Krugman's Cyprus Solution: Seize Property and Print Money

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

...Cyprus should leave the euro. Now.

The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.

He continues:

If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP.

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

Getting to the same point by cutting nominal wages would take much longer and inflict much more human and economic damage.

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

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

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

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

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

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

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

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

Krugman Tell a Lie? Oh, Surely Not!

In a blog post following the first presidential debate, Paul Krugman insisted that while Obama did rather poorly, he spoke only the truth while Mitt Romney spoke only lies. Given that I cannot imagine the president or his main challenger telling the truth, I would say that Krugman was guilty of speaking only half a lie, but nonetheless, by insisting that Obama tells only the truth, that half was a whopper.

Krugman, being the political operative that he is, insisted in his latest column that the economy is not in any kind of crisis. In a recent speech in Europe, however, Krugman told a different story, warning of impending collapses if Europe continues its present course of what Krugman calls "austerity." What I find most interesting about his speech, however, is his insistence that the European Central Bank engage in what would be nothing more than a pure print-the-euro scheme, as though the "Zimbabwe Solution" would be sustainable. He declared that Europe must

...contain immediately the financial threat to troubled countries and stabilize yields on their borrowing, which in the end requires the ECB to be ready to be the lender of last resort and buy sovereign bonds.

Understand what he is saying. In effect, he is recommending that the European authorities create what would be an inflation crisis -- and that is what pure money printing schemes like this always create -- in order to solve the fiscal crisis. So, I guess that if Europeans are drowning in euros, they will forget that their economies are grinding to a halt. The Krugman "solution," or what we call the "Inflation Fairy."

Krugman: "Save" the Euro by Creating Another Unsustainable Boom

In his latest column, Paul Krugman explains why he believes that the euro has been crashing, and in part, I agree. Europe, he says, is not like the United States which actually is a unified country which also has a federal government that spreads its own spending programs throughout those states. (This is not in praise of those programs, but rather an admission that there is more tying the USA together than what we see in the European Union.)

Furthermore, I agree with Krugman that the housing boom especially covered the underlying flaws of the EU and its currency. Krugman writes:

Why did the euro seem to work for its first eight or so years? Because the structure’s flaws were papered over by a boom in southern Europe. The creation of the euro convinced investors that it was safe to lend to countries like Greece and Spain that had previously been considered risky, so money poured into these countries — mainly, by the way, to finance private rather than public borrowing, with Greece the exception.

And for a while everyone was happy. In southern Europe, huge housing bubbles led to a surge in construction employment, even as manufacturing became increasingly uncompetitive. Meanwhile, the German economy, which had been languishing, perked up thanks to rapidly rising exports to those bubble economies in the south. The euro, it seemed, was working.

I even agree with Krugman's next statement:

Then the bubbles burst. The construction jobs vanished, and unemployment in the south soared; it’s now well above 20 percent in both Spain and Greece. At the same time, revenues plunged; for the most part, big budget deficits are a result, not a cause, of the crisis. Nonetheless, investors took flight, driving up borrowing costs. In an attempt to soothe the financial markets, the afflicted countries imposed harsh austerity measures that deepened their slumps. And the euro as a whole is looking dangerously shaky.

At that point, however, the agreement stops, as Krugman then decides that the best way to "fix" the crisis is essentially to engage in an economic version of "hair of the dog." He writes:

What could turn this dangerous situation around? The answer is fairly clear: policy makers would have to (a) do something to bring southern Europe’s borrowing costs down and (b) give Europe’s debtors the same kind of opportunity to export their way out of trouble that Germany received during the good years — that is, create a boom in Germany that mirrors the boom in southern Europe between 1999 and 2007. (And yes, that would mean a temporary rise in German inflation.) The trouble is that Europe’s policy makers seem reluctant to do (a) and completely unwilling to do (b).

I must admit that even though I have read Krugman for many years, something like this shocks me. The European and U.S. economies have been suffering in the aftermath of the collapse of the housing bubble, and the response of governments and central banks has been to try to recreate boom conditions somewhere else via easy credit and monetary expansion. We see how well that has worked.

So now Krugman claims that Europe and the euro will be saved if the EU Central Bank can do in Germany pretty much what it did in Greece, Ireland, Spain, and Portugal. And what happens when that boom/bubble in Germany collapses, as it inevitably would?

That's easy. Krugman will demand that the authorities create a bubble somewhere else. Maybe he wasn't joking in 2003 when he called for the creation of a housing bubble in the USA. And when the bubble crashes, then he can blame private enterprise.

Will inflation save the European economy?

In his latest column, Paul Krugman believes that he has the answer to saving the European economy from disaster. The solution? In a word, inflation. Yes, if the European Central Bank will show the "courage" to print more money, everything will be fine.

I admit that at one level, Krugman is correct when he writes:

So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.

More specifically, the creation of the euro fostered a false sense of security among private investors, unleashing huge, unsustainable flows of capital into nations all around Europe’s periphery. As a consequence of these inflows, costs and prices rose, manufacturing became uncompetitive, and nations that had roughly balanced trade in 1999 began running large trade deficits instead. Then the music stopped.

Note that Krugman does not think that countries like Greece have been irresponsible, or at least he indicates such in this column. Instead, he seems to believe that another round of inflation would pretty much solve everything.

Krugman is correct when he says that the single currency of the euro did impose some requirements, although like a typical Keynesian, he believes that any fiscal discipline really is a bad thing, given that all wealth creation begins with government spending. When Europe went to the euro, it meant that when governments like that of Greece borrowed from European banks, they would have to generate the revenues via taxation to pay back the loans.

Obviously, that would restrict the Greek government's behavior, given that it could not print euros, and borrowing would have to be done at a sustainable rate. Unfortunately, given the fact that Greece, like many other small European countries, has a bloated public sector that is controlled by militant labor unions, it was inevitable that the Greeks sooner or later would borrow well beyond any threshold to pay back the loans, given that fiscal discipline does not exist with the Greek government.

Unfortunately, Krugman believes that fiscal discipline is bad, bad, bad, and that inflation is a much better "solution" to any problem that the Law of Opportunity Cost might pose when governments spend themselves into a corner. (Don't forget that in his book, The Return of Depression Economics, Krugman declares that literally printing money creates a "free lunch" -- his words.) He writes:

If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation. Their debt crises are mainly a byproduct of this sad prospect, because depressed economies lead to budget deficits and deflation magnifies the burden of debt.

That might be true, although Krugman forgets that if Greece still were on the drachma, then the banks might have been more reluctant to lend to that government -- although the prospect of being backstopped by the European Central Bank might have been enough to encourage the banks to lend even when they figured being paid back in euros was a stretch. Even so, if the loans had been in euros and Greece were on the drachma, then Greece still would have had the same issues, given that the banks would not have been willing to accept drachmas in repayment.

By being on the euro and with the liberal lending policies by banks, the Greeks were getting a free ride, and they knew it and believed that they were entitled to it. This is something Krugman never addresses because (1) the inevitable outcome would fall into the Opportunity Cost category, and all good Keynesians know that printing money trumps laws of economics, and (2) government spending CREATES wealth and the more government spends, the better off we are.

Likewise, when Krugman has called for the U.S. Government to borrow money and then give it to state governments, he claims that such actions would "stimulate" the economy and foster economic recovery. When California's government employee unions take an ever-growing bite of the Golden State's revenues and overall economy, Krugman refuses to see this situation as the unions plundering everyone else. Instead, he seems to believe that the unions are the responsible actors, and anyone who thinks otherwise is evil.

Keynesian theory literally turns economics on its head. Spending and printing money create wealth; wealth creation through saving, capital formation, and judicious choices by consumers and investors creates depressions and should be stopped by government, which should use force, if necessary, to keep people from acting responsibly.

Can we "save" the euro through inflation and outright financial fraud? Good luck!

It has come to this: all we need is a bit more time to sort out the financial mess that now engulfs Europe (and, by proxy, the United States). In the meantime, the Federal Reserve System, the European Central Bank, as well as four other banks, will resort to the usual "fixes" of inflation and the everlasting game of "Let's pretend that the worthless securities they purchase really are valuable."

The latest reprieve, for all its ballyhoo, is nothing but a stay of execution for the euro and (next) the dollar, but for the moment the central bankers -- and especially Ben Bernanke -- can share the spotlight and have the Usual Suspects praising them for their Great Wisdom and Foresight:

In Europe and the United States, where the announcement broke well ahead of stock market openings, the prospect of more cheap money to ease banks’ operations sent stock indexes soaring. A broad index of German stocks, the DAX, jumped almost 5 percent Wednesday, while the broad measure of American stocks, the Standard & Poor’s 500-stock index, climbed more than 4 percent. Short-term borrowing costs also declined modestly for some European governments and banks.

But policy makers and analysts were quick to caution that the Fed’s action did not address the fundamental financial problems threatening the survival of the European currency union. At best, they said, efforts by central banks to ease financial conditions could allow the 17 European Union countries that use the euro sufficient time to agree on a plan for its preservation.

In other words, the head has been temporarily moved from the chopping block, and that is cause for a party. Keep in mind, however, that the very people who celebrated in the stock and bond exchanges sooner or later will return with very different looks on their faces, as they realize that this lurching from crisis to crisis -- with the "solution" being more "liquidity" (read that, inflation) -- is unsustainable. The debt is unmanageable, period, and these economies are incapable at the present time of generating enough income to pay back these loans, especially given that the current set of "bailout" loans coming from the Fed and elsewhere are nothing more than loans to enable these countries to pay their current debt service.

Now, according to Paul Krugman, there really is a way out for the euro and the dollar. Yes, in response to the Greek crisis and others that follow in its wake, the European and U.S. government must follow policies that resemble...Greece. No, I'm not kidding.

Read for yourself:

I hope, for our sake as well as theirs, that the Europeans will change course before it’s too late. But, to be honest, I don’t believe they will. In fact, what’s much more likely is that we will follow them down the path to ruin.

For in America, as in Europe, the economy is being dragged down by troubled debtors — in our case, mainly homeowners. And here, too, we desperately need expansionary fiscal and monetary policies to support the economy as these debtors struggle back to financial health. Yet, as in Europe, public discourse is dominated by deficit scolds and inflation obsessives.

Yes, what is needed is inflation and more borrowing, the very things that put us in this untenable position in the first place. The U.S. economy is not producing enough to give the tax revenues needed for this burst of spending in the last four years, so borrowing and, essentially, monetizing U.S. debt are the only ways even to continue this spree.

There is another way out, one that is painful but at least will not have the long-term destructive effects of the kind of massive inflation that seems to be on the horizon: default. Yes, default.

First, a real default versus what Krugman is demanding -- default via inflation -- will not have the same distorting economic effects that inflation (and especially if it reaches double-digits...and beyond) would have, and second, a default would provide a much more realistic picture of what the situation really is, as opposed to what happens when inflation undercuts the price system. Yes, there will be a sharp downturn when this happens, but afterward, there will be the real prospect of an economic recovery, something that simply is not going to happen if this borrowing and printing madness continues.

When Krugman calls for "expansionary fiscal and monetary policies," he is not talking about policies that actually will expand the real economy. No, he is talking about more financial trickery, more central bank "pulling rabbits out of hats," more "stimulus" money given to politically-connected groups that are tied to the Obama administration, and so on.

Trickery and inflation won't save the euro. The irony as I see it is that the euro has a lot better chance of surviving if some honesty is permitted to enter the discussion. At the present time, unfortunately, the loudest voices are those that call for further debasement of the euro (and the dollar) and even more borrowing to cover the payments for the last set of loans. Neither option is sustainable, but for now, that is all the Keynesians seem to be offering.

Krugman: "Save" the euro by inflating it to death

Like most Keynesians, in the end, Paul Krugman is a one-trick pony who always recommends inflation as the answer to economic problems. (After all, he DID say in The Return of Depression Economics that inflation could provide a "free lunch" during economic downturns. In other words, the printing press negates the Law of Opportunity Cost.)

So, I see that Krugman now is giving the "Vietnam Strategy" to the Europeans: in order to "save" the euro, you must destroy it -- via inflation. Furthermore, we are supposed to think that had the German government in 1930 embarked on a policy of inflation, that it would have "saved" the country. Somehow, I doubt it.

How should the Europeans do it? Krugman already has set out a strategy that marks the way in which the European Central Bank would purchase the short-term debt of countries like Ireland, Portugal, Spain and Greece and hope that in the future, these countries will get their fiscal house in order. (Even Krugman knows that Greece cannot and won't do it, given Greek policies and its bloated government sector. Nonetheless, he believes that maybe the European Central Bank can inflate Greece's problems away, too.)

However, Krugman does not even contemplate any realistic outcomes of his strategy. If the ECB simply acts as the Big Sugar Daddy for countries by purchasing government bonds wily-nily, what is to keep everyone else from joining the Free Lunch? Sure, the European Parliament can enact policies that supposedly will limit this foolishness, but it is doubtful that once the shower of goodies starts, that anyone will hold to fiscal discipline.

In the end, this is a strategy that would inflate the euro out of existence. Now, that might be "good" for the dollar, given that investors around the world holding money are looking for safe havens. But the dollar sucks, too, thanks to the money-pumping strategy of the Obama administration.

So, in the end we are left with blizzards of paper money. But never fear, says Krugman. After all, everyone from Princeton and Washington knows that paper is more valuable than gold because paper is managed by Really Smart People Who Know More Than Everyone Else.

Krugman's Fed Road Map: Print Money, Buy Government Bonds!

In reading Paul Krugman, I am struck by the man's chutzpah, his willingness to accuse others of being immoral while simultaneously claiming that his money-printing schemes are moral. Yeah, it's confusing, but to Krugman and his followers, it all makes sense.

Krugman's latest morality play, however, even outdoes himself, and at the same time, he unwittingly presents the "road map" he believes that governments should use when they get into financial trouble. It is hard for me to believe that America's supposed "best" economist is recommending a scheme in which he both calls for governments simply buy their own bonds with their own newly-printed money, and declares that anyone who might oppose such financial trickery as being immoral, but there it is.

Krugman writes:

Here’s how such a run works: Investors, for whatever reason, fear that a country will default on its debt. This makes them unwilling to buy the country’s bonds, or at least not unless offered a very high interest rate. And the fact that the country must roll its debt over at high interest rates worsens its fiscal prospects, making default more likely, so that the crisis of confidence becomes a self-fulfilling prophecy. And as it does, it becomes a banking crisis as well, since a country’s banks are normally heavily invested in government debt.

Now, a country with its own currency, like Britain, can short-circuit this process: if necessary, the Bank of England can step in to buy government debt with newly created money. This might lead to inflation (although even that is doubtful when the economy is depressed), but inflation poses a much smaller threat to investors than outright default.

Before tackling what really is a mind-boggling proposition, let me say that "for whatever reason" is really not economic analysis. Instead, it is Krugman once again demonstrating that he does not understand what Carl Menger called the Law of Cause and Effect.

You see, there is no real reason for this sudden unwillingness for investors to purchase government bonds except for maybe changes in "animal spirits" or maybe just whatever. It is like his "under consumption" theme that under girds his theme in which there is no real cause for this sudden change of mass consumer preferences for buying anything. Blame it on "whatever."

As for the bond-buying scheme, apparently it never occurs to Krugman that once a government resorts to this kind of financial trickery -- and no other term will suffice -- that it is sending the message to investors that its bonds essentially are worthless. I simply cannot see how a contrivance would lead to anything but disaster.

If a government were to do what Krugman recommends, then there would be no constraint at all in its spending, as politicians would claim that it had "free money." Why worry about taxes? Investor confidence? We don't need no stinkin' CONFIDENCE FAIRY! Just print the money and spend!

By the way, this is exactly how Zimbabwe financed its government and it brought ruinous inflation. Yet, Krugman not only recommends this nefarious financing as a "solution," but he also has the gall to claim that anyone who might oppose it is a "moralizer," as though there were something wrong with pointing out that when governments engage in this kind of madness, they also destroy the wealth of every citizen who uses that government's currency.

Since a number of European countries are using the euro, Krugman claims that the European central bank should be printing more euros to buy the debt of countries like Spain and Italy (and I am sure he believes likewise for Greece). Here he is in his own words:

What Mr. (Jean-Claude Trichet) Trichet (the president of the European Central Bank or E.C.B.) and his colleagues should be doing right now is buying up Spanish and Italian debt — that is, doing what these countries would be doing for themselves if they still had their own currencies. In fact, the E.C.B. started doing just that a few weeks ago, and produced a temporary respite for those nations. But the E.C.B. immediately found itself under severe pressure from the moralizers, who hate the idea of letting countries off the hook for their alleged fiscal sins. And the perception that the moralizers will block any further rescue actions has set off a renewed market panic.

Notice that anyone who might point out that this "pull-the-rabbit-out-of-the-hat" finance sows its own seeds for disaster is nothing but a "moralizer" who apparently is bent on inflicting pain on others for no good reason. It doesn't take training in economics for someone to see where such a scheme would lead -- and I have no doubt that government employee unions would demand such a "fix" in order to prop up their own bloated trickery -- but from what I have read of Krugman, he seems to think that these unions really are creating wealth.

At least we see Krugman's road map for the USA: Have the Fed directly purchase short-term U.S. bonds. For now, such a scheme would be illegal, given that the Federal Reserve Act of 1913 expressly forbids exactly what Krugman has proposed for other countries to do. (No doubt, the people who wrote the original act were "moralizers," too.)

As I said before, it does not take training in economics to see where such actions would lead. However, if one has "economics" training from a lofty U.S. university, then one apparently is free to discard all laws of economics -- and all rules of common sense.

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.

California's Krugman Solution: A Modest Proposal

In his best seller The Return of Depression Economics (which I had my MBA students read this past year), Paul Krugman writes: “Recessions, in other words, can be fought simply by printing money—and can sometimes (usually) be cured with surprising ease.”

Indeed, as I read his latest string of columns that increasingly are laced with partisan invective and personal attacks, there is one constant theme: government needs to fight this downturn by churning out new money and quickly spending it. There are problems, however, when political bodies like Greece and Ireland fall into crisis because their currency, the Euro, is created by the European Central Bank.

In Krugman's view, the solution always lies in creating more money, and since he thinks that Europe is being stingy, he has been writing that the real shame is that Ireland, Greece, and Spain cannot "devaluate" in the way that Iceland has done. As I see it, if printing money would work for Iceland, then it would work for the biggest banana republic in the USA (which increasingly is becoming a banana republic, itself), California.

Yes, debt-and-deficit-riddled California, the once-Golden State now has become a prisoner not only of its mismanagement of prosperity, but also of the leftist ideology that is its governing philosophy. The state that gave us Apple Computer and Google now gives us bloated government worker unions, high tax rates, ridiculous regulations, a swarm of bureaucrats, and Nancy Pelosi.

California now is at the end of the line. It is driving out businesses, criminalizing and demonizing entrepreneurship, and things only will become worse. What to do? Why, there is only one thing to do: print money.

Of course, California is part of the big political union called the USA, but it seems to me that a "Krugman solution" already has been reached: government scrip. Yes, the outgoing Guhvuhnatuh, Ahnuhld Himself, used IOUs to pay California workers, and if Krugman is to be believed (and he IS a Nobel Prize winner, after all), then California really has no budget problems at all.

Yes, the Ultimate Chartalist Solution is at hand, and I hope that Krugman will recognize it, since he already has supported the concept of the idea. California can stop paying its workers in USD and use its own scrip. Given the state legislature's penchant for passing law after law, it can declare the scrip to be California legal tender and ORDER state businesses to accept it, on pain of workers and business owners going to prison.

(This would be quite appropriate, since one of the fastest-growing areas of criminal prosecution in this country has been the category of "economic crimes," as the USA borrows from the legal past of the USSR.)

Granted, there might be a showdown from Washington, although I figure that since Democrats control the executive branch of the U.S. Government and the U.S. Senate, and children in California DID sing praises to Obama ("Obama's gonna save us"), perhaps the god in the White House will relent and let California carry on its Krugman scheme.

Everyone would be happy, I guess. California would not be "budget constrained," the state could multiply its bureaucracies, authorities could arrest and try more business owners, Google could be used to spy on capitalists and other evil-doers, and there would be enough money for all!

Furthermore, California could enjoy an "export boom." (I'm sure Krugman would like that.) True, the only thing the state could export would be bureaucracy and videos of children singing praises to Obama, but that should be enough to entertain the masses. (California would NOT be able to use "Yes, We Can!" as its state slogan, since Obama already took that one. Maybe the incoming Gov. Moonbeam might employ "Accept our money -- or else" as the state slogan.)

So, all it takes is guts, I suppose. Make Paul Krugman California's secretary of the treasury and the country will take off. Moonbeam, you have a mission!! (It cannot be a "mission from God," however, as California intellectuals are godless.)

Krugman on Flexible Labor Markets

In a recent blog post, Paul Krugman makes what I believe to be an insightful comment on the flexibility of labor markets, and there is no reason to disagree with him as far as the statement goes. The disagreement, of course, is about what to do regarding this situation.

He writes:

Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro. With a unified currency, adjustment to differential shocks requires adjustments in relative wages — and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Let me repeat that:

WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY.

For many years, government employee unions in countries like Greece and Spain have been able to extract attractive pay packages and because the employees were being paid in euros, they found themselves enjoying a very high standard of living. However, this is not because they were earning such a standard, but rather because they had the political power to extract such standards from other people who were poorer -- and who had to do real productive work.

Unfortunately, Krugman, as a True-Believing Keynesian, does not see this relationship at work. Instead, he relies on the Keynesian belief -- based upon what I believe are accurate empirical observations -- that labor markets are less-flexible than markets for commodities. He notes:

How hard will it be to achieve this? Look at Latvia, which has pursued incredibly draconian austerity. Unemployment has risen from 6 percent before the crisis to 22.3 percent now — and wages are, indeed, falling. But even in Latvia labor costs have fallen only 5.4 percent from their peak; so it will take years of suffering to restore competitiveness.

The official answer is that this just shows the need for more flexible labor markets. But this was a subject we all batted back and forth in the initial debate about the euro, circa 1990: nobody has labor markets that flexible. If the euro isn’t workable without highly flexible nominal wages, well, it isn’t workable. (Emphasis his)

Thus, the Keynesian "solution" to this problem: inflation. In The General Theory, Keynes recognized the problem of labor costs being out-of-kilter and the difficulty in bringing them back into line, with the result being that labor would be priced out of the market and would result in high rates of unemployment.

I don't think anyone disagrees with that point, for it is pure classical economic theory at work. However, Keynes' "solution" was for government to give workers a wage cut through inflation, and he wrote that since he believed that workers only were concerned about their nominal (not real) wages, this "trick" would work time and again.

Indeed, since Krugman says that letting wages adjust by falling is not "workable," then he has the solution: inflation. Where Keynesians and Austrians differ, however, is that Keynesians see labor and factor markets as being somewhat homogeneous, while Austrians recognize that there are imbalances in these markets that are made worse by inflation. In the Austrian view, inflation is not a "solution" at all; it only exacerbates the problem, creating more malinvestments and leading to future crises.

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."

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.