes from Krugman who apparently was for printing money before he was against it.

The vast pull-the-rabbit-out-of-the-hat schemes by the Fed in the end are little more than naked wealth transfers. By propping up the financial institutions that made bad decisions, the Fed is disregarding price signals and rewarding the people who made bad decisions at the expense of those that didn't. Wealth transfers might perform political miracles -- the last election proved that point -- but they are not free lunches. Indeed, they are very expensive lunches, much more costly than should be the case.


Mike said...

Krugman: “which means selling off the Federal debt it bought.”

Sell it to whom???

Krugman :“So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.”

Yup. In the form of a depreciated currency and reduced standard of living.

ayassos said...

Prof. Anderson, thank you for taking this latest Krumania on. I think the esteemed NYT columnist has finally slipped his tether altogether. Krugman has never been very good at explaining things, but this "explication" takes the cake. Regarding the trillion dollar platinum coin, which would take care of the deficit for one year. He states that "eventually the Treasury would want to buy it back." But why? If the Treasury can issue a token which allows the Fed to print a trillion dollars and spend it into the general economy through government spending, why the necessity of "retiring" the coin? Bernanke could put it into his desk drawer and say it doesn't exist anymore. Problem solved. There is no "debt instrument" created along with the coin, so there's no obligation to extinguish. The Constitutional point is that the coin itself has intrinsic value equal to what Congress says it has. Krugman says let that value be $1 trillion. This "gimmick" is not part of the Fed Reserve Treasury/money printing operation. So why would the Treasury need to replace something with a value of $1 trillion with $1 trillion in cash which the Treasury would have to borrow? And as you suggest, why stop there? Why not finance the government with platinum coins? Issue one for $4 trillion each year, deposit it with Bernanke, and when the year is up, Bernanke throws the coin into the used drawer. If we're going to have a free lunch, let's eat!

Mike said...

Krugman’s “trillion dollar platinum coin” scheme is just more obfuscation tactics that he so loves. Among the many fallacies in his example are:

The marketplace values the coin, not fiat pronouncement by the biased parties.

The Treasury doesn’t have a Trillion dollars to make the coin.

To get the Trillion it either has to borrow it (no advantage for the example) or take it away from its citizens via taxation thus substituting government spending for private sector spending and investment.

The Treasury would need to get a Trillion dollars net to buy the coin back. No chance of that happening.

They can’t deflate the currency under this scheme to buy the coin back as the real value of the metal would adjust upward accordingly.

Krugman says “We are living in weird economic times…”

Well what’s weird is the continued adolescent, narcissistic immediate gratification mindset that continues all under the guise it will never change and never have to be paid for.

This would be all entertaining but for the ugly reset that is coming.

Dinero said...

If the government keeps dipping into the central bank to fund its actions then that brings up the issue of the democrtaic legitamcy of those actions as they do not involve the general population by taxation

Tel said...

There must be at least *some* free lunch available, otherwise there would be no point having an economy at all.

If I have plenty of chickens but I want a pig, and my neighbour has plenty of pigs but wants a chicken then we trade and we both get what we want. Thus the trade makes everyone better off and we all enjoy our free lunch. In the bigger picture, division of labour and specialization makes each individual more efficient so when we trade with each other we get more done between us.

Therefore it IS possible to have a free lunch based around improved organization and better opportunities for mutual gain. Whether Krugman's approach can achieve that is another issue, one strong indicator of a scam is to hear, "none of the normal rules apply here" because someone is trying to break down your normal common sense.

Dinero said...

Paul Krugman, now mr "hard money man", doesn.t explain why he only thinks gvmt debt is a problem when it is held by the public. Considering that as for the captital sum the bond holders are only getting their own money back, is it the interest he is focusing on.

Pulverized Concepts said...

No, Tel, there is no free lunch, period. To get one of the neighbor's pigs you had to give up a chicken. Seems like a good deal but it's not free.

Krugman has slid, or maybe careened, into the fantasy statist world of MMT.

William L. Anderson said...

I think that Tel is confusing the "free lunch" (creation of something from nothing) with gains from trade. The second still requires trade and giving up of something scarce in order to obtain something else that is scarce.

If the exchange is successful, there are individual gains from trade in which both parties believe themselves to have been made better off. That is not a "free lunch," but rather a "surplus" gained from one's actions.