Wednesday, March 27, 2013

Krugman's Cyprus Solution: Seize Property and Print Money

In answer to the "What would you do about Cyprus if you were dictator?" question, Paul Krugman has shared his Nobel-level of economic intelligence with the rest of us, and it comes down to two actions: the Cyprus government should seize as much private property as it can, go off the euro and print its own currency, lots of it. Krugman writes:
...Cyprus should leave the euro. Now.

The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.
He continues:
If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP.

What’s the path forward? Cyprus needs to have a tourist boom, plus a rapid growth of other exports — my guess would be agriculture as a driver, although I don’t know much about it. The obvious way to get there is through a large devaluation; yes, in the end this probably does come down to cheap deals that attract lots of British package tours.

Getting to the same point by cutting nominal wages would take much longer and inflict much more human and economic damage.
At one point he is correct in that the boom that Cyprus enjoyed by playing the role of bankster is over, kaput. (The biggest offender of banksterism, the government-owned bank Laiki, does seem to contradict Krugman's belief that government usually is a responsible entity and only private enterprise is reckless.) But the party is over, truly over, although Krugman seems to want us to believe that Cyprus can avoid consequences by engaging in yet more financial tricks and that a Cyprus with its own government-issued scrip will be just fine.

By the way, Krugman (as a true Keynesian) believes that no one will notice that by getting out of the euro and printing its own money (and converting the deposits in its banks into Cyprus-scrip) that Cyprus has gone bankrupt. In reality, everyone there still will be getting a major head-shaving. We are talking about a currency that would be as popular in world markets as the Zimbabwe dollar at the height of that country's hyperinflation. Imports would fall to near-zero, to be paid only by the euros and other currencies in the seized bank accounts.

In other words, we are not looking for a happy ending. On one side, Cyprus and its people could face the truth, take the up-front medicine, and then try to create a real economy producing things people actually might want to purchase. On the Krugman side, Cyprus goes on with its "let's pretend" game of slashing real wages through inflation and continuing the Big Lie that the only problem there is a currency problem.

My sense is that Krugman's easy solution might be less attractive than what he might predict. First, given the proclivity of the government there to seize the property of others, I doubt seriously that the government would offer a true market exchange rate when those hordes of British tourists invade Cyprus looking for the Good Deal. Instead, we will see the infamous Third World "dirty rates" that are notorious elsewhere.

Second, people who are the victims of outright theft -- and that is what Krugman has been advocating -- are not going to take their situations lightly. Tourists are not going to want to come to a place where mobs are pillaging and burning -- and robbing tourists. (Well, completing the robbery process that would start when the government cheated on the exchange rates.)

The best way to avoid a crisis is not to create one in the first place. Booms created through monetary tricks and inflation have a way of blowing up, and starting a second boom to replace the first is not as easy as Krugman thinks it is.

Robert Murphy notes that Krugman's "solution" is to "ignite a boom" in place of the boom that has crashed. Of course, Krugman does not come clean and tell us what will happen when that boom inevitably crashes. No doubt, his "solution" is to create yet another boom, but in reality, financial trickery has a way of being exposed and at some point, not only is the party over, but people who have been fed a diet of inflation become so addicted to it that they cannot and will not do what is necessary to fix their economies.

In the end, Keynesianism is not about long-term solutions. It is about monetary manipulation in hopes that something -- Anything! -- can hide the fact that inflation is destroying the economic fundamentals. But to the homogeneous-factors Keynesians, there are no fundamentals, just the printing press and government, lots of government. Krugman's Inflation Fairy turns out to be a wicked witch after all.


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Anonymous said...

Professor Anderson, have you seen this video from Mike Norman? He has a degree from UPenn if you didn't already know that.

Anonymous said...

Mike Norman is a condescending idiot. When the arc of history proves him unequivocally and indisputably wrong in another 5-10 years, he will deserve nothing less than a public execution for his wicked and warped ideas that distort and attempt to re-write the very foundation of classical economics.

William L. Anderson said...

Well, the fact that he has a degree from Penn means he knows everything. Now Norman is correct in that dollar-denominated debts can be paid off in dollars.

However, he assumes that there is no problem at all associated with the government essentially printing trillions of dollars, and that everyone will gladly accept the money.

This is typical thinking from the Keynesians and MMTers, who believe that wealth really is created by the printing press.

Anonymous said...

It's not like the guy has a ton of subscribers anyway. He only has a little over 600 and usually a couple of hundred to a few thousand views on many of his individual videos. Norman seemed to sort of make sense since Bob Murphy acknowledged that the monetary base hadn't increased that much since mid-2011.

The anti-Schiff accounts and possible sock puppets are highly dogmatic and insistent that MMT is correct and everything else is wrong and tend to get nasty when trying to deal with someone that disagrees with them. You can go through some of Norman's other videos where he explains basic MMT concepts and attacks neoliberals and neoclassical economists.

I think you meant to say that he doesn't know everything.

Anonymous said...

Since you're associated with the Austrian School and the Ludwig von Mises Institute, do you know how valid this claim from Norman is?

Nick said...

Good blog, and I typically agree with all your analysis, but...

I think, in this particular instance, Krugman may be semi-correct. While I don't think the Keynesian theory makes for good monetary policy (in any respect), I do think Cyprus is drawing out their necessary economic correction by sticking with the Euro, and adopting austerity measures to try to cope with their current debt. This will prolong the correct period, relative to an immediate devaluation which switching to their own currency would accomplish immediately (as it would effectively be worthless, marking the country's assets to market in an expedient fashion).

What comes next, of course, would be the problem with Krugman's plan, as undoubtedly the government doesn't stop with the one-time devaluation, but continues to print money to cover spending and such, rather than dealing with the fundamental national economic problems. However, if we assume (in a pure hypothetical, since it's absurdly unrealistic) that Cyprus was able to completely avoid inflating their monetary base after the conversion, and just take the one-time haircut and adjustment to market (while building a real economy producing things people actually want), it could actually be the optimal action for the government.

My 2c. :)

Salamano said...

If I recall correctly, Krugman's philosophical view of "economy" is fundamentally different from many others, even with his expertise in the arena of international and macro model-based economics.

In that-- "economy" does not require any 'long term solutions'. If economy is simply a tool available for the material benefit of society (even benefits that are only/barely related to economics itself), then why not try whatever manipulation that keeps us achieving prefered goals in the present, so the argument might go.

William L. Anderson said...

Thanks, Nick. The problem comes when people who have had one standard of living suddenly find themselves being, well, poor. They want to blame someone and at the same time most will demand the government "do something" to change their state of affairs.

Anonymous said...

I'm sorry but anything coming from Mike Norman doesn't merit further discussion, period. The more you see from that guy, the more apparent it is that he's nothing more than a self-aggrandizing, narcissistic, and pompous jackass who is borderline mentally instable.

The clues are plenty. He's quite prolific at making "informative" videos, but he spends very little time actually discussing economics and devotes most of his time to either insulting or attacking people who hold beliefs contrary to his. He really tips his hand when he makes bombastic claims like "We (MMTers) have been RIGHT about everything" or "They (Austrians) have been WRONG about everything." He doubles-down on his own instability with the faux-psychoanalysis where he tries to smear those same people with accusations of having "deep character flaws" such as insecurity, narcissism, cognitive dissonance, etc.

No serious economist would resort to the kind of antics Mike Norman has. They wouldn't have to as their analysis would speak for itself. There's no reason to take petty swipes at or smear those who hold differing viewpoints or blather on and on about always being right and your opponents always being wrong - and having deep character flaws - if your argument is sound.

No, Mike Norman is nothing more than a common blowhard - like a drunk frat boy at the bar - and should be treated as such.

Anonymous said...

mises pointed out that the demand for cash holdings can increase, and when it does, the effect is deflationary. mike norman at least grasps this, i feel some austrians who predicted runaway inflation did not.unfortunately.

Nick said...

@William: The other problem (or one of many) with the "quick correction" approach is that it tends to jolt people into awareness that fiat currency, especially in control of willing inflationists, is a pretty poor storage of wealth. Moreover, if the government is willing to seize assets arbitrary to pay for its largess, it substantially discourages investment (and particularly foreign investment) in assets within the target zone, be that holdings in banks, direct investment in businesses, foreign bonds, etc.

That's fine if you have resources in-place that you can confiscate, as Cyprus is doing with all the large-money depositors who were unable to move their money out of the country before the capital flow controls (or, for example, when authoritarian regimes seize foreign businesses for "nationalization"). There is a price to pay, though: investors will be wary (once burned, twice shy), which means little foreign investment, and someone will need to backstop government debt in the face of a pretty negative economic outlook. It's possible to have a quick correction, turnaround, restructuring, and resume growth on solid footing... but it requires acknowledgement of the fundamental economic problems, something which (to date) has been missing among all the Euro-zone countries (and from Krugman, as an aside).

I don't think it's a good strategy for Cyprus... but only because they are not ready to admit the fundamental problems, give credible assurances that they will be fixed, and work on real reform. Until that time, they are much "better" with crushing debt, austerity, and unrest, in the overarching interest of getting to that point (where it's possible to get real fixes). IMHO, anyway.

Anonymous said...

"i feel some austrians who predicted runaway inflation"

The key words here are "some" and "runaway," which is a weasel word if there ever was one being used as a strawman in an attempt to discredit warnings over a vast expansion of the monetary base. Somehow when "some," or a few, Austrians make a fairly bold claim, Keynesians, Krugmanites, and MMTers try and find a way to take it out of context to smear the whole lot of us.

And I'm pretty sure "runaway" means different things to different people. To Krugman, Keynesians, MMTers and their ilk, I doubt they'd blink unless annual inflation was running 5% or higher, probably wouldn't accept it as a potential threat until it exceeded 10%, and wouldn't deem it serious (and thus acknowledge the concerns put forth by Austrians) unless it was 15%-20% of higher. However, I can assure you that, for people on fixed incomes (which is a big share of the country), be it in retirement or just through flat nominal wages, a 3%-4% increase in the headline CPI, a feat we've achieved 5 times since 2000 with several other years of 2%-3% increases, is pretty darn close to "runaway." That might be hard to imagine for guys like Krugman and Norman from where they sit in their Ivory Tower.

Anonymous said...

Fair enough. I cannot wait for that debate between Robert Murphy and Warren Mosler. Some of the commentators over at Norman's site think Austrian ideas are dangerous or that Murphy will repeat everything Peter Schiff has been saying. Bob did a critique of MMT over at the Mises Institute website that I don't think MMTers were convinced by at all.

The most recent blog posts at Norman's blog average at around 3-5 comment and no comments for several of them. Some have gotten up to 15.

Luke said...

To the poster saying Austrian commentators were debunked about run away inflation following the 08 crash I think you are completely wrong and have missed a fundamental lesson about inflation from Hayek.

Inflation does not work the way Keynsians think it does. CPI, while low, is essentially useless. Inflation does not decrease the general purchasing power of a currency nor does it increase the prices of goods on average. It shifts capital from productive areas to unproductive areas. Just take one quick look at our stock market and you can easily see where all the inflation is. A 2.5% CPI means balls if nominal values of investment assets have increased at 10% without real economic gains.

The dollar will loose the majority of its value as Austrians predicted, but not through a stagflation or hyperinflation event as many interpreted Austrian warnings. A crack boom in either bond or investments will be an economic event that triggers a loss of value in the dollar. Many misinterpret Rothbard's concept of inflation (money added to system=inflation) and made the simple assumption that adding huge amounts of capital into the system would decrease the value of the dollar automatically. That isn't how it works, the dollar will loose its value during the bust part of the boom/bust cycle. Deflation is not, as Keynes and Friedman thought, what caused the Great Depression but rather an impact of the fundamental factors that caused the Great Depression. Best books for this topic Rothbard's "America's Great Depression," and Hayek's "Road to Serfdom."