Yes, Krugman, Empower the Inflation Fairy

Lest anyone think that Paul Krugman is an economist, his latest column bemoaning the lack of hardcore inflation presents every reason as to why he is a crank, although a famous crank. Yes, the Inflation Fairy has the answer: sprinkle magic dust and watch it turn into money, lots of money. We'll all be rich!

Let us read Krugman in his own words:

...at this point, inflation — at barely above 1 percent by the Fed’s favored measure — is dangerously low.

Why is low inflation a problem? One answer is that it discourages borrowing and spending and encourages sitting on cash. Since our biggest economic problem is an overall lack of demand, falling inflation makes that problem worse.

Low inflation also makes it harder to pay down debt, worsening the private-sector debt troubles that are a main reason overall demand is too low.

But it gets better:

So why is inflation falling? The answer is the economy’s persistent weakness, which keeps workers from bargaining for higher wages and forces many businesses to cut prices. And if you think about it for a minute, you realize that this is a vicious circle, in which a weak economy leads to too-low inflation, which perpetuates the economy’s weakness.

And this brings us to a broader point: the utter folly of not acting to boost the economy, now.

One can surmise that Krugman really believes that if Ben Bernanke were to unload his proverbial helicopter and shower Americans with lots of money to the tune of, say, a million dollars apiece, then the economy would have plenty of demand and everyone would be rich. It would be so easy. Granted, the Inflation Fairy would have a beard and her wings would look like helicopter rotors, but she still could turn magic dust into money.

There is another reason I say Krugman is no economist, and the following statement demonstrates my point:

From the beginning, it was or at least should have been obvious that the financial crisis had plunged us into a “liquidity trap,” a situation in which many people figure that they might just as well sit on cash. America spent most of the 1930s in a liquidity trap; Japan has been in one since the mid-1990s. And we’re in one now.

Economists who had studied such traps — a group that included Ben Bernanke and, well, me — knew that some of the usual rules of economics are in abeyance as long as the trap lasts. Budget deficits, for example, don’t drive up interest rates; printing money isn’t inflationary; slashing government spending has really destructive effects on incomes and employment.

Perhaps the most important "rules" of economics to be "suspended" by a "liquidity trap" is the Law of Opportunity Cost and the Law of Scarcity, or so Krugman would have us believe. Interestingly, he wants us to believe that by the simple act of printing lots of money, government essentially is creating real wealth, as in Krugman's view, governments self-generate wealth.

For all of the Keynesians out there who believe that the real problem is "idle resources" that can be "stimulated" by government doling out lots and lots of new cash, one must remember that after the new money has been farmed out to the economy, people will act, whether they pay down debts or use it to spend on consumption goods.

However, what they want us to believe is that after the Inflation Fairy unloads her magic dust and people have gone on a spending spree, somehow the economy then will magically arise and move forward. All that was needed was some "pump priming"!

But why should that be the case. Why should the act of dumping a lot of new money on people give long-term revival to the economy? How is it that a bunch of new money the first time around would awaken the owners of those "idle resources" but not be needed for round two and beyond? Krugman writes of the economy "gaining traction," but he never explains what it means.

This last point is important, for Krugman and his followers want us to believe that after a massive round of distributing new money (and the new money always goes to those most in need), the prosperity that follows will move into ever-widening circles and spreads employment to the unemployed. In other words, Krugman wants us to believe at least a little bit more inflation will bring hope:

I wrote recently about how, by allowing long-term unemployment to persist, we’re creating a permanent class of unemployed Americans. The problem of too-low inflation is very different in detail, but similar in its implications: here, too, by letting short-run economic problems fester we’re setting ourselves up for a long-run, perhaps permanent, pattern of economic failure.

It has been a long time since an economist was publicly willing to claim that inflation would bring prosperity, give that a lot of us still remember the huge inflation that occurred around 1980, and it was not a wonder drug. (Krugman would argue that we were not in a liquidity trap, so the laws of economics were different.)

But here is the problem: over time, a new bounce in the economy becomes dependent upon yet another round of inflation. At first, inflation seems to be a miracle cure, as no doubt a bunch of new money in the hands of at least some people will make them better off relative to others. They will spend or maybe pay off some debts and be able to purchase things at prices that reflect the time before the surge of new money. (It takes a while for the money to work its way through the economy and finally push up prices, although the process of increasing prices will be uneven.)

But then what? Because it was the inflation that produced the temporary surge in activity, the only way to replicate the economic bounce is to inject another round of new money. This time, the "good" effects are not quite as good and the "bad" effects become a little more pronounced. One can understand what happens as this process is repeated time and again.

When the 1960s began, even though the economy was in a recession, nonetheless times overall were pretty good and inflation was low. As the government began to grow massively during the next decade and the American military venture into Vietnam metastasized, the government, through the Fed, turned to more and more inflation. By 1965, all silver coins were gone (although the government insisted that the new "sandwich" coins were just as valuable as the old silver ones), and by 1971, there was a monetary crisis.

The theme of Krugman's column is that inflation itself can bring prosperity to an economy languishing in a "liquidity trap." I have no doubt that a massive injection of money into the hands of people like me would have a stimulative effect -- at first. As I noted before, this would not be real prosperity, but rather a trap. Unfortunately, Krugman really does believe that inflation -- the debasing of the marginal unit of money -- is the key to a new prosperity.

And it all comes out in three words: not enough inflation. It is better spoken in two words: Inflation Fairy. Or maybe it is better spoken in one word: insanity.

The Federal Deficit is a Symptom, Not a Disease

Member of Congress are infamous for attacking symptoms of a problem instead of going straight to the heart of the disease, and the current "discussion" on the massive federal deficits are yet another case in point. While I do find myself in some agreement with Paul Krugman on the issue of deficits in his most recent column, nonetheless I also find that once again Krugman sets up the straw man argument and falsely portrays himself as a lonely voice of sanity.

I will say it again; the federal budget deficits are symptoms of the larger problem of federal spending and lawmakers and economists should not be fixated upon them while ignoring more important issues. While I agree with Krugman that as the economy improves, deficits will grow smaller, I contend that the Keynesian prescription -- spend like crazy during the recession -- actually has made the economy worse and has prevented a more robust recovery.

Then there are following statements like this that make me scratch my head in disbelief:

What’s really remarkable at this point, however, is the persistence of the deficit fixation in the face of rapidly changing facts. People still talk as if the deficit were exploding, as if the United States budget were on an unsustainable path; in fact, the deficit is falling more rapidly than it has for generations, it is already down to sustainable levels, and it is too small given the state of the economy.

Yes, readers are told simultaneously that (a) the deficit is dwindling because the economy is improving and, (b) the deficit needs to be bigger to help the economy. This is the classic non sequitur in which (a) does not imply (b). His logical chain, I believe, runs as such:

• Deficits should be large if the economy is depressed because extra spending (as long as the revenues come from borrowing or outright money printing or taxes on the "idle hoards" of the rich) boosts the economy, as more deficit spending ultimately will lead to less deficit spending;
• The current federal deficit is dwindling even as government spending increases because the U.S. economy is rapidly improving;
• Therefore, the current U.S. federal deficit is too small.

The idea behind Krugman's thinking here is that the U.S. economy has been mired in a "liquidity trap," a set of circumstances in which individuals as a whole are mired in a perverse Nash Equilibrium in which no one will seek better gains from trade because no one else is willing to do the same. If government does not try to break the logjam with massive new spending (no worry of where to spend, just spend), then the economy will permanently be stuck at a miserable steady-state of high unemployment and low output. Only new government spending can change the circumstances.

Keep in mind that U.S. Government policies before 1929 pretty much adhered to what Krugman says not to do, yet the economy always recovered from downturns. Only from 1929 to 1940 did the government actively intervene, and we call that era the Great Depression, yet today we are told that the New Deal programs actually ended the Depression, which clearly is not true.

Murray Rothbard wrote about the penchant of governments to try to internally bring prosperity by more spending, and he predicted (accurately) that the programs would fail. This section from America's Great Depression is a very poignant commentary on what has been done in the past five years:

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:

1. Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.


2. Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government "easy money" policy prevents the market's return to the necessary higher interest rates.


3. Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.


4. Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.


5. Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by "food stamp plans" and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed. Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.


6. Subsidize unemployment. Any subsidization of unemployment (via unemployment "insurance," relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.

Both the Bush and Obama administrations have done all of these things in spades, yet even now Krugman complains that we need larger budget deficits (although the current shrinking deficit reflects economic improvement). The above suggestions definitely set Keynesians to fits of apoplexy, but they pretty much have summed up what the government did before, and the economy always recovered.

The Keynesian response always is the same: we haven't spent enough money. How much is enough? The Keynesians will let us know when we have reached that point - but we haven't reached it yet.

Krugman is correct; the issue is not finding ways to cut the deficit per se, as much of the deficit is due to the condition of the economy. However, as Rothbard so clearly stated above, the massive government interventions have not helped the economy, but instead have slowed the recovery and have made it much harder for entrepreneurs to find those lines of production that are going to be profitable.

The fixation should not be on balancing the budget, both of us believe. However, we part company when we look at how to deal with the issue at hand.

I would ask this final question: If what Krugman has claimed earlier is true - that the U.S. Government's response to the crisis has essentially been one of "austerity" - then how is the economy growing fast enough to shrink the deficit? Furthermore, let me ask if this quote from Krugman even makes "Keynesian" sense:

“People are exhausting their savings,” he (Krugman) said. “People are running out of hope.”

Isn't the destruction of savings during a recession a key to bringing back prosperity? How can this be a sign of "losing hope" if the actions actually stimulate consumption, and every good Keynesian knows that consumption actually is the form of production that creates real prosperity? Furthermore, are we not supposed to be cheering on the Inflation Fairy as it destroys savings and raises real costs to individuals? Inquiring non-Keynesians really would like to know.

Thornton vs. Krugman on "Austerity"

Paul Krugman is on another "austerity" roll, as witnessed by his most recent column, although his definition of "austerity" seems to be something right out of Wonderland. As I have read Krugman, from what I can tell, he defines "austerity" as a government spending less than it did before an economic downturn began.

Mark Thornton, whose skills as a real economist I respect more than I do Krugman's (since Krugman long ago abandoned economics for political advocacy), sees things differently. In a recent article, Thornton examines the definitions of "austerity," and then takes apart the Keynesian "logic" (an oxymoron, of course):

But what is austerity? Real austerity means that the government and its employees have less money at their disposal. For the economists at the International Monetary Fund, “austerity” may mean spending cuts, but it also means increasing taxes on the beleaguered public in order to, at all costs, repay the government’s corrupt creditors.

In other words, the European style of "austerity" includes both spending cuts (or alleged spending cuts) and raising taxes, which means that while government burdens might be declining somewhat on one side of the ledger, they are increased on the other side in an attempt to prop up the banks that irresponsibly lent large sums of money to corrupt governments like Greece. Thornton continues:

Keynesian economists reject all forms of austerity. They promote the “borrow and spend” approach thatis supposedly scientific and is gentle on the people: paycheck insurance for the unemployed, bailouts for failing businesses, and stimulus packages for everyone else.

I don't believe that is a misrepresentation of either the Keynesians or Krugman, who has argued vociferously that during a downturn, the government must increase its spending and do so in dramatic fashion. (From what I can tell, he is more ambivalent regarding tax increases, at one point advocating expiration of all Bush-era tax rate cuts, including those on lower-income individuals, and elsewhere calling just for more taxes on high-income people. In other words, he tends to blow with the political winds.)

For that matter, Krugman often has claimed that because the Obama administration has not increased spending enough (or at least enough to satisfy Krugman's Keynesian tastes), that it, too, is engaged in "austerity." Defining the term in this manner, as I see it, is tantamount to moving the goalposts, as a Keynesian always can claim that there should have been more spending and borrowing. The government spends an extra $800 billion for stimulus? Not enough! Had it spent just $400 billion more, the recession would have ended!

How do we know this? Krugman says so, and that should be the only "proof" needed to confirm the thesis. The syllogism goes like this:

• The Obama administration pushed through an $800 billion "stimulus" spending package;
• Unemployment actually increased dramatically in the months afterward;
• Therefore, government did not spend and borrow enough money.

Built into the assumptions is the view that a stimulus actually would have a real effect upon the economy, creating economic growth over a longer period of time, as opposed to just making some politically-connected people better off in the short run (while making others worse off, something Keynesians don't want to admit, as they want us to believe that "stimulus" funds consist of new wealth, not transferred wealth).

When one uses such a syllogism, however, as proof that a "stimulus" actually would improve the real economy, then we are witnessing the informal fallacy of Begging the Question. Furthermore, the Keynesians want it both ways, wanting to claim that increased government spending is a response to a downturn, which is caused purely by internal "contradictions" within a market economy, while at the same time claiming that a decrease in government spending can cause a recession. (This is more of the "heads I win, tails you lose" economic propositions that Krugman and his allies like to use when engaging in what they call arguing.)

Thornton sees things differently, writing:

Austrian School economists reject both the Keynesian stimulus approach and the IMF-style high-tax, pro-bankster “Austerian” approach. Although “Austrians” are often lumped in with “Austerians,” Austrian School economists support real austerity. This involves cutting government budgets, salaries, employee benefits, retirement benefits, and taxes. It also involves selling government assets and even repudiating government debt.

Thornton then gives a very interesting example, one that I am sure will drive the Krugmanites batty, as it is totally counterintuitive to their own theories of political history:

One historical example of austerity legislation is the Economy Act of 1933. This legislation, submitted by Franklin Roosevelt six days after his inauguration, slashed government spending, wages, and benefits, including cuts of 50 percent to veterans’ benefits, which at the time constituted a quarter of the federal budget.

The Act helped jump-start the economy. Combined with the repeal of Prohibition it helped reduce unemployment from 25 percent to almost 15 percent. These two pieces of legislation were the real reason for FDR’s popularity. Unfortunately Congress acted on less than half of Roosevelt’s requested cuts and increases in government spending greatly diminished the beneficial impact of FDR’s austerity legislation.

In fact, Thornton argues that it was the later spending and regulation side of the New Deal that prevented a real recovery and turned the 1930s into a lost decade:

Worse still, FDR quickly adopted Hoover’s “New Deal” programs, expanded some, and added new ones. With respect to the Great Depression, Murray Rothbard’s thesis was that Hoover’s and Roosevelt’s “New Deal” prevented the economy from recovering. In an attempt to keep prices and wages high, they both continuously intervened with one program after another. More spending, more regulation, and more resources were withdrawn from the economy, yet nothing worked. Today, mainstream economists Harold Cole and Lee Ohanian have verified the soundness of Rothbard’s thesis.

Thornton then uses the post-World War II period to point out that "austerity" in the form of cutting federal spending did not bring about the predicted postwar depression, but actually had the opposite economic effect:

The proof for real austerity, however, came after World War II ended. All the Keynesian economists warned of a return of the Great Depression. In sharp contrast, the American Austrian School economist Benjamin Anderson predicted that the economy would recover, in a very short period, despite multi-billion dollar budget cuts and millions of government jobs being slashed. What was the verdict on this debate? There was no real Depression of 1946, as the economy recovered very quickly despite the fact that the government was running large budget surpluses.

No doubt, the Keynesians would claim that 1946 did not have "liquidity trap" characteristics, but I see that as just another example of how they "move the goalposts." (We are supposed to believe that there are certain magical conditions in which entrepreneurs are paralyzed and that individuals can find no gains from trade even though the potential for such gains is in abundance if only -- If Only! -- the government would spend more money.)

Austrians have not favored the general European approach in which taxpayers of countries like Greece, Ireland, or Spain are supposed to labor to pay back banks even while banks make new loans to their governments to try to prop up current spending. It is not sustainable, and I suppose that even the Keynesians would agree there.

However, like Thornton, I believe that neither the USA nor the Europeans can rebuild their economies by trying to launch another boom cycle. Such cycles, of course, have a way of ending in yet more busts and resulting in even more long-run government burdens that ordinary people must bear. European "austerity" and Keynesian profligacy are two sides to the same coin: both promote economic destruction.

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.

Is Rejection of the Liquidity Trap Doctrine an Act of Willful Blindness?

A number of posters write that this blog does not engage in any economic analysis, and while I might disagree with that claim, nonetheless this blog is not as analytical as some others, including Bob Murphy's Free Advice and Robert Wenzel's Economic Policy Journal, both of which are excellent blogs and well worth reading. (Both of them take on Paul Krugman and do it quite well. Murphy's latest devastating salvo is found here.)

Instead of going after Krugman's Monday NYT column, instead I want to deal -- using economic analysis -- with a recent Krugman blog post entitled: "Against Willful Denseness, The Gods Themselves Contend In Vain," in which he declares:

From the very beginning of the Lesser Depression, the central principle for understanding macroeconomic policy has been that everything is different when you’re in a liquidity trap. In particular, the whole case for fiscal stimulus and against austerity rests on the proposition that with interest rates up against the zero lower bound, the central bank can neither achieve full employment on its own nor offset the contractionary effect of spending cuts or tax hikes.

This isn’t hard, folks; it’s just Macro 101. Yet a large number of economists — never mind politicians or policy makers — seems to have a very hard time grasping this basic concept.

He adds:

We’re not talking about stupid people here; clearly, there’s something about the notion that the rules for policy depend on the situation that some economists just don’t want to understand.

In other words, Krugman has explained it, so it must be true, and anyone who might disagree with him either is hopelessly ignorant or, frankly, evil. There can be no honest disagreement, since to disagree with Krugman on this point is dishonest.

Understand, I am taking his words and, I believe, interpreting them fairly.This is what I learned in Logic 101 as the "appeal to authority," which here means that since the term "liquidity trap" is taught in macroeconomics, then there can be no argument against it, any more than one is permitted to claim that FDR's New Deal extended the Great Depression or that high tax rates just might squelch capital investment.

Moreover, just because Krugman appeals to the "liquidity trap" does not mean it is a legitimate economic concept. Murray N. Rothbard 50 years ago took on this doctrine and had a number of criticisms, writing:

The ultimate weapon in the Keynesian arsenal of explanations of depressions is the "liquidity trap." This is not precisely a critique of the Mises theory, but it is the last line of Keynesian defense of their own inflationary "cures" for depression. Keynesians claim that "liquidity preference" (demand for money) may be so persistently high that the rate of interest could not fall low enough to stimulate investment sufficiently to raise the economy out of the depression. This statement assumes that the rate of interest is determined by "liquidity preference" instead of by time preference; and it also assumes again that the link between savings and investment is very tenuous indeed, only tentatively exerting itself through the rate of interest. But, on the contrary, it is not a question of saving and investment each being acted upon by the rate of interest; in fact, saving, investment, and the rate of interest are each and all simultaneously determined by individual time preferences on the market. Liquidity preference has nothing to do with this matter.

Furthermore, interest rates are not low because people's time preferences have changed and they are saving more. No, they are low because the Federal Reserve System has pushed them down to artificially-low levels, while at the same time, the Fed is trying to prop up malinvestments not only  here but also across the globe.

I would add the the "liquidity trap" doctrine also is based upon the economic fallacy that government essentially can do away with the Law of Scarcity by pushing down interest rates and by printing money. If one were to ask Krugman how this is possible, he would counter that there are "idle resources" (including lots of unemployed labor) that are sitting fallow because of a "lack of demand."

If one were to continue the questioning with, "What caused the 'lack of demand'?" he would answer, "Because people stopped spending." And if one asked, "Why did people stop spending," he most likely would answer, "Because of the financial crisis."

Yet, what caused the financial crisis? Malinvestments. That's right, malinvestments, those very things that Keynesians claim can be turned profitable with just a little more "stimulus" money, created the crisis in the first place. (Kind of like the housing market, which the government unsuccessfully has tried to reflate since its collapse in 2008.)

Now, that is interesting, given that malinvestment is an Austrian term, and Austrians are not supposed to know anything about economics. The idea behind "stimulus" and ratcheting up spending is that if the government spends enough money on lots of things, somehow those malinvested items will be resurrected and become profitable again. Now, why these things would supernaturally become profitable is another question, but Krugman and the Keynesians seem to believe that as long as the government is throwing money at something, sooner or later it will become a winner. (Krugman's insistence that massive government subsidies of "green energy" some day will magically transform that industry into something genuinely profitable is an example of the wishful thinking that accompanies Keynesianism.)

I also would add that the "liquidity trap" doctrine assumes that even though mutually-beneficial exchanges would be possible, individuals will act irrationally refuse to act on those opportunities. Why? "Because we are in a liquidity trap," and everyone knows that the liquidity trap overturns logic, the Law of Opportunity Cost, and probably the Law of Gravity.

My larger point is that Austrians really do have a basis for disagreeing with the Keynesian viewpoints, and the basis is grounded in logic and fundamental laws of economics. That Krugman interprets this disagreement as nothing more than yahoos wallowing in their willfulness says much more about Krugman than it does the Austrians.

Do economic conditions make opportunity cost disappear?

With the flavor-of-the-week being blaming China for the economic depression this country caused, Paul Krugman is at it again. At least the theme is constant: a "liquidity trap" changes all the "rules" of economics.

This is a nice way of saying that if Paul Krugman believes the economy is in that "liquidity trap," then he gets to say what the "new rules" of economics are, and the first thing to go is that oppressive Law of Opportunity Cost. He writes:

Now, some people will ask, didn’t I used to be a free-trader? Yes, and under normal circumstances I still mostly am. But these are not normal circumstances! In an economy that isn’t in a liquidity trap, one can reasonably assume that jobs lost due to Chinese exports will be offset by jobs gained elsewhere, although that may be small comfort to the workers affected. Under current conditions, however, there is absolutely no reason to believe that there are offsetting gains — on the contrary, the losses to import competition are magnified through multiplier effects.

Like everything in economics, support for free trade should be based on analysis, not slogans. And if you’re in a situation where the analysis says normal rules don’t apply, then they don’t apply.

The idea of "free trade" is nothing more than a rendition of opportunity cost. One's production decisions are based upon the opportunity costs involved, period.

What Krugman is saying is that our situation today repeals the Law of Opportunity Cost and with it the Law of Scarcity. Thus, we are left with the head-scratching notion that goods no longer are scarce, even as people are being deprived.

(I am sure I will have a host of angry readers claiming I am putting words into Krugman's mouth. All I can say is that by debunking the Law of Comparative Advantage, which is based upon the Law of Scarcity and the Law of Opportunity Cost, Krugman is doing away with those things. There is no way around it, even if Krugman's fans don't like it.)

Krugman and Austrians: the depression will get worse

While Austrians and Keynesians don’t agree on a lot of things, there is one thing upon which they both seem to agree: the U.S. economy is sinking into the morass of depression. At that point, however, the agreement ends, as the two schools have very different explanations as to why this is happening.

The Keynesians, through their Paul Krugman and the New York Times megaphone, have been claiming that the original Barack Obama “stimulus” was too little, and the current emphasis upon budget cutting at all levels of government is exactly the wrong strategy. Austrians, not surprisingly, believe that this explanation is nonsense, and dangerous nonsense.

In a recent column, Krugman lays out his thesis, and it is useful, for it truly exposes the Keynesian mind at work, and a Keynesian mind that allows for no other explanations as to what is happening. The problem is – and always will be – a lack of “aggregate demand,” and the only solution is for governments to spend as though they hit the jackpot.

He writes:

The great housing bubble of the last decade, which was both an American and a European phenomenon, was accompanied by a huge rise in household debt. When the bubble burst, home construction plunged, and so did consumer spending as debt-burdened families cut back.

Everything might still have been O.K. if other major economic players had stepped up their spending, filling the gap left by the housing plunge and the consumer pullback. But nobody did. In particular, cash-rich corporations see no reason to invest that cash in the face of weak consumer demand.

Nor did governments do much to help. Some governments — those of weaker nations in Europe, and state and local governments here — were actually forced to slash spending in the face of falling revenues. And the modest efforts of stronger governments — including, yes, the Obama stimulus plan — were, at best, barely enough to offset this forced austerity.

So we have depressed economies. What are policy makers proposing to do about it? Less than nothing.

If anything described the Keynesian mindset, it is this: Spend, spend, spend. It is a simple thesis, one that certainly appeals to politicians, and even to much of the general public, and has dominated professional economic thinking in the USA since World War II. As Krugman has stated above, households cannot spend what they don’t have, and businesses are not going to invest (read that, spend through capital investment – which always is defined by Keynesians as being valuable because of spending, not by aspects of capital productivity) because they don’t see future demand.

So, we are stuck in what Krugman and Keynesians call a “liquidity trap,” which Krugman seems to believe ends all other discussion. (The notion is that the Law of Opportunity Cost is suspended during a “liquidity trap” because interest rates are low, resources are “idle,” and government can borrow at near-zero percent and spend without consuming any resources. As Krugman said in his book, The Return of Depression Economics, government spending in this situation can create a “free lunch.” He actually used that term.)

While most mainstream economists are not willing to engage the Keynesians on the idea of the “liquidity trap,” Murray Rothbard did not back away. In his book, America’s Great Depression, he takes on the whole notion of the “liquidity trap” head on, writing:

The ultimate weapon in the Keynesian arsenal of explanations of depressions is the "liquidity trap." This is not precisely a critique of the Mises theory, but it is the last line of Keynesian defense of their own inflationary "cures" for depression. Keynesians claim that "liquidity preference" (demand for money) may be so persistently high that the rate of interest could not fall low enough to stimulate investment sufficiently to raise the economy out of the depression.

Rothbard points out a serious problem with that analysis, noting that Keynes never got the theory of interest correct, claiming interest is based upon “’liquidity preference’ instead of time preference,” which then leads to more incorrect conclusions about the state of the economy. Other Austrians have criticized the theory, as well, including William Hutt and Henry Hazlitt.

Both Hutt and Hazlitt took on the whole idea of “idle resources,” which is behind the notion that opportunity cost can be suspended during a depression. The idea of “idle resources” is based upon a notion that factors of production are unemployed because of a lack of spending, and that a burst of government borrowing (at near-zero, which means almost no opportunity cost) will spread to these unemployed assets and put them back to work.

As I noted before, the Keynesian theory is disarmingly simple; resources are unemployed, so government “stimulates” the economy through more spending, the resources are put to work, and somehow, the economy magically sustains itself. On the flip side, Keynesians hold that if new spending does not occur, then deflation will result, making more resources unemployed until ultimately the economy is in a perverse equilibrium in which huge numbers of people are out of work with no prospects for economic improvement.

Krugman is adamant about this point and is so convinced of his rightness that anyone who might disagree does so only because that person wants to see people suffer or because that person is so beholden to the “discredited” Austrian theories that he or she is incapable of adding anything to the public debate. (In fact, Krugman believes there is no debate at all. His position is right, is proven empirically, and cannot be refuted – even when it is refuted.)

Thus, even though we have seen an explosion of government spending the past few years, according to Krugman, we really are on an “austerity” plan. Why? It is because if the government actually had increased spending on a massive scale, then we would be out of this depression. In other words, since there is only one way out of this morass, and since we are not out of that morass, there hasn’t been enough government spending.

What about the Robert Higgs thesis of “regime uncertainty”? Krugman dismisses that one, too, derisively calling it the “confidence fairy.” Businesses, he argues, are hoarding cash because they see a lack of consumer demand. If governments spend and spend and spend, then businesses will invest, period.

(As for the anti-business rhetoric pouring out from the White House, the surge in regulation, and the demonizing of the oil and coal industries – which are essential players if this economy is going to recover – all of that, according to Krugman, either is non-existent or just white noise, and it certainly has no relevance to our current situation. Why? Because Krugman says so.)

The ultimate answer, according to Krugman and the Keynesians, is to find yet another boom, another possible asset bubble that can work its “magic” at least for a while before it, too, collapses. (Perversely, in a post endorsed by Krugman, Karl Smith hopes that it will be another housing boom.

In reading Krugman and the Keynesians, I always am struck by their notion that assets, economically speaking, really are homogeneous. It doesn’t matter where new spending is directed, just as long as there is spending. Spend, and everything else falls into place.

Second, the Krugman/Keynesian viewpoint is based on an extremely mechanistic interpretation of human action. People within a market setting do not purchase goods they believe will meet their individual needs; no, they spend, as though the spending itself is the ultimate end of an economy.

This is a view that separates production and consumption, making them independent of one another with no true purposeful human action to be found anywhere. There is no meaningful connection between desires of consumers and the valuation of factors of production or the direction that factors go in the various lines of production. It all is something that simply can be described as Y = C + I + G with no need to think further than that tautology.

As I said at the beginning, both Austrians and Keynesians believe we are headed for a steeper economic downturn, perhaps into the abyss of a major depression. However, Krugman and the Keynesians believe that the only salvation is for massive spending and intervention by government. Austrians believe that it is the massive spending and intervention by government that makes things worse, and while Krugman and Company never will admit otherwise, it ultimately is the Austrian paradigm that explains these matters, and explains them with accuracy.

Gold at $1600? Paul Krugman says it is a nefarious plot by Glenn Beck!

One of Paul Krugman's constant themes is that the U.S. economy is in a liquidity trap and the only way out is for the government to borrow and spend trillions of dollars. (In other words, if we are not prosperous, we spend as though we are, and the debt created through this scheme magically will take care of itself.)

Of course, a liquidity trap also means deflation, as the normal central bank tool of cutting interest rates to stimulate private borrowing cannot work, as interest rates are too low. Thus, the only way out is through massive government spending.

There is a problem with all of this, however, and that is the fact that not only are food and fuel prices rising, but also other commodity prices, including gold, silver and platinum. What's a Keynesian to do?

Well, since Krugman is in that Princeton group with Ben Bernanke and Alan Blinder, all of which utterly disdain gold and believe that anyone who would buy it as an inflation hedge is a "nut case," I was wondering how The Great One would handle the fact that gold prices have skyrocketed.

(As for the rising price of food and fuel, Krugman on many occasions has blamed the rise on "volatility" or demand from other countries. Since he has declared that there can be no inflation in a liquidity trap, the whole matter is settled -- by definition.)

As always, Krugman fails to disappoint. This time we see that the rise in gold prices is the result of a nefarious plot by...Glenn Beck. After quoting at length from The Street Light, which proclaims that gold prices have "nothing to do with the economy," Krugman declares:

Glenn Beck was financially intertwined with Goldline, and therefore had a financial stake in pushing fears of hyperinflation. And he had many, many viewers. So there was a direct channel through which conservative Americans were being pushed into buying gold.

Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.

Here is the problem with Krugman's analysis: if Glenn Beck and his friends are secretly buying gold in order to entice other people to buy it so that the price will go up well past its fundamentals, they are playing a dangerous game with their own money.

Remember the Hunt Brothers in the late 1970s when they tried to corner the world market on silver? In the short run, they drove the price to nearly $50 an ounce before the whole scheme collapsed. The biggest losers were the Hunts, who lost big when silver dropped to about $11 an ounce in two months (after the scheme was exposed), and then were driven into bankruptcy in 1988 after investors filed numerous lawsuits against them.

Now, I am no expert in buying gold or other commodities, but I don't think that Glenn Beck or any other investor is secretly manipulating the price of gold or anything else. Inflation is a real possibility, given the fact that the U.S. Government has been sending dollars around the globe in an attempt to paper over the financial weaknesses both of banks and central banks. Krugman's insistence that debasing the dollar is the key to prosperity does not exactly give me confidence that I should follow his investment advice and buy government bonds.

Against learned economic laws

In a recent column, Paul Krugman rightly calls unemployment a "terrible scourge" across our country and much of Europe. And as usual, Krugman not only misdiagnoses the problem, but he then calls for a "solution" that will make matters worse.

Why are people unemployed? What can be done? Krugman explains:

Bear in mind that the unemployed aren’t jobless because they don’t want to work, or because they lack the necessary skills. There’s nothing wrong with our workers — remember, just four years ago the unemployment rate was below 5 percent.

The core of our economic problem is, instead, the debt — mainly mortgage debt — that households ran up during the bubble years of the last decade. Now that the bubble has burst, that debt is acting as a persistent drag on the economy, preventing any real recovery in employment. And once you realize that the overhang of private debt is the problem, you realize that there are a number of things that could be done about it.

For example, we could have W.P.A.-type programs putting the unemployed to work doing useful things like repairing roads — which would also, by raising incomes, make it easier for households to pay down debt. We could have a serious program of mortgage modification, reducing the debts of troubled homeowners. We could try to get inflation back up to the 4 percent rate that prevailed during Ronald Reagan’s second term, which would help to reduce the real burden of debt.

Krugman is correct that the bursting of the housing bubble unleashed a lot of the problem, but once again he fails to understand the larger and more underlying problems. First, while I doubt that even Krugman would want a return of the housing bubble, he still refuses to see it as an economic "correction," but rather just a temporary bump in the onward march of "aggregate demand." In other words, he refuses to admit that vast amount of resources were malinvested, and that we cannot have a meaningful recovery until most of these malinvestments either have been liquidated or moved to other uses.

Instead, he claims that the government should give us "a serious program of mortgage modification," although he fails to mention that the Obama administration already has thrown billions of dollars into housing, yet the slump continues as it has for the past four years. Maybe his claim would be that the current program is "not serious" or that maybe someone like Krugman should have developed it. As I see it, however, any program that attempts to prop up prices that are going to fall no matter what is not going to be successful.

Second, I would hope that we someday could move beyond the notion that the WPA was a great and wonderful program. As numerous researchers have pointed out, it was politics-ridden and mostly involved make-work jobs that did not move the economy to recovery. Yes, Krugman has claimed that the WPA was pure and absolutely uncorrupted, but the facts speak otherwise, not that Krugman ever would misrepresent history.

Yes, I am sure that turning every unemployed person into a road-crew worker would result in some better roads, although I am not sure from where Krugman believes the resources to finance all of this, other than more borrowed money. (Oh, I forgot. All we have to do is to raise the top rate on all incomes above $250K a year to 39.6 percent from 35 percent, and the economy magically will jump back into shape.)

In the end, he resorts to calling for inflation. After all, he reasons, if inflation was 4 percent during Ronald Reagan's second term, then we should be willing to accept it, as though inflation is a good thing. Yes, I know that Krugman really believes that by inflating the currency and reducing the value of the monetary holdings of most people, government can bring about economic recovery, but once again, we see that he never addresses some of the real issues of unemployment.

Thank goodness, there is Robert Murphy. His recent article on unemployment sheds some light on the subject and is a wonderful antidote to Krugman's latest screed.

Krugman ends with this:

So there are policies we could be pursuing to bring unemployment down. These policies would be unorthodox — but so are the economic problems we face. And those who warn about the risks of action must explain why these risks should worry us more than the certainty of continued mass suffering if we do nothing.

In other words, because the economy is in what Krugman claims is a "liquidity trap," we can dispense with the Law of Opportunity Cost and just pretend we are prosperous by printing and borrowing money and spending as though we were in a time of prosperity. Economics does not work that way.

Are we in a "liquidity trap"?

Paul Krugman insists that at the present time, the economy is in what Keynesians call a "liquidity trap," so the ONLY policy that will set the economy back on a boom track is massive government spending. In my Wednesday column for the Freeman Online, take on that point:

Some economists claim the economy is in a Keynesian liquidity trap, which makes it a special case calling for “unorthodox” policies. Paul Krugman writes:

I know that some people find this hard to understand — perhaps because they don’t want to understand — but people like me have never claimed that fiscal expansion is always and everywhere the right policy, even in response to recession…. All of the unorthodox policy recommendations and conclusions are contingent on the economy being in a liquidity trap, in which short-run nominal interest rates are up against the zero lower bound and can’t go lower.

And liquidity-trap conditions are rare; in fact, they’ve only happened twice in US history. Unfortunately, we’re living in one of those episodes right now.

Well, are we in a liquidity trap? And does the present situation require constant bursts of government spending?

Read the rest of the column

Jobs programs and the stratified society

[Update]:Here is the link to my appearance last night on "Freedom Watch" with Judge Andrew Napolitano. I'm not sure exactly where on the list I am, but I'm in there somewhere. (My thanks to the makeup team at Fox Business News, as they managed to make me look younger than I am!)[End Update]

For years, elites of the academic, media, and political classes have argued that we should be more like Europe, but now that we have managed to create something akin to the European economy -- high rates of unemployment and high job stratification -- Paul Krugman and others don't like it.

Today, he argues that we need more "jobs programs," that young people cannot find work and that the Bad People in Congress aren't interested in spending billions more in "creating" new jobs for people who cannot find work. Now, I don't make light of people who lose their jobs and often lose their homes and face other financial calamities. Furthermore, it is very discouraging for young people who are graduated from college or even graduate school and then find door after door closed to them.

This is what we have seen in Europe for a long time, and I don't think we should be surprised that this country adopts European-style policies, that we get European-style results. I doubt Krugman recognizes this, and even if he did, he still would advocate that the government create what essentially would be "make-work" jobs.

In the past, Krugman has pointed to the "success" of the WPA during the Great Depression, a program that Krugman has claimed was devoid of politics. The truth is much, much different. Some WPA programs (which tended to be run by local Democratic politicians) required that anyone with a WPA job pay donations to the Democratic Party, and nationally, Harry Hopkins, FDR's right-hand-man who ran the program, used it as a way to buy votes for his party.

(William Shughart and James Couch in their book The Political Economy of the New Deal, do a lot of myth busting in this book, and I would tend to trust some people doing real research as opposed to a guy who has become a party shill under the guise of being an academic economist.)

Today, Krugman claims that the government not only should avoid cutting the budget, but should EXPAND this already unsustainable budget because, after all, interest rates are now very low. (Gee, think that the Federal Reserve might have something to do with this?) Thus, we are dealing with near-free money, he reasons:

Yet polls indicate that voters still care much more about jobs than they do about the budget deficit. So it’s quite remarkable that inside the Beltway, it’s just the opposite.

What makes this even more remarkable is the fact that the economic arguments used to justify the D.C. deficit obsession have been repeatedly refuted by experience.

On one side, we’ve been warned, over and over again, that “bond vigilantes” will turn on the U.S. government unless we slash spending immediately. Yet interest rates remain low by historical standards; indeed, they’re lower now than they were in the spring of 2009, when those dire warnings began.

On the other side, we’ve been assured that spending cuts would do wonders for business confidence. But that hasn’t happened in any of the countries currently pursuing harsh austerity programs. Notably, when the Cameron government in Britain announced austerity measures last May, it received fawning praise from U.S. deficit hawks. But British business confidence plunged, and it has not recovered.

Now, the only references I have seen to "bond vigilantes" in recent times have been in Krugman's columns. Second, cutting government spending is only one aspect of getting our economic house in order.

Krugman approaches the subject purely from standard macroeconomic viewpoints. An economy is a homogeneous mass of factors that will become "fully employed" when enough money flows through the system, a "just add money." He has absolutely no idea of what entrepreneurs do, or that they even matter.

The problem, from an Austrian viewpoint, is not that of "idle resources," but instead we have massive amounts of malinvested resources. This country, like other countries in Europe, went whole hog in throwing money into housing at a rate that clearly was unsustainable, and when the crisis finally hit, the government's response was sad, but predictable: it ratcheted up the spending in hopes of propping up the housing market and everything else.

In the end, Krugman really does not believe that there is opportunity cost, or he seems to believe that opportunity cost does not matter when "interest rates are at the zero bound," as though the laws of economics are superseded by high rates of unemployment. The U.S. Government has thrown literally trillions of dollars at this economy and yet we are dead in the water.

It does not have to be like this, but we get the worst of both worlds. We have just enough "spending" to at least give the Keynesians a few bones, but then the government does everything it can to block real entrepreneurs through regulations and tax policies, which means the government is blocking a recovery.

Contra Krugman, contra the "Liquidity Trap" doctrines, the Law of Opportunity Cost is not repealed by low interest rates and high rates of unemployment.

Why No Hyperinflation?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Krugman's Treasure Trove of Shibboleths

Paul Krugman definitely has been busy since the last election, and so have I -- but not in reading Krugman's material as the day job (and some consulting work on the side) have taken front-and-center. Nonetheless, as I read the Nobel Prize winner's blog this morning, I must admit that I have missed a real treasure trove of Krugman's Shibboleths, including a number that he has written himself.

It is hard to know where to begin, but I think I will begin with Krugman's own Shibboleth: inflation. Some years ago, I read a book by someone lambasting the Keynesians in which he said that their only real "arrow in the quiver" was inflation, and I think that Krugman has continued that long tradition. According to Krugman, the only way that an economy can recover from a depression is via inflation, coming in the form either of central bank monetary expansion or increased government spending.

As Krugman has claimed many times, the U.S. economy -- for that matter, all of the world (except for Zimbabwe) -- is mired in a "liquidity trap" in which individuals and businesses are selfishly holding onto their cash and not spending it. Obviously, THAT is intolerable, so the government either must find a way to confiscate it by force (raise taxes, which Krugman has advocated) or via inflation (which Krugman pursues with religious zeal).

Along the way, he attacks Jim Rogers, a person who actually understands capital, unlike Krugman, who seems to believe that capital magically springs from the ground when people start spending. Yes, Krugman wants us to believe that if the government tries to recreate the government-run financial cartel in which external capital markets were scarce (and the system clearly was running into a wall by the mid-70s), and if government showers the economy with newly-printed dollars, blocks Chinese imports, raises taxes, forces taxpayers to pay for high-cost, subsidized "clean energy," and demonizes any business that actually is profitable (except for those businesses getting government subsidies), that the U.S. economy will roar back into a state of real growth and full-employment.

Yes, Krugman definitely identifies himself with the Inflationists, claiming that if government debases the currency -- and that is what inflation really is -- and, thus, depreciating the cash that people have earned, that we will have prosperity. In a world in which all labor and capital are homogeneous, that would be true. However, in a world in which a government-caused boom creates huge malinvestments -- as we saw with the housing boom -- we have to face reality.

According to Krugman, we can keep the original boom alive via spending and more spending. Assets mean nothing; depreciated currency is everything. In the meantime, blame everything on Goldstein: the Chinese and Republicans. And that is what passes for Great Economic Wisdom with modern Progressives.

To use Krugman's own words: Paul Krugman makes my head hurt.

Is There Really a "Keynesian Case"?

Despair overtakes Paul Krugman. It is so bad that he wants "to stick a pencil" in his eye, which not only would hurt a lot, but also just might blind him and make him even more despairing.

Why this deep, dark depression? It seems that pundits do not "understand" the so-called Keynesian Case, that special set of circumstances which, according to all True Believing Keynesians, justifies government spending sprees, printing of money, and borrowing into oblivion. As Krugman writes:

I’ll be frank: the discussion of fiscal stimulus this past year and a half has filled me with despair over the state of the economics profession. If you believe stimulus is a bad idea, fine; but surely the least one could have expected is that opponents would listen, even a bit, to what proponents were saying. In particular, the case for stimulus has always been highly conditional. Fiscal stimulus is what you do only if two conditions are satisfied: high unemployment, so that the proximate risk is deflation, not inflation; and monetary policy constrained by the zero lower bound.

That doesn’t sound like a hard point to grasp. Yet again and again, critics point to examples of increased government spending under conditions nothing like that, and claim that these examples somehow prove something.

In other words, Krugman is demanding that we meet him on what he considers to be HIS ground. He then takes issue with Tyler Cowen's criticism of "fiscal stimulus" when Cowen uses the experience of Germany in the early 1990s:

1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.

2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.

3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.

In short, it’s hard to think of a case less suited to tell us anything at all about fiscal stimulus under the conditions we now face.

While Krugman never is going to admit that one can legitimately criticize his positions, nonetheless I do believe it is instructive to look into this "special Keynesian Case," better known as the "Liquidity Trap." Because I include Krugman's explanation above about this particular set of circumstances, and even though he does not identify it as a "Liquidity Trap," that is what he is describing.

My counter arguments will feature Murray N. Rothbard, who was the best-known Austrian economist of the late 20th Century after F.A. Hayek. In fact, Rothbard deals directly with the "Liquidity Trap" theories both in America's Great Depression and his tome, Man, Economy and State. In America's Great Depression, he has this to say about the "Keynesian Case":

What, then, does an expectation of rising interest rates really mean? It means that people expect increases in the rate of net return on the market, via wages and other producers' goods prices falling faster than do consumer goods' prices. But this needs no labyrinthine explanation; investors expect falling wages and other factor prices, and they are therefore holding off investing in factors until the fall occurs. But this is old-fashioned "classical" speculation on price changes. This expectation, far from being an upsetting element, actually speeds up the adjustment. Just as all speculation speeds up adjustment to the proper levels, so this expectation hastens the fall in wages and other factor prices, hastening the recovery, and permitting normal prosperity to return that much faster. Far from "speculative" hoarding being a bogy of depression, therefore, it is actually a welcome stimulant to more rapid recovery.

Understand that Rothbard and Krugman are arguing from two very different vantage points. Krugman sees deflation as tragic because he believes that it will lead to a downward spiral in which falling factor prices mean lower absolute incomes, and lower incomes mean less aggregate demand, and the beat goes on.

Rothbard, on the other hand, believes that deflation can be positive because it means that the true relative values of the factors are getting into balance, and are shaking off the distortions that occurred during the inflationary booms. Deflation, in Rothbard's view, means that the previous malinvestments are being cleansed from the system, and that a recovery based upon real values of factors can begin.

Obviously, the two cannot be farther apart. Krugman sees everything in aggregates (Y = C + I + G + [X-M]), while Rothbard views the economy as being a complex web of capital, labor, and other factors in which entrepreneurs are moving resources in ways that they anticipate consumers will desire. For good measure, Rothbard also attacks the entire Keynesian concept of "Liquidity Preference," which is a nice way of saying that during deflation, money increases in value relative to other factors, so that people want to hold more money. Rothbard writes:

The final Keynesian bogey is that people may acquire an un­limited demand for money, so that hoards will indefinitely in­crease. This is termed an “infinite” liquidity preference. And this is the only case in which neo-Keynesians such as Modigliani be­lieve that involuntary unemployment can be compatible with price and wage freedom. The Keynesian worry is that people will hoard instead of buying bonds for fear of a fall in the price of securities. Translating this into more important “natural” terms, this would mean, as we have stated, not investing because of expectation of imminent increases in the natural interest rate. Rather than act as a blockade, however, this expectation speeds the ensuing adjustment. Furthermore, the demand for money could not be infinite since people must always continue consum­ing, whatever their expectations. Of necessity, therefore, the de­mand for money could never be infinite. The existing level of consumption, in turn, will require a certain level of investment. As long as productive activities are continuing, there is no need or possibility of lasting unemployment, regardless of the degree of hoarding.

Indeed, Rothbard believes (and so do I) that there really is an alternative explanation for what Krugman calls a "Liquidity Trap," and that further borrowing and spending by government only will exacerbate the current situation. Like Krugman, I tend to despair, but I am fearful because I believe government is spending and borrowing too much, not to little.

Krugman and the "Liquidity Trap"

One thing I appreciate about Paul Krugman's columns is that he clearly explains the Keynesian paradigm, and does it in short space. One of his favorite themes in his promotion of Keynesianism has been the "liquidity trap." Here is what he says about this term:

In my analysis, you’re in a liquidity trap when conventional open-market operations — purchases of short-term government debt by the central bank — have lost traction, because short-term rates are close to zero.

In other words, interest rates are at about zero (or what he calls the "zero-bound,"), which means that typical monetary policy in which the Federal Reserve System increases bank reserves which then can be lent to businesses for capital expansion is ineffective. When that happens, Keynesians then recommend the government follow "fiscal policy," in which the government borrows (or prints money) and spends it directly in the economy as a "stimulus."

Krugman is quite consistent on this point. He goes by the following syllogism:

• Spending drives the economy, and there must be a certain level of spending to keep the economy afloat;
• Private investors are not borrowing enough even though there are lots of bank reserves, which means the economy is in a "liquidity trap";
• Therefore, to boost spending, government must directly spend by borrowing or getting the Federal Reserve System to purchase government bonds directly, which will "stimulate" the economy and allow us to "spend our way out of the" depression.

In a recent post on his NYT blog, Krugman again claims that the rules are different because much of the world is in a "liquidity trap."

However, there is a different approach, as is laid out by Murray N. Rothbard in his classic America's Great Depression. I include Rothbard's description and criticism of the "liquidity trap" in this link. It is quite long, so I don't include the text in this post. However, it is worth reading if you wish to understand that theoretical basis for the current government policies, and a good antidote to them.

Krugman: "Mercantilism Works"

Lest anyone think that my recent post on Krugman channeling Bernard Mandeville was an exaggeration, today, the Nobel Laureate lets himself go in a blog post. In his own words, "Mercantilism works." Read on:

As I’ve written many times in various contexts since the crisis began, being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice: attempts to save more actually make us poorer, in both the short and the long run. Prudence becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the road to disaster. Mercantilism works: countries that subsidize exports and restrict imports actually do gain at their trading partners’ expense. For the moment — or more likely for the next several years — we’re living in a world in which none of what you learned in Econ 101 applies.

I did not make up these things. Krugman is claiming that the very things that Mandeville declared almost 300 years ago all are true.

So, are you cutting back purchases, getting out of debt, and building up your savings? Then you are an Enemy of the People, for you are engaged not only in folly, but folly that is destroying our economy and making us poorer.

Krugman defines the "liquidity trap" (which came from John Maynard Keynes) as such:

In my analysis, you’re in a liquidity trap when conventional open-market operations — purchases of short-term government debt by the central bank — have lost traction, because short-term rates are close to zero.

Now, you may object that there are other things central banks can do, and that they actually do these things to some extent: they can purchase longer-term government securities or other assets, they can try to raise their inflation targets in a credible way. And I very much want the Fed to do more of these things.

But the reality is that unconventional monetary policy is difficult, perceived as risky, and never pursued with the vigor of conventional monetary policy.

It is difficult to point out all of the major fallacies here, as time and space stand in the way, but let me say that anyone who has read Murray Rothbard's America's Great Depression or Henry Hazlitt's classic Economics in One Lesson can see just how badly Krugman misses the mark. In Krugman's world, an economy is not made up of purposeful individuals who engage in mutually-beneficial exchange in order to better themselves.

No, according to Krugman, an economy is a perpetual motion machine, an entity that needs (in Krugman's words) "traction." Just push the thing forward via government spending and -- yes -- inflation, and it will run by itself. However, in the meantime, make sure everyone spends whatever they have, and go into huge debt, if necessary, or the motion machine will stop working.

Krugman claims that the economy is greased by spending, but spending, especially in the Keynesian view, is a much different concept than consumption. Under a spending regime in Keynesian economics, people simply are "buying back the products" that they have produced. In other words, they are clearing the shelves so they can produce more stuff to put on the shelves.

This is not purposeful activity; it is a caricature of an economy and certainly is a caricature of what consumers actually do. People don't spend so they can produce more goods so that they can spend and keep the process going indefinitely.

In this view, there is no particular structure of production. As a professor at the recent Austrian Scholars Conference told me, Keynesianism would hold that it does not matter if the capital improvements at his college involve building new buildings and improving old ones, or if all of the money were spent building a new bell tower that would rival the old Tower of Babel, since the only thing that matters is spending.

The problem is not that consumers are failing to spend enough money. Instead, as the Austrians have pointed out time and again, the problem is that during the past decade, government policies have directed people to create huge amounts of malinvestments that must be liquidated before we can have a recovery. Instead, Krugman and the world's politicians and central bankers are insisting that we just keep going in the same unsustainable direction and somehow the light at the end of the tunnel will be a ray of sunshine instead of the train headed straight at us.