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Guest Post: Keynesians, Please Exit Stage Left

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Submitted by Rolfe Winkler, publisher of OptionARMageddon

Back in February, amidst the neo-Keynesian rage to spend our way out of recession, I argued that stimulus wouldn’t stimulate. Pointing to the graph of the 10-year Treasury vs. 30-year mortgage rates I said that the government wouldn’t be able to flood the market with Treasurys without driving up interest rates. Higher rates on government debt imply higher rates for mortgages, which would hammer house prices and other assets, blowing an ever-larger hole in bank balance sheets.

The Fed knows long-term rates can’t be allowed to rise because that would run their economic “recovery” off the rails. Enter “quantitative easing,” the policy by which the Fed prints money to buy fixed-income securities like Treasurys and MBS. By printing money to inflate demand, they hope to hold interest rates down.

Sounds great, right? Why can’t the Fed just keep printing money to buy bonds in order to hold interest rates artificially low?

Because bond investors call bullsh*t. As the Fed prints money, inflation expectations rise. When investors anticipate higher future inflation they demand higher interest rates to buy debt. After all, they don’t want to hold fixed-income securities when fixed-incomes lose their purchasing power to inflation.

And so we have a great game of chicken between the Fed and the bond market. The Fed prints money to keep interest rates down while bond investors zip tight their wallets because Fed printing makes bonds less appealing. What is the Fed going to do, become the lender of last resort to the federal government? Print whatever cash is necessary to literally displace vanishing private demand for government debt? This is no solution of course; in the long-run it implies hyperinflation.

And so we return to the question Keynesians like Krugman simply won’t address when they advocate government “stimulus:” How do we pay for it? If we run up additional debts without making some provision to pay them, then in the long-run interest rates have to rise.

You could raise taxes to pay down debt, but that would destroy the positive impact of additional government spending.

The point is there’s no way to financially engineer our way out of this crisis.

Economists love the idea that the Fed is all powerful, that it has some magic wand to wave which can rescue Americans from debt deflation. I suspect this is because, deep down, they harbor ambitions to be Fed Chairman themselves. For most economists, the Fed’s printing press is the ultimate toy….one they’ve always wanted to play with.

And it is a powerful one. Most recessions are easily “solved” because the Fed can always use that printing press to inflate a credit bubble, to inflate demand artificially. This works great until it doesn’t. Eventually the credit bubble becomes so big it’s simply impossible to sustain with more printing.

I suspect this is why Keynesians never bothered asking how we’d pay for stimulus. The answer—”we can’t”—shatters their economic theory.

Krugman offers a partial rebuttal to this argument in his column today. He argues that inflation isn’t a big issue right now. And he’s right: deflation is the real threat. He argues that Fed printing is necessary to counteract it, but he misses the larger point that, in the long-run, higher government debts imply higher interest rates regardless of what the Fed does. Debt is not a static thing. It has to be rolled over, paid down or repudiated (via default). In ascending order of economic violence, each of these implies a debt deflationary depression.

Outright default isn’t an option. Imagine the worldwide economic calamity if Tim Geithner stops making interest payments on Treasurys

Paying down debt means running surpluses. To do so would require draconian cutbacks in spending by indebted governments, corporations and individuals. Aggregate demand would collapse, leading to depression.

Both of the above are unappealing so the Fed conspires with government to inflate aggregate demand with more borrowing. But more borrowing means more debt that has to be paid down later. More debt means bigger future cutbacks. The longer we kick the can down the road, the deeper the depression we’ll be faced with in the “long-run.”

The bottom line is that we have to pay down debt. We’ve no other choice. Yeah, it’s going to be very painful, but we should have thought of that before we inflated the credit bubble.

———

Post Script:

I can’t leave this piece without rebutting the conclusion to Krugman’s op-ed:

But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.

Because Republicans lost their fiscal bearings during the Bush years doesn’t mean that budget arithmetic somehow no longer applies. Deep down, Krugman desperately wants to support Democratic ambitions to dramatically increase the size of government. But “Republicans did it so we can too” is not an argument. PK knows this but, hyper-partisan that he is, he can’t resist getting in the dig. He should know that plenty of independents abhorred runaway government spending under Bush. We were hoping Obama would bring “change” by putting our fiscal house in order.

Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.

Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.

Here, for the first time that I’m aware of, Krugman acknowledges the paradox of his prescription. Spending creates a long-run budget problem! But by adding the “long-run” modifier, he gets to kick the can down the road. Deficits aren’t an issue we have to address now so Democrats shouldn’t let themselves be “bullied” into a policy of spending restraint.

But my goodness: what is the the “groundwork” we should be “laying” to provide a “long-run solution” to this “problem?” Krugman owes his readers an answer to this question.

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53 comments

  1. Anon1

    How about raising marginal tax rates on the top of the income ladder (to also partly address the unsustainable disparity in top vs the rest of us in wealth distribution too)? How about closing all loopholes in corporate taxation so they can no longer skip on their taxes by setting up bogus offices in tax haven countries? How about taxing corporations based on the differential between top executive compensation (ALL forms) vs their average worker compensation? The greater the disparity beyond a max of 25x differential the higher the taxes. Taxes are minimized at <25x differential. How about taxing corporations based on the percentage above 15% of their workforce that they outsource/offshore?

    How about quit subsidizing oil companies, agribusiness, and any and all other corporations? How about cutting the "defense" budget in half? We'd STILL have the biggest defense expenditure in the known universe but it would free up a LOT of money. How about cutting our nuclear weapons down DRASTICALLY sooner rather than later? The infrastructure necessary to maintain and guard the stockpile is enormous…wastage.

    How about getting rid of the Department of dur Faderland Security (DHS)? That crap costs good money for nothing more than to trample all over the Bill of Rights. How about closing AT LEAST 50% of our 700+ overseas military bases? LOTS of money saved there.

    There are lots of things we can do without forcing grandma to eat catfood and live in a cardboard box in an alley. Start at the top and work down, NOT from the bottom and work up.

  2. Falletta

    Don’t they believe that economies can grow their way out of debt? As long as GDP is growing, any interest payments from the debt incurred so as to keep it growing grow increasingly smaller. Though of course then we must determine what the breaking point is. Not saying that they are correct, they do seem to avoid any question of when the breaking point is reached, but your argument is something of a strawman.

  3. Bruce Wilder

    Tax the banksters and the rest of the plutocracy and corporate criminal class.

    Republicans did not “lose their fiscal bearings”. Phil Gramm and friends knew exactly what they were doing.

    We don’t need to be paying off debt to these thieves. We need to be using enhanced interrogation techniques on them. For the fun of it.

  4. Rolfe Winkler

    Anon1….I agree with you. The only “long-run” solution to the economic crisis is paying down debt, which means cutting spending and/or raising taxes. But both of these are incompatible with “stimulus” as advocated by Keynesians. They imply falling aggregate demand and, consequently, debt deflation.

    Faletta….real growth is very likely impossible and certainly not sustainable, not with the amount of debt we’ve run up.

  5. Anonymous Jones

    This is a long run chess game. People like Krugman found out the hard way that balancing the budget only opened the doors to letting the other party give away the store to their constituents once they assumed power. Obviously, it makes much more sense to spend the money now and then let the other party clean it up. Don’t take everything at face value. Obama is not going to make the same mistake that Clinton did. It will be almost impossible to reverse certain social programs like comprehensive health care once they are put in motion. Obama knows this and is setting up a situation where taxes will have to be raised down the line. It is the GOP that’s totally delusional. They’ve operated on the basis that bankrupting the government will lead to social programs being axed. What a moronic miscalculation. (Sorry for the epithet). It will be taxes that will be raised, not programs that will be cut, especially when the biggest and most active political base is soon to be retirees (if it isn’t already).

  6. redst8r

    Rolf: I appreciate and concur with your post. Keynesians, like Krugman seemingly believe that since in the long run we are all dead it doesn’t matter what we do today?

    Paul Krugman and many other, brillant though they may be, have a political not economic agenda. That they hide behide economic equality (better to be all poor than to have some rich – unless they are the favored class of course) makes their schemes all the more insidious.

    Let us revise the tax codes (simplify and broaden dramatically); let us reduce spending (political and personal); let us begin to work our way out of this debacle.

    But wait [ {;) ] there’s an election in less than 18 months. Can’t we just wait until after that one?

  7. beetgirl

    krugman just wrote a terrible article. to comment on it is almost worse. he is now officially a hack and has no credibility like the rest of us. that article coming from high up the economist food chain leads one to believe it is unraveling in strange unpredictable ways and we are all really just plain dumb and have no idea what is happening.

    not only did he phone it in, he did it in myopic fashion. and with the logic and brevity of a toddler.

    wonk that krugman.

    -from a real communist (im not kidding)

  8. Alex

    The debate between the monetarists and Keynesians is almost amusing to watch because it’s rather like the members of the Titanic arguing over the appropriate music to play to lift the mood of the passengers.

    The US is slowly bankrupting itself in its foolish pursuit of empire. This problem is as old as civilisation itself and requires no formal degree to understand.

    The more the economic ideologues on both sides try to dress up the issue the faster the decline will happen.

  9. Brian's Blog

    Krugman covered this a few months ago with a chart showing decreasing private debt and increasing public debt spanning the period from the beginning of the Great Depression to the end of WWII. At the end of the war, public debt as a percentage of GDP was around 110%. Why did the ratio of debt to GDP fall? Economic growth.

    Krugman would have given you an ‘F’ for this bit of political diatribe, Rolfe.

  10. Brian's Blog

    Krugman covered this a few months ago with a chart showing decreasing private debt and increasing public debt spanning the period from the beginning of the Great Depression to the end of WWII. At the end of the war, public debt as a percentage of GDP was around 110%. Why did the ratio of debt to GDP fall? Economic growth.

    Krugman would have given you an ‘F’ for this bit of political diatribe, Rolfe.

  11. Jeff Burton

    what is the the “groundwork” we should be “laying”

    Windmills and electronic medical records. Duh.

  12. Stevie b.

    “Economic growth” = the old, clapped-out orthodox mantra. And what happens to oil prices with (world-wide) economic growth? And how quickly? And what will this do to that growth? And never mind oil, what about unfettered global demand for other raw resources? None of it computes any more. The developed world needs to mark time for quite a time.

  13. Rolfe Winkler

    Brian….do you (and Krugman) honestly believe we can grow our way out of a $50 trillion debt hole (counting the government’s unfunded liabilities)? That’s patently absurd.

    We aren’t going to grow to infinity. Best we recognize that now.

  14. Tortoise

    Krugman is right on the money when stating “…current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the [Obama] government started spending money …”

    The shadow government statistics site predicted hyperinflation in a report dated April 8, 2008. http://www.shadowstats.com/article/hyperinflation That is to say, for those who cannot get the point, well before Obama even got close to the nomination. The crowd who now scream HYPERINFLATION paid no attention. In fact, the old-fashioned version of the CPI indicated 10 percent average annual inflation between 1998 and 2008, see http://www.shadowstats.com/alternate_data (In my view and personal experience, that is close to the inflation rate many households felt during that period.) Most of those who now predict hyperinflation were apparently happy with inflation when it was actually happening. Now, the same folks fret about something that may or may not happen.

  15. Jamie

    Rolfe

    What is more dangerous to the real economy: the deflationary cycle we are now in or the uncertainty of how we get out of the public debt hole?

    Both are dangerous, but surely the deflationary cycle is more dangerous, not least because it is here now.

    If one believes that fiscal stimulus is effective in combating a deflationary cycle then one should support it.

  16. Rolfe Winkler

    Jamie….if that were true I would agree with you. But fiscal stimulus doesn’t combat debt deflation, it merely delays it. In the meantime stimulus brings with it larger deficits that will be even harder to pay down in future.

    The wages of stimulus, in other words, will be more violent debt deflation later on.

  17. Jamie

    Rolfe…. but isn’t it the case that the rate of private sector debt deflation is currently greater than the rate of public sector debt increase. If so, the net effect of fiscal stimulus is a slowing down of the current aggregate debt deflation.

  18. porttfe

    Money doesn’t grow on trees for most of America. We sit down at our kitchen tables and write out checks to the phone-company, electric company, credit card-company, mortgage-company, and auto finance company every month. We clip coupons and go to the grocery store every week to put food in the mouths of our children. This is what our parents did before us.

    bankers selling our childrens futures..for more bailouts? the disgrace. it’s horrible. too big to fail needs to fail. we neeed LESS bailouts. If you fail U fail. Tons of informative articles.
    I came across this interesting site..check it out Econ & Finance Articles Updated Daily

  19. Joe Costello

    I’d say again, we don’t understand deflation, that goes for Mr. Krugman too.

    The US debt simply represents the great imbalances in the economy from oil to trade, to stagnant wages and and increasingly unaffordable empire.

    Added to this was the great financial bubble of the last decade and half, which is now trying to be pumped up.

    If deflation sets in, and it sure looks to be, there will be no inflation. It means quite a long time of economic stagnation and/or decline. Government spending will only lessen, not cure. The only cure for bubbles and there devastating popping is prevention.

    There’s no monetary solution to the problem, only a very long structural adjustment and no one is talking about that yet.

  20. chasd00

    WWII was a big part of the end of The Great Depression no? With all the comparisons floating around about now and the Great Depression wouldn’t it make sense to include WWII as a factor in the ending of the depression?

    Isn’t the fact that we won WWII without any battles fought on our soil (Pearl Harbor aside) the reason we were able to grow like we did?

    I fail to see how anyone can use the growth from the 40′s onward as a model for going forward from here unless they’re including another world war. I don’t think a world war on the scale of WWII is feasible with today’s technology.

    I hope whatever model the powers that be are using to lay the ground work going forward isn’t based on the 20th century.

    (disclaimer, i’m not educated or employed in the financial biz so i could be way off base)

  21. epar

    Well, Rolfe’s central argument is that the Keynesians have put us in a situation where it’s impossible to unwind the current public debt without significant economic harm. But to support his claim he engages in the same kind of hand-waving that he accuses Krugman of performing. It is worth noting that there is not one number in his whole piece – no attempt to provide an objective, concrete basis for saying how much debt is “too much”, or that the current debt level will prevent us from returning to “real” or “sustainable” growth.

    It’s perfectly reasonable to think that when economic growth resumes we will be able to take counter-cyclical fiscal measures without crushing aggregate demand to the extent that plunges us into another recession (Anon1 raised some great ideas for how we might do this). If Rolfe really wants to make an effective counter-argument he should provide a more substantive analysis to back his claims.

  22. Andrew Bissell

    I hope whatever model the powers that be are using to lay the ground work going forward isn’t based on the 20th century.

    LOL, that’s *exactly* the model the Keynesians are using! “In the 1930s-1940s there was a recovery that coincided with massive government deficit spending and intervention in the economy, so that will get us out of this mess as well.” Strap yourself in, because the 20th Century is the ONLY model we have! Our economists and historians literally consider the period before FDR’s election in 1932 a Dark Age whose only relevance is providing examples of what not to do.

  23. DownSouth

    Anonymous Jones said…”It will be taxes that will be raised, not programs that will be cut, especially when the biggest and most active political base is soon to be retirees (if it isn’t already).”

    That’s the point that Kevin Phillips makes in Wealth and Democracy:

    To begin with, high taxes on the assets, incomes, or consumption patters of the rich–or all three–could be used in the twenty-first century to fund the late-twentieth-century promises of entitlements like Social Security and Medicare…In Britain, changes that seemed impossible in 1902 or 1904 became serious discussions in 1909, law in 1913, and were supplanted by even tougher statutes in 1919 or 1938.~

    And I am in agreement that is most likely the way the U.S. will go. However, there is some risk the U.S. could follow the path that Germany took the 1930s and 40s, combining a supercharged nationalism with military agression.

    I just finished reading Greg Grandin’s Empire’s Workshop yesterday and he makes a compelling case that the people of the U.S. have quite a propaganda juggernaut aimed at them. Grandin’s detailed and thoroughly documented account starts with Guatemala in the 50s where psych-war techniques were developed in collaboration with Edward Bernays, Sigmund Freud’s nephew and “a pioneer in pubic proaganda” and “disinformation tactics.” It ends with Nicaragua and an extensive network of public relations firms, think tanks, pundits, evangelical preachers and psych-ops from the CIA and the U.S. Army’s Fourth Psychological Operations Group, all melded into a phalanx aimed directly at the American public.

    We saw this highly sophisticated disinformation machine unleashed against the American people during the Iraq war. Grandin cites this example:

    Consider this chain of influence: the Pentagon funded the Rendon Group (a public relations firm), which organized the Iraqi National Congress and trained its members in the arts of propaganda. The INC, in turn, put Iraq defectors in contact with CIA operatives. When one such defector, Adnan Ihsan Saeed al-Haideri, who claimed to have first-hand knowledge of Iraqui Weapons of Mass Destruction, failed a CIA lie detector test, Chalabi, never one to miss a main chance, put al-Haideri in contact with New York Times reporter Judith Miller. Miller based her then influential but now infamous December 2001 front page “Iraqui Tells of Renovations at Sites for Chemical and Nuclear Arms” story on this one source. That story was then seized on by the Bush administration as justification for war and recycled by papers and TV news stations around the world. Needless to say, al-Haideri’s account was a complete fabrication.~

    It’s pretty scary stuff. But on the other hand Americans, like the British, come from a long democratic tradition. They are also strongly pragmatic.

    I think it’s pretty safe to conclude that the long-range plans of the security-industrial and financial-industrial complexes that currently curry so much favor with our politicians is one of militarism and economic imperialism abroad and austerity at home.

    So even though I think your prognostication will eventually prove correct, the American people are going to have to wake up and pay attention, and we may have some hair-raising experiences in getting there.

  24. ThreeFifty

    Rolfe,
    I like the article but I think you need to distinguish two kinds of spending clearly:
    1. Stimulus spending which is about $800B in two (?) years.
    2. Sustained spending for social programs like health care etc. — probably in trillions.

    Does this make sense: The government as a buyer of last resort in times of crisis. If nobody else is buying, the government can renew itself on the cheap, help replace inventories of companies, employ unemployed labor and jump-start the cycle. Of course this HAS TO BE temporary and probably targeted towards goods with surplus inventory or available labor rather than wishful-thinking programs like clean energy.

    If that is the case, I don’t quite understand why you’re so opposed to the stimulus. To me, it sounds like your beef is more with the sustained spending programs like healthcare — and the stimulus being used as a cover to pass these spending increases.

  25. praxis22

    I’m a Neo-Keynesian, English, and a Socialist.

    Krugman, like Friedman and Keynes before him, is a public intellectual. But in adopting the “it’s Krugman so it must be economics” argument I think you’re misrepresenting his argument. Which IMO is not economic but political. If anything he’s speaking to public policy.

    I think the world has three roads out of this, one is pure Austrian, but since politicians don’t want to be lynched, and have a vested interests in staying in power they will not go that way. Minsky was an “Austrian” but he wrote a biography of Keynes, and said effectively that he thought most people misunderstood the message. This would be the quickest, but there is no guarantee of anything especially that the rich and the politically connected would survive. IMO vested interest militates against this more than the common man.

    The second is what could be thought of as “Austrian lite” in that you support the system, but allow things to fail. you could for instance force debt holders to take a haircut, and give the ordinary man some debt relief.This will hurt in the short term but clear out the mess quicker, if it was allied to the kind of program that Anon1 alluded too, then this would be over much quicker IMO. But this too is too politically divisive. The petulant child that is “the market” will spit the dummy, so it must be coddled. The illusion that the average college grad can some day become a multi-millionaire with very little work is so much a part of the “American Dream” (which doesn’t mean what you think it does according to Vanity Fair) that it is seemingly sacrosanct. Lehman was a start, but they looked into the abyss and were afraid.

    The third, is a form of “manage down and muddle through” presided over by a Monetarist, (Go watch Bernanke fawn in front of Friedman. Somewhere around 2000/2001) or simply check his Bio. With initial “help” from Paulson, Ex CEO of Goldman, and Geithner, a backroom technocrat, thrust into the limelight by ill circumstance. This is a thoroughly right wing establishment affair. It will take years and will happily wear Keynesian clothing as cover, but it too preserves the wealthy and the senior debt holders, at the expense of the common man, who at the end of the day will be paying most of the taxes.

    This isn’t socialism, not even close. It has no social conscience for a start. Where is the new “new deal”, the G.I bill? The generation that went through the second world war begat the boomers, who begat the current soft handed crop, who think that the SUV, the McMansion, and the plasma TV are a birthright. When will they be tested by austerity? When will they find the same spirit? The backbone that took their grand parents through a depression and a war, back to back? Or indeed the drive that takes the immigrant and the underprivileged out of the slum.

    I’ll have an economic argument with you, if you’re willing to have an economic argument. A very simple form of which Neo-Keynesians and Monetarists agree upon is that the government should step in to bridge the output gap, to inject liquidity into the system, so to ensure the monetary/payment system continues to function normally.

    You could run a line of thought that said that if the USA did step back from military adventurism, then the world would be a more dangerous place. This would cause countries to re-arm, this would create demand for a useless consumption good, (armaments) which would not crowd out anything else, and would provide employment. This would do in a longer time frame what full militarisation did in a short time frame at the advent of the Second World War. Namely pull the World out of a global depression. There need not be a war, re-armament on a global scale, and the spending brought about by a more uncertain future should do the trick.

    If you want to make an economic argument, make it, if you want to make a political argument don’t dress it up as economics. Paying down debt is not incompatible with stimulus, and endless growth is the philosophy of a cancer cell.

  26. VG Chicago

    Forget about paying down debt. But neither is defaulting a viable solution. We got our pride. I hereby propose that We, The People (also known as “Americans” or “noble perpetual rulers of the world”) drive the entire world into total financial collapse. “Yes, We Can!”
    Then, once everybody’s in the gutter, we default too. But we don’t do it first. Got that? Capishe?

    Signed,
    Vinny GOLDberg (a.k.a. Maverick Economist Supremo, laureate expert in all kinds of economic theory, research, and practice, some of which used to be legal in Zimbabwe).

  27. Andrew Bissell

    Minsky was an “Austrian” but he wrote a biography of Keynes, and said effectively that he thought most people misunderstood the message.Minsky was definitely *not* an Austrian. In fact, I believe he even described himself as a Keynesian.

    Despite so clearly discerning the dangers of a “Great Moderation” caused by continual government propping of the financial markets, he continued to believe that “apt intervention” could effectively mitigate the consequences of the resulting debt deflation in the eventual bursting of the bubble. I believe the exact quote was something along the lines of (I’m seriously paraphrasing here), “the central bank should always stand ready to provide liquidity and prevent major failures in a crisis, and yet at the same time keep the market convinced that it *will* allow failures, so that risk taking does not get out of hand.” No self-respecting Austrian would write something like that, because Austrians do not hold this conceit, which Keynesians do, that the market can be fooled over the long term like that.

  28. DownSouth

    Andrew Bissell said…”Our economists and historians literally consider the period before FDR’s election in 1932 a Dark Age whose only relevance is providing examples of what not to do.”

    And perhaps with good reason:

    The nation’s citizens may well have thought of themselves as more vigorous, more inventive, more in harmony with the wishes of the Almighty, than any of their competitors. But judging by the outcome of some of the more important public debates of the period, most of them also believed that their good fortune resulted in the first instance from wise policy, in particular from the triumph of laissez-faire notions of political economy.

    Following the publication of Adam Smith’s treatise, An Inquiry into the Nature and Causes of the Wealth of Nations, in 1776, the idea that minimal government interference in trade and production meant maximum wealth and well-being gained at a rapid pace. Smith’s theories regarding the benefits of free trade were embellished by scholars like David Ricardo, and they entered the popular vocabulary through the speeches and pamplets of Richard Cobden and John Bright. By the middle of the century, after a series of intense struggles that tended both to demonstrate and to increase the political power of the new middle classes, most existing government constaints on commerce and, in particular, on overseas trade had been removed. What had begun as “a purely utilitarian and piecemeal movement, thriving on the mild modification of import duties,” had become “a doctrinaire force making for complete freedom of trade, backed by a whole philosphy of commerical liberalism and a new popular faith in the virtues of free competitive enterprise”…

    The apostles of free trade believed that commerce was a “grand panacea” for the world’s ills. By promoting global exchange they believed themselves to be unleashing a force that would eventually overwhelm national differences and unify mankind…

    Unencumbered exchange meant optimum efficiency and maximum global welfare, but it did not guarantee the lasting predominance of any one political unit. The free play of economic forces would undoubtedly result in shifts in comparative advantage in certain crucial industries, and it might also cause one nation to displace another as the leader in overall production and wealth. These were theoretical fine point with which most free traders did not concern themselves.~
    –Aaron L. Friedberg, The Weary Titan: Britain and the Experience of Relative Decline

    One must always keep in mind that these multi-national corporations have absolutely no loyalty to the United States nor to its people. Their interests align with only a very, very small number of Americans.

  29. Jamie

    Rolfe… the sticky leverage article is misleading because it tries to define leverage as debt/earnings rather than debt/equity. The former can rise whilst the later falls – which I assume it is doing.

    I wasn’t familiar with the feds flow of funds report, so thanks for that. It will be very interesting to see what the June figures will bring as I remain doubtful that aggregrate debt could possibly be rising in this environment. There is also the complication of previously hidden shadow banking system debt now coming into view.

  30. VG Chicago

    praxis22: “I’m a Neo-Keynesian, English, and a Socialist”

    Any other shameful personal secrets you’d like to confess about today?…LOL

    Vinny GOLDberg

  31. praxis22

    Andrew Bissell says “No self-respecting Austrian would write something like that”

    Minsky was a maverick, but got his doctorate from Chicago and studied under Schumpeter. He wasn’t a Keynesian.

  32. Russell

    I fail to see how anyone can use the growth from the 40′s onward as a model for going forward from here unless they’re including another world war. I don’t think a world war on the scale of WWII is feasible with today’s technology.It isn’t just WWII.

    We forget the numerous experiments in Europe and Asia with centrally planned economies (aka communism). This includes to a lesser extent France and Britain. The US was competing with essentially no one else except Japan and half of Germany (two former enemies!) who, by hook or by crook, did not fall into the trap of centrally planned stupidity.

    When China and half of Korea finally took their feet off the gas pedal of communism, they finally started producing things to trade. With LBJ and ALL of his successors (including the “conservatives”) variably increasing their acceleration of centrally directed industries, American competitiveness weakened and accounts receivable turned into accounts payable.

    In short, WWII begat American hubris and until we cure ourselves of that sin, we will pay the price.

  33. Rolfe Winkler

    ThreeFifty….thanks for a helpful opportunity to clarify. I don’t have a problem with stimulus, per se. I have a problem with runaway deficit spending.

    WSJ published a great piece on Chile a couple days back. Their stimulus plan is huge relative to GDP, but it’s being funded out of existing government savings.

    Stimulus funded with savings makes plenty of sense. My problem is that stimulus financed with deficit spending is counterproductive since, over the long-run, additional borrowing will put upward pressure on interest rates. This will cancel out any positive impact the stimulus might have had in the first place.

  34. Russell

    Our economists and historians literally consider the period before FDR’s election in 1932 a Dark Age whose only relevance is providing examples of what not to do.QFT.

  35. Russell

    However, there is some risk the U.S. could follow the path that Germany took the 1930s and 40s, combining a supercharged nationalism with military agression.Some risk?

    It’s been going on since Korea.

    Even Nixon’s ending of the Viet Nam fisaco was merely replaced by going to war on his own people with the moronic War On Drugs. Asset seizures, militarization of the local police…all from the fascist playbook. The US has the highest incarceration rate of any industrialized nation. It’s a shame and a disgrace.

  36. Hugh

    This article is based on a false premise. It leaves banks in their destructive current form and then says a Keynesian approach won’t work. Well, no approach is going to work under those circumstances.

    We actually need to be addressing all the fundamental problems underlying this collapse: mortgages through cramdowns, banks through bankruptcy, credit through bringing back usury laws, too big to fail with re-imposition of Glass-Steagall, regulation through simplifying derivatives and getting rid of some classes of them, like CDSs completely.

    And of course we need real stimulus for the real economy. Somehow the Fed has found trillions, and is promising trillions more, for banks. But when we come to the real economy where most of us live, suddenly the money is gone. Keynes won’t work, etc.

    There are two things to be said about this. First, Keynes will work now because the US can still borrow and there aren’t a lot of other places for money to go right now, at least if banks were forced out of their current return to speculative bingeing. Second, there is a real danger that the Obama Administration will waste the trillions it has access to the point where a Keynesian approach can’t be financed. Then we will really be in for it.

  37. Russell

    The second is what could be thought of as “Austrian lite”That’s called Chicago-School, which is the proper placement of Minsky.

  38. porttfe

    Total credit market debt as a percentage of GDP has risen from 130% of GDP in 1952 to 350%
    of GDP today. The various bailout and stimulus schemes enacted in the last year will drive
    this percentage above 400% in the near future. When a country allows this much debt to
    accumulate versus its GDP, they have done something seriously wrong. The country’s
    politicians, business leaders, and citizens have all contributed to this disaster.

    Interesting link>>> http://url.moosaico.com/10424 interesting finance and economics

    articles. cool site

  39. The Pragmatic Progressive

    What’s wrong with just inflating/devaluing the currency our way out of this? Obama’s economic and energy team are focused on making huge investments in alt. energy. If we can get off the $700 billion worth of imported oil, most other stuff we can provide for ourselves. Who cares if it costs $40 for a hamburger in Paris?

  40. Tortoise

    Wow, one of the best discussions taking place right on this thread.

    praxis22 is oh-so-right when saying: “If anything [Krugman] is speaking to public policy.” And so was Keynes, von Mises, or Friedman. And “If you want to make an economic argument, make it, if you want to make a political argument don’t dress it up as economics.” Yes, indeed!

    Russell: “In short, WWII begat American hubris and until we cure ourselves of that sin, we will pay the price.” Ouch, but I think you are right.

  41. Brian's Blog

    Rolfe wrote, “Brian….do you (and Krugman) honestly believe we can grow our way out of a $50 trillion debt hole (counting the government’s unfunded liabilities)? That’s patently absurd.

    We aren’t going to grow to infinity. Best we recognize that now.”

    Your OP is about government spending and macro policy. Including private debt, which is undergoing debt deflation via bankruptcies, writeoffs and being paid down – same thing happened in the Depression – has nothing to do with your neo-Keysian rant in the OP. Government debt as a percentage of GDP is nowhere near post WWII levels. Your response is a red herring.

  42. Brian's Blog

    Rolfe wrote, “Brian….do you (and Krugman) honestly believe we can grow our way out of a $50 trillion debt hole (counting the government’s unfunded liabilities)? That’s patently absurd.

    We aren’t going to grow to infinity. Best we recognize that now.”

    Your OP is about government spending and macro policy. Including private debt, which is undergoing debt deflation via bankruptcies, writeoffs and being paid down – same thing happened in the Depression – has nothing to do with your neo-Keysian rant in the OP. Government debt as a percentage of GDP is nowhere near post WWII levels. Your response is a red herring.

  43. Argel

    Rolfe, I actually thought you were quoting someone else and were going to debunk them afterwards. How disappointing!! Unfortunately for you I just read Krugman’s Intro to Keynes’s General Theory earlier today and quite frankly after that it’s just hard to take your post seriously. In fact, it’s hard to take anyone who attacks a specific column or post by Krugman seriously because his opinions, ideas, etc. are often spread across multiple posts, columns, etc. For example, here’s a post expressing concerns about deflation: A history lesson for Alan Meltzer. All of these inflation concerns, etc. remind me of the Eurozone, where their leaders (especially in Germany) have been so worried about inflation that even now as (according to Simon Johnson) deflation concerns continue to loom on the horizon they are still in denial. We need to tackle the problems of today or the ones tomorrow will not even matter. Sorry, but I think the likes of Krugman, DeLong, Mark Thoma, Felix Salmon, Simon Johnson, et. al. have this one covered better.

  44. Brian's Blog

    From Krugman’s “Debt in wartime” post:

    http://krugman.blogs.nytimes.com/2009/02/15/debt-in-wartime/

    “One way to look at our current predicament is through the lens of Irving Fisher’s theory of debt deflation: as everyone tries to work off excessive debt, the combination of a contracting economy and falling prices puts everyone deeper in the hole. But how do you get out? I’ve drawn the above chart using debt data from Historical Statistics of the United States Millennial; it shows the debt-deflation spiral of 1929-1933, and the partial recovery of the New Deal years.”

    Nice chart showing % of private and government debt relative to GDP

  45. Brian's Blog

    From Krugman’s “Debt in wartime” post:

    http://krugman.blogs.nytimes.com/2009/02/15/debt-in-wartime/

    “One way to look at our current predicament is through the lens of Irving Fisher’s theory of debt deflation: as everyone tries to work off excessive debt, the combination of a contracting economy and falling prices puts everyone deeper in the hole. But how do you get out? I’ve drawn the above chart using debt data from Historical Statistics of the United States Millennial; it shows the debt-deflation spiral of 1929-1933, and the partial recovery of the New Deal years.”

    Nice chart showing % of private and government debt relative to GDP

  46. VG Chicago

    DownSouth said: “However, there is some risk the U.S. could follow the path that Germany took the 1930s and 40s, combining a supercharged nationalism with military agression.”

    America becoming nationalist would be the best outcome we could hope for. However, anybody who is truly familiar with the U.S. and Europe will quickly realize that Europe is far, far more inclined to follow that path once again. Underneath the “soft power” bullsh*t spewing out of Brussels, and the self-righteous garbage that the EU is selling the world, there lies the same two-headed monster ready to lash out once again.

    Do a little research on Dominique de Villepin and the German counterpart and you will realize what they really are after, and what their goals are. Make no mistake, this de Villepin double-speaking mediocrity is deluded into believing that the degenerate France of today can recreate the Napoleonic glory. Fortunately, it’s likely the French army will go on strike just before it’s call to duty…LOL

    Also, go spend some time in places like Italy, Spain, Austria, and parts of France, and mingle with the locals, and you will be shocked to see how Fascist they still are in their thinking.

    Worse yet, when you are in Spain, check out the Basque Country, and ask people what is the current favorite torture technique employed by La Guardia Civil (Spain’s paramilitary police established by El Generalisimo himself).

    Now, here are a few more reasons why I think the EU (minus Eastern Europe) will become militaristic and start another round of carnage:

    First, the EU is not a democracy. Never was.

    Second, most EU citizens (not the ones from the east) are so brainwashed into thinking that they live in paradise, they are ready to do anything to maintain this “privileged” status, including go to war. They pity the Americans, but in their ignorance have not noticed that most median Western European salaries are well below the U.S. poverty line.

    Third, psychologically speaking, there is an incredible amount of anger in the European psyche (as a psychiatrist I tend to notice these things). A combination of anger for having to play third fiddle to the U.S., plus a repressed inferiority complex, combined with an overt superiority complex.

    Fourth, continuing to speak as a shrink, much of Western Europe shares the unconscious guilt of their murderous past centuries. However, because the anxiety of facing the truth would be unbearable, Western Europeans resort to a complex psychological defense mechanism known as “reaction formation,” by which they reject their past (and present) murderous wishes and project them onto somebody else, particularly the United States. They simply accuse us of what they are. Otherwise how do you explain their hate for the U.S. and love for murderers like Saddam Hussein?

    Fifth, do not underestimate the narrow-mindedness and ignorance of the average European, thus the ease of being manipulated. There is no discourse or debate going on in Europe. It all resumes to opposing the U.S. and Israel (today’s Europeans likely have repressed regrets for not having killed off all the Jews in concentration camps, 70 years ago). If you hang around Europeans long enough you will notice they have no ability to think critically.

    Sixth, do not underestimate the European official manipulation machine. The Orwellian MiniTruth is fully operational in Europe. Just watch the BBC or the French or German channels for a while, and you will see the patterns. It’s thinly veiled behind pseudo-dignified theatrics, but they are simply an ultra left-wing version of Fox News without the humor.

    My friend, I have been bashing on Europe here because they are The Beast to fear. The U.S. is too sincere, too introspective, too self-searching to do what Europe had done just a few decades ago. The only defense we have against amoral nations like those in Western Europe is to keep America strong, and to maintain our military bases across Europe (i.e., to keep Europe as “occupied territory”).

    Vinny GOLDberg

  47. Oregon Guy

    Krugman’s debt in wartime post doesn’t seem relevant to me because today the Fed/Gov are doing their utmost to encourage private consumption versus the policy in WWII, which didn’t just discourage private consumption, it was prevented via rationing. WWII brought full employment, forced savings, and an automatic rebuilding of personal balance sheets. In the aftermath of WWII the U.S. emerged as the world’s manufacturing leader competing against countries that had been decimated by war. Hence the (apocryphal?) steel salesman’s boast that “I don’t take customer orders, I tell customers how much we are willing to deliver.” And public debt could be paid down because the top tax bracket rate was 90% and capital gains were taxed as income.

    What policy today would lead to the same result in a non-wartime context?

    Examine a graph of 10-year bond rates since 1948. Rates have trended lower since 1981 as the Fed has labored to maintain 3.5% real GDP growth. The result has been two asset bubbles, stagnant wages, and a transfer of wealth to the highest income brackets.

    Wither now?

    I’m no Austrian, but I find myself in agreement with Rolfe here. What is the Keynesian plan beyond filling the “output gap” in our economy? I don’t feel a strong need for more strip malls, 3,500 sq. ft. homes in the great sprawling Suburbia, or another Starbucks on the corner. What future are we building and how will we pay for it?

    - Why is interest on debt tax deductible for individuals (mortgages) and business?
    - Why are capital gains taxed at 15%?
    - Why is the top tax bracket 35%?
    - Why does the payroll tax limit out at $100K in gross income?
    - Why does the U.S. spend significantly more on health care than any other country yet not lead the world on measures of general health?
    - Why does the U.S. have military bases across the globe and 13 aircraft carrier groups?

  48. Alex

    Oregon Guy: I think you’re already seeing the future, in forward-looking cities that are focusing on sustainability. As much as I hate the appropration/hijacking by the big PR and marketing firms of the important concepts of “green” and “sustainability”, the very fact that it has landed on their radars is a sign that people are beginning to think differently.

    The simple fact is that the US and most of the western world is overdeveloped. We produce so much food that a large percentage of it ends up being thrown away, and much of the rest is overconsumed (ie the growing obesity epidemic). This overconsumption ends up just destroying our health and quality of life in the plastic debris that shows up on our beaches, the cancer and asthma we get from our polluted air and general bad health from stress due to overwork and anxiety (but hey, we got some pills for that!).

    Our lives should not be mere bits being shifted around in databases.

    Of course the knuckle draggers who just want to enrich themselves at the expense of everyone will prevent any such heresy with all their power.

  49. bb

    1 objection: the treasury does not pay interest. it either rolls over with the next greatest fool, or prints the bills and monetizes the debt.

  50. praxis22

    Alex,

    The stagnant wages were a “gift” of monetarism. The only way to keep inflation low in a consumer economy in the long term is to suppress wage growth.

    However, in order to buy the new goods (output) of a consumer economy without wage growth, (inflation) the consumer must now take a out loans, (debt) in this way the balance is kept. Well, at least until we run over that old economics saw, “if something is unsustainable, it won’t be sustained”

    We have now reached that point in the cycle where an excess of debt and consumption has reached the point of being unsustainable.

    Hence, while Monetarism, is good for blowing bubbles, you need Keynesian technocrats or Austrian entrepreneurs to deal with the debt overhang.

    As previously noted, Austrian theory isn’t good for politicians or the ruling classes who have a vested interest in maintaining the status quo.

    YMMV

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