The nobel prize winning economist is (in)famous for his belief that more government spending will help solve short term unemployment without threatening Federal long term fiscal health. The first half of his position is arguably correct but the second half is a dangerous gamble.
Let’s assume Krugman gets his way and deficits increase even beyond their present day historical levels, how much debt will be on the books by the time we experience an economic recovery? Nobody can know for sure, but despite the market for Treasuries being the largest and most liquid in the world, the government already issues more bonds than can be absorbed today. The only reason the Treasury is able to continue even at the present inadequate (according to Krugman) levels is because during a depression the Federal Reserve can intervene without causing price inflation – the Federal Reserve is “printing money” to buy them.
However, by the time Krugman is satisfied with employment levels and government spending can begin to decline, the debt will have reached such historic proportions it will not be practical for the Federal Reserve to allow interest rates to rise; any increase will swamp the Federal government in interest payments. In response to such a crisis, the government will either have to raise taxes and kill the fledgling recovery or continue selling bonds to the Federal Reserve (printing money) despite the economic recovery… imagine how QE during an economic boom will be received by the market. How can the system keep inflation under control while printing money to finance the debt?
While Krugman is technically correct, the best kind of correct, about the ability of the government to increase spending today and not experience a fiscal collapse until some point in the future, he is not correct about the ability of the government to get its finances in order before that crisis hits. There will be no calm before the storm, we will transition directly from depression to crisis with no time to catch our breath.
But I’m sure you’re telling yourself they are smarter than that, if random internet guy has figured it out, I’m sure all the PHD’s at the Federal Reserve have as well. You’re partially correct, they have been buying longer term bonds in recent years to help prevent a sudden tsunami of interest payments when rates start to rise, but that means the Federal Reserve is sitting on an enormous amount of government securities that will soon plummet in value. There is no way they can sell long term government bonds yielding 3 or 4 percent back into the market to return it’s balance sheet to normal and prevent inflation from getting out of control, nobody will take them.
The Federal Reserve will have to mark down the value of those assets and probably render itself insolvent. Of course, the Federal Reserve can print money so maybe it doesn’t matter, but just imagine the politics. The economy is booming with inflation raging out of control and the central bank that brilliantly engineered a recovery without a tsunami of interest payments is now bankrupt and demanding the government reduce liquidity by raising taxes because it is unable to intervene in the market with anything other than words and interest rates. So much for independence, do you trust Congress that much?
And besides, this all assumes the economy will recover. What happens to the economy when the spending stops? If the economy never rebalances to something more sustainable than complete dependency on consumer debt and bubbles of various flavors, what happens to all those shiny new jobs once government demand disappears again? Can the government ever actually stop spending? It’s an important question we should not dismiss.
The value of any asset, no matter how vital, cycles between under valuation and over valuation – does the same concept hold true for aggregate demand? Can it ever be too high and actually need to drop for the economy to improve its health? It’s hard to argue America hasn’t been on a consumption and spending binge for the better part of the past several decades, perhaps a drop in demand is not the problem, but the solution.
I made this case years ago, America will have difficulty attracting new talent.
I have been discussing with Prof. David Andolfatto (a VP at the St. Louis Fed) the “idiocy” of a few accusations recently made by Ron Paul and the risks of transparency, however for some reason I am unable to post my latest response to this site. I won’t accuse him of blocking my IP (maybe there is a glitch with blogspot) but let it be known I could very easily use a different connection or a proxy to get around such a pathetic attempt at censorship. Instead I will just post it here, you should read the entire discussion on his site for this to make sense.
Update: David has confirmed he did not attempt to block my IP, I have been able to submit comments to his blog since this post. I look forward to his follow up post on this topic.
We have two banking systems, the official banking system and the shadow banking system. The official banking system runs on dollars, the shadow banking system runs on collateralized debt and other derivatives that trade as if they were dollars, I will call those derivatives shadow bucks. The reason dollars increased in value (which many people, myself included, didn’t expect) is due to what I call a “hyperinflation” of shadow bucks. The value of shadow bucks collapsed (as the housing and credit bubbles burst) causing prices measured in shadow bucks to soar. As any intelligent Zimbabwean with Zimbabwe dollars has already demonstrated, when the value of your money collapses you find alternate forms of money. Zimbabweans fled to US dollars, so did the holders of shadow bucks. The effect may not have been that significant if it weren’t for the size of this market — I didn’t appreciate the extent to which the shadow banking system dwarfs the official banking system. The buying pressure from economic refugees overwhelmed any other consideration.
I hear many people predicting gold will drop below $500. If it does, it would represent the buying opportunity of a lifetime, perhaps of several lifetimes. Those who believe gold should not continue its bull market advance believe we are entering a long-term economic bust that will reduce demand for everything other than money and consumer essentials. Indeed that would be true should the government sit idle, and they’re not, but that’s a topic for another post. Even if we experience a long term quasi-deflationary bust, here is where their analysis is mistaken — they presume people will always consider dollars the best form of money. Some say, “inflation in what you need, deflation in what you don’t” and since gold isn’t edible the price should drop, but that assumes people don’t need savings. Of course people need savings, especially rich people, and when you have a distribution of income as unequal as today, that means an enormous amount of savings may be looking for a new home.
This is my entry to Nick Rowe’s challenge to come up with a model demonstrating the damages of fiscal stimulus. The belief in government stimulus requires us to believe the previous level of demand is sustainable, desirable and not declining for some fundamental reason. That isn’t necessarily a question of economics, you can’t plot culture on a chart. If people were comfortable in previous decades living with more debt-based consumption and a bias towards equities instead of savings, but the culture changes and people are no longer comfortable with that formula, the economy has changed for a very real and fundamental reason. If people want less, why should the government force feed us things we don’t want? If people are determined to save and the government threatens to destroy savings (with negative interest rates or some other stupid ideas) people will simply find alternate means to save. Maybe they will hoard food or gold and cause other problems like shortages and hunger.
Arthur Keynes is the man largely responsible for creating the economic theories that justify our current form of big government capitalism. He is the man most commonly cited to defend fiscal stimulus and bailout packages and is followed by most modern economists, but is he the true father of abundance, and the current economic collapse the attempt to create abundance has created?
Everyone is looking for convincing evidence that prices have bottomed before concluding the recession is on the way out. I strongly disagree with that approach. Rising prices in the stock market reflect the speculative mood of investors and the lack of alternatives, it’s not a measure of new productive jobs. Rising prices for housing should actually be considered a negative given the millions of homes still waiting to be sold, if anything we should hope for lower prices so the market can clear and construction can resume. Rising prices for consumer goods or commodities can just as easily reflect a reduction in supply as an increase in demand. Prices are not irrelevant, but almost.
A single currency has been rumored as the goal of international bankers by conspiracy theorists for decades, it’s nothing new. The conspiracy goes much further, saying this is the first step on the road to one world government. Rockefeller has even admitted as much in his own auto-biography.
Many economists have long known that Chinese consumer demand must rise eventually to balance the excessive trade surpluses of previous years, but the government in Beijing has been actively preventing a shift in trading trends by manipulating the exchange rate through dollar recycling. Their intent is to maintain attractive prices and encourage further American consumption of their products; however, now that American demand is drying up despite cheap prices, there is no longer a reason to maintain an artificially low currency. It hurts China unnecessarily.