Friday, July 27, 2012

Krugman is wrong again: Slash spending now!

Paul Krugman (known as St Paul among liberals) is at it again. In an article,“Money for nothing”, Krugman makes the following case:
1) Investors and businesses aren’t spending right now and can’t find investment opportunities, therefore they choose to buy government bonds. In fact, they are buying government bonds to such an extreme extent that the interest rate on (inflation-protected) government bonds is now negative.
2) Therefore, as government bonds are in such great supply, governments should issue more bonds. Simply supply and demand, Krugman thinks; government should give the customers what they want. Also, as the money is free, there is no harm in doing this. Why not borrow when you get the money for nothing?
This argument really shows how clueless Krugman really is: By Krugmans logic, if humans are eating grass, then the only sensible thing to do is for the government to supply them with more grass. Instead, a non-keynesian would argue correctly that if people are eating grass, then the reason is because they don’t have real food. The sensible thing is providing food, not grass, as grass is something you eat not because you want to, but because you lack actual food (humans eating grass have been observed in North Korea among other places).
Government bonds is something that investors don’t willingly buy. They buy it, if there are no other investment opportunities (of course, almost every investor holds SOME bonds to diversify his or her portfolio). Krugman agrees with me on this, but he forgets to ask the question: Why are there no other investment opportunities? Why are employers not hiring, instead stuffing their money into negative-interest government bonds?
Could it be… because of destructive government policies? Because employers are worried about Obamacare increasing their costs? Because the US has a president who has constantly demonized them and implicitly made it his mission to destroy them?
Interestingly, as we have observed, bad government policies can create a demand for government bonds (because they bring down the return on the stock market, making bonds relatively more attractive). That doesn’t mean said  policies are suddenly good, and it certainly doesn’t mean the solution is to take on debt. The fact that the US is taking on debt is one of the reasons why employers don’t hire (they are worried about future interest rates). Interestingly, the fact that they don’t hire and instead put their money into government bonds is exactly what keeps government bond yields down – an interesting paradox. Of course this can’t last forever, even Krugman should be able to see that.
Also, as for the money being “for nothing”. It’s not for nothing. If you borrow $100 dollars at a negative 0.6 % interest (which the US is currently doing through inflation-protected bonds), you have to pay back 99.4 dollars. Now suppose you borrow the 100 dollars and literally throw them into the lake. Will you be able to afford to pay the 99.4 dollars? Of course not. Sure, if you had kept the 100 dollars, you would have made a 60 cent profit, but you didn’t – you threw them into the lake, remember?
And, this is quite a good parallell for what the government is doing: Borrowing money and spending them on things with a negative return. Throwing money into the lake, in short. Of course, a government is not a company and not every government investment has to yield a positive return (government investments can be justified if they lead to non-financial benefits big enough to outweigh the financial cost). So the US will have a big problem repaying the $99.4 dollars it after all has to pay back. Money isn’t spent in a way that will increase future tax revenues, instead, they are spent in a way that is more likely to decrease them. And by more than 0.6 % too.
Then, there’s the behavioral aspect too which I’ve written of before: Habits die hard. Once a person develops a habit, even if the habit is rational at the time it is developed, he or she is likely to continue with the habit long after it’s stopped being rational. I believe this can be applied to governments too: Once borrowing 1 trillion or more dollars every year becomes the “new normal” (if that hasn’t already happened), governments will continue to borrow such amounts until they reach state bankruptcy. Habits die hard. Krugman, and all other keynesians, assume governments are much more flexible than reality has shown them to be.
If governments were to instead follow the opposite approach, the one advocated by us conservatives, and cut spending, deregulate and most of all create a simpler tax code (may I suggest the FairTax?), then investments will grow, government revenues will go up, and the deficit will then fall (both because spending is slashed and because revenue goes up). Interest rates may go up temporarily as investors return to the stock market, but that’s a good thing in the long run – and unlike Krugman, we conservatives are more concerned with the long run than with temporary fluctuations. Besides, as long as you balance the budget, you really don’t need to worry what the interest rate on your bonds are.
Finally, Krugman, in order to (I can only assume) really drive home the point that he seriously doesn’t have a clue what he’s talking about, mentions infrastructure and education as good long-term investments. That may well be the case, but that’s not what keynesianism is about: Keynesianism is about governments pumping money into the economy when the private sector isn’t spending and investing, temporarily off-setting the fall in aggregate demand. This is all temporarily, which is why, in order to have the intended effect of easing a recession, the money that the government spends has to hit the economy quickly: Some keynesians have jokingly suggested the government should just print money and drop them off helicopters. With infrastructure spending, you have a lot of planning before you actually can spend money: You have to decide where to build the infrastructure, you have to draw the airports, roads, railroads etc, you have to decide whom to give the job too etc. This is a process that can take years; the recession may well be over before the government infrastructure stimulus has actually been spent. And it’s practically the same thing all over again with education.
How did this guy ever get a Nobel Prize?


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