Krugman and the "Magic" of Inflation

I remember reading a book 30 years ago in which the author said that in the end, Keynesians have one arrow and only one in their quiver: inflation. While they might deny that to be true (Hey! We have FISCAL policy!! We borrow a lot of money that is created by the Fed!)

But Paul Krugman certainly seems anxious to prove the author's point, as once again he calls for the "solution" of printing money as salvation for Europe. For that matter, he has long advocated the same "salvation" for this country, continuing that fallacy that our economy is exactly like the so-called babysitting co-op in Washington.

Today's column is pretty typical of Krugman. While I agree that the bank-imposed "austerity" measures put on the regimes of Greece and Spain are not helpful to economic growth, my differences with Krugman are substantial. To Krugman, the entire thing is spending; the more a government spends, the richer everyone becomes, end of discussion. And if the government does not have enough to spend in tax revenues, then print money or borrow, but spend, spend, spend.

As I see it, restructuring any economy in order to place its debt service at the top (which means high tax rates) is likely to be counterproductive in the short run AND long run. Like it or not, governments usually are an impediment to economic growth and certainly not an engine of the same.

For Krugman, financial bubbles ARE the soul of capitalism, period. In his view, investors are a bunch of lemmings that always run over the cliff unless wise government agents steer them otherwise. As Austrians see it, the culprit is going to be the central bank or government in one form or another.

(For those people who claim that the housing bubble was SOLELY the result of private investment, they ignore the role of the Federal Reserve System, Freddie and Fannie, and a government that demanded that more people be put into home ownership, damn the consequences.)

So, what is Krugman's "solution"? He provides it here:

Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect of emerging from austerity and depression. Realistically, the only way to provide such an environment would be for the central bank to drop its obsession with price stability, to accept and indeed encourage several years of 3 percent or 4 percent inflation in Europe (and more than that in Germany).

Both the central bankers and the Germans hate this idea, but it’s the only plausible way the euro might be saved. For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time. Now time has run out.

So will Europe finally rise to the occasion? Let’s hope so — and not just because a euro breakup would have negative ripple effects throughout the world. For the biggest costs of European policy failure would probably be political. 

Yes, salvation through inflation, as though a central bank can "manage" rates of inflation over time. Krugman's love affair with inflation totally ignores the underside of such a policy, and ignores the fact that over time, the corrosive effects of inflation grow and any "positive" effects (i.e. "deleveraging") tend to diminish.

You see, Krugman truly seems to believe that the only "bad" effects of inflation would be higher prices, although those higher prices would be offset by higher incomes. Inflation, at least in Wonderland, has no effect upon investors' choices, it does not direct money into lines of production that are unsustainable, and it has no destructive effects at all unless it gets out of hand, and even then, the results are not very bad.

Like the Bourbons who, in the words of Tallyrand, "learned nothing and forgot nothing," the Keynesians never learn from inflation, and in the end always reach for that last arrow. Like Krugman, who apparently believes that the Obama administration can subsidize the economy into recovery (see "green energy" and other such nonsense), Keynesians truly believe that all assets are homogeneous, and that an economy is a mixture into which one stirs money and if one stirs in enough money and forces everyone to spend, out of it comes prosperity.

That is a Wonderland view of economics, but apparently that is what our economic and political elites are trying to claim is the truth. So print and spend yourselves into prosperity, Europeans! It must be so, it must be so!

My Big, Fat Greek Disaster

The old saying, "Beware of Greeks bearing gifts," might now be changed to, "Beware of Greeks bearing debt." Indeed, after yesterday's murderous riots, people also need to beware of Greeks bearing Molotov Cocktails, as Greek government employees, after living high on financial bubbles, do not believe they should have to face financial reality.

In a blog post, Paul Krugman acknowledges that the "Greek end game" is going to be disastrous no matter what, as no one there is willing to face the truth: Greece was living in a bubble economy, and when the bubble bursts, there is nowhere to hide. Unfortunately, as a true Keynesian, Krugman believes that the Very Worst Thing that can happen Greece is deflation.

But even Krugman admits that the Greeks need to get their economy into some kind of balance, and that is amazing, given that Keynesians believe that all factors of production, for purpose of economic analysis, are homogeneous, and the way to get costs of factors (especially labor) and prices of goods into "balance" is through inflation. Yet, even that bit of wisdom is tempered with Keynesian foolishness. He writes:

The only thing that could reduce that need for austerity would be something that helped the economy expand, or at least not contract as much. This would reduce the economic pain; it would also increase revenues, reducing the needed amount of fiscal austerity.

But the only route to economic expansion is higher exports — which can only be achieved if Greek costs and prices fall sharply relative to the rest of Europe.

He admits, however, that Greece is not a cohesive society, so the most likely scenario is for Greece to "leave the Euro" and go to printing Drachmas again. That, Krugman admits, will be disastrous, triggering bank runs and worse.

Yet, Krugman does not realize that the problem of leaving the Euro would create even more problems for Greece than bank runs. Should Greece leave the Euro and go back to the Drachma, the currency markets will treat the Drachma as "soft money" and give it the same status as money from Zimbabwe, which does not trade on any currency markets.

To put it another way, Greece will become essentially a Third World country. How did this happen? It happened because central banks around the world engaged in Keynesian "expansion" by creating Dollars, Euros, you name it. Keynesians believe that such action can go on forever without creating any consequences. As you can see, that simply is not true.

Greece is living the consequences. They either can get their house in order and suffer the short-term consequences, or they can go on living in the inflationist fantasy that is Keynesian "economics."