The perennial question of modern economics is simple: how are market downturns best combated? It’s a good question, if you are trying to deduce truth in matters. It also makes for good fodder to appease career-granting benefactors, i.e. the government. It was not always this way however. Economists, if true to their craft, do not make for barrels of optimism. They are supposed to be a splash of cold water on wishful thinkers.
The unholy alliance between the state and the economic profession would never last if dismal science practitioners were gadflies who swatted down every harebrained scheme that festered in the dreams of central planners. This was one of the problems encountered by classical economists. Being market-friendly, it was tough appealing to monarchs or government leaders who wanted a quick fix to economic doldrums. No head of the public wants to tell his citizens, “Sorry, I cannot help you today. You must help yourself.”
Eventually John Maynard Keynes would come along and give the economic vocation the crony justification it needed to become respectable in the eyes of the state. His The General Theory of Employment, Interest and Money was a how-to guide for pols looking to spend other people’s money. At last they had an excuse: to boost unemployment by paying laid-off workers to dig holes aimlessly.
Our friend Paul Krugman is Keynes’s most vocal disciple, and never tires of reinvoking his intellectual master’s teachings of mo’ money, mo’ debt, and no mo’ problems. In a recentinterview with the forever exhausted-looking Joe Weisenthal of Business Insider, Kruggy is perplexed by the Federal Reserve’s inability to inflate out of the ongoing economic slowdown. He snakes out a position between naysayer Larry Summers, who thinks the economy can only grow with artificial bubbles, and someone who is more optimistic about the future. On necessary bubbles, Krugman tells us:
“If we look at the evidence…and it kind of looks like…we need bubbles to grow. We’ve had one bubble after another. Long-term rise in debt, with no inflation…the economy is looking like it’s just barely managing to keep its above water with all those bubbles so…that’s the observation.”
Krugman blames the news status quo on slowing technological innovation and lower population growth. As for the United States, the Nobel Laureate is convinced the trade deficit is largely at fault. Lastly, he concedes that no one really knows why the economy must be goosed by a shot of exuberance.
That’s all true, if you forget the fact that some folks do actually understand why Krugman and his like-minded colleagues are scratching their heads over bubbles.
That the past few decades have witnessed financial bubble after financial bubble is not proof positive of a great need for them. Krugman’s assumption is that had the Fed not interfered in the marketplace to boost particular assets, the whole economy would have imploded. It’s a false assumption, but totally in line with Keynesian theory.
From the stagflation in the late 1970s to the stock market crash of 1987, forward to the failure of Long Term Capital Management in 1998, the popping of the dot-com bubble years later, and finally culminating in the housing crisis of 2007-2008, Krugman and Summers appear to have a point. All of these cases of faux prosperity were caused by the Fed’s meddling with the money supply, pushing interest rates down below their natural level. The headache after each instance was cured with the hair of the dog – meaning more inflation, more stimulus, and more central bank liquidity. The roller coaster ride of money printing has left the economy distorted and unable to find true balance again.
For the life of him, Krugman can’t seem to find any evidence of market stability without the animal spirits being thrown a liquidity bone. And yet, his go-to example of angelic prosperity – the 1950s – has all the markings of a relatively calm period of prosperity absent of central bank interference. As former Office of Management and Budget Director David Stockman points out, the heads of the Federal Reserve following World War II were less-than-enthusiastic about ginning up growth via the printing press. This was when William McChesney Martin was at the helm and President Eisenhower was reluctant to keep up the hog wild spending of his predecessor. In an interview with the American Mises Institute, Stockman comments:
Although central banking does cause moral hazards and lends itself to abuses, there have been periods in which monetary and fiscal discipline have been employed. Fed Chairman William McChesney Martin, for example, really did take the punch bowl away when the party got started because he took monetary discipline seriously. Fiscal discipline under Eisenhower and the gold standard behind Bretton Woods helped put off the day of reckoning for quite a long time.
After wartime price controls were relaxed in the late 1940s, capitalists and private investors were freed of government burden and began investing in the country yet again. Washington’s budget was cut significantly, including hundreds of billions removed from the Pentagon’s death machine expenditures. Stockman brings attention to the data: “Between 1954 and 1963, real GDP growth averaged 3.4 percent while annual CPI inflation remained subdued at 1.4 percent.”
So yes, this was the non-bubble prosperity Krugman is looking for. As Justin Raimondowrites, “[E]ight years of relative fiscal sanity under the Eisenhower presidency ushered in the greatest economic expansion in modern times.” What’s funny is that Krugman is one of the biggest cheerleaders of post-war prosperity and continually advocates going back to the Ike-era. But he wrongly attributes the golden times to pro-union labor policies and high rates of taxation.
Regardless, the takeaway from the decade of General Motors, Elvis, decent manners, and the Red threat is bubbles are not necessary for economic growth. By trying to stimulate demand, the Fed only mucks up economic calculation and capital accumulation.
Krugman’s solutions for the bubble-addicted economy are no better than his own understanding of economic theory. Widespread unemployment can be cured, in his opinion, by weaker purchasing power, a stronger welfare state, and continual government spending. In other words, by top-down central planning that attempts to tweak society “just so.” All these efforts are nothing but a shell game that take money from some and give it to another. Basically, Krugman is King Solomon with a sword, cutting everyone into parts he sees most fit.
Saying we need continuous financial bubbles to keep full employment is such a flawed conception of economics, it belongs on an island of misfit philosophies. Krugman’s incessant promotion of statism is doing more harm to the economy than good. As an opinion-molder, he is perpetuating the economic malaise of the last few years. More bubbles won’t help the recovery, just harm it more. In the middle of a grease fire, Krugman calls for more pig fat. And the rest of us are the ones left burnt.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail