Babies With Candy

Heretofore my posts have been sort of whatever-grabbed-my-attention. I think the blog would be better was posting more systematic. To that end, I introduce, what I hope will be the first of many recurring topics: Babies With Candy.

The theme of this topic is to comment, hyper-critically, on Paul Krugman's NY Times columns, to argue generally that he is more then a bit of a hyper-political fraud of an economist. The title of the topic stems from my sense that the task isn't particularly difficult.

Unfortunately for me, I am mostly in agreement with his latest column Decade at Bernie’s. Anyways, without further ado:

By now everyone knows the sad tale of Bernard Madoff’s duped investors. They looked at their statements and thought they were rich. But then, one day, they discovered to their horror that their supposed wealth was a figment of someone else’s imagination.

Last week the Federal Reserve released the results of the latest Survey of Consumer Finances, a triennial report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation at all since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers...

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. And if the belief of many Americans that they could count on capital gains forever sounds naïve, it’s worth remembering just how many influential voices — notably in right-leaning publications like The Wall Street Journal, Forbes and National Review — promoted that belief, and ridiculed those who worried about low savings and high levels of debt.

Krugman is certainly correct in arguing that we should have borrowed less and saved more. He is also certainly right that its worth remembering who encouraged such irresponsible behavior. In as much as American personal indebtedness begins with student and home loans, it silly to suggest that the chorus was strictly on the right. More productive then looking back, of course, is looking forward. For example, which congressman were demanding of Bank CEOs that they lend more.

Then reality struck, and it turned out that the worriers had been right all along. The surge in asset values had been an illusion — but the surge in debt had been all too real.

More accurately: The surge in asset values was a partial function of the surge in debt. (It was also, in part, a function of the Fed's easy monetary policy.)

So now we’re in trouble — deeper trouble, I think, than most people realize even now. And I’m not just talking about the dwindling band of forecasters who still insist that the economy will snap back any day now.

For this is a broad-based mess. Everyone talks about the problems of the banks, which are indeed in even worse shape than the rest of the system. But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

And as the great American economist Irving Fisher pointed out in the 1930s, the things people and companies do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

With this, I am in perfect agreement and have posted similarly here.

Its worth, in this vein, noting the effect of easy credit + leveraged buy outs on the economy. The banks did not only lend recklessly to consumers, they lent recklessly to private equity. These shops used the easy money available to buy healthy businesses, raid them of their cash, and saddle them with debt, that they are now, increasingly, unable to repay.

Are policy makers ready to do what it takes to break this vicious circle? In principle, yes. Government officials understand the issue: we need to “contain what is a very damaging and potentially deflationary spiral,” says Lawrence Summers, a top Obama economic adviser.

In practice, however, the policies currently on offer don’t look adequate to the challenge. The fiscal stimulus plan, while it will certainly help, probably won’t do more than mitigate the economic side effects of debt deflation. And the much-awaited announcement of the bank rescue plan left everyone confused rather than reassured.

If the situation is as dire as Krugman describes, why-does-he-believe-that/in-what-way-will an inadequate (and somewhat unfocused) stimulus plan will help at all?

Its also not clear to me that some deflation is not a good, or at least necessary, thing. Can prices be sustainably maintained at levels that were artificially inflated by unsustainable lending practices (and monetary policy). A little deflation might bring us closer to more sustainable price levels. Put differently: Would the economic shock and awe that the administration has planned and Krugman deems inadequate be more effective were it aimed at preserving more sustainable price levels.

There’s hope that the bank rescue will eventually turn into something stronger. It has been interesting to watch the idea of temporary bank nationalization move from the fringe to mainstream acceptance, with even Republicans like Senator Lindsey Graham conceding that it may be necessary. But even if we eventually do what’s needed on the bank front, that will solve only part of the problem.

On some level, it does, generally, seem like a government run sorting out, in which some banks a scrubbed and blessed as healthy and others are forced out of business may be the least bad option available. However politicized, corrupt and wasteful the process is bound to be, there are worse outcomes if you are left, at the end, with at least some reasonably healthy banks.

On the other hand, I think there is good reason to fear that the scrubbed, newly healthy banks, will as quickly as they can -- and with the encouragement of government -- get back into the business of making reckless loans they haven't the skill to manage. That, especially as they will be survivors of a government scrubbing, the will be far more attentive to regulator- and legislator- than risk- management.

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

One interesting thing about Krugman -- captured above -- is the way as an economist he seems to feel some professional obligation to write accurately even while, as a partisan columnist, covering over the truth in a politicized attempt to mislead his readers.

To recognize that it was WWII that pulled the US out of the Great Depression is to acknowledge that the New Deal was fundamentally ineffective (although he no doubt believes it "certainly" helped). Branding WWII as a "large public works program" rhetorically covers over the failure of the New Deal.

Identifying WWII as a "large public works program" is, of course, more spin then reality. During WWII the economy was effectively nationalized and many people -- draftees -- were coerced into working. The implication that he would prefer to see some parrelel option on the table is a bit perverse.

More fundamentally, if it is true -- as Krugman claims -- that given time, even without coercing labor, families and firms can work off their debt and that will lift us out of our slump, its why was WWII required to lift us out of the Great Depression? It started more then a decade after the stock market crash. Shouldn't we have been able to lift ourselves out of the depression without it?

The depression of the 1930s was, of course, neither the first, and apparently not the last, depression we have experienced. Nor was it the shortest historical depression. The simple truth, covered over in Krugman's column, is that we got out previously without "large public works programs" and we can do so again.

The conservative claim, with which Krugman-the-economist apparently agrees, is that free markets are intrinsically self-correcting and regenerative. That, given the time and opportunity, free people making free choices will rebuild vibrant economies out of the carcasses of dead ones. It follows that that ham handed intrusive Government economic meddling can crowd out private initiative and dampen the regenerative process. It is easy to see that happening now. Conservatives, though not Krugman, attribute the failure of the economy to recover in the 1930s to this.