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.
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.
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.
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The ideological arguments regurgitated by television talking heads, regarding how governments should intervene to resolve our current economic crisis, focus on whether bailouts should be directed at the rich or the poor… a difference without a distinction, in my opinion. Regardless of how money is injected it will always end up in the same place. Money flows in streams like water and it always trickles up because the rich own everything. When money is given to the poor, they will likely just save it in the bank, pay down debt or purchase consumer products — in other words, immediately rush to line the pocket of their neighborhood rich guy.
In most developed countries when people go bankrupt they become dependent on a government “social safety net” and drain the nation’s resources with unproductive expenditures. Keeping people fed is important, but it’s not going to help stimulate an economy out of recession. People aren’t likely to increase consumption with diminished income from employment insurance or the credit cards they don’t have. They aren’t likely to become more productive in a job they lost. Social stabilizer, yes. Economic recovery plan, no.
This guy claimed back when oil was near its peak that he was given inside knowledge of a coming oil collapse, the purpose of which would be to bankrupt OPEC countries and consolidate control over America. I remember reading his article at the time, and ignoring it, thinking he was nuts. I forgot about it until I came across this interview with Alex Jones.
How can a currency be in short supply and hyperinflationary at the same time?
Economics 101 tells us that reducing supply should increase price, but that doesn’t seem to apply in this case. Perhaps it’s because most banking happens electronically, or perhaps it’s because hyperinflation is as much psychological as monetary. They have lost confidence in the Zimbabwe dollar and there is nothing the government can do about it. Once the process gets going, even if you take away the punch bowl nobody cares.
I seem to remember Bernanke making the case US dollars will not lose their reserve currency status because there is a shortage around the world.