Krugman's 1 Percent Fallacy

I know all readers are shocked, SHOCKED that Paul Krugman still is going off on the Reinhart-Rogoff paper, but today he ups the ante. Anyone who believes that setting off yet another unsustainable boom is not good policy actually is a people-hating moralist who sides with the Evil 1 Percent.

In other words, folks, it's Goldstein (or maybe "Scoldstein") time again. Yes, everyone knows that the way to "fix" the economy is for the government to borrow vast sums of money for consumption goods, and the spending that comes with that and printing money will give the economy enough "traction" to move on itself -- at least until the next boom runs out of steam and government has to repeat the process.

Krugman goes on to explain that anyone who might question this economic "wisdom" does so out of malevolence and (maybe) some ignorance or a false belief in some sort of economic "morality," writing:

...austerity maintained and even strengthened its grip on elite opinion. Why?

Part of the answer surely lies in the widespread desire to see economics as a morality play, to make it a tale of excess and its consequences. We lived beyond our means, the story goes, and now we’re paying the inevitable price. Economists can explain ad nauseam that this is wrong, that the reason we have mass unemployment isn’t that we spent too much in the past but that we’re spending too little now, and that this problem can and should be solved. No matter; many people have a visceral sense that we sinned and must seek redemption through suffering — and neither economic argument nor the observation that the people now suffering aren’t at all the same people who sinned during the bubble years makes much of a dent.

However, we find that this brand of economic fundamentalism really is nothing more than a dastardly plot hatched by the Evil 1 Percent (or maybe just the Evil One himself, namely Scoldstein):

What, after all, do people want from economic policy? The answer, it turns out, is that it depends on which people you ask — a point documented in a recent research paper by the political scientists Benjamin Page, Larry Bartels and Jason Seawright. The paper compares the policy preferences of ordinary Americans with those of the very wealthy, and the results are eye-opening.

Thus, the average American is somewhat worried about budget deficits, which is no surprise given the constant barrage of deficit scare stories in the news media, but the wealthy, by a large majority, regard deficits as the most important problem we face. And how should the budget deficit be brought down? The wealthy favor cutting federal spending on health care and Social Security — that is, “entitlements” — while the public at large actually wants to see spending on those programs rise.

You get the idea: The austerity agenda looks a lot like a simple expression of upper-class preferences, wrapped in a facade of academic rigor. What the top 1 percent wants becomes what economic science says we must do.

Could Krugman be engaging in...conspiracy theories? Read on:

Does a continuing depression actually serve the interests of the wealthy? That’s doubtful, since a booming economy is generally good for almost everyone. What is true, however, is that the years since we turned to austerity have been dismal for workers but not at all bad for the wealthy, who have benefited from surging profits and stock prices even as long-term unemployment festers. The 1 percent may not actually want a weak economy, but they’re doing well enough to indulge their prejudices.

And this makes one wonder how much difference the intellectual collapse of the austerian position will actually make. To the extent that we have policy of the 1 percent, by the 1 percent, for the 1 percent, won’t we just see new justifications for the same old policies?

This is a most interesting position he is taking. There are two sets of policies in which government policy directly enriches that "1 percent." The first involves the massive bank and financial bailouts that have been at the heart of the "austerity" policies imposed upon countries like Greece, Ireland, Portugal, and Spain, not to mention the continuing bailouts being pushed by the central banks of Europe, the USA, and Japan.

And guess what? Krugman supports the bailouts, even though he believes that they should be financed, at least in Europe, via booms, the very kind of booms that collapsed and created the financial crises in the first place. To put it mildly, Krugman demands another round of "hair of the dog" economics.

The second enrichment-of-the-wealthy policy is crony capitalism, but when David Stockman speaks out against this get-rich-by-being-politically-connected set of schemes, Krugman lambasts him for being a "scold." So, it seems that The Great One wants it both ways: cry crocodile tears about how government policies hurt the poor, and then endorse economic schemes that...hurt the poor.

What about the so-called morality play of which Krugman speaks? He is saying that Austrians believe that somehow booms are "sinful," and that if Wall Street and the rest of the economy get drunk, then it is time to hide the alcohol and everything else. No soup for you!!

Yet, what is it that Austrians have been saying? We hold that credit-fed booms, and especially the credit-fed booms that involve heavy borrowing for purchasing consumption goods, are going to run aground because they are not sustainable. The borrowing and investment patterns do not match consumer spending and saving preferences, which means that the boom runs out of steam on its own.

If the economy is to have a real recovery, then entrepreneurs must be able to find those assets that are potentially profitable and be able to move resources from lower-valued uses to higher-valued uses. But, the Krugman plan is to have government subsidize moving resources from higher-valued uses to lower-valued uses, and keep doing it until one day things magically turn around.

The housing boom crashed when it became apparent that most Americans could not afford the super-high prices created by the boom and when a wave of mortgage defaults hit the system, it went down. Krugman, apparently not appreciating the hard fact that a family making $50K a year probably cannot afford the payments on a house selling for $500K, says that trying to keep an asset bubble alive not only is economically feasible, but also the only moral policy that can be implemented.

Austrians are not calling for "austerity" for austerity's sake or because they want people to be thrown out of work, but rather because they believe the current sets of policies are not economically sustainable. The American economy cannot subsidize itself into prosperity via "green energy," nor can the economy continue to exist as a series of asset bubbles. Furthermore, while the Fed can mask the problems by purchasing financial instruments like mortgage securities in order to prop up their prices, it cannot repeal the Law of Demand or the Law of Scarcity.

And Austrians certainly are not "austerians" of the European variety. We simply are saying we don't believe in the Debt Fairy or the Inflation Fairy, and we don't need Scoldstein to convince us that we cannot rebuild an economy by having Ben Bernanke pull financial rabbits from his hat.

Krugman, on the other hand, fervently believes that even though debt piled up during the last boom, which finally ran aground, the way to create a stronger economy -- and somehow magically pay down some of the debt, at least in the future -- is for more of the same. So, who is practicing a religious fundamentalism?

Krugman: We Need a Debt Fairy to Accompany the Inflation Fairy

Paul Krugman has become the master of picking up the stray phrase and claiming that it is standard policy. The Wall Street Journal, for example, years ago used "bond vigilantes" in an editorial warning about taking on more debt, and now Krugman wants us to think that every editorial in the WSJ repeats the same error.

Someone in the Austrian camp said that large-scale inflation could be in our future, so now every Austrian is predicting hyperinflation all of the time. And since we don't have hyperinflation, why then every aspect of Austrian Economics must be totally wrong.

Today, Krugman is claiming that an error in an influential paper written by Carmen Reinhart and Kenneth Rogoff of Harvard is responsible for "destroy(ing) the economies of the Western world." According to the paper, if a government's debt exceeds 90 percent of a nation's GDP, then economic growth will tail off "sharply." However, some researchers looking at the data have concluded that the paper's methodology was fatally flawed and that there was no real 90 percent threshold, although higher levels of debt did correlate with lower growth rates.

According to Krugman, this paper was the deciding factor in "austerity" plans for governments in the West, and since "austerity" is bad, the paper played an important role in economic destruction. However, there is only one problem with that thesis: Krugman's commentary itself undercuts the paper's influence. He writes:

For the truth is that Reinhart-Rogoff faced substantial criticism from the start, and the controversy grew over time. As soon as the paper was released, many economists pointed out that a negative correlation between debt and economic performance need not mean that high debt causes low growth. It could just as easily be the other way around, with poor economic performance leading to high debt. Indeed, that’s obviously the case for Japan, which went deep into debt only after its growth collapsed in the early 1990s.

Over time, another problem emerged: Other researchers, using seemingly comparable data on debt and growth, couldn’t replicate the Reinhart-Rogoff results. They typically found some correlation between high debt and slow growth — but nothing that looked like a tipping point at 90 percent or, indeed, any particular level of debt.

OK, here is the problem. If economists from the start doubted its accuracy, then how can one also say that this paper -- THIS paper -- had such a powerful impact that most of the political leaders of the western world fully embraced everything these economists claimed and then designed their economic plans accordingly. This just does not make sense.

The U.S. Government continues to borrow at an astounding rate, Japan is openly attempting to print jillions of yen, and the European Central Bank and the Federal Reserve System are flooding the world with euros and dollars. Furthermore, as Bob Murphy already has pointed out, the only thing Krugman and other Keynesians deem to be acceptable as economic recovery is another boom, yet it was the unsustainable boom that got us into trouble in the first place.

Does Krugman think that this time governments will be better able to manage future financial bubbles or that booms won't run aground if Krugmanites are calling the shots? Somehow, I doubt seriously that another unsustainable boom is the answer.

So, we have Krugman claiming that what the world economies needed was more debt and, thus, also more printing of money. To put it another way, what Paul Krugman is claiming is that an Inflation Fairy is not enough. No, we also need a visit from the friendly Debt Fairy.

Joseph Salerno on Bernanke's Asset Bubbles

While I realize that Paul Krugman insists that only "unregulated" markets can create asset bubbles (and that government plays no role in creating them), Joseph Salerno begs to differ, saying that the U.S. Government and its Federal Reserve System is "addicted" to a bubble economy.

Helicopter Ben Runs Out of Ideas for Creating Money

Ben Bernanke confided on January 14 that he is unaware of any new method of stimulating economic growth. Bernanke said: “As far as I’m aware, there’s no completely new method that we haven’t [already tapped].” So Helicopter Ben has run out of innovative and unconventional ways to create new money. Lest you be tempted to breathe a bit easier, however, rest assured that the now conventional method of quantitative easing, involving the Fed’s monthly purchase of $85 billion worth of mortgage-backed and U.S. government securities, seems to be working just fine according to Bernanke and he foresees its continuation. Noting the stubbornly high unemployment rate combined with the low inflation rate in the U.S. economy, Bernanke stated, “That is the case for being aggressive, which we are trying to do.” Although he is “cautiously optimistic,” he does promise to closely monitor the risks, efficacy, costs, and benefits of this inflationary policy.

I guess the rapid asset price run-up in stock and commodities markets, which are nearly back to financial bubble levels, and booming farmland prices do not count in Bernanke’s benefit-cost calculus. More likely, Bernanke accounts them as a benefit, which, via the “wealth effect,” will induce another debt-driven consumption spree on the part of the American public that will stimulate economic growth, i.e., create another bubble economy.

Read the Entire Article Here

Paul Krugman and His Zombie History

Murray Rothbard liked to say that economist often tended to specialize in the area where their knowledge was the worst, and given Paul Krugman's butchery of the historical record, I'd say Rothbard had a good point. Regular readers of Krugman's columns and blog posts and other public statements would believe, for example, that World War II ended the Great Depression, that Jimmy Carter and Ted Kennedy were conservative Republicans, and that the only thing better than war to bring prosperity would be the nationwide preparation to fight an invasion of imaginary space aliens.

As always, whenever Krugman goes on a partisan political screed, truth is left behind, and his recent column is no exception. While I have no problem with his criticizing Republicans, nonetheless I actually would want for him to get his criticisms correct, especially his points that the Republican Party is dedicated to laissez-faire economics and actually cutting the size and scope of government.

Unfortunately, he decides to make essentially this set of claims:

• The financial meltdown was purely the fault of private enterprise except for one governmental error: it did not regulate enough;
• The GSEs, Freddie and Fannie, had absolutely nothing to do with the meltdown.

Krugman writes:

Start with the big question: How did we get into the mess we’re in?

The financial crisis of 2008 and its painful aftermath, which we’re still dealing with, were a huge slap in the face for free-market fundamentalists. Circa 2005, the usual suspects — conservative publications, analysts at right-wing think tanks like the American Enterprise Institute and the Cato Institute, and so on — insisted that deregulated financial markets were doing just fine, and dismissed warnings about a housing bubble as liberal whining. Then the nonexistent bubble burst, and the financial system proved dangerously fragile; only huge government bailouts prevented a total collapse.

Instead of learning from this experience, however, many on the right have chosen to rewrite history. Back then, they thought things were great, and their only complaint was that the government was getting in the way of even more mortgage lending; now they claim that government policies, somehow dictated by liberals even though the G.O.P. controlled both Congress and the White House, were promoting excessive borrowing and causing all the problems.

Every piece of this revisionist history has been refuted in detail. No, the government didn’t force banks to lend to Those People; no, Fannie Mae and Freddie Mac didn’t cause the housing bubble (they were doing relatively little lending during the peak bubble years); no, government-sponsored lenders weren’t responsible for the surge in risky mortgages (private mortgage issuers accounted for the vast majority of the riskiest loans).

But the zombie keeps shambling on — and here’s Mr. Rubio Tuesday night: “This idea — that our problems were caused by a government that was too small — it’s just not true. In fact, a major cause of our recent downturn was a housing crisis created by reckless government policies.” Yep, it’s the full zombie.

The only accusation he left out was that Republicans were responsible for keeping the space aliens away from us, thus nullifying our chances for economic recovery. But, let us take a look at the record, given that Krugman has made some very important claims.

Understand that he is quietly making the larger claim: price signals mean nothing to entrepreneurs; only government regulators and agents can understand the economy and what actually is happening, and that only government, through spending, regulation, and outright ownership and control of the factors of production, can bring about prosperity.

So, let us talk about the government's role in this whole thing. First, he leaves out an important player, the Federal Reserve System, and the fact that neither Alan Greenspan nor Ben Bernanke would admit to the creation of the housing bubble and both continued with their policies of pushing down interest rates and directing funds into the housing market through their statements and actions.

Second, Krugman ignores the simple fact that government is the single largest player in the mortgage business through its policies of encouraging and funding home ownership. To claim that the only influence government had through the housing bubble was not regulating enough is yet another Krugman howler, and his claims that Freddie and Fannie were not lending during the "peak bubble years" and that government agencies did not encourage loans to "sub-prime" borrowers is the typical Krugman rewriting of history.

I'll get to Freddie and Fannie in a moment, but the notion that the banks simply came up with the idea of lending to sub-prime borrowers on their own really does defy history. Yes, it is true that the vast majority of sub-prime loans DID come from the banks, and that their attempts to securitize these loans in order to mitigate the risks were a disaster. I have no problem with this accusation against the Wall Street firms, but there is one thing that Krugman leaves out: the infamous Greenspan-Bernanke "Put."

When the financial deregulation occurred both during the Carter-Reagan years and at the end of the Clinton administration, the government did not get rid of the moral hazard that essentially guaranteed reckless behavior. Both Greenspan and Bernanke time and again promised to "create liquidity" if the banks got into trouble, and when the markets had the trillions of the Fed standing behind them, it is no wonder that they ran off the rails. Moral hazard has a way of encouraging the very actions that lenders and the entities supporting them should not be taking.

Free markets entail both profits and losses, and when the government essentially lets the banks keep their profits but then promises to socialize the losses, why are we shocked, SHOCKED when the banks do the things they did? What Krugman refuses to do is to acknowledge that the players in private enterprise really will respond to the prospect of losses when they engage in risky behavior. Instead, he simply ignores the fact that the banks knew the Fed and the taxpayers were covering their behinds and so they could be free to engage in behavior that anyone with half a brain knew could produce very bad outcomes.

I'll make another point about the crisis: the Austrians were on it long before the Keynesians and the rest of American economists jumped on the bubble bandwagon. Mark Thornton in 2004 wrote:

Signs of a "new era" in housing are everywhere. Housing construction is taking place at record rates. New records for real estate prices are being set across the country, especially on the east and west coasts. Booming home prices and record low interest rates are allowing homeowners to refinance their mortgages, "extract equity" to increase their spending, and lower their monthly payment! As one loan officer explained to me: "It's almost too good to be true."

In fact, it is too good to be true. What the prophets of the new housing paradigm don't discuss is that real estate markets have experienced similar cycles in the past and that periods described as new paradigms are often followed by periods of distress in real estate markets, including foreclosure sales, bankruptcy and bank failures.

Furthermore, while the Austrians may be laissez-faire in their economic viewpoints, they hardly are fans of the banks and they certainly did not believe that the Fed and the housing bubble constituted a new era of prosperity. (For that matter, I warned the property tax appeals board in Allegany County, Maryland, in the spring of 2006 that the current housing situation was a bubble and that it would crash, and that government officials should not make future budget predictions off what we were presently seeing. They told me flat out that I was wrong.)

By leaving out the Fed's "Put" and the other quiet assurances from Congress and the Bush administration that the government had the backsides of the banks, Krugman ignores an important reason as to why the banks ignored price signals and engaged in reckless behavior. While I am sure that Krugman was taught early in in graduate school about moral hazard, his leaving out that important point more to his intellectual dishonesty than it does his lack of economic knowledge.

Freddie and Fannie

Were the GSEs actually non-players in this whole affair, as claimed by Krugman? First, if that were so, then neither entity would have gone bankrupt in 2007, since they did not have risky loans on their books. While it is true that neither GSE was responsible for the vast creation of the subprime loans and their subsequent securitization, but that did not mean they were minor players in the system at the time.

Veronique de Rugy writes:

Fannie and Freddie contributed to the housing crisis by making it easier for more people to take out loans for houses they could not afford. Beginning in 2000, Fannie and Freddie took on loans with low FICO scores, loans with low down payments, and loans with little or no documentation.

The federal government’s role in the housing market goes back at least to 1938, but that role changed fundamentally in the 1990s when the government made a push to increase homeownership in the United States. At that time, the federal government pursued several policies that were meant to encourage banks to lend money to lower income earners and to give incentives to low income earners to buy houses. The result, as we now know, was a gigantic amount of subprime mortgages at a time when house prices were starting to go down.

In other words, the encouragement to create sub-prime housing loans came from federal policies, something that Krugman ignores. (Krugman apparently wants us to believe that the banks would suddenly create a bunch of bad loans on their own, and with the full knowledge that if they lost money, the government would not be there to force taxpayers to underwrite these bad loans.) Freddie and Fannie did play a role in creating these sub-prime securities, even if Krugman and the NYT want to ignore that fact.

It gets better. Far from being an almost non-existent player in the crisis, we find that the GSEs actually did have large housing portfolios during this time:

...Fannie Mae and Freddie Mac are considered government-sponsored enterprises (GSEs). Although both were, before the crisis, privately financed, the general sentiment was that in the event of a crisis in the mortgage market, the federal government would step in and back the GSEs. In other words, the government implicitly guaranteed Fannie and Freddie's securitized loans. This allowed them to borrow at interest rates below those of the financial markets and to hold much lower capital requirements than commercial and investment banks. The aggregate value of this subsidy has been estimated to range "somewhere between $119 billion and $164 billion, of which shareholders receive respectively between $50 and $97 billion. Astonishingly, the subsidy was almost equal to the market value of these two GSEs."

As a result, by the time the housing crisis began to unfold, Fannie and Freddie had become the dominating force in the secondary mortgage market, providing 75 percent of financing for new mortgages through securitization at the end of 2007. At the end of 2010, they still held about 50 percent of securitized, first-lien home loans.

Economist Russ Roberts also investigated and found that Freddie and Fannie were more like silent partners in the crisis, contra Krugman:

Fannie and Freddie bought 25.2% of the record $272.81 billion in subprime MBS [mortgage-backed securities] sold in the first half of 2006, according to Inside Mortgage Finance Publications, a Bethesda, MD-based publisher that covers the home loan industry.

In 2005, Fannie and Freddie purchased 35.3% of all subprime MBS, the publication estimated. The year before, the two purchased almost 44% of all subprime MBS sold.

We are not speaking of insignificant numbers. Furthermore, as de Rugy points out, Congress and the administration were not exactly non-players in setting the table for a housing crisis:

In addition, lawmakers in both parties enacted policies directed at increasing home ownership rates, resulting in lower mortgage underwriting standards for Fannie and Freddie. Roberts notes that from 2000 on, Fannie and Freddie bought loans with low FICO scores, loans with very low down payments, and loans with little or no documentation. Contrary to Paul Krugman’s assertions, Fannie and Freddie did not “fade away” or “pull back sharply” between 2004 and 2006.

As the following chart from Roberts’ study shows, during that same time Government Sponsored Enterprises (GSEs) bought near-record numbers of mortgages, including an ever-growing number of mortgages with low down payments.

Moreover, as the chart below shows, while private players bought many more subprime loans than Freddie and Fannie, GSEs purchased hundreds of billions of dollars worth of subprime mortgage-backed securities (MBS) from private issuers, holding these securities as investments. (The charts are shown in the Roberts article.)

What Krugman would have us believe is that the government, along with its Frankenstein financial creatures, only wanted banks to make sound mortgages with the usual minimum of 20 percent down, good credit scores, and the like. That clearly is nonsense. As Thomas DiLorenzo notes, the only way that banks on their own would have made such risky loans was the fact that federal policies demanded they do so.

One does not need to hold the banks to be innocent bystanders to recognize the role of government policy in the financial crisis. Furthermore, while I have no problem with financial deregulation, I DO have a problem with financial deregulation that is backed by moral hazard. Deregulation was supposed to free financial entities to diversify their loan portfolios and to be able to provide liquid capital to entrepreneurs and businesses that had promising and new ventures.

Furthermore, financial deregulation did make possible the revolution in computers and telecommunications, and had we kept the regulatory system Krugman endorses in place, there would be no Apple Computers, cellphone networks, improved transportation, and IBM would still be the industry leader in the dominant mainframe computer business. Since Keynesians know nothing about entrepreneurship and even less about finance, Krugman probably is incapable of understanding how economies grow, still being stuck in the "aggregate demand" intellectual ghetto.

But financial deregulation only could have worked in the long run had the government made banks and financial houses responsible for their losses. By increasing the various government-led financial backstops as deregulation occurred, Congress almost guaranteed more reckless behavior, and no one should be surprised at what happened.

Unfortunately, these tidbits of truth are left out in Paul Krugman's own zombie version of economic history. That this rewriting of history comes on the editorial pages of the New York Times should shock no one. After all, the "Newspaper of Record" has been fabricating the "record" for a long time.

Yes, Inflation is our Savior

One of Paul Krugman's repeated themes in his columns and blog posts is that inflation is a wonderful thing, and apparently we never can have enough of it. Inflation wipes out debt, transfer wealth from creditors to debtors, and makes all of us feel rich.

Hyperinflation? No problem. It might make things inconvenient for a while, but it really doesn't do any damage. The only damage comes if we stop inflating and even have the dreaded and evil deflation.

In a recent blog post, "It's Always 1923," Krugman once again accuses others of rewriting history. This is rich from the guy who wants us to believe that all of the major deregulatory initiatives of 30+ years ago were the product of Ronald Reagan, despite the fact that many of the major initiatives already had passed or were in the hopper before Reagan even won the 1980 presidential election. (As I have said many times before, Krugman wants us to believe that Jimmy Carter and Ted Kennedy were conservative Republicans.)

While praising a recent piece by David Glasner that praises (What else?) "easy money," Krugman writes about the famous German hyperinflation of 1923:

...the 1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation and depression. Hard money and a gold standard obsession, not excessive money printing, was the proximate disaster.

Technically, he is correct. Hitler came to power nine years after the hyperinflation during the Great Depression (which hit Germany very hard). However, one gets the sense that Krugman does not take that inflation very seriously, and that any policy other than "easy money" will bring an economy to ruin.

That should not surprise anyone, given Krugman's constant drum-beating for more inflation today. While extolling the government's own inflation index, Krugman wants us to believe that only the rich are inconvenienced by inflation, and that the rest of us are better off because of it.

What he does not say is that most middle and lower-economic class Americans have not seen increases in their incomes in years, but the prices they have had to pay for food, gasoline, and other commodity-based goods have gone up substantially. (Of course, Krugman has claimed that THOSE price increases have nothing to do with the massive money-printing operation at the Fed, and that they are due entirely to the fact that commodity prices are "volatile" -- his words.)

Furthermore, he is in a quandary when he praises inflation. If inflation does no economic damage -- other than to supposedly transfer wealth from rich to poor and middle-class people, something that Henry Hazlitt pointed out decades ago is simply not true -- then hyperinflation also would be a good thing. In Wonderland, there is no such thing as inflation distorting structure of production or encouraging lines of production that are unsustainable.

In fact, in Wonderland, inflation does the opposite: it encourages more capital formation and investment in everything, since it supposedly increases "demand," and "aggregate demand" is the key to prosperity. If that be the case, then we have discovered the secret for Haiti to become more prosperous: print money and lots of it.

Keynesians are not free to claim here that Haiti's problems lie elsewhere, since they have debunked any arguments that say capital formation and production structures don't matter. All that matters is demand, so if Haiti's government wants to print "demand," it should do so and then investors will flock to Haiti to build more things, given the "demand" for goods, all courtesy of the printing press.

Hazlitt made a very good analogy when he wrote that inflation is like the "Dead Sea Fruit," which "turns to ashes" when one puts it in one's mouth. I'm not surprised that yet another economics faculty member at Princeton has praised that economic wonderdrug, inflation.

Paul Krugman: The Real Friend of Fraud

One of Paul Krugman's constant themes is that financial regulation, if done by people who properly have been schooled as Democrats, will guard against fraud, and he is at it again in his most recent column. The flip side of that point, of course, is that Republicans want fraud to happen because they are evil and beholden to Wild West Capitalism.

Before I deal with Krugman's own enthusiastic support for outright financial fraud, let me address one point that he claims: Barney Frank had absolutely no influence regarding the collapse of Fannie and Freddie. Krugman writes:

How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.

In reality, this is a nonsense story that has been extensively refuted; I’ve always been struck in particular by the notion that a Congressional Democrat, holding office at a time when Republicans ruled the House with an iron first, somehow had the mystical power to distort our whole banking system. But it’s a story conservatives much prefer to the awkward reality that their faith in the perfection of free markets was proved false.

This is one of those True Krugman Moments when he claims that (1) Frank had absolutely no influence in Congress even though he was the Democrat's Congressional point man on banking and financial matters; (2) the government never attempted to have large sums of money funneled to borrowers in the "sub-prime" category; and (3) the financial system that existed during the housing boom was pure free market without a hint of government intervention anywhere.

(Given Krugman's belief that Democrats are pure of heart and never would engage in financial fraud, I am surprised that he does not go after Jon Corzine, who was responsible for more than a billion dollars in very questionable losses for investors. Oh, I forgot. Corzine was a Democrat politician; he lost the money honestly trying to help his dear clients. And Bernie Madeoff also was a Democrat.)

As that famed right-wing publication, The Boston Globe, declared in a feature on Frank:

When US Representative Barney Frank spoke in a packed hearing room on Capitol Hill seven years ago, he did not imagine that his words would eventually haunt a reelection bid.

The issue that day in 2003 was whether mortgage backers Fannie Mae and Freddie Mac were fiscally strong. Frank declared with his trademark confidence that they were, accusing critics and regulators of exaggerating threats to Fannie’s and Freddie’s financial integrity. And, the Massachusetts Democrat maintained, “even if there were problems, the federal government doesn’t bail them out.’’

Now, it’s clear he was wrong on both points — and that his words have become a political liability as he fights a determined challenger to win a 16th term representing the Fourth Congressional District. Fannie and Freddie collapsed in 2008, forcing the federal government to buy $150 billion worth of stock in the enterprises and $1.36 trillion worth of mortgage-backed securities.

Now, I absolutely agree that Frank did not cause the meltdown nor did he cause the collapse of Fannie and Freddie, but even though his party did not hold a majority in the House of Representatives, nonetheless he did have influence and lots of it. (The influence comes out in the committee action, not the actual vote on the floor.) Furthermore, I do not recall any prominent Democrats during that period calling for lending restrictions on people with bad credit.

The blame for the meltdown is bipartisan, although Krugman will never admit to such. As for the Consumer Protection Bureau which he champions throughout the column, I do not believe that Washington and the Democrats are ready to jettison the very tenets of political liberalism and call for strict lending standards and to shut out people with bad credit from mortgage markets. That really would be a first!

Krugman's enthusiastic support for massive fraud, however, comes in his enthusiastic calls for inflation and lots of it, and inflation is a fraudulent way to repudiate debt (although Krugman has written that such a method is perfectly moral). As I have pointed out before, Krugman has openly agitated for government financial measures such as the Fed purchasing worthless financial instruments in order to jack up their market prices (if a private firm does the same, it is called "manipulation," which is against the law).

The difference is in the sheer numbers. While the meltdown featured head-scratching decisions by banks, nonetheless the actual losses due to the Corzine-Madeoff kind of fraud (where people actually set out to deceive others) were small compared to the over-the-cliff losses that came from lots of people jumping into the housing market because it was hot.

Krugman, like most Keynesians, believes that regulators have excellent foresight and know beforehand what lines of production will be profitable and which will not. (One remembers the Democrats pushing "industrial policy" in the 1980s, a brainchild of Bill Bradley and Gary Hart, both of whom believed that government agencies should target upcoming industries and then subsidize them. We see how well that works with "green energy.")

As Murray Rothbard once put it, if regulators actually had the kind of knowledge Krugman believes they have, then they would be in the markets themselves making lots of money employing their great foresight instead of making paltry government salaries. Instead, we find that regulators mostly will try to block any innovation, since they never will get credit for market successes, but surely will be blamed for market failures.

When it comes to fraud, however, keep in mind that it was the players in the market that realized Madeoff was running a scam, not the regulators. In fact, the lack of insight by regulators actually permitted Madeoff to run his operation longer than it should have gone, as people tended to think that if the regulatory agencies were OK with the guy, then he must be on-the-level.

The kind of fraud I fear, however, is not the fraud of some people being scammed in the financial markets. The greater and more dangerous fraud is that which Krugman heartily endorses: government money printing and the destructive inflation that follows it. Krugman's Inflation Fairy is as dishonest as Bernie Madeoff and much more dangerous.

The Fed and its Role in the Economy: No Conspiracies, Just Bad Policy

In the comment section of my last post, one of my critics identified as JG made a point that I believe truly highlights the differences between Keynesians and the Austrians:

@ Anderson,"The Fed wants to drive money toward those assets by keeping their prices artificially high..."

Is that really what the Fed's goal is? To keep prices high? Do you really believe that QE is really a conspiracy to inflate MBS prices?

Someone less given to conspiracy theories would assume that the Fed was buying MBS to maintain liquidity in the financial system to faciliate lending during a time of weak demand.

True, the commenter was trying to lump me in with conspiracy theorists who seem to believe that the Fed principals conspire to wreck the economy and that they know exactly what they are doing and that is part of their dastardly plan. Now, I would agree that a bad economy in which an increasing number of people become dependent upon the government is good for President Obama in particular and the Democratic Party in general, especially if people come to believe that their state of dependence exists because the government is not taxing others enough or if businesses are conspiring to destroy the economy. We certainly see a lot of that from the Democrat/Keynesian camp, which is not without conspiracy theories of its own.

If I might use somewhat simplistic  models that I believe do reflect the differences in thinking between Keynesians and Austrians, the differences are portrayed as followed:

Keynesians: They believe that a market economy is internally flawed and will hurdle toward underconsumption at every turn. Their underconsumption lynchpin (wild swings in private investment, depending upon the "animal spirits" of investors) differs from that of the Marxists (capitalist profits suck the purchasing power from the proletariat, which leads to internal collapses of capitalist economies), but the results are similar.

For example, the housing boom and bust was a product of a pure, unregulated (by government) market in which none of the government agencies had anything to do with the crisis, except that the animalistic capitalist spirit so infected every regulatory agency that none of the regulatory agents -- even those who had perfect foresight (since most government agents are blessed with such foresight if they are performing under a regime run by the Democratic Party) -- did anything to stop it. The capitalists refused to read any price signals and led the economy into the abyss, as pure, unregulated capitalism always does. Had government agents been properly regulating the directing the housing market, it would have performed perfectly.

The Keynesians believe that capitalists do not respond to price signals (which are overblown, anyway, since an actual economy does not replicate the mathematical models of perfect competition), and that prices are useful mostly in their aggregation into various price indices, which themselves are statistics, not points of economic analysis.On the production side, market economies are prone to slide into the scourge of being overrun by monopolies, which create income inequality when then exacerbates the downward slide even more. Thus, without government oversight, and without the presence of a central bank like the Fed along with various government spending mechanisms, a market economy will implode into a miserable abyss of high unemployment and underconsumption. If there is deflation -- which always looms within a market economy -- then the system automatically will plunge into depression and stay there, since in the real world, entrepreneurs don't respond to price signals, anyway.

The important point here is that the Fed, along with the government agencies, exist in order to respond to private market failures, which the capitalists create on their own, with capitalist failures always being systematic. The Fed and the government, then, do not create conditions that lead to mass unemployment (unless someone at the Fed believes in Austrian theories that will make the central bank raise interest rates and choke off aggregate demand), but rather exists to offset those private market failures.

I believe this has been a fair interpretation of the Keynesian position. I now turn toward the Austrians.

Austrians: They believe that market economies are internally stable, and that government interventions, such as the ones made by the Fed, not only are counterproductive but actually help cause the downturns in the first place. No one is blessed at any time with "perfect information," but a price system actually sends the information that entrepreneurs and managers need to make production and exchange decisions regarding the future. Not all people respond properly to price signals, but the errors tend to be random, not systematic.

Intervention by government is harmful because it creates perverse incentives and directs production away from lines that are sustainable into those lines of production which are not. For example, far from being a free-market failure, the housing boom occurred because government in the form of the Federal Reserve System and the various government agencies that are tied to housing engaged in activities that directed investment and spending toward housing in amounts that could not be sustained. Not only did the Fed push down interest rates that encouraged more home buying and refinancing than what would happen in a normal market (without the intervention), but government agencies especially aimed their programs toward the "sub-prime" market in which were created vast amounts of mortgage securities that sold at prices well beyond what would have been the case had the government not been targeting housing in the first place.

Now, it was Wall Street, with its politically-connected banks and financial houses, that created many of these securities (Freddie and Fannie being the other two entities) but one must remember that these banks did not act within the structure of free markets. Instead, their principals acted knowing that the infamous Greenspan/Bernanke "Put" existed in the background, and that even though the mortgage securities certificates clearly stated that they were not guaranteed by the government, in essence that was a mere formality, for the government stood by to do just that: bail out Wall Street.

The point that Austrians emphasize is that without the government intervention and the promise of bailouts, the banks would have been much more likely to have followed the price signals that the markets were sending and not have marched over the cliff. Government here was not an entity that followed in the wake of private disasters in order to clean up the mess, but rather government was actively taking part in creating the mess in the first place.

As for the post-crisis mess, Austrians believe that since government interventions set the stage for the collapse, doing more of the same will not rescue the economy. In fact, it simply continues the same mistakes that occurred in the first place.

In response to the comment that I see Bernanke's purchases of mortgage securities as some sort of sinister plot to undermine the recovery, that is nonsense. My criticism is not of Bernanke's motives, but rather his actions. He is not "preserving liquidity" or anything like that; instead, he is propping up securities that markets already have rejected and continues to direct resources into lines of production that are unsustainable.

Keynesians counter with the "idle resources" argument that states that in a depressed economy such as ours, there are "idle resources" that are made idle by a lack of aggregate demand. When government resorts to what essentially are financial tricks such as the Fed purchasing securities, it is doing nothing more than engaging in unorthodox actions that are needed at this particular time because of very specific conditions that for the most part don't exist, i.e. the "liquidity trap." Without those actions, the economy will plunge into the abyss of a miserable, high-unemployment steady state in which we will be mired forever.

The Austrian response is that many of the "idle resources" are idle because they were malinvestments. The market does not support them because the patterns of purchasing and preferences shown by consumers do not and cannot keep those resources unemployed. Instead, entrepreneurs guided by price signals and interest rates (that follow a natural rate of interest, not something set by the Fed) will move resources from lower to higher-valued uses.

At the base of the thinking, I believe we can say the following: Keynesians believe that a market is not self-correcting in the event of a downturn, while Austrians believe that it is. There really is no middle ground between the two lines of thinking, which is why we see the kinds of responses we observe on this blog and elsewhere.

Is the Fed Hampering the Recovery?

In his blog post on "Calvinist Monetary Economics," Paul Krugman claims that a recent Wall Street Journal op-ed by John Taylor on why he believes the Fed is hampering the recovery by keeping interest rates low falls into the "Calvinball" category. Writes Krugman:

For those who don’t read the classics, Calvinball is a sport in which you change the rules whenever you feel like it, very much including in the middle of games.

Back then the tight-money types were inventing new and peculiar principles of monetary policy on the fly; it was obvious that they were looking for some reason, any reason, to justify a rise in rates, because, well, because.

Krugman goes on:

Now Taylor is doing the same thing. He claims that he can show that the Fed’s low-rate policy is actually contractionary, using “basic microeconomic analysis”. Actually, as Miles Kimball points out, he’s committing a basic microeconomic fallacy — a fallacy you usually identify with Econ 101 freshmen early in the semester (and as it happens the same fallacy committed by Rajan).

For Taylor argues that low rates engineered by the Fed are just like a price ceiling that reduces the supply of loans, and therefore reduces overall lending.

Wow. No, the Fed’s interest rate target isn’t a price control; there is no legal or other restraint on the rates lenders can charge. The Fed is driving down interest rates, or equivalently driving up the price of bonds, by buying bonds; I can’t think of any kind of economic analysis in which that would reduce the quantity of bonds sellers end up issuing, that is, the amount of borrowing (and lending) in the economy.

 I'll put all of this controversy in the simplest of terms: Keynesian orthodoxy claims that lower interest rates will always have a positive effect upon the economy because the low rates encourage more borrowing, ceteris paribus, even in a so-called liquidity trap. The issue of the "liquidity trap," according to Keynesians, is that other factors are holding back "aggregate demand" so that lowering rates by themselves cannot create enough aggregate demand to lift the economy out of a downturn.

That is where fiscal policy comes in, and that is what Krugman has been saying. Thus, anyone who might claim that attempts by the Fed to push down interest rates might have an opposite effect of what is intended is playing "Calvinball."

The Keynesian approach is pretty straightforward, maybe even crude. All economic activity of an economy, all of the relative prices, all of the relations of production, the products creates, everything, can be put into two functions, aggregate demand and aggregate supply. Push aggregate demand to the right, and as long as the AS curve in not in its steep region, economic growth will occur without too much inflation.

Should the economy be in a "liquidity trap," then the only way to get the AD curve to move to the right is for government to engage in lots and lots of spending. The positive results from the spending then will trickle down to everyone else, provided government spends "enough." However, as Bob Murphy has noted, it seems that Krugman is playing some "Calvinball" of his own:

Here is my observation: Paul Krugman will say that government spending has surged under Obama (and Bernanke has engaged in monetary stimulus) when he wants to blow up right-wingers for their failed predictions, yet referring to the same period of time he will say that government spending has actually been either normal or even contractionary, when explaining why his Keynesian solutions haven’t fixed the economy.

 Certainly, Krugman is not above using the "Heads I win, tails you lose," method of arguing. However, I'd like to address a larger question: Can the Fed's "expansionary policies" actually have a contractionary effect upon the economy?

I'd like to take a different approach than has Taylor and point out that the Fed's purchases of securities of all types -- government, mortgage securities, private assets -- is done in order to keep the asset prices high and send false signals to the markets that these securities are worth more than they really are. (The only word for it is fraud and I should point out that when someone in private business, as opposed to Ben Bernanke, tries to artificially jack up the price of securities, he is likely to be prosecuted.)

The Fed wants to drive money toward those assets by keeping their prices artificially high, and I would argue this has two problems that do hamper the economy:

• First, it prevents the needed liquidation of those assets which cannot be supported by market activity so that investors and entrepreneurs can follow real price signals to see where lines of sustainable investments are located. By throwing in what essentially are false prices, the Fed is making it harder for entrepreneurs to find the suitable production lines;

• Second, the Fed's policies discourage savings (which makes Keynesians very happy, given their vaunted "multiplier" is 1 over the savings rate, so the less we save, the greater the "multiplier"), as real savings provide the liquid capital for long-term investments.

Given Krugman's mechanistic views of the economy and his overt hostility toward economic activity that is not created by government fiat, I doubt what I have said would convince Keynesians of anything. To them, the economy is a simple thing controlled by levers of spending with the Really Smart People in Washington and at Princeton knowing at all times when to "step on the gas" and "when to apply the brakes."

Nonetheless, I also would argue that the Fed is holding back the recovery, even as it acts in the name of "aggregate demand." This isn't "Calvinball." It is economics.

Moral Obligation Fraud

One of the hallmarks of Keynesian "economics" is the view that one does not differentiate between a real and a paper asset. Paper currency is just as valuable as, say, gold coins and a heck of a lot better, since one can more easily reproduce paper money. Likewise, Keynesians are quick to jump on the "print-money" bandwagon as a quick fix for dealing with a real economic crisis, including the demand that governments essentially defraud its citizens.

Paul Krugman has done this whole thing one better as he calls for the Obama administration to engage in financial fraud under the guise of "moral obligation bonds." Yes, this is the same Paul Krugman who in the past has called for criminal investigations for Wall Street executives (except for Jon Corzine, who was a Democrat politician, so it doesn't matter how badly he defrauded his clients), but the amount of financial fraud in Krugman's proposal would dwarf anything that the most dishonest people in the financial markets had done. Indeed, Bernie Madeoff has slain his thousands and Krugman his tens of thousands.

Before I explain why I believe Krugman is demanding financial fraud, let us examine his own words. He writes:

Don’t like the platinum coin option? Here’s a functionally equivalent alternative: have the Treasury sell pieces of paper labeled “moral obligation coupons”, which declare the intention of the government to redeem these coupons at face value in one year.

It should be clearly stated on the coupons that the government has no, repeat no, legal obligation to pay anything at all; you see, they’re not debt, and therefore don’t count against the debt limit. But that shouldn’t keep them from having substantial market value. Consider, for example, the fact that the government has no legal responsibility for guaranteeing the debt of Fannie and Freddie; nonetheless, it is widely believed that there is an implicit guarantee (because there is!), and this is very much reflected in the price of that debt.

One must admit that this is rich, calling a bond upon which the government legally could default a "moral obligation" security. (And don't forget that the government, even if it paid back this loan, would essentially default via the "magic" of inflation.) This from a person who in past columns has marveled that governments in the past actually took financial obligations and financial treaties seriously.

But it gets even better, as Krugman writes:

And maybe the coupons wouldn’t have to be sold on the open market; why not just have the Fed buy them? Bear in mind that the Fed doesn’t always buy safe assets; it’s buying a lot of mortgage-backed securities (from Fannie and Freddie; see above), and during the worst of the financial crisis it bought lots of commercial paper. So why not slightly speculative pieces of paper sold by the Treasury?

 In other words, the Fed can pretend that what essentially are political securities has real value. That is financial fraud, period. People have gone to prison for much less. And lest one think I have misread Krugman, he gives us this gem:

If there is a legal problem even with selling these coupons, there are still alternatives, such as paying suppliers with these coupons and then having the Fed buy them. The mechanics really don’t matter; as long as we’re in a liquidity trap, printing money, printing conventional debt securities, or printing funny money with no legal standing that nonetheless lets the government pay its bills are all equivalent.

 So, instead of facing the hard reality that the government cannot spend at current levels given the ability of the U.S. economy to produce enough tax revenues, Krugman claims that we can fix our problems by having Treasury and the Fed pull more rabbits from their proverbial hats. Call it what you wish, but this is fraud by every legal and moral definition. It also is the hallmark of Keynesian "economics."

Booms and "Trickle-Down" Spending

One of the real differences between Austrian Economics and what is taught in mainstream Neoclassical thought is the view of the individual. Austrians see individuals as acting with a purpose while many Neoclassicals see people as acting in a more mechanistic fashion. What comes out of this is the viewpoint by Neoclassicals that what might be good for individuals runs at cross purposes to what supposedly is "good" for society as a whole.

I don't mean violent or coercive behavior in which one steals from someone else and makes himself better off while making someone else simultaneously worse off. Instead, I am referring to peaceful, private, and mutually-agreed-upon economic exchange or decisions involving my person or my family, which is at the heart of Austrian thinking. Mises wrote that individuals will act in order to make themselves better off, and when that action comes about via mutually-beneficial exchange with others, the action can have positive social benefits.

For example, when I make an exchange at the grocery store, I am purchasing food that I believe will make me better off in the future, both relieving me of hunger and also providing healthy personal benefits. Likewise, the people within the store who are recipients of my money are able to use that to accomplish their own individual purposes. This is not "mindless" behavior, as many Marxist critics of capitalism like to claim; it is purposeful and not based upon coercion.

Now, I agree that this is pretty much Exchange 101 found in many economics texts, including the mainstream ones, but Austrians and the mainstream part ways when it comes to a broader social viewpoint. To put it another way, Austrians believe that individual freedom to trade one's possessions, be they accumulated wealth in the form of money or goods, or one's labor or talents will have positive social and economic effects across an economy, provided that individuals are free to do these things without coercion. It is the non-aggression principle at work.

Keynesians such as Krugman see things differently. What is good for an individual often is not good for the economy at large. In his recent column, Krugman writes:

...an economy is not like a household. A family can decide to spend less and try to earn more. But in the economy as a whole, spending and earning go together: my spending is your income; your spending is my income. If everyone tries to slash spending at the same time, incomes will fall — and unemployment will soar.

 This is something that intuitively sounds right, but is based upon a principle founded upon a belief that mutually-agreeable exchange and individual action that can be harmful economy-wide, and that if a lot of people decide, for example, to save more money, that is what creates unemployment. The Keynesian-Krugman point has been made on many occasions, and I don't believe I am being controversial when I state it.

At one level, if a lot of people suddenly decide to stop spending all of their income and decide to withhold some present income so that they may consume more later, that obviously will have certain effects upon some part of the economy, as there will be less demand for certain kinds of goods and services. That is obvious and non-controversial.

There is, however, a larger issue Krugman and Keynesians ignore, and that is why this change of behavior has occurred. In the Keynesian view, just as Malthus once held, this change is not a rational response to a set of changing economic conditions; instead, it is irrational, "animal spirits" behavior. It just happens. People just stop spending and start saving, and then the whole Fallacy of Composition kicks in and kicks down the economy.

 Austrians note that when booms run their course -- as they invariably do -- and that the current level of activity in certain sectors cannot be sustained through normal exchange, then people are going to adjust their behavior. Furthermore, Austrians are going to point out that booms over time (1) result in wasted or malinvested resources, (2) are financed via borrowed money that sooner or later must be paid back, and (3) create conditions in which there must be a "correction" within the economy as the booms run aground.

Moreover, Austrians also believe that if the government does not interfere with the creation and application of directing resources, then entrepreneurs will look for and find those lines of production that are compatible with current economic conditions. It is those lines of production, then, that will lead a recovery.

Even Krugman will admit that the Housing Bubble could not be sustained, although he is not going to claim resources were "malinvested" if for no other reason than to do so would hand Austrians an important intellectual victory, and that is not something Krugman can countenance. Still, what is a "bubble" if it is not malinvestment or based upon malinvestment? Krugman is not going to claim that the Housing Bubble was infinitely sustainable, and if a set of investments cannot be sustained when other normal market factors expose that fact, then we are dealing with malinvested resources, period, even if he refuses to cite the M-word.

However, we now come to the response to what should be done when the markets have exposed the malinvestments. (I note here that Krugman believes that unless government agents are all over those participating in peaceful, private exchange, markets will run blindly over a cliff, dragging everyone else with them. Yet, it was the markets that exposed the Housing Bubble just as the markets exposed Bernie Madeoff's fraud, not government regulators.)

Krugman's answer is for government to create yet more bubbles and create more malinvestments. Yes, we have the infamous Krugman quote from about a decade ago on the need for Alan Greenspan to create a housing bubble, but I am not talking about that. Instead, Krugman believes that governments should borrow and print and spend in order to fill a "hole" of spending, since money and exchange no longer will be directed toward the part of the economy that collapsed, i.e. housing in this case.

(For example, Krugman has strongly endorsed boondoggles like wind power and mass-subsidized electric cars, yet the fact that these entities continually need subsidies to stay alive speaks volumes for their economic sustainability. These are malinvestments pure and simple, yet Krugman and President Obama wish for us to believe that this economy can fashion an economy recovery from them.)

The Keynesians argue that if there are "unemployed or idle resources," then malinvestments are not possible, since the economy can absorb a lot more spending without overall prices rising. Such reasoning ignores the question of why those resources are "idle" in the first place. Krugman would claim that they are "idle" because people are not spending money, and so government must take the place of everyone else and spend in order to pump up the economy again, creating the "trickle-down" effects that supposedly would boost the economy.

Yet, these resources are idle because earlier investments in them could not be sustained. The markets are telling us something, but Keynesians ignore the obvious, instead demanding that these sectors receive extra injections of government spending.

In effect, Krugman and the Keynesians are claiming that the Law of Scarcity is suspended during severe economic downturns, but unless government starts borrowing and spending in huge amounts, then everyone else will be severely limited by scarcity. Likewise, households are bound by scarcity, but governments are not.

Lest anyone claim that I am misrepresenting Krugman, here he is in his own words:

So what can be done? A smaller financial shock, like the dot-com bust at the end of the 1990s, can be met by cutting interest rates. But the crisis of 2008 was far bigger, and even cutting rates all the way to zero wasn’t nearly enough.

At that point governments needed to step in, spending to support their economies while the private sector regained its balance. And to some extent that did happen: revenue dropped sharply in the slump, but spending actually rose as programs like unemployment insurance expanded and temporary economic stimulus went into effect. Budget deficits rose, but this was actually a good thing, probably the most important reason we didn’t have a full replay of the Great Depression.

But why should the the private sector "regain" its balance? If mutually-beneficial exchange over an economy has harmful effects, and if the natural tendency of a market economy is to implode as people increase their savings, then why should we expect any kind of recovery at all, and why should governments stop their massive spending?

If one sees individual spending as being mechanistic instead of purposeful, then the Keynesian viewpoint might make sense. An economy, in this view, is little more than a perpetual motion machine kept running by spending that moves in a circular flow, with resources being homogeneous.

There is one more point I believe that needs to be made. Krugman claims that our recovery is weaker than it should be because the federal government is not taxing, printing, and borrowing enough, and that if the government were to bolster its spending habits even more -- like preparing for the imaginary invasion of "space aliens" -- then all would be right with the world and we would see a wondrous recovery.

As I see it, we lack a real recovery for a number of reasons, including the government's insistence upon forcing resources from higher-valued to lower-valued uses. ("Green energy" investments are a case in point.) The federal government, and especially the Obama administration, demonstrate hostility toward entrepreneurs who are not connected to the political classes, and the Fed's slashing of interest rates to near-zero not only take away incentives for people to save, but also sends false price signals to the markets, making it harder for entrepreneurs to find truly profitable and sustainable lines of production.

Krugman believes that all that is necessary for recovery is for government to shower money upon politically-favored enterprises, with the spending having a huge "trickle-down" effect on the rest of us. Yes, if resources are purely homogeneous and if individuals do not act purposefully, then Krugman has a point, but if that is not the case, then he is demanding that the government continue the behavior that has put us in a depression in the first place.

There is Plenty of Delusion to Go Around

Paul Krugman writes that the Republican Party is delusional, and who could disagree with him? The USA spends more on "defense" than the rest of the world put together, yet Republicans still are claiming that it is not enough. Moreover, few Republicans left in office are willing to admit that the current rates of spending by the federal government are not sustainable without massive money printing that will turn the dollar into worthless paper.

Unfortunately, the Republicans are not the only party that is defined by delusion, and the number one academic shill for the Democrats -- Krugman himself -- has penned a column that truly is breathtaking its own web of fantasies. But first his attack on the Republicans. Krugman writes:

By all accounts, Republicans have, so far, offered almost no specifics. They claim that they’re willing to raise $800 billion in revenue by closing loopholes, but they refuse to specify which loopholes they would close; they are demanding large cuts in spending, but the specific cuts they have been willing to lay out wouldn’t come close to delivering the savings they demand.

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I have no reason to doubt his claim, although one also has to understand that President Obama and the Democrats have no intention of cutting any spending of their own, so we really do have an example of the worst kind of hypocrisy in which each side's accusations against the other are nothing more than mirrors held up to themselves. In fact, Krugman seems to revel in the huge expansion of the welfare state that has occurred with the Obama presidency.

One would think this to be a problem, given the state of the economy, but Krugman has an answer: We don't need to worry about paying for all of this because we can borrow-and-print our way to prosperity. He writes:

We are not having a debt crisis.

It’s important to make this point, because I keep seeing articles about the “fiscal cliff” that do, in fact, describe it — often in the headline — as a debt crisis. But it isn’t. The U.S. government is having no trouble borrowing to cover its deficit. In fact, its borrowing costs are near historic lows.

Yep. We can just borrow and spend, and if the markets per chance won't readily accept U.S. paper in the future, then the Federal Reserve System can borrow U.S. bonds in the primary market, provided that Krugman's "clever lawyers" can find a way around the Federal Reserve Act that forbids such practices. The financial well is bottomless.

This is delusion, and it is even more delusional than anything we are hearing from Republicans, if that is possible. Yes, Krugman knows that maybe some day in the future, we might have to rein in the spending, but for now, we can pretend we are rich, and if we pretend long enough, we will become rich.

This is nothing more than the MMT nonsense that we have been hearing from James Galbraith and others, that we can take advantage of the fact that the dollar is a reserve currency, so we can print to our heart's content and beyond. It is a free pot of gold.

I don't have to say what nonsense this is. One cannot inflate the dollar forever, and the damage that is being done to the economy right now is such that we will not be able to climb out of this hole at all.
Whether the Republicans are having an "existential crisis," I don't know. However, I do know that if the U.S. Government continues to follow Krugman's advice, an existential crisis will be the least of our worries. Krugman may believe that he is so clever and so brilliant that he can find ways to circumvent the laws of economics, but those laws have a way of asserting themselves in the end.

The Capitalists are Coming! The Capitalists are Coming!

There is a new specter on the horizon, a blood-sucking monster that will destroy the lives of people even as it makes goods that improves their lives! Yes, the capitalists are coming, but Paul Krugman is ever vigilant against these evil ones!

According to Krugman, the evil robber barons have made a comeback, benefiting from monopolies, and it is up to the government to save us -- and make the economy more "efficient" at the same time. He asks how it is that the economy can be depressed even while corporate profits are at high levels. Is the old Marxist "capital versus labor" argument back in play?

Krugman, apparently not wanting to go quite as far as his forebears like John Kenneth Galbraith, says that maybe a different explanation is needed, writing:

Why is this happening? As best as I can tell, there are two plausible explanations, both of which could be true to some extent. One is that technology has taken a turn that places labor at a disadvantage; the other is that we’re looking at the effects of a sharp increase in monopoly power. Think of these two stories as emphasizing robots on one side, robber barons on the other.

First, the attack language is the type of thing that one has come to expect from Krugman whenever he speaks of private enterprise. He cannot explain how it might be that people who cannot coerce anyone into making an exchange are engaging in acts of theft, but if the government forces someone to do something at the point of a gun, that is "community" or "caring for the poor."

Second, his overall explanation of why we have higher rates of unemployment among college-educated workers harkens back to the days of FDR when the government was claiming that "automation" or "capital" was the cause of the employment problems. He continues:

About the robots: there’s no question that in some high-profile industries, technology is displacing workers of all, or almost all, kinds. For example, one of the reasons some high-technology manufacturing has lately been moving back to the United States is that these days the most valuable piece of a computer, the motherboard, is basically made by robots, so cheap Asian labor is no longer a reason to produce them abroad.

In a recent book, “Race Against the Machine,” M.I.T.’s Erik Brynjolfsson and Andrew McAfee argue that similar stories are playing out in many fields, including services like translation and legal research. What’s striking about their examples is that many of the jobs being displaced are high-skill and high-wage; the downside of technology isn’t limited to menial workers.

Still, can innovation and progress really hurt large numbers of workers, maybe even workers in general? I often encounter assertions that this can’t happen. But the truth is that it can, and serious economists have been aware of this possibility for almost two centuries. The early-19th-century economist David Ricardo is best known for the theory of comparative advantage, which makes the case for free trade; but the same 1817 book in which he presented that theory also included a chapter on how the new, capital-intensive technologies of the Industrial Revolution could actually make workers worse off, at least for a while — which modern scholarship suggests may indeed have happened for several decades.

This reminds me of the Paul Craig Roberts's claim that if capital is mobile across international borders, the Law of Opportunity Cost no longer applies (which is a way of saying that mobile capital eliminates the Law of Scarcity). Actually, the actual "law" is the Law of Comparative Advantage, but in truth, comparative advantage is just a restatement and application of opportunity cost.

However, what Krugman does not say is that government regulation -- and especially the spate of regulation that has come about through the Obama administration -- also results in stratification of the workplace. The reason is that regulations tend to try to classify and formalize everything and force requirements of specific areas of formal education for any number of jobs that really should not require that much education.

Furthermore, government regulations tend to make hiring much more bureaucratic and formalized, which makes it more costly to hire workers. Yes, the government says it is trying to keep employers from engaging in certain kinds of discrimination, but the end result is that the regulatory state forces up real costs of production and hiring, and that those costs ultimately are borne by workers.

When one adds the real costs that governments at all levels impose upon people wanting to start up even small businesses, it should not be surprising that the very kinds of laws of which people like Krugman approve are making the entrepreneurial transitions very costly. (Oh, I forgot. When governments effectively mandate higher business costs, that also is a good thing, since higher costs supposedly mean more spending, and everyone knows that more spending brings back recovery.)

There is another problem, and that is that government regulations that pertain to labor also make the addition of capital more attractive than it otherwise might be in a free market. Yes, I know it might be shocking to admit that government regulations just might change the terms of opportunity cost.

But Krugman is not satisfied there. No, the evil capitalists not only are using robots and permanently displacing workers, but they also are engaging in creating monopolies:

What about robber barons? We don’t talk much about monopoly power these days; antitrust enforcement largely collapsed during the Reagan years and has never really recovered. Yet Barry Lynn and Phillip Longman of the New America Foundation argue, persuasively in my view, that increasing business concentration could be an important factor in stagnating demand for labor, as corporations use their growing monopoly power to raise prices without passing the gains on to their employees.

Earth to Krugman: every academic economist should know that wages and salaries are not "passed on" by employers; they are payments to owners of the factor of production known as labor. Second, while economists like Krugman (and, of course, the usual places like the leftist Daily Kos) make the assumption that profits exist at the expense of workers, the truth is that in a free market, profits are what an entrepreneur will earn if he or she makes the correct assumption regarding present prices for factors of production versus perceived future prices for final goods. Without the possibility of profits, those jobs and, more important, the quality of the goods people can purchase, would not exist.

Investor and writer Kel Kelly notes that at the present time, the inflationary policies of the Federal Reserve System have more to do with the present state of corporate profits than any entrepreneurial success of many of these firms. When one adds that the Obama administration actively has promoted what essentially is crony capitalism, or corporatism, we should not be surprised if politically-favored firms tend to do better.

On a larger point, it would seem that high corporate profits would invite more entrepreneurial activity and more competition, but that clearly is not happening. In a free market, there would be nothing out of the ordinary that would would block entrepreneurs and entrepreneurial firms from pursing those opportunities and, in the process, compete for those profits. However, given the overt hostility of the Obama administration to entrepreneurs in general (or at least entrepreneurs that seek to compete in real markets rather than the government's crony markets) and the fact that every year or so, there is a huge political tug-of-war regarding business and individual tax rates, we should not be surprised that there is not more long-term business investment.

Of course, Krugman holds that the best way to deal with this problem is through government coercion and specifically through anti-trust litigation and higher taxes. Now, someone will have to explain to me how we can revitalize the business sector by unleashing regulators, federal prosecutors, and the IRS on business owners and investors, but I guess that since those people drive up costs, we will assume that they will "spend" their largess and make the economy stronger.

Is Government a Bottomless Well of Wealth Creation?

Having essentially adopted the MMT position on "endogenous" monetary creation by the U.S. Government, Paul Krugman goes whole hog in claiming that economies themselves are near-totally dependent upon government spending. To put it another way, government spending (in Krugman's view) is the source of wealth creation.

Now, Krugman does not use terms like "wealth" because, in his view, an economy is a mechanism by which people have jobs, spend money and buy things. Those "things" simply appear on store shelves put there by people who are employed, and as long as people are employed, they will have money to buy those things and clear the shelves so that they can make more things for people to buy in the future.

While macroeconomists might call this the "Circular-Flow" model, I would say it more resembles circular reasoning. As long as people continue to spend, then the model can flow freely, but if people stop spending, then the economy breaks down. So, the argument goes as follows: (1) People quit spending which then causes the economy to slow down, and people then lose their jobs; (2) Why did they quit spending? (3) Because they either lost their jobs or were afraid they would lose their jobs, so they needed to save money.

The reasoning problem here is obvious, but let us move on. When people stop spending, and when the "animal spirits" of investors turn investors from tigers to pussycats, then it is government to the rescue. Government reaches into its own currency well (as in the case of the USA, where its official money is monopolized by the government) and spends (we call it "fiscal policy") until people have jobs again and start spending confidently.

As Krugman and other Keynesians note, this is "counter-cyclical" policy. Government spends a lot when the economy is in the tank and adopts more "austerity" when the economy is doing well.

A lot of Keynesians and fellow-travelers have told me that the real problem is that when times are good, governments still continue free-spending habits. Hey, no joke! When the economy is good, tax takes are higher, and the prospect of more revenue then feeds the spending habits of politicians. Why is this such a surprise?

So the government then is supposed to resort to what essentially are gimmicks, such as "Operation Twist" or QEWhatever, in which the Federal Reserve System purchases assets that the market already has declared worthless in order to try to prop up their prices. The idea is that if the government can prevent prices from adjusting downward (or should I say, correcting downward) the economy won't go bad, since everyone knows that falling prices are not an effect of a downturn, but a cause. (More interesting causal logic from the Keynesians.)

Out of all this comes Krugman's view that government wealth creation is endogenous, that is, economies grow because government spend money. (Because people save money, i.e., don't spend all of their income immediately, Keynesians believe market economies are always in peril of imploding, so the only thing that can keep that from happening is for governments to spend, and that is how economies grow.)

The problem with Krugman's view is that in reality, economies grow when entrepreneurs over a wide scale have the freedom to bring resources from lower-valued uses to higher-valued uses as ultimately determined by consumers. During that process, other resources can be applied to those uses that previously were being neglected.

In the Keynesian view, governments flood the markets with new money (or new spending) and stuff just appears out of thin air. Capital just happens. Investment just happens. All it takes is a new injection of money.

As I read Krugman over and over again, I see that there are three things he clearly does not understand: (1) Opportunity Cost, (2) Capital, and (3) Entrepreneurship. To Krugman, an entrepreneur is someone who makes something in a garage, and his or her actions have little to do with the economy. He already has noted that to him, the real value of capital is the spending required to create it, and anyone who believes governments can create prosperity by printing money does not understand opportunity cost.

So, from where I sit, it seems that Krugman is saying that government endogenously can reignite an entire economy by spending on those things that, frankly, are tied to political connections, such as "green energy," which is nothing more than an industry on federal life supports. Yet, Krugman insists that by draining profitable ventures and redirecting resources into failing industries, the entire economy can be reborn!

Are the Austrians Wrong?

Paul Krugman is at it again with the Austrians, creating straw men and then shooting down the arguments that they never made in the first place. Today, he goes after Peter Schiff, who actually did a very good job warning people about the housing bubble. Of course, in the process of supposedly discrediting Schiff, he discredits himself, too.

Krugman writes:

Now, the thing about Schiff and all the other Austrians predicting runaway inflation is that they were right to make this prediction given their model. If you believe that a recession is caused by a failure on the production side of the economy, the result of past malinvestment or something, you should also believe that any attempt to correct this decline by expanding credit will simply result in too much money chasing too few goods, and hence a lot of inflation.

By the same token, the failure of high inflation to materialize amounts to a decisive rejection of that model. (And no, it’s not because the numbers are fudged; independent estimates don’t differ significantly from official inflation.)

First, I agree that since the increase in the monetary base has come about by expanding bank reserves, the only way the new money will move into the economy will be through a huge expansion of loans, which has not happened. Yes, much of that new money has gone into government bonds, but we have to remember that much of what is raised through government bond auctions is used to pay off previous bonds. (This is something the ancients once called "robbing Peter to pay Paul.") Even Austrians know that the new money has to circulate before it affects asset prices.

However, Krugman misses something that is obvious: The Austrians, including Schiff, recognized the housing bubble for what it was, a huge set of malinvestments. After all, if there are no malinvestments, there is no bubble. So, how could a theory that actually predicted the meltdown also be a bad theory, if we are to use Krugman's criteria for determining if a theory has validity or not.

Second, while we have seen significant price increases in food and fuel, and these increases come in part because of the continual debasing of the dollar. What we have not seen has been hyperinflation and I agree with Krugman that this is because the economy is depressed. No one in the Austrian camp would deny this.

Third, the very fact that we have had massive malinvestments that cannot be supported by the market certainly is going to bring a downward effect on the economy and on prices. Furthermore, with government moving vast amounts of money to prop up the failing housing market, not to mention subsidizing "green energy" and banks, why should we be surprised that there is a huge lack of economic growth?

However, understand that Krugman also has called for government measures that would vastly expand the rate of inflation, that being his call for the Federal Reserve System to be the primary buyer of U.S. short-term securities, something that for now is prohibited by law. (Krugman claimed that a "clever lawyer" could find a way to re-interpret the law, and I am sure he is right, given how the government has re-interpreted other laws to fit the interests of politicians.)

If that were to take place, then there is no doubt we would see massive inflation as the bond sales would be financed almost entirely by new money, which then would be spent by the government. Krugman pretty much said the same thing in his Monday column, claiming that government can just print its way out of this morass without any real consequences, since inflation would "be good for the economy."

There is one thing that troubles me whenever Krugman claims that Austrians are willfully blind because they have not bowed to Krugman's demands that they declare the Austrian Theory of the Business Cycle to be invalid, and it is this: If real increases in government spending, massive Fed purchases of both private and public securities, and vast subsidies given to "green" industries, along with a huge auto industry bailout have not produced a robust recovery, then should not Krugman also take a hard look at his model?

(Yes, yes, I know. Krugman says that the problem is we have not had enough government spending, enough taxation, enough printing, enough borrowing, and, of course, enough inflation. After all, Krugman is a strong believer in the post hoc ergo propter hoc fallacy of inflation and economic growth, and despite historical evidence to the contrary, Krugman is not going to abandon what seems to be his real religion.)

Krugman: Actually PRODUCING a High Standard of Living is a "Zombie" Idea

Like most Keynesians, Paul Krugman has no idea of how societies prosper. In his view, governments borrow, print, and then spend money and out of that comes, like magic, a prosperous economy. If times are hard, then spend even more and, like the Great Pumpkin, prosperity will rise out of the pumpkin patch.

Take his view of what should be done in Europe, for example, and especially for Greece and Spain. As he has written on numerous occasions, instead of facing the fact that the economies of those two nations cannot produce enough wealth in order to support their bloated unionized government workforces and sustain their ridiculous work rules for private employers. Greece and Spain are in trouble not because they are on the euro, but rather because they used the financial and monetary arrangements of the European Union in a way that was not sustainable.

Now, I agree that most "austerity" packages are wrongheaded because the state swallows much of the GDP of the affected nation and then directs that money to the banks (or, as some libertarians call them, "banksters") that foolishly lent money to those nations for things that ultimately went bust, or to pay for simple operating expenses of the various governments. However, there is another aspect of economics and economies that Krugman not only refuses to admit, but belittles it at every turn: societies that consume much also produce much, and that production is the source of their consumption.

To Paul Krugman, such a notion -- that an economy actually has to produce a standard of living -- is a "zombie idea." Every good Keynesian knows that consumption actually creates production, that one consumes first and then produces later. And, no, Keynesian "demand" is NOT the same kind of demand which entrepreneurs anticipate as they try to move resources from lower-valued to higher-valued uses. Keynesian "demand" is nothing more than new money or wealth transfers being directed to politically-connected people who ostensibly will "spend" that money, and out of which is supposed to come general prosperity. Anything to the contrary is nothing more than "Say's Law," which everyone knows has been discredited. (I mean, people really believe that we can have consumption without production? Get real!)

And so, he demands that Congress, the president, and governments at state and local levels ratchet up their spending, and if the economy is not producing enough wealth to pay the taxes necessary to support this blizzard of spending, no worry. Why? The government can manipulate the Federal Reserve Act of 1913 to permit the Fed to purchase U.S. treasuries in the primary market, so if need be, there would be no barriers at all to vast new amounts of spending and if the shower of new money creates an inflationary environment, all the better! Inflation, as Krugman has written, is a great tool for "deleveraging," which in his view would transfer wealth from rich to the poor.

(For those who insist that Krugman is not an apostle of inflation, note that he strongly endorses the views of Mark Thoma, who is a hardcore inflationist. Like so many other Keynesians, Thoma believes that all it takes is for government to inject new money, which will solve problems painlessly and put the economy back on track. The only problem, people like Thoma and Krugman claim, is that governments are too reluctant to aggressively debase their currencies. The "Inflation Fairy" is hard at work.)

So, yes, do you believe that government wealth transfers are a cost and not a boon to the economy? Do you believe that over time, a nation cannot consume more than it produces? Then you, too, are a "zombie." Wear that moniker proudly.