Yves here. Even though I agree with a good bit of Hudson’s post, I take exception to part of his argument, both in general and with Krugman. Hudson fails to distinguish between private sector debt (particularly consumer debt, whose overall level is negatively correlated with economic growth) and debt issued by a government that also issues its own currency. As we have stressed, unless a country runs a trade surplus (and if some countries run surpluses, other countries must run deficits), when the private sector delevers, the government sector needs to run deficits to accommodate the private sector deleveraging (otherwise GDP and wages contract, which is the austerian result Hudson wants to avoid). And that includes debt writeoffs. Although Krugman argues for deficit spending largely from a Keynesian perspective, he sometimes invokes the sectoral balances approach we described above.
Richard Koo, who coined the expression “balance sheet recession” stresses how financial-crisis-hangover high private sector debt loads are crippling. Consumers and businesses prioritize paying down debt over investing.
By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City and a research associate at the Levy Economics Institute of Bard College. His new book summarizing his economic theories, “The Bubble and Beyond,” will be available in a few weeks on Amazon.
Paul Krugman is widely appreciated for his New York Times columns criticizing Republican demands for fiscal austerity. He rightly argues that cutting back public spending will worsen the economic depression into which we are sinking. And despite his partisan Democratic Party politicking, he said from the outset in 2009 that President Obama’s modest counter-cyclical spending program was not sufficiently bold to spur recovery.
These are the themes of his new book, End This Depression Now. In old-fashioned Keynesian style he believes that the solution to insufficient market demand is for the government to run larger budget deficits. It should start by giving revenue-sharing grants of $300 billion annually to states and localities whose budgets are being squeezed by the decline in property taxes and the general economic slowdown.
To focus the argument against “Austerian” advocates of fiscal balance, Mr. Krugman hopes that economists will stop distracting attention by talking about what he deems not necessary. It seems not necessary to write down debts. All that is needed is to reduce interest rates on existing debts, enabling them to be carried. He does not advocate shifting taxes off labor onto property. The implication is that California can afford its Proposition #13 that has fiscally strangled the state by freezing taxes on commercial property and homes at long-ago levels. It is not necessary to change the economy’s tax shift off real estate and finance, except to restore a bit more progressive taxation.
The effect of Mr. Krugman’s suggestions is for the government to subsidize the existing financial and tax structures, not write down debts or make the tax system more efficient. So I am afraid that his book might as well have been subtitled “How the Economy can Borrow its Way Out of Debt.” That is what budget deficits do: they add to the debt overhead.
Mr. Krugman has gotten censorial regarding the debt issue over the last month or so. In last Friday’s New York Times column he wrote: “Every time some self-important politician or pundit starts going on about how deficits are a burden on the next generation, remember that the biggest problem facing young Americans today isn’t the future burden of debt.” Failure to see today’s economic problem as one of debt deflation means a failure to recognize the need for debt writedowns, restructuring the banking and financial system, and shift taxes off labor back onto property, economic rent and asset-price (“capital”) gains. The effect is to defend the status quo – and to me, that makes Mr. Krugman a conservative. I see little in his logic that would oppose Rubinomics, which has remained the Democratic Party’s program under the Obama administration.
Many of Mr. Krugman’s readers find him the leading hope of opposing even worse Republican politics. But what can be worse than the Rubinomics that Larry Summers, Tim Geithner, Rahm Emanuel and other Wall Street holdovers from the Democratic Leadership Committee have embraced?
Perhaps I can prod Mr. Krugman into taking a stronger position on this issue. But what worries me is that he has moved sharply to the “Rubinomics” wing of his party. He insists that debt doesn’t matter. Bank fraud, junk mortgages and casino capitalism are not the problem, or at least not so serious that more deficit spending cannot cure it.
Criticizing Republicans for emphasizing structural unemployment, he writes: “authoritative-sounding figures insist that our problems are ‘structural,’ that they can’t be fixed quickly. … What does it mean to say that we have a structural unemployment problem? The usual version involves the claim that American workers are stuck in the wrong industries or with the wrong skills.”
Using neoclassical sleight-of-hand to bait and switch, he narrows the meaning of “structural reform” to refer to Chicago School economists who blame today’s unemployment as being “structural,” in the sense of workers trained for the wrong jobs. This diverts the reader’s attention away from the pressing problems that are really structural.
The word “structural” refers to the systemic imbalances that neoclassical economists dismiss as “institutional”: the debt overhead, the legal system – especially bankruptcy and foreclosure laws, regulations against financial fraud, and wealth distribution in general. In 1979, for example, I juxtaposed economic structuralism to Chicago School monetarism in my monograph on Canada in the New Monetary Order. I have elaborated that discussion my textbook on Trade, Development and Foreign Debt (new ed. 2010). The tradition is grounded in the Progressive Era’s reform program. That is what classical political economy was all about – and what the neoclassical reaction sought to exclude from the economic curriculum. From the neoclassical writers through Rubinomics deregulators, the debt problem simply disappears.
So this is getting serious. I realize that it is more difficult to criticize someone for an error of omission than for an error of commission. But the distinction was erased a month ago when Mr. Krugman got lost in the black hole of banking, finance and international trade theory that has engulfed so many neoclassical and old-style Keynesian economists. But last month Mr. Krugman insisted that banks do not create credit, except by borrowing reserves that (in his view) merely shifts lending savings from wealthy people to those with a higher propensity to consume. Criticizing Steve Keen, who has just published a second edition of his excellent Debunking Economics to explain the dynamics of endogenous money creation, he wrote:
Keen then goes on to assert that lending is, by definition (at least as I understand it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand.
Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter? He seems to assume that aggregate demand can’t increase unless the money supply rises, but that’s only true if the velocity of money is fixed…
But “velocity” is just a dummy variable to “balance” any given equation – a tautology, not an analytic tool. As a neoclassical economist, Mr. Krugman is unwilling to acknowledge that banks not only create credit; in doing so, they create debt. That is the essence of balance sheet accounting.
Mr. Krugman then doubled down on his assertion that bank debt creation doesn’t matter. People decide how much income they want to save or how much to borrow to buy goods that its stagnant wage levels no longer are enabling them to afford. Everything is a matter of choice, not a necessity (“price-inelastic” is the neoclassical euphemism):
First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.
So how much currency does the public choose to hold, as opposed to stashing funds in bank deposits? Well, that’s an economic decision, which responds to things like income, prices, interest rates, etc.. In other words, we’re firmly back in the domain of ordinary economics, in which decisions get made at the margin and all that. Banks are important, but they don’t take us into an alternative economic universe.
As I read various stuff on banking — comments here, but also various writings here and there — I often see the view that banks can create credit out of thin air. There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect.
“Your money or your life” is what banks mean when they say, in effect, “Take out a mortgage or go without a home,” or “Take out a student loan or go without an education and try to get a job at McDonald’s.”
This blind spot with regard to debt derails Mr. Krugman’s trade theory as well. If Greece leaves the Eurozone and devalues its currency (the drachma), for example, debts denominated in euros or other hard currency will rise proportionally. So Greece cannot leave without repudiating its debts in today’s litigious global economy. Yet Mr. Krugman believes in the old neoclassical nonsense that all that is needed is “devaluation” to lower the cost of domestic labor. Costs can “be brought in line by adjusting exchange rates.” the problem is simply exchange rates. That will reduce labor’s cost and other domestic costs to the point where governments can export enough not only to cover their imports, but to pay their foreign-currency debts (which will soar in depreciated local-currency terms).
If this were the case, Germany could have paid its reparations debt by de
preciating the mark in 1921. But it did – a billion-fold, and even this did not suffice to pay. Neoclassical trade theorists just don’t get this.
Blindness to the debt issue results in especial nonsense when applied to analysis of why the U.S. economy has lost its export competitiveness. How on earth can American industry be expected to compete when employees must pay about 40 percent of their wages on debt-leveraged housing, about 10 percent more on student loans, credit cards and other bank debt, 15 percent on FICA, and about 10 to 15 percent more in income and sales taxes? Between 75 and 80 percent of the wage payment is absorbed by the Finance, Insurance and Real Estate (FIRE) sector even before employees can start buying goods and services! No wonder the economy is shrinking, sales are falling off, and new investment and hiring have followed suit.
How will the government running a larger deficit cope with today’s dimension of the debt problem – except to enable states and localities to spend marginally more revenue and avoid further layoffs, while the military industrial complex steps up its “Pentagon capitalism”?
This is the problem not only the United States but also in Europe. Germany balks at bailing out Greece until it will streamline its bloated government and inefficient bureaucracy, stop tax evasion by the wealthy, clean up corruption and, in a word, be more Germanic. The U.S. “Austerian” budget cutters whom Mr. Krugman criticizes likewise can point to wasteful government spending, failing to distinguish positive infrastructure investment from “roads to nowhere” promoted by Congressional earmarks to the tax loopholes inserted by politicians whose campaigns are sponsored by special financial interests, real estate and monopolies.
But I fear that Mr. Krugman is being drawn into the gravitational pull of Rubinomics, a dark Democratic Party hole from which the light of clarity dealing with the debt issue and bad financial and legal structures simply cannot escape. The only variables he admits are structure-free: The federal government can spend more, and interest rates can be lowered (especially on mortgages) so that the higher debt overhead can be afforded more easily. No need to write it down. That extreme a structural solution lies outside the scope of his neoclassical economics.
The problem is that bank debt creation plays no analytic role in Mr. Krugman’s proposals to rescue the economy. It is as if the economy operates without wealth or debt, simply on the basis of spending power flowing into the economy from the government, and being spent on consumer goods, investment goods and taxes – not on debt service, pension fund set-asides or asset price inflation. If the government will spend enough – run up a large enough deficit to pump money into the spending stream, Keynesian-style – the economy can revive by enough to earn its way out of debt.”
That is the problem with neoclassical economics. It brainwashes students to treat all activity as current spending and consumption. Debt is left out of account.
Without recognizing its role, on cannot see that what is preventing American industry from exporting more is the heavy debt overhead diverting income to pay Finance, Insurance and Real Estate (FIRE) expenditures. How can U.S. labor compete with foreign labor when employees and their employers are obliged to pay such high mortgage debt for its housing, such high student debt for its education, such high medical insurance and Social Security (FICA withholding), such high credit-card debt – all this even before spending on goods and services?
In fact, how can wage earners even afford to buy what they produce? The problem interfering with the circular flow between producers and consumers (“Say’s Law”) is not “saving” as such. It is debt payment. And without writing down debts, the U.S. economy will shrink just as will those of Greece, Spain, Portugal, Italy, Ireland, Iceland and other countries subjected to the Washington Consensus of neoliberal austerity.