It’s Time to Stop Taking Paul Krugman Seriously
Jeremy R. Hammond
December 26, 2012
In his New York Times column from Sunday, Paul Krugman ridicules the “cult” of “people who told us that a fiscal crisis was imminent”. He writes that
Of course, Krugman is never wrong. He brags,a chorus of voices has warned that unless we bring down budget deficits now now now, financial markets will turn on America, driving interest rates sky-high. And these prophecies of doom have had a powerful effect on our economic discourse.
After boasting about how right he has been, he returns to mocking anyone who disagrees with him in his conclusion:I and other economists argued from the beginning that these dire warnings of fiscal catastrophe were all wrong, that budget deficits won’t cause soaring interest rates as long as the economy is depressed — and that the biggest risk to the economy is that we might try to slash the deficit too soon.
This is a recurring theme with Krugman. Earlier this month, he wrote:The key thing we need to understand, however, is that the prophets of fiscal disaster, no matter how respectable they may seem, are at this point effectively members of a doomsday cult. They are emotionally and professionally committed to the belief that fiscal crisis lurks just around the corner, and they will hold to their belief no matter how many corners we turn without encountering that crisis.
So we cannot and will not persuade these people to reconsider their views in the light of the evidence. All we can do is stop paying attention. It’s going to be difficult, because many members of the deficit cult seem highly respectable. But they’ve been hugely, absurdly wrong for years on end, and it’s time to stop taking them seriously.
Run the printing presses! Inflation is good for you! And, look, the government can finance its debt by borrowing at “incredibly low interest rates” because “markets” have confidence in the credit standing of the U.S. government! The market demand for U.S. government debt is limitless!Moreover, despite years of warnings from the usual suspects about the dangers of deficits and debt, our government can borrow at incredibly low interest rates — interest rates on inflation-protected U.S. bonds are actually negative, so investors are paying our government to make use of their money. And don’t tell me that markets may suddenly turn on us. Remember, the U.S. government can’t run out of cash (it prints the stuff), so the worst that could happen would be a fall in the dollar, which wouldn’t be a terrible thing and might actually help the economy.
But hang on just a minute… Can wealth come from a printing press? Why would investors be paying the government to use their money? Isn’t the incentive to purchase bonds to get a return on the investment, not to incur a loss? Are “markets” really so unconcerned about their loans to the government being paid back with devalued dollars?
Here’s the thing: Krugman knows perfectly well that interest rates aren’t low because “markets” are confident in the dollar and U.S. creditworthiness. They are low because the Federal Reserve is keeping them low by buying up U.S. Treasury securities and inflating the money supply.
In fact, by the end of March, the Fed was buying up 61% of the government’s debt issued by the Treasury Department. As former Treasury official Lawrence Goodman wrote in the Wall Street Journal,
Indeed. Including, of course, our dear Mr. Krugman. As Goodman explains:The conventional wisdom that nearly infinite demand exists for U.S. Treasury debt is flawed and especially dangerous at a time of record U.S. sovereign debt issuance.
The recently released Federal Reserve Flow of Funds report for all of 2011 reveals that Federal Reserve purchases of Treasury debt mask reduced demand for U.S. sovereign obligations. Last year the Fed purchased a stunning 61% of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis. This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.
Still, the outdated notion of never-ending buyers for U.S. debt is perpetuated by many.
Here is the chart he refers to:But in recent years foreigners and the U.S. private sector have grown less willing to fund the U.S. government. As the nearby chart shows, foreign purchases of U.S. Treasury debt plunged to 1.9% of GDP in 2011 from nearly 6% of GDP in 2009. Similarly, the U.S. private sector—namely banks, mutual funds, corporations and individuals—have reduced their purchases of U.S. government debt to a scant 0.9% of GDP in 2011 from a peak of more than 6% in 2009.
The Fed is in effect subsidizing U.S. government spending and borrowing via expansion of its balance sheet and massive purchases of Treasury bonds. This keeps Treasury interest rates abnormally low, camouflaging the true size of the budget deficit.
That’s not quite the same story Krugman is telling us.
And that was March. The situation has changed since then. Now the Fed is buying 90% of U.S. bonds. As Bloomberg reported:
Bloomberg contradicts Goodman, though, stating:Even as U.S. government debt swells to more than $16 trillion, Treasuries and other dollar fixed- income securities will be in short supply next year as the Federal Reserve soaks up almost all the net new bonds."
The apparent explanation is that Goodman was looking at foreign holdings of U.S. debt in terms of GDP rather than in absolute terms. Let us stipulate that there remains demand from the markets for U.S. bonds, for the reasons given by Bloomberg. The dollar may look relatively “safe” compared to other currencies, and the euro in particular, but that’s not really saying much. And the fact remains that the government is increasingly dependent upon the Fed to purchase its Treasury securities. Here’s what JPMorgan has to say about it, via Zero Hedge (their emphasis):Persistent demand for U.S. securities as a haven from turmoil in the world’s financial markets since the subprime mortgage collapse in 2007 and Europe’s three-year-old sovereign debt crisis has helped damp yield increases even as government supply rose.
Foreign governments and banks have been among the biggest buyers. Brazil, Belgium, Luxembourg, Russia, Switzerland, Taiwan and Hong Kong boosted their holdings by a collective $264.8 billion since August 2011, Treasury data released Nov. 16 show.
Krugman’s column from Sunday is titled “When Prophecy Fails”. What the “cultists” have warned about hasn’t occurred. Therefore, Krugman argues, they are wrong. But this is a non sequitur. What the “cultists” have been warning about hasn’t occurred yet. That does not mean it isn’t going to. This situation is unsustainable. That means it will end. What will Krugman say when he is proven wrong (again)?Since the Lehman crisis, the Fed has been purchasing Treasuries and Agencies at a $500bn per year pace. This flow, which is equivalent to around 3.5% of US GDP, has offset more than a third of the government deficit since the end of 2008. In other words, QE purchases meant that the QE-adjusted government deficit has averaged 5.8% of GDP since the end of 2008 instead of 9.3% for the actual government deficit. This week’s Fed announcement means that this QE flow will double from a $500bn pace currently to $1tr. Coupled with a projection of a lower government deficit next year, to around 6% of GDP, this means that QE will offset almost all of next year’s government deficit.
What do I mean “again”? Krugman’s smug arrogance is matched only by his hypocrisy. His own record is abysmal, as I document in my book Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis. While Ron Paul in the late 90s was warning of an asset bubble that would burst and plunge the economy into a recession, Paul Krugman was assuring his readers that the economy had no place to go but up.
Once the dot-com bubble had burst, Ron Paul warned that soon we would hear people calling for the Fed to lower interest rates, but that the Fed’s inflationary monetary policy was the cause of the problem, so couldn’t possibly therefore also be the solution. Paul Krugman, of course, was among those calling for the Fed to lower interest rates.[W]hile Ron Paul was warning of a bursting bubble and imminent recession, Krugman continued to reassure readers that the U.S. economy was in fundamentally sound condition. While Ron Paul was warning of the danger of people spending beyond their means, Paul Krugman was hailing excessive consumerism as a positive force for job creation that had helped to insulate the U.S. economy from the financial troubles other countries were facing….
Even after the NASDAQ began to plummet, Krugman could still write that “the U.S. economy has cheerfully broken all the old limits” with “almost every fresh economic statistic” having been “a cause for celebration.”
In 2001, Ron Paul warned that the Fed’s policy would only prolong the pain and was creating a housing bubble that would precipitate a global financial crisis when it burst. Paul Krugman was meanwhile hailing the Fed’s policy as the cure for the recession, and criticizing the Fed for not lowering interest rates enough in order “to create a housing bubble to replace the technology bubble.” The solution was simple, Krugman insisted:
Of course, the policy Krugman advocated was one of the primary causes of the financial crisis that was precipitated by the collapse of the housing bubble, the consequences of which we are still dealing with. His record as abysmal. One of the most remarkable things about his record, as I also document in my book, is how he still managed to convince himself that the financial crisis had vindicated the Keynesian economic beliefs to which he subscribes, and he even tried to argue that Ron Paul had been wrong. As I wrote on page 58:"a global slump is quite an easy thing to prevent” (August 30, 1998); “But even if we do have a recession, so what?” (December 3, 2000); “cut interest rates a couple of percentage points, provide plenty of liquidity, and call me in the morning”; “We don’t need to fear a recession; if it does happen, it’s something that the Fed can easily cure” (December 27, 2000); and “Another few shots in the arm like that and talk of recession might well evaporate” (January 17, 2001)?
One could well apply Krugman’s own standard against him. To wit:The suggestion that Ron Paul had “been proved utterly wrong by events” would seem to be a case of classic psychological projection, and indicative of an extreme self-delusion.
The key thing we need to understand is that the prophets of financial recovery, no matter how respectable they may seem, are at this point effectively members of a Keynesian cult. They are emotionally and professionally committed to the belief that a “recovery” lurks just around the corner, by printing more money and going even deeper into debt, and they will hold to their belief no matter how many corners we turn without encountering that recovery.
So we cannot and will not persuade Paul Krugman to reconsider his views in the light of the evidence. All we can do is stop paying attention. It’s going to be difficult, because this member of the cult of Keynesianism seems highly respectable, with his Nobel Prize for economics and prominent platform as a columnist for the New York Times. But he’s been hugely, absurdly wrong for years on end, and it’s time to stop taking him seriously.