Krugman's 1 Percent Fallacy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

All Hail the Debt Fairy! All Hail the Inflation Fairy!

In September 2008, if it had not been obvious before, it had become abundantly clear since that the borrow-and-spend party has been over for nearly five years, yet Paul Krugman is becoming even more shrill about the need to a large dose of the fiscal equivalent of "hair of the dog." Yet, governments, including that of the USA, have been attempting to appeal to the Debt Fairy and the Inflation Fairy to wave their magic wands and heal the economies with more of the same.

In his latest column, Paul Krugman combines a relatively true statement about the current state of economic affairs -- long-term joblessness is becoming chronic -- with a non-sequitur. First, he comments upon the desperate situation that has become normal for many people, and second, he then blames it on a paper published a few years ago by a couple of economists:

Well, the famous red line on debt, it turns out, was an artifact of dubious statistics, reinforced by bad arithmetic. And America isn’t and can’t be Greece, because countries that borrow in their own currencies operate under very different rules from those that rely on someone else’s money. After years of repeated warnings that fiscal crisis is just around the corner, the U.S. government can still borrow at incredibly low interest rates.

But while debt fears were and are misguided, there’s a real danger we’ve ignored: the corrosive effect, social and economic, of persistent high unemployment. And even as the case for debt hysteria is collapsing, our worst fears about the damage from long-term unemployment are being confirmed.

Understand what Krugman is saying. As long as the USA can print money and borrow from the Federal Reserve, then Americans don't have to worry about how much debt the government piles up and how much money the Fed prints. The Debt Fairy and the Inflation Fairy will sprinkle magic dust and do what no fairy before has been able to do: conjure up a real economic recovery by encouraging the very kind of economic behavior that put this country into the mess in the first place.

Lest anyone think I exaggerate, Krugman himself qualifies the points I have made:

And let’s be clear: this is a policy decision. The main reason our economic recovery has been so weak is that, spooked by fear-mongering over debt, we’ve been doing exactly what basic macroeconomics says you shouldn’t do — cutting government spending in the face of a depressed economy.

It’s hard to overstate how self-destructive this policy is. Indeed, the shadow of long-term unemployment means that austerity policies are counterproductive even in purely fiscal terms. Workers, after all, are taxpayers too; if our debt obsession exiles millions of Americans from productive employment, it will cut into future revenues and raise future deficits.

Our exaggerated fear of debt is, in short, creating a slow-motion catastrophe. It’s ruining many lives, and at the same time making us poorer and weaker in every way. And the longer we persist in this folly, the greater the damage will be.

First things first. U.S. debt today stands at roughly 105 percent of current GDP, and only about 40 percent of current spending is financed via taxation. This is not "austerity" by any definition of the word, and one can bet that the next time the debt ceiling issue comes to the fore, Congress and the president -- after yet another dog-and-pony show complete with the Usual Suspects giving their usual talking points -- will come to an agreement. This number will grow, although it won't grow fast enough for Krugman.

Furthermore, Krugman fails to point out that the Obama administration has been relentless in trying to drive the U.S. economy in a direction in which vast amounts of resources are being used to push economic frauds like "green energy" and even another housing boom. In other words, it is more of the same. The government places huge burdens upon entrepreneurs who wish to operate in a relatively free market and drives resources into destructive "Crony Capitalism," as though policies that enrich contributors to Obama and the Political Classes will translate into general prosperity.

Keynesians are fond of claiming that as long as we have "idle resources," this is a wise policy, as at some point, if the Debt Fairy and Inflation Fairy sprinkle enough magic dust, all of these "idle resources" will awaken like Snow White after the kiss from the prince and come to life again. This is an amazing claim, for it is saying that when the economy is depressed, the Law of Scarcity can be ignored.

Yes, Keynesians believe that if only government spends enough and borrows enough, that we can emerge from this morass, and that the only thing standing in the way of progress is the presence of Goldstein -- I now dub him "Scoldstein" -- telling us we need to put something in our piggy banks. We can spend our way into another boom, and when that boom collapses -- as it surely will -- we just invoke the incantations of the Twin Fairies and begin another ride into the sunrise.