Thursday, February 28, 2013

Ben Bernanke, Inflationist

Hail, Ben Bernanke! He has received praise from on high, or at least from someone on the Princeton faculty (lavishing accolades upon the former chair of the economics department). Paul Krugman has taken notice that Bernanke isn't about to be the skunk at the party. No, Uncle Ben wants us and our government to spend as though there is no tomorrow. (And with Bernanke running things at the Fed, there very well might not be a tomorrow.)

Krugman compares Bernanke's call for more inflation and expansion of government spending with the earlier opposition some people had to the war in Iraq. (The idea here is that having the courage to speak out against a war in its early stages when the war was popular is the same as having the "courage" to call for the Fed to print more money.)

That's right. Krugman wants us to believe that it takes real courage for someone to demand that the government pretend as though the economy is doing well by borrowing, taxing, printing, and, of course, spending. (Of course, wars entail government spending, lots of government spending, so how could a Keynesian be against that?) Yes, yes, Ben Bernanke also believes in the Inflation Fairy.

In reading Krugman and now Bernanke, I have come to understand that these men see no downside at all in runaway government spending. There is no transfer of wealth from individuals to the state and then to politically-connected people; no. government spending in and of itself creates wealth. Thus, when governments spend money, they actually are producing consumption (or something like that).

Krugman gives all of the usual accolades to government spending (We don't have near enough of it), but my favorite portion of his column is what follows:
The point is not that Mr. Bernanke is an unimpeachable source of wisdom; one hopes that the collapse of Alan Greenspan’s reputation has put an end to the practice of deifying Fed chairmen. Mr. Bernanke is a fine economist, but no more so than, say, Columbia’s Joseph Stiglitz, a Nobel laureate and legendary economic theorist whose vocal criticism of our deficit obsession has nonetheless been ignored. No, the point is that Mr. Bernanke’s apostasy may help undermine the argument from authority — nobody who matters disagrees! — that has made the elite obsession with deficits so hard to dislodge.

And an end to deficit obsession can’t come a moment too soon. Right now Washington is focused on the idiocy of the sequester, but this is only the latest episode in an unprecedented run of declines in public employment and government purchases that have crippled our economy’s recovery. A misguided elite consensus has led us into an economic quagmire, and it’s time for us to get out.
So,there you have it. The CAUSE of the current economic malaise is the lack of government spending. Now, since government spending comes the wealth government confiscates from private individuals who actually produce it might lead us to think that the reason government spending is not as high as Krugman wants it to be is that the economy is depressed. If the economy were doing better, government would be able to take more in taxes and, thus, increase its spending.

In Wonderland, however, things are backward. Government spending creates the wealth that comes from private firms. The more government spends, borrows, prints, and takes in taxes, the wealthier all of us become. Why? Because Krugman, Joe Stiglitz, and now Ben Bernanke tell us that is so.

Tuesday, February 26, 2013

Thornton vs. Krugman on "Austerity"

Paul Krugman is on another "austerity" roll, as witnessed by his most recent column, although his definition of "austerity" seems to be something right out of Wonderland. As I have read Krugman, from what I can tell, he defines "austerity" as a government spending less than it did before an economic downturn began.

Mark Thornton, whose skills as a real economist I respect more than I do Krugman's (since Krugman long ago abandoned economics for political advocacy), sees things differently. In a recent article, Thornton examines the definitions of "austerity," and then takes apart the Keynesian "logic" (an oxymoron, of course):
But what is austerity? Real austerity means that the government and its employees have less money at their disposal. For the economists at the International Monetary Fund, “austerity” may mean spending cuts, but it also means increasing taxes on the beleaguered public in order to, at all costs, repay the government’s corrupt creditors.
In other words, the European style of "austerity" includes both spending cuts (or alleged spending cuts) and raising taxes, which means that while government burdens might be declining somewhat on one side of the ledger, they are increased on the other side in an attempt to prop up the banks that irresponsibly lent large sums of money to corrupt governments like Greece. Thornton continues:
Keynesian economists reject all forms of austerity. They promote the “borrow and spend” approach thatis supposedly scientific and is gentle on the people: paycheck insurance for the unemployed, bailouts for failing businesses, and stimulus packages for everyone else.
I don't believe that is a misrepresentation of either the Keynesians or Krugman, who has argued vociferously that during a downturn, the government must increase its spending and do so in dramatic fashion. (From what I can tell, he is more ambivalent regarding tax increases, at one point advocating expiration of all Bush-era tax rate cuts, including those on lower-income individuals, and elsewhere calling just for more taxes on high-income people. In other words, he tends to blow with the political winds.)

For that matter, Krugman often has claimed that because the Obama administration has not increased spending enough (or at least enough to satisfy Krugman's Keynesian tastes), that it, too, is engaged in "austerity." Defining the term in this manner, as I see it, is tantamount to moving the goalposts, as a Keynesian always can claim that there should have been more spending and borrowing. The government spends an extra $800 billion for stimulus? Not enough! Had it spent just $400 billion more, the recession would have ended!

How do we know this? Krugman says so, and that should be the only "proof" needed to confirm the thesis. The syllogism goes like this:
  • The Obama administration pushed through an $800 billion "stimulus" spending package;
  • Unemployment actually increased dramatically in the months afterward;
  • Therefore, government did not spend and borrow enough money.
Built into the assumptions is the view that a stimulus actually would have a real effect upon the economy, creating economic growth over a longer period of time, as opposed to just making some politically-connected people better off in the short run (while making others worse off, something Keynesians don't want to admit, as they want us to believe that "stimulus" funds consist of new wealth, not transferred wealth).

When one uses such a syllogism, however, as proof that a "stimulus" actually would improve the real economy, then we are witnessing the informal fallacy of Begging the Question. Furthermore, the Keynesians want it both ways, wanting to claim that increased government spending is a response to a downturn, which is caused purely by internal "contradictions" within a market economy, while at the same time claiming that a decrease in government spending can cause a recession. (This is more of the "heads I win, tails you lose" economic propositions that Krugman and his allies like to use when engaging in what they call arguing.)

Thornton sees things differently, writing:
Austrian School economists reject both the Keynesian stimulus approach and the IMF-style high-tax, pro-bankster “Austerian” approach. Although “Austrians” are often lumped in with “Austerians,” Austrian School economists support real austerity. This involves cutting government budgets, salaries, employee benefits, retirement benefits, and taxes. It also involves selling government assets and even repudiating government debt.
Thornton then gives a very interesting example, one that I am sure will drive the Krugmanites batty, as it is totally counterintuitive to their own theories of political history:
One historical example of austerity legislation is the Economy Act of 1933. This legislation, submitted by Franklin Roosevelt six days after his inauguration, slashed government spending, wages, and benefits, including cuts of 50 percent to veterans’ benefits, which at the time constituted a quarter of the federal budget.

The Act helped jump-start the economy. Combined with the repeal of Prohibition it helped reduce unemployment from 25 percent to almost 15 percent. These two pieces of legislation were the real reason for FDR’s popularity. Unfortunately Congress acted on less than half of Roosevelt’s requested cuts and increases in government spending greatly diminished the beneficial impact of FDR’s austerity legislation.
In fact, Thornton argues that it was the later spending and regulation side of the New Deal that prevented a real recovery and turned the 1930s into a lost decade:
Worse still, FDR quickly adopted Hoover’s “New Deal” programs, expanded some, and added new ones. With respect to the Great Depression, Murray Rothbard’s thesis was that Hoover’s and Roosevelt’s “New Deal” prevented the economy from recovering. In an attempt to keep prices and wages high, they both continuously intervened with one program after another. More spending, more regulation, and more resources were withdrawn from the economy, yet nothing worked. Today, mainstream economists Harold Cole and Lee Ohanian have verified the soundness of Rothbard’s thesis.

Thornton then uses the post-World War II period to point out that "austerity" in the form of cutting federal spending did not bring about the predicted postwar depression, but actually had the opposite economic effect:

The proof for real austerity, however, came after World War II ended. All the Keynesian economists warned of a return of the Great Depression. In sharp contrast, the American Austrian School economist Benjamin Anderson predicted that the economy would recover, in a very short period, despite multi-billion dollar budget cuts and millions of government jobs being slashed. What was the verdict on this debate? There was no real Depression of 1946, as the economy recovered very quickly despite the fact that the government was running large budget surpluses.

No doubt, the Keynesians would claim that 1946 did not have "liquidity trap" characteristics, but I see that as just another example of how they "move the goalposts." (We are supposed to believe that there are certain magical conditions in which entrepreneurs are paralyzed and that individuals can find no gains from trade even though the potential for such gains is in abundance if only -- If Only! -- the government would spend more money.)

Austrians have not favored the general European approach in which taxpayers of countries like Greece, Ireland, or Spain are supposed to labor to pay back banks even while banks make new loans to their governments to try to prop up current spending. It is not sustainable, and I suppose that even the Keynesians would agree there.

However, like Thornton, I believe that neither the USA nor the Europeans can rebuild their economies by trying to launch another boom cycle. Such cycles, of course, have a way of ending in yet more busts and resulting in even more long-run government burdens that ordinary people must bear. European "austerity" and Keynesian profligacy are two sides to the same coin: both promote economic destruction.

Friday, February 22, 2013

Krugman and the NY Times: Consuming Wealth Actually is the Same as Producing Wealth

With the Big, Bad Sequester looming as the Crisis of the Week and all of the media and political angst accompanying it, I have come to understand that how one responds to the prospect of the government being forced to cut back on spending also helps to define how one sees government spending as it relates to the economy. Not surprisingly, Paul Krugman and his part-time employer, the New York Times, believe that government spending is the very key to wealth itself.

In an unsigned editorial calling for higher taxes, the NYT declares:
Democrats and Republicans remain at odds on how to avoid a round of budget cuts so deep and arbitrary that to allow them now could push the economy back into recession. The cuts, known as a sequester, will kick in March 1 unless Republicans agree to President Obama’s demand to a legislative package that combines spending reductions and tax increases. As of Thursday, with the deadline a week off, Republicans seemed determined to say no to any new tax increases.

“Spending is the problem,” declared the House speaker, John Boehner. “Spending must be the focus.” Reflecting the views of many of her Republican colleagues, Representative Martha Roby said Wednesday that Mr. Obama “already got his tax increase” as part of the January agreement over the “fiscal cliff” and that no further increases were necessary. (Emphasis mine)
Now, I'm sure that Gail Collins actually believes what either she or one of her underlings has written, that a small cut in the increase of government spending will be so catastrophic that the entire economy will fall over the cliff. But the next paragraph is even more over-the-top, and demonstrates without a doubt that the editors of the "Newspaper of Record" are out of touch with reality:
Both are wrong. To reduce the deficit in a weak economy, new taxes on high-income Americans are a matter of necessity and fairness; they are also a necessary precondition to what in time will have to be tax increases on the middle class. Contrary to Mr. Boehner’s “spending problem” claim, much of the deficit in the next 10 years can be chalked up to chronic revenue shortfalls from the Bush-era tax cuts, which were only partly undone in the fiscal-cliff deal earlier this year. (Wars and a recession also contributed.) It stands to reason that a deficit caused partly by inadequate revenue must be corrected in part by new taxes. And the only way to raise taxes now without harming the recovery is to impose them on high-income filers, for whom a tax increase is unlikely to cut into spending. (Emphasis mine)
This one calls for some analysis. First, the notion that almost the entire federal deficit is due to the fact that the Bush administration pushed through a reduction in the top tax rate from 39.6 percent to 35 percent is beyond laughable. It is dishonest, but what else can we expect from the newspaper that tried to convince its readers that prosecutor Mike Nifong had in his possession what literally would have been a "magic towel" that would prove those bad Duke lacrosse players raped Crystal Mangum?

Second, we see the real goal of Progressives, and that is to stick the middle class with even more burdens, with the idea that the poorer Progressive government makes people, the more they will have to depend upon government and, of course, Progressive politicians. But, as I read through this editorial along with Krugman's post, "Sequester of Fools," I realize that Krugman and those editors of his part-time employer are True Believers when it comes to the idea that government spending -- no matter what kind of spending it might be -- creates wealth.

This is not an argument about government building roads and bridges, and I'm not about to say that all government roads and bridges constitute economic waste. But the vast amount of government spending is not on constructing things or even providing the delivery system for formal education, but rather for wealth transfers, subsidizing public works boondoggles, and fighting wars of aggression.

It is this spending especially that Austrians see as a burden, but Keynesians see as wealth creation itself. In the Keynesian view, government consumption really is production. This is not the same as saying the end of production is consumption, which is fundamental to Austrian theory. No, this is a way of thinking that sees production as an end in itself (i.e., a "jobs" recovery) and holds that government spending (along with government money creation) is a source of wealth.

In Austrian theory, government spending generally is a burden upon taxpayers and the economy, but we also see that as an economy grows, government spending will grow in real terms along with it. The important thing to keep in mind, however, is that government spending grows with economic growth, not the other way around. The causality chain begins with the growing economy, not the government.

Keynesians would have you believe that it is government spending that triggers economic growth, and that private enterprise is the real burden. After all, individuals and businesses save money or they invest for the future instead of spending everything right now. Households and businesses balance budgets as opposed to governments that engage in deficit spending.

To buttress that point, I present the following from Krugman's column:
Meanwhile, we have a weak economy that is recovering far too slowly from the recession that began in 2007. And, as Janet Yellen, the vice chairwoman of the Federal Reserve, recently emphasized, one main reason for the sluggish recovery is that government spending has been far weaker in this business cycle than in the past. We should be spending more, not less, until we’re close to full employment; the sequester is exactly what the doctor didn’t order. (Emphasis mine)

"Weak" government spending (a relative term if ever there was one) has come about because the economy and the recovery have been weak. This lack of spending has not occurred because Washington is beholden to an alien ideology that claims less government spending is a good thing; no the "lack" of spending is happening because the revenues are not there.

Given the Keynesian mentality, the NYT can editorialize that cutting a few government jobs here and there would devastate the economy and throw it back into recession and not surprisingly, the Obama administration will make sure that the job cutting will be done in the most public way possible, as the White House will work hand-in-hand with the adoring press to ensure that there will be maximum coverage of long lines at airports and elsewhere, as the government will make sure that individuals are inconvenienced or worse as much as can be done.

The purpose of this very public display of job cutting will be to make it seem as though the economy really is being destroyed, and no doubt Krugman and the NYT will be willing partners with the White House to write and distribute propaganda about what might be coming down the pipe. Since they have managed to convince a lot of people that economies grow because governments spend money, I'm sure they will be up to the task to help the Obama administration claim that those mean and nasty Republicans have trashed our fragile economy.

Thursday, February 21, 2013

Austrians and Predicted Inflation: My Reply to John Carney

Your points in the November 29 column on Paul Krugman and the Austrians makes good points, and I would like to make a few comments of my own.

I do believe that when one makes apocalyptic comments, one gets what he deserves if the predictions don't pan out. As you said, that does not mean the Austrians are wrong regarding money and inflation, but expansions of money, especially in the way that the Fed has gone about doing so, are going to have a number of effects, rising consumer prices being only one of them.

I also believe that some of the Austrians, when they predicted near-instant hyperinflation, should have known better. An expansion in the monetary base can lead to what Milton Friedman called the "pushing on a string" effect, as an expansion of bank reserves will not increase the amount of money in circulation (at least not significantly) if businesses and individuals are not borrowing.

This is not to say that the Law of Marginal Utility, as applied to money, is somehow invalidated. An expansion of money in circulation will mean that the value of the marginal unit – in this case, the dollar – will fall, which means more money will be necessary to complete monetary transactions. That is the straight Law of Marginal Utility, and it applies to money as much as it would to anything else that is scarce.

As Murray Rothbard points out in his book, America's Great Depression, the amount of money in circulation during the 1920s grew, and he terms that as "inflation." However, according to the Consumer Price Index of that time, consumer prices fell by roughly one percent a year, which the late Jude Wanniski used as "proof" that Rothbard was wrong when he claimed that the 20s was an inflationary period. What we witnessed was an apples-and-oranges kind of comparison, as most people (including most economists) generally are used to defining inflation as an increase in the government's CPI, but the Austrians would say that changes in the CPI would be the result of inflation and in our case, the result of the monetary policies of the Fed.

While both Austrians and the Monetarists would see inflation as a monetary phenomenon where changes in relative prices of goods and services occur because the value of money, which is used to denote those relative price relationships, changes as the supply expands and contracts. The Austrians take one step further, however, as they go beyond the quantity effects of increases in the amount of money and look at how these monetary increases change the relative prices of real goods. In other words, the significant effect of changing the amount of money in circulation is not necessarily the changes in consumer prices (although they will change over time relative to the money in circulation), but rather the effect that monetary changes will have upon the relationships of the value of real goods to each other.

This point is vital, for the Austrians hold in their business cycle theory that when the central bank manipulates the banking system to increase the amount of money in circulation, the larger effect is not in consumer price changes but rather the fact that relative values of real goods are changed in a way that directs longer-term investment into lines of production that would seem to be profitable but over time turn out not to be. We certainly saw that in the housing boom and in the tech boom a decade earlier. Investments were directed into production lines that could not be sustained, given the preferences of consumers and their own financial constraints.

In the meantime, the actions of the central bank, when added to various policy initiatives by government, can create these booms that are unsustainable within a market setting and sooner or later are exposed by the markets themselves. When the meltdown became absolutely apparent in September 2008, we were seeing a situation where the market was declaring the mortgage securities held by Wall Street firms to be near-worthless.

(I would like to add a separate point here. Why is it that when a firm tries to manipulate the market to make an asset look more valuable than the market would say it is, authorities view that as being illegal, but when the Fed does it, as it is doing with its QE policies, that is considered "good for the economy"? After all, by purchasing billions of dollars of mortgage securities, the Fed is manipulating their values, given that the sheer purpose of Ben Bernanke's actions is to artificially raise security prices, which is deemed criminal behavior if a private firm does it.)

Krugman has explained that these bubbles were due to nothing more than the failures of private markets, and that unless government regulators intervene, markets always will go over the cliff because, well, because markets are just like that. Yet, if one holds that price signals really do matter, then one would ask why all markets do not behave in the manner we saw. Why not an automobile bubble or a bubble gum bubble or a firewood bubble? Instead, Krugman wants to absolve the Fed, Freddie and Fannie, and the various government agencies that were pushing home ownership and refinancing through policies of having played any part whatsoever in the housing bubble, as he wants us to believe that the problems were due solely to what he and other Keynesians believe to be the inherent failures that automatically accompany market transactions.

Austrians, on the other hand, look for the cause-and-effect. Carl Menger, the original Austrian Economist, begins his classic 1871 Principles of Economics with: "ALL THINGS ARE SUBJECT to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary." Why the "irrational exuberance?" Krugman holds to the Keynesian line of "animal spirits" of investors, but that is no cause at all. Why shouldn't "animal spirits" bid down the values? Do they believe that investors are irrational when bidding up asset prices, but are rational when bidding them down? The Austrians would say that Fed policies of driving down interest rates where they would greatly affect mortgage markets, along with the drive-people-into-home-ownership policies of the Federal government created huge incentives for the creation of the housing boom, which ultimately turned into a bubble, and then a huge bust.

Regarding the consumer price effects of the Fed's policy of spreading dollars around the world, we can see some price increases in various commodities, i.e. food and fuel. Those of us who purchase gasoline or go to the grocery story can attest to some very large price increases over the past five years, and farmers where I live tell me they are having to absorb large increases in the price of animal feed, fertilizer, and diesel fuel. While Krugman wants to explain away these changes as being driven purely by inherent "volatility" and economic growth in places like China, it would seem to me that large increases in the money prices of those things denominated worldwide in dollars just might be due to large increases in the amount of money being poured into these assets and lines of production.

There is one more point. The Fed has vastly increased its balance sheet and has been spreading dollars around the world, mostly to purchase "assets" that essentially have little or no value so that the holders of those assets do not have to take the necessary financial bath. Such actions would not necessarily result in a huge increases of consumer prices overall, but they would have the effect of directing real investment away from those lines of production that would be both profitable and sustainable. Whether it is protecting the banks or the "green investors" or governments that have spent themselves into financial oblivion, the Fed has stymied the recovery by forcing assets into production areas that are doomed to failure. The result is what we see around is in the anemic economic growth.

Where some of the Austrians went wrong was in assuming that all of the Fed's new money pumping would be channeled into the purchase of consumer goods, thus driving up their prices. We have to look at where the new money is going, not where we might think it is going.

Monday, February 18, 2013

Raise that Teenage Unemployment Rate

If one were to read only Paul Krugman's column and blog, the reader would find many interesting things about economics. That would include things like governments make economies grow by printing money (we call that "creating demand"), only government regulators can accurately read price signals (and know the future), and that the U.S. economy as a whole behaves exactly as an alleged babysitting co-op in Washington, D.C.

Today, however, we find yet another gem in the Krugman lexicon: forcing wages above the market level not only will have no effect on employment of low-skill workers and raises real wages overall, but will be an overall plus to the economy supposedly "corrects" a glitch in the earned income tax credit. Oh, and forcing up the minimum wage is "good economics."

To his credit, Krugman does not rely on the fallacy of confusing marginal measurements for total measurements, something I have heard on NPR and read in various editorials and columns. (That fallacy is to assume that if the government raises the minimum wage, then it has raised overall income, which gives people more money to spend, which creates prosperity. Yes, people have been making that argument, which is based upon the Fallacy of Composition, but I think Krugman understands that if he does try to do that, he would be jettisoning the entire Diamond-Water Paradox explanation of value which has under-girded neoclassical economics since the late 19th Century.)

In fact, Krugman anticipates the Reductio ad absurdum response by declaring:
Well, Economics 101 tells us to be very cautious about attempts to legislate market outcomes. Every textbook — mine included — lays out the unintended consequences that flow from policies like rent controls or agricultural price supports. And even most liberal economists would, I suspect, agree that setting a minimum wage of, say, $20 an hour would create a lot of problems.
Now, I am not sure why $20 an hour would be bad, at least if one depended upon the reasoning I have heard on NPR, the NY Times, and from other pundits, if they are insisting that it increases aggregate demand. The obvious reason -- and Krugman does not want to stray altogether from an a priori view of the laws of economics -- is that $20 an hour would have the same effect as a big agricultural price support but instead of there being a huge surplus of wheat, there would be a huge surplus of low-skilled workers not being able to find legal employment. (I am sure that my mentioning of a priori analysis is going to set off the Usual Suspects who want us to believe that there is no Law of Scarcity at all because government can do away with scarcity simply by printing and borrowing, but we should face it that when Krugman does allude to real supply-and-demand functions and how they behave, he is engaging in a priori.)

Instead, Krugman is trying apparently to make the claim that the present $7.25 an hour minimum wage probably is below true market levels and that employers are able to hire on the cheap. He declares:
First of all, the current level of the minimum wage is very low by any reasonable standard. For about four decades, increases in the minimum wage have consistently fallen behind inflation, so that in real terms the minimum wage is substantially lower than it was in the 1960s. Meanwhile, worker productivity has doubled. Isn’t it time for a raise?

There are a couple points I need to make here. First, he is saying that inflation effectively cuts wages, something nearly every economist, including John Maynard Keynes, would say and Keynes even advocated inflation precisely for its wage-cutting effects. However, Krugman in recent years also wants us to believe that inflation has a wealth-enhancing effect in that it "stimulates" economic activity and actually is necessary for economic growth.

We have a logical disconnect here. If the very thing that helps to bring about economic growth also has the bad effect of putting whole classes of workers behind, then we need to ask if economic growth is occurring at all, or if people are better off without the growth, or if economic growth as we know it is nothing more than a transfer of wealth from lower-income people to higher-income people.

Time and again we have read not only from Krugman, but also from many other "liberal" sources that over the past 30 years, income inequality has increased demonstrably and that (according to Krugman's statements on numerous occasions) real wages for the vast majority of Americans have fallen relative to where they were before 1980. For that matter, Krugman makes that argument here, along with implying that the minimum wage workers of 30 years ago are the same people working minimum wage jobs now.

So, we are left with an interesting chicken-and-egg question: does economic growth occur because of this increase in inequality, or does it occur despite the advent of economic growth? If it is because of the former, then economic growth by itself would be deemed immoral by any standards of human decency. If it is the latter, then the only logical conclusion one can reach is that overall standards of living have risen, but that the very wealthy benefit more from growth than do others.

In order to make the argument using the first point of view, one would have to demonstrate that since the advent of capitalism more than 200 years ago, standards of living for the vast majority of people have fallen, given we have seen nothing more than a wealth transfer from the poor to the rich. Not even Paul Krugman is willing to make that argument.

For that matter, he would have to say that standards of living (as measured by real wages) for the vast majority of Americans have fallen in the past 30 years ever since the top federal income tax rate was moved from 70 percent (a rate Krugman personally told me in 2004 was "insane") to 50, then 28, then 33, then 39.6, then 35, then 39.6 percent. I'm not sure that Krugman is going to try to claim that most Americans actually are poorer than they were three decades ago, but from what I see, that is his only logical conclusion. Since Krugman has argued elsewhere that the various economic "classes" in this country are rigidly stratified, and that there is little economic mobility, I don't see how he gets out of this jam.

If he uses the second argument I presented -- that overall living standards have risen, but the class of wealthy people has done better than everyone else -- then he simply is trying to say that we have had economic growth, but it has been somewhat uneven, and that goes against his own liberal sense of "fairness." But elsewhere he and others (especially Robert Reich and Joseph Stiglitz) have argued that inequality has blocked economic growth, so we are in a quandary, as Krugman and others have tried to argue against themselves -- but manage to get away with it because they are the darlings of the current political classes and their adoring media.

I have no idea how Krugman can justify logically holding to conflicting and mutually-exclusive viewpoints, but in the end he does not try to do so. Instead, he uses both arguments and expects the readers to believe both.

His second point is while logic might propose that raising the minimum wage above market levels would increase unemployment, we don't see that happening, which means that arguments against raising the minimum wage are wrong:
Now, you might argue that even if the current minimum wage seems low, raising it would cost jobs. But there’s evidence on that question — lots and lots of evidence, because the minimum wage is one of the most studied issues in all of economics. U.S. experience, it turns out, offers many “natural experiments” here, in which one state raises its minimum wage while others do not. And while there are dissenters, as there always are, the great preponderance of the evidence from these natural experiments points to little if any negative effect of minimum wage increases on employment.

Why is this true? That’s a subject of continuing research, but one theme in all the explanations is that workers aren’t bushels of wheat or even Manhattan apartments; they’re human beings, and the human relationships involved in hiring and firing are inevitably more complex than markets for mere commodities. And one byproduct of this human complexity seems to be that modest increases in wages for the least-paid don’t necessarily reduce the number of jobs.

What this means, in turn, is that the main effect of a rise in minimum wages is a rise in the incomes of hard-working but low-paid Americans — which is, of course, what we’re trying to accomplish.
His explanation (seen in the second paragraph) is a non sequitur. Yes, human beings can be complex, but either the Law of Demand, the Law of Opportunity Cost, and the Law of Scarcity hold or they do not. If a government edict calling for a rise in the minimum wage essentially can eliminate opportunity cost, then we have discovered the pathway to riches.

For that matter, if his "humans-are-complex-creatures" explanation is valid for explaining away why "studies" have shown raising the minimum wage -- even "modest" ones -- has no effect on unemployment, then why not $20 or $50 or even $100 an hour instead of the measly $9 an hour? If Krugman makes an appeal to the Law of Demand and supply-and-demand functions, then the only logical explanation would be that American employers are paying less than market wages and getting away with it.

If that is the case, then he needs to explain why they can get away with it. Instead, he offers mutually-exclusive explanations and expects readers to be awed by them, and in the last paragraph of his quote, he then tries to use the "it-raises-overall-incomes" argument. Again, this makes sense only if the current minimum wage is less than the market or "equilibrium" rate or if the current employment situation is such that the current demand for low-wage labor is inelastic.

Should current demand for that labor be elastic, then forcing up the minimum wage would result in lower overall incomes for those unskilled workers making that lowest wage. However, the current state of the economy is such that it is hard to make an argument that the demand for current labor is inelastic, for if that is the case, then there would have to be another explanation for the high levels of unemployment we see in this country.

Again, Krugman simultaneously is trying to argue two mutually-exclusive points and claiming both are true. His next argument says that raising the minimum wage has a synergistic effect with the Earned Income Tax Credit, making it work better:
Finally, it’s important to understand how the minimum wage interacts with other policies aimed at helping lower-paid workers, in particular the earned-income tax credit, which helps low-income families who help themselves. The tax credit — which has traditionally had bipartisan support, although that may be ending — is also good policy. But it has a well-known defect: Some of its benefits end up flowing not to workers but to employers, in the form of lower wages. And guess what? An increase in the minimum wage helps correct this defect. It turns out that the tax credit and the minimum wage aren’t competing policies, they’re complementary policies that work best in tandem.
This is not an economic argument, because it does not say whether or not the EIC has economic merit or not. He only says that since people of both parties support it, then it must be a good thing, which is an appeal to the ad populum fallacy. Furthermore, when one examines his argument, he is saying that something that might harm an employer is good for the worker, but that assumes that workers and employers are in competition with each other, which violates another basic tenet of economic analysis.

Moreover, there is nothing in the EIC argument that would mitigate the Great Wonders of imposing a significantly higher minimum wage than $9 an hour. If a little bit of harm to employers is a good thing, then would not a great amount of harm be great?

Unfortunately, he then comes up with a fourth argument, one that is tried-and-true in the NYT: We should raise the minimum wage because evil Republicans hate low-wage workers and are trying to keep them in poverty. He writes:
So Mr. Obama’s wage proposal is good economics. It’s also good politics: a wage increase is supported by an overwhelming majority of voters, including a strong majority of self-identified Republican women (but not men). Yet G.O.P. leaders in Congress are opposed to any rise. Why? They say that they’re concerned about the people who might lose their jobs, never mind the evidence that this won’t actually happen. But this isn’t credible.

For today’s Republican leaders clearly feel disdain for low-wage workers. Bear in mind that such workers, even if they work full time, by and large don’t pay income taxes (although they pay plenty in payroll and sales taxes), while they may receive benefits like Medicaid and food stamps. And you know what this makes them, in the eyes of the G.O.P.: “takers,” members of the contemptible 47 percent who, as Mitt Romney said to nods of approval, won’t take responsibility for their own lives.
This is not an economic argument. Instead, it is yet another cheap political appeal that is based on any number of logical fallacies. His syllogism works as such:
  • Premise A: Republicans hate nearly everyone, and they especially hate low-wage workers;
  • Premise B: Republicans are against raising the minimum wage to $9 an hour;
  • Conclusion: Therefore, raising the minimum wage to $9 an hour won't increase unemployment of low-wage workers. 
He second syllogism operates this way:
  • Republicans are evil;
  • Republicans oppose raising the minimum wage to $9 an hour;
  • Therefore, anyone who opposes raising the minimum wage to $9 is evil, or at least one's belief that it is a bad thing is motivated by evil.
This is the kind of logic one expects to hear from a politician on the stump, not economic analysis from an academic economist who has received the highest honors his profession can give. However, there is even more, as economist Robert Murphy has demonstrated.

Murphy's Law?

Robert Murphy, in a couple of blog posts, takes issue with Krugman on two fronts. In this post, he notes that a Krugman vs. Krugman battle presently is brewing, as it seems that Krugman not long ago was making essentially the classic economic arguments against raising the minimum wage. (That must have been the John Bates Clark winner Krugman, which only could mean that he no longer holds to the economic views he believed when he won that award.)

In a second post, Murphy looks at the empirical arguments claimed by Krugman and others: that states that have raised their minimum wages above the national level have not experienced any problems in unemployment of low-wage workers. Murphy's post includes the unemployment rates for people in the 16-19 age bracket (and who most likely would qualify for minimum-wage jobs), comparing the rates in those states that have wage minimums above federal minimum, and those that do not.

Interestingly, of the top eight states in teenage unemployment, six have higher-than-national minimum wages, led by California. Now, one has to be careful with simple empirics like this because one cannot assume that minimum wage is the only factor in teenage unemployment, but certainly one would assume that it would be statistically significant.

Friday, February 15, 2013

Paul Krugman and His Zombie History

Murray Rothbard liked to say that economist often tended to specialize in the area where their knowledge was the worst, and given Paul Krugman's butchery of the historical record, I'd say Rothbard had a good point. Regular readers of Krugman's columns and blog posts and other public statements would believe, for example, that World War II ended the Great Depression, that Jimmy Carter and Ted Kennedy were conservative Republicans, and that the only thing better than war to bring prosperity would be the nationwide preparation to fight an invasion of imaginary space aliens.

As always, whenever Krugman goes on a partisan political screed, truth is left behind, and his recent column is no exception. While I have no problem with his criticizing Republicans, nonetheless I actually would want for him to get his criticisms correct, especially his points that the Republican Party is dedicated to laissez-faire economics and actually cutting the size and scope of government.

Unfortunately, he decides to make essentially this set of claims:
  • The financial meltdown was purely the fault of private enterprise except for one governmental error: it did not regulate enough;
  • The GSEs, Freddie and Fannie, had absolutely nothing to do with the meltdown.
Krugman writes:
Start with the big question: How did we get into the mess we’re in?

The financial crisis of 2008 and its painful aftermath, which we’re still dealing with, were a huge slap in the face for free-market fundamentalists. Circa 2005, the usual suspects — conservative publications, analysts at right-wing think tanks like the American Enterprise Institute and the Cato Institute, and so on — insisted that deregulated financial markets were doing just fine, and dismissed warnings about a housing bubble as liberal whining. Then the nonexistent bubble burst, and the financial system proved dangerously fragile; only huge government bailouts prevented a total collapse.

Instead of learning from this experience, however, many on the right have chosen to rewrite history. Back then, they thought things were great, and their only complaint was that the government was getting in the way of even more mortgage lending; now they claim that government policies, somehow dictated by liberals even though the G.O.P. controlled both Congress and the White House, were promoting excessive borrowing and causing all the problems.

Every piece of this revisionist history has been refuted in detail. No, the government didn’t force banks to lend to Those People; no, Fannie Mae and Freddie Mac didn’t cause the housing bubble (they were doing relatively little lending during the peak bubble years); no, government-sponsored lenders weren’t responsible for the surge in risky mortgages (private mortgage issuers accounted for the vast majority of the riskiest loans).

But the zombie keeps shambling on — and here’s Mr. Rubio Tuesday night: “This idea — that our problems were caused by a government that was too small — it’s just not true. In fact, a major cause of our recent downturn was a housing crisis created by reckless government policies.” Yep, it’s the full zombie.
The only accusation he left out was that Republicans were responsible for keeping the space aliens away from us, thus nullifying our chances for economic recovery. But, let us take a look at the record, given that Krugman has made some very important claims.

Understand that he is quietly making the larger claim: price signals mean nothing to entrepreneurs; only government regulators and agents can understand the economy and what actually is happening, and that only government, through spending, regulation, and outright ownership and control of the factors of production, can bring about prosperity.

So, let us talk about the government's role in this whole thing. First, he leaves out an important player, the Federal Reserve System, and the fact that neither Alan Greenspan nor Ben Bernanke would admit to the creation of the housing bubble and both continued with their policies of pushing down interest rates and directing funds into the housing market through their statements and actions.

Second, Krugman ignores the simple fact that government is the single largest player in the mortgage business through its policies of encouraging and funding home ownership. To claim that the only influence government had through the housing bubble was not regulating enough is yet another Krugman howler, and his claims that Freddie and Fannie were not lending during the "peak bubble years" and that government agencies did not encourage loans to "sub-prime" borrowers is the typical Krugman rewriting of history.

I'll get to Freddie and Fannie in a moment, but the notion that the banks simply came up with the idea of lending to sub-prime borrowers on their own really does defy history. Yes, it is true that the vast majority of sub-prime loans DID come from the banks, and that their attempts to securitize these loans in order to mitigate the risks were a disaster. I have no problem with this accusation against the Wall Street firms, but there is one thing that Krugman leaves out: the infamous Greenspan-Bernanke "Put."

When the financial deregulation occurred both during the Carter-Reagan years and at the end of the Clinton administration, the government did not get rid of the moral hazard that essentially guaranteed reckless behavior. Both Greenspan and Bernanke time and again promised to "create liquidity" if the banks got into trouble, and when the markets had the trillions of the Fed standing behind them, it is no wonder that they ran off the rails. Moral hazard has a way of encouraging the very actions that lenders and the entities supporting them should not be taking.

Free markets entail both profits and losses, and when the government essentially lets the banks keep their profits but then promises to socialize the losses, why are we shocked, SHOCKED when the banks do the things they did? What Krugman refuses to do is to acknowledge that the players in private enterprise really will respond to the prospect of losses when they engage in risky behavior. Instead, he simply ignores the fact that the banks knew the Fed and the taxpayers were covering their behinds and so they could be free to engage in behavior that anyone with half a brain knew could produce very bad outcomes.

I'll make another point about the crisis: the Austrians were on it long before the Keynesians and the rest of American economists jumped on the bubble bandwagon. Mark Thornton in 2004 wrote:
Signs of a "new era" in housing are everywhere. Housing construction is taking place at record rates. New records for real estate prices are being set across the country, especially on the east and west coasts. Booming home prices and record low interest rates are allowing homeowners to refinance their mortgages, "extract equity" to increase their spending, and lower their monthly payment! As one loan officer explained to me: "It's almost too good to be true."

In fact, it is too good to be true. What the prophets of the new housing paradigm don't discuss is that real estate markets have experienced similar cycles in the past and that periods described as new paradigms are often followed by periods of distress in real estate markets, including foreclosure sales, bankruptcy and bank failures.
Furthermore, while the Austrians may be laissez-faire in their economic viewpoints, they hardly are fans of the banks and they certainly did not believe that the Fed and the housing bubble constituted a new era of prosperity. (For that matter, I warned the property tax appeals board in Allegany County, Maryland, in the spring of 2006 that the current housing situation was a bubble and that it would crash, and that government officials should not make future budget predictions off what we were presently seeing. They told me flat out that I was wrong.)

By leaving out the Fed's "Put" and the other quiet assurances from Congress and the Bush administration that the government had the backsides of the banks, Krugman ignores an important reason as to why the banks ignored price signals and engaged in reckless behavior. While I am sure that Krugman was taught early in in graduate school about moral hazard, his leaving out that important point more to his intellectual dishonesty than it does his lack of economic knowledge.

Freddie and Fannie

Were the GSEs actually non-players in this whole affair, as claimed by Krugman? First, if that were so, then neither entity would have gone bankrupt in 2007, since they did not have risky loans on their books. While it is true that neither GSE was responsible for the vast creation of the subprime loans and their subsequent securitization, but that did not mean they were minor players in the system at the time.

Veronique de Rugy writes:
Fannie and Freddie contributed to the housing crisis by making it easier for more people to take out loans for houses they could not afford. Beginning in 2000, Fannie and Freddie took on loans with low FICO scores, loans with low down payments, and loans with little or no documentation.

The federal government’s role in the housing market goes back at least to 1938, but that role changed fundamentally in the 1990s when the government made a push to increase homeownership in the United States. At that time, the federal government pursued several policies that were meant to encourage banks to lend money to lower income earners and to give incentives to low income earners to buy houses. The result, as we now know, was a gigantic amount of subprime mortgages at a time when house prices were starting to go down.
In other words, the encouragement to create sub-prime housing loans came from federal policies, something that Krugman ignores. (Krugman apparently wants us to believe that the banks would suddenly create a bunch of bad loans on their own, and with the full knowledge that if they lost money, the government would not be there to force taxpayers to underwrite these bad loans.) Freddie and Fannie did play a role in creating these sub-prime securities, even if Krugman and the NYT want to ignore that fact.

It gets better. Far from being an almost non-existent player in the crisis, we find that the GSEs actually did have large housing portfolios during this time:
...Fannie Mae and Freddie Mac are considered government-sponsored enterprises (GSEs). Although both were, before the crisis, privately financed, the general sentiment was that in the event of a crisis in the mortgage market, the federal government would step in and back the GSEs. In other words, the government implicitly guaranteed Fannie and Freddie's securitized loans. This allowed them to borrow at interest rates below those of the financial markets and to hold much lower capital requirements than commercial and investment banks. The aggregate value of this subsidy has been estimated to range "somewhere between $119 billion and $164 billion, of which shareholders receive respectively between $50 and $97 billion. Astonishingly, the subsidy was almost equal to the market value of these two GSEs."

As a result, by the time the housing crisis began to unfold, Fannie and Freddie had become the dominating force in the secondary mortgage market, providing 75 percent of financing for new mortgages through securitization at the end of 2007. At the end of 2010, they still held about 50 percent of securitized, first-lien home loans.
Economist Russ Roberts also investigated and found that Freddie and Fannie were more like silent partners in the crisis, contra Krugman:
Fannie and Freddie bought 25.2% of the record $272.81 billion in subprime MBS [mortgage-backed securities] sold in the first half of 2006, according to Inside Mortgage Finance Publications, a Bethesda, MD-based publisher that covers the home loan industry.

In 2005, Fannie and Freddie purchased 35.3% of all subprime MBS, the publication estimated. The year before, the two purchased almost 44% of all subprime MBS sold.
We are not speaking of insignificant numbers. Furthermore, as de Rugy points out, Congress and the administration were not exactly non-players in setting the table for a housing crisis:
In addition, lawmakers in both parties enacted policies directed at increasing home ownership rates, resulting in lower mortgage underwriting standards for Fannie and Freddie. Roberts notes that from 2000 on, Fannie and Freddie bought loans with low FICO scores, loans with very low down payments, and loans with little or no documentation. Contrary to Paul Krugman’s assertions, Fannie and Freddie did not “fade away” or “pull back sharply” between 2004 and 2006.

As the following chart from Roberts’ study shows, during that same time Government Sponsored Enterprises (GSEs) bought near-record numbers of mortgages, including an ever-growing number of mortgages with low down payments.

Moreover, as the chart below shows, while private players bought many more subprime loans than Freddie and Fannie, GSEs purchased hundreds of billions of dollars worth of subprime mortgage-backed securities (MBS) from private issuers, holding these securities as investments. (The charts are shown in the Roberts article.)
What Krugman would have us believe is that the government, along with its Frankenstein financial creatures, only wanted banks to make sound mortgages with the usual minimum of 20 percent down, good credit scores, and the like. That clearly is nonsense. As Thomas DiLorenzo notes, the only way that banks on their own would have made such risky loans was the fact that federal policies demanded they do so.

One does not need to hold the banks to be innocent bystanders to recognize the role of government policy in the financial crisis. Furthermore, while I have no problem with financial deregulation, I DO have a problem with financial deregulation that is backed by moral hazard. Deregulation was supposed to free financial entities to diversify their loan portfolios and to be able to provide liquid capital to entrepreneurs and businesses that had promising and new ventures.

Furthermore, financial deregulation did make possible the revolution in computers and telecommunications, and had we kept the regulatory system Krugman endorses in place, there would be no Apple Computers, cellphone networks, improved transportation, and IBM would still be the industry leader in the dominant mainframe computer business. Since Keynesians know nothing about entrepreneurship and even less about finance, Krugman probably is incapable of understanding how economies grow, still being stuck in the "aggregate demand" intellectual ghetto.

But financial deregulation only could have worked in the long run had the government made banks and financial houses responsible for their losses. By increasing the various government-led financial backstops as deregulation occurred, Congress almost guaranteed more reckless behavior, and no one should be surprised at what happened.

Unfortunately, these tidbits of truth are left out in Paul Krugman's own zombie version of economic history. That this rewriting of history comes on the editorial pages of the New York Times should shock no one. After all, the "Newspaper of Record" has been fabricating the "record" for a long time.

Thursday, February 14, 2013

Yes, Inflation is our Savior

One of Paul Krugman's repeated themes in his columns and blog posts is that inflation is a wonderful thing, and apparently we never can have enough of it. Inflation wipes out debt, transfer wealth from creditors to debtors, and makes all of us feel rich.

Hyperinflation? No problem. It might make things inconvenient for a while, but it really doesn't do any damage. The only damage comes if we stop inflating and even have the dreaded and evil deflation.

In a recent blog post, "It's Always 1923," Krugman once again accuses others of rewriting history. This is rich from the guy who wants us to believe that all of the major deregulatory initiatives of 30+ years ago were the product of Ronald Reagan, despite the fact that many of the major initiatives already had passed or were in the hopper before Reagan even won the 1980 presidential election. (As I have said many times before, Krugman wants us to believe that Jimmy Carter and Ted Kennedy were conservative Republicans.)

While praising a recent piece by David Glasner that praises (What else?) "easy money," Krugman writes about the famous German hyperinflation of 1923:
...the 1923 hyperinflation didn’t bring Hitler to power; it was the BrĂ¼ning deflation and depression. Hard money and a gold standard obsession, not excessive money printing, was the proximate disaster.
Technically, he is correct. Hitler came to power nine years after the hyperinflation during the Great Depression (which hit Germany very hard). However, one gets the sense that Krugman does not take that inflation very seriously, and that any policy other than "easy money" will bring an economy to ruin.

That should not surprise anyone, given Krugman's constant drum-beating for more inflation today. While extolling the government's own inflation index, Krugman wants us to believe that only the rich are inconvenienced by inflation, and that the rest of us are better off because of it.

What he does not say is that most middle and lower-economic class Americans have not seen increases in their incomes in years, but the prices they have had to pay for food, gasoline, and other commodity-based goods have gone up substantially. (Of course, Krugman has claimed that THOSE price increases have nothing to do with the massive money-printing operation at the Fed, and that they are due entirely to the fact that commodity prices are "volatile" -- his words.)

Furthermore, he is in a quandary when he praises inflation. If inflation does no economic damage -- other than to supposedly transfer wealth from rich to poor and middle-class people, something that Henry Hazlitt pointed out decades ago is simply not true -- then hyperinflation also would be a good thing. In Wonderland, there is no such thing as inflation distorting structure of production or encouraging lines of production that are unsustainable.

In fact, in Wonderland, inflation does the opposite: it encourages more capital formation and investment in everything, since it supposedly increases "demand," and "aggregate demand" is the key to prosperity. If that be the case, then we have discovered the secret for Haiti to become more prosperous: print money and lots of it.

Keynesians are not free to claim here that Haiti's problems lie elsewhere, since they have debunked any arguments that say capital formation and production structures don't matter. All that matters is demand, so if Haiti's government wants to print "demand," it should do so and then investors will flock to Haiti to build more things, given the "demand" for goods, all courtesy of the printing press.

Hazlitt made a very good analogy when he wrote that inflation is like the "Dead Sea Fruit," which "turns to ashes" when one puts it in one's mouth. I'm not surprised that yet another economics faculty member at Princeton has praised that economic wonderdrug, inflation.

Monday, February 11, 2013

Partisan-Based "Evidence"

I'll be brief today. Krugman is off on yet another partisan rant and because I have no interest in defending the Republican Party, I'll let others offer whatever defense they might choose.

However, I will point out that the column itself involves the usual kind of snobbery one would expect from a college professor who truly sees himself as being an example of brilliance and reason. I do find it strange, thought, that he chooses Hillary Clinton and the Benghazi attacks as an example of GOP malfeasance.

After all, the Obama administration from Hillary Clinton to President Obama himself lied about the attacks, what happened, and why they happened. We were supposed to believe that an obscure video was the cause of all this carnage and that the attacks occurred spontaneously.

The "evidence-based" world told a different story, but Clinton, Obama, and Krugman are moving on and then falsely accusing anyone who does not go with the administration's latest story as being part of an "ignorance-based" caucus.

As for Krugman and the claims that anyone who might disagree with his view of global warming is subject to intense persecution, he might want to look at the facts and make an "evidence-based" assessment. He wants us to believe that oil companies and crazy conservatives dominate the media conversation and the policy prescriptions, not to mention the research funding. Single government-funded research projects receive more than the entirety of Exxon-Mobile grants, but to Krugman, any questioning at all of the government's paradigm is tantamount to murderous treason.

Evidence-based, indeed.

Friday, February 8, 2013

Kick That (Keynesian) Habit

One think I do like about Paul Krugman's columns extolling Keynesian theory is that they are predictable and easy to follow. I cannot say they really constitute economics, given that Krugman seems to believe that government can eliminate the Law of Scarcity if the economy allegedly is in a "liquidity trap," but at least one can follow them.

Krugman's latest creation, "Kick That Can," is more of the same. The Evil Republicans want to downsize spending, ostensibly to reduce it to the size where it can be drowned in a bathtub, and then throw the economy into depression where there will be poverty, starvation and, of course, weeping and gnashing of teeth:
While it’s true that we will eventually need some combination of revenue increases and spending cuts to rein in the growth of U.S. government debt, now is very much not the time to act. Given the state we’re in, it would be irresponsible and destructive not to kick that can down the road.

Start with a basic point: Slashing government spending destroys jobs and causes the economy to shrink.

This really isn’t a debatable proposition at this point. The contractionary effects of fiscal austerity have been demonstrated by study after study and overwhelmingly confirmed by recent experience — for example, by the severe and continuing slump in Ireland, which was for a while touted as a shining example of responsible policy, or by the way the Cameron government’s turn to austerity derailed recovery in Britain.
He adds:

But aren’t we facing a fiscal crisis? No, not at all. The federal government can borrow more cheaply than at almost any point in history, and medium-term forecasts, like the 10-year projections released Tuesday by the Congressional Budget Office, are distinctly not alarming. Yes, there’s a long-term fiscal problem, but it’s not urgent that we resolve that long-term problem right now. The alleged fiscal crisis exists only in the minds of Beltway insiders.

In other words, it really does not matter that the debts the U.S. Government has accumulated -- especially in the current downturn -- cannot and will not be repaid. After all, the government can print whatever it wants or have the Fed buy and hold all its debts and if bondholders are paid back with dollars worth a tenth of what they were when the bondholders purchased those bonds, well, it is good for exports!

The Keynesian paradigm always points to a non-existent future in which a rush of present spending will produce magical "traction" for the economy, the product of Krugman's Inflation Fairy. Unfortunately, Krugman refuses to admit that what he touts as new spending, or "stimulus," actually is nothing more than a thinly-disguised wealth transfer. Yes, we can transfer spend ourselves into prosperity.

We don't need to "kick the can" down the road; we need to kick the Keynesian habit.

Monday, February 4, 2013

Paul Krugman: The Real Friend of Fraud

One of Paul Krugman's constant themes is that financial regulation, if done by people who properly have been schooled as Democrats, will guard against fraud, and he is at it again in his most recent column. The flip side of that point, of course, is that Republicans want fraud to happen because they are evil and beholden to Wild West Capitalism.

Before I deal with Krugman's own enthusiastic support for outright financial fraud, let me address one point that he claims: Barney Frank had absolutely no influence regarding the collapse of Fannie and Freddie. Krugman writes:
How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.

In reality, this is a nonsense story that has been extensively refuted; I’ve always been struck in particular by the notion that a Congressional Democrat, holding office at a time when Republicans ruled the House with an iron first, somehow had the mystical power to distort our whole banking system. But it’s a story conservatives much prefer to the awkward reality that their faith in the perfection of free markets was proved false.

This is one of those True Krugman Moments when he claims that (1) Frank had absolutely no influence in Congress even though he was the Democrat's Congressional point man on banking and financial matters; (2) the government never attempted to have large sums of money funneled to borrowers in the "sub-prime" category; and (3) the financial system that existed during the housing boom was pure free market without a hint of government intervention anywhere.

(Given Krugman's belief that Democrats are pure of heart and never would engage in financial fraud, I am surprised that he does not go after Jon Corzine, who was responsible for more than a billion dollars in very questionable losses for investors. Oh, I forgot. Corzine was a Democrat politician; he lost the money honestly trying to help his dear clients. And Bernie Madeoff also was a Democrat.)

As that famed right-wing publication, The Boston Globe, declared in a feature on Frank:
When US Representative Barney Frank spoke in a packed hearing room on Capitol Hill seven years ago, he did not imagine that his words would eventually haunt a reelection bid.

The issue that day in 2003 was whether mortgage backers Fannie Mae and Freddie Mac were fiscally strong. Frank declared with his trademark confidence that they were, accusing critics and regulators of exaggerating threats to Fannie’s and Freddie’s financial integrity. And, the Massachusetts Democrat maintained, “even if there were problems, the federal government doesn’t bail them out.’’

Now, it’s clear he was wrong on both points — and that his words have become a political liability as he fights a determined challenger to win a 16th term representing the Fourth Congressional District. Fannie and Freddie collapsed in 2008, forcing the federal government to buy $150 billion worth of stock in the enterprises and $1.36 trillion worth of mortgage-backed securities.
Now, I absolutely agree that Frank did not cause the meltdown nor did he cause the collapse of Fannie and Freddie, but even though his party did not hold a majority in the House of Representatives, nonetheless he did have influence and lots of it. (The influence comes out in the committee action, not the actual vote on the floor.) Furthermore, I do not recall any prominent Democrats during that period calling for lending restrictions on people with bad credit.

The blame for the meltdown is bipartisan, although Krugman will never admit to such. As for the Consumer Protection Bureau which he champions throughout the column, I do not believe that Washington and the Democrats are ready to jettison the very tenets of political liberalism and call for strict lending standards and to shut out people with bad credit from mortgage markets. That really would be a first!

Krugman's enthusiastic support for massive fraud, however, comes in his enthusiastic calls for inflation and lots of it, and inflation is a fraudulent way to repudiate debt (although Krugman has written that such a method is perfectly moral). As I have pointed out before, Krugman has openly agitated for government financial measures such as the Fed purchasing worthless financial instruments in order to jack up their market prices (if a private firm does the same, it is called "manipulation," which is against the law).

The difference is in the sheer numbers. While the meltdown featured head-scratching decisions by banks, nonetheless the actual losses due to the Corzine-Madeoff kind of fraud (where people actually set out to deceive others) were small compared to the over-the-cliff losses that came from lots of people jumping into the housing market because it was hot.

Krugman, like most Keynesians, believes that regulators have excellent foresight and know beforehand what lines of production will be profitable and which will not. (One remembers the Democrats pushing "industrial policy" in the 1980s, a brainchild of Bill Bradley and Gary Hart, both of whom believed that government agencies should target upcoming industries and then subsidize them. We see how well that works with "green energy.")

As Murray Rothbard once put it, if regulators actually had the kind of knowledge Krugman believes they have, then they would be in the markets themselves making lots of money employing their great foresight instead of making paltry government salaries. Instead, we find that regulators mostly will try to block any innovation, since they never will get credit for market successes, but surely will be blamed for market failures.

When it comes to fraud, however, keep in mind that it was the players in the market that realized Madeoff was running a scam, not the regulators. In fact, the lack of insight by regulators actually permitted Madeoff to run his operation longer than it should have gone, as people tended to think that if the regulatory agencies were OK with the guy, then he must be on-the-level.

The kind of fraud I fear, however, is not the fraud of some people being scammed in the financial markets. The greater and more dangerous fraud is that which Krugman heartily endorses: government money printing and the destructive inflation that follows it. Krugman's Inflation Fairy is as dishonest as Bernie Madeoff and much more dangerous.

Saturday, February 2, 2013

The Fed and its Role in the Economy: No Conspiracies, Just Bad Policy

In the comment section of my last post, one of my critics identified as JG made a point that I believe truly highlights the differences between Keynesians and the Austrians:
@ Anderson,"The Fed wants to drive money toward those assets by keeping their prices artificially high..."

Is that really what the Fed's goal is? To keep prices high? Do you really believe that QE is really a conspiracy to inflate MBS prices?

Someone less given to conspiracy theories would assume that the Fed was buying MBS to maintain liquidity in the financial system to faciliate lending during a time of weak demand.
True, the commenter was trying to lump me in with conspiracy theorists who seem to believe that the Fed principals conspire to wreck the economy and that they know exactly what they are doing and that is part of their dastardly plan. Now, I would agree that a bad economy in which an increasing number of people become dependent upon the government is good for President Obama in particular and the Democratic Party in general, especially if people come to believe that their state of dependence exists because the government is not taxing others enough or if businesses are conspiring to destroy the economy. We certainly see a lot of that from the Democrat/Keynesian camp, which is not without conspiracy theories of its own.

If I might use somewhat simplistic  models that I believe do reflect the differences in thinking between Keynesians and Austrians, the differences are portrayed as followed:
Keynesians: They believe that a market economy is internally flawed and will hurdle toward underconsumption at every turn. Their underconsumption lynchpin (wild swings in private investment, depending upon the "animal spirits" of investors) differs from that of the Marxists (capitalist profits suck the purchasing power from the proletariat, which leads to internal collapses of capitalist economies), but the results are similar.

For example, the housing boom and bust was a product of a pure, unregulated (by government) market in which none of the government agencies had anything to do with the crisis, except that the animalistic capitalist spirit so infected every regulatory agency that none of the regulatory agents -- even those who had perfect foresight (since most government agents are blessed with such foresight if they are performing under a regime run by the Democratic Party) -- did anything to stop it. The capitalists refused to read any price signals and led the economy into the abyss, as pure, unregulated capitalism always does. Had government agents been properly regulating the directing the housing market, it would have performed perfectly.

The Keynesians believe that capitalists do not respond to price signals (which are overblown, anyway, since an actual economy does not replicate the mathematical models of perfect competition), and that prices are useful mostly in their aggregation into various price indices, which themselves are statistics, not points of economic analysis.On the production side, market economies are prone to slide into the scourge of being overrun by monopolies, which create income inequality when then exacerbates the downward slide even more. Thus, without government oversight, and without the presence of a central bank like the Fed along with various government spending mechanisms, a market economy will implode into a miserable abyss of high unemployment and underconsumption. If there is deflation -- which always looms within a market economy -- then the system automatically will plunge into depression and stay there, since in the real world, entrepreneurs don't respond to price signals, anyway.

The important point here is that the Fed, along with the government agencies, exist in order to respond to private market failures, which the capitalists create on their own, with capitalist failures always being systematic. The Fed and the government, then, do not create conditions that lead to mass unemployment (unless someone at the Fed believes in Austrian theories that will make the central bank raise interest rates and choke off aggregate demand), but rather exists to offset those private market failures.

I believe this has been a fair interpretation of the Keynesian position. I now turn toward the Austrians.

Austrians: They believe that market economies are internally stable, and that government interventions, such as the ones made by the Fed, not only are counterproductive but actually help cause the downturns in the first place. No one is blessed at any time with "perfect information," but a price system actually sends the information that entrepreneurs and managers need to make production and exchange decisions regarding the future. Not all people respond properly to price signals, but the errors tend to be random, not systematic.

Intervention by government is harmful because it creates perverse incentives and directs production away from lines that are sustainable into those lines of production which are not. For example, far from being a free-market failure, the housing boom occurred because government in the form of the Federal Reserve System and the various government agencies that are tied to housing engaged in activities that directed investment and spending toward housing in amounts that could not be sustained. Not only did the Fed push down interest rates that encouraged more home buying and refinancing than what would happen in a normal market (without the intervention), but government agencies especially aimed their programs toward the "sub-prime" market in which were created vast amounts of mortgage securities that sold at prices well beyond what would have been the case had the government not been targeting housing in the first place.

Now, it was Wall Street, with its politically-connected banks and financial houses, that created many of these securities (Freddie and Fannie being the other two entities) but one must remember that these banks did not act within the structure of free markets. Instead, their principals acted knowing that the infamous Greenspan/Bernanke "Put" existed in the background, and that even though the mortgage securities certificates clearly stated that they were not guaranteed by the government, in essence that was a mere formality, for the government stood by to do just that: bail out Wall Street.

The point that Austrians emphasize is that without the government intervention and the promise of bailouts, the banks would have been much more likely to have followed the price signals that the markets were sending and not have marched over the cliff. Government here was not an entity that followed in the wake of private disasters in order to clean up the mess, but rather government was actively taking part in creating the mess in the first place.

As for the post-crisis mess, Austrians believe that since government interventions set the stage for the collapse, doing more of the same will not rescue the economy. In fact, it simply continues the same mistakes that occurred in the first place.

In response to the comment that I see Bernanke's purchases of mortgage securities as some sort of sinister plot to undermine the recovery, that is nonsense. My criticism is not of Bernanke's motives, but rather his actions. He is not "preserving liquidity" or anything like that; instead, he is propping up securities that markets already have rejected and continues to direct resources into lines of production that are unsustainable.
Keynesians counter with the "idle resources" argument that states that in a depressed economy such as ours, there are "idle resources" that are made idle by a lack of aggregate demand. When government resorts to what essentially are financial tricks such as the Fed purchasing securities, it is doing nothing more than engaging in unorthodox actions that are needed at this particular time because of very specific conditions that for the most part don't exist, i.e. the "liquidity trap." Without those actions, the economy will plunge into the abyss of a miserable, high-unemployment steady state in which we will be mired forever.

The Austrian response is that many of the "idle resources" are idle because they were malinvestments. The market does not support them because the patterns of purchasing and preferences shown by consumers do not and cannot keep those resources unemployed. Instead, entrepreneurs guided by price signals and interest rates (that follow a natural rate of interest, not something set by the Fed) will move resources from lower to higher-valued uses.

At the base of the thinking, I believe we can say the following: Keynesians believe that a market is not self-correcting in the event of a downturn, while Austrians believe that it is. There really is no middle ground between the two lines of thinking, which is why we see the kinds of responses we observe on this blog and elsewhere.