Olduvaiblog: Musings on the coming collapse

Home » Posts tagged 'Krugman'

Tag Archives: Krugman

Ponzi World (Over 3 Billion NOT Served): Collapse-O-Nomics: Commonsense is Extinct

Ponzi World (Over 3 Billion NOT Served): Collapse-O-Nomics: Commonsense is Extinct.

No Reasonable Idea Will Go unClusterfucked by the Idiocracy
The Lost Boys continue to decry today’s “Keynesian” policy failures – this obviously ludicrous idea of borrowing the economy out of debt. However, when I took (Macro) Econ 101 way back in 1987, the Professor at the time – an ardent Keynesian – taught us that correct application of fiscal stimulus is to run deficits during recessions and surpluses during expansion. Therefore, in the context of a typical five year business cycle, that would lead to one year of deficit followed by four years of surplus and hence a balanced budget (if not net surplus). However, today’s Keynesian bashers don’t know any of that, because they never took Econ 101 nor even Commonsense 101. These Keynesian bashers are as deluded as the Krugmanites who think they too know anything about appropriate use of fiscal policy. No sane doctor would prescribe using antibiotics for 30 years straight and then declare like a dumbfuck at the end of it all that antibiotics don’t work. This is all just a game by and for morons of which there is no shortage on all sides of this equation.

Keynes Didn’t Envision Reagan, Bush or Faux News
Unfortunately, Keynes never envisioned the Idiocracy, nor how bastardized his policies would become over the course of time, when placed in the hands of hill billies and B Actors looking for a retirement gig. Fiscal policy was never intended to sponsor tax cuts for the ultra-wealthy, military blunders, nor military build-ups. Nor did he envision this concept endorsed by Krugmanites of bailing out a 30 year leveraged consumption binge and multi-year housing boom via the application of totally unlimited government borrowing. And needless to say, he never envisioned monetization of debt solely to prop up the stock market while the real economy was outsourced in the background. All of this chicanery is the result of what happens when Frat Boys go to college to socialize rather than to get a real education. They become very good at pretending to know things, while having absolutely zero judgement as to how these policies need to be applied in order to be effective. In other words, a little bit of knowledge is an extremely dangerous thing.
Extreme Deflation Doesn’t Mean Cheaper Computers at Best Buy
Keynes himself was an extremely intelligent man – whose ideas were far beyond the grasp of today’s policy-making game show hosts. Anyone who has ever read “The General Theory of Employment, Interest and Money” is standing on the shoulders of an intellectual giant, if they understand what he is saying, at all. Moreover, the problem he was trying to solve was how to mitigate the devastating human impacts resulting from The Great Depression. He was addressing a real depression, not a three month hiatus from shopping binges and expensive dinners, which is what the Idiocracy deems to be this recent “great recession”.
Worse yet, the Lost Boys seem to believe that deflation means lower prices at Best Buy. Unfortunately in a real depression, deflation means a total collapse in demand leading to a collapse in prices. In a fixed cost-based world wherein all corporate entities have taken full advantage of 0% interest rates to maximize financial leverage – then deflation means bankruptcy. In other words, every possible mistake that could be made leading up to this lethal juncture, has been made, specifically around subsidizing cheap debt. In a fixed cost world, deflation means mass unemployment and accompanying turmoil. Which gets us to the next point.
The Polling Booth (and/or Molotov Cocktail) is the Final Arbiter of all Economic Theories
The rule of one vote per woman or man can work eventually. In the interim, however, it may not work well, if at all. The subversion of democracy via mass brainwashing aka. Faux News in addition to the dumbing down of a population via junk food and junk culture, is a lethal combination. In the interim, democracy can lead to any ludicrous outcome including the mass accumulation of wealth in the hands of an ever-dwindling minority.
Ultimately, however, there is only so much pain the masses can take and then they revolt. At that point, political democracy becomes economic democracy. No one can predict what new bastardized economic model will result from this ensuing pandemonium, however, rest assured it will look nothing like the current one.
In other words, in the fullness of time, economics and politics are one and the same. No economic model regardless of how textbook “efficient” it is deemed to be, can indefinitely withstand the polling booth. That’s just one more lesson that today’s frat boys and billionaires are going to find out the hard way. The future will not be about what a handful of entitled people want for themselves, with zero concern for their fellow man. That childish fantasy will be flushed down the toilet of history, where it belongs.The Pendulum Swings
At this late juncture, the political pendulum is still hard to the right on economic policy, not withstanding the feel good election of Obama to Bush’s third and fourth terms. The political economy is the furthest to the right it has been since the early 1900s just prior to the Great Depression, during the heyday of the “robber barons”. Today’s power elite have pushed their luck to the absolute limit and then a lot further. What they don’t realize is that momentum has halted and the pendulum is getting set to swing back in the other direction. The Idiocracy has been conned into voting against their own economic interest for thirty fucking years straight. It’s an unprecedented run in modern history. When the political pendulum begins to swing the other way, the status quo political ideologies will be obliterated in lockstep with the status quo pseudo-economy. The recalibration will be instantaneous and the elite’s grasp on power will be challenged, violently.

Commonsense Doesn’t Sell Text Books
Lastly, this omnipresent buffoonish devotion to economic ideology – Keynesianism, Monetarism, Austrianism, Communism, Socialism, Capitalism etc. has meant that commonsense has been thrown out the window. Commonsense of course being the only moderating control rod in all of these economic “systems”. However, to be a commonsense-based centrist is to be seen as being weak and lacking confidence. Clearly, the “best ideas” deserve slavish unquestioning devotion. Unfortunately, in the real world, all of these theories – which is what they are – have massive flaws so wide you can drive a truck through them, therefore it’s only a matter of time before their brainwashed proponents take the application of theory to the ludicrous extreme, at which point these “systems” all collapse in their own uniquely spectacular fashion.Voila.

The Emerging Market Collapse Through The Eyes Of Don Corleone | Zero Hedge

The Emerging Market Collapse Through The Eyes Of Don Corleone | Zero Hedge.

Submitted by Ben Hunt of Epsilon Theory

It Was Barzini All Along

Tattaglia is a pimp. He never could have outfought Santino. But I didn’t know until this day that it was Barzini all along.

— Don Vito Corleone

Like many in the investments business, I am a big fan of the Godfather movies, or at least those that don’t have Sofia Coppola in a supporting role. The strategic crux of the first movie is the realization by Don Corleone at a peace-making meeting of the Five Families that the garden variety gangland war he thought he was fighting with the Tattaglia Family was actually part of an existential war being waged by the nominal head of the Families, Don Barzini. Vito warns his son Michael, who becomes the new head of the Corleone Family, and the two of them plot a strategy of revenge and survival to be put into motion after Vito’s death. The movie concludes with Michael successfully murdering Barzini and his various supporters, a plot arc that depends entirely on Vito’s earlier recognition of the underlying cause of the Tattaglia conflict. Once Vito understood WHY Philip Tattaglia was coming after him, that he was just a stooge for Emilio Barzini, everything changed for the Corleone Family’s strategy.

Now imagine that Don Corleone wasn’t a gangster at all, but was a macro fund portfolio manager or, really, any investor or allocator who views the label of “Emerging Market” as a useful differentiation … maybe not as a separate asset class per se, but as a meaningful way of thinking about one broad set of securities versus another. With the expansion of investment options and liquid securities that reflect this differentiation — from Emerging Market ETF’s to Emerging Market mutual funds — anyone can be a macro investor today, and most of us are to some extent.

You might think that the ease with which anyone can be an Emerging Markets investor today would make the investment behavior around these securities more complex from a game theory perspective as more and more players enter the game, but actually just the opposite is true. The old Emerging Markets investment game had very high informational and institutional barriers to entry, which meant that the players relied heavily on their private information and relatively little on public signals and Common Knowledge. There may be far more players in the new Emerging Markets investment game, but they are essentially one type of player with a very heavy reliance on Common Knowledge and public Narratives. Also, these new players are not (necessarily) retail investors, but are (mostly) institutional investors that see Emerging Markets or sub-classifications of Emerging Markets as an asset class with certain attractive characteristics as part of a broad portfolio. Because these institutional investors have so much money that must be put to work and because their portfolio preference functions are so uniform, there is a very powerful and very predictable game dynamic in play here.

Since the 2008 Crisis the Corleone Family has had a pretty good run with their Emerging Markets investments, and even more importantly Vito believes that he understands WHY those investments have worked. In the words of Olivier Blanchard, Chief Economist for the IMF:

In emerging market countries by contrast, the crisis has not left lasting wounds. Their fiscal and financial positions were typically stronger to start, and adverse effects of the crisis have been more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have largely recovered, and whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in advanced countries. … The challenge for most emerging countries is quite different from that of advanced countries, namely how to avoid overheating in the face of closing output gaps and higher capital flows. — April 11, 2011

As late as January 23rd of this year, Blanchard wrote that “we forecast that both emerging market and developing economies will sustain strong growth“.

Now we all know what actually happened in 2013. Growth has been disappointing around the world, particularly in Emerging Markets, and most of these local stock and bond markets have been hit really hard. But if you’re Vito Corleone, macro investor extraordinaire, that’s not necessarily a terrible thing. Sure, you don’t like to see any of your investments go down, but Emerging Markets are notably volatile and maybe this is a great buying opportunity across the board. In fact, so long as the core growth STORY is intact, it almost certainly is a buying opportunity.

But then you wake up on July 9th to read in the WSJ that Olivier Blanchard has changed his tune. He now says “It’s clear that these countries [China, Russia, India, Brazil, South Africa] are not going to grow at the same rate as they did before the crisis.” Huh? Or rather, WTF? How did the Chief Economist of the IMF go from predicting “strong growth” to declaring that the party is over and the story has fundamentally changed in six months?

It’s important to point out that Blanchard is not some inconsequential opinion leader, but is one of the most influential economists in the world today. His position at the IMF is a temporary gig from his permanent position as the Robert M. Solow Professor of Economics at MIT, where he has taught since 1983. He also received his Ph.D. in economics from MIT (1977), where his fellow graduate students were Ben Bernanke (1979), Mario Draghi (1976), and Paul Krugman (1977), among other modern-day luminaries; Stanley Fischer, current Governor of the Bank of Israel, was the dissertation advisor for both Blanchard and Bernanke; Mervyn King and Larry Summers (and many, many more) were Blanchard’s contemporaries or colleagues at MIT at one point or another. The centrality of MIT to the core orthodoxy of modern economic theory in general and monetary policy in particular has been well documented by Jon Hilsenrath and others and it’s not a stretch to say that MIT provided a personal bond and a formative intellectual experience for a group of people that by and large rule the world today. Suffice it to say that Blanchard is smack in the middle of that orthodoxy and that group. I’m not saying that anything Blanchard says is amazingly influential in and of itself, certainly not to the degree of a Bernanke or a Draghi (or even a Krugman), but I believe it is highly representative of the shared beliefs and opinions that exist among these enormously influential policy makers and policy advisors. Two years ago the global economic intelligentsia believed that Emerging Markets had emerged from the 2008 crisis essentially unscathed, but today they believe that EM growth rates are permanently diminished from pre-crisis levels. That’s a big deal, and anyone who invests or allocates to “Emerging Markets” as a differentiated group of securities had better take notice.

Here’s what I think happened.

First, an error pattern has emerged over the past few years from global growth data and IMF prediction models that forced a re-evaluation of those models and the prevailing Narrative of “unscathed” Emerging Markets. Below is a chart showing actual Emerging Market growth rates for each year listed, as well as the IMF prediction at the mid-year mark within that year and the mid-year mark within the prior year (generating an 18-month forward estimate).

Pre-crisis the IMF systematically under-estimated growth in Emerging Markets. Post-crisis the IMF has systematically over-estimated growth in Emerging Markets. Now to be sure, this IMF over-estimation of growth exists for Developed Markets, too, but between the EuroZone sovereign debt crisis and the US fiscal cliff drama there’s a “reason” for the unexpected weakness in Developed Markets. There’s no obvious reason for the persistent Emerging Market weakness given the party line that “whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand.” Trust me, IMF economists know full well that their models under-estimated EM growth pre-crisis and have now flipped their bias to over-estimate growth today. Nothing freaks out a statistician more than this sort of flipped sign. It means that a set of historical correlations has “gone perverse” by remaining predictive, but in the opposite manner that it used to be predictive. This should never happen if your underlying theory of how the world works is correct. So now the IMF (and every other mainstream macroeconomic analysis effort in the world) has a big problem. They know that their models are perversely over-estimating growth, which given the current projections means that we’re probably looking at three straight years of sub-5% growth in Emerging Markets (!!) more than three years after the 2008 crisis ended, and — worse — they have no plausible explanation for what’s going on.

Fortunately for all concerned, a Narrative of Central Bank Omnipotence has emerged over the past nine months, where it has become Common Knowledge that US monetary policy is responsible for everything that happens in global markets, for good and for ill (see “How Gold Lost Its Luster”). This Narrative is incredibly useful to the Olivier Blanchard’s of the world, as it provides a STORY for why their prediction models have collapsed. And maybe it really does rescue their models. I have no idea. All I’m saying is that whether the Narrative is “true” or not, it will be adopted and proselytized by those whose interests — bureaucratic, economic, political, etc. — are served by that Narrative. That’s not evil, it’s just human nature.

Nor is the usefulness of the Narrative of Central Bank Omnipotence limited to IMF economists. To listen to Emerging Market central bankers at Jackson Hole two weeks ago or to Emerging Market politicians at the G-20 meeting last week you would think that a great revelation had been delivered from on high. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.

The problem, though, is that once you embrace the Narrative of Central Bank Omnipotence to “explain” recent events, you can’t compartmentalize it there. If the pattern of post-crisis Emerging Market growth rates is largely explained by US monetary accommodation or lack thereof … well, the same must be true for pre-crisis Emerging Market growth rates. The inexorable conclusion is that Emerging Market growth rates are a function of Developed Market central bank liquidity measures and monetary policy, and that all Emerging Markets are, to one degree or another, Greece-like in their creation of unsustainable growth rates on the back of 20 years of The Great Moderation (as Bernanke referred to the decline in macroeconomic volatility from accommodative monetary policy) and the last 4 years of ZIRP. It was Barzini all along!

This shift in the Narrative around Emerging Markets — that the Fed is the “true” engine of global growth — is a new thing. As evidence of its novelty, I would point you to another bastion of modern economic orthodoxy, the National Bureau of Economic Research (NBER), in particular their repository of working papers. Pretty much every US economist of note in the past 40 years has published an NBER working paper, and I only say “pretty much every” because I want to be careful; my real estimate is that there are zero mainstream US economists who don’t have a working paper here.

If you search the NBER working paper database for “emerging market crises”, you see 16 papers. Again, the author list reads like a who’s who of famous economists: Martin Feldstein, Jeffrey Sachs, Rudi Dornbusch, Fredric Mishkin, Barry Eichengreen, Nouriel Roubini, etc. Of these 16 papers, only 2 — Frankel and Roubini (2001) and Arellano and Mendoza (2002) — even mention the words “Federal Reserve” in the context of an analysis of these crises, and in both cases the primary point is that some Emerging Market crises, like the 1998 Russian default, force the Fed to cut interest rates. They see a causal relationship here, but in the opposite direction of today’s Narrative! Now to be fair, several of the papers point to rising Developed Market interest rates as a “shock” or contributing factor to Emerging Market crises, and Eichengreen and Rose (1998) make this their central claim. But even here the argument is that “a one percent increase in Northern interest rates is associated with an increase in the probability of Southern banking crises of around three percent” … not exactly an earth-shattering causal relationship. More fundamentally, none of these authors ever raise the possibility that low Developed Market interest rates are the core engine of Emerging Market growth rates. It’s just not even contemplated as an explanation.

Today, though, this new Narrative is everywhere. It pervades both the popular media and the academic “media”, such as the prominent Jackson Hole paper by Helene Rey of the London Business School, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.

Market participants today see Barzini/Bernanke everywhere, behind every news announcement and every market tick. They may be right. They may be reading the situation as smartly as Vito Corleone did. I doubt it, but it really doesn’t matter. Whether or not I privately believe that Barzini/Bernanke is behind everything that happens in the world, I am constantly told that this is WHY market events happen the way they do. And because I know that everyone else is seeing the same media explanations of WHY that I am seeing … because I know that everyone else is going through the same tortured decision process that I’m going through … because I know that everyone else is thinking about me in the same way that I am thinking about them … because I know that if everyone else acts as if he or she believes the Narrative then I should act as if I believe the Narrative … then the only rational conclusion is that I should act as if I believe it. That’s the Common Knowledge game in action. This is what people mean when they say that a market behavior of any sort “takes on a life of its own.”

For the short term, at least, the smart play is probably just to go along with the Barzini/Bernanke Narrative, just like the Corleone family went along with the idea that Barzini was running them out of New York (and yes, I understand that at this point I’m probably taking this Godfather analogy too far). By going along I mean thinking of the current market dynamic in terms of risk management, understanding that the overall information structure of this market is remarkably unstable. Risk-On / Risk-Off behavior is likely to increase significantly in the months ahead, and there’s really no predicting when Bernanke will open his mouth or what he’ll say, or who will be appointed to take his place, or what he or she will say. It’s hard to justify any large exposure to public securities in this environment, long or short, because all public securities will be dominated by this Narrative so long as everyone thinks that everyone thinks they will be dominated. This the sort of game can go on for a long time, particularly when the Narrative serves the interests of incredibly powerful institutions around the world.

But what ultimately saved the Corleone family wasn’t just the observation of Barzini’s underlying causal influence, it was the strategy that adjusted to the new reality of WHY. What’s necessary here is not just a gnashing of teeth or tsk-tsk’ing about how awful it is that monetary policy has achieved such behavioral dominance over markets, but a recognition that it IS, that there are investment opportunities created by its existence, and that the greatest danger is to continue on as if nothing has changed.

I believe that there are two important investment implications that stem from this sea change in the Narrative around Emerging Markets, which I’ll introduce today and develop at length in subsequent notes.

First, I think it’s necessary for active investors to recalibrate their analysis towards individual securities that happen to be found in Emerging Markets, not aggregations of securities with an “Emerging Markets” label. I say this because in the aggregate, Emerging Market securities (ETF’s, broad-based funds, etc.) are now the equivalent of a growth stock with a broken story, and that’s a very difficult row to hoe. Take note, though, the language you will have to speak in this analytic recalibration of Emerging Market securities is Value, not Growth, and the critical attribute of a successful investment will have little to do with the security’s inherent qualities (particularly growth qualities) but a great deal to do with whether a critical mass of Value-speaking investors take an interest in the security.

Second, there’s a Big Trade here related to the predictable behaviors and preference functions of the giant institutional investors or advisors that — by size and by strategy — are locked into a perception of Emerging Market meaning that can only be expressed through aggregations of securities or related fungible asset classes (foreign exchange and commodities). These mega-allocators do not “see” Emerging Markets as an opportunity set of individual securities, but as an asset class with useful diversification qualities within an overall portfolio. So long as market behaviors around Emerging Markets in the aggregate are driven by the Barzini/Bernanke Narrative, that diversification quality will decline, as the same Fed-speak engine is driving behaviors in both Emerging Markets and Developed Markets. Mega-allocators care more about diversification and correlations than they do about price, which means that the selling pressure will continue/increase so long as the old models aren’t working and the Barzini/Bernanke Narrative diminishes what made Emerging Markets as an asset class useful to these institutions in the first place. But when that selling pressure dissipates — either because the Barzini/Bernanke Narrative wanes or the mega-portfolios are balanced for the new correlation models that take the Barzini/Bernanke market effect into account — that’s when Emerging Market securities in the aggregate will work again. You will never identify that turning point in Emerging Market security prices by staring at a price chart. To use a poker analogy you must play the player — in this case the mega-allocators who care a lot about correlation and little about price — not the cards in order to know when to place a big bet.

In future weeks I’ll be expanding on each of these investment themes, as well as taking them into the realm of foreign exchange and commodities. Also, there’s a lot still to be said about Fed communication policy and the Frankenstein’s Monster it has become. I hope you will join me for the journey, and if you’d like to be on the direct distribution list for these free weekly notes please sign up at Follow Epsilon Theory.

Krugman Blowing Bubbles – Ludwig von Mises Institute Canada

Krugman Blowing Bubbles – Ludwig von Mises Institute Canada.

Sunday, December 15th, 2013 by  posted in CapitalismEconomicsHistory.

krugman

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

 

Krugman: “Fiat Money…Backed By Men With Guns” – Ludwig von Mises Institute Canada

Krugman: “Fiat Money…Backed By Men With Guns” – Ludwig von Mises Institute Canada.

Say what you will about Keynesian superstar Paul Krugman, he doesn’t mince words. In a recent interview with Business Insider’s Joe Weisenthal, Krugman gave his opinion that Bitcoin was in a bubble because it wasn’t backed by a tangible asset.

krugman

Perhaps sensing that this may have undercut the case for Krugman’s preferred monetary system, Krugman was quick to add thatgovernment-issued fiat money was “backed by men with guns.” (See the video for yourself.) Thus, Krugman thought that government currencies were not in a bubble, even if they weren’t backed by tangible assets, because people needed to obtain the currency in order to pay taxes.

Krugman’s analysis provides a good opportunity to explore the subtlety of Ludwig von Mises’ monetary economics. On the one hand, Mises was a “hard money” man who was a fierce opponent of government fiat money. It is also true that Mises was a classical liberal who would have opposed government coercion in the form of legal tender laws, capital gains taxes on gold and silver, and other ways that governments currently use their “guns” to solidify the present system where most people on Earth use government-issued notes as their primary form of money.

However, even though a libertarian and proponent of Misesian economics might object to government-issued fiat money because of the coercion–”men with guns”–involved, strictly speaking Mises would not agree that a currency can be backed by guns, in the way Krugman describes. To speak in this manner is a complete surrender in the face of the economist’s task of explaining money.

Mises’ grand work in this area is his The Theory of Money and Credit, for which my free study guide is available. As Mises conceived it, the central theoretical task when it comes to money is to explain why money has a particular purchasing power. Why should it be that people give up valuable goods and services for a particular item–the money commodity–according to definite exchange ratios?

Mises’ answer is that people form expectations about the future purchasing power of money, and that is what gives it purchasing power today. These expectations in turn are based on their observations of the money’s purchasing power in the past. Thus lays the groundwork for Mises’ famous “regression theorem,” in which people’s subjective valuations of money necessarily involves a historical component (unlike their subjective valuation of, say, pizza). Gold, silver, and other forms of commodity money could ultimately be traced back to the days of barter, in which they had definite exchange ratios with other goods because of their usefulness as regular commodities.

In the case of government-issued fiat currencies, Mises explained their purchasing power using the same theoretical apparatus. The only difference is that at some point in the past, the currencies (such as the dollar, pound, franc, etc.) had been explicitly linked to the precious metals, and that’s what grounded everyone’s valuations of them.

Thus, Krugman’s glib assertion that today’s government fiat monies derive their value from guns completely dodges the problem for the economist: to explain the magnitude of that value. Even if we conceded that the government could force everyone to use something–let’s say a particular type of sea shell–as money, by insisting on payment of taxes in the form of sea shells, that policy wouldn’t explain why an hour of labor should trade for 10 shells, rather than 100 or 1,000. This is especially true when we reflect that most government taxes are expressed in terms of percentages, rather than an absolute amount.

Furthermore, it’s obvious that Krugman’s “explanation” would have no way of accounting for changes in either variable. For example, in the 1970s in the United States, price inflation took off dramatically, meaning the purchasing power of the dollar fell sharply. Was this because of a reduction in taxes? Of course not. And in the 1920s, there were sharp cuts in marginal income tax rates at the federal level. Did this lead to severe price inflation, as people now didn’t need as many dollars to pay Uncle Sam? On the contrary, consumer prices were fairly stable in this period.

As these observations should demonstrate, Krugman really hasn’t offered a viable explanation for the purchasing power of money. One might be tempted to say that at best, governments can use their taxing power to dictate what the monetary unit is, even though they would still have little control over its purchasing power.

Yet even this concedes too much. Strictly speaking, if the only policy we are considering is that the government says every year, “Citizens must turn in such-and-such number of sea shells as tax payment,” that alone won’t even be sufficient to conclude that the sea shells will be the money in this society. People could still use some other commodity as the money, and then use the actual money to buy the sufficient number of sea shells each year right before paying their taxes.

UPDATE: After originally posting this, I realized there was a problem with one of my examples: In the 1920s amidst the marginal income tax rate cuts designed by Treasury Secretary Mellon, the U.S. was still on the gold standard. Thus this period is not a good refutation of Krugman’s explanation for fiat money’s exchange value. (Of course, we can simply look at other examples of governments that engaged in large-scale tax cuts even while using a fiat currency, and we don’t typically see a sharp rise in price inflation accompanying them.)

Robert P. Murphy is the author of The Politically Incorrect Guide to Capitalism, and has written for Mises.org, LewRockwell.com, and EconLib. He has taught at Hillsdale College and is currently a Senior Economist for the Institute for Energy Research. He lives in Nashville.

 

End this Depression? Never | Business Spectator

End this Depression? Never | Business Spectator.

Larry Summers’ speech at the IMF has provoked a flurry of responses from New Keynesian economists that imply that Summers has located the “Holy Grail of Macroeconomics” – and that it was a poisoned chalice.

“Secular stagnation”, Summers suggested, was the real explanation for the continuing slump, and it had been with us for long before this crisis began. Its visibility was obscured by the subprime bubble, but once that burst, it was evident.

So the crisis itself was a sideshow. The real story is about inadequate private sector demand, which may have existed for decades. Generating adequate demand in the future may require a permanent stimulus from the government – meaning both the Congress and the Fed.

What could be causing the secular stagnation – if it exists? Krugman noted a couple of factors: a slowdown in population growth (which is obviously happening: see Figure 1); and “a Bob Gordon-esque decline in innovation” (which is more conjectural).

Figure 1: Population growth rates are slowing

 

 
Graph for End this Depression? Never

So is a secular trend to lower growth the reason for the continuing stagnation, six years after the crisis began? And is Summers now the Messiah?

Reading Krugman or Miles Kimball, you’d think so on both counts. Kimball headlines his coverage with “Larry Summers just confirmed that he is still a heavyweight on economic policy”, while Krugman states that while he’s been thinking on the same lines, “Larry’s formulation is much clearer and more forceful, and altogether better, than anything I’ve done. Curse you, Red Baron Larry Summers!”

On the issue itself, you’d also think that suddenly the lightbulb has switched on as well, after years in the darkness before and after the crisis. Though Summers’ thesis has its critics (such asStephen Williamson),  there’s a chorus of New Keynesian support for the “secular stagnation” argument, which implies it will soon become the conventional explanation for the persistence of this slump long after the initial financial crisis has passed.

Krugman’s change of tune here is representative. His most recent book-length foray into what caused the crisis – and what policy would get us out of it – was entitled End This Depression Now!. The title screamed that this crisis could be ended “in the blink of an eye”, while the text argued that all it would take is a sufficiently large fiscal stimulus to help us escape the “zero lower bound”. Krugman wrote:

“The sources of our suffering are relatively trivial in the scheme of things, and could be fixed quickly and fairly easily if enough people in positions of power understood the realities.

“One main theme of this book has been that in a deeply depressed economy, in which the interest rates that the monetary authorities can control are near zero, we need more, not less, government spending. A burst of federal spending is what ended the Great Depression, and we desperately need something similar today.”

Post-Summers, Krugman is suggesting that a short, sharp burst of government spending will not be enough to restore “the old normal”. Instead, to achieve pre-crisis rates of growth in future – and pre-crisis levels of unemployment – we may need permanent government deficits, and permanent Federal Reserve spiking of the asset market punch via QE and the like. Not only that, but past apparent growth successes – such as The Period Previously Known as The Great Moderation – may simply have been above-stagnation rates of growth motivated by bubbles:

Krugman asks: “So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’ answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest. And this hasn’t just been true since the 2008 financial crisis; it has arguably been true, although perhaps with increasing severity, since the 1980s.”

This argument elevates the “zero lower bound” from being merely an explanation for the Great Recession to a General Theory of macroeconomics: if the zero lower bound is a permanent state of affairs given secular stagnation, then permanent government stimulus and permanent bubbles may be needed to overcome it.

Or, as Krugman puts it: “One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations.”

So is secular stagnation the answer to the puzzle of why the economy hasn’t recovered post the crisis? And is permanently blowing bubbles (as well as permanent fiscal deficits) the solution?

Figure 2:  A secular slowdown in growth caused by a secular trend to stagnation
Graph for End this Depression? Never

Firstly, there is evidence for a slowdown in the rate of economic growth over time, as well as its precipitous fall during and after the crisis. The growth rate was as high as 4.4 per cent per annum on average from 1950-1970, but fell to about 3.2 per cent per annum from 1970-2000 and was only 2.7 per cent in the noughties prior to the crisis, after which it has plunged to an average of just 0.9 per cent per annum (see Table 1).

Table 1: US Real growth rates per annum by decade
Graph for End this Depression? Never

The sustained growth rate of the US economy is lower now than it was in the 1950s-1970s, and the causes go well beyond the undoubted demographic trend that Krugman nominates and the rather more dubious suggestion of a decline in innovation.

Firstly, the corporate transfer of production from the US (and Europe) to the third world over the last 40 years has substituted low-wage, low-consumption third world workers for high-wage, high-consumption Americans and Europeans. This benefited Western and third-world capitalists, but at the expense of reducing global demand. The free trade that conventional economists champion has in fact help replace the ‘beggar the neighbour’ politics of the protectionist past with ‘beggar thy working class’ politics today.

Secondly, there’s the impact of rising inequality on consumption. Inequality is at unprecedented levels today, possibly the highest it has ever been in human history, according to James K Galbraith, the global authority on this topic. That inequality leads to huge demand for luxury yachts, but diminished demand for almost everything else. Demand in the aggregate could fall.

And there’s a third factor that Krugman alludes to in his post, which I suspect might start to turn up in future in his explanation of the crisis: the rise in household debt during 1980-2010. With the notable exception of Robert Shiller, this wasn’t foreseen by mainstream economists in neither thefreshwater nor saltwater sects.

Figure 3, sourced from the St Louis Fed’s excellent FRED database, and taken from Krugman’s post, outlines this trend.

Figure 3: Ratio of household debt to GDP
Graph for End this Depression? Never

Now, as any well-trained economist knows, it’s a matter of simple logic that what happens to private debt is irrelevant to macroeconomics most of the time because “debt is one person’s liability, but another person’s asset”.

However, private debt does matter during a liquidity trap, because then lenders might get worried about the capacity of borrowers to repay and impose a limit on debt that borrowers have already exceeded, forcing borrowers to repay their debt and spend less. To maintain the full-employment equilibrium, people who were once lenders have to spend more to compensate for the fall in spending by now debt-constrained borrowers.

But lenders are patient people, who by definition have a lower rate-of-time preference than borrowers, who are impatient people.

In the New York Times, Krugman wrote: “Now, if people are borrowing, other people must be lending. What induced the necessary lending? Higher real interest rates, which encouraged “patient” economic agents to spend less than their incomes while the impatient spent more.”

The problem in a liquidity trap is that rates can’t go low enough to encourage patient agents to spend enough to compensate for the decline in spending by now debt-constrained impatient agents.

Krugman elaborates: “You might think that the process would be symmetric: debtors pay down their debt, while creditors are correspondingly induced to spend more by low real interest rates. And it would be symmetric if the shock were small enough. In fact, however, the deleveraging shock has been so large that we’re hard up against the zero lower bound; interest rates can’t go low enough. And so we have a persistent excess of desired saving over desired investment, which is to say persistently inadequate demand, which is to say a depression.

Summers’ thesis now implies that the US economy has in fact been in a liquidity trap for decades, possibly “since the 1980s”, Krugman contends.

This suggests a hypothesis that I wouldn’t at all be surprised to see tested in the pages of theNew York Times. Firstly, America hasn’t always been suffering secular stagnation, nor has it always been in a liquidity trap. Secondly, sound economics tells us that only when the economy is in one does private debt matter macroeconomically. So it should be possible to work out how long the liquidity trap has applied, by working out when the level (or rate of change, or some other measure) of private debt correlated with macroeconomic variables (say the level, or rate of change of unemployment), and when it didn’t.

I await the test of this hypothesis. I might even check it out myself.

Steve Keen is author of Debunking Economics and the blog Debtwatch and developer of the Minsky software program.

 

TRYING TO STAY SANE IN AN INSANE WORLD – PART 2 « The Burning Platform

TRYING TO STAY SANE IN AN INSANE WORLD – PART 2 « The Burning Platform.

%d bloggers like this: