Friday, January 29, 2010

Paul Krugman and Tired Old Thinking

In today's NYT column March of the Peacocks, Paul Krugman lays out the progressive/liberal view that government is the ultimate actor in the economy:

The nature of America’s troubles is easy to state. We’re in the aftermath of a severe financial crisis, which has led to mass job destruction. The only thing that’s keeping us from sliding into a second Great Depression is deficit spending. And right now we need more of that deficit spending because millions of American lives are being blighted by high unemployment, and the government should be doing everything it can to bring unemployment down.

This view is open to dispute. The 1929 downturn became a "great" depression during the unprecedented activism of President Hoover, and involved post-WW I debt repayments imposed on Germany as a unique complicating factor. In another sense, the Great D involved a series of events that comprised a perfect storm.
Think of it as a Hurricane Katrina which before the levees gave way, first made a direct hit on New Orleans and devastated it; and then the levees broke. A truly "perfect" storm.

And re the Great D, also remember that candidate FDR harshly criticized Hoover's Federal deficits, and pledged to bring the budget back into balance.

There is no replaying history. No one can disprove the concept that had FDR kept his pledge, the economy would not have recovered just as it recovered from the severe depression of 1920-21 or the Panic of 1873.

All we know is that in the 1930s, the government had a balance sheet that was a fortress founded both on gold and on untapped taxing and borrowing power.

This situation is quite different today, thanks to generations of Krugman-praised policies. The consolidated balance sheet of the Federal Government shows, let us say, $60 T of debt against $2 T of income. That's a 30 to one leverage ratio, and only includes the present value of Social Security and Medicare obligations. It excludes other obligations such as the financial backstops for FDIC and the like, and other implicit obligations.

Why a solution that was tried in the 1930s is the same solution that should be tried after decades of increasing debt and chronic price inflation is unclear. Something about Einstein's definition of insanity being doing the same thing and expecting a different result.

Moving to the recent past, there is no evidence that the disorderly bankruptcy of Lehman Brothers was going to lead to anything worse than we got.

Going farther, remember that one year ago, Mr. Obama's advisers were forecasting 8.5% peak unemployment in the absence of a massive deficit-spending "stimulus" bill.

Were these top-tier economists off by, say, an additional 15-20% unemployment points (these numbers are all U-3 for consistency)?

Could it be that all the activist government--cap and trade and then healthcare reform, for example--inhibited animal spirits amongst small business owners?

Yours truly has an only-partially tongue-in-cheek solution. Let us say that there is, net, 20% unemployment/underemployment (U-6 and then some). The average American with a job works 2000 hours per year. All one has to do is shorten the work week to 4 days, and poof, everyone has a job.

This solution is as obvious as simply taxing fossil fuel use directly rather than going to the sham of cap and trade.

In other words, go more European in work effort. Now, this can be spun in various ways: shorter work days, earlier retirement, etc.

In fact, the more leisure time people have, the more time they can spend consuming (not that consumption is the goal of life in richer countries). For sure, less work means more play.

Now, this is partly satirical, but only partly. America produces about 3000 calories of food a day for a population that needs, on average, only 2000. Our current solution is to stuff people with this overproduction, and the result is an obesity epidemic.

Less food production (less GDP) would be a good thing for our health, economy and environment. One can go down the list. Driving to work 4 days a week would save lots of gas, wear and tear on autos and roadways, and thus have positive aspects. In fact, working 4 ten-hour days a week would create savings over 5 eight-hour days.

In the real world where resources are finite, we need to think creatively and humanistically about practical approaches, not reflexively take Dr. Krugman's approach and turn to Leviathan for fixes.

Dr. Krugman is oriented toward government. In Europe, he would likely be a member of a Social Democrat-type party. Fine, legitimate point of view. But the key is to avoid imbalances such as massive deficits other than in wartime. A Great Recession caused by hot money, mortgage fraud and imprudent borrowing/lending simply does not get "solved" by repaving roads.

Two macro economic solutions are: Win a world war and thus dominate the global economy (the way out of the Great D); or deleverage at all levels (the post-WW II solution until leverage got excessive in the past decade).

Since a world war is not desired, the solution is to simplify our accounts, and as the world turns, commit ourselves to replacing debt with equity.

I would suggest starting with Citigroup.

The disagreement between Dr. Krugman and President Obama is one between similar thinkers. Both advocate government increasing its leverage to a greater extent than the rest of the economy is simultaneous decreasing its own.

There is no current cleared, trodden path away from this roadway, and until there is, I believe that the fundamental case for gold is strong and that new gold buyers can and will easily be found.

Remember: 30 to 1 leverage is a conservative measure of current Federal leverage. Sounds like Bear and Lehman to me. Paul Krugman thinks that raising this to 31 to 1 is the solution for 2010. Barack Obama perhaps prefers 30.8 to 1. I favor bringing it down an order of magnitude to, say, 3 to 1, and then going below that, and rethinking all current economic dogma built on the alleged virtues of an ever-expanding gross domestic product.

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