Free market economists use New York Times columnist and Nobel Laureate Paul Krugman as their constant punching bag. He makes a convenient target. He’s uber-Keynesian, providing a constant flow of liberal cheerleading and wrong-headed economics. Austrian fanboys and Facebook friends of free market opinion constantly wonder if the Nobel prize winner is evil or just stupid.
While Krugman believes Bernanke has been too tight with Fed monetary policy and the sequester’s slight crimping of the federal budget is a disaster, he sees the future, and I think he is likely right.
He devoted a recent column “A Permanent Slump?” to what may be in store for us. His piece pointed at Larry Summer’s talk at the International Monetary Fund annual research conference, where the former Treasury Secretary made the case that the U.S. is headed toward, in Krugman’s words, “‘secular stagnation’ — a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between.”
Summers and Krugman say this is becoming the narrative of mainstream economists, and like all Keynesians they believe the problem is the economy lacks aggregate demand. Krugman writes, “We have, he suggested, an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles.”
Krugman wonders how on earth the economy can return to full employment given this lack of aggregate demand and the inability of consumers to lever up. Even when households were using their homes as ATMs “the economy’s performance over the period as a whole was mediocre at best, and demand showed no sign of running ahead of supply,” writes Krugman.
In 2009, the Nobelist told The Guardian,
What we do know is that recessions normally end everywhere because the monetary authority cuts interest rates a lot, and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn’t enough. And, so far, although we made the cuts faster than they did and cut them all the way to zero, it isn’t enough. We’ve hit that lower bound the same as they did. Now, everything after that is more or less speculation.
Krugman went on to say the two economic stories playing out are, “The ‘Nipponisation’ of the world economy with a bunch of ‘Argentinafications’ playing a role in the acute crisis. But even after those are over, we have the Nipponisation of the world economy. And that’s really something.”
Krugman believes the Japanese stagnation was caused by excess debt, excess leverage and, of course, lack of demand. This was all brought about by an collapsed asset bubble. Central bank stimulus could not overcome this.
So here we are in the U.S. five years down the road from a collapsed asset bubble. The Fed has taken interest rates to nearly zero and has promised rates won’t go anywhere for a long time. The stock and art markets make new highs while, as Krugman writes, “the evidence suggests that we have become an economy whose normal state is one of mild depression.”
This is where Krugman says, “Easy money should, and probably will, be with us for a very long time.” Besides the central bank doing more of what has already been done, we should all abandon good sense. Excess government debt is not to be worried about and understand “virtue is vice and prudence is folly, in which attempts to save more (including attempts to reduce budget deficits) make everyone worse off — for a long time.”
It is for this very reason Krugman’s crystal ball is clear. These artificially low interest rates will not set wealth generation in motion but instead only lead, as economist Frank Shostak writes, “to the misallocation of scarce capital and the weakening of the wealth generation process.”
The creation of more money, Shostak explains, “will only result in an increase in the consumption un-backed by the production of real wealth; and this leads to the consumption of capital and to the weakening of the wealth generation process.”
Prosperity cannot be printed. “On the contrary,” writes the Mises Institute adjunct scholar, “monetary pumping sets in motion a process of economic impoverishment by activating an exchange of something for nothing. It diverts real wealth from wealth generating activities towards non-productive activities.”
As real wealth is diverted to malinvestments, the real pool of savings stagnates and may possibly decline. As real wealth shrinks the worse economic conditions become.
The Fed’s low interest rate policy has resuscitated industries decimated by the 2008 crash–banking, automakers, Fannie Mae, Freddie Mac and real estate–at the cost of renewed economic growth. Precious capital is being wasted keeping companies that should have failed afloat.
While central bank intervention may well have kept the economy from bottoming out, such a bottoming out was the cleansing of malinvestments the economy required.
Krugman quotes Summers who said the crisis “is not over until it is over,” and concluded “depression rules will apply for a very long time.” Krugman is undoubtedly right. Unfortunately he doesn’t understand why.