Addressing an RGD "review"

Jonathan Birge commits several errors in what he attempts to pass off as a "review" of The Return of the Great Depression, but they all stem from a single source. This is his inability to understand Paul Krugman's purpose in writing the "Hangover" essay or connect that purpose to Krugman's statement that total income is equal to total spending. This failure is the foundation of his bizarre attack on both my character and RGD; as he writes: “I'm simply pointing out that if Vox can't even understand what Krugman is talking about, on simple matters like this, how can one trust his dismissal of Krugman? One can be right for the wrong reasons, and if Vox is right about Krugman being an idiot, it's certainly not because Vox grasps what Krugman is trying to say.”

So, Jonathan's “review” can be summarized as three basic claims:

1. Paul Krugman had no substantive reason to declare that total spending equals total income.
2. I misread what Krugman had written when he declared total spending equals total income.
3. This single “misreading” justifies the complete dismissal of RGD.

I will now proceed to demonstrate the falsity of all three of these claims. When I read his review, it was immediately obvious to me that Jonathan did not understand what Krugman was saying about income and spending, much less why he said it, but Jonathan helpfully proceeded to admit as much in his subsequent comments. “Krugman wasn't making a big point: he was saying that whenever you get a dollar, some other entity gave it to you and had to consider that spending.... Why the hell Krugman brings it up is beyond me.” And yet, even when his erroneous assumptions were pointed out to him, Jonathan insisted that this supposedly inexplicable statement of Krugman's was not merely true, but a downright tautology “because it's simply a statement that when money changes hands, it's a debit for somebody and a credit for someone else. Debt doesn't change this, and time-preference isn't even germane to the debate. The fact that Vox brings up time-preference proves he had no idea what Krugman was trying to say.”

This is incorrect on several levels. Unlike Jonathan, I not only understand what Krugman was saying, I also understand why he was saying it. Far from being an irrelevant tautology, Krugman's statement that total spending necessarily equals total income is the basis of his erroneous argument against the Austrian concept of the business cycle. It is so important, in fact, that it was the only part of the essay that I deemed necessary to quote directly and in full. Although Krugman has since modified the position he took in his 1998 essay and admitted that perhaps investment bubbles do lead to economic contractions after all, the entire point of the essay was to prove that the Austrian school theory is wrong and that recessions are not a consequence of economic booms. Hence the title “The Hangover Theory”.

But before I explain why the assertion that total spending equals total income was both a) integral to Krugman's case and b) incorrect, it's worth pointing out that Krugman doesn't even believe that the assertion is intrinsically true, let alone tautologically obvious as Jonathan insists. When asked in October if the dichotomy between statistical reports of rising consumer spending and higher unemployment numbers contradicted “the economic maxim that expenditures are equal to income” Krugman replied: “That 'economic maxim' is deeply misleading. Consumers can and do spend either more or less than their income. And even for the economy as a whole, in the short run income adjusts to match spending, not the other way around.”

Krugman admits what I originally stated: total spending does NOT necessarily equal total income. It cannot, obviously, since income has to adjust in order to match spending. Now, why does income have to adjust to spending and why doesn't it work the other way around? We can only surmise that there must be some additional factor that would allow spending to take place without income... whatever could that be? Finally, why would Krugman declare something that he later states to be misleading? In this case, it is not an example of his occasional inconsistency or because he changed his mind since 1998, but because he needed to make the income-spending equivalence in order to attack a specific point of Austrian business cycle theory. While Krugman doesn't know much about Austrian theory and mistakes malinvestment for “overinvestment” in “investment goods” (capital goods is the Austrian term), he knows just enough about it to understand that the Austrians place great theoretical importance on the shift from investment in the production of consumer goods to investment in the production of capital goods. However, because he has not actually read much, if any, Austrian theory, he does not understand the mechanism of that shift, which in its conventional formulation is the result of expanded bank credit producing false signals that encourage businesses to invest in producing higher-order capital goods rather than lower-order consumer goods. Since he doesn't understand the mechanism, he wrongly concludes that a converse shift in investment from consumer goods to capital goods will have an equal but inverse effect as the shift from capital goods to consumer goods. If the former can cause a recession, he decides, then the latter should too.

This is why he wrote: “So if people decide to spend less on investment goods, doesn’t that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom?” This is a major sticking point for Krugman; earlier this year he wrote: “you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.” He derives this false equivalence from the very statement for which Jonathan sees no point, the statement that is the foundation of his argument against Austrian business cycle theory.

“Here’s the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods....”

It should now be clear that Jonathan is incorrect, that Krugman's statement is not a tautology and that Krugman was using it to make a big point, the central point of his argument. It should also be clear that I understand what Krugman is saying and why he is saying it. But, even if I didn't misread Krugman, did I make a mistake in referring to individual decisions about equities and cars? Was it an error to highlight the facts that not every dollar of income must be spent today, and not every dollar that is spent today is earned? No, of course not. Here is why.

Let's start with Jonathan's assertion about the first point. “In no case would the actions of a single person possibly illuminate or refute the point Krugman was making (which is that each transaction requires two parties where each take the opposite side of the trade).” But, as I've already demonstrated, Jonathan failed to understand the point Krugman was using that statement to make. The actions of single person serve very well to illuminate the fact a failure to invest in capital goods does not require an investment in consumer goods, for the obvious reason that what is being considered is the sum total of all the actions of individuals. Krugman himself refers to precisely such individual actions when he writes that “if people decide to spend less on investment goods, doesn’t that mean that they must be deciding to spend more on consumption goods...?” These are individual decisions, nor can Jonathan claim they are not thanks to Krugman's more recent distinction between “consumers” who can and do spend either more or less than their income and “the economy as a whole.” While there are a few areas that Keynesian theory insists on making a distinction between that which benefits an individual and that which benefits the aggregate, such as Keynes's Paradox of Thrift, that does not apply to this example where the individual's investment decisions will have a directly quantifiable effect on the aggregate.

Now to my two statements about the observable facts that puncture Krugman's dilemma. Because Jonathan did not read the book, he is unaware that a great deal of attention is given to the nature of money, central banking and the fractional-reserve system. By his own admission, he does not understand how a modern monetary system works; he says: “I don't know how the accounting works for things like Fed operations....” More importantly, his subsequent comments reveal that he doesn't even know what money in a modern economy actually is, as after being given a hint of the magnitude of his error by Steveo, he attempts to equivocate by creating a false distinction between bank-created debt and money.

that makes it sound like banks can print money, which they can't. they issue debt that, in our system of fractional reserve banking, is legally declared equivalent to money. when a bank issues a loan, the bank is not spending money any more than you're getting income when using your credit card.

Had Jonathan actually read RGD, he would know that in the U.S. and most modern financial systems, money is debt, which is why the politicians around the world are so desperate to force the banks to increase their lending. This is the heart of the very important debate over inflation vs debt-deflation that has been going on for the past five years between economists who foresaw the crisis and actually understand what is taking place right now. But for the purposes of this explanation, it is sufficient to point out that when a bank issues a loan, it is not spending money, it is creating money. In fact, this fractional reserve-created money is by far the larger portion of the money supply; Jonathan's knowledge doesn't even rise to the level of Wikipedia, which states: “The different forms of money in government money supply statistics arise from the practice of fractional-reserve banking. Whenever a bank gives out a loan in a fractional-reserve banking system, a new sum of money is created. This new type of money is what makes up the non-M0 components in the M1-M3 statistics... central bank money is M0 while the commercial bank money is divided up into the M1-M3 components”

Now, where does M1-M3 come from? From savings deposited in the banks, or in other words, “every dollar of income that is not spent today.” So, far from being equal to income, spending in a fractional-reserve system is always a multiple of income, the process which Paul Samuelson laid out in detail in the table entitled Multiple Expansion of Bank Deposits through the Banking System in his influential textbook. Jonathan's mistake here is to assume that the mere fact of money changing hands causes it to be regarded as both income and spending. He writes: “You don't need to know much about economics to grasp the simple idea that every buy involves a sell. It's as simple as that. Your income is somebody else's expenditure.”

Therein lies his fundamental mistake. Every buy does involve a sell and your income may be somebody else's expenditure, but that does not mean your income is somebody else's expenditure derived from their own income. In claiming that spending equals income, Jonathan has erroneously assumed a closed loop. If a company borrows money from a bank in order to pay me for my services, its expenditure was not derived from its income and only a fraction of it was derived from anyone else's income. Spending can come from income, but it does not have to do so. And, as I have shown in past posts, the larger part of the growth in aggregate spending has come from this very bank-created non-income that Jonathan claims does not exist.

Perhaps it might have been easier on economic novices like Jonathan had I troubled to go into detail explaining that the existence of savings in a fractional-reserve banking system is sufficient to explode the false equivalency of spending and income. Perhaps it was too much to expect that the average reader would be able to correctly grasp the consequential implications of a failure to spend 100 percent of one's income. Nevertheless, my failure to spell things out for the reader does not change the accuracy of my observation that unless every dollar of income is spent rather than saved, deposited, and loaned out, total spending will never equal total income in a modern economy with fractional-reserve banking. Nor would additional explanation alter in the slightest the correctness of my statement that not every dollar that is spent today has been earned. Because debt is not income and some spending is funded by debt, total spending does not equal total income, but rather, exceeds it. This is, of course, the very first thing I pointed out in addressing Krugman's fallacious attack on the business cycle.

So, Jonathan's first two points fail, which thereby causes his third point to fail as well. It makes no sense to dismiss a book for a nonexistent error and the only misreading of Krugman that took place was Jonathan's. These were not his only errors, but this demonstration of the falsehood of his three primary claims will suffice to prove that his "review" of RGD is flawed to the point of utter irrelevance. And I will also take strong exception to his assertion that an error, even an egregious error, renders the entirety of a book useless. For example, if we were to accept Jonathan's specious logic, we would have to conclude that Paul Krugman's most recent book, The Return of Depression Economics, should be junked due to Krugman's statement that “about half the banks in the United States failed” in 1931. The correct number was about 11 percent. Contra Jonathan, I assert that ignoring Krugman's book would be a mistake and that despite his failure to account for debt or time preferences, Krugman is not an idiot, but is merely crippled by his past success, his stubborn dedication to an erroneous and outmoded economic model, and his willful refusal to consider other, more reliable economic theories.

As to the questions, credit yourself if you spotted Jonathan's errors:

5 points: I did not interpret Krugman's income-spending equivalence “to mean that every dollar of one's income one must spend.”

10 points: Krugman's income-spending equivalence was not an obvious tautology. Nor was it a pointless statement.

25 points: Fractional-reserve banking.

It is not my habit to copy and paste complete texts from other sites, but since Jonathan elected to question my "balls" for merely quoting the most relevant part and providing a direct link to it, here it is in its entirety:

Vox Day, for those who don't know, is a libertarian Christian blogger, known more for his penchant for hyperbole than reasoned argument. However, he's intelligent and well-read enough that it takes a little while to realize that he's all bluster and little substance, and this, coupled with his supreme confidence in his own intelligence, has resulted in him attracting a moderately large legion of sycophantic followers to his website. No doubt it is such people who have given glowing reviews to this book.

However, anybody with a capacity for independent thought ned only peruse a few sample pages from this book to see what a charlatan Vox is, at least when it comes to economics. His prose is so self-consciously academic, that it almost lulls one into complacently following along. But where he is right, he is regurgitating the work of others. Where he strays from this, however, close inspection reveals profound mistakes. Styling himself an Austrian economist, a reading of his criticism against Krugman makes it clear that Vox is well out of his depth, so embarrassingly so that one need read no further. On pages 163-164, he make an ludicrous strawman rebuttal of an argument of Krugman's. To be specific, he misreads Krugman's statement that all income is spending (and vice versa) to mean that every dollar of one's income one must spend. He then spends the next several paragraphs ackwardly informing us of the obvious, such as that when one doesn't buy a factory, that doesn't mean they must buy something else. I almost feel bad for Vox, as he gloats in his victory over an argument nobody would ever be dumb enough to make. (And I would think nobody would be dumb enough to think somebody with a Nobel Prize would make it, either.) He accuses Krugman of not understanding simple things like time-preference or the effects of debt, of essentially being a base moron.

Of course, what Krugman means is that one person's income must come from somebody else's spending, an obvious tautology. Sadly, I don't think Vox was trying to pull anything. I think Vox really believes he understands this stuff enough to write about it, when it's seems all he knows how to do is reference other works in a pseudo-academic tone and parrot the names of concepts he's read.

It takes some serious guts to write a book insulting a Nobel Prize winning economist when you never worked a day as an economist, but if this book makes one thing clear (and it would be the only accomplishment of this book) it would be that Vox Day is a pathological narcissist. In fact, I'm sure if Vox ever comes across this review, he'll make equally shoddy strawman arguments against it, skewer it to the front page of his website, and sooth his ego with the reassurances of those who are greater fools than he.

(For the record, I'm not defending Krugman or Keynesian economics. I'm a libertarian myself, and subscribe to Austrian economics to the limited extent I understand it. I actually came to this book thinking I'd like it and learn a lot from it. Unfortunately, I'm compelled to review it poorly. I've never written a review on a book I didn't read completely, but sometimes it's justified when the author makes such egregious errors in the first chapter one peruses. You don't need to finish an entire turd sandwich to know the last bite is going to taste as bad as the first.)

Krugman for OMB

In which I wholeheartedly support Simon Johnson's call for Obama to nominate Nobel-winning economist Paul Krugman to the Office of Management and Budget:

The president should nominate Paul Krugman to replace Peter Orszag as director of the Office of Management and Budget. We have previously reviewed Krugman’s outstanding qualifications for this (or any other top level) job (link to details). The main reason Krugman himself has been reluctant in the past relates to a potentially difficult Senate confirmation hearing – for example, if Krugman had been put forward to replace Ben Bernanke.

But for the OMB position, the dynamic of a hearing would be terrific for the president’s specific agenda and broader messages. Krugman, of course, is the leading advocate for continued (or increased) fiscal stimulus. This is exactly President Obama’s message to the G20 this weekend.

Plus, when Republicans push back against Krugman on this issue, he will let them have it full blast on fiscal policy during the Bush administration. Krugman has, again and again, been an outspoken critic of the Bush era fiscal policy. He has precise chapter and verse on where the Bush team went off the deep fiscal edge.

I think this is a fantastic proposal for three reasons. Consider the benefits: 1) Krugman gets the chance to prove once and for all that Neo-Keynesian economics does not work even when its foremost champion is in a position of power. 2) He will no longer be writing ridiculous opinion columns. 3) Within 18 months, the rest of the world will be forced to acknowledge that Krugman is a maleducated ignoramus who knows virtually nothing about relevant economic theory. 4) Mainstream economics can finally move on from an outdated and destructive economic theory.

And there's no downside. It's not as if Obama is going to appoint anyone who understands the first thing about the present contractionary crisis, after all. Krugman can't possibly make things any worse than whatever clueless hack ends up getting appointed; for all Krugman's willful theoretical incompetence, he's actually less cretinous than the average mainstream economist.

A note to Paul Krugman

Paul Krugman writes on his blog:

Hmm. I’m fairly accustomed to having speaking events disrupted by Larouchies (when I was in Cambridge a while back we had a guy yelling about banana fungus, among other things, who had to be shouted down by the audience).

But last night at Baruch the problem was Austrian economics/Ron Paul people who just wouldn’t stop talking.

On the whole, I might prefer the banana fungus.

I wrote the following reply and much to my surprise, it passed NYT moderation:

Dr. Krugman, I own all your books and have quite enjoyed several of them, particularly “The Accidental Theorist”. You are an engaging writer and have done some fascinating and genuinely ground-breaking work in the area of currency attacks.

Unfortunately, you literally do not know what you are talking about whenever you attempt to discuss Austrian economics. In your 1998 Slate essay entitled “The Hangover Theory”, it is perfectly clear that you have never read any Austrian economic theory because you are demonstrably unfamiliar with both the relevant economists and Austrian terminology. (For example, Schumpeter was an Austrian national and an economist, but he was not an Austrian economist.) What you have been criticizing and belittling is nothing more a strawman of your own concoction.

When even The Economist is describing the global financial crisis and the developing Great Depression 2.0 as a failure of academic economics, it should be clear to everyone that your appeal to academic authority is nonsensical. Your refusal to learn from the school of Menger, Bohm-Bawerk, Mises, Hayek, and Rothbard is precisely why your policy prescriptions for the Japanese and U.S. economies have reliably failed for more than ten years.

The biggest problem is your theory-based inability to understand that debt not only matters, it is the single most important variable in the modern economic equation. The fact that Keynes left it out of his general theory and Samuelson subsequently left it out of his practical application has badly crippled your ability to understand the present situation. It does not behoove an intellectual to dismiss what he does not know, so therefore I encourage you to give Austrian business cycle theory a sincere shot before casually dismissing it again.

UPDATE: We have our first one-star Amazon review by someone who admits he didn't read the book! It took longer than I thought, but one Jonathan Birge has produced a beauty that really has to be read to be believed. The astounding thing is that the guy read my criticism of Krugman's critique of what he imagines Austrian economics might be, and somehow managed to reach this conclusion:

Styling himself an Austrian economist, a reading of his criticism against Krugman makes it clear that Vox is well out of his depth, so embarrassingly so that one need read no further. On pages 163-164, he make an ludicrous strawman rebuttal of an argument of Krugman's. To be specific, he misreads Krugman's statement that all income is spending (and vice versa) to mean that every dollar of one's income one must spend. He then spends the next several paragraphs ackwardly informing us of the obvious, such as that when one doesn't buy a factory, that doesn't mean they must buy something else. I almost feel bad for Vox, as he gloats in his victory over an argument nobody would ever be dumb enough to make. (And I would think nobody would be dumb enough to think somebody with a Nobel Prize would make it, either.) He accuses Krugman of not understanding simple things like time-preference or the effects of debt, of essentially being a base moron.

Of course, what Krugman means is that one person's income must come from somebody else's spending, an obvious tautology. Sadly, I don't think Vox was trying to pull anything. I think Vox really believes he understands this stuff enough to write about it, when it's seems all he knows how to do is reference other works in a pseudo-academic tone and parrot the names of concepts he's read....

(For the record, I'm not defending Krugman or Keynesian economics. I'm a libertarian myself, and subscribe to Austrian economics to the limited extent I understand it. I actually came to this book thinking I'd like it and learn a lot from it. Unfortunately, I'm compelled to review it poorly. I've never written a review on a book I didn't read completely, but sometimes it's justified when the author makes such egregious errors in the first chapter one peruses. You don't need to finish an entire turd sandwich to know the last bite is going to taste as bad as the first.)

By "limited" Jonathan clearly means "not even a little". Now, Five points if you can spot what the kid got hopelessly wrong about what I wrote. Ten points if you can spot what he got completely wrong about what Krugman wrote. And twenty-five points if you can spot what major aspect of a modern economy, besides debt and time-preferences, Krugman revealed his theoretical model is not taking into account.

Krugman attacks logic, hilarity ensues

Paul Krugman inadvertantly reveals a glimpse into his reasoning process:

My wife and I were thinking of going out for an inexpensive dinner tonight. But John Boehner, the speaker of the House, says that no matter how cheap the meal may seem, it will cost thousands of dollars once you take our monthly mortgage payments into account. Wait a minute, you may say. How can our mortgage payments be a cost of going out to eat, when we’ll have to make the same payments even if we stay home? But Mr. Boehner is adamant: our mortgage is part of the cost of our meal, and to say otherwise is just a budget gimmick.

O.K., the speaker hasn’t actually weighed in on our plans for the evening. But he and his G.O.P. colleagues have lately been making exactly the nonsensical argument I’ve just described — not about tonight’s dinner, but about health care reform.

in 1997 Congress enacted a formula to determine Medicare payments to physicians. The formula was, however, flawed; it would lead to payments so low that doctors would stop accepting Medicare patients. Instead of changing the formula, however, Congress has consistently enacted one-year fixes. And Republicans claim that the estimated cost of future fixes, $208 billion over the next 10 years, should be considered a cost of health care reform.

But the same spending would still be necessary if we were to undo reform. So the G.O.P. argument here is exactly like claiming that my mortgage payments, which I’ll have to make no matter what we do tonight, are a cost of going out for dinner.

Krugman's column is based upon three assertions. Number one, that the large divergence in the cost of a mortgage versus an inexpensive dinner is comparable to the cost of future fixes versus the total cost of health care reform. Let's consider that one first. The average monthly mortgage payment is around $1,750. An inexpensive dinner for two is around $50. Krugman tells us the cost of fixing Medicare for 10 years is $208 billion. The CBO's revised estimate for health care reform, which does NOT include the Medicare fix, is $1,055 billion. (The Republicans say that the total will be $2,600 billion, but we'll go with Krugman's favored estimate just to be fair to him.)

So, the Nobel Prize-winning economist Krugman is claiming that 1750/50=208/1055, or that 35=0.197. And you wonder why the economy is in such dire straits...

Number two, Krugman is assuming that the Medicare fix is as inevitable as a mortgage payment. But this quite clearly isn't the case; whereas not making the mortgage payment entails losing the house, (or at least it did back when mortgage banks held legitimate title to houses and were actually willing to foreclose on properties and write off the bad loan), the possibility that doctors might elect not to see Medicare patients hardly makes increasing Medicare payments a necessity. There are other options available that don't require spending the money, which is not the case when it comes to making mortgage payments.

Number three, Krugman declares that "the modern G.O.P. has been taken over by an ideology in which the suffering of the unfortunate isn’t a proper concern of government, and alleviating that suffering at taxpayer expense is immoral, never mind how little it costs." But if this were actually the case, then the modern G.O.P. would simply solve the budgetary problem by not spending the $208 billion instead of insisting that it be counted as part of the cost of health care reform. Even if we ignore the fact that this is the fiscally responsible decision as well as the Constitutionally correct thing to do since Medicare is not a legitimate function of the federal government, Krugman's failure to realize that the Republicans are not advocating this only underlines his complete logical incoherence.

Far be it from me to defend the Congressional Republicans, but for all their ill-conceived enthusiasm for illegitimate military adventures, a war on logic is not one in which they are presently engaged. It is instead Paul Krugman who is waging a public one-man crusade against it.

Krugman gets it wrong... again

Imagine that:

Paul Krugman has weighed in to an ongoing debate sparked by Jonathan Chait’s criticism of a passage in my essay “Keeping America’s Edge.” I believe that I have responded to Mr. Chait’s assertions comprehensively. Unlike Chait, Professor Krugman has argued that I have presented incorrect data.

Krugman says this:

But I went back to Manzi's source of data, and it turns out that it's even worse than that. If you use the broad definition of Europe, which includes the USSR, it did indeed have 40 percent of world output in the early 1970s. But that share has not fallen to 25 percent — it's still above 30 percent.

His assertion is flatly false.

First, Krugman has incorrectly identified my source of data. I have never corresponded with Krugman concerning data sources and analysis for the passage in question (unlike Chait, who was careful to contact me prior to publishing his blog post, and to whom I sent data sources and calculation details), so I cannot know on what basis Krugman asserts that the dataset to which he links is my “source of data.” It is not. As per the blog post in which I reviewed multiple data sources for the analysis in question, I averaged multiple sources of data. Krugman has selected only one of these sources, presented it as if it were my sole source, and therefore (obviously) failed to replicate the published result. The error is his.

Second, Krugman incorrectly interpreted the economic dataset that he did identify.

I know I'm shocked that A NOBEL-WINNING ECONOMIST could get it so wrong. And speaking of errors and Krugman, a recent reviewer of RGD managed to impressively cock things up in "correcting" my explanation of the loan multiplier in a fractional reserve system. Amusingly, he seizes upon this "error", combined with the fact that I dared to criticize A NOBEL-WINNING ECONOMIST, to claim that the book "Should Never Have Been Published". While I have to take responsibility for failing to distinguish between "the bank" and "the banking system", our intrepid reviewer nevertheless managed to completely miss both the obvious context (the fractional reserve system) as well as the point (the increase in the money supply created by the loans). I'll explain this in more detail later this week for the six regulars who are actually interested in this sort of thing as well as any anklebiters who would like to revel in the possibility that I am wrong about something, but if you'd like to verify this for yourself, I would encourage you to plug a 0.75% reserve ratio into the table in the Wikpedia example - note that I was completely unaware of this table until about two weeks ago - and compare it to the Loan Multiplier of 133.33x to determine for yourself whether Mr. Eskildson's "correction" is on target or not.

It should be noted, that this method only provides an estimate for the amount of interest collected over the course of the year, since this completely depends upon the number of loan-and-deposit cycles that occur over the course of the year as well as the three caveats mentioned in the book. Using the 10x example from Wikipedia would mean that $4.80 in annual interest is collected, which is neither the maximum $6.67 mentioned in RGD nor the $0.0599 which the reviewer claims is the correct amount.

An economic masochist

Paul Krugman endorses Ben Bernanke's reappointment to a second term as Chairman of the Federal Reserve Board of Governors:

Ben S. Bernanke deserves another term as Federal Reserve Chairman based on his success in battling the financial crisis, said Princeton University Economist Paul Krugman, a winner of the Nobel Prize.

“He’s earned the right to a second term,” Krugman, 56, said yesterday in an interview in Kuala Lumpur. “He turned the Fed into the financial intermediary of last resort. When the banking system failed to deliver capital where it was needed, he put the Fed into the markets.”

Debate over the fate of Bernanke, 55, is intensifying as he nears the end of his four-year term as chairman on Jan. 31. While Krugman and economist Nouriel Roubini have voiced support for the former Princeton economist, others including Anna Schwartz have said a lack of transparency exacerbated the financial crisis.

“I think Bernanke has done a really good job,” Krugman said. “He failed to see this coming and he was behind the curve in early phases. But he’s been really very good in the sense that it’s really very hard to see how anyone could have done more to stem this crisis.”

Krugman's logic is, as usual, hopelessly hapless. One suggests that it would have been fairly easy to do more to stem this crisis, beginning with seeing it coming and not getting behind the curve in the early phases. And, of course, that's not even beginning to get into the insane attempt to prevent home loan defaults by giving billions to the holders of mortgage-backed securities. Or cutting interest rates when raising them was required. Or driving total credit market debt to nearly 4x GDP. Or refusing to turn over the hidden records of more than 12.8 trillion in grants and loans given out by the Fed and funded by the public. Undsoweiter....

And on a related note, read this and cringe in terror:

What most readers probably don’t know is the reason Krugman became an economist in the first place. “I went into economics,” he wrote in an e-mail message, “because I read Isaac Asimov’s Foundation novels, in which social scientists save galactic civilization, and that’s what I wanted to be.”

As an Austrian who has read Foundation several times and therefore fully grasps the implications of what drives Krugman's emotional attachment to Keynesianism, one thought leaps immediately to mind: Sweet St. Darwin of the Galapagos, prega per noi condannati!

UPDATE- Some words were simply made for eating:

So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.
- Paul Krugman, August 9, 2009

Krugman's article is not only likely to blow up in his face over time, it's simply wrong. "The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed." This is hugely misleading. Bank failures as a percentage of total bank deposits in 2008 and 2009 are running at a rate double that of the bank failures of 1930 and 1931. In August, with at least three very large bank failures known to be in the works but not yet counted, it's already 3.75% in 2008-09 vs 1.99% in 1930-31

The Irrational Economist

A Keynesian who rejects the Austrian theory of the business cycle is no more credible than an alcoholic who doesn't believe in hangovers or a rocket scientist who doesn't believe in gravity:

A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle—a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking—not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

Is there anything more foolish than responding to an inquiry about your own inadequacies than making a naked appeal to your own authority? Paul Krugman isn't just an intellectual coward afraid to engage his critics, in this essay he shows that he's an unmitigated ass to boot. The idea that Austrian theory isn't worthy of serious study was remarkably stupid in 1998; it's arguably insane now that not one, not two, but THREE credit inflation-induced "hangovers" have occurred since then. One could make a much more reasonable case that Keynesian theory is only worthy of serious study in sense that a flight recorder demands intense examination after an airplane crash. It would also be interesting to see if Krugman would describe gravity in a similarly perjorative fashion: the damage an object suffers in falling to earth being the "necessary punishment" for having been projected aloft. AGDers will note that Krugman's incorrect terminology is precisely what Rothbard predicted of Keynesian critics 25 years before:

“Overinvestment” or Malinvestment? The second misconception, given currency by Haberler in his famous Prosperity and Depression, calls the Misesian picture of the boom an “overinvestment” theory.
- Murray Rothbard, America's Great Depression, p. 30.

The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love. Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

Krugman is frantically waving a red herring about by attempting to bring morality into the discussion. But morality has absolutely nothing to do with the accuracy or inaccuracy of the Austrian model; it simply doesn't enter into the equation. And the strange frequency with which economic recessions follow expansions can no more be blithely wished away than the consequences of gravity. As Rothbard pointed out, Keynesians like Krugman have no rational explanation for the observable fact that busts do follow booms, which is why their witch-doctoring and appeal to "animal spirits" and "consumer confidence" are so hopelessly ineffective. Krugman is also factually wrong about the effect of "Liquidationist views" in bringing about the Great Depression, as the following statement on the matter conclusively demonstrates that the liquidationist position was uniformly rejected by the pro-intervention financial and monetary authorities in power at the time:

"[W]e might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. . . . We determined that we would not follow the advice of the bitter-end liquidationists and see the whole body of debtors of the United States brought to bankruptcy and the savings of our people brought to destruction.
- Herbert Hoover, 1932

While Joseph Schumpeter was both an Austrian national and an economist, he is generally not numbered among the economists of the Austrian School. Krugman's mention of Schumpeter rather than Mises, Bohm-Bawehrk, Ropke, or Rothbard indicates that he knows next to nothing of the theory he is attempting to critize. And how, one wonders, can the views held by proponents of the Austrian school, precisely none of whom are holding any positions of political influence and power of the sort currently held by Monetarists and Neo-Keynesians, possibly be blamed for the very ills of which they have been warning everyone for more than a decade, especially by a prize member of the economic elite who, at the time of this essay's writing, was still seven years from recognizing the existence of the housing boom... and subsequent bust.

The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity—of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes—investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.

As every AGDer knows, the investment boom does not get out of hand for some mysterious, unknowable reason, it gets out of hand due to credit inflation caused by the central bank. Amazingly enough, a survey of the Federal Reserve's actions between 1998 and 2008 will show that the bank engaged in a tremendous amount of credit inflation, subsequently followed by the investment boom in housing. I note that the historic boom in housing prices was followed by the very economic hangover that the Austrians predict, and which Krugman is mocking here.

Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles. Anyone who has watched the ups and downs of, say, Boston's real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life. But let's ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole? Don't say that it's obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them. And in fact the key to the Keynesian revolution in economic thought—a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles—was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.

Krugman is turning the facts upside-down here vis-a-vis the explanations offered by the competing economic models. Austrian theory articulates a very clear answer to why the whole economy slumps. The misallocation of investment resources due to credit inflation means that goods are being produced that consumers neither want nor need. This, combined with price increases that increasingly put goods out of reach of those who are not the beneficiaries of inflation, causes the demand gap that so concerns Krugman. It's a concrete explanation and much more empirically demonstrable than the mysterious disappearance of consumer confidence that the Keynesians blame, and is directly connected to other observably causal factors such as the interest rate cuts. Krugman is either playing dumb or is genuinely ignorant of how the Austrian school answers these questions.

Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

Krugman here makes the error that Joseph Schumpeter dismissed as "the Ricardian vice", freezing all but a few variables in order to pose a false dichotomy. This artificial dilemma is punctured by the obvious fact that not every good produced must be sold; like most Keynesians, Krugman gets hung up on the inability of the Keynesian model to properly account for time-preferences or savings. If someone doesn't buy a stock or put his cash in a money-market fund, that doesn't mean he must have bought a lawnmower. And why should there be a rise in unemployment? Because when there is a credit-inflated boom that results in you working at a job producing goods that no one wants, needs, or can obtain financing for, and your employer cannot sell those goods, neither you nor your co-workers are going to be employed in the near future. In their myopic focus on the aggregate picture, the Keynesians constantly forget that inflation, investment, and unemployment all have a disparate impact on different areas of the economy, and those diverse impacts eventually have a cumulative effect on the aggregate.

Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.

Because he doesn't understand what Austrian theory actually teaches, Krugman creates a nonsensical strawman which, as he himself notes, bears little resemblance to what happens in a recession. His error stems his failure to understand that the Austrian concept of an investment boom has nothing to do with workers being employed in the investment goods sector per se; an investment boom merely means that credit-inflated investment is disproportionately directed to a specific sector of the economy which can be either investment goods or consumer goods. Hence the 1996 investment boom in the stock market (investment goods) and the 2003 investment boom in housing (consumer goods).

As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?

Because the problem is not that people want to hold more money than there is in circulation, the problem is that no one wants, or can afford, the goods that are being produced. All productive capacity is not created equal; the fact that it is available does not make it "perfectly good". What use is GM's "perfectly good productive capacity" today, when so few people want to buy GM cars? Again, the focus on the macroeconomic aggregate blinds the Keynesian to the obvious and observable material fact.

The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present. Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can't stand the thought that positive action by governments (let alone—horrors!—printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. And some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors. But moderates and liberals are not immune to the theory's seductive charms—especially when it gives them a chance to lecture others on their failings.

As I already pointed out, numerous Austrians have "managed to explain why bad investments in the past require the unemployment of good workers in the present". Bad investments in Detroit's auto-making capacity in the past means that Detroit workers have to lose their jobs now. It's really not a difficult concept; even a Nobel Prize-winner should be able to grasp it. The fact that Paul Krugman demonstrably does not understand the basic fundamentals of Austrian theory does not make the theory "intellectually incoherent". Instead, it tends to explain the man's dependable incoherency on a wide range of political and economic topics. The idea of any Keynesian, with their shamanistic belief in "animal spirits", criticizing any economic theory as "intellectually incoherent" is downright risible. And the fact that the Keynesian model has so many historical and logical failings to explain away should be Krugman's first clue that that perhaps it would be worth listening to a lecture or two on them.

Few Western commentators have resisted the temptation to turn Asia's economic woes into an occasion for moralizing on the region's past sins. How many articles have you read blaming Japan's current malaise on the excesses of the "bubble economy" of the 1980s—even though that bubble burst almost a decade ago? How many editorials have you seen warning that credit expansion in Korea or Malaysia is a terrible idea, because after all it was excessive credit expansion that created the problem in the first place?

Plenty, these days. Krugman himself has written on it, as a matter of fact. Austrian theory was warning about the dangers of credit expansion long before the Japanese, Koreans, and Malaysians began slashing their interest rates; again Krugman only manages to demonstrate his near-complete ignorance of the literature.

And the Asians—the Japanese in particular—take such strictures seriously. One often hears that Japan is adrift because its politicians refuse to make hard choices, to take on vested interests. The truth is that the Japanese have been remarkably willing to make hard choices, such as raising taxes sharply in 1997. Indeed, they are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct. Keynes had it right: Often, if not always, "it is ideas, not vested interests, that are dangerous for good or evil."

It would be interesting to feed Krugman his decade-old words now, given that the Austrian-predicted "pushing on a string" problem has hit the United States and Europe as well as Japan. Japan tried to spend its way out of trouble and failed, just as Hoover and Roosevelt tried to spend the American economy out of trouble and failed. History definitively shows that Krugman is not telling the truth when he claims that government austerity was the cause of the Great Depression. No one claims that the Austrian theory of economics is flawless or holistically complete. But in objective scientific terms, as a predictive model, it is demonstrably far superior to Milton Friedman's Monetarist model as well as the Neo-Keynesian model to which this hapless would-be critic subscribes.

Krugman and the 50 Hoovers

UPDATE: Krugman keeps piling on the verifiable historical falsehoods. It may interest you to note that I prepared a version of this chart the day before his most recent column, that's how predictably wrong he is:

All of this is depressingly familiar to anyone who has studied economic policy in the 1930s. Once again a Democratic president has pushed through job-creation policies that will mitigate the slump but aren’t aggressive enough to produce a full recovery. Once again much of the stimulus at the federal level is being undone by budget retrenchment at the state and local level.

Where, one wonders, is this "budget retrenchment" of which he speaks. It was only Federal spending that declined in 1937 and 1938, as Krugman even notes in describing 1937 as "the year that F.D.R. gave in to the deficit and inflation hawks",so to point the finger at the state and local governments who were doing precisely the opposite of that Democratic president is bizarre. Krugman is playing a dishonest game, implicitly referencing the two-year decline in local spending with regards to events three years later. And state spending never declined, so Krugman's 50 Hoovers theme is not only demonstrably wrong on two levels, as can be seen in the three charts below.

Now, it must be admitted that Krugman could, theoretically, have made a case by utilizing spending as a percent of GDP. However, he doesn't dare because that would show Herbert Hoover to have been significantly more aggressive in his use of expansionary fiscal policy than FDR and that would explode far more than Krugman's argument for a third fiscal stimulus package in three years.



Our favorite Nobel prizewinner wrote the following back in December:

But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future.

Very well, let's look at the action of Herbert Hoover and compare his four years in office to the previous four years using constant 2000 dollars in order to correct for inflation/deflation. I don't know about you, but I sure don't see any spending being slashed.



While the deflation of what Milton Friedman called The Great Contraction often confuses the economic analysis of those who fail to account for it, Krugman doesn't even have that excuse as a potential fall-back position. Federal spending not only increased in real terms and as a percentage of GDP, but increased in nominal terms as well.



Now, Krugman may well be right in that the state governments will be forced to slash spending as the economy continues to contract. However, this does not change the fact that this was not the historical behavior of either Herbert Hoover or the state governments, and likely has nothing to do with economic ideology. It is nothing more than the deficit-spending of the recent past limiting their range of options.

Disrespecting Krugman

Daniel Okrent writes in the NYT:

For a man who makes his living offering strong opinions, Paul Krugman seems peculiarly reluctant to grant the same privilege to others. And for a man who leads with his chin twice a week, he acts awfully surprised when someone takes a pop at it.

Because only a fool or a supply-sider would eagerly engage in a debate on economics with Prof. Krugman, I’ll try to eschew argument and stick to facts – or, at least, the sort of statements that he himself represents as purely factual:

1. I offered him only three examples of “shaping, slicing and selectively citing” (for some reason, he’s left one out of his rebuttal) because I was at home when he began bombarding me with outraged demands for retraction and apology; I’d completed my tenure as public editor the preceding week, and did not have any files with me. When I had the chance to consult some of my reader mail later in the week, some of his greatest mis-hits immediately came to the fore. I’ll get to a few of those in point No. 5, below.

2. This was the first he heard from me on these specific issues partly because I learned early on in this job that Prof. Krugman would likely be more willing to contribute to the Frist for President campaign than to acknowledge the possibility of error. When he says he agreed “reluctantly” to one correction, he gives new meaning to the word “reluctantly”; I can’t come up with an adverb sufficient to encompass his general attitude toward substantive criticism. But I laid off for so long because I also believe that columnists are entitled by their mandate to engage in the unfair use of statistics, the misleading representation of opposing positions, and the conscious withholding of contrary data. But because they’re entitled doesn’t mean I or you have to like it, or think it’s good for the newspaper.

3. The mixing of household and establishment numbers in his 5/25/04 column: Missing from the BLS chart he cites is any number that even resembles the 140,000 new jobs each month needed to keep up with the growing population a statistic he cites in the column, and upon which he seems to have based some of his computations. To my knowledge, that number only appeared in the household survey.

4. The Polivka-Miller paper: On the substance, readers can come to their own conclusions by examining the report themselves, particularly the chart and related narrative addressing “Duration of Unemployment” on page 23 (pdf). On Prof. Krugman’s defense of his unfamiliarity with it, he’s effectively saying, “If I didn’t know about it, it must not be important.” This is a polemicist’s dodge; no self-respecting journalist would ever make such an argument.

5. Some other examples of Krugmania that popped out of my copious files:


His 1/27/04 assertion that the cost of unemployment insurance “automatically” adds to the federal deficit. This two-fer misrepresents a pair of facts: that unemployment insurance is largely borne by the states, and that major federal contributions to the states come about only because of an act of Congress, which is hardly automatic.
His 2/3/04 assertion that tax proposals offered by Democrats would help the 77 pecent of taxpayers in the 15 percent bracket or less. The most recent generally accepted figures available at the time indicated that the number was actually 64 percent.
A very recent example that nonetheless escaped my memory until Prof. Krugman generously reminded me of it in his letter: His 5/9/05 column on progressive indexing. The column itself (without the ex post facto explanation) suggestively conflates “retirement income” and “social security benefits” without sufficient explanation, but with plenty of apparent point-making.
Believe me -- I could go on, as could a number of readers more sophisticated about economic matters than I am. (Among these are several who, like me, generally align themselves politically with Prof. Krugman, but feel he does himself and his cause no good when he heeds the roaring approval of his acolytes and dismisses his critics as ideologically motivated.) But I don’t want to engage in an extended debate any more than Prof. Krugman says he does. If he replies to this statement, as I imagine he will, I’ll let him have what he always insists on keeping for himself: the last word.

I hate to do this to a decent man like my successor, Barney Calame, but I’m hereby turning the Krugman beat over to him.

Whoo-pah!

Krugman the historian

Thomas DiLorenzo demonstrates that Krugman knows even less about American history than he does about Austrian economics:

Krugman said he has always been infatuated by the "symbolism" of Lee’s surrender at Appomattox, with "Lee the patrician in his dress uniform," compared to General Grant, who was "still muddy and disheveled from hard riding." Krugman is apparently unaware that by the late 1850s, on the eve of the war, Robert E. Lee was in his thirtieth year as an officer in the United States Army, performing mostly as a military engineer. He was hardly a "patrician" or member of a ruling class. Grant, by contrast, was the overseer of an 850-acre slave plantation owned by his wealthy father-in-law. The plantation, located near St. Louis, was known as "White Haven" (which sounds like it could have been named by the KKK) and is today a national park. (On the "White Haven" Web site the National Park Service euphemistically calls Grant the "manager" of the slave plantation rather than the more historically-accurate word "overseer").

In 1862 Lee freed the slaves that his wife had inherited, in compliance with his father-in-law’s will. Grant’s White Haven slaves were not freed until an 1865 Missouri emancipation law forced Grant and his father-in-law to do so. The fact that Lee changed clothes before formally surrendering did not instantly turn the 36-year army veteran into a "patrician," contrary to the "all-knowing" Krugman’s assertion.

Krugman goes on to assert that the North’s victory in the war was a victory in "manners" by a region that "excelled at the arts of peace." Well, not really. What the North "excelled" in was the waging of total war on the civilian population of the South. The Lincoln administration instituted the first federal military conscription law, and then ordered thousands of Northern men to their death in the savage and bloody Napoleonic charges that characterized the war. When tens of thousands of Northern men deserted, the Lincoln administration commenced the public execution of deserters on a daily basis. When New Yorkers rioted in protest of military conscription, Lincoln ordered 15,000 soldiers to the city where they murdered hundreds, and perhaps thousands of draft protesters (See Iver Bernstein, The New York City Draft Riots). It also recruited thousands of European mercenaries, many of whom did not even speak English, to arm themselves and march South to supposedly teach the descendants of James Madison, Patrick Henry, and Thomas Jefferson what it really meant to be an American. Lee Kennett, biographer of General William Tecumseh Sherman, wrote of how many of Lincoln’s recruits were specially suited for pillaging, plundering and raping: "the New York regiments were . . . filled with big city criminals and foreigners fresh from the jails of the Old World" (Lee Kennett, Marching Through Georgia, p. 279).

The North waged war on Southern civilians for four long years, murdering at least 50,000 of them according to historian Jeffrey Rogers Hummel. It bombed cities like Atlanta for days at a time when they were occupied by no one but civilians, and U.S. Army soldiers looted, ransacked, and raped their way all throughout the South. The "arts of peace" indeed.

As for the war being a victory of "manners," as Krugman says, consider this: When the women of New Orleans refused to genuflect to U.S. Army troops who were occupying their city and killing their husbands, sons and brothers, General Benjamin "Beast" Butler issued an order that all the women of that city were to henceforth be treated as prostitutes. "As the officers and soldiers of the United States have been subject to repeated insults from the women . . . of New Orleans," Butler wrote in his General Order Number 28 on May 15, 1862, "it is ordered that thereafter when any female shall, by word, gesture, or movement, insult or show contempt for any officer or soldier of the United States, she shall be regarded and held liable to be treated as a woman of the town plying her avocation." Butler’s order was widely construed as a license for rape, and he was condemned by the whole world.

It is remarkable that so many Americans still believe that their Civil War was about anything but the continuation of the Yankee empire. It is perhaps worth noting that were the USA of today to be confronted with the American Civil War, there can be little doubt that it would be bombing the Union in support of the Southern separatists.

However, it appears that Hispanic separatists may ultimately succeed where the Southern ones failed. The South may not rise again, but the Southwest almost certainly will.

Correcting Krugman

I completely understand if some people think I'm attacking strawmen rather than Krugman's actual arguments. Except I'd create more convincing strawmen:

It seems that more and more Serious People (and Fox News) are rallying around the idea that if Obama really wants to create jobs, he should cut the minimum wage.

So let me repeat a point I made a number of times back when the usual suspects were declaring that FDR prolonged the Depression by raising wages: the belief that lower wages would raise overall employment rests on a fallacy of composition. In reality, reducing wages would at best do nothing for employment; more likely it would actually be contractionary.

Here’s how the fallacy works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?

First, a reduction in the minimum wage doesn't mean that EVERYONE'S PAY is going to get cut. There aren't a lot of surgeons and computer programmers who are suddenly going to face competition from those whose labor is worth less than 7.25 per hour. Second, there are two ways that a general cut in wages could lead people to buy more in the aggregate. If labor costs are reduced, then the price of consumer goods are reduced. The Law of Supply and Demand states that there will be more demand for those lower-priced consumer goods... as well as more demand for the lower-priced labor. Also, it is an established fact that higher-income people save a greater portion of their income and spend less of it than lower-income people. Therefore, creating a larger pool of people making less money on average is going to cause people to buy more across the board.

Please note that I do not agree with the Keynesian aggregate perspective nor do I believe it is the responsibility of government to micromanage the economy, I am merely showing that Krugman is incorrect even from his chosen perspective.

Now, Krugman attempts to evade the obvious criticism in his subsequent post by stating: "the whole point is that reducing all money wages doesn’t necessarily reduce real wages. And for what it’s worth, the little AS-AD analysis I linked to is Econ 101, at least if you use a good textbook."

This argument against reducing the minimum wage boils down to the possibility that cutting the minimum wage will cause interest rates to rise. That is simply not credible in the current monetary policy environment, as the 20-year example of Japan should suffice to demonstrate. Krugman rests his case on asking us to "suppose that the AD curve is vertical", but a request for a supposition is a very long way from demonstrating that the AD curve actually is vertical. And even if Krugman's simplified model had been correct, once one considers the fact that the U.S. Treasury auctioned 3-month bills at 0.005 percent in December 2008, it becomes obvious that America was not liquidity trapped at 0.14 percent in the mid-1930s as Krugman imagines, but actually had room for expansion by an order of magnitude... 28x to be precise.

Perhaps not the best idea

It appears that a few of the less intelligent atheist ankle-biters have decided that it's a good idea to attack my writing on economics because they find my opinions on atheism and evolution to be so distasteful. Amusingly, they have decided that my criticism of Paul Krugman proves that I don't know anything. Because, you know, he has a Nobel Prize and all. As it happens, last night I was re-reading Krugman's book The Accidental Theorist, published in 1999 with absolutely no perception of the tech bubble that was about to burst. Instead, he was still worried about currency crises. I rather like the book because Krugman isn't a complete idiot, he's just willfully ignorant and inclined to cling to his defunct Keynesian models. I intend to go through the chapters and highlight various points of interest good and bad, of which this snide slam on the supply-siders, written in the summer of 1997, is a good example of the latter.

Suppose that you had managed your personal finances based on what you heard four years ago from Newt Gingrich, read in Forbes, or for that matter saw on this very page [The Wall Street Journal]. You would have sold all your stocks and probably put your money into gold. If the supply-siders were fund managers, not only would you have fired them, you would have sued them for the lack of due diligence.

This inspired me to take a look at the prices of stocks vs gold since August 1997. Needless to say, there is a very good reason that Paul Krugman admits that he is not a successful investment forecaster.

Gold: +336% From $324.10 to $1,087.45
S&P 500: +9.5% From 954.29 to 1,045.41

And this is not even taking into account the fact that the S&P 500 of today is not the S&P 500 of 12 years ago, as mergers, bankruptcies, and shrinking market caps have caused numerous stocks to vanish. 43 changes were made in 2007 alone! Suppose that you had managed your personal finances based on what you heard 12 years ago from Paul Krugman... unfortunately, a lot of Americans basically did and went heavily into stocks and real estate instead of gold and commodities. You would have done rather better to listen to a non-laureate's advice. And even for the five years from 1997 to 2002, you were better off with flat gold than with your stocks down 15 percent.

I somehow doubt this has caused Paul Krugman to revisit supply-side theory. Not that I subscribe to it either, but if the performance of the stock markets vs gold is your metric of comparison, well, it would appear a serious rethink is in order.

But it must be said that Krugman reaches some very worthwhile conclusions on occasion. Such as when, in the same book, he wrote what are arguably the most relevant words he has ever written: "I am always grateful when influential pundits make such statements, especially in prominent places, for in doing so they protect us from the ever-present temptation to take people seriously simply because they are influential, to imagine that widely-held views must actually make at least some sense."

WND column

In which it is explained how the three extant economic schools recommend dealing with the current crisis:

The failure of monetary policy has caused many economists and politicians to return to the Keynesian school, which primarily concerns itself with fiscal policy. Just as the Federal Reserve's control of the price of money – the interest rate – is the primary tool of the monetarists, government spending is the primary tool of the Keynesians, or more properly, Neo-Keynesians, since even the biggest fans of John Maynard Keynes have been forced to acknowledge at least some of the fundamental flaws in his economic theories. The core of the Keynesian theory of economic contraction is a failure of demand to meet supply, or to put it more simply, people are refusing to buy enough stuff to keep the economy growing. This is why Neo-Keynesians like Nobel Prize-winner Paul Krugman worry about "the looming hole in the U.S. economy," by which he means the difference between what could be produced by the economy and what will actually be bought.

Filling this gap is the purpose of the stimulus package; it represents the government stepping in to buy what consumers will not. In his column entitled "The Destructive Center," Krugman fearfully cites the Congressional Budget Office's calculation that this gap between potential supply and expected demand is $2.9 trillion over the next three years. His worries are based upon the idea that the $787 billion stimulus package which passed last week is only one-quarter the size it would have to be to fill the demand gap.

On a related note, the Mises Economics blog posts a link to an interesting interview with noted neokeyn Paul Krugman. The following exchange comes from the 14 minute mark:

CSPAN: Our next caller is from Urbana, Illinois.

CALLER: Hi, Thanks for taking my call. Mr. Krugman represents the Keynesian view of the economy and he was blindsided by this debacle. The Austrians, on the other hand, represented by Ron Paul, the Mises Institute, and Peter Schiff, did predict this. Now, they're [the Keynesians] the ones who are given the role of getting us out of this debacle, but they didn't predict it.

KRUGMAN: Um, tch, boy, tch, I don't even want to go into the Austrian stuff. It's, ah, it's not major school. But look, um, I was, what can you say... uh, I was closer to this than, ah, the bulk of the people who were giving pronouncements about the economy. I saw the housing bubble, I saw the bursting of the housing bubble was going to be nasty. So, I don't know what more to say. We can bring in Austrians, we can bring in whatever you want, but this is a classic crisis. This looks very much like what happened in the beginning of the Thirties. It looks like what happened in Japan. Those of us who did see those parallels are in better shape to hopefully find a way out than those who assured us everything was fine....

CSPAN: So the lesson is, whether it's the tulip mania in Holland or the Internet mania here in the US, what can we take away from this, these bubbles?

KRUGMAN: Well, bubbles happen. Bubbles which people believe prices of assets only go up happen. Um, defective financial systems happen, banking crises, very much. We thought we had ended those but it turns out the banking system was not effectively regulated. So, um, but, this is bigger. The main thing to understand is that this is much bigger than the dot com bubble of the late nineties. This is on the same scale as the Japanese bubble of the late eighties and therefore is very, very serious.

Bubbles happen? Seriously, just... bubbles happen? And more regulation would have somehow prevented it? That response, above all, tells you everything you need to know about the intellectual bankruptcy of the neokeyns. I have no doubt that he doesn't want to get into the Austrian stuff... nothing like an appeal to a nonexistent authority to avoid getting embarrassed. And are we seriously supposed to be impressed that he managed to discern the reality of the housing bubble in 2005? How very impressive, especially for a Nobel Prize-winner who failed to see either the dot com bubble or the credit crash until after the fact.

May 27, 2005: Remember the stock market bubble? With everything that's happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses. I've never fully accepted that view. But looking at the housing market, I'm starting to reconsider.

Notice that Krugman didn't manage to see how the housing crash would bring about the subsequent financial crisis, even though I had pointed out the probability three years before, as had many other Austrians.

End this depression II

In Chapter Two, Depression Economics, Krugman resorts to his favorite analogy, the babysitting coop, whose travails were chronicled by a 1977 article in the Journal of Money, Credit and Banking.  This is at least the third book in which he has resorted to the analogy, this time to demonstrate that overall lack of demand can’t hurt the economy and that "your spending is my income and my spending is your income."  But this time, he also cites the 150 babysitting couples as an example of his proposed cure for the global economy

"That’s where we come to the third lesson from the babysitting co-op: big economic problems can sometimes have simple, easy solutions. The co-op got out of its mess simply by printing up more coupons.

This raises the key question: Could we cure the global slump the same way?  Would printing more babysitting coupons, aka increasing the money supply, be all that it takes to get Americans back to work?

Well, the truth is that printing more babysitting coupons is the way we normally get out of recessions. For the last fifty years the business of ending recessions has basically been the job of the Federal Reserve, which (loosely speaking) controls the quantity of money circulating in the economy; when the economy turns down, the Fed cranks up the printing presses. And until now this has always worked. It worked spectacularly after the severe recession of 1981–82, which the Fed was able to turn within a few months into a rapid economic recovery—“morning in America.” It worked, albeit more slowly and more hesitantly, after the 1990–91 and 2001 recessions.

But it didn’t work this time around. I just said that the Fed “loosely speaking” controls the money supply; what it actually controls is the “monetary base,” the sum of currency in circulation and reserves held by banks. Well, the Fed has tripled the size of the monetary base since 2008; yet the economy remains depressed. So is my argument that we’re suffering from inadequate demand wrong?

No, it isn’t. In fact, the failure of monetary policy to resolve this crisis was predictable—and predicted. I wrote the original version of my book The Return of Depression Economics, back in 1999, mainly to warn Americans that Japan had already found itself in a position where printing money couldn’t revive its depressed economy, and that the same thing could happen to us. Back then a number of other economists shared my worries. Among them was none other than Ben Bernanke, now the Fed chairman.

So what did happen to us? We found ourselves in the unhappy condition known as a “liquidity trap.”"

Krugman's first claim is harmless enough.  Obviously, an overall lack of demand can hurt the economy, those who erroneously insist that supply is always capable of creating demand notwithstanding.  His second claim is partially true, but incomplete, because not all spending comes from income.  A considerable amount of spending also comes from credit, but since that is neither part of the Neo-Keynesian aggregate model nor the babysitting coop story, Krugman simply omits it.  And it can't be denied that the babysitting coop did appear to get out of its impasse by printing more coupons.

However, Krugman is guilty of a significant omission when he claims that Fed inflation - cranking up the printing presses - worked spectacularly in ending the 1981-1982 recession.  And what he omits is that one of the chief causes of the recession was the Fed's need to slam on the brakes due to the rampant inflation of the 1970s, inflation that completely failed to cure the high rates of unemployment as it was supposed to according to conventional Neo-Keynesian economic theory.  In fact, it was this failure that led to the widespread rejection of Neo-Keynesianism and the adoption of Milton Friedman's monetarist spin on it.

Also, when Krugman claims that the Fed was cranking up the money presses in 1983, he omits to mention that throughout that year, which more than covers his "few months" the interest rate never fell below 10.5 percent, which is higher than it was at any time after November 1978!  Somehow, we're supposed to believe that observably tighter monetary policy amounts to cranking up the money presses!

That being said, the money supply did observably begin increasing in 1983.  From mid-1982 to mid-1983, M2 rose $228 billion.  However, L1, total credit, grew $598 billion over the same period.

Now, Krugman admits that tripling the monetary base has not succeeded in moving the economy out of depression.  If the true lesson of the spring 1983 expansion is that credit, and not money supply is the issue, then we can assume that the current dearth of economic growth should be correlated with a similar lack of growth in Z1.

As it happens, that is precisely what we see.  Z1 has been very nearly flat since 2008 and is currently $5 trillion lower than its 60-year historical rate of growth would predict.  So, the basic foundation for Krugman's case is not only incomplete and historically inaccurate, but flawed in precisely the way that those familiar with the Neo-Keynesian model would expect.

The endless "temporary"

Paul Krugman asks why he is a Keynesian:

Noah Smith sort-of approvingly quotes Russ Roberts, who views all macroeconomic positions as stalking horses for political goals, and declares in particular that

Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government.

OK, I’m not going to clutch my pearls and ask for the smelling salts. Politics can shape our views, in ways we may not recognize. But I’m aware of that risk, and make a regular practice of asking myself whether I’m letting that kind of bias slip in. In fact, I lean against studies that seem too much in tune with my political preferences. For example, I’ve been aggressively skeptical of studies that seem to show a negative relationship between inequality and growth, precisely because that result is so convenient for my political tribe (which doesn’t mean that it’s wrong.)

So, am I a Keynesian because I want bigger government? If I were, shouldn’t I be advocating permanent expansion rather than temporary measures? Shouldn’t I be for stimulus all the time, not only when we’re at the zero lower bound? When I do call for bigger government — universal health care, higher Social Security benefits — shouldn’t I be pushing these things as job-creation measures? (I don’t think I ever have). I think if you look at the record, I’ve always argued for temporary fiscal expansion, and only when monetary policy is constrained. Meanwhile, my advocacy of an expanded welfare state has always been made on its own grounds, not in terms of alleged business cycle benefits.

In other words, I’ve been making policy arguments the way one would if one sincerely believed that fiscal policy helps fight unemployment under certain conditions, and not at all in the way one would if trying to use the slump as an excuse for permanently bigger government.

This all sounds very well and good, except for one thing. Do you EVER recall Paul Krugman once calling for a REDUCTION in government spending at any point of the business cycle? Do you ever remember him recommending spending cuts or tighter monetary policy at all?

In 2013, Krugman wrote: "I’ve often argued on this blog and in the column that now is a particularly bad time to cut spending." And this was four years into the Fed-reported economic recovery. Last year, he pointed out that "Prima facie, cutting spending depresses economies." Even looking back to the heights of the 2007 and 1999 booms, I can't find any evidence that Krugman called for fiscal contraction or anything but more spending and more taxes.

In any event, we already know why Krugman is a Keynesian. He read Foundation, he wants to be Hari Seldon, and Keynesianism permits him to wallow in the delusion of controlling future events.

Paul Krugman, mean girl

Kyle Smith of Forbes notes Paul Krugman's unusual style:

Reading Paul Krugman isn’t like reading most other economists. In a field whose notoriously poor track record in predicting the future (or even quantifying what has already happened) tends to generate a becoming modesty, he is utterly certain about everything. Breaking with the fraternal nature of the academic community, he is extraordinarily combative. Ever-snarky but never witty, his writing emits a sour smell of contempt.

Another way he stands out among academics: He repeatedly cites the authority of the mob as support for his positions.

This is an odd tactic for someone who would impress upon you the empirical rigor of his thinking. Like a Mean Girl given to saying, “Everyone is wearing wedges this summer” or “the in-crowd knows that animal prints are super-hot right now,” he is an alpha who is constantly looking over his shoulder to reassure himself that a pack is following closely behind. At times reading “The Conscience of a Liberal” is like a dip into the psychodrama of Teen Vogue or “Glee.”

There is an important secret to Krugman's success.  It is essentially that of EL James, JK Rowling, or Britney Spears. He tells people what they want to hear and he does so in a manner that is sufficiently dumbed-down that even the simplest reader can follow it.  It is a talent, but as anyone who has read Krugman critically will know, it is not indicative of being right about anything.  All that matters to most of his fans is that he takes a firm position and shouts in a confident manner.

I mean, one really has to read his attempt to take down Austrian economics to believe it, as it is readily apparent that Krugman has no idea what it is.

How to blow $7.5 billion

It doesn't come as a massive surprise to learn that the billions in government money to Chrysler have already vaporized:

Buried in the Chrysler filings was the revelation that US government investments in Chrysler will not be paid back, though the government will probably take an 8% equity interest in Chrysler: Chrysler LLC will not repay U.S. taxpayers more than $7 billion in bailout money it received earlier this year and as part of its bankruptcy filing.

This revelation was buried within Chrysler's bankruptcy filings last week and confirmed by the Obama administration Tuesday. The filings included a list of business assumptions from one of the company's key financial advisors in the bankruptcy case. Some of the main assumptions listed by Robert Manzo of Capstone Advisory Group were that the Treasury would forgive a $4 billion bridge loan given to Chrysler in the closing days of the Bush administration, a $300 million fee on that loan, and the $3.2 billion in financing approved last week by the Obama administration to fund Chrysler's operations during bankruptcy.

Only $7.5 billion for an 8 percent share of a bankrupt company owned by the United Auto Workers in a dying industry? Yeah, these financial whizzes are going to do a bang-up job "fixing" the economy. And just in case you weren't convinced that the economy is doomed...

"Mindful of his predecessor, Barack Obama seems to be trying harder to make sure he hears all sides. On the night of April 27, for instance, the president invited to the White House some of his administration's sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system."

Summers: "Do you think we ought to give Citi and BOA two trillion apiece or three trillion to recapitalize?"

Krugman: "More, more! Spend more!"

Summers: "How much more?"

Krugman: "Um, fiver?"

Stiglitz: "My bearded little buddy is right. Increasing banker bonuses will reduce the wage sluggishness effect, so the more you give them, the less sluggish they'll be and the more loans they'll make, thus jump-starting the economy. It is science."

Obama: "Um, ah, ha ha ha ha ha!"

Summer: "Ignore him, he's just a little punch-drunk after celebrating the Cinco de Cuatro. Fiver it is."

Setting aside the fact that Krugman's sharp "criticism" of Obama is that he hasn't been quite as stupendously wonderful as Krugman believes he has the potential to be, the idea that the architects of the Chrysler deal should more aggressively intervene in any enterprise more complicated than a lemonade stand is risible. In fact, I expect that if Obama, Geithner, and Summers ever did run a lemonade stand, they'd somehow manage to drive away half the customers while poisoning the other half.

Ignorant and slackminded

I was not at all impressed by the lunatic defense of economic credentialism by an economist employed by the very institution that is most responsible for the incoming Great Depression 2.0. But then I read this astonishingly ignorant appeal to morality by Fred Clark and I had to admit that Kartik Athreya may have had a point in insisting that at least some bloggers shouldn't write about economic matters:

I'm not an economist, but we've got five applicants for every single job opening. If you tell me that the best response to that situation is to lay off hundreds of thousands of teachers, I will not accept that this means that you're smarter and more expert than I am. I will instead conclude -- regardless of your prestige or position or years of study -- that you're a moral imbecile. And knowing what I know about your inability to make moral judgments I will have no reason to trust you to make complicated macroeconomic ones.

No, Fred, it's perfectly clear that you're not an economist and you don't know a damn thing about economics. I've read a lot of nonsense since the credit crunch began in the summer of 2008, most of it written by economists, but this is remarkably stupid even by those standards. There is simply no defense for either the infantile moral posturing or the spectacular ignorance revealed by it. The misplaced Keynesian faith in animal spirits notwithstanding, economics is not magic. It is complicated, yes, and there are a few special exceptions to the law of supply and demand, but that law is not significantly more flexible than the laws of physics. What the clueless Clark doesn't recognize is that the federal government has massively and permanently distorted the signals of the labor market for a long period of time, leading to an incredible malinvestment of human capital into various industries, including the education industry. Now that the artificially extended limits of demand have been reached in that and many other industries, the education bubble is in the process of popping precisely as Austrian theory predicts, leaving hundreds of thousands of teachers, (or more accurately, hundreds of thousands of non-teaching admininstrative bureaucrats employed by the school districts), whose labor is no longer necessary or affordable at their current rates by deeply indebted communities.

Morality has nothing to do with the correct conclusion that when a glass is already full, you cannot pour more water into it. It's simply an observable matter of fact. And if a full glass happens to be shrinking, then water is going to have to come out of it. Taking exception to such basic logic does not make you a moral exemplar, rather, denying it makes you an intellectual imbecile. Based on the evidence here, logic also dictates that no economist, or even economically aware individual, need concern themselves with what Mr. Clark thinks of their moral judgments or anything else.

If Clark wishes to wax indignant over gross and destructive immorality, he should focus his ire on the Fed, on the banks, and on the politicians who constructed a fraudulent financial system that was mathematically certain to fail and inflict millions of job losses on teachers, real estate agents, government employees, Fortune 500 corporations, and small family businesses alike. The salient fact is not whether 9.7% unemployment is high enough or not, but that utilizing more government intervention to prevent that rate from rising higher is guaranteed to extend and exacerbate the trauma to the labor force.

The reason the economic contraction confounds so many political bloggers like Slacktivist regardless of their party allegiance is that the problem cannot possibly be characterized as a Democratic problem or a Republican problem. It is, instead, a fundamentally structural problem with the financial system that dates back to the establishment of the fourth U.S. central bank. The long run has arrived and it has rendered the conventional liberal vs conservative debate completely irrelevant. Ironically, the solution is to be found in the example set by a Democratic president, Andrew Jackson. If Democrats want to find an plausible answer, they need to look to their party roots, not their present ideology.

UPDATE: the comments are even better. This was my favorite: "If Krugman and DeLong are right (and Paul Krugman is always right) then short-term government borrowing and spending should be a high priority right now."

Paul Krugman is always right? That's an intriguing statement.

1. Paul Krugman recommended investing in real estate and stocks while making fun of gold investors in 2002.
2. Paul Krugman thought the Fed should inflate a housing bubble in 2002.
3. Paul Krugman declared a $600 billion stimulus plan was required in November 2008. In 2009, he complained that the Obama adminstration's $787 billion stimulus plan was too small.
4. And he was a bit late in recognizing the obvious.