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."

Will inflation save Europe?

In a recent column, Paul Krugman says that Europe essentially is committing "economic suicide" with its various "austerity" programs, with the only thing that can save the Continent being inflation. While I can agree with him in part that "austerity" programs as outlined by the European Central Bank can be harmful to economic growth, the idea that inflation is the magic elixir that turns bad economies into engines of prosperity is pure snake oil.

Krugman writes:

So if European leaders really wanted to save the euro they would be looking for an alternative course. And the shape of such an alternative is actually fairly clear. The Continent needs more expansionary monetary policies, in the form of a willingness — an announced willingness — on the part of the European Central Bank to accept somewhat higher inflation; it needs more expansionary fiscal policies, in the form of budgets in Germany that offset austerity in Spain and other troubled nations around the Continent’s periphery, rather than reinforcing it. Even with such policies, the peripheral nations would face years of hard times. But at least there would be some hope of recovery. (Emphasis mine)

 How much inflation? Krugman does not say, although he should know that once a government goes down the inflation path, it needs to apply increasing amounts of inflation over time to get the same effects. The history of inflationary episodes is quite clear on that point.

However, at the same time, we have to understand just what is meant by "austerity" in the European sense. The ECB (with the Federal Reserve System lurking in the background) has engineered a bailout of the banks that lent these governments lots of euros, and in order to now pay back the loans, the governments must cut spending and raise taxes.

Cutting spending, contra Krugman, is not necessarily contractionary, although European governments impose heavy costs upon business, making it harder for businesses to be an engine for recovery. Krugman mentions Spain and its near-24 percent unemployment. What he does not say is that Spain has some of the most restrictive employment regulations in the world in which employees, once hired, pretty much have something akin to tenure, which means employees pretty much cannot be fired for any reason.

Under that set of incentives, when businesses find the back door nailed shut, it means that the front door is much harder to open. Unfortunately, people like Krugman cannot see such policies as having any effect upon employment rates in Spain because they tend to see government employment as morally and financially superior to private employment, so that if Spain makes it difficult for businesses to hire people, then let government "pick up the slack."

There is an underlying issue that Krugman cannot see because of his anti-enterprise ideology. For many years, Europeans have looked down their noses at the USA because it has not had the same restrictions on businesses as Europe and the USA's welfare state is not as vast as that on the Continent.

Yet, such restrictions and heavy spending have made it more difficult for businesses to generate real wealth, which ultimately has translated into slow growth and high unemployment. Unfortunately, the current spate of "austerity" programs fails to recognize how new wealth can be created and what it really would take for Europe's economies to grow.

Krugman, however, would have none of that. His message to Europe is simple: keep the restrictions on business in place, increase government spending, and print money, lots of money. Such actions in the present might mask the underlying problems, but in the long run, it would be disastrous.

But to Keynesians such as Krugman, it doesn't matter. In the long run, all of us are dead.

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.

Krugman: Save "democracy" via inflation

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

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

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

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

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

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

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.)

The Inflation Prisoner

About 30 years ago, I read a book by Irwin Schiff (yes, THAT Irwin Schiff) called The Biggest Con in which he exposed Keynesian economics and declaring that the only "arrow in the quiver" of Keynesianism was inflation. As I read Paul Krugman's column today on Spain and its problems, I can see that if Krugman is the most public spokesman today for Keynesian thinking, then Schiff was correct. Let me begin.

In The General Theory, John Maynard Keynes argues that the standard supply-demand wage theory holds only if there is full employment of labor. However, if there is widespread unemployment, the way to get labor back to full-employment levels is to sneak in a general wage cut via inflation. Keynes writes:

...it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, inasmuch as they resist reductions of money-wages, which are seldom or never of an all-round character, even though the existing real equivalent of these wages exceeds the marginal disutility of the existing employment; whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment and leave relative money-wages unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment. Every trade union will put up some resistance to a cut in money-wages, however small. But since no trade union would dream of striking on every occasion of a rise in the cost of living, they do not raise the obstacle to any increase in aggregate employment which is attributed to them by the classical school. (Emphasis mine)

I believe that the concepts shown in this paragraph really are at the heart of Krugman's column today in which he says that Spain easily could get out of its present situation if it had its own currency and could engage in a devaluation which, in his view, would establish something close to full employment and boost Spanish exports. He writes:

Now what? If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.

And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems.

What all this means for Spain is very poor economic prospects over the next few years. America’s recovery has been disappointing, especially in terms of jobs — but at least we’ve seen some growth, with real G.D.P. more or less back to its pre-crisis peak, and we can reasonably expect future growth to help bring our deficit under control. Spain, on the other hand, hasn’t recovered at all. And the lack of recovery translates into fears about Spain’s fiscal future.

Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”

The concept is strikingly similar to what Keynes wrote, although Krugman also exposes his own biases of aggregation in this column. After all, what happens when a government devaluates the currency? There is a cut in real wages, and while the goods denominated in that currency become cheaper relative to goods made elsewhere, nonetheless people at home do suffer a fall in their standard of living.

Like Keynes, Krugman argues that what he calls an "internal devaluation" is bad because real wages are cut and people can see firsthand that they are making less, and in countries like Spain that are dominated by labor unions, that spells trouble. However, an inflation-led "wage cut" tends to be less visible or less clear, even if the same thing, relatively speaking, is accomplished.

However, all of this assumes that the effects of inflation are exactly the same as a cut in wages and government spending. (Actually, Krugman believes that inflation is superior because, in his view, people spend more in the short term, which he claims gives an economy "traction," enabling it to move forward on its own.) According to Krugman, or at least what I ascertain through his columns, inflation does not distort the structures of production nor cause any internal dislocations.

This last point is important, because one can have such a view ONLY if factors of production are homogeneous. However, if there are malinvestments that come about through inflation, and these malinvestments over time become unsustainable, then there is a problem.

In a nutshell, that is a huge difference between Austrians and Keynesians. While the devaluation of which Krugman speaks might have some "good effects" at first, nonetheless, this "solution" only exacerbates the long-term problem. For example, within an economy, the wages that tend to be out-of-kilter with the rest of the economy often are centered in unionized industries, and when inflation hits, those sectors tend to be able to force employers (and the government, since these countries have powerful public sector unions) to give raises that better keep up with inflation than workers who either are not unionized or have weak or non-existent political connections.

Thus, the internal distortions are likely to grow. In countries like Spain, Greece, and Portugal, the very sectors that are bloated and are gobbling up resources are the government sectors. A bout of inflation in the long run then would further empower those very employment groups that are most responsible for the current trouble.

To a Keynesian like Krugman, none of this matters, as all sectors are homogeneous and there is no such thing as economic distortion. The only thing that matters are aggregate numbers, as economics to him is nothing more than charts, numbers, and aggregations. To "cure" an economy, give it a bout of inflation, and when the inevitable problem arise, deal with them via another bout of inflation.

When things deteriorate -- as they surely will -- then one blames the "greedy" corporations which, in the view of someone like Krugman, need to be reined in by activist government. All that is needed is to find the "Goldstein," demonize, rage on, and then inflate some more. In the end, THAT is the "Krugman solution."

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.

Yes, Yes, Inflation Solves All Economic Problems

If inflation really could save the world, then we would be looking to Zimbabwe as our savior, given that its government over the past few years has been producing some memorable moments in the history of crankdom. Alas, inflation is a scourge, not an economic solution.

Unfortunately, Paul Krugman does not seem to get it. In his latest column, "Making of a Euromess," he blames the economic crisis in Spain on...the Euro. Now, I am no more fond of the Euro than I am of the 1923 German Mark, but Krugman's reasoning is something to behold. In his own words:

And there’s not much that Spain’s government can do to make things better. The nation’s core economic problem is that costs and prices have gotten out of line with those in the rest of Europe. If Spain still had its old currency, the peseta, it could remedy that problem quickly through devaluation — by, say, reducing the value of a peseta by 20 percent against other European currencies. But Spain no longer has its own money, which means that it can regain competitiveness only through a slow, grinding process of deflation.

Notice that he is saying that Spain really is in trouble because it cannot engage in inflation, since it does not control the Euro, unlike its former fiat currency, the peseta. However, devaluation really does nothing but put off the Day of Reckoning for a while, but that day will arrive.

On the other hand, perhaps the best thing that Spain needs is the "grinding process of deflation," as that simply means that the prices paid for overvalued Spanish factors of production (and especially labor) are going to have to fall into line with economic reality. Most people, and especially the heavily-unionized Spanish workforce, don't want to hear that "option," as they would like to continue the charade that economic recovery is not going to require some short-term painful medicine.

However, if the Spanish were willing to take the medicine, they would be hurting now, but their economy would recover and become a beacon in Europe. Inflation, while delivering the "good effects" in the short-run, runs the economy off the rails as bout after bout of money devaluation takes its toll.

Not surprisingly, Krugman advocates inflation and denounces deflation. Yet, the only hope for Spain is deflation. The European Union is not going to bail out Spain, and that is a good thing. No, Spain needs to get its house in order. Likewise, on this side of the Pond, perhaps the USA needs to get its own house in order and stop preaching the Gospel of Inflation.