Why No Hyperinflation?

As I have commented before, a number of economists and commentators (and not just Austrians) have been loose with making predictions of hyperinflation, yet we don't see that happening in the real world. However, at the same time, we cannot ignore the fact that prices of a lot of things are going up -- and not just the price of gold, Krugman's "barbaric relic" comments notwithstanding. (Yeah, I know that line came from Keynes, but Krugman used it this week, too.)

In a blog post today, Krugman once again gloats about inflation, or the lack thereof, but then goes off on a weird tangent, talking about "grocery inflation." Now, I cannot recall in any of my grad classes there being a term called "grocery inflation," and being that the average grocery store has thousands of items, with some going up in price and other things not.

Nonetheless, especially in the aftermath of the voyage of the QE2, we have seen prices of commodities go up and, no, I believe Krugman is wrong when he goes off on the "commodity prices are volatile" tangent. No doubt, Krugman dismisses the run-up in gold and silver prices (not to mention oil, which is getting close to $90 a barrel in my last check.)

There also are some other issues here, and one has to remember that when Krugman and I speak of inflation, it is as though we were speaking different languages. Krugman's approach is purely macro-speak, with inflation being the measure of a particular index, i.e., the Consumer Price Index (CPI), the GDP Deflator, or something similar. (That is where he gets "grocery inflation," I guess.)

Austrians are more fundamental when it comes to inflation. To us, inflation is a situation in which the value of money falls relative to the goods for which it is used to purchase. In other words, inflation to us is a monetary phenomenon, not a price phenomenon. Instead, increases in prices reflect inflation (the loss of value of money), as when money loses value relative to other goods, more money then is needed to fulfill transactions.

Now, according to Keynesians, this is foolish, since to them, money is nothing more than a quantity variable. They may have an inkling of why money exists in the first place, but they are much more interested in aggregate variables, and certainly not anything that might smack of a marginal utility theory of money.

That being said, I will once again invoke the hated (by Keynesians) Say's Law to point out that while money facilitates trade, it is not by itself wealth, only a measure of wealth. Money is subject to the laws of economics, even if Paul Krugman doesn't believe it.

Now, there is no doubt that the U.S. Dollar is losing ground overseas, and if we really were in a period of deflation, as Krugman claims, then the dollar would be gaining strength, not losing it. (Deflation occurs when the value of money relative to goods it is used to purchase increases, and that clearly is not happening.) We are seeing asset prices such as housing fall, but those prices need to fall because they were out of kilter with everything else.

(Yes, that means people like me who are homeowners and probably swimming in negative equity have to live with it. The bank gets my house payment every month, and I just consider it to be something akin to a rent payment. I don't like it, but that is the way it is.)

I want to come back to this whole "deflation" issue soon enough, but now want to deal with how new money comes into our economic system. Remember, the Fed mostly has piled up new reserves in banks, raising (actually, spiking) the monetary base. However, a monetary base in the form of bank reserves is a lot different than new money actually floating about in the economy.

When we think of hyperinflation, we think of places like Weimar Germany in 1923 or Argentina and Bolivia in the 1970s and 1980s, or Chile during Allende's three-year rule from 1970 to 1973. In Chile's case the government seized a number of private businesses, mines, and factories, and then directly printed money to pay the workers. (More "proof" that government is not "revenue-constrained," I guess.)

When the government seized the factories, it tripled the wages of workers, but the political organizing and other moves actually lowered workplace productivity. At the same time, the government threw up new tariffs and trade barriers, so people soon were awash in money, but little else.

During that period when inflation got to about 1,000 percent, people got out of money if they could, using items like tobacco, auto parts, and other hard goods that they could use to barter. In Bolivia, where there were (and are) a large number of state-owned enterprises, workers in the mid-1980s would be paid twice a day. They would rush to the streets and trade their money with tourists for dollars or other hard currencies, and then the tourists quickly would spend the money.

That is very, very difficult to happen in our economy. Even during the last big inflation of the late 1970s and early 1980s, the new money came in through the bank lending process. Government workers were not paid with newly-printed dollars, nor did they rush out into the streets to trade for pesos.

What happens at a time when businesses are not borrowing for long-term projects, as is the case today? This is what Milton Friedman called "pushing on a string," or what Paul Krugman calls a "liquidity trap."

Is there a way for the current situation to bust into hyperinflation? Obviously, I certainly hope not, as I and my family would go down like everyone else. Certainly, one can see the problems that would arise if the Fed were to directly purchase large amounts of U.S. Treasuries on the primary market to finance the government's borrowing, as it would not take long to see how this transmission device would inject a lot of new money into the economy and certainly would result in much higher prices over time.

There is one more issue, and that is the claims by Krugman that we are falling into "deflation." Frankly, I don't see it. Prices for consumer goods, not to mention food and other commodities, are going up, not down. Yes, the value of those assets that were highly-inflated during the bubble are going down, but that is a good thing (even if my own house is included in this "good thing"). I use that term not because it makes everyone happy, but rather because factor prices need to get into balance, and the government's "stimulus," bailouts, and attempts to build a "recovery" by pouring money into "green energy" are only making the situation worse.

No, we are not about to burst into the holocaust of inflation as we saw in Latin America or recently Zimbabwe, but neither are we falling into deflation as Krugman says. Instead, we are going to muddle along until someone in power learns that one cannot subsidize an economy into prosperity.

Yeah, I Kind of Agree With Krugman Here

Last March on my other blog (just before the Tonya Craft case basically took over its subject matter), I had a post on recent statements by James K. Galbraith. Professor Galbraith took umbrage and made a post, which I was glad to see him do.

His point was this: We don't have to worry about the government going bankrupt as long as it has legal control over what is called "money." Thus, government always will pay its bills because it can print the currency by which the bondholders receive payment. Thus, the size of deficits does not matter because government cannot (by definition) go bankrupt.

Obviously, if one stops to think about what Galbraith claims, it is almost mind-boggling. However, keep in mind that, like his late father, he is partial to socialism and even the more virulent forms of communism, in which governments used murder and imprisonment to try to force people into behavior that they otherwise would not want to follow. In other words, like John Kenneth Galbraith, James Galbraith believes that governments can do what they want as long as (1) they have a printing press and monopoly over money, and (2) they employ whatever coercive methods they wish.

Now, in his criticism of Galbraith today, Paul Krugman does not go as far as I do, but I do find myself in agreement with much of what he writes. First, Krugman outlines Galbraith's position fairly and accurately, so if you wish to get a good interpretation, read Krugman's post.

Second, he creates a mathematical model that reminds me of some of the things I saw in grad school (and is easy to follow) in which he sets up a scenario in which the government runs up against its limits of borrowing (what can be borrowed by others who have a "surplus" to lend). What he concludes is that at some point, the rate of inflation takes off into the empty space of hyperinflation.

How might that play out in our system? At some point, the Federal Reserve becomes the primary purchaser of U.S. debt (as opposed to its current role of purchasing debt in the secondary market), so government is directly spending newly-printed dollars which quickly move through the economy (as velocity increases). In fact, I think that if there is a weakness in this model (and any model which simply acts on the pure quantity of money theory has fundamental weaknesses in explaining economic behavior on behalf of individuals), it is the assumption that velocity (V) remains constant throughout.

One of the characteristics of a hyperinflation is the quickening of velocity -- how quickly money changes hands in an economy. The other thing -- and Krugman accurately mentions this -- is that people will get out of money altogether and use substitutes that either hold or increase in value (relative to money).

My sense is that Galbraith believes that government simply can "crack down" and force people to accept money (On pain of death, if need be?). Krugman does not go that far, but he is a True Believer in coercion, at least "progressive" style.

Nonetheless, Krugman's point here is well-taken, and I would agree that there is the danger of hyperinflation, given the government's path. Galbraith argues that government can exercise its powers to the point where people are forced to use the government's money, while Krugman simply says that we are not near any point of hyperinflation, given that the current Consumer Price Index is pointed downward.

There is much more I would like to say here, but I wanted to point out that when I believe Krugman is at least partially right, I will give him credit.

Is Deflation the Enemy, or Is It Inflation?

Like all Keynesian True Believers, Paul Krugman believes that the worst enemy of the economy is deflation. In his view, deflation causes unemployment and inflation reduces it, and he repeats that canard in this recent column.

Not surprisingly, Krugman claims that unless the Fed under Ben Bernanke engages in massive new money creation (and, of course, spending), the economy is doomed:

Today, Mr. Bernanke is the Fed’s chairman — and his 2002 speech reads like famous last words. We aren’t literally suffering deflation (yet). But inflation is far below the Fed’s preferred rate of 1.7 to 2 percent, and trending steadily lower; it’s a good bet that by some measures we’ll be seeing deflation by sometime next year. Meanwhile, we already have painfully slow growth, very high joblessness, and intractable financial problems. And what is the Fed’s response? It’s debating — with ponderous slowness — whether maybe, possibly, it should consider trying to do something about the situation, one of these days.

The Fed’s fecklessness is, to be sure, not unique. It has been astonishing and infuriating, as the economic crisis has unfolded, to watch America’s political class defining normalcy down. As recently as two years ago, anyone predicting the current state of affairs (not only is unemployment disastrously high, but most forecasts say that it will stay very high for years) would have been dismissed as a crazy alarmist. Now that the nightmare has become reality, however — and yes, it is a nightmare for millions of Americans — Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let’s talk about the evils of budget deficits.

In response, I will include material from Murray N. Rothbard's America's Great Depression, a recent article by Robert Higgs, and something I wrote for the Mises Institute two years ago. First, we look at what Rothbard has to say regarding deflation:

With the supply of money falling, and the demand for money increasing, generally falling prices are a consequent feature of most depressions. A general price fall, however, is caused by the secondary, rather than by the inherent, features of depressions. Almost all economists, even those who see that the depression adjustment process should be permitted to function unhampered, take a very gloomy view of the secondary deflation and price fall, and assert that they unnecessarily aggravate the severity of depressions. This view, however, is incorrect. These processes not only do not aggravate the depression, they have positively beneficial effects.

There is, for example, no warrant whatever for the common hostility toward "hoarding." There is no criterion, first of all, to define "hoarding"; the charge inevitably boils down to mean that A thinks that B is keeping more cash balances than A deems appropriate for B. Certainly there is no objective criterion to decide when an increase in cash balance becomes a "hoard." Second, we have seen that the demand for money increases as a result of certain needs and values of the people; in a depression, fears of business liquidation and expectations of price declines particularly spur this rise. By what standards can these valuations be called "illegitimate"? A general price fall is the way that an increase in the demand for money can be satisfied; for lower prices mean that the same total cash balances have greater effectiveness, greater "real" command over goods and services. In short, the desire for increased real cash balances has now been satisfied.

Furthermore, the demand for money will decline again as soon as the liquidation and adjustment processes are finished. For the completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers' scramble for cash. A rapid unhampered fall in prices, both in general (adjusting to the changed money-relation), and particularly in goods of higher orders (adjusting to the malinvestments of the boom) will speedily end the realignment processes and remove expectations of further declines. Thus, the sooner the various adjustments, primary and secondary, are carried out, the sooner will the demand for money fall once again. This, of course, is just one part of the general economic "return to normal."

In other words, Rothbard says that deflation will help the adjustment process in which the economic fundamentals get back into balance. Given that Krugman operates on the theory that all assets are homogeneous, he is incapable of understanding anything else.

Prof. Higgs notes this about Keynesians and inflation and deflation:

With their great, simple faith in the efficacy of government spending as a macroeconomic balance wheel, vulgar Keynesians disregard malinvestment, past and future, and support government spending in excess of the government’s revenues, the difference being covered by borrowing. Of course, they favor central-bank actions to make such borrowing cheaper for the government. In fact, they chronically prefer “easy money” to more restrictive central-bank policies. As noted previously, they prefer easy money not only because it lowers the cost of financing the government’s deficit spending, but also because it induces individuals to borrow more money and spend it for consumption goods ― such increased consumption spending being viewed as always a good thing, notwithstanding the recent near-zero rate of saving by individuals in the United States. Reflecting on the vulgar Keynesian attitude toward Fed policy, I keep recalling a old country song whose refrain was: “older whiskey, faster horses, younger women, more money.”

Vulgar Keynesians do not spend much time worrying about potential inflation; on the contrary, they are obsessed with an irrational fear of even the slightest hint of deflation. If inflation should become an undeniable problem, we may count on them to support price controls, which, they are convinced on the basis of sketchy knowledge of such controls during World War II, can be made to work well.

In this article, I noted that the current crisis came about because of the Fed's reckless money creation, so it certainly is NOT possible that the Fed can SOLVE the problem with more inflation:

The central issue is that the Fed pushed a policy of inflation, with much of the new money going into the mortgage markets; there is no way to avoid the painful and terrible corrections that must follow such fiscal foolishness. (Now we finally see massive commodity-price increases, which have occurred because there is nowhere for the new money to go but directly into commodities and consumer goods.)

Anyone who believes that the Fed can pretend that heavily damaged mortgage securities are worth more than toilet paper and literally build a $200 billion loan portfolio upon them does not understand finance. Just because Ben Bernanke declares something to be "valuable" does not bestow value upon it.

The simple issue is not lack of liquidity. It is the fact that billions — make that trillions — of dollars were malinvested in markets where the increasing values could not be sustained. To pump near-worthless dollars into this mix does not solve anything; it only ensures that the coming day of reckoning will be even more unpleasant than it would have been otherwise.

So, if the Fed follows Krugman's demands, we can look forward to even more secondary contractions and more malinvestments. The "day of reckoning" won't arrive all at once; it will become a permanent part of our economic landscape.

Krugman: F.A. Hayek Wants You to Lose Your Job

One of the reasons I started this blog was to highlight the real differences between Keynesian "economics" and the economics of the Austrian School, and to defend Austrian concepts against the missives coming from Paul Krugman of Princeton University and the New York Times. Thank goodness, mine is not the best or most articulate voice from the Austrian camp, and I have highlighted others, including Robert Higgs, who I believe is infinitely a better economist than Krugman.

Krugman over the years has refused to explain the Austrian viewpoints in anything but outright caricatures and exaggerations. For example, here we get what he calls the "Hangover Theory," which outright misrepresents everything written by Ludwig von Mises, F.A. Hayek, and Murray Rothbard on the subject of business cycle theory.

In this June 14 post on his NYT blog, Krugman once again refuses to take a serious look at what the Austrians claim, deciding, instead, to place them in a false light in order to make them seem as though they are united by one thing: hatred of humanity. He takes the following quote from Hayek as his example of Austrian cruelty:

…still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.The only way permanently to ‘mobilise’ all available resources is, thereforeto leave it to time to effect a permanent cure by the slow process of adapting the structure of production.

If one reads Hayek carefully, he is saying that when governments hold down interest rates to artificially low levels, they actually BLOCK the economic recovery, yet all Krugman can see is "persistent high unemployment." Krugman writes:

These days, relatively few economists are willing to say straight out that they regard persistent high unemployment as a good thing. But they find reasons to oppose any and all suggestions to use government policy — including monetary policy — to alleviate the slump. Same as it ever was.

Notice that Hayek has not said any such thing, but to Krugman, free markets and an economy not steered by government must by definition have "persistent high unemployment," although he does not explain why that would be so. (In fact, Krugman seems to believe that he really is above any such explanation, as his declaration alone should be regarded as ex cathera.)

In claiming that economists like Joseph Schumpeter and Hayek were champions of depression, Krugman (and his partner-in-crime Brad DeLong) violently misrepresent the Austrian viewpoint. The Austrians don't claim that the Great Depression was a "good thing," but rather the Great Depression occurred precisely because governments intervened in the economy to prop up malinvestments and to keep the necessary liquidations from occurring. Because of those policies, the economy got both liquidation AND high unemployment.

Unfortunately, Krugman and DeLong never see that simple point. In the Austrian view, we have EITHER liquidation of malivestments or long-term high unemployment, with any high amounts of unemployment coming from the liquidation process being temporary. Krugman and the Keynesians, on the other hand, believe that once the liquidation process begins, the economy never recovers. Ever.

As Robert Higgs writes about these "vulgar Keynesians":

With their great, simple faith in the efficacy of government spending as a macroeconomic balance wheel, vulgar Keynesians disregard malinvestment, past and future, and support government spending in excess of the government’s revenues, the difference being covered by borrowing. Of course, they favor central-bank actions to make such borrowing cheaper for the government. In fact, they chronically prefer “easy money” to more restrictive central-bank policies. As noted previously, they prefer easy money not only because it lowers the cost of financing the government’s deficit spending, but also because it induces individuals to borrow more money and spend it for consumption goods ― such increased consumption spending being viewed as always a good thing, notwithstanding the recent near-zero rate of saving by individuals in the United States. Reflecting on the vulgar Keynesian attitude toward Fed policy, I keep recalling a old country song whose refrain was: “older whiskey, faster horses, younger women, more money.”

Vulgar Keynesians do not spend much time worrying about potential inflation; on the contrary, they are obsessed with an irrational fear of even the slightest hint of deflation. If inflation should become an undeniable problem, we may count on them to support price controls, which, they are convinced on the basis of sketchy knowledge of such controls during World War II, can be made to work well.

I think that pretty much says it.

Liquidity Trap or Malinvestments?

One of the standard Krugman-Keynesian beliefs is that assets are homogeneous, and that the only thing that matters in an economy is spending. (This is separate from real-live purposeful consumption, which is the end of all productive activity.)

In this line of thinking, a "liquidity trap" view of things makes perfect sense, and Krugman is fond of claiming that the U.S. economy, like Japan 20 years ago, suffers from such a condition. In his post on inflation and Japan, he repeats the old canard that deflation is the enemy and that inflation means nothing, at least at the present time.

(I find it interesting that in yesterday's post, he claims that "inflation did have to be brought down," although he does not specify what that was so, given that at the time, the nation's rate of unemployment was unacceptably high. There is no real consistency here, except to throw out partisan political barbs of "Democrats good, Republicans bad," which is acceptable at DNC headquarters, but I do not think is such when coming from a supposed Nobel Prize winner in economics.)

According to Krugman-Keynesian doctrine, an economy is in a "liquidity trap" if interest rates have a lower bound of zero or near-zero, yet businesses are not borrowing at a rate necessary to keep the economy going at the boom rates. That is why Krugman is fond of repeating his contention that current government borrowing only is replacing lost business borrowing, as though all borrowing has its use ONLY in the money spent.

When the economy is in such a "liquidity trap," according to Keynesians, then the only thing that can "stimulate" an economy is more government spending. That is because, according to Keynesians, there is no mechanism within a market economy that will allow economic activity to be generated, as though it were a dead battery that needs to be "jump-started" from the outside.

In a recent post on the Freeman Online, I take issue with the Keynesian approach, pointing out that the real issue we face -- as did Japan two decades ago -- is that government intervention has generated massive amounts of malinvestment. Our current situation is not a "liquidity trap," but rather is one in which the government has kept the malinvestments alive through the intervention via the Federal Reserve System.

For example, the huge amounts of resources poured into propping up the banks and other financial houses, along with keeping General Motors and Chrysler alive, drain the economy of productive capacity. Furthermore, the Obama administration clearly has shown itself to be hostile to real productivity and profitability, labeling profitable firms as being the cause of our problems and calling for higher taxes and other measures to cut the healthy firms down to the level of the unhealthy ones.

The real problem that Japan faced was that its economy had generated malinvestments during its previous boom, and those malinvestments needed to be liquidated, not propped up. Instead, the government tried to keep everything afloat and the result was the "lost decade." Likewise, we are seeing the same thing here.

Krugman, as a True Believer, does not see that. Instead, he really seems to hold that all assets are homogeneous, profits are a drain on the economy, and high taxes and the iron hand of the state will guide us to prosperity. This will not be the case, but I doubt seriously that he will change his tune, given the public worship that intellectuals and the political classes have bestowed upon him.

Krugman: A Central Government Solves All Economic Problems. Yeah, Right

I am thankful for Paul Krugman, if for no other reason he has helped me keep my thinking diversified even as the Tonya Craft sham of a trial goes on and takes most of my attention. As the "Greek tragedy" unfolds and Krugman makes his commentaries, once again we see the difference between the Keynesian approaches and the Austrian ones.

Today (Friday, May 7), Krugman once again gives the standard Keynesian theme: A central government can save the day because it can print money. If you think I jest, read on:

The problem, as obvious in prospect as it is now, is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.

Now, how would a strong central government be able to rescue Greece from its current crisis? Krugman explains:

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation (emphasis mine); this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third, Berlin could become to Athens what Washington is to Sacramento — that is, fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

So, the idea would be for all of Europe to have more inflation via action from the central bank, and thus all of the Europeans could damage their economies simultaneously, creating new crises that Krugman conveniently fails to mention. (Inflation has a way of doing that.)

But, Krugman is not finished, as he also lays out another scenario: Greece leaves the Euro and goes back to the Drachma. In his own words:

What remains seems unthinkable: Greece leaving the euro. But when you’ve ruled out everything else, that’s what’s left.

If it happens, it will play something like Argentina in 2001, which had a supposedly permanent, unbreakable peg to the dollar. Ending that peg was considered unthinkable for the same reasons leaving the euro seems impossible: even suggesting the possibility would risk crippling bank runs. But the bank runs happened anyway, and the Argentine government imposed emergency restrictions on withdrawals. This left the door open for devaluation, and Argentina eventually walked through that door.

If something like that happens in Greece, it will send shock waves through Europe, possibly triggering crises in other countries. But unless European leaders are able and willing to act far more boldly than anything we’ve seen so far, that’s where this is heading.

Here is the problem that Krugman forgets: if Greece leaves the Euro, its currency will be considered "soft" on the world markets, like the currencies of Third World nations or of the old communist bloc. Combined with the big increase in inflation as Greece tries to print its way out of the crisis will be the fact that the Greeks will find the costs of imported goods skyrocketing, and they will be reduced quickly to poverty.

Krugman does not understand that deflation and recession would be the BEST things to happen to Greece, as while there might be default, the Greeks once again would be able to get their fiscal house in order. Yes, there would be a quick drop in their standard of living, but they not only would get past that quickly as the economy recovers, but they also would have a brighter future.

The Krugman "solution," however, only extends the problem into the healthier economies of Europe and with inflation, the "good" effects come first, and the "bad" effects are felt later. With deflation, it is the other way around. The Greeks will have troubles up front, but things will get better.

What Krugman does not understand is that the inflation "solution" only will distort the Greek economy even more without solving ANY of the underlying problems. Look, the Greeks are headed for very rough times no matter what they do. However, it would make sense for them at least to be able be doing something that would give them a decent economic future.

Instead, Krugman insists that printing money will solve all problems. I don't think so.

Krugman: Greece Could "Solve" Its Problems if it Could Print More Money

In his best-seller, The Return of Depression Economics (which I am having my MBA students read this spring), Paul Krugman declared that most economic problems can be "solved" rather easily: the government prints more money. I am not making up that declaration, nor am I embellishing it or putting it out of context. That is what he said, and, like Sgt. Friday, just the facts, ma'am.

Today, he looks once again at the crisis in Greece, which has spread to Spain and where Austrians see fiscal folly and wages and work policies that are totally out of line with the structures of production in those country, a situation that must be put back into balance to end the crisis, Krugman sees the lack of inflation being at fault. Don't take my word for it. Read on:

The fact is that three years ago none of the countries now in or near crisis seemed to be in deep fiscal trouble. Even Greece’s 2007 budget deficit was no higher, as a share of G.D.P., than the deficits the United States ran in the mid-1980s (morning in America!), while Spain actually ran a surplus. And all of the countries were attracting large inflows of foreign capital, largely because markets believed that membership in the euro zone made Greek, Portuguese and Spanish bonds safe investments.

Then came the global financial crisis. Those inflows of capital dried up; revenues plunged and deficits soared; and membership in the euro, which had encouraged markets to love the crisis countries not wisely but too well, turned into a trap.

What’s the nature of the trap? During the years of easy money, wages and prices in the crisis countries rose much faster than in the rest of Europe. Now that the money is no longer rolling in, those countries need to get costs back in line.

But that’s a much harder thing to do now than it was when each European nation had its own currency. Back then, costs could be brought in line by adjusting exchange rates — e.g., Greece could cut its wages relative to German wages simply by reducing the value of the drachma in terms of Deutsche marks. Now that Greece and Germany share the same currency, however, the only way to reduce Greek relative costs is through some combination of German inflation and Greek deflation. And since Germany won’t accept inflation, deflation it is.

Krugman, of course, supports Germany having a round of inflation. We have been down this road before, people, and it ends in disaster. In the late 1920s, Great Britain did not want to devalue the Pound, which at that time should have been trading at about $3.50 instead of the $4.86 "official" rate.

To keep the $4.86 rate intact, Benjamin Strong, who then was the chairman of the New York Federal Reserve Bank, cut a deal with Montagu Norman, Britain's equivalent of the Secretary of the Treasury, to inflate the U.S. Dollar. This led to the infamous stock market bubble that burst in October, 1929, and President Hoover's response to that crash (to try to prop up failing firms, as well as prop up high prices and wages) led to the Great Depression.

The Germans have their own history with inflation (1923 anyone?) and are not about to go the Benjamin Strong route, as to do so would create a series of troubles down the road. Unfortunately, inflation ultimately distorts an economy's structure of production, leads to unsustainable booms, and then to disaster. However, Keynesians like Krugman hold that the Very Worst Thing that can happen to an economy is deflation, and that prosperity is possible only through inflation.

Here is the problem with Krugman's prescription (Germany inflate, Greece continue as is): It does nothing to get the Greek fundamentals back into order and it distorts the economic fundamentals in Germany. In other words, it does nothing to solve the real, underlying problems in Greece, but it lays the foundation for a future crisis in Germany, as inflation will create its own problems.

If you wish to see an important difference between Austrians and Keynesians, here it is. Keynesians really don't see economic fundamentals, nor do they see any issues with factors of production. Instead, in their view, the economy is a homogeneous mix that works when government throws lots of money into the recipe. If there are imbalances (and the theory does not allow for that to happen, although Krugman himself recognizes that imbalances could be an issue), then inflation can solve everything. Unfortunately, what happens when governments engage in policies of inflation is that the seeming good effects come first, but then when the factor prices get out of balance with what is being produced, the economy moves toward an inevitable bust, and any attempts to "fix" things through another round of inflation only make things worse.

Austrians, on the other hand, look first at the factors of production for the distortions in the entire structure of the economy. Deflation, far from being the enemy of the economy, allows those factors to get back into balance with the overall structure of production, and direct production to consumer desires. It is the opposite of inflation: the bad effects come first (unemployment and initial dislocation), but the "good" effects come later (a recovery).

There is no way to bridge the gap between Keynesians and Austrians. Today, it is the Keynesians that rule, and it is economy that ultimately will suffer because their "theories" ultimately lead to disaster.

No, Greece cannot "solve" anything by going back to the Drachma and printing out the wazoo. Instead, it is up to that country to get its house back in order by letting the factors, including labor, get back into balance. That means, in the initial stages, that Greeks will find their wages being cut and their standard of living will fall. Yet, that initial stage is absolutely necessary if, in the long run, Greeks want to enjoy a higher standard of living in the future with an economy that is sustainable.

[Note]: It is good to be posting here again. I have been following the Tonya Craft trial in Ringgold, Georgia, and it is a fiasco. The prosecutors are running the show, and they are acting like typical high school bullies. It is a tragedy and a train wreck in progress.

Paul Krugman: We Need Inflation, and Lots of It

As I have said before, I appreciate Paul Krugman's openness in explaining his Keynesian views. True, he gives a few platitudes toward fiscal responsibility, but basically he recommends that government spend lots and lots of borrowed and printed money, and by doing so, will bring about economic recovery and prosperity.

The problem is not Krugman's saying such things; it's a semi-free country, after all. No, the problem is that when government follows these recommendations, disaster follows, even while Krugman and others are denying it or blaming the free market and sound money for economic evils. In today's column, he gives us more of the same.

As everyone knows, the government of Greece is in deep trouble. It overspent, went into deep debt, and now cannot pay back the debts. Even Krugman recognizes that fact, but then (as usual) draws the false conclusion that the way to deal with financial irresponsibility is, well, to be even more irresponsible:

Yes, Greece is paying the price for past fiscal irresponsibility. Yet that’s by no means the whole story. The Greek tragedy also illustrates the extreme danger posed by a deflationary monetary policy. And that’s a lesson one hopes American policy makers will take to heart.

Now, to say that any country now has a "deflationary monetary policy" is to be hallucinating. No one, I repeat, no one is engaging in deflation. Would be that were the case.

Here is Krugman in his own words about the crisis:

The key thing to understand about Greece’s predicament is that it’s not just a matter of excessive debt. Greece’s public debt, at 113 percent of G.D.P., is indeed high, but other countries have dealt with similar levels of debt without crisis. For example, in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed. And debt as a percentage of G.D.P. continued to fall in the decades that followed, hitting a low of 33 percent in 1981.

So how did the U.S. government manage to pay off its wartime debt? Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation, with both real G.D.P. and the overall level of prices rising about 40 percent from 1946 to 1956.

Unfortunately, Greece can’t expect a similar performance. Why? Because of the euro.

Until recently, being a member of the euro zone seemed like a good thing for Greece, bringing with it cheap loans and large inflows of capital. But those capital inflows also led to inflation — and when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies. Over time, Greek prices will have to come back down. And that means that unlike postwar America, which inflated away part of its debt, Greece will see its debt burden worsened by deflation.

Once again, Krugman gets it wrong. The USA followed pro-growth policies after World War II, unlike Greece (you know, where people actually are allowed to produce real goods without the government trying to put them out of business). However, Krugman, while admitting that Greece is not going to be so fortunate, then blames the semblance of sound money.

Like most Keynesians, Krugman believes a boom can last forever, just as long as government provides lots and lots of money, even if it leads to, well, double-digit (and worse) inflation. According to Krugman, the worst thing that can happen is deflation, and the real lesson here is that we need to debase the currency even more. Read on:

But what are the lessons for America? Of course, we should be fiscally responsible. What that means, however, is taking on the big long-term issues, above all health costs — not grandstanding and penny-pinching over short-term spending to help a distressed economy.

Equally important, however, we need to steer clear of deflation, or even excessively low inflation (Emphasis mine).

While Krugman does not define "excessively low inflation," nonetheless his point is clear. We need lots and lots of inflation, and anything else will be a disaster.

This is foolish advice, and it does not surprise me to read such nonsense from a Keynesian. After all, Keynesians believe that money is nothing more than a quantity variable that is to be manipulated to make aggregate models "work better." Is there unemployment? No problem; just add inflation, which will increase "aggregate demand" (because the demand for money falls as it loses value and velocity increases) and result in "full employment."

You see, to a Keynesian, this trick can be repeated time and again, as there are no real consequences from higher inflation except that prices go up. However, as Austrians point out, when inflation continues, malinvestments distort the structure of production, changing relative values of assets and ultimately leading to a crisis.

For example, contra Krugman, the housing boom could not continue because ultimately the factor prices in housing relative to everything else became too distorted to continue the charade. When the whole market depends upon being able to cram family incomes of $50K into paying a mortgage for a $500K house, the system cannot be sustained no matter how much new money government throws into the mix. Even Krugman recognizes that the housing market went bad, but then he reasons that it came about because of a lack of regulation, not because government was holding down interest rates and trying to direct that new money into housing. As I wrote in this post, such notions make no sense at all.

As I have stated many times before, the central problem is that Krugman and the Keynesians work from models in which all capital and all other assets are homogeneous. There can be no distortions in the structure of production, which always responds negatively to deflation and positively to inflation. This is a methodology that appeals to politicians and the modern, mainstream media, but it is not economics; it is Harry Potter Science.

Furthermore, we need deflation. That's right, far from avoiding it, we need to experience it. Yes, the initial results will be very painful (as though we are not experiencing pain now), but soon enough the factors of production will become balanced again, relative prices will make sense, and then the economy can find new lines of production that actually can be sustained.

However, because the initial stages of deflation are painful, Krugman says me must avoid it at all costs, even to the cost of destroying our money via inflation. Now, Krugman also believes that deflation will lead to a permanent downward spiral in which the economy ultimately becomes stuck at low production and high unemployment.

That is not true, not by a long shot. If Krugman were right, then the economy never would have recovered in 1982, when President Ronald Reagan and Fed Chairman Paul Volcker (who is the real hero here) permitted interest rates to rise, yet we had a real recovery in 1983 and beyond. While Krugman tries to claim that the recovery came about because of Keynesian-inspired deficit spending, the real results of that recovery contradict his story.

Had it been a "Keynesian recovery" (which in Austrian terms is an oxymoron), we would have seen growth in the usual sectors of manufacturing instead of seeing the growth centered on high-technology and telecommunications. Furthermore, Keynesians hold that one cannot have a recovery and have high interest rates, yet that is exactly what happened in the mid-1980s.

I agree with Krugman that the fact that Greece is on the Euro means that the government cannot inflate its way out of this mess -- and create a bigger mess. Yes, that means some real pain in the short run, but, contrary to what Krugman is claiming, in the long run it actually presents the Greeks with the opportunity to get things right.

Yes, there is a lesson from the fall of Greece. It is this: get your house in order and keep it in order. Don't keep printing money and claiming you are "saving the economy." Inflation is like heroin. It might feel good at the beginning stages, but in the end it destroys everything.

Krugman's New Oracle at Delphi

As everyone knows, the Greek government is in serious trouble, and the nation's economy is taking a hit. Defaults are a terrible thing, and Greece is taking a page from Wall Street and demanding a bailout by the EU Central Bank. (Apparently, Germany is standing in the way, demanding -- Horrors! -- that the Greeks put their own house in order, something that the socialist Prime Minister George Papandreou is denouncing. Gee, why should socialists have to shoulder the costs of, well, being socialist?)

Not surprisingly, Paul Krugman has weighed in on the Greek crisis and at least some of his commentary has truth. Unfortunately, since many of his pronouncements seem to be something akin to the Oracle at Delphi, in which the Pythia (after sniffing some gas from a vent in the earth) would mumble something that the Greeks would hold as true prophecy, it is hard to separate what makes sense from what does not. My rule of thumb in examining anything Krugman says is to pay attention to his analysis of what is happening, but to ignore his Keynesian "solutions," just as the ancient Greeks should have ignored the priestess.

Like so many other countries, Greece drank the Kool-Aid Bubble, and now is experiencing the pain of the inevitable economic contractions that accompany the bubble's collapse. Krugman seems to recognize it, and he even declares (correctly) that "now it faces a prolonged era of grinding deflation as it works its way back to competitive costs."

I absolutely agree. However, what is Krugman's "solution" to this problem? Why, inflate, inflate, inflate. As I pointed out in my post on Krugman and Spain, Krugman laments the fact that Spain no longer can devalue its own currency, since it uses the Euro. This is like complaining that after the alcoholic checks into rehab, those mean people running the place will not let the guy imbibe in his "hair of the dog" solution to alcohol withdrawals.

Where Krugman and I differ is here: Krugman sees inflation as the solution, while I believe it is the problem. He sees nothing good coming from deflation, as he believes (as did Keynes) that it creates a permanent downward spiral. However, as I have written elsewhere, deflation begins with what we see to be "bad effects," but ultimately helps to put the economy back into order again.

Inflation, however, provides the "good effects" first, but ultimately deteriorates. Where Krugman is so very wrong is that he believes that the "good effects" can be made to last indefinitely, just as long as government has the "courage" to continue inflating its currency. In other words, the alcoholic can remain the "happy drunk" indefinitely, just as long as he can keep drinking! So, in the end, Krugman sniffs the gas and then makes a pronouncement that makes about as much sense as came from the Pythia.