Krugman: The USA should borrow and spend itself into prosperity

Paul Krugman is on the austerity kick again, and in part, he is right. The austerity measures that have been imposed upon Ireland and Greece by the European Union, are awful, and they are imposing a lot of suffering.

There are some things that Krugman is not saying, however, and I think they bear mentioning. First, we forget that the banks in Europe, plus the European Central Bank, were all-too-anxious to lend billions to Greece even when it was obvious that the Greek government was irresponsible and that Greece has some of the worst government employee unions in the world.

(I know, I know. Public employee unions are great because they encourage spending, and everyone knows that spending creates prosperity, so the unions in Greece simply were spreading wealth.)

Yet, the average Greek must face a grim future because the banks need to be saved. Yes, the bankers of the world most fear a series of world-wide runs, and so the Greeks must pay back the loans, or at least pay back a lot of the loans.

By the way, one of the features of "austerity" programs is raising taxes and tax rates. Not that Krugman mentions this point; all he says is that it is bad that governments are spending less, and that the road to prosperity is paved with government paper.

I am among those who believe that default is best, and that Greece would be wise to leave the euro. Now, where I believe Krugman is wrong is when he thinks that Greece, if it went back to the Drachma, could inflate itself into recovery. He does seem to believe that the USA definitely could do that:

...the main point is that America does have an alternative: we have our own currency, and we can borrow long-term at historically low interest rates, so we don’t need to enter a downward spiral of austerity and economic contraction.

Yes, the USA can borrow and print itself into economic recovery and beyond. Or so says Paul Krugman.

Sean Rosenthal on Krugman's claim on British "austerity"

On a number of occasions, Paul Krugman has claimed that "austerity" measures are hurting the British economy and should be ended immediately in favor of more spending. Sean Rosenthal demonstrates that the British government has both raised taxes (which Krugman ignores) AND run large budget deficits.

Rosenthal writes:

Interestingly, Krugman neglects to provide any data on British government actions. In particular, although he asserts that British policies have simply been to "slash spending," he neglects that Britain ignored the advice of free-market supporters by increasing tax rates significantly, such as raising the top marginal income-tax rate to 50 percent, the capital-gains-tax rate to 28 percent, and the value-added-tax rate to 20 percent. More damaging to his view, as can be seen on tables 25 and 27 of this Organisation for Economic Co-operation and Development (OECD) document, British spending has experienced no significant cuts and still represents a sharp increase compared to prerecession levels.

This does not exactly square with Krugman's claims, but that hardly is unusual.

Spend and pretend

[Update]: Don Boudreaux today has commentary about Krugman's insistence that Herbert Hoover was an "austerity" president. (Remember that it was Hoover in his memoirs where Andrew Mellon's "liquidate" quote was found, and that Hoover writes that he rejected Mellon's advice.)

Writes Boudreaux:

Describing "austerity policies" as "the insistence that governments should slash spending even in the face of high unemployment" in the hope that such spending cuts will restore business confidence, Paul Krugman remarks: "If this sounds to you like something Herbert Hoover might have said, you're right: It does and he did" ("Pain Without Gain," Feb. 20).

Easily accessed evidence prove Mr. Krugman wrong.

Here, for example, is economist Steven Horwitz: "the real size of government spending in 1933 was almost double that of 1929. The budget deficits of 1931 and 1932 represented 52.5 percent and 43.3 percent of total federal expenditures. No year between 1933 and 1941 under Roosevelt had a deficit that large." Also contrary to Mr. Krugman's claim, Hoover proudly trumpeted his administration's high-spending and interventionist policies. On the campaign trail in 1932 Hoover bragged that "We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and the Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic."**

Mr. Krugman's unfamiliarity with history is disturbing.

[End Update]

The eternal downturn continues and no real recovery is in sight, yet the advice from Paul Krugman always is the same: borrow, spend, pretend. Pretend what? Pretend that borrowing and essentially printing new dollars is the same thing as actually having a productive, prosperous economy. Print money and get rich!

The Keynesian view of the economy is pretty simple. Factors of production are homogeneous, production and consumption are not related except to say that the purpose of consumption is to clear the shelves so that producers can make new goods to put on the shelves. The sole purpose of a "job" is to put income in the hands of workers so that they can spend and in order to make way for new production. In other words, it is a model-driven, mechanistic view of economics in which human action is not purposeful, but rather robotic.

In dealing with the situation with the European countries such as Greece, Spain, Ireland, and Portugal, he rightly condemns the policies that the European Central Bank has imposed, but for all of the wrong reasons. You see, Krugman really believes that if the ECB simply slashed its interest rates and loaned near-infinite amounts of money to these countries, that they soon would spend themselves into prosperity and that somehow there would be so much economic activity and new tax revenues that the extra loans would pay for themselves.

Austerity, according to Krugman, is bad but not because it imposes unjust tax and regulatory burdens upon people in order to pay the debt service for loans that profligate governments took out in order to spend beyond their means. No, austerity is bad because it cuts government spending.

Furthermore, the real reason that these countries are forced into austerity measures is because the banks that made these foolish loans (with the promise of being backstopped by central banks) are now calling the policy shots. Yet, we now see the ridiculous scenario of banks lending money to these governments so they can pay their debt service for previous loans although everyone knows that these countries cannot generate enough economic activity to pay back these loans in full.

In other words, we are looking at default. Now, the USA, which Krugman holds as a model of how to properly deal with the recession (or at least has not engaged in European-style "austerity"), is defaulting through inflation. I believe that it would be much better for Greece and the other European states that are facing these crises to default on their loans, and reduce their payments or suspend them altogether.

Unfortunately, Krugman prefers the game of "Let's Pretend We're Rich." He urges Congress to borrow even money to give to states for their own spending, with the idea that we can worry about the unpayable debt tomorrow, a Scarlett O'Hara approach.

Even Krugman knows that this cycle of debt cannot continue forever, but he seems consumed with the belief that sooner or later the perpetual motion machine that is the economy will gain "traction" and move on its own, paying down the debt as it goes. That is nonsense, but unfortunately it is nonsense that is being passed off as sophisticated economic thinking.

Russ Roberts on "Postwar Austerity"

I know, I know, Keynesians never are wrong. Only government spending can give us prosperity, and that certainly is what the greatest of the Keynesians were saying as the end of World War II approached.

Russ Roberts of George Mason University has this wonderful post that I am sure never will make it to Paul Krugman's articles or blog. (HT, Christopher Westley)

Here is a great quote from...Paul Samuelson, Mr. Keynesian himself:

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

(From Paul Samuelson, “Full Employment after the War,” in S.E. Harris, ed., Postwar Economic Problems, 1943.)

Don Boudreaux's latest take on Krugman's "austerity" claims

I'm letting Don Boudreaux provide the answer today to Paul Krugman's claim that Great Britain's government is following a policy of "austerity." (By the way, "austerity" is nothing more than government not engaging in reckless borrowing and spending. I guess if I am not trying to get as many credit cards and maxing out of them, then my household is in an "austerity" pattern, and all of us know about the dastardly Paradox of Thrift of which Krugman warns.)

Take it away, Don.

Krugman: Save "democracy" via inflation

Paul Krugman is sounding the alarm on Europe and to a certain extent, I agree with him. Economic collapses tend to bring out the worst in people, and invariably, they will turn to the worst politicians who appeal to resentment, envy and hatred.

Invoking the rise of the political lunatics that took power in the 1930s, Krugman writes that "democratic values are under siege," and says that worse things are down the road. Furthermore, when "austerity" measures involve actually empowering the State to grab more in taxes in the name of "balancing budgets," I agree that "austerity" is a bad thing, but, ironically, the only thing Krugman seems to like about austerity measures is raising taxes.

I also agree with him that we are in a depression, but we fully disagree on how we got here and what must be done to get out. Krugman believes that governments should take more power, inflate the currency, borrow heavily (thus, creating new financial bubbles in sovereign debt that cannot ever be repaid with future tax revenues), confiscate more income from wealthy people, and engage in Crony Capitalist measures like funding "alternative energy."

In a nutshell, everything that Krugman demands the European and U.S. governments do will worsen this depression. Everything. From his scheme of having central banks purchase sovereign debt in the primary markets (which are no markets at all) to government bailing out failing firms and giving huge subsidies to "green" industries, Krugman is calling for putting malinvestments on steroids, in the belief that flooding the economies of the world with even more paper money will save us.

This is not something that will lead to recovery; instead, it is not just "hair of the dog," but rather a call to consume the entire dog itself. And, invoking the "babysitting cooperative" as "proof" that he is right might work at the NY Times and with fellow Keynesians, but it makes no sense in the real world.

Europe seems to be on the brink and so is the USA. And if Krugman really does believe that the "solution" involves more sovereign debt, more subsidies, and more malinvestments, then I would like to sell him some real estate in Princeton.

Yes, Paul, it IS politics!

In what Jeffrey Tucker of the Mises Institute calls "The Most Evil Column Ever," Paul Krugman begins to come clean. If I read his recent statements correctly, Krugman is claiming that the economy easily can be "fixed" with a dose of inflation, heavy taxation, and borrowing, and that anyone who might see things differently does so because that person is pure evil.

Krugman has not gone as far as Michael Moore, who recently called for the arrest of the CEO of Standard & Poors for permitting his agency to downgrade U.S. Government debt, but he is moving in that direction. As Anthony Gregory has put it, we are seeing the totalitarian mindset of the Progressives in action, and Krugman is right in the middle of it with his unhinged rhetoric. (Gregory, one of the most insightful writers out there today, notes that we now are faced with totalitarian thinking on both right and left. His column definitely is worth a read.)

Before deconstructing Krugman's column and his latest blog posts, I would like to quote Tucker who makes a most salient observation regarding S&P's supposed sin:

Krugman seems to regard the down-rating as the sin that cries out to heaven for vengeance. And why? Because S&P had given Lehman Bros. an A rating before it went bankrupt and therefore the company has no credibility.

Huh? Doesn’t his point suggest the opposite of what he intends? By his own account, S&P has a bias to overrate bonds. S&P down rated U.S. debt from AAA to AA+. Seems like S&P could continue to downlist U.S. debt a long way before even approaching Lehman territory. Plus, if A is supposed to be a vote of confidence in Lehman, how can AA+ constitute a pessimism so horrible that it is a crime against humanity?

That is an excellent point. Furthermore, what Krugman does not point out is that the government was strongly encouraging the formulation of the toxic assets through its various programs, and the Federal Reserve System quietly stood in the background with its promised "Greenspan-Bernanke Put."

To say it another way, one easily can argue that S&P was doing what its political masters wanted it to do: give high ratings to government-inspired debt. Likewise, as we can see with the reaction of Krugman, Moore, Congress, and the White House to the latest S&P move, the consequences of telling the truth -- that the emperor wears no clothes -- are severe. With upcoming Senate hearings on S&P, we can be assured that the iron fist of the state is going to follow.

So, it is politics after all, but a different kind of politics. Krugman blames Goldstein, er, the Republicans, for all of the problems -- ALL of them. According to Krugman, even when the Democrats held the White House AND insurmountable majorities in the House and Senate, somehow Goldstein, er, the Republicans, managed to keep them from spending what Krugman says was enough money to "stimulate" the economy and give it "traction."

How did the Republicans do that dastardly deed? Why they disagreed with Paul Krugman. Yes, mere words, something that never bothered the Democrats before, suddenly stopped them dead in their tracks and made them initiate what Krugman has called "austerity." Yes, through Fox News (which Krugman and his allies never watch, anyway), the conservatives managed to destroy all the good Krugman demanded that Obama do. The fact that the Democrats had the major media all on their side from the NY Times to the news networks apparently meant nothing, as just the existence of dissent somehow overpowered the powerful.

To me, that is a huge howler. What Krugman is saying is that the very presence of people who might see the world differently than him is unacceptable. Given his recent endorsement of the view that the only way we can bring back prosperity is through state violence against businesses and banks, we can see where he and his political allies are headed. Look for Krugman to endorse measures in the future that smack of totalitarianism and outright violence.

Krugman no longer is even engaging in debate. The same person who spoke glowingly of "death panels" now is claiming that only the conservatives have used the term. For that matter, Krugman's ally Robert Reich also has endorsed "death panels," although he termed things differently.

For all of his talk of being the prophet in the wilderness, Krugman clearly is part of the political establishment. The recent Time screed against the Tea Party points out that the establishment view is that Ben Bernanke is a sober tiller of the economy, that John Maynard Keynes provides the way to prosperity, and that Ron Paul is a wacko nut job. In other words, the political establishment -- and Time is part of that group -- has no problem with Krugman.

What we are seeing is a roadmap to destruction. On one side, Krugman is claiming that tax-borrow-print-spend will bring us prosperity when, in fact, it will only make things worse. And as the hole continues to get deeper, Krugman and his friends are going to call for outright totalitarian measures against anyone who disagrees with them. You can bank on that one.

Krugman and "economic fallacies"

With the job numbers today looking dismal, I figured that the Paul Krugman would call for more borrowing and spending, and he did not disappoint. However, as an added bonus, Krugman also declares certain things to be "economic fallacies," which not only turns upside down any meaning of "economics," but also is built upon that Mother of All Economic Fallacies, the "Fallacy of the Broken Window."

Krugman writes:

One striking example of this rightward shift came in last weekend’s presidential address, in which Mr. Obama had this to say about the economics of the budget: “Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.”

That’s three of the right’s favorite economic fallacies in just two sentences. No, the government shouldn’t budget the way families do; on the contrary, trying to balance the budget in times of economic distress is a recipe for deepening the slump. Spending cuts right now wouldn’t “put the economy on sounder footing.” They would reduce growth and raise unemployment. And last but not least, businesses aren’t holding back because they lack confidence in government policies; they’re holding back because they don’t have enough customers — a problem that would be made worse, not better, by short-term spending cuts.

Notice what Krugman is saying: Government magically can do away with opportunity cost by spending. (Yes, I know, his argument is that government spending will transform "idle resources" and then give the economy "traction" to move on its own.)

Furthermore, he is not listing anything close to an "economic fallacy." Instead, he is dealing with policy issues, while having economic implications, are not economic theories themselves. An "economic fallacy" deals with a violation of either premises or what we might call a "law" of economics.

Perhaps the most famous of the fallacies is about which Frederic Bastiat wrote in "What is seen, and what is not seen" when he described the view that "broken windows" are necessary to keep an economy going:

Have you ever been witness to the fury of that solid citizen, James Goodfellow, when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: "It's an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?"

Now, this formula of condolence contains a whole theory that it is a good idea for us to expose, flagrante delicto, in this very simple case, since it is exactly the same as that which, unfortunately, underlies most of our economic institutions.

Suppose that it will cost six francs to repair the damage. If you mean that the accident gives six francs' worth of encouragement to the aforesaid industry, I agree. I do not contest it in any way; your reasoning is correct. The glazier will come, do his job, receive six francs, congratulate himself, and bless in his heart the careless child. That is what is seen.

But if, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.

It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.

What Krugman advocates, of course, is something like the "Broken Window Fallacy" (all in the name of claiming that the BWF is a fallacy in itself), for unless government spending via taxation, monetary creation, and borrowing can create wealth where there was none before, government simply is transferring resources or it is blocking the transference of resources from lower-valued to higher-valued uses.

Now, it is true that if government cuts spending, it will create more unemployment in the short run, but to Krugman, there only is a short run. Because the Keynesian viewpoint holds that resources (for economic purposes) are homogeneous, it does not matter where spending is directed, just as long as "new jobs" are created.

Yet, it DOES matter where spending is directed and it is not a fallacy to emphasize that point. For the past three years, the government has engaged in policies of bailouts, "stimulus" spending, new regulations, and throwing huge amounts of money at "green" energy projects, and we are further away from an economic recovery than when we started.

Yes, Krugman can claim that government spending is falling and that the government already is engaging in "austerity." That is nonsense, but nonsense is what prevails in Washington.

Is it austerity, or reality?

One of Paul Krugman's constant themes has been that "austerity" is the wrong prescription to deal with a shrinking economy. If the economy is going south, he claims, then governments must spend and spend prodigiously in order to prop up everything. (Krugman adds that this should be the case when the economy is in a "liquidity trap," which he believes changes the rules of economics.)

At one level, I understand his point. The "austerity" programs often mean increased taxes and other government activities that can drag down an economic recovery (although Krugman has been insistent that we need massive tax increases in the USA, so I don't know why he would be against that aspect of "austerity").

Yet, there is something else out there, something that really divides the Keynesian and Austrian camps: Keynesians really believe that spending money is what creates wealth, and that governments can create wealth out of thin air simply by cranking up the spending. Furthermore, assets really are not real; if the economy goes into the tank, government simply can declare prosperity and if people believe (yes, only believe) that the spending will make everyone prosperous, then all is well.

How else can someone really claim that heavily-subsidized industries like "wind power" and "corn-based ethanol" can create overall prosperity and lead us into recovery. How else can someone really claim that if government takes enough resources away from everyone else and gives them to GM, Chrysler, and the United Auto Workers, that we will have overall prosperity?

Austrians do not see "austerity" as a policy, but rather a reality. This is not a morality play (even if Krugman has accused us of enjoying the infliction of "pain"), but rather a bowing to reality of the fact that one cannot fix a broken economy by pretending it is not broken.

There is something else I have noticed; in Krugman's view, if a policy has immediate "good effects," then the policy must be good. Thus, ANY liquidation of malinvestments also must be bad, bad, bad, as that means short-term pain.

It was not just the Keynesians who have demanded that we play a "let's pretend" game about the economy. Shortly after the financial crisis of the fall of 2008 became painfully obvious, Martin Feldstein, who was President Ronald Reagan's chief economic adviser, called for the government to enact what was little more than a scheme to prop up housing prices. Like the Keynesians, Feldstein could not recognize that falling prices were a symptom, not a cause of the larger problem.

In the Keynesian world, there are no malinvestments, only idle resources. Spend enough, and those resources will rise up. After all, doesn't Y = C+I+G+(X-M) tell us everything we need to know about the economy?

Well, not it doesn't. In fact, I will go as far as to say that the equation tells us next-to-nothing about an economy and how it works. The economy is not in recession because there is a lack of spending; there is a fall in spending because the economy is in recession, and we cannot spend ourselves into prosperity no matter what Krugman and the Keynesians tell us.

Krugman rewrites history (again)

One of the most famous lines said by anyone in the Herbert Hoover administration was what Secretary of the Treasury Andrew Mellon supposedly told his boss: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Oh, and he said one other thing: "Purge the rottenness out of the system."

In his column today, Paul Krugman takes that quote and decides to rewrite history. True, Krugman is famous for that, as he gives us several howlers per week, but this one is important because not only does Krugman give us a false accounting of history then, he makes an equally-spurious claim for today.

The first and most important thing to remember (and something Krugman always seems to leave out -- not surprisingly) is that Hoover brags that he rejected Mellon's advice. This is important, because Krugman always presents that quote as an official policy of the Hoover administration when, as Hoover notes in his memoirs, he not only refused to follow Mellon's suggestion but he also tried actively to keep the liquidation from happening.

My sense is that Krugman ignores that fact because it does not fit into his chain of events, and because he wants to claim that the Republicans, who apparently want to cut all of $61 billion from a $3.5 TRILLION federal budget are trying to engage in what he calls Mellon-style austerity:

But never mind the lessons of history, or events unfolding across the Atlantic: Republicans are now fully committed to the doctrine that we must destroy employment in order to save it.

And Democrats are offering little pushback. The White House, in particular, has effectively surrendered in the war of ideas; it no longer even tries to make the case against sharp spending cuts in the face of high unemployment.

So that’s the state of policy debate in the world’s greatest nation: one party has embraced 80-year-old economic fallacies, while the other has lost the will to fight. And American families will pay the price.

Now, I am not sure how a tiny proposed cut in spending translates to "austerity," but like Blutarsky in "Animal House" who asked his frat brothers if the Americans quit "when the Germans bombed Pearl Harbor," Krugman is on a roll.

However, I think for all his botching of history, Krugman does perform a useful function here, and that is to ask the question (in his own, nasty way, of course) as to the larger issue underlying debate about boom and bust. Are we dealing with simple idle resources that need to be jump-started via an infusion of government spending, or are we dealing with malinvested resources that need either to be liquidated or transferred to other uses?

This is not an idle question, for I believe it is at the heart of all of Krugman's anti-"austerity" diatribes. Krugman clearly believes that the problem is that of idle resources; people stopped spending, and the only way to get the economy moving again is to bring in wads of new government spending that will give the economy "traction" and continue the circular process.

To Krugman, a boom is just that: a boom. It can and should be continued by all means possible, including policies of massive borrowing, spending, and, yes, creation of new money. (As Krugman claims in The Return of Depression Economics, many economic problems can be solved simply by printing money, and that printing money creates what he calls "a free lunch.")

In that world, all factors of production, economically speaking, are homogeneous. It does not matter from what direction the spending comes, as everything moves in the same way. If a boom is touched off by something like the housing bubble, it creates the very kind of mix of capital and labor that a huge infusion of government spending would produce.

Should that be the actual situation, then Krugman is correct and the way to long-term prosperity is for government to print and spend. Money in that view would be nothing more than a tool used by government to manipulate events, and as long as the "correct" people are in political power, such policies will create a second-best nirvana.

The Austrian position, however, is much different. Austrians hold that factors of production are heterogeneous, and that the mix of capital created during a credit-fed boom cannot be sustained, even if the government throws in new spending measures after new measures. In fact, Austrians believe that the very wave of spending that Krugman demands government do only exacerbates the situation, as it only deepens the unsustainable capital structures and creates even more malinvestments. That is the heart of the Austrian Theory of the Business Cycle (ATBC).

I'm not about to claim that the "austerity" measures of what Krugman speaks are based upon the ATBC or that finance ministers across the globe suddenly have embraced Austrian Economics. Nonetheless, I will say that until the economy can deal with the very real malinvestments that piled up during the last 20 years, we are doomed to have a low-growth economy with high unemployment.

This is the Austrian critique in a nutshell. As for Krugman's claims that the Republicans suddenly have become the Second Coming of Andrew Mellon, I believe that is, to put it mildly, a bit of hyperbole. But, Krugman never would engage in that kind of rhetorical fallacy, would he?

It's Not the Euro, Paul

When I went to Baylor School in Chattanooga (when it was an all-boys' military school), one of our traditions was to have senior write-ups in the yearbook, along with a quote that would characterize the particular senior. (Perhaps my favorite quote was that given to Mike Aiken of our Class of 1971, which read, "Life is one damn thing after another." If you know Mike, you know that one is perfect.)

For another friend who was graduated several years before me, there was this: "The problem with the world is wine, women, and song. We must stop singing." Obviously, that line is meant to be humorous, but when someone actually tries to apply something similar to economic analysis, well, the joke ceases to be funny.

One of the reoccurring themes in Paul Krugman's blog posts has been his dissatisfaction with the results of European countries adopting the Euro as a single currency. In a recent post, he writes:

As readers may have guessed, I’ve been working on a euro-related project; more about that one of these days. But for now, I thought it might be worth explaining a bit more about how I see the political economy.

Some readers have chimed in that the euro is essentially a political rather than economic project. Well, it’s both; that has been the European strategy ever since the Schuman declaration. The point is to deliver a series of economic integration plans that do double duty: they’re economically productive, but they also create “de facto solidarity”, moving Europe closer to political union.

For 60 years, this strategy has been highly successful. Europe is one of the great, inspiring stories of the modern world, maybe of all time: peace, prosperity, and democracy flourishing where once there were minefields and barbed wire.

But: the strategy depends on each move toward economic integration being both a political symbol and a good economic idea. That was clearly true of coal and steel, the common market, the eurosausage, and so on. It is, however, by no means clear that the euro passes that test. Europe’s limited labor mobility (although there’s more than there used to be) and, crucially, lack of fiscal integration makes a common currency a dubious proposition at best.

In this and in other posts and columns in which he blames the Euro for much of the turmoil on the Continent, Krugman confuses cause with effect. As I have noted in other posts dealing with Krugman's Euro fetish, Krugman seems to believe that the "solution" for Europe is yet another round of inflation, a "hair of the dog" monetary and fiscal strategy.

At the center of this problem is the fact that the huge European welfare apparatus, along with the power of government employee unions such as those in Greece, Spain, and Frace, only can be supported if the economies of those nations produce enough wealth to enable governments to spread it around. Furthermore, the taxation and regulation policies of those nations must be such that it is possible for private firms to create enough wealth in the first place.

Unfortunately, one of the things that happens in economic downturns is that tax revenues fall and it becomes obvious that the lavish government benefits given to government employees cannot be supported by that country's economic activity. Now, as Krugman has noted, in the past, when each of these government controlled its own fiat currency, one "solution" was devaluation, which in reality is nothing more than a government's admission of trying to paper over its losses by engaging in a glorified printing of new money.

This, economically speaking, is not a solution at all. It simply masks the underlying problems and creates new problems in the process. Not only does this strategy continue the charade of "giving" people something that is illusory, but it also undermines an economic recovery.

However, when a country does not control its fiat currency, as is the case of the Euro, then the problems become much more front-and-center. Greece, for example, is in trouble because it no longer can afford to give government employees pay and benefits that they are not earning, and the Greek government employees have responded by going on a rampage of rioting, murder, and destruction of property.

The Euro is not the cause of this trouble; instead, it is the messenger, the entity that bears the bad tidings. What is Krugman's response? It is shoot the messenger. In Krugman's view, there is nothing wrong with runaway government benefits; in fact, he argues, such spending helps the economy by "stimulating" it.

While there often is much not to like about "austerity" moves, nonetheless for the most part they are little more than policies that reflect the economic reality of the present time. (My problem with "austerity" is that it often emphasizes the implementation of new taxes without cutting enough spending; I'm all for the reality of "pay as you go," but we have to understand that we cannot kill the Golden Goose in the process.)

Krugman really seems to believe that we can pretend we are creating wealth simply by borrowing, spending, and creating new money. Yet, these actions don't create wealth; they destroy it. Krugman may call such a statement the product of "zombie economics," but to claim that government spending by itself "creates wealth" is the real "zombie" position.

The Austerity Bogey

I do hope that Paul Krugman practices what he preaches, and does not have a savings account and maxes himself on credit cards. If he saves any of his money, then he really is an Enemy of the People.

The guy who recently claimed that the U.S. Government really didn't go on a spending spree now says that the British Government is channeling Andrew Mellon. I think it is important that we understand a couple of things: first, even if Britain or the U.S. Government will not be raising spending as much as Krugman claims they should be doing, nonetheless both countries are characterized by bloated public sectors.

Second, Herbert Hoover did not take Mellon's advice to "liquidate the farmers" and "purge the rottenness out of the system." This is a quote that people like Krugman are fond of laying out, but all Mellon was saying was that the government cannot and should not prop up malinvestments, and needed to let the markets take their courses. Contra Krugman, that is what happened in 1921, and the economy recovered nicely. (Notice that Krugman never speaks of that particular recession because he can't spin a Keynesian tale out of the recovery.)

Given that Krugman generally rewrites history, I find this quote to be amusing. Krugman writes:

The operative word here should, however, be “eventually.” Fiscal austerity will depress the economy further unless it can be offset by a fall in interest rates. Right now, interest rates in Britain, as in America, are already very low, with little room to fall further. The sensible thing, then, is to devise a plan for putting the nation’s fiscal house in order, while waiting until a solid economic recovery is under way before wielding the ax.

But trendy fashion, almost by definition, isn’t sensible — and the British government seems determined to ignore the lessons of history.

Both the new British budget announced on Wednesday and the rhetoric that accompanied the announcement might have come straight from the desk of Andrew Mellon, the Treasury secretary who told President Herbert Hoover to fight the Depression by liquidating the farmers, liquidating the workers, and driving down wages. Or if you prefer more British precedents, it echoes the Snowden budget of 1931, which tried to restore confidence but ended up deepening the economic crisis.

The British government’s plan is bold, say the pundits — and so it is. But it boldly goes in exactly the wrong direction. It would cut government employment by 490,000 workers — the equivalent of almost three million layoffs in the United States — at a time when the private sector is in no position to provide alternative employment. It would slash spending at a time when private demand isn’t at all ready to take up the slack.

From where does the British Government get all of those resources that Krugman claims it should be spending? Well, in Wonderland, governments crank up the printing press and - Voila! - create wealth. Krugman never does seem to grasp the simple fact that when governments spend, they are using real resources that have to come from somewhere; he really does believe that borrowing and printing money is the economic equivalent of serious private investment.

There is one more thing. I never have known politicians not to want to spend, spend, and spend some more. The notion that politicians are stingy with other people's money is laughable, and the notion that the only thing saving us from utter destruction is government's ability to borrow and print is a joke, a sick joke, but a joke, nonetheless.

Veronique de Rugy on Austerity

In reply to Paul Krugman's numerous missives that the only way governments should react to the downturn is to spend, spend, spend, Veronique de Rugy has a piece in Reason that contradicts Krugman's points. (Yeah, I know, Reason gets Koch money, just as Krugman's people get Soros money. Call it a wash.)

Ms. de Rugy writes:

One of the key signaling devices for international investors is how a government behaves under financial duress—how it balances the demands of its debtors with those of its welfare recipients. Announcements of lower spending and higher taxes tell investors a country is willing to go to great lengths not to default on its debt obligations. If the government instead focuses on preserving its welfare state and public employee benefits, investors know default is more likely and will shy away from that country’s bonds.Japan has the world’s biggest debt as a percentage of GDP, at 227 percent, nearly four times the economist-recommended 60 percent ceiling. It has gotten away with its carelessness without risking default because the country relies more heavily than most on domestic investors to fund its follies. The United States, despite a dangerous debt burden relative to GDP (66 percent) and a structural deficit among the highest of developed countries (almost 4 percent), has so far also escaped investor censure, thanks to the perception that the dollar remains the safest currency in the world. European countries don’t have that luxury.

I would add that the people in power in this country act as though the U.S. Dollar is impervious to any kind of international challenge. They forget that just 40 years ago, that is precisely what happened, and the crisis of 1971 left the USD in the lurch.

She continues:

The notion that austerity is bad and stimulus is good rests on the Keynesian theory that if government spends a lot of money, that money will create more value in economic growth. This purported increase in gross domestic product is what economists call the “multiplier effect.” It’s a nice story, but like most fairy tales, it has scant basis in reality.

In a 2010 paper published by George Mason University’s Mercatus Center (where I work), economists Robert Barro and Charles Redlick showed that in the best-case scenario, a dollar of government spending produces much less than a dollar in economic growth—between 40 and 70 cents. If that was the rate of return on our private-sector investments, America would soon cease to be a leading economic force.

Barro and Redlick also looked at the economic impact of raising taxes to pay for spending increases. They found that for every $1 in tax-financed spending, the economy actually shrinks by $1.10. In other words, greater spending financed by tax increases damages the economy. The stimulus isn’t working, because the economic theory it is based on is fundamentally flawed.

As I said before, this piece is worth reading. Krugman won't like it, but people who actually believe that economics is more than just stuffing money into an economy of homogeneous factors are going to find it stimulating reading.

Krugman, Keynesians, the Austrians, and the Housing Bubble

In a blog post, Paul Krugman points out that a number of "austerians" (people who believe we need to have fiscal and monetary responsibility) did not see the "housing bubble" approaching -- and he did. Therefore, according to Krugman logic, "austerity" must be bad.

As I see it, the logical construct goes this way:

1. The "austerians" were wrong on the housing bubble;
2. Krugman was right on the housing bubble;
3. Therefore, we need lots more government spending because Krugman believes that is what we need.

This is a classic non sequitur, and I hate to say it, but Krugman's correct view of the bubble does not mean he is correct today. The rightness or wrongness of his argument depends upon both the application of laws of economics and the current situation, period.

Now, in looking at the whole housing bubble business, let me say that I am not going to jump on Krugman's 2002 comment about Alan Greenspan needing to create "a housing bubble to replace the NASDAQ bubble." Krugman has denied that he was advocating such a bubble, and I am willing to take him at his word.

Nonetheless, there are two things that need to be discussed here. The first is the fact that the Austrians, and specifically Mark Thornton, were out in front to call the housing bubble what it was. Thornton wrote in 2004 that the housing market was "too good to be true," and also had this article in February 2004 that buttresses his claims.

Yet, Professor Thornton also is an "austerian," at least in Krugman's definition. He also predicted and recognized the housing bubble long before even Krugman made mention of it. So, there seems to be a crack in Krugman's rejection of "austerity" measures for the economy.

Before going further, however, I need to point out that Austrians are not "austerians" in the mainstream (or statist) view of economics. Austrians believe that the market should be free to sort out the malinvestments that came with the boom, and for the necessary liquidation and repositioning of assets to occur. This is quite different than the view that GOVERNMENT should be IMPOSING austerity. In the Austrian view, the government role is passive while in the mainstream view, government is active in its imposition of policies.

(I need to point out that Krugman rejects both viewpoints. Government needs to be active, showering new money, encouraging spending, and doing lots of borrowing and spending itself, according to Krugman.)

My second point is more theoretical. Keynesians deal solely in aggregates, because they believe that if government both engages in generalized spending (and encourages consumers and businesses to do the same), the economy will recover and grow to full employment -- provided the spending is great enough. However, Keynesianism does not have any kind of coherent capital theory, and I don't see how one can have a bubble, which constitutes a malinvestment in the Austrian view, AND, at the same time, claim that all that is needed is spending.

As I have written many times before (and I am hardly the only Austrian to be saying this), the Keynesian view implies that factors of production are homogeneous, and that it does not matter what kind of spending takes place, just as long as there is adequate spending. This cannot logically square with the creation of bubbles, since asset bubbles are specific and they clearly are malinvestments, yet Krugman continues to deny any theory that includes malinvestments.

Furthermore, Krugman knows that one cannot sustain a bubble, since bubbles by their very definition are not sustainable. Yet, he seems to be arguing that we need to both try to sustain this bubble, or at least not let housing prices fall, and, at the same time, recognize what a bubble really is. These two views are mutually exclusive.

So, in both sets of arguments, I believe that Krugman is using a non sequitur, nor does it surprise me he is doing so.

Will "Austerity" Doom Us? Or Is It a Plot By Bond Buysers?

Paul Krugman is a guy on a mission, and when he writes all of his columns and blogs on a single theme -- "Austerity" is Bad, Really Bad -- then one can tell he is serious about his message. His column today falls into that category (again), but now he also presents the problem as being caused both by ignorance (not agreeing with Krugman is being ignorant) and A Sinister Plot By Bond Buyers To Destroy The World.

Riding in on his steed, Krugman declares:

For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity. That is, somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed.

This conventional wisdom isn’t based on either evidence or careful analysis. Instead, it rests on what we might charitably call sheer speculation, and less charitably call figments of the policy elite’s imagination — specifically, on belief in what I’ve come to think of as the invisible bond vigilante and the confidence fairy.

Bond vigilantes are investors who pull the plug on governments they perceive as unable or unwilling to pay their debts. Now there’s no question that countries can suffer crises of confidence (see Greece, debt of). But what the advocates of austerity claim is that (a) the bond vigilantes are about to attack America, and (b) spending anything more on stimulus will set them off.

But the 2008 Nobel Laureate has declared that the USA can and should continue on its spree of borrowing, printing money, and spending. (Thus, we can pretend we prosperous and rich even when we are broke, since printing money creates wealth, according to this Keynesian acolyte.)

Krugman's poster child for "austerity" is Ireland, which according to him is in the Very Throes of Permanent Destruction:

And current examples of austerity are anything but encouraging. Ireland has been a good soldier in this crisis, grimly implementing savage spending cuts. Its reward has been a Depression-level slump — and financial markets continue to treat it as a serious default risk.

However, according to Financial Times, Ireland is not doing as badly as Krugman claims, and seems to be moving in the right direction:

Ireland climbed out of recession on Wednesday with the economy returning to growth in the first quarter, after suffering one of the deepest downturns of any advanced industrialised economy.

Ireland’s return to growth, in spite of having undertaken a huge fiscal retrenchment over the past two years which prolonged the downturn, will provide encouragement to other European economies facing up to tackling rising public deficits.

Furthermore, FT notes Krugman's recent criticisms of Ireland's policies:

Paul Krugman, the Nobel-laureate economist, argued last week that Ireland had seen little reward for its brave fiscal measures. “Virtuous, suffering Ireland is gaining nothing,” he wrote in the New York Times. He was referring to the reaction in the bond markets, where Ireland is still paying 3 per cent more than Germany to finance its budget. But Irish ministers argue they had little choice but to tackle the deficit.

“Had we not done so, the deficit would have ballooned towards 20 per cent of GDP – a level at which the very financial survival of this country would have been at risk,” Mr Lenihan said at the time of the December budget.

Ireland has slashed public sector salaries by about 15 per cent. Welfare has been cut, including 10 per cent off child benefit. New income and health levies have also been imposed.

The return to growth reflects a buoyant performance by the export sector, particularly the foreign-owned multinationals, who have benefited from the euro’s decline and from Ireland’s falling cost base. Ireland sells close to 60 per cent of its exports outside the eurozone – to the UK, US and other economies.

Now, FT is not claiming that Happy Days Are Here Again on the Emerald Isle, but it is clear that after chasing the same housing bubble as much of the rest of the world, Ireland is putting its house in order, unlike the USA. Krugman's entire analysis depends upon the notion that governments should spend and spend until the economies "recover," but with government continuing to prop up malinvestments and discouraging private investment in healthy sectors due to what economist Robert Higgs calls "regime uncertainty," there is not going to be a recovery in the private sector, period.

In Keynesian analysis, the "end game" is the magical recovery of the private sector. Yet, FDR's New Deal (which Krugman generally praises) clearly did not bring recovery, and it created a huge regime uncertainty. However, given the Obama administration's attacks upon productive people and its attempts to force high-cost, low-output things like "green jobs" upon us, not to mention Obama's own anti-entrepreneurial rhetoric, government spending is likely to be the only game in town.

It won't bring recovery, but it does permit people like Krugman to claim that the state really is our savior when, in reality, it is anything but.

(Hat tip to Chris Westley for the FT article)

Does Unlimited Government Spending Bring Prosperity?

Paul Krugman still is on his anti-austerity kick, which I guess is his economic flavor-of-the-week. His blog post on "austerity" and Ireland (among other countries), while clever, really does not answer the question he is asking, plus he inadvertently paints himself into a corner. Let me explain.

First, let us look at what Krugman writes:

...now the cause is fiscal austerity — and we keep hearing about supposed examples of countries that experienced a boom after tightening fiscal policy, supposedly demonstrating that austerity is good, not bad, for employment. First was Canada in the 1990s, which turns out to be a quite different story. Now we’re hearing about Ireland in the 1980s.

So, time for a little research. And whaddya know: this story is also not at all the way it’s being told (pdf). Yes, Ireland had fiscal austerity — but it also benefited from a devaluation and an inflationary boom in the UK.

Oh, and Irish interest rates fell sharply, which was possible because they were very high to begin with; that’s not much of a precedent for the United States today, which starts with very low rates.

So yes, you can boost your economy with fiscal austerity, as long as you also devalue your currency and sharply reduce interest rates; also, incantations will destroy a flock of sheep, if administered with a sufficient portion of arsenic.

We have to remember that Krugman is demanding that governments can bring back prosperity by (1) borrowing trillions of dollars for which there is no appreciable way to pay back the money unless they (2) repudiate the debt by printing money, which is what Krugman wants them to do.

There is nothing surprising here, when one is beholden to Keynesian orthodoxy. When interest rates (as set by the central bank) are at what Krugman calls "zero-bound," then the only entity that can spend freely is government, since it has a legal monopoly on "creating money."

However, Krugman's economic logic in this passage is wanting. First, what does he mean by an "inflationary boom," and why should he care? In Keynesian thinking, inflation is NECESSARY for bringing an economy to "full employment," at least until the economy reaches its highest levels of "capacity." Thus, when one holds to this way of thinking, ALL booms are necessarily "inflationary," as inflation is required for the boom to occur in the first place (and Krugman holds that booms are good).

Second, why did Ireland's interest rates fall? Krugman gives no causality; they just fell. Third, none of this explains why Ireland in the 1980s had a fundamental economic change in which the country went from a quaint, but poor nation that mostly exported people to a place that attracted new investment AND people who wanted to be part of what was happening.

With Krugman, the change just happened, but lots of places have currency devaluations and even lower interest rates, yet do not have paradigm shifts in the economy. In other words, Krugman really has no causality theory for what happened.

James Burnham in a 2003 paper in the Independent Review wrote about the Irish boom, and gives much more detail into what happened. Yet, Krugman, holding to his Keynesian orthodoxy, simply gives us one more example of post hoc ergo propter hoc.

Again, we are dealing with two very different paradigms. In the Keynesian way of thinking, spending is everything. This is very different than "demand" as we know it, economically speaking, in which demand reflects what people want and what they are willing to give up in order to obtain it. In other words, demand cannot be separated from opportunity cost.

In the Keynesian view, however, "demand" really means "aggregate demand," which exists when people have "purchasing power" fueled by money. Thus, when government prints more money, it creates new "purchasing power" and, therefore, new "aggregate demand." There is nothing purposeful about this whole scenario; in fact, there really is nothing economic about it, for real economics deals with opportunity cost, something that pretty much is missing in Keynesianism.

So, we really are arguing two very different views of the world, and I believe that the Austrian view, while hated by the Krugmans of the world, better explains economic phenomena than does Keynesianism. However, don't forget that the very first line of Carl Menger's ground-breaking Principles of Economics makes the important point: "All things are subject to the law of cause and effect." In other words, to Austrians, causality really matters.

We are left, then, with the question that I asked in the title of this post. Krugman assumes that government spending financed via borrowing and printing really exacts no opportunity cost. I cannot accept that view under any circumstances. The fundamental building block of economic thinking is opportunity cost, and to ignore it is to jettison economics in the whole.

Austerity Hysteria: Krugman's Employer Joins the Chorus

In yesterday's post, I noted that Paul Krugman does not understand that an economy is made up of heterogeneous assets and that printing money is not the same thing as getting the fundamentals of the economy back into order. However, it seems that once again (as they tag-teamed after the election of Ron Paul), Krugman and his employer (most likely Gail Collins) are joining forces again to demand that our economic malinvestments continue until we inflate ourselves into oblivion.

Today, the NYT has an editorial, "The Wrong Message on Deficits," that Krugman himself could have written. While the "vulgar Keynesian" might agree with the assessment in this editorial, nonetheless it demonstrates that the editors are clueless about what an economy really is. The editorial begins with:

The whip-deficits-now fever is running hot on both sides of the Atlantic. In Europe, politicians are understandably spooked by investors dumping government bonds in the wake of the Greek meltdown. But the sudden fierce enthusiasm for fiscal austerity, especially among stronger economies, is likely to backfire, condemning Europe to years of stagnation or worse.

The United States is running the same very high risk. Democrats have soured on job creation and economic stimulus in favor of antideficit rhetoric, which Republicans have long seen as the easy road to discontented voters in a confusing election year.

Right. Democrats suddenly are turning "fiscally responsible" as an election ploy. From what I can recall about politicians, they usually begin spending like drunken sailors when up for re-election. Would be that were the case.

First, there is NO "job creation" going on, just wealth destruction. When the government borrows another trillion dollars in order to pay people to lay sod on median strips or to send to politicians somewhere, the government actually is moving resources from higher-valued uses to lower-valued uses.

For example, there is a reason that the "alternative energy" industries need to be subsidized: they are taking valuable resources that go into the growing of corn and then fermenting it in large-scale operations, and then forcing Americans to pay not only for inferior fuels, but also for the resources of these operations that would be better used elsewhere.

Contra Krugman and his employer, recessions don't occur because people spend less; people spend less because the economy is in recession. Furthermore, the only way to get OUT of the recession is to permit the fundamentals to get back into balance. This is not some sort of Zen "balance," but rather a reflection of the real opportunity costs of the factors of production.

Second, it is clear that Krugman and Collins and Company are clueless on what it will take to end this crisis, as they believe that the way to END the crisis is to continue upsetting the economic fundamentals, as though they did not matter. We have to face the issue that if this spending spree continues, we are headed for disaster, as the economy slowly but surely will deteriorate and our ability to repair things in the future will be even more difficult.

Even they point out things for which they have no explanation. For example, they acknowledge already that "global recovery is already faltering." Yet, they see no irony in that after the spending of trillions of "stimulus" money, things still are going downhill. It never seems to occur to this bunch that we have been going down the wrong path for several years, and we need to stop the madness.

The other path is to take the medicine now (medicine that should have been taken three years ago), deal with the temporary crisis, and then let a real recovery take place. Now, that is something that few politicians are willing to do, but that is what MUST be done, the NYT notwithstanding.