The Fairy Tale of Our Time

Paul Krugman is nothing if not consistent. Once again, we are told that Kenneth Rogoff is the main reason that our economy is not roaring along like boom times, and that massive consumer spending is what fuels an economy, and that by employing the Debt Fairy and the Inflation Fairy, or, more specifically, putting them on steroids, we can lick this thing and have yet another boom.

Writes Krugman:

Families earn what they can, and spend as much as they think prudent; spending and earning opportunities are two different things. In the economy as a whole, however, income and spending are interdependent: my spending is your income, and your spending is my income. If both of us slash spending at the same time, both of our incomes will fall too.

And that’s what happened after the financial crisis of 2008. Many people suddenly cut spending, either because they chose to or because their creditors forced them to; meanwhile, not many people were able or willing to spend more. The result was a plunge in incomes that also caused a plunge in employment, creating the depression that persists to this day.

Why did spending plunge? Mainly because of a burst housing bubble and an overhang of private-sector debt — but if you ask me, people talk too much about what went wrong during the boom years and not enough about what we should be doing now. For no matter how lurid the excesses of the past, there’s no good reason that we should pay for them with year after year of mass unemployment.

Thus, the Twin Fairies should make their grand entrance:

So what could we do to reduce unemployment? The answer is, this is a time for above-normal government spending, to sustain the economy until the private sector is willing to spend again. The crucial point is that under current conditions, the government is not, repeat not, in competition with the private sector. Government spending doesn’t divert resources away from private uses; it puts unemployed resources to work. Government borrowing doesn’t crowd out private investment; it mobilizes funds that would otherwise go unused.

Now, just to be clear, this is not a case for more government spending and larger budget deficits under all circumstances — and the claim that people like me always want bigger deficits is just false. For the economy isn’t always like this — in fact, situations like the one we’re in are fairly rare. By all means let’s try to reduce deficits and bring down government indebtedness once normal conditions return and the economy is no longer depressed. But right now we’re still dealing with the aftermath of a once-in-three-generations financial crisis. This is no time for austerity.

(I can envision the debate in the halls of government around the world in which politicians declare their utter fealty to Ken Rogoff and tremble in fear at the prospect of violating his "90 percent" Rule. Yes, politicians that invariably benefit from spending schemes meant to gain votes are going to tremble in fear lest they disturb The Rogoff.)

Understand that Krugman defines "austerity" as anything short of a massive increase in government spending, with debt and inflation leading the charge, since the economy is not producing enough in order to pay for this spending with taxes. Whatever increases in spending that have come from the Obama administration, they are not enough, not nearly enough.

In Krugman's view, money coming from the sources of borrowing and creating new money is a near-perfect substitute for real wealth, as money borrowed at low interest rates essentially is "free" money and more spending will bring about more capital investment, although Krugman has made it clear elsewhere that capital investment is pretty much irrelevant in the scheme of things, except for the spending that comes with that investment.

Krugman also seems to believe that money borrowed essentially for consumption purposes really is no different than money borrowed for private capital investment. (J.M. Keynes in The General Theory surmised that changes in investment spending were what caused ups and downs of the business cycle, and those changes centered around the "animal spirits" of investors.) In the end, it is the spending and only the spending that matters.

Furthermore, as Krugman wrote last week, the real villains behind supposed austerity are the wealthy "one percent" who benefit from others being out of work. He continues today with that theme:

Is the story really that simple, and would it really be that easy to end the scourge of unemployment? Yes — but powerful people don’t want to believe it. Some of them have a visceral sense that suffering is good, that we must pay a price for past sins (even if the sinners then and the sufferers now are very different groups of people). Some of them see the crisis as an opportunity to dismantle the social safety net.

There really is no way to bridge the intellectual gap between Austrians and Keynesians. In the Keynesian view, the "social safety net," massive subsidies for "green energy," and other instances of government spending are the economic equals of private investment. Perhaps Obama said it best when he announced he was delaying action on the Keystone Pipeline and declared that an increase in unemployment benefits actually would be economically superior to investment in an oil pipeline, since new benefits (which would be financed by new borrowing) would fuel immediate consumer spending, as opposed to the spending that would accompany creation of Keystone.

(This is not an endorsement of the pipeline itself. Instead, I am demonstrating how Keynesians and fellow travelers like Obama see an entire economy in terms of nothing but current spending.)

In contrast to the Keynesian position, Bill McNabb of the Vanguard Group writes that what Robert Higgs has called "regime uncertainty" is behind the dearth of private capital investment:

Companies and small businesses are also dealing with the same paradox. Many are in good shape and have money to spend. So why aren't they pumping more capital back into the economy, creating jobs and fueling the country's economic engine?

Quite simply, if firms can't see a clear road to economic recovery ahead, they're not going to hire and they're not going to spend. It's what economists call a "deadweight loss"—loss caused by inefficiency.

Today, there is uncertainty about regulatory policy, uncertainty about monetary policy, uncertainty about foreign policy and, most significantly, uncertainty about U.S. fiscal policy and the national debt. Until a sensible plan is created to address the debt, America will not fulfill its economic potential.

Yes, Krugman derides such thinking as the "Confidence Fairy," but Krugman and the Keynesians want us to believe that as long as government borrows and spends, business investors are going to ignore the heated anti-enterprise rhetoric from the administration, and are not going to be affected at all by hostile regulators from the EPA and Department of Labor, and the new burdens of ObamaCare, not to mention all of the new taxes that Obama is demanding as part of any budget deal. Keynesians can speak all they want about businesses simply waiting for people to spend, but if they believe that the president wants to impose new policies that will negate any future profits, they are not going to invest at all.

As I see it, the biggest fairy tale of all is that government can bring back prosperity by borrowing, printing and spending and substituting Crony Capitalism for the real thing. There is a reason this economy wallows in depression, and empowering the Twin Fairies and a president who believes private enterprise is evil will magically turn around our fortunes. It is more likely that a poor maid can spin straw into gold.

Krugman and Regime Uncertainty

In a recent blog post, Paul Krugman has labeled what Robert Higgs has called "Regime Uncertainty" nothing less than a "scam." Now, when speaking of research by another economist, especially an economist like Higgs who has developed a good reputation over the years, "scam" is a fighting word, so one would think that Krugman would do more than just write another partisan screed, especially since he is a decorated academic economist.

Think again. As usual, Krugman writes a partisan screed complete with Krugman logic (an oxymoron):

Premise#1: "Regime Uncertainty" has no effect, since business investors only want to know if the economy will be strong before they invest;

Premise #2: Everyone knows that if the government spends a lot of money via printing and borrowing, the economy automatically will be strong;

Conclusion: Since Republicans have not supported everything President Obama has done, they are responsible for creating "uncertainty," even though "uncertainty" really has no effect. But we should blame Republicans, anyway, because they don't support Obama's Jobs Act, which everyone knows would bring back prosperity because Krugman says so.

So, there it is.

The Inflation Fairy

One of the most repeated themes in Paul Krugman's columns has been the ridicule of what he calls "The Confidence Fairy," which is in reference to Robert Higgs's theory that says "regime uncertainty" has a real effect upon present economic growth. However, because Krugman has no conception of capital investment (other than it brings spending) and does not have any understanding of the difference between the long and short run, he is intellectually ill-equipped to refute the Higgs thesis.

I bring this up because Krugman's latest column is more of the same: inflation and massive borrowing will solve all of our economic ills, and anything else is just something out of fairy tales. Now, I realize that Krugman is working with the Obama campaign to write columns critical of Mitt Romney, and part of his ridicule is of Romney's recent statements about market confidence; in other words, his primary goal is to attack Romney, not to increase public economic knowledge. However, he does bring up his whole "Confidence Fairy" line, and I think it is worth a look. He writes:

Back in 2010, as European nations began implementing savage austerity programs to placate bond markets, it was common for policy makers to deny that these programs would have a depressing effect. “The idea that austerity measures could trigger stagnation is incorrect,” insisted Jean-Claude Trichet, then the president of the European Central Bank. Why? Because these measures would “increase the confidence of households, firms and investors.”

At the time I ridiculed such claims as belief in the “confidence fairy.” And sure enough, austerity programs actually led to Depression-level economic downturns across much of Europe.

Yet here comes Mitt Romney, declaring, in effect, “I am the confidence fairy!”

 Where I agree with Krugman is that confidence, and especially any "confidence" that Romney could bring to the table, is a relative thing. Just because a supposed "pro-business" president is in the White House is not going to resurrect long-term capital investment and provide a lift for private enterprise. Business investors would have to see that there not only is a strong possibility of return on their investments, some of which may take years to come to fruition, but that there will not be the kind of "regime change" in Washington that either would forcibly confiscate those returns or change the rules of the game to where that original investment now becomes worthless. Robert Higgs says:

"Regime uncertainty" is the name I give to widespread fears that the nature of the economic order will be changed. This has to do mainly with fear that private-property rights will be altered for the worse by higher taxes, more costly regulation, more hostile treatment by government functionaries of all kinds, and perhaps outright confiscation of private property. When investors feel regime uncertainty, they are reluctant to make long-term investments, because they fear that they will be unable to receive the income those investments will generate and may even lose the capital itself. Between 1935 and 1940, many US investors feared that the market-oriented US economy was being transformed into fascism, socialism, or some other system dominated by the government.

I certainly believe that President Obama has firmly placed himself into the "Crony Capitalism" camp in which his government will subsidize and protect those business firms that are loyal to his administration, but will use tax laws, regulations, and verbal (and legal) bullying against anyone else who does not recognize the Greatness of Obama. Whether or not Mitt Romney can end such an order is an empirical question, although I don't think I would be willing to take a bet that he would.

Yet, Krugman does not even address that point. No, what Krugman claims will create confidence in the economy is inflation, which is why I call his "plan" to end the depression one that is based upon the Inflation Fairy. The claim by Krugman and his supporters is that should the Federal Reserve System link its efforts with the U.S. Government to directly inject new money via government spending, the new money magically will flow only to those industries that are depressed and bypass those areas of production that currently are producing at higher capacities.

I'm not sure how this is possible, but Krugman believes that the Inflation Fairy will be able to pull it off. You see, when the Inflation Fairy is at work, there never is any dislocation within price systems, as all factors automatically adjust perfectly to the changing conditions. Moreover, whenever business investors realize that inflation is on the horizon, they automatically will produce more goods and engage in capital investment because inflation always equals more aggregate demand, and aggregate demand means that everyone wants to buy everything.

When the Obama administration demands that capital gains tax rates be raised to the highest levels in four decades, the Inflation Fairy will ensure that such calls for widespread confiscation of property will have absolutely no effect upon business investment. Furthermore, if greedy private investors are put off by the fact that government is going to take nearly all of their economic profits, then the Inflation Fairy will ensure that government spending will take up the slack and employ everyone in meaningful jobs with high pay.

And so on. I marvel that Krugman continues either to create caricatures of the Higgs assertion of "Regime Uncertainty" while making wild claims about the Wonders and Greatness of the Inflation Fairy. The problem with Paul Krugman is not that he has become a partisan shill who coordinates his columns with the Obama presidential campaign.

No, the problem is that Krugman wants us to believe that when depression conditions occur, the Law of Scarcity and the Law of Opportunity Cost become irrelevant. Economics is based upon those two things, and when one declares they no longer are relevant, one no longer is an economist. In short, Paul Krugman tells us that government under the correct people (read that left-wing Democrats) can magically make scarcity and opportunity cost disappear.

Why? The Inflation Fairy says so.

Krugman: Not enough economic destruction

There are times when Paul Krugman is merely outrageous, and then there are times when he really lets himself go, and today's column reflects the latter. In one fell swoop, Krugman exposes his ignorance on money, on investment, and on economics itself.

I'll go further. Krugman is not advocating a real economic recovery; instead, he is demanding that the Federal Reserve System and Ben Bernanke take the kind of action that will be utterly destructive and thus guarantee that in order to have a real economic recovery, people in the United States are going to have to suffer the kind of pain that would not have been necessary had we done the right thing four years ago and, for that matter, 11 years ago.

The theme of Krugman's column is explained by his title, "Not enough inflation." In other words, we don't need less destruction of the dollar; we need more, and make no mistake about it, inflation is the destruction of the value of money.

As Steve Horowitz pointed out in my recent post, Keynesians like Krugman cannot differentiate between factors of production and consumer goods, nor can they differentiate among capital and other factors. For that matter, Krugman cannot even explain what real investment is. Take the following from his column:

How so? For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recovery. (Emphasis mine)

This simply is an outrage; no other word will do. What Krugman is saying is that inflation would create incentives to invest, which is something that no real economist would say. As Robert Higgs has noted here, and here, the economy is lacking the kind of long-term investment that is needed for real recovery, and inflation will NOT bring that about.

In fact, inflation would have the opposite effect, as it would create even more regime uncertainty and would force people to put it into things where the value of money can be sheltered, and that would NOT be the kind of long-term investment that requires both confidence and low interest rates and, yes, low or no inflation. As one can see in this column, such investment is not even on Krugman's radar screen; after all, to a Keynesian, the real value of investment is the short-term spending that takes place and little or nothing else.

Once again, we also see the "Goldstein" analogy that Krugman is fond of giving. Yeah, if it were not for those evil right-wingers, we would have lots of inflation and lots of prosperity. What Krugman does not say is that the kinds of "investments" promoted by inflation are not sustainable because they are malinvestments. That is the hard truth, even if Krugman denies it.

One of Krugman's constant revisionist themes is that the 1970s were a golden age of investment and economic growth. He can throw all the charts he wants, but we had two serious recessions, double-digit inflation, price controls, and a lot of economic chaos. Yes, since Krugman and I were in college at the same time, both of us remember what it was like, and people were not spinning the happy tales that Krugman wants us to believe.

If Krugman is successful in encouraging Ben Bernanke to unleash the wolves of inflation, the result is not going to be one with a happy ending. The economy still will be moribund, there will be lots of unemployment, and people will have to deal with higher real prices, which means they will become poorer with no hope in sight. True, Krugman believes that somehow the Fed can "manage" inflation rates of 4-6 percent quite easily, but as F.A. Hayek once noted, inflation creates a "tiger by the tail" situation, and it does not take long for the situation to get out of hand.

And when and if it does, then look for Krugman and his acolytes to call for price controls, capital controls, and all other modes of coercion, as though the state can coerce an economy into prosperity. Don't kid yourselves about what Krugman is demanding; he is calling for economic destruction in the name of promoting economic recovery. We cannot have both.

Higgs vs. Krugman

I feature a wonderful 2009 piece by Robert Higgs (I had a link to it last year) that I think really shows the differences between the Austrians and what Higgs calls the "Vulgar Keynesians," including Paul Krugman.

Higgs lays out six areas where the Keynesians especially are weak, including:

• Aggregation: Keynesians believe that they can explain an entire economy through aggregate demand, aggregate supply, price levels, and the rate of interest;
• Relative prices: The only thing that means anything regarding prices to Keynesians is the overall "price level. Higgs writes: "If relative prices change, which of course they always do to some extent, even in the most stable periods, these changes are "averaged out" and affect the calculated change, if any, in the aggregate price level only in a shrouded and analytically irrelevant manner."
  
• The rate of interest: Higgs points out that the rate of interest "is a crucial relative price — namely, the price of goods available now relative to goods available in the future." Keynesians, on the other hand, believe it is just a "price of money," so the lower the price, the better;
• Capital and its structure: In the short run, notes Higgs, Keynesians view capital as being homogeneous, with its only real value being the money spent in creating it. Furthermore, Keynesians see capital stock as a "given" and cannot conceive of malinvested capital, believing that capital that is not in use only is "idle," and can be revived with enough spending;
• Malinvestments and money pumping: Because Keynesians don't believe that massive malinvestments have anything to do with an economic downturn, their "solution" of pumping more money into the economy cannot have any other result except success -- provided government pumps enough money. Higgs writes that Keynesians also seem to have an abiding faith in the healing powers of inflation;
• Regime uncertainty: What Krugman calls the "Confidence Fairy," Higgs notes that the political atmosphere does make a difference regarding investment and especially long-term capital investment. He writes: "The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty," a pervasive uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future. This kind of uncertainty especially discourages investors from putting money into long-term projects."

While I am sure that Higgs' points will enrage the Keynesians, nonetheless it is clear that Higgs is writing about economics, not statistical aggregates. There really is a difference.

Keynes was and always will be wrong

Here we go again. Paul Krugman not only attacks the Law of Cause and Effect (substituting Effect for Cause), but also manages to fracture history a bit. However, given that he has claimed that Ronald Reagan was the architect of business and financial deregulation -- thus confusing Reagan with Jimmy Carter and Ted Kennedy -- it is safe to say that Krugman is not a particularly good economic historian.

Apparently, Krugman believes that governments are not running large enough deficits and are not spending enough money, although much of the spending he is demanding comes from accumulation of massive debt (which Krugman believes later can happily be inflated away). In his own words:

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Governments around the world, claims Krugman, could have had us in recovery had they just borrowed and spent enough. Of course, the massive borrowing ONLY could have been financed by central banks, and especially the Federal Reserve System, and the only way such a scheme could have been hatched was the central banks creating "money" from thin air. In other words, Krugman is excoriating governments for not getting their finance arms -- central banks -- to print enough money, as though printing money is the key to economic success.

(If that were true, then the USA should not prosecute counterfeiters but actually encourage them. Maybe Krugman can write a future column on why counterfeiters are an economic blessing and why every household should have its own money printing press.)

Thus, if one is to understand Krugman, the European Central Bank and the Fed should be lending billions of dollars to Greece not so that Greece can use the money to pay its previous debts, but rather to spend itself into prosperity, with the idea that a future Greek economy -- yes, that economy that features bloated government unions and low productivity -- will produce so much wealth that it can pay back the debts or, better still, have the central banks just write off the debt because, after all, it was just funny money in the first place.

However, let us get back to Krugman's Fractured Fairy Tales. According to Krugman, Franklin D. Roosevelt's New Deal government slashed spending after 1936 and THAT was the cause of the recession of 1938 in which the rate of unemployment went to nearly 20 percent, a recession within a depression.

In looking at the numbers from that time, however, I must admit to a very nagging question. Indeed, the federal deficit fell during that time and unemployment rose. However, earlier in that decade, deficits rose and so did unemployment, so to claim that falling deficits would create unemployment is to ignore the earlier record.

It also is true that in that time period, taxes rose and government spending fell, although I remember a year ago Krugman calling for the end of ALL of the "Bush tax cuts," which would have significantly increased the tax bill not only for the wealthiest of American taxpayers, but also for people in lower income groups. Krugman said that if he were president, he would let ALL of the cuts expire and then spend the extra revenue, his words, not mine.

Government spending as a percentage of Gross Domestic Product fell from 10.5 percent in 1936 to 7.7 percent in 1938, and I find it hard to believe that a decrease of less than three percent would be the sole cause of this massive slide back into high unemployment.

You see, Krugman ignores other developments during that time, developments which Robert Higgs chronicled in his paper on the New Deal. Higgs notes that FDR was becoming increasingly shrill in his anti-business rhetoric at this time, and federal legislation aimed at crippling business investment came forth in the latter parts of the 1930s.

Since Krugman seems to believe that federal legislation raising business costs and hostile rhetoric from Congress and the executive branch have nothing to do with business investment (he calls all of this the "Confidence Fairy"), what happened outside of government spending in the late 1930s is completely irrelevant. Yet, as Higgs adptly showed in his paper, that clearly was not the case, and he cites a number of historians to back up his claims.

While I am sure that True Believers would claim the Higgs paper is nonsense, others who actually believe that economic success depends upon wealth that is created, not the amount of money printed, are going to see things differently. Government spending is a very poor substitute for sustainable business investment, and businesses are not going to do long-term investment and capitalization while a hostile government that threatens to confiscate their earnings and dumps trainloads of new and costly regulations on them is in power.

We should not forget that Barack Obama never has had to meet a payroll and never has worked in anything but settings in which at very best, business enterprises existed in order to give campaign contributions to politicians. This is a president who has no idea how an economy works, how entrepreneurs create wealth, and what is needed to bring the economy back from this depression.

Unfortunately, his most influential critic is someone who actually believes that money-printing and government-spending schemes are going to overcome everything else and create prosperity and full employment. Or, to paraphrase the book of I Kings, if Obama wants to bring about economic recovery, he should not chastise us with whips, but rather with scorpions.

Now, if government would concentrate on the weather, we would have no more hurricanes....

With the latest employment numbers looking bleak, the Usual Suspects are out in droves explaining why after spending trillions of dollars, the economy continues to sink. Leading the way is Paul Krugman, who insists that this continuing downturn exists because the government has been “concentrating” on the wrong thing: budget deficits.

Krugman writes:

I don’t mean to dismiss concerns about the long-run U.S. budget picture. If you look at fiscal prospects over, say, the next 20 years, they are indeed deeply worrying, largely because of rising health-care costs. But the experience of the past two years has overwhelmingly confirmed what some of us tried to argue from the beginning: The deficits we’re running right now — deficits we should be running, because deficit spending helps support a depressed economy — are no threat at all.

And by obsessing over a nonexistent threat, Washington has been making the real problem — mass unemployment, which is eating away at the foundations of our nation — much worse.

The Keynesian explanation of what is happening is pretty straightforward, and Krugman does it on a regular basis (along with Brad DeLong and, to a lesser extent, Robert Reich). Details include:

• The economy operates in a circular motion, with consumer spending propping up business activity, which in turn provides jobs for consumers so that they can continue to spend and give themselves jobs (so that they can continue to spend);

• If marginal taxes on the wealthiest people are not high enough to confiscate much, if not most, of their income, then the rich will “hoard” the money and not spend enough, which slows and ultimately breaks what Reich calls the “virtuous circle” of spending;

• When that happens, government must raise tax rates on the “rich” (Reich calls for a return of the 70 percent marginal rates that existed in 1981) in order to get money into the hands of the “middle class” (which apparently is a creation of the State) so that the spending circle can be revived;

• At the present time, interest rates are very low, which means that the economy is in a “liquidity trap” in which the only way that the spending circle can move is via more government spending, which should be financed by borrowing, and since interest rates are low, the borrowed money essentially is “free;”

• If a person makes a point of discussion that deviates from what has been presented, that person is motivated by hatred of the unemployed and wants people to lose their jobs and wants the economy to tank;

• Thus, in the end, the debate on Keynesian “solutions” ultimately is a debate on good and evil. Those who support Keynesianism are “good” and those who disagree are evil.

In the numerous columns and blog posts Krugman has written in the past few months, the theme is consistent: there can be no intellectual disagreement with Keynesian analysis because the truth of the Keynesian position is self-evident. Anything else is evil and delusional. For example, the “Regime Uncertainty” position that Robert Higgs and others have taken is nothing more than a figment of one’s imagination:

O.K., I know what the usual suspects will say — namely, that fears of regulation and higher taxes are holding businesses back. But this is just a right-wing fantasy. (Emphasis mine) Multiple surveys have shown that lack of demand — a lack that is being exacerbated by government cutbacks — is the overwhelming problem businesses face, with regulation and taxes barely even in the picture.

For example, when McClatchy Newspapers recently canvassed a random selection of small-business owners to find out what was hurting them, not a single one complained about regulation of his or her industry, and few complained much about taxes. And did I mention that profits after taxes, as a share of national income, are at record levels?

So short-run deficits aren’t a problem; lack of demand is, and spending cuts are making things much worse. Maybe it’s time to change course?

While all of this seems to be self-evident to Krugman, there are some important things that are left out. The first is the role of the economist, who is supposed to be able to look beyond the rhetoric and the “man on the street” view that ultimately leads to the “Broken Window Fallacy.” For example, the marginalist position on value is one that is not easily seen or understood by the typical layperson, who is more likely to believe that the value of a final product is determined by its cost of production.

The second is that the typical small business owner is not going to be able to relate how government “job-saving” programs like the subsidizing of corn-based ethanol or the bailout of General Motors has diverted resources from productive to unproductive uses. Instead, the business owner is going to see how people directly are purchasing products and what it costs to make them, and then make decisions from that vantage point.

As I said before, economists are supposed to be able to take in the whole picture, or to contemplate not only what is “seen,” but also what is “unseen,” to quote Frederic Bastiat. In other words, one should expect a journalist to concentrate on what is “seen,” and to miss the aspects of the larger picture. That is excusable, even if it is irritating.

However, it is unexcusable for an economist, and especially one who has the stature of a winner of the Nobel Prize, to concentrate only on what is seen and not only to ignore those important things not seen, but then to personally attack other economists who do their real duties to examine the entire picture and declare that their motivation for doing so is that they are evil and want Americans to lose their jobs.

The truth is that Krugman’s argument is a red herring; had the Obama administration and Congress done nothing but talk about jobs and launch one employment program after another, the rate of joblessness still would be high, and the fiscal picture of this government and this country would be as bad as it is now. The U.S. economy is not doing poorly because of lack of “concentration” by government officials, but because the government stands in the way of an economic recovery.

By bailing out the banks, by bailing out companies, by spending at record levels, and by holding down interest rates, the U.S. Government is preventing resources from moving from lower-valued to higher-valued uses. Furthermore, the government through political intimidation (see the recent raid on Gibson Guitars) and hostile rhetoric against firms that are legitimately profitable is sending the message that private enterprise is the enemy that ultimately must be replaced by state-sponsored enterprise.

There is another problem to this “oversight” issue, and that is the promotion of the wrong view of a “job” itself. As I read the Progressives on jobs, I have come to realize that they (and that includes “economists” such as Krugman) see the “job” solely as a transmission mechanism for income and, therefore, spending.

In other words, the actual services that one provides are irrelevant in and of themselves, or at best are secondary to the income that those providing them receive for their work. In that view, an economy is just one big circle of spending, with “spending” itself taking on a meaning that is quite removed from the actions and desires of consumers.

Spending, according to the Keynesians, is rather impersonal, and it cannot be tied to purposeful behavior by individuals. The value of “spending” is not that individuals are able to purchase goods and services in order to meet their needs, but instead is a mechanism that keeps that “virtuous circle” known as an “economy” moving in the “right” direction.

This is not economics; it is a mechanistic view of the world that ignores individual preferences and the actual movement of resources and factors of production. Unfortunately, people like Krugman add to the tragedy by claiming that those who look to actual economic explanations of this continuing saga by employing the tools of economic analysis do so because they are both stupid and evil. When the “leading lights” of modern academic economics claim that the employment of historically-accepted intellectual instruments is in itself “evil,” then one must wonder about the very future of this discipline.

Krugman's Keynesian Cash Con

In the Keynesian system, spending IS demand, and the more spending, the more demand, and the more demand, the more production to meet the demand. There is a nice logic to the system, which is why it has a widespread appeal.

Economics, however, looks under the surface to deal not only with issues of causality, but also to take apart that which seems to be true and to ferret out those things which others taking a superfluous view have missed. For example, the typical "man on the street" believes that the value of, say, gasoline is derived from the value of crude oil and the various aspects of cost of production.

Thus, when the U.S. Government slapped price controls on domestic crude oil in the name of making it less expensive to create gasoline, the typical politician, journalist, and Keynesian economist, as well as the "man on the street," believed that was supposed to be the case. It was as though the Marginalist Revolution of 1871 and the development of Neoclassical Economics had not happened, that Alfred Marshall's "Derived Demand" of the factors as well as Carl Menger's important insights never existed.

I say this for two reasons. First, much of what Krugman writes is in the line of the discredited "Cost of Production" Theory of Value. Here is a guy who along with other "liberal" economists during the California electricity crisis of a decade ago (brought about by price controls levied by California authorities) declared that the way to "solve" the problem was...more price controls. (He even said that price controls would increase the supply of electricity, which even for Krugman is an amazing thing in its repudiation of Neoclassical value theory.)

Second, in recent commentary, Krugman has turned to the situation of so-called "corporate cash" in which banks and corporations are making paper profits, but holding onto large sums of money. Now, I have no problem with the numbers he is using, and I have no doubt that banks are not loaning out a lot of their excess reserves (and Krugman hardly is the only one saying this, given Robert Higgs has written similar things and his perspective of this crisis is 180 degrees opposite of what Krugman is saying).

People can agree on basic data, but the interpretation not only of why banks and corporations are not loaning and investing long-term but also of the reason that we don't have more inflation is where the debates exist. Krugman, not surprisingly, takes the Keynesian view:

So here’s what you should answer to anyone defending big giveaways to corporations: Lack of corporate cash is not the problem facing America. Big business already has the money it needs to expand; what it lacks is a reason to expand with consumers still on the ropes and the government slashing spending.

What our economy needs is direct job creation by the government and mortgage-debt relief for stressed consumers. What it very much does not need is a transfer of billions of dollars to corporations that have no intention of hiring anyone except more lobbyists.

Elsewhere, he writes:

In fact, that idle cash has become a major conservative talking point, with right-wingers claiming that businesses are failing to invest because of political uncertainty. That’s almost surely false: the evidence strongly says that the real reason businesses are sitting on cash is lack of consumer demand. In any case, if corporations already have plenty of cash they’re not using, why would giving them a tax break that adds to this pile of cash do anything to accelerate recovery?

In other words, all that needs to happen is for the government to accelerate spending, either by taking some burdens off consumers or for the government to seize and spend the money itself. That is why Krugman has reversed his view that he told other economists and me in 2004 that 70 percent tax rates "were insane," and now is endorsing higher income and corporate taxes in order for government to confiscate money and spend it.

What I find interesting is his utter dismissal of Higgs' contention that "regime uncertainty" has anything to do with corporate investment. Even if government is to confiscate most corporate profits in the future with high taxes, not to mention the imposition of more regulations, in Krugman's view, the band in "Animal House" will continue to try to march through the wall. As long as there might be "spending" in the future, corporations automatically will engage in capital investment. That is nonsense.

Furthermore, as Higgs pointed out, if banks start making loans wily-nily from their huge monetary base, we WILL see a big rise of inflation. For Krugman, inflation is good; it will "stimulate demand" and repudiate debt, and magically remove us from what he calls a "liquidity trap." Higgs, on the other hand, who is a far wiser person than Krugman ever will be, has much better insights. Uncertainty really does matter, and while Keynesians refuse to read Higgs, the man is right.

Krugman writes that we are forgetting the "lessons of 2008" as though his view were self-explanatory. He refuses to acknowledge that the housing bubble occurred because government guarantees and the infamous "Greenspan/Bernanke Put" in which the Fed promised to backstop whatever foolishness the banks engendered was a major reason that banks and other lenders ran over the cliff.

To Krugman, profits and losses mean nothing, and prices and interest rates don't send any meaningful economic signals. The regulator under the Democratic administration is All-Knowing and All-Wise, while the regulator (usually the same person) under the Republican administration is a devotee of Ayn Rand.

So, Krugman actually wants us to believe that if government confiscates large amounts of corporate cash and spends them on politically-based projects, that corporations automatically will start investing for the future. Apparently, one of those projects must be that proverbial bridge in Brooklyn that Krugman is trying to sell us.

Who is to blame for the coming downturn?

When Barack Obama took office, Paul Krugman urged him to emulate Franklin Roosevelt, and it looks as though Obama might just achieve what FDR did: have a depression within a depression.

As the economy begins another long and sad slide, Krugman is claiming that our government just did not spend enough money the past few years, and that is why we are headed south:

Back when the original 2009 Obama stimulus was enacted, some of us warned that it was both too small and too short-lived. In particular, the effects of the stimulus would start fading out in 2010 — and given the fact that financial crises are usually followed by prolonged slumps, it was unlikely that the economy would have a vigorous self-sustaining recovery under way by then.

Krugman's retrospective is his usual self-aggrandizing nonsense, the idea being that had Obama borrowed and spent an extra trillion, dollars, Krugman then would have argued for two trillion, and had the administration dumped two trillion, Krugman would have demanded four. And so it goes.

What Krugman does not say is that like FDR, Obama went on a regulatory rampage, and on top of that, the government continues to pursue wars abroad and now openly admits to having CIA-sponsored death squads roaming the globe in search of the "bad guys." Obama has openly demonstrated himself to be quite hostile to private enterprise (of the non-subsidized variety), and the government through the Federal Reserve System is showering the world with dollars, yet he wonders why U.S. business firms do not engage in long-range capital planning and expenditures.

As Robert Higgs notes in this excellent essay, the Roosevelt administration created huge amounts of "regime uncertainty," which led to a slowdown of private investment. It seems that Obama, through his rhetoric, his initiatives, and the brazen hostility of Washington toward private investment, we are seeing a repeat.

Krugman, of course, won't mention this point, and why should he? Keynesians believe that all we need to do is to shower an economy with money and everything else follows. Well, it doesn't.

Every(Krug)man

Paul Krugman is a bit upset that someone could accuse him of being a "warmonger," since he claims that World War II ended the Great Depression. Now, having spoken personally to Krugman about his opposition to the U.S. war in Iraq (and I share that opposition and told him so), I don't think Krugman loves war.

Nonetheless, his view is problematic, especially when one compares his views to those of economist Robert Higgs, who in this essay clearly debunked the "World War II as the end of the Depression" nonsense. Nonetheless, Krugman counters that the amoral nature of economics allows for war to be a positive catalyst in ending a downturn, even if we are against the war itself.

Economics, he writes, "is not a morality play." That is true, at least at one level. Ludwig von Mises himself wrote that economics is a "value-free" science, but he was writing from a very different perspective.

Krugman's contention is this:

...economics is not a morality play. It’s not a happy story in which virtue is rewarded and vice punished. The market economy is a system for organizing activity — a pretty good system most of the time, though not always — with no special moral significance. The rich don’t necessarily deserve their wealth, and the poor certainly don’t deserve their poverty; nonetheless, we accept a system with considerable inequality because systems without any inequality don’t work. And before the trolls jump in to say aha, Krugman concedes the truth of supply-side economics, that’s not an argument against progressive taxation and the welfare state; it’s just an argument that says that there are limits. Cuba doesn’t work; Sweden works pretty well.

(Now, I would suspect that Krugman would not be able to explain why Cuba "doesn't work," given he thinks that the two greatest critics of socialism of the 20th Century, F.A. Hayek and Mises, were idiots and people of no insight. He probably would mumble something about "incentives," but I doubt Krugman would even be able to comprehend the "economic calculation" issue that Mises and Hayek developed.)

Krugman goes on:

And when we’re experiencing depression economics, by which I mean a situation in which it’s hard to create sufficient demand to achieve full employment — mainly because short-term interest rates are up against the zero lower bound — the essentially amoral nature of economics becomes even more acute. As I’ve said repeatedly, this is a situation in which virtue becomes vice and prudence is folly; what we need above all is for someone to spend more, even if the spending isn’t particularly wise. (Emphasis mine)

It is interesting that he uses such phrasing, given it comes almost word for word from Bernard Mandeville's "Fable of the Bees," which was written in 1705, and which I lampooned in this piece, "The Fable of the Krugman."

Keep in mind, however, that Krugman's turning of the "virtue" of saving upside down to embrace the "vice" of reckless spending is not what Mises meant by describing economics as "value-free." Krugman is just saying that while saving would seem to be a good thing, what is needed now is spending, and lots of it. Thus, "situational ethics" becomes the basis for economic analysis.

However, the problem is not in our interpretation of economic morality. The problem is that Krugman insists that massive spending on behalf of the state will magically transform the U.S. economy, give it "traction," and send us on the Yellow Brick Road to Prosperity if not Oz itself.

Krugman does not embrace war; he embraces the government spending, the planned economy, the interventions, and the intrusions of the state into economic decisions. To him, that is Oz. However, if one reads the Higgs piece, one gets a much better understanding of the "prosperity" that war can bring.

For that matter, the Great Depression did not linger on because of a lack of government spending; as Higgs points out, it was "regime uncertainty," and I will put my money on that every time.

Ironically, while Krugman might not see himself as "Everyman," nonetheless his columns are full of condemnation for those people who might disagree with him or (horrors) vote differently than he does. So, even if the economy might not be a morality play, his columns tell a different story.

Krugman (Sort Of) Responds to "Regime Uncertainty" Arguments

Although Paul Krugman does not want to use the term "regime uncertainty," nonetheless, he seems to be referring to that argument in a July 7 post on business investment. He writes:

Truly, we live in a time of mass delusion — or maybe make that elite delusion — where there are lots of things that everyone believes, without a shred of evidence to back that belief. Here’s one more: everywhere you go, you encounter the claim that businesses aren’t investing, they’re just sitting on piles of cash, because they’re worried about future government policies.

There is, of course, a much more prosaic alternative: businesses aren’t investing because they have lots of excess capacity. Why build new structures and buy new machines when you’re not using the ones you already have?

So is there anything in the data suggesting that we need to invoke fear of government to explain low investment? Not a bit.

He goes on to present a graph that contrasts business investment with the CBO's estimate of the gap between potential GDP and real GDP. Since the pattern of the investment follows the CBO's "gap," according to Krugman, that is the end of the argument.

Krugman's argument is based upon the following sets of questions and answers:

Q: Why is the economy bad?

A: Because businesses and individuals are not spending as much as they used to spend.

Q: Why aren't businesses and individuals spending like they used to spend?

A: Because the economy is bad.

Q: What would make the economy recover?

A: Businesses and individuals have to start spending again.

As you can see, this is a circular argument, and Krugman bases much of his analysis upon such "logic," yet he claims that people who disagree with him are suffering from "mass delusion." Now, I don't doubt that businesses as a whole are going to invest less during a recession, but Krugman is leaving out some important matters.

The "capacity" argument is not really an economic argument at all. First, it operates on what Austrian economists call the view that factors of production (for analytic purposes) are homogeneous. Second, "capacity" is a theoretical term for the capability of a firm to create output provided that all factors were operating at "full employment."

The idea behind the Keynesian emphasis on "capacity" is that government can "stimulate" the economy to a point where all firms are operating at full capacity, which then signals that we have arrived at a full-employment Nirvana. Of course, this argument contains the assumption that "stimulus" spending affects all sectors of the economy equally, as though an economy is a homogeneous mass of factors.

I have read a number of Robert Higgs' articles and papers, and never once have I seen him resort to the straw man characteristic of Barack Obama as a "socialist." For that matter, he did not call FDR a "socialist" in his "regime uncertainty" paper published 13 years ago.

If, indeed, government spending is what drives a successful economy, then why was there not a "Great Depression of 1946-48" following the end of World War II, when real prosperity returned. Higgs writes:

Finally, this way (regime uncertainty interpretation) of understanding the Great Duration meshes nicely with a proper understanding of the Great Escape after the war. The Keynesians all expected a reversion to depression when the war ended. Most businesspeople, in sharp contrast, “did not think that there was any threat of a serious depression” after the war (Krooss 1970, 217). The businesspeople forecasted far better than the Keynesian economists: the private economy blossomed as never before or since. Official data, which understate the true increase because of mismeasurement of the price level, show an increase of real nongovernment domestic product of 29.5 percent from 1945 to 1946 (U.S. Council of Economic Advisers 1995, 406). Private investment boomed and corporate share prices soared in 1945 and 1946 (Higgs 1992, 57–58). None of the standard explanations can account for this astonishing postwar leap, but an explanation that incorporates the improvement in the outlook for the private-property regime can account for it.

From 1935 through 1940, with Roosevelt and the ardent New Dealers who surrounded him in full cry, private investors dared not risk their funds in the amounts typical of the late 1920s. In 1945 and 1946, with Roosevelt dead, the New Deal in retreat, and most of the wartime controls being removed, investors came out in force. To be sure, the federal government had become, and would remain, a much more powerful force to be reckoned with. But the government no longer seemed to possess the terrifying potential that businesspeople had perceived before the war. For investors, the nightmare was over. For the economy, once more, prosperity was possible.

One does not have to believe Obama is a socialist to understand that the anti-business rhetoric coming from the White House and Congress is having a chilling effect upon long-term business investment. For example, Obama's claim that his administration would "create 700,000 'green' jobs" does not point out that government subsidies to companies not capable of turning a profit ultimately must come from the hides of presently "healthy" companies, and one can be assured that this "plan" actually would destroy more wealth (and jobs) than it would create. 

Yet, instead of trying to understand a differing point of view, we see vengeful politicians now being urged to seize the funds of individuals and businesses in order that government "may better spend it." No doubt, that will create real prosperity.

Krugman, Business Spending, and "Regime Uncertainty"

Paul Krugman has laid down a challenge in his latest blog post, claiming that much of the current joblessness is the result of businesses "sitting on a lot of cash, but not spending it." Indeed, he likens this situation to the extreme cautiousness of Gen. McClellan during the Civil War, which brought about the ire of President Lincoln.

At one level, Krugman claims that the reluctance of businesses to spend is understandable, given what he calls "huge excess capacity." (More on the "capacity" argument later.) He declares:

(Reluctance to spend) then raises the question: how can you believe that, and not also believe that if the U.S. government were to borrow some of the cash corporations aren’t spending, and spend it on, say, public works, this would also create jobs? (Brad DeLong has tried to make this argument repeatedly).

Which brings me to Lincoln and McClellan. General McClellan had raised a powerful army, but seemed disinclined to actually seek battle. So Lincoln sent him a letter: “My dear McClellan: If you don’t want to use the Army I should like to borrow it for a while.” (Yes, there are various versions of the quote).

So shouldn’t that be our response to all that idle corporate cash? We don’t literally have to borrow from the corporations; they’re parking their funds in the money market, and the feds would borrow from that market. But the end result would be to put some of that idle cash to work — and, ultimately, to give the corporations a reason to start investing, too, so that the deficit spending would crowd investment in, not out.

First, the government IS borrowing a lot of cash from businesses and especially from the banks. Second, Krugman is not advocating that businesses seek better deals; no, he is quietly but obviously demanding that government confiscate this "excess cash" if businesses don't increase their spending.

He then throws down the glove: "I have never seen a coherent objection to this line of argument."

My sense is that Krugman has seen "coherent" arguments against this line of thinking, but simply will not acknowledge that anyone else can fashion anything contrary to his own ex cathedra pronouncements. However, in the spirit of Krugman's challenge, I will fashion my own argument, and will lean heavily upon an economist that I really respect, Prof. Robert Higgs.

First, and most important, the "capacity" argument is a red herring that is based upon circular arguments (one of Krugman's favorite tactics). According to Krugman, businesses have large, unused productive capacity that will only become engaged after businesses start spending again. Thus, businesses are causing their own demise, so it is up to the government to break this circular pattern of job destruction and confiscate business cash and spend it wisely.

Once again, we see Krugman claiming that the CAUSE of a recession is less spending, which he also claims in a recent column. Yet, as I see it, this is a violation of what Carl Menger called "The Law of Cause and Effect." Krugman is confusing effect with cause and is missing the larger picture.

He is right that businesses (and many individuals) are putting money in relatively safe places (all of which Krugman would equate to stuffing money in one's mattress), but his circular argument as to why simply fails on its face. However, Robert Higgs has noted many times that "regime uncertainty" on behalf of the Obama administration's actions, which he equates to what happened during the Great Depression.

In 1997, Higgs published a paper in The Independent Review on the Great Depression in which he blamed the "regime uncertainty" promoted by the Roosevelt administration for the lack of long-term investment by businesses. Higgs writes:

Evidence from public opinion polls and corporate bond markets shows that FDR’s policies prevented a robust recovery of long-term private investment by significantly reducing investors’ confidence in the durability of private property rights. Not until the New Deal/war economy ended and resources became available for peacetime production did private investment—and the nation’s economic health—fully recover.

Higgs elaborates on the Great Depression theme in this piece, using a lengthy quote from a member of FDR's "brain trust," noting that FDR's anti-business rhetoric and his punitive policies toward business kept business owners from making longer-term decisions. Higgs in this column equates the current hostility to business by the Obama administration and the equally anti-business Congress to what happened with FDR and points out that we should not be surprised that the present "regime uncertainty" is not going to bring about recovery. He writes:

Speaking to CNBC in Las Vegas recently, Steve Wynn, the billionaire developer and operator of entertainment properties, said: “Washington is unpredictable these days. No one has any idea what’s next . . . the uncertainty of the business climate in America is frightening, frightening to everybody, and it’s delaying recovery.” Wynn complains of “wild, uncontrolled spending” and “unbelievable, unsustainable debt.”

Wynn also has operations in China, and he remarks that he “has no qualms about dealing with the Chinese government. Macau has been steady. The shocking, unexpected government is the one in Washington.” Not very long ago, such a statement would itself have been shocking.

The gambling and real estate magnate expresses concerns about inflation, FHA’s making the same mistakes Fannie and Freddie have made, and the business costs arising from the new health-care law. “We’re on our way to Greece,” he declares, “in the hands of a confused, foolish government.” Exasperated, he mutters, “It’s got to stop. It’s got to stop.”

These observations remind me of similar statements made by investor Lammot du Pont in 1937: “Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate.” Even members of Franklin D. Roosevelt’s cabinet eventually appealed to him to clear the air in which private investors were finding it difficult to breathe, but he refused to do so, preferring to plunge ahead with the New Deal and to publicly blame “economic royalists” for his policies’ failures.

Now, I am sure that Krugman would claim that the above arguments are nonsense and don't provide a "coherent" argument, but nonetheless I believe Higgs has the much stronger argument than Krugman's claim, which is based upon circular logic.

The Meaningless GDP Growth Numbers

The latest GDP numbers were released Friday and, no, despite what the Associated Press tells us, the economy in the last three months of 2009 did not boom. Yes, 5.7% is a gaudy number, but even Paul Krugman says that it is a "blip." (Yes, when I agree with Krugman, I put that one on, too. Broken clocks can be correct twice a day.)

The current situation, as Krugman explains, is based upon what is called an "inventory bounce." He writes:

Such blips are often, in part, statistical illusions. But even more important, they’re usually caused by an “inventory bounce.” When the economy slumps, companies typically find themselves with large stocks of unsold goods. To work off their excess inventories, they slash production; once the excess has been disposed of, they raise production again, which shows up as a burst of growth in G.D.P. Unfortunately, growth caused by an inventory bounce is a one-shot affair unless underlying sources of demand, such as consumer spending and long-term investment, pick up.

It is interesting that Krugman brings up "long-term investment," because at the current time, we don't see businesses investing for the long haul, especially in this country. This is not due to myopia on part of business owners, but rather because we have a situation of what Robert Higgs in this excellent paper calls "regime uncertainty."

During the 1930s, the Roosevelt administration was openly hostile to business owners, forcing up taxes to confiscatory levels (FDR even tried to have a 100 % tax on all income above $25,000 a year), and making open threats to seize companies or force them to shut down. Now, this made him popular with lots of voters, as "populism" does seize upon the resentments of people.

If you notice, Obama is doing the same thing. Now that many of his initiatives are being beaten into the ground with the loss of the 60th Democrat in the U.S. Senate, he is resorting to Huey Long-style threats against private enterprise. No doubt, this will please the Paul Krugmans of the world, but it also means the end of long-term investment here.

And the end of long-term investment here means that businesses will try to keep current operations going but also are going to have an exit strategy, just as they had during the 1930s. However, during that decade, they did not have the option of investing in places like China, which has shown itself to be much more friendly to capital investment than the United States.

To a Keynesian like Krugman, I might as well be speaking gibberish. Keynesians believe that all that is necessary is for the government to print lots of money, make sure that people receive it, and then watch them spend. The more people spend, the more the economy magically grows, since in the Keynesian mind, all assets are homogeneous and spending is the yeast that makes the economic bread rise.

Remember, Krugman holds that investment is useful only because it is another mechanism for spending. The concept that capital investment means more production in the future, and creates the means for people to obtain a higher standard of living simply does not exist in the Keynesian thinking. It is always spending all the time.