"Deficit Hawk Down," Financial Delusion Up

Yes, readers, I do agree with Paul Krugman when he says that the federal budget deficit is not the central fiscal issue that the U.S. Government and the U.S. economy face today. However (and you KNEW there would be a "however" coming), we disagree for opposing reasons.

In his latest column, Krugman attacks what he calls the "deficit hawks" (thus, the clever title for the column) who he says have always been wrong on the real effects of federal budget deficits:

Mr. Obama’s clearly deliberate neglect of Washington’s favorite obsession was just the latest sign that the self-styled deficit hawks — better described as deficit scolds — are losing their hold over political discourse. And that’s a very good thing. Why have the deficit scolds lost their grip? I’d suggest four interrelated reasons.

His reasons are as follows:

• A true Greece-style meltdown has not happened; therefore, it cannot happen here;
• Deficit spending as a share of GDP supposedly has started to decline, and the "deficit hawks" had predicted a reverse secular trend, i.e. recent deficits have become slightly smaller than previous years;
• Advocates of government "austerity" are wrong because "austerity" did not immediately bring about full economic recovery where it was practiced;
• The anti-deficit agenda really was a not-so-secret attempt by Evil Republicans to impose an unrelated evil political agenda.

 There is what I would call a "fifth reason" that Krugman says is a reason why the deficit hawks should not worry: the deficit is a good thing, not bad:

...it was, in fact, a good thing that the deficit was allowed to rise as the economy slumped. With private spending plunging as the housing bubble popped and cash-strapped families cut back, the willingness of the government to keep spending was one of the main reasons we didn’t experience a full replay of the Great Depression.

Whether or not one believes that the government's bank bailouts and subsequent "stimulus" spending prevented a return to 1933 is not answerable because one would have to prove a negative. What we are supposed to believe, however, is that "trickle-down" economics works when the government is in charge.

What happens? The government gives money or financial credits to politically-connected financial institutions and everyone pretends that the market values of the assets of those institutions are higher than what everyone understands is the case. (If you try to do this in private, the government will charge you with "fraud." However, if it is done by the government, it is called "saving the economy.")

Under outright stimulus, the government directly issues funds to politically-favored groups and the individuals then spend the money with the idea being that the good effects will "trickle down" to the rest of us who do not have the same political connections. Somehow, after we spend what money is left over, the effects will be such that the economy will magically have "traction" and it will move forth on its own.

Moreover, as Krugman argues, since the Fed has managed to push interest rates for U.S. securities to near-zero, then there is almost no opportunity cost for borrowing (and more borrowing). As he declared in a blog post a while back, it is "free money." Because the Fed and the Social Security Administration own the largest single blocs of U.S. debt, we "owe it to ourselves" which apparently means that there are no problems associated with the high debt of the U.S. Government.

What puts the USA in the "catbird's seat" (as opposed to other countries like Greece) is that this country has its own currency, which means that the government essentially can pay its bills with printed money, and since the U.S. Dollar effectively has been the "world currency" for a long time, we can get away with it, while countries like Zimbabwe could not. Unlike Greece, which is on the euro, we can print and devalue forever, and the rest of the world simply has to take it.

The federal deficit is not the problem in and of itself; instead, it is a symptom of a much larger fiscal problem, and that is that the U.S. Government is spending at rates that impose huge burdens on everyone else. In Krugman's Wonderland, government spending always is a net plus, especially when the economy is down.

(Yes, I know that Krugman calls for "austerity" during a boom, but in reality, politicians spend even more if they think the funds are available. Furthermore, I don't recall hearing Krugman call for massive cuts in government spending during the last few years of the Clinton Stock Bubble or during the Bush Housing Bubble.)

Furthermore, in Wonderland, those who are productive are the real "takers," entrepreneurs are irrelevant to a growing economy, the most desired industries are those that receive massive subsidies, and it is the people receiving direct government benefits that are most likely to take the entrepreneurial risks that our economy needs to grow. (Face it, that was the gist of Barack Obama's "Progressive" inauguration speech, and Krugman himself declared that there was "a lot for progressives to like" in that speech.

So, if the government spends enough money, if enough people can receive new benefits that they will spend quickly, if the spending "trickles down" to those not receiving the direct benefits, if the government continues to massively subsidize politically-favored "green energy" firms and "green" research, if the Fed continues to keep interest rates low, if the government continues to print money, if the "Inflation Fairy" does its magic, and if everyone just believes in the Greatness of Barack Obama, we someday will have real prosperity. That is the financial delusion that apparently rules in "elite" academic and political economics these days.

Keynesians: Fight the collapse of the bubbles by creating bigger bubbles

In 2002, Paul Krugman made his infamous statement:

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Krugman, of course, later defended his comments to claim that he did not think such a thing to be desired, but nonetheless the underlying Keynesian principle was there: in order to fight a slump in "aggregate demand," the government must think and act boldly, or, to be more accurate, recklessly.

Indeed, Krugman's fellow Keynesian, Lawrence Summers, has taken this Keynesian principle in the same direction, recently declaring:

The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending. (Emphasis mine)

While Summers is recommending yet another attempt to reflate the housing bubble (in the name of "fixing" the housing market), the larger principle is the same: inflate SOMETHING. However, as I see it, Keynesians such as Krugman and Summers have overlooked the obvious, and that is the sad fact that governments around the world -- and especially the U.S. Government -- have created the Mother of All Bubbles with government paper. Indeed, as I will point out, the government debt bubble that has been created since the housing bubble fell apart about four years ago dwarfs whatever Wall Street produced with its subprime paper, and the U.S. Government and the Federal Reserve System (with Keynesians on the sidelines acting as cheerleaders) are hellbent on "solving" the current bubble-created crisis by unleashing massive inflation.

Before going on, however, I believe I need to point out the obvious: economic "theories" that declare that economies can grow only by the financial system creating phantom assets should be scrutinized and called what they really are: fraudulent. We have to understand that Keynesians now are saying that the financial system and the economy-at-large are at the point where the value of money must be ground down to near-zero in order to maintain our present economic standard of living.

Surely, people should be able to step back and understand just how destructive such beliefs really are, but instead, they are the core of current government policies and they dominate academic economics to the point where dissenters really are being cast into the Outer Darkness Where There Is Weeping And Gnashing Of Teeth. Indeed, in academic economics, the loudest criticism of the Obama administration and the Federal Reserve System has been that it has not inflated enough, that is, make the bubble in government paper even bigger in hopes that all of this finally will give the economy what Krugman calls "traction" and it can move on its own.

Now, Krugman and the others give no explanation as to how this can occur; they simply take it as an article of faith: the economy moves because the economy moves. They respond to dissent with, "No soup for you!"

However, we need to understand that the blizzard of public spending and borrowing now does not reflect the actual performance of the economy (present or future), but rather is just another bubble, this time with government securities. Furthermore, as debt markets go, it is pretty darned unregulated, chock full of moral hazard, and utterly unpayable. As for responsible policy, let us just say that the government policies of the past four years make the Housing Bubble look like the epitome of financial responsibility.

If a bubble means the blowing up of the value of assets well beyond any values as set by their fundamentals, then the government paper bubble easily fits that definition. I say this for the following reasons:

• The amount of debt the government openly admits to having is staggering, almost $15 trillion, and with the government financing about 40 percent of all its present spending via borrowing, we are not dealing with a situation like that of post-World War II, when the national debt as a percentage of Gross Domestic Product was higher than it is now. In other words, while U.S. debt fell rapidly after the war, right now it is growing like mad.

• There is no way the U.S. economy can pay its way out of this debt trap, and all of the "experts" are calling for accompanying inflation to allow the government to slowly repudiate its debt or what Krugman has called "deleveraging." (Krugman holds that inflation is good because it is a form of debt repudiation.)

• The budget numbers do not account for all of the hidden but very real liabilities that government obligations to Freddie and Fannie, Social Security and Medicare, which up those numbers at least another $50 trillion. These are paper obligations, obviously, as the U.S. economy will not perform well enough in any of our lifetimes to be able to meet these numbers. In other words, after a crisis caused in large part by moral hazard, the government has increased the amount of moral hazard in the system. Summers lives!

So, why do I say that we are in a government-paper bubble? After all, financially speaking, U.S. government paper is every bit as toxic as the sub-prime paper that collapsed Lehman and would have collapsed a number of other banks and financial houses. Yet, as Krugman happily points out, the interest rate on government bonds is extremely low, which he then uses to claim that the "market" is bullish on the U.S. Government and specifically the Obama administration.

Now, I find it strange that someone like Krugman who believes that markets usually get things wrong and only can operate properly under rigid state control all of a sudden is claiming that the Fed-manipulated low interest rates on U.S. bonds actually reflects the market view of things. If anything, the high price of U.S. bonds tells us that the rest of the economy, not to mention the troubles of the euro and the European Union, are in the tank even more than the government will admit.

In other words, the market for U.S. Government paper is not popular because of any underlying strength, but because it is perceived as being less awful than the situation in Europe. Krugman, of course, sees things differently. U.S. bonds are strong, he argues, because the government can print its own money, something I covered in this post. He writes:

Think about countries like Britain, Japan and the United States, which have large debts and deficits yet remain able to borrow at low interest rates. What’s their secret? The answer, in large part, is that they retain their own currencies, and investors know that in a pinch they could finance their deficits by printing more of those currencies. If the European Central Bank were to similarly stand behind European debts, the crisis would ease dramatically.

One hopes that Krugman would believe that such a scenario could not go on forever, with the government using "clever lawyers" (in Krugman's words) to have the Fed directly purchase government bonds instead of buying them (as the law states) on the secondary market.

Keynesians seem to believe that this is an optimal solution, if Krugman is representative of that group. Ultimately, the "Krugman Solution" would result in massive inflation, which would be a default by other means.

What we do know is that the massive government debt, be it in the USA or in Europe, cannot be paid back, especially since governments now are borrowing in order to fund their own debt services. This is not sustainable, not at all. And given that the dollar value of the government debt overwhelms anything we saw in the housing market, the future is not pretty.

There was another path we could have taken. We could have let the banks and financial houses that were holding mortgage securities to take the necessary haircuts and even go out of business if they were hopelessly insolvent. Despite what the Keynesians claim, the entire economy would not have collapsed, but I am sure that some CEOs would have lost their Connecticut mansions.

Likewise, instead of trying to find ways to prop up the unsustainable housing market, the government instead should have told the banks and mortgage holders that there would be no Uncle Sugar bailouts, and they would have to negotiate with borrowers instead of expecting the government to stand behind them as they went wily-nily with foreclosures. Yes, I believe there would have been a short and severe recession, but the difference is that we would be in a real recovery now.

Instead, we are in a depression. The economy is stuck at an "official" rate of 9 percent unemployment and probably an unofficial rate that is much higher, and there is no hope of a real and sustainable recovery in the future. Instead of looking to market entrepreneurs and at least getting out of the way of the still-profitable and productive entities in our economy, the Obama administration has decided to fight this downturn with massive subsidies and a vast number of new regulations that is raising the cost of doing business.

In other words, Obama and Krugman actually believe we can have a recovery by directing resources from higher-valued to lower-valued uses. That is not a prescription for bringing the economy back; it is a prescription for dragging down this economy until it reaches Third World status.

Krugman: In denial about spending and borrowing

In reading through Paul Krugman's material through the years, I find that time and again he is in denial both about history and the present state of the U.S. Government. You see, in Krugman's world, whatever Progressivist historians (or, more accurately, distorians) claim about history MUST be true. Why? Because they said so.

Herbert Hoover, despite all evidence to the contrary, was a True Believer in laissez-faire. The New Deal was bringing economic recovery to the nation until the Fed raised interest rates in 1937. World War II brought the USA out of the Great Depression. The regulated banking cartel worked wonderfully but was phased out because of the ideology of free markets, the Republican Party, and Ronald Reagan. (This is despite the fact that much of the banking deregulation of which Krugman speaks took place when Democrats had an overwhelming majority in Congress and Jimmy Carter was in the White House.)

The beat, of course, goes on. We had prosperity during the late 1990s because Bill Clinton got Congress to raise the top income tax rate from 33 percent to 39.6 percent, and that the Fed-sponsored stock market bubble never existed or was irrelevant to the boom. Or, that cutting the top tax rate from 39.6 percent to 35 percent is largely responsible for the current deficits. We now get Krugman's latest rewriting of history: there has not been an increase in government spending since Obama took office. And so on.

As for the current state of affairs, Krugman actually seems to believe that the responsible thing is for the U.S. Government to continue to borrow and spend as though there is no tomorrow (for inflation can repudiate the debt, and, as all followers of Krugman know, inflation is your friend). Now, despite Krugman's utter partisanship, I am not taking the Republican side of things, especially given that it was the Republicans from 2003 to 2007 who jacked up spending, escalated U.S. involvement in military conflicts around the world, and encouraged the financial bubble that brought down the house.

However, when Krugman is claiming that Obama somehow is a "moderate conservative Republican," then I wonder what planet he inhabits. This president has run the largest deficits in history, has unleashed the EPA to throw a slew of new regulations in the middle of a depression, who is demanding that colleges and universities conduct what essentially are kangaroo courts in order to increase sexual assault claims so feminists will be satisfied, and Krugman fails to acknowledge any of this?

The Keynesian party is over, even if Krugman cannot recognize that we cannot spend our way out of an economic crisis. Contrary to what he claims in The Return of Depression Economics, printing money does not create a "free lunch." However, if the government continues to follow the Keynesian directives of borrowing and spending, the "free lunch" soon enough will create enough destruction to ensure that there will be no lunch at all.

Falling Into Economic Illiteracy

During the fall of 2008, a video made its way around the Internet. Some children of Hollywood producers and Democratic activists were put into a small choir, complete with a leader who directed them to sing about how "Obama's gonna save us." The children sang praises like the choirs of Chinese children four decades earlier who had sung praises to Mao, the Great Leader who was portrayed as the very Sun.

The camera panned on the parents who listened with enraptured hearts, and the expressions on their face were of unalloyed joy. The Very Messiah was here, and he was going to spread freedom, happiness, and plenty. All it would take would be a vast expansion of the State and Obama was the One to do it.

Paul Krugman was not in the audience, but he might as well have been, given the tone of his columns that fall. Indeed, even those who decided upon the Nobel Prize were caught up in the Messiah Fever and awarded its highest honor to Obama's Prophet Krugman.

Two years later, there are no choirs singing praise to the Holy One of Chicago, and the economy is in much worse shape than we could have imagined, and all signs on the horizon are bad. What could Obama have done? Paul Krugman knows, and he shares his Prophetic Vision (Oh, lucky us!) in his column today.

Obama, Krugman writes, did not do enough. He did not spend enough, nor regulate enough, or spread Joy and Peace and Happiness. He should have immediately imposed the very medical system that Canadians would like to change. According to Krugman's fellow NY Times columnist, Frank Rich, Obama apparently did not arrest enough people, either, nor throw enough people into prison, to join with the other two-million plus that already are spending time in government cages.

Yes, the state has neither been a great enough Sugar Daddy, nor has the state killed enough people overseas, nor has it been harsh enough to people who don't meet the approval of the editorial board of the "Newspaper of Record." The same newspaper that decries the state of imprisonment in this country claims that our Real Problem is that we don't have enough people in prison. It has come to that. The children sang of Obama "spreading freedom," but apparently (at least at the NY Times) spreading "freedom" means more incarceration of people who don't meet the newspaper's definition of being politically correct.

So, what does Krugman claim is the reason that unemployment is higher than it was when Obama took office? The government did not pretend that it is wallowing in riches and money, and while it boosted spending and debt, it engaged in Krugman's definition of "austerity."

A few commentators will point out, with much more justice, that Mr. Obama never made a full-throated case for progressive policies, that he consistently stepped on his own message, that he was so worried about making bankers nervous that he ended up ceding populist anger to the right.

But the truth is that if the economic situation were better — if unemployment had fallen substantially over the past year — we wouldn’t be having this discussion. We would, instead, be talking about modest Democratic losses, no more than is usual in midterm elections.

The real story of this election, then, is that of an economic policy that failed to deliver. Why? Because it was greatly inadequate to the task.

Krugman, it seems, was the Keeper of the Secret, and he gives us the Answer For Which We Have Waited:

When Mr. Obama took office, he inherited an economy in dire straits — more dire, it seems, than he or his top economic advisers realized. They knew that America was in the midst of a severe financial crisis. But they don’t seem to have taken on board the lesson of history, which is that major financial crises are normally followed by a protracted period of very high unemployment.

If you look back now at the economic forecast originally used to justify the Obama economic plan, what’s striking is that forecast’s optimism about the economy’s ability to heal itself. Even without their plan, Obama economists predicted, the unemployment rate would peak at 9 percent, then fall rapidly. Fiscal stimulus was needed only to mitigate the worst — as an “insurance package against catastrophic failure,” as Lawrence Summers, later the administration’s top economist, reportedly said in a memo to the president-elect.

But economies that have experienced a severe financial crisis generally don’t heal quickly. From the Panic of 1893, to the Swedish crisis of 1992, to Japan’s lost decade, financial crises have consistently been followed by long periods of economic distress. And that has been true even when, as in the case of Sweden, the government moved quickly and decisively to fix the banking system.

To avoid this fate, America needed a much stronger program than what it actually got — a modest rise in federal spending that was barely enough to offset cutbacks at the state and local level. This isn’t 20-20 hindsight: the inadequacy of the stimulus was obvious from the beginning.

One wonders at the ingratitude of Krugman's words. After all, has not the Obama administration done everything in its power to undermine entrepreneurs all the while giving lip service to them? Oh, the administration has found clever ways to offer low interest rates to those firms who Follow In The Way Of Obama instead of doing real entrepreneurship.

Instead of insightful people finding ways to put resources to use that will enable real economic growth to occur, the Obama administration is dunning taxpayers to continue to finance and to expand the Ethanol fraud. Favored firms from those on Wall Street to GM to the producers of "clean energy," the vast subsidy machine rolls on, pushing us further into depression. Yes, 15 percent Ethanol in our gas tanks "is gonna save us." (Given the performance of this administration, I think that the Ethanol would do better as cheap whiskey, which at least would permit us to better drown our sorrows.)

The fundamental issue here is that not one person in this administration, nor its acolytes like Krugman, has a clue as to what makes an economy grow. They really believe that it is little more than a perpetual motion machine, a mixture of homogeneous stuff into which one throws money to make everything work magically.

So, today, instead of singing praises to His Messiah, Paul Krugman is left to rage that Obama didn't listen to him and borrow, print, and spend even more money, further empower labor unions, jack up the minimum wage to a zillion dollars an hour, or give all government employees a big raise. Thus, we see that those most honored in academic economics really have no idea what economics is, a discipline that is based upon the simple Law of Scarcity.

No, Obama refused to pretend that the Law of Scarcity did not exist. And why not? Two years ago, he was the Chosen One, the Holy One of Chicago, the One Who Would Save Us.