From exchanging emails with him, I've known for a decade that Paul Krugman was an egomaniacal jerk, but he was always described as being intelligent. Yet, here are parts of a 1998 column he wrote in Slate that is just jaw-droppingly dumb. This is the kind of thinking that kept us from having the medium strong recession we deserved in 2001 after the Tech Bubble, instead, postponing it until a recession/depression of Biblical proportions arrives now.
While you are reading Krugman's theorizing denouncing the the Austrian business cycle theory that malinvestment causes recessions, think about Las Vegas.
Sin City had the biggest boom of the decade and now the biggest bust with, by far, the highest foreclosure rates. Why? Because it's next to California. The median homeowner in California saw his home equity rising by, say, $60,000 per year in the middle of the decade. A lot of those Californians took out home equity loans, gassed up their new cars, and headed to Vegas to spend some of that $60,000 in additional wealth. (My barber used to go five or ten times per year to Vegas.)
So, businesses built more gigantic casinos in Las Vegas, which employed lots of construction workers and then service workers to work inside the casinos. In turn, they built tons of homes outside Vegas for, depending on the price range, all the new construction and service workers, or all the people trying to get away from living next to the new construction and service workers. Meanwhile, the price of existing homes was going through the roof in Las Vegas, so the local homeowners were all spending money like they were Californians, too. And, in turn, they built tons of retail and other stuff, like, say, water parks, to service all those new residents and their kids.
All of sudden, people in California wake up to the fact that they aren't as rich as they thought they were. In fact, they are much poorer because they've already spent much of the pseudo-wealth they thought they had garnered in the middle of the decade. They can't cash out on their houses, so they are suddenly looking at 28 years of writing big monthly checks to pay for all those trips to Las Vegas.
What's the first thing you can cut out of the household budget? Well, the single most obvious luxury to eliminate is those goddam trips to Las Vegas.
Thus, news stories like this one from today on Channel 8 in Las Vegas:
Here's what the $4.75 billion Echelon project looked like when work was suspended last August.Wall Street Crushing Las Vegas Strip
There are more signs of just how much the Las Vegas Strip is hurting in this economic downturn. One of the valley's biggest casino companies, Boyd Gaming, saw a huge drop in profits, down 73-percent in the third quarter.
The company has also announced the delay of its signature resort, Echelon, will be much longer than anyone expected. The construction site will sit quiet until at least January of 2010.
The jobs are gone and the equipment will be parked longer than first thought.
After the Stardust saw its last roll of the dice in a spectacular demolition, from the ashes would rise Echelon, a multibillion dollar mega resort. But for now, all bets are off.
"It is unlikely that we will resume construction in 2009. Nonetheless, we remain committed to having a meaningful presence on the Las Vegas Strip," said Boyd Gaming President and CEO Keith Smith.
Boyd Gaming announced in its third quarter earnings conference call. Echelon will remain a shell of steel through 2009. Construction will be halted while executives consider a list of options.
Think about things from Boyd Gaming's point of view: So, you bought the Stardust, a tired but no doubt still profitable casino, blew it up, and poured vast amounts of money into building a superstructure for the multibillion dollar Echelon. Except now, there are no more gamblers coming from California. So, it won't pay to finish it for years. Except, while it's sitting unfinished, you are still losing all the cost of capital you've invested in it so far.
Keep that in mind while you are reading the new Nobel Laureate's explanation of why the Austrian theory is all wrong (via Zoho).
The Hangover Theory
Are recessions the inevitable payback for good times?
By Paul Krugman
Posted Friday, Dec. 4, 1998, at 3:30 AM ET
A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle—a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking—not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.
The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.
The problem in the Great Depression was the sharp contraction of the money supply due to bank runs, which is why we now have FDIC insurance.
The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity—of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes—investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.
Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles. Anyone who has watched the ups and downs of, say, Boston's real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life. But let's ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole?
It depends upon how big the bubbles are. Consider an almost forgotten bubble -- the 1983 Initial Public Offering NASDAQ bubble for new technology-related firms. The marketing research firm where I worked, which was the first marketing research company to sell data from those now-ubiquitous laser scanners in supermarket checkout counters, was supposed to go public in March 1983 at $16 per share. At the last moment, the investment bankers realized that a mania was developing for IPOs, so they kicked the offering price to $23. The stock closed the first day of trading at $43. Woo-hoo! My $2000 investment had gone up to almost $4000 in one day! I bought everybody expensive drinks that night.
By 1984-1985, our stock was back down to its opening $23 per share, and yet that was a much better performance than the great majority of IPOs that came out in 1983, many of which had by then been demoted to the penny stock exchange. Yet, the IPO Bubble of 1983 didn't cause an economy-wide recession because it was too small, in sharp contrast to the California-centric Housing Bubble of this decade, which was huge.
Don't say that it's obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them. And in fact the key to the Keynesian revolution in economic thought—a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles—was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.
Yes, but, you'll notice that this here recession isn't being caused just by investment spending going down. It's also being caused by consumer spending going down. Why? Because consumers just woke up to the fact that they aren't as rich as they thought they were. So, no more trips to Vegas, so no more investment in $4.75 billion Vegas casinos. The Keynesian distinction between consumption and investment is largely irrelevant in explaining this collapse.
Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?
Krugman is so proud of his little abstract tautology.
No, what's happening now is fundamentally driven by a wealth effect. Yes, we currently have a liquidity crisis and an insolvency crisis. The government throwing money at the liquidity crisis might well help, and there's some possibility of it helping the insolvency crisis.
But there's no way no how the government wasting money will help the fundamental problem: the wealth crisis. That's only going to be dealt with by years of hard work.
People now realize they aren't as wealthy as they thought they were. Something like one-tenth of the national wealth was made up of ridiculous valuations of homes. That's gone. It ain't coming back for decades. Another, harder to estimate, fraction of the national wealth was made up of ridiculous valuations of financial instruments based on the ridiculous valuations of the homes. That's gone, too.
They are gone because they never really existed in the first place. They were just mass delusions that 500 sq. ft. homes in Compton were worth $340,000, or that complicated mortgage-backed securities and credit derivatives based on the expectation that the guy who got the $340,000 mortgage on that one-bedroom house in Compton was pretty damn likely to pay it all off, were worth what Moody's said they were worth.
Both consumption and investment spending up through the first half of 2007 were driven by estimates of how much we could afford based on our wealth that we now know were ludicrous. Economic activity will therefore contract to the level appropriate for our smaller level of wealth.
Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.
As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?
I'm surprised Krugman didn't also win the Nobel in Medicine, because his advice is equally applicable to physiology:
A death happens when, for whatever reason, a heart stops beating. Yet, for all its simplicity, the insight that a death is about a heart no longer beating makes nonsense of the whole disease / trauma theory. For if the problem is that the heart isn't beating, why not simply increase the supply of heartbeats? You may tell me that it's not that simple, that the patient has died of bubonic plague or from falling off a cliff. Well, fine. Junk the bad heart and write off the bad organs. Why should this require that perfectly good productive capacity be left idle?
Look, the hulk of the Echelon on the Strip isn't perfectly good productive capacity. It is, at present, perfectly no good productive capacity. It's worse than nothing because the owner has to keep paying the interest on the loans he took out for the money he's already spent on it. He has calculated, however, that it's somewhat less ruinous to let it sit idle than to finish the monstrosity for the Californians who won't be coming again for years. So, the owner of the Echelon isn't going to be spending as much on either consumption or investment as he had been planning to.
The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present.
But the newly unemployed of Las Vegas aren't good workers in the post-Bubble economy. They are construction workers, croupiers, waiters, touts, whores, and other professions that we won't have much use for for a number of years. Hopefully, some of them will develop new, more valuable skills, but that will take years. And when you actually check the numbers on the newcomers to Las Vegas, you don't get a warm feeling that many of these folks are going to turn into solar energy technology inventors or whatever anytime soon. If we're lucky, a lot of them will go home to Mexico, where it's much cheaper to be poor than in America. If we're not lucky ...
Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can't stand the thought that positive action by governments (let alone—horrors!—printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. And some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors.Well, we can't have that!
Unfortunately, due to advice like Krugman's, we didn't have much of a recession in 2001-2002 due to inflating the money supply, both by the Fed and by easing up on mortgage lending rules, so now we are paying the price in spades.
The Tech Bubble was stupid, but at least pouring huge amounts of money into Cisco Systems had a certain surface plausibility. Cisco actually made something (either switches or routers, I can't remember which, despite reading dozens of articles in 1996-2000 but how the world could never get enough switches and/or routers). In contrast, building oversized homes outside of Las Vegas for the mortgage brokers who sold their old homes to the new blackjack dealers who got hired by the new casinos to fleece the Californians with home equity loans on their houses that were going to rise in price to infinity never ever made any sense.
Now, anti-Krugmaniac realist economics has a very valuable policy implication, which is: "frictional problems" are incredibly painful. So, don't waste money in the first place. More specifically, the spending of a population is based on its wealth. In the long run, its wealth is mostly a function of its human capital (i.e., the population's ability to earn money). So, don't debauch the average human capital of your population.
My published articles are archived at iSteve.com -- Steve Sailer
Krugmans problem, beside his obvious arrogant, is that he is sharper than he is deep.
ReplyDeleteUnlike true intellectuals he argues like a politician, trying his best to win argument at any cost, usually by using strawmen. For impressive liberal undergraduates this works, his case seems very strong, and his opponents appear as morons. But he is gaining this by dumbing himself down as well, since he always ignores the strongest part of the argument he is fighting rather than try to face it.
So when people who actually know the issue and can’t be fooled by withholding the full argument read Krugman they often become angry at his combination of, quoting Steve, Smug stupidity.
In this particular case, I find it extra amusing that he is attacking Austrians for lacking stringency. Well, they do lack it, but this coming from an ultra-Keynesian?!? They don’t have any coherent model of the business cycle either. The only guys that have coherent models are the neoclassical, and their models are obviously wrong (newkensians have models too, but they are not very good, they get their results by cheating, such as assuming all firms are monopolies, rather than tying actual patterns we observe to their results).
Keynes has not explain any better than the Austrians why say’s law doesn’t always hold.
Obviously to anyone other than Krugman a theory doesn’t have to be complete to be right in some circumstances. I have gained a lot of respect for Austrian theory these last few months. It also seems these bubbles are extra likely when cheap money is combined with big innovations (IT, mortgage backed securities).
A simple test of wealth effect vs. Krugman will be the next stimulus package, which I predict people will stuff in the mattress. Regarding the last one Feldstein writes “Recent government statistics show that only between 10% and 20% of the rebate dollars were spent. The rebates added nearly $80 billion to the permanent national debt but less than $20 billion to consumer spending.”
PS.
Krugman didn’t really deserve the Noble prize (obviously he was a decent economists, but there are hundreds of people at his level). He got it because of self-promotion, and as a thanks from his palls in the committee for his political activism.
One effect, which I don’t mind, is that the decision de-based the economics prize as unscientific.
Yes, Krugman is a bit of a dummy at times and a dishonest partisan at all times. He is a good example of the ideologue who uses his smarts to convince others of the correctness of his gut political instincts. The truth be damned.
ReplyDeleteSpeaking of the Great Depression, an interesting study by two UCLA economists recently estimated that FDR's anti-competitive policies doubled the length of the Great Depression.
As I've stated before the *only* 'fact' in economics actually worth something is that the price of any good or service is what the potential purchase is willing to pay for it.
ReplyDeleteEverything else is bullshit.
The real estate bubble sure paid off for those who timed it right.
ReplyDeleteBubbles really are like mini-lotteries for those who time them right. Invest on the way up, short sell on the way down. I bet Soros is laughing like a hyena somewhere.
Example: A pal of mine bought a house in the Hamptons in 1996 for 250K. It was supposedly appraised at 500K in 2000. It DOUBLED in VALUE in FOUR years. He got divorced and didn't get the benefit of cashing out of it at that time, but if he could have he would have pocketed a cool 280K or so with the equity he already had in it, and bought a 3,000 sq. foot economy-sized McMansion in Atlanta, Nashville, or Cincinnatti ex-urbs for cash.
My mortgage-officer-pal M, tells me that although he is doing alright (strong real estate market in Nashville ex-urbs due to white flight--sometimes laughably from other cities LOL), several real-estate agents are lucky to have one sale a month in these parts.
Of course, we all know what the real estate agents answer to this is: we need to just legalize as many new Americans as are willing to come here-----as long as they personally dont have to live around them. Boy are we going to pay for this "faux boom" we just had.
Think about what the past ten years or so have really been folks. We allow in tons of illegals to cheaply build excessive houses so builders and developers make a mint in profit margins, extend credit to our underclass and those new illegals and "create money" by lending it to them to buy some of the cheaper homes that they build and to buy some of the former working class-white homes of whites who have been "churned" to move to the ex-urbs to live amongst their own kind. Well it seems that after the ARM's went up, many of the underclass and "new" Americans (legal or not) can't afford their notes and now the package-mortgage-investments aren't returning a dividend that keeps place with inflation. We are printing more money to re-invigorate the economy, but it just adds to that inflation which means the mortgage-backed securities REALLY need to pay off.........so we bilk the taxpayer for 700 billion to make sure the "investor class" who politically hankered for the current bubble by backing all the new housing and new immigration, doesn't lose ITS PRECIOUS money.
Joe the average taxpayer, will be paying for all of this for a decade. When will a candidate emerge who gives a tinker's damn about Joe the average taxpayer, who is squeezed by illegals, sees his life chances dwindled by affirmitive action for everyone EXCEPT him, sees his home value dwindle because of the decline in his neighborhood, sees his friend's jobs outsourced, and is bailing out Wall Street's investor class with his taxes over the next two decades to save THEIR PRECIOUS jobs (but not his own). By the way, Joe's son's fights their wars--In Iraq, Afgahnistan, possibly Syria or Iran, all for William Kristol.
I think Thomas Jefferson said, "I tremble at the thought that there might be a just God", or something to that effect. Me too. M
Actually, though I hate to acknowledge it, I think Krugman is right on this, which he usually is on the subjects he has spent a lifetime studying, as opposed to the topics to which he devotes ten minutes a week.
ReplyDeleteThere was no necessity for the emergency easy money of 2001-2002 to turn into the housing disaster of 2007-08, if other features of our financial system had remained honest and functional.
I just got back from a conference in Vegas last week. Yeah, there is a skeleton and a few vacant lots on the strip, and housing prices are diving, but the town still looked booming and busy, and Vegas has to have the most flexible workers in the world, outside maybe Texas oil field workers. These people never expected a lifetime, secure job in one place. They can pack up and move out, and many are looking forward to getting out of Vegas, which becomes a little tiresome after a while anyway.
Awesome takedown, Steve.
ReplyDeleteAfter arguing with leftists on the web, I don't think it is so much that they are stupid, but they get wedded to some narrow world view and spend their energy interpreting all things to fit that view.
A death happens when, for whatever reason, a the heart stops beating. Yet, for all its simplicity, the insight that a death is about a heart no longer beating makes nonsense of the whole disease / trauma theory. For if the problem is that the heart isn't beating, why not simply increase the supply of heartbeats? You may tell me that it's not that simple, that the patient has died of bubonic plague or from falling off a cliff. Well, fine. Junk the bad heart and write off the bad organs. Why should this require that perfectly good productive capacity be left idle?
ReplyDeleteSteve,
Are you trying to resuscitate the broken window fallacy? Or am I missing something here? That fallacy, for all its imperfections (it sometimes doesn't account for the chance to apply new technology to old circumstances) isn't taken serious by economists anymore. I still think it is a fount of wisdom.
AO
Steve,
ReplyDeleteGreat post. I've made up my mind that if I ever return to school for a PhD, this fusion of behavioral genetics and economics will be an easy field for generating new but old and obvious insights. After all, it's fairly obvious that economic theories can be improved if we analyze human capital and the mobility of labor with the insights garnered from evolutionary theory. It's just sad that no one has the temerity to do so.
AO
Ok, Steve - so the casinos in Las Vegas are useless. Why does that require auto plants in Detroit and Tokyo to be idle?
ReplyDeleteYou should read your piece over again, keeping in mind that financial wealth and real wealth are not, in fact, the same thing, and see if you can spot the fallacies in your argument.
Frankly, I'm disappointed. You usually have a coherent and interesting alternative viewpoint. This is just drivel of the sort you can read on any rightwing nutjob's site.
The thing to keep in mind here is that economics is a sham science. It's a bunch of political opinions backed up, purely for effect, with some math-like nonsense. I've always thought that the existance of a Nobel Prize in economics was a disgrace. In every real sceintific field there is broad consensus about large chunks of knowledge pertaining to that field. Sure, physicists can argue about the unified field theory, etc., but such things represent the margins of what is known about physics. There are oodles of volumes of stuff about which physicicts don't argue anymore, stuff that's been proven beyond a reasonable doubt to be true. Nothing like that is possible in a sham science like economics. You can have a Marxist and a Libertarian economist hold opposite views about everything that economics is supposed to be about, including the basics.
ReplyDeleteA good way to tell a science from a pseudo-science is to see if the field in question can provide useful predictions that cannot be made by people ignorant of that field. If you understand a process thoroughly, you should have a good idea of where that process is heading, right? Economists' predictions of the future direction of economies are the stuff of comedy. They never beat the proverbial monkey throwing nuts at a newspaper, and yet they rarely decline an opportunity to opine about the future anyway.
Steve, if you want to have more fun at Krugman's expense, dig up some specific predictions of his. He's writing a column, so he's bound to have made tons of them by now.
He says "As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income"
ReplyDeleteNot on any planet where people save or borrow. As you point out there has been rather to much of the latter. Fear of inflation has seriously eroded the former.
I find it amazing that they razed the STARDUST. It was one of the few old time Vegas places left. You know, the ones with sentimental value and diehard loyalists. A brand name that was recognizable. My guess also, a building that was paid off! People just get caught up in the bubble and suspend all logical thought. Vegas was overhyped anyway. America has to get back to creating,engineering, and manufacturing. It is what built us up as a superpower and is the foundation for a powerful country, not gaming(I like that little euphemistic work change from gambling). I have seen what casinos do to communities and it is not pretty. Even Lefty Rosenthal, the real person behind the Deniro character in CASINO who just passed away on Oct. 13th,has said in an articles that Casinos just suck money out of the economy. Here is the long link the frontline article, http://pbs.gen.in/wgbh/pages/frontline/shows/gamble/interviews/lefty.html
ReplyDeleteI have a request for all you American bloggers who write about your economists. It would help this forgetful foreigner if, after you name the rogue, you put in brackets some salient characteristic that would help me distinguish him - as in "worked for Enron", or "looted Russia", or "too odious even for Harvard". Just a suggestion. P.S there would be no need to do it when you come to disparage Broad deRound - his name is truly memorable.
ReplyDeleteTo paraphrase one of the clowns involved in perpetuating the entire government illusion: They create their own reality.
ReplyDeleteSteve, it is your bounden duty as a sceptic (or, if you must, skeptic) to point out that the Economics prize is a pseudo-Nobel, invented by the likes of Krugman, for the likes of Krugman.
ReplyDelete"Look, the hulk of the Echelon on the Strip isn't perfectly good productive capacity. It is, at present, perfectly no good productive capacity."
ReplyDeleteMoreover, if the it had been built, and was open for business right now, and was turning a profit, it would STILL not be productive capacity.
Gambling is an innocuous pastime, when it consists of a friendly poker game, an office basketball pool, or a day at the races. When it becomes the basis for whole regions, and sectors of the economy, it is a pernicious vice. There is a reason that gambling was traditionally considered a marginal activity - because it necessarily had to stay at the margins of society.
The problem with this economy is that guys who think like Krugman are winning Nobel Prizes and setting economic policy while guys who think like you are reviewing films. WTF?
ReplyDeleteWhat we need out of our technocrats is less theory and more "WTF". When the houses featured on the gangster movie Friday are selling at mansion prices and banks are offering people like me zero-down mortgages...WTF?
When there are more banks and payday loan centers downtown than fast food restaurants...WTF? When Indiana's population and economy are stagnant but McMansion farms are forming in every direction...WTF?
I remember when I first learned about money market accounts, and listened to the banker explain to me that money market accounts offer great interest rates without any risk of losing money, I asked myself...WTF?
If this decade gets its own label, I believe it should be "The WTF Decade", a surreal period which began with a froth of nonsensical groupthink in every direction and climaxed this month with a political and economic WTF so loud that it shook our political and economic institutions to their foundations.
In the long run, its wealth is mostly a function of its human capital (i.e., the population's ability to earn money). So, don't debauch the average human capital of your population.
ReplyDeleteAll the more reason to replace taxes on economic activity with a use fee for net liquidation value of property rights (with a subsistence exemption including home and small family business):
The value of human capital gains will skyrocket.
Good takedown, Steve. Krugman was of course awarded the Swedish Central Bank's prize for telling central bankers and their government enablers what they want to hear.
ReplyDeleteBTW, can anybody in Steveland tell me why GM and Ford are still breathing oxygen? I have to believe the institutions that own almost every share of these dying behemoths are just trading them back and forth to keep them from being de-listed.
--Senor Doug
Absolutely brilliant, Steve.
ReplyDeleteKeynes wasn't completely wrong as an economist, because he specified that whatever deficits were run in a recession should be counterbalanced by surpluses in the boom times to slow things down. But in practice that has never worked, and all we've ever gotten are bigger and bigger deficits and the need for more and more debt to keep the withdrawal symptoms away.
Let's see how Krugman feels about firing government workers and shutting down programs during the next recovery. Hey, it's just Keynesian, right?
Krugman on 'their' theory
ReplyDeleteDon't say that it's obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them.
Krugman on 'his' theory
A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time.
Now that's some handwaving! I wonder if it takes an epic intellectual journey to see those companies could be increasing their cash reserves to cover bad investments?
My theory: recessions occur when everything recedes. This whole post was hilarious...
Milton Friedman was no advocate of the Austrian school - you wanna strip that dumb stupid moron (kidding) of his Nobel?
ReplyDeleteYour analysis is missing a critical element that is formative to Mr. Krugman's perception of the world.
ReplyDeleteHe's 4 feet tall.
I believe the psychiatric journals are chock-a-block with accurate predictions of what this does to the intellect.
I think we'll still need whores, come what may.
ReplyDeleteIt seems that Krugman isn't denying that "bad investments in the past lead to unemployment of good workers in the present," he's arguing that recessions aren't *necessarily* result of booms. As he argues later, the Austrian theory cannot explain the correlation between ups and downs in investment demand and ups and downs in the economy in general - rather, it takes that correlation as a starting principle. He's arguing against a theory that seeks to offer a comprehensive and even totalizing view of how economies function - not responding to the fiscal situation in 1998 much less the one in 2008. Ultimately, it seems unfair, not to mention intellectually suspect, to extrapolate arguments that Krugman made over 10 years against an already discredited economic theory to take him to task for somehow getting the current financial crisis wrong.
ReplyDeleteIn defense of Krugman, he was one of the first journalists to even notice that there was a housing bubble. He's also been several steps ahead of the government in his assessment of the problems at hand, advocating for equity stakes when Paulson wouldn't even consider it. Moreover, the implication of the Hang-Over theory seems to be that governments shouldn't intervene to increase credit or money supply - which, I don't know, seems too laissez-faire.
Steve,
ReplyDeleteDerb is giving you some publicity on "The Corner." Peter Schiff wrote about this in his book about how we desperately needed a moderate recession in 2001 to atone for our tech-bubble sins (remember Pets.com?) but Greenspan thought he could stand athwart history yelling stop by pumping trillions of dollars into the US economy. I live in Northern NJ and it is not nearly as bad as it is in Vegas, So Cal, Phoenix. Did the people in Vegas actually believe that they were generating wealth? Were they serious? No one is talking about this but Las Vegas and Phoenix are just terrible places to have large metropolitan areas. No infrastructure, no natural resources (water anyone?). I'm all in favor of blanketing the desert with solar panels but you aren't going to build is viable city with that....
@Steve Sailer
ReplyDeleteGreat fuckin' piece. Luv it.
-Patrik
In short, he can't see the difference between wealth and money. He is also confusing the distinction between jobs and wealth creation. To be fair, almost nobody has been taught to think in those terms.
ReplyDeleteDon't forget also, we are getting less wealthy because of our massive spending on security, police, and military, all of which create jobs, but do not create wealth. Also, the massively expanding industry of health care. Taking care of the sick and dying employs a lot of people, but produces no wealth.
I don't think you should have the right to vote unless you can explain the difference between jobs, money, and wealth.
Good read. The passage from "The tech bubble was stupid..." to "... never ever made any sense" was hilarious.
ReplyDeleteRead your last three paragraphs again and you've got it right. What has happened now has nothing to do with the usual recession or overbuilding that happens in ordinary times. We all are paying for the completely false economy based on money that was NEVER there or would be there. These derivatives/credit default swaps produced an entire unregulated false global economy, not just a local recession to be worked out over a short period of time. Read Greenspan's testimony.
ReplyDeleteKrugmans theory stands.
The Austrian business cycle theory is the only economic theory that has ever made a lick of sense to me.
ReplyDeleteExcellent!
ReplyDeleteAn additional point:
Even had the Echelon opened it would be facing a shrinking market and probably be operating at a loss while stealing business from competitors. The fact that it did not open is not critical to your example. Operating at a loss is inefficiency, and the only cure is for the growth curves to only point up or a long recession while they catch up. (Or, conversely, destruction of assets to get capacity back in line with demand -- perhaps Krugman would advise hiring the unemployed as wrecking crews until they can resume constructing again?)
Krugman has never read a word of Hayek.
ReplyDeleteI'm fairly convinced of this fact.
He says himself he can't read more than a page or two of pre-mathematical economics, he simply doesn't have the stomach for it.
And all evidence of his writings on Hayek point to the fact that he's never read a bit of Hayek -- or even any of relevant secondary literature on Hayek, or Hayek's role in the development of modern economics.
Krugman is a "math jock" or "idiot savant" as the American Economic Association committee on graduate education termed such morons who excel at 3rd rate mathematization of long-known economic ideas.
So don't trust anything Krugman writes on Hayek -- or any other economist born before, say 1950. He simply does NOT know the material.
Never read it. Never studied it.
Never understood it.
Krugman DOESN'T know much economics, if truth be known, outside of some modern mathematical economics -- most of it build on deep scientific mistakes about the nature of pursuing a successful explanatory strategy in economics.
There is no contradiction between your take on events and Krugman's description of the causes of a recession. You say it's a wealth effect. But how does the wealth effect work ? People feel wealthy, so they spend on consumption and investment goods. When they stop feeling wealthy, they cut back on spending. But how are the retrenchments actually manifested ? Krugman's short sentence says it all :
ReplyDelete" A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. "
Banks attempt to collect (cash) on defaulted mortgages through foreclosures. Investors sell mortgage bonds and rush to own cash. Everyone hoards cash because they are afraid of the future prospects of the economy.
You see ? No contradiction between you and Krugman. You just didn't understand this because you are too obsessed with your hobbyhorses and thus misinterpreted a theoretical dispute in macroeconomics without knowing the relevant context.
Krugman's point was to criticise an incoherence in Austrianism. The chief problem with Austrianism is, it assumes that markets clear -- if investment spending falls, then consumption spending should rise to keep income level the same -- but this obviously does not happen in reality, at least not quickly. Austrians explain it away as frictional unemployment, the reallocation of labour from capacity building to production. The long-drawn out pain we will likely experience as a result of the mortgage crisis is not some f***king reallocation from investment to consumption. It's a general slump.
The only dispute is the policy response. You think the rot must be worked out of the system. But overinvestment in capacity in one sector (housing) should not mean that capacity in other sectors should be left idle. That is the bad thing about recessions, one sector may be responsible for the mess, but general credit conditions can affect all sectors.
Note well that your argument here implicitly attack's Milton Friedman's work on the "consumption function".
ReplyDeleteFriedman worked within the Keynesian framework to undermine it.
You are suggesting here that Fiedman's work fails to take into consideration systematic time structure illusions which are the building blocks of the Hayekian macroeconomic framework.
STeve, you and Krugman are both wrong.
ReplyDeleteThe reason the tech bubble when it burst was not a depression starter, as due to cheap energy.
ENERGY is the basic input of the economy. People are not going to Vegas because gas and airfare costs too much, and the energy costs hit them in the pocketbook everywhere: going to work, school, food, etc.
Cheap energy is like "free money" and allows for all sorts of things and a lot of economic activity that gets choked off at high energy prices. One example: trans-Pacific container trade.
The Housing crisis by itself would have been no more destructive than the S&L crisis (which it resembles) or the tech crisis or any other bubble burst in cheap energy.
Make energy very expensive, and you have a recession-depression lasting years.
This is not "minorities fault" or "evil greedy bankers" ... it is the fault of policy makers dating back to Bush 1 deciding to pander to the Greens and not drill here.
That's a fine essay deconstructing Krugman's deconstruction of Hayek and the Austrian School. The concepts you illustrate so concretely remind me of Boudreaux's rants at Cafe Hayek when Krugman won the Nobel.
ReplyDeleteConsidering all the fuss about job retraining in the past, you'd think the left wing would understand the fundamentals of coordination problems
The Tech Bubble was stupid, but at least pouring huge amounts of money into Cisco Systems had a certain surface plausibility. Cisco actually made something (either switches or routers, I can't remember which, despite reading dozens of articles in 1996-2000 but how the world could never get enough switches and/or routers)
ReplyDelete----------------------
Cisco makes both switches and routers, as well as hubs and other network appliances. It's not easy to explain the difference among these devices unless you are familiar with networking concepts and the OSI model.
To top it off, some manufacturers actually mislabel switches as hubs. The home user can't tell the difference, because a switch provides more network functionality, but networking specialists who need to reliably monitor and predict network routes notice the difference.
Mark Sanford has an op-ed in today's Washington Times about the mortgage fiasco.
ReplyDeleteI think Justin Halter nailed it in his comment!!! Just look at New York City's budget, projected to be $69 billion in 2009! Vast amounts of money spent on what is essentially used to babysit NYC citizens. Vast amounts of money employing vast amounts of people, creating very little wealth. Now there is no one that is more pro-NYPD than I am. My best friend is an NYPD officer and they work their tails off. However, there are roughly 38,000 NYPD officers right now, whose primary function is to babysit NAMs. Yes, alot of jobs are created there but is much wealth being created? Money that could be used for savings, which leads to capital investment, which leads to wealth is instead spent on infinite bureaucratic make work programs. But remember what our philosopher king, Mike Bloomberg has to say, "America is committing mass suicide by putting restrictions on immigration." Because as we all know, the South Bronx, Corona, Queens and East Harlem are really the drivers of America's technology growth.
ReplyDelete>>jimbo said...
ReplyDelete>>Ok, Steve - so the casinos in Las Vegas are useless. Why does that require auto plants in Detroit and Tokyo to be idle?
B/c the marginal buyers of new cars were Las Vegas casino workers (and mortgage brokers, and Wall Street debt securitizers, and other boom-related occupations). Throw them out of work, and you don't need to build as many new cars -- hence, idle auto plants.
t99,
ReplyDeleteHigher energy prices caused the tech bubble to burst? You mean the dot-coms just couldn't cover the costs for coal to shovel into their boilers or to power their steam locomotives? Townhomes plopped down anywhere there was spare acreage would still be worth $600K if gas were $3/gal?
Do you read ANYTHING besides Jane's Defense Weekly?
--Senor Doug
He may be *stupid*, in the sense that he gets it all wrong, but I would be very suprised (in fact I do not think it is possible that he could be of average intelligence) if he did not have a very high IQ.
ReplyDeletePhD in econ.? Not easy.
I find it amazing that they razed the STARDUST. It was one of the few old time Vegas places left.
ReplyDeleteIt had a great sports book -- best in Vegas.
Las Vegas has turned into a caricature. Of itself.
Okay, I like most of what Steve wrote and will try to deal with the nay-sayers.
ReplyDelete(By the way, I did my oiwn deconstruction of Krugman here.
henry canaday:There was no necessity for the emergency easy money of 2001-2002 to turn into the housing disaster of 2007-08, if other features of our financial system had remained honest and functional.
But the whole point of easy money is to make the various parts of our financial system dishonest and dysfunctional. If not the housing bubble, then something else.
anonymous (AO): Are you trying to resuscitate the broken window fallacy?
No, Steve's point is that all sectors of the economy are interrelated; you can't excise the bad loans and bad investments without doing some damage to other parts of the economy. That is, there are no painless corrections.
jimbo: Ok, Steve - so the casinos in Las Vegas are useless. Why does that require auto plants in Detroit and Tokyo to be idle?
Well, perhaps because at this time people don't want to buy cars, or maybe they do not want to buy the cars that are currently available? Maybe people do not have a lot of available wealth right now and they would rather use their resources for something else. Maybe various factors required for the production of automobiles are absent or in short supply.
Trying to make these atuo plants run through government subsidy could have the effect of impoverishing other sectors of the economy that are competing for the same resources, or result in the produciton of large numbers of cars of a sort that people really don't want.
It seems that Krugman isn't denying that "bad investments in the past lead to unemployment of good workers in the present,"
He is arguing that there is no reason why they should, and that the correct policy can make good workers immune to the effects of bad investments.
he's arguing that recessions aren't *necessarily* result of booms.
Austrians never claimed that all economic downturns are the result of booms. The Austrian model explains why there is a business cycle with more or less predictable ups and downs rather than a smoother economy with ups and downs being sporadic.
As he argues later, the Austrian theory cannot explain the correlation between ups and downs in investment demand and ups and downs in the economy in general - rather, it takes that correlation as a starting principle.
The reason for the correlation is simple - investments are what fund the means of production. What you nd Krugman are arguing is equivalent to wondering "why does a reduction in the demand for seed corn result in a famine? People are still eating corn, and demand for corn to eat goes up, which should offset the decrease in demand for seed corn." The problem is that no seed corn means no corn next year, no matter how great the demand.
He's arguing against a theory that seeks to offer a comprehensive and even totalizing view of how economies function - not responding to the fiscal situation in 1998 much less the one in 2008.
The Austrian theory of the business cycle is not comprehensive; it explains one phenomenon in the modern economy.
Read your last three paragraphs again and you've got it right. What has happened now has nothing to do with the usual recession or overbuilding that happens in ordinary times. We all are paying for the completely false economy based on money that was NEVER there or would be there.
To the contrary, what has happened now is just a much more severe example of the usual recession or overbuilding that happens in "ordinary times." It's just that the "completely false" section of the economy (which has existed for a long time) was allowed to grow far more than in previous cycles.
pseudoerasmus:There is no contradiction between your take on events and Krugman's description of the causes of a recession. You say it's a wealth effect. But how does the wealth effect work ? People feel wealthy, so they spend on consumption and investment goods. When they stop feeling wealthy, they cut back on spending.
They cut back on spending because they have little left to spend, which corresponds to the fact that there is less to spend it on. Getting them to "feel" wealthier and to spend more will not make more goods and services materialize out of the ehter.
But how are the retrenchments actually manifested ? Krugman's short sentence says it all :
" A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. "
While technically he is just noting that the recession and the cash hoarding are occurring simultaneously, it is clear from the context that the assumption Krugman is making here is that the attempt to hoard is what causes the recession. Steve's point is that the "hoarding" represents the facts on the ground resource-wise. It is not an independent development causing the recession, it is a symptom of the recession.
Banks attempt to collect (cash) on defaulted mortgages through foreclosures. Investors sell mortgage bonds and rush to own cash. Everyone hoards cash because they are afraid of the future prospects of the economy.
Yes, but this is an effect, not a cause, of the recession.
You see ? No contradiction between you and Krugman.
Except that Krugman believes that the hoarding is an irrational response that causes the recession and that you can end the recession by getting rid of the effects of the hoarding. That's like trying to make a room warming by removing a layer of clothing.
The chief problem with Austrianism is, it assumes that markets clear -- if investment spending falls, then consumption spending should rise to keep income level the same -- but this obviously does not happen in reality, at least not quickly.
Austrianism does not assume that income levels must remain the same. Rather, they assume that during the boom, that investment and consumption both rise to the point where they exceed the resources available to sustain them. Consumption need not rise when investment falls, because the total resources available have fallen.
Austrians explain it away as frictional unemployment, the reallocation of labour from capacity building to production. The long-drawn out pain we will likely experience as a result of the mortgage crisis is not some f***king reallocation from investment to consumption. It's a general slump.
Unemployment occurs as the economy tries to build up resources and capacity in the underfunded sectors in order to provide the raw materials to the other sectors. As Bob Murphy said, you need the wheat before you can make bread. A computer factory will and a computer factory worker will remain idle until all of the materials necessary to build the computer are available again.
The only dispute is the policy response. You think the rot must be worked out of the system. But overinvestment in capacity in one sector (housing) should not mean that capacity in other sectors should be left idle.
But that "overinvestment" has left "underinvestment" in the other sectors. The other sectors will not be running at full capacity until all of the resources being shunted into the "overinvested" sector are liquidated and invested into them. Even then, most of the other sectors do not run independently of one another. Some sectors will have underutilized capacity until all of the sectors that it needs to propoerly function are running at full steam again.
The problem in the Great Depression was the sharp contraction of the money supply due to bank runs, which is why we now have FDIC insurance.
ReplyDeleteThe only reason the money supply contracted when depositors took their money out of the banks is because the banks were *fractional reserve* banks, and therefore did not actually have their depositors money, having lent it out.
You have to hand it to Steve for calling a guy stupid immediately after he wins the Nobel prize. However, in this post Steve is the stupid one and Krugman is the smart one. Actually, this post would flunk you in intro macro. You don't get macroeconomics unless you understand why this analogy is false:
ReplyDeleteYet, for all its simplicity, the insight that a death is about a heart no longer beating makes nonsense of the whole disease / trauma theory. For if the problem is that the heart isn't beating, why not simply increase the supply of heartbeats? You may tell me that it's not that simple...
Yes, Steve, it IS that simple. Or, it can be. We can increase the supply of economic "heartbeats" just by increasing the money supply and getting bad debt off the books. Economic "heartbeats" are social creations, not creations of nature like the human body. So we really can wish them into existence through a political decision, as we can't do with heartbeats.
This is not true if there is a *real* resource shock to the economy -- if we no longer have physical access to a real production process we had access to yesterday. E.g. in testing99s example, if we run out of oil, or can't get access to oil any more. That's real business cycle theory. But in the case of a pure financial shock, nothing in the real physical world has changed, the problem is social, and can potentially be solved socially. (Whether we can iron out all the political and social problems in the way of such a solution is another question, of course).
To put things another way: there were no illusory resources or wealth in the current U.S. economy. All the resources to build those houses and hand them out to people really existed...we know that because the houses were actually built. The illusion was the implicit beliefs about *future* wealth growth that underpinned the various committments that were made. But there is no physical or natural reason the economy has to shrink, if we can rearrange those committments then there's no reason we can't absorb the change in beliefs about the future with no reduction in current wealth.
That's not to say the Austrians are wrong. They have their arguments as well. It's just that the issues here are deep, Krugman gets them and Steve apparently just doesn't. So he's not engaging with the force of Krugman's arguments at all.
Krugmans problem, beside his obvious arrogant, is that he is sharper than he is deep.
ReplyDeleteNo, Krugman is very deep. In fact, he's so good at explaining very deep concepts in a simple and accessible manner that people sometimes miss how deep he is. That's what he's doing here -- he's explained a very deep concept about Says Law that took economists a century to understand, and that Keynes never fully unpacked in non-technical terms, and Krugman does it in a very accessible manner. But Steve just doesn't get it.
MQ asserts:
ReplyDelete"But in the case of a pure financial shock, nothing in the real physical world has changed, the problem is social, and can potentially be solved socially. (Whether we can iron out all the political and social problems in the way of such a solution is another question, of course). To put things another way: there were no illusory resources or wealth in the current U.S. economy. All the resources to build those houses and hand them out to people really existed...we know that because the houses were actually built."
These houses were to a large extent built out of manufactured items from China bought, in essence, on credit. (We sent them checks and they turned around and bought Fannie Mae stock and T-bills with the dollars.) The Chinese expect to get their money back from us at some point. If they don't get it back, well, then they won't ship us as many manufactured goods. Moreover, they won't be as wealthy as they thought they were either, so they'll stop going to Las Vegas, too, and the Echelon will just sit there unfinished even longer.
Hi Steve,
ReplyDeleteSeems like you have a lot of angst. If he is so stupid an you the opposite, where is your Nobel Prize?
Paul
Steve, by the basic principle of Stevism you can't call a guy with a very high IQ stupid. I can, because I don't believe there's a thing properly called "intelligence" that IQ tests measure, but you can't.
ReplyDeleteGlaivester said :
ReplyDeleteThey cut back on spending because they have little left to spend, which corresponds to the fact that there is less to spend it on.....While technically he is just noting that the recession and the cash hoarding are occurring simultaneously, it is clear from the context that the assumption Krugman is making here is that the attempt to hoard is what causes the recession. Steve's point is that the "hoarding" represents the facts on the ground resource-wise. It is not an independent development causing the recession, it is a symptom of the recession."
This is obviously false, because in a financial bubble there is always more money -- either through easy monetary policy, or through capital account surpluses (i.e., Chinese money). What changes is perception : there is a sudden EXOGENOUS change in the perception about the sustainability of the bubble. But if people keep believing that real estate prices will keep going up, then the money is there to keep borrowing against the real estate and spending on goods.
But where are the real resources ?
Apparently it has escaped your notice what the US current account deficit represents : it represents both the net value of goods that the rest of the world is selling to the USA AND the net money flows from the same source which are financing those purchases. In other words, both the money and the real resources are there, it's only a matter of investor perception whether these keep flowing.
Getting them to "feel" wealthier and to spend more will not make more goods and services materialize out of the ehter.
The wealth effect is Sailor's argument.
"Rather, they assume that during the boom, that investment and consumption both rise to the point where they exceed the resources available to sustain them. Consumption need not rise when investment falls, because the total resources available have fallen."
You're just assuming what you need to prove : there are fewer resources as the spur to the recession.
John of London said:
ReplyDelete"Steve, by the basic principle of Stevism you can't call a guy with a very high IQ stupid. I can, because I don't believe there's a thing properly called "intelligence" that IQ tests measure, but you can't."
How do you know Krugman has a high IQ? Did you guess that he has a high IQ because he writes in complicated sentences, looks smart in photographs and on TV, etc.? But, if you don't believe that the concept of IQ is valid, then shouldn't you stop yourself from equating a complicated writing style, etc. with high IQ? In other words, aren't you being inconsistent WHILE accusing Steve of being inconsistent?
Unlike Steve I don't think that Krugman is stupid. Krugman has a political position to push, and, since he has a lot of verbal intelligence and few scruples, is able and willing to demagogue, over-complicate and mislead in support of this position. His reasoning doesn't work, but that's because he's dishonest, not because he's stupid.
John, the most authoritative book out there on the science of intelligence is "The g Factor" by Arthur Jensen. I recommend it highly.
As I've said before all economics (apart from the tautological basics as expounded by the 18th century classicists), is a load of bollocks (to coin a fine English phrase).
ReplyDeleteAs the great mathematician Stanislaw Ulam once stated, there is no 'true uncontested fact' in economics that is not trivial.
Case in point is the rise to economic superiority of modern China.Cast your mind back 30 years - China, such an unpromising land, the North Korea of its day, all Mao suits, bicycles and impoverished peasants.The only natural resource the talent and hard-work of its people.
- And that's just it. The only determinant of economic success isthetalent and industry of the particular people of a particular nation.All the rest is nonsense.
I do realise that state Marxism did dampen the natural entrepeneurship of the Chinese previous to 1978 - but that'san argument against academic theory rather than for it.
To put things another way: there were no illusory resources or wealth in the current U.S. economy. All the resources to build those houses and hand them out to people really existed...we know that because the houses were actually built. The illusion was the implicit beliefs about *future* wealth growth that underpinned the various committments that were made. But there is no physical or natural reason the economy has to shrink, if we can rearrange those committments then there's no reason we can't absorb the change in beliefs about the future with no reduction in current wealth.
ReplyDeleteExcept that much of our wealth takes resources to maintain. True, if we just forgave a bunch of mortgages, everyone could keep their houses, but we will have to reduce our levels of consumption a great deal, a much larger percentage of our income will go into maintenance of these houses, we may drive older, decrepit cars a lot longer, and when we have problems with our big, fancy TVs, we may have to go without instead of repacing or repairing them.
Meow.
ReplyDeleteJealousy is not healthy.
The astute Walter Williams in his latest column delivers a good blow against Krugman also:
ReplyDeleteWackonomics isn't just practiced by the uninitiated. This year's Nobel Laureate, Princeton University Professor Paul Krugman, after the terrorist attack on the World Trade Center, gave one rendition of wackonomics in his column "After the Horror," New York Times (9/14/01). Krugman wrote, "Ghastly as it may seem to say this, the terror attack -- like the original day of infamy, which brought an end to the Great Depression -- could do some economic good." He went on to point out how rebuilding the destruction in New York and Washington, D. C., would stimulate the economy through business investment and job creation. For practitioners of non-wackonomics, this reasoning doesn't even pass the smell test. If Professor Krugman's vision is correct, and extending his logic, the terrorists would have made an even larger contribution to our economic well-being had they been able to fly a plane into the White House and destroyed buildings in other cities.
Wackonomics isn't all bad. There's an upside to it. It spares people the bother of having to understand the complexities of the world.
"MQ said...
ReplyDeleteYou have to hand it to Steve for calling a guy stupid immediately after he wins the Nobel prize."
There is NO Nobel prize in economics. We should stop calling it that.
"-- he's explained a very deep concept about Says Law that"
It is always amusing when economists try to talk about their field as if were a real science.
"Anonymous said...
t99,
Higher energy prices caused the tech bubble to burst?"
You've misread Testing99. He is saying that the tech bubble burst did not cause a general economic downturn because energy was still comparatively cheap at the time.
There is a lot of truth in what Testing99 says here (an unusual circumstance for him). Energy is the single most important input into the economy. It is the real source of wealth. When it becomes scarcer, we all become poorer.
"To put things another way: there were no illusory resources or wealth in the current U.S. economy. All the resources to build those houses and hand them out to people really existed...we know that because the houses were actually built. The illusion was the implicit beliefs about *future* wealth growth that underpinned the various committments that were made. But there is no physical or natural reason the economy has to shrink, if we can rearrange those committments then there's no reason we can't absorb the change in beliefs about the future with no reduction in current wealth."
ReplyDeleteI haven't seen anything like Krugman's depiction of the Hangover Theory in my brief exposure to the Austrian School. Really, with the libertarian underpinnings, any hellfire and damnation slant on the Austrian explanation is suspect. Their focus is often on the miracle of fractional reserve banking which seems to be operating on the basis that wealth we expect to have in the future is money we have in the here and now. Making unwise investments just further undermines an economy already compromised by operating as if future wealth is already in existence.
I think real estate is the most tangible evidence of the problem of malinvestments. For instance, I know of strip malls from the last building boom some 20 years ago, that have sat empty much of the time and/or have rarely been even half occupied. Buildings deteriorate, styles change, a natural disaster might wipe it out in the decade or so before it becomes a profitable endeavor. How is this not evidence of money that could've and should've been invested in a different way. (I've even considered government intervention to insist that these behemoths be bought or leased before more acres of forest are allowed to be levelled for newer behemoths in more desirable locations but that would probably make me a heretic.)
Developers mistakenly thought that lowered construction costs - cheap loans, cheap illegal labor, cheap land - equated to a good investment. Feedback in the form of the free market setting the cost of borrowing was distorted due to the FED interfering to encourage the housing boom/minority homeownership. The potential effects of this malinvestment are numerous. Money was spent on homebuilding that could've/should've been spent elsewhere. Creating alternatives to fossil fuels for instance.
Many economists had no idea what the unintended consequences would be this time, the last time or the time before. I don't understand why you would hold any of them in such high esteem that you would attack anyone who challenged their theories. And, unlike science, the decisions of economists can directly and negatively impact your life. Stop worshipping Krugman because he gets prizes and learn how to evaluate his advice. It's not out of the question that he is both very smart and very wrong.
I mean really are we all supposed to move to those neighborhoods built miles away from shopping malls, hospitals, and jobs like colonists and start civilization anew? Or maybe people can start businesses dismantling the useless structures to be sold for scrap and plant trees to cover the land cleared for streets and foundations decades too soon. Seems to me it would be a lot more efficient and productive to avoid making mistakes on such a grand scale in the first place but we could create a boom cleaning up the mess made by the last one. Sure, why not? : )
ENERGY is the basic input of the economy. People are not going to Vegas because gas and airfare costs too much, and the energy costs hit them in the pocketbook everywhere: going to work, school, food, etc.
ReplyDeleteChecked oil prices lately? Problem solved, I gather.
mq,
But there is no physical or natural reason the economy has to shrink, if we can rearrange those committments then there's no reason we can't absorb the change in beliefs about the future with no reduction in current wealth.
"Rearrange those commitments" as in borrow more or print money? You plan on doing that indefinitely, do you?
john of london,
Steve, by the basic principle of Stevism you can't call a guy with a very high IQ stupid. I can, because I don't believe there's a thing properly called "intelligence" that IQ tests measure, but you can't.
If you don't believe there's any such thing as intelligence, how can calling someone stupid have any meaning at all? (How much longer do you plan on being offended by reality, John?)
And that's just it. The only determinant of economic success isthetalent and industry of the particular people of a particular nation.All the rest is nonsense.
ReplyDeleteMarket economy + Human capital. Cool, I'm not the only one who believes this. (Monetary policy's another biggie, but just varies the growth rate.)
Growth is created by the production and consumption of increasingly higher value products. An economy's ability to do so is determined by its human capital.
We could have had a high tech economy with domestic fruit pickers making $20/hour. Impatient capitalist pigs decided to import cheap labor for the short term gain and now we'll never have the high paying economy.
Nothing is so egregious as leftwing economists' failure to scream bloody murder over wage-killing immigration.
"But overinvestment in capacity in one sector (housing) should not mean that capacity in other sectors should be left idle."
ReplyDeleteThe other sectors suffer during investment bubbles because the easy credit draws human and material resources away from productive (wealth producing) activities and into the unproductive (wealth-consuming) activities of the bubble. It is the misallocation of these real resources which inevitably leads to the "hangover" as people eventually must stop engaging in unprofitable, wealth-consuming activities and go back to working in productive activities and repairing balance sheets (i.e. accumulating capital).
The cure for a hangover is to stop drinking and get back to work, not to take the hair of the dog and go back on a bender.
pseudoerasmus:This is obviously false, because in a financial bubble there is always more money -- either through easy monetary policy, or through capital account surpluses (i.e., Chinese money). What changes is perception : there is a sudden EXOGENOUS change in the perception about the sustainability of the bubble. But if people keep believing that real estate prices will keep going up, then the money is there to keep borrowing against the real estate and spending on goods.
ReplyDeleteTrue, as long as the Chinese are willing to trade us goods for money.
The point is, though, is that people trade with the concept that you will give them something of value in exchange. If we have nothing to give the Chinese in exchange for their products, i.e. if they can't spend the money we pay them to get stuff from us, then they have no reason to keep providing us with products.
You are suggesting that we artificially inflate housing prices to maintain the boom. The problem with that is that it relies on the Chinese (and other countries with whom we have a trade deficit) being willing to give us their products without receiving anything in return.
Unless we can enslave China to give us stuff and ask for nothing in return, or unless they are either stupid or overly generous, eventually our perception of what our houses are worth will mean very little.
You're just assuming what you need to prove : there are fewer resources as the spur to the recession.
I have explained why there are fewer resources - because the resources that have been saved aside for later use have all been used up due to the malinvestment of the bubble. The point is, the "prosperity" of the bubble is financed by people eating their savings. If people spend more than they save, they do so by consuming previous savings. If this continues, at some point the savings are gone - at this point, no amount of money printing can stimulate more investment, just increase the prices of whatever goods are available.
Some links on Austrian cycle theory-
ReplyDeletehttp://www.lewrockwell.com/podcast/index.php?p=episode&name=2008-10-22_053_he_predicted_the_great_depression_ii.mp3
http://mises.org/story/3064
http://mises.org/story/3151
Yet, for all its simplicity, the insight that a death is about a heart no longer beating makes nonsense of the whole disease / trauma theory. For if the problem is that the heart isn't beating, why not simply increase the supply of heartbeats? You may tell me that it's not that simple...
ReplyDeleteYes, Steve, it IS that simple. Or, it can be. We can increase the supply of economic "heartbeats" just by increasing the money supply and getting bad debt off the books. Economic "heartbeats" are social creations, not creations of nature like the human body. So we really can wish them into existence through a political decision, as we can't do with heartbeats.
Put another way, mq is saying the recession is simply a crisis of perception and psychology. There is no underlying reality to the recession.
He is wrong.
This is not true if there is a *real* resource shock to the economy -- if we no longer have physical access to a real production process we had access to yesterday.
The problem is that you need a lot of different resources working together in the right way to produce the goods that people want.
If you want to start a pizza delivery joint, you need the space (a building or part of a building), an oven, access to electricity (or some other source of cooking power), a means of communication (phones for people to make orders), all of the necessary ingredients to make pizza, a means of delivering the pizza, and people with the relevant skills to take orders, cook pizzas, and deliver them. If one of these things is not available, your business cannot open until it is (I suppose you could open a walk-in pizza joint if you didn't have the delivery vehicle, but that might not work if you have determined that ou cannot sell enough pizza to make a profit without delivery.
What causes a recession is the fact that a misallocation of resources has caused shortages of one or more of the necessary factors of production for various businesses. In the case of the pizza business, perhaps too much land where wheat could have been grown was left fallow as the farmer had decided to take a year off and live off the equity value of his house.
So there's not enough wheat for you to make dough for your pizza (at least not so that you can make a profit). But you've already bought the property - why does it have to sit idle?
Because you've already fitted it for pizza making, and the costs of re-fitting it for something else (and of finding out what you could re-fit it for) or the costs of running a pizza business that will not sell enough pizzas to make a profit are much greater than the costs of the building sitting idle for a year until wheat prices come back down.
But in the case of a pure financial shock, nothing in the real physical world has changed, the problem is social, and can potentially be solved socially. (Whether we can iron out all the political and social problems in the way of such a solution is another question, of course).
The financial shock could be the results of the real physical world effects of the previous financial situation. For example, people living off the equity in their homes might have resulted in fewer hours worked and less produced, or in people consumption patterns changing and subsequently in production patterns changing to meet cosumer demand. This change may have to be reversed to get the economy back on track, and this change-back is neither instantaneous nor costless.
To put things another way: there were no illusory resources or wealth in the current U.S. economy. All the resources to build those houses and hand them out to people really existed...we know that because the houses were actually built. The illusion was the implicit beliefs about *future* wealth growth that underpinned the various committments that were made. But there is no physical or natural reason the economy has to shrink, if we can rearrange those committments then there's no reason we can't absorb the change in beliefs about the future with no reduction in current wealth.
Translation: The problem isn't that people built houses they an't afford. The problem is that their creditors expect to be paid back. Screw the creditors. Either erasethe loans, or just print money and give it to them [which amounts to screwing both the creditors and anyone else who has dollar-denominated assets].
This ignores the fact that the changes in production patterns as a result of the housing boom may have impoverished sectors of the economy that we need to keep our current standard of living going. It also ignores the deleterious effects on future investment that a message of "loan money and don't get it back" will have. It also ignores the fact that we do not have legal leverage over some of our creditors (i.e. we cannot simply command China to forgive our debts), and that if we declare the debts null and void those creditors could lower the boom on us (i.e. stop exporting or export things at much higher prices).
It's just that the issues here are deep, Krugman gets them and Steve apparently just doesn't.
Right. Consume and more will magically appear.
Krugman's essentially correct in that Keynesism works in the ways others in this thread have explained.
ReplyDeleteYou're also essentially correct that malinvestment is malinvestment, independent of macroeconomic policy.
Both of you are correct, per core arguments anyway.
Major problem lies with Krugman, though, for arguing his position sloppily and erroneously, leaving it open to attack. (This is one of his weaker articles.)
What it all boils down to, is that you have to save before you can produce, and you have to produce before you can consume. This requires frugality and low tax rates, which derails the bold, visionary schemes of liberals like Krugman. Thus, he advocates monkeying around with the supply-demand curve for loanable funds, and printing money to support consumption. This is an unsustainable process, as Keynes himself admitted, but airily dismissed by saying in the long run we are all dead. Thus, modern economics and political theory continues to be warped by the present-centered bias of childless homosexuals.
ReplyDelete--Senor Doug
The fact is that there is just one source of 'wealth creation' - namely technological innovation.
ReplyDeleteThink about it.At the time the first primitive Homo Sapiens started to knap flints (they probably couldn't even speak at that time), the world population of Homo Sapiens was probably only a few hundred thousand - that was all that could be supported by the hunting/gathering of the time and the injury/mortality toll.
Of course other breakthroughs followed - the smelting of copper and then iron (woods could now be cleared for farming), the invention of agriculture, domestification of wild beasts, crafting of boats, wheels, ploughs textile weaving etc etc until we get close to the modern period in which the steam engine was inveted (muscle power was no longer, apart from wind and water power, the the main driver), modern iron ships, electricity and artificial fertilizers and pesticides, to name but a few examples.
The point of that little lecture was to illustrate the point that 'wealth' or the ability of the planet earth to support a whole host of Homo Sapiens surplus that it could in man's 'natural state' was entirely developed by the engineers, technologists, inventors and scientists of the day - economics professors had absolutely nothing whatsoever to do with it then as now.
In fact most of the big breakthroughs - and a highly stratified, productive cash economy existed before the rudiments of 'academic economics' were ever dreamed up in 18th century France.
I think the moral is that a free market solution should be given to all academic economic departments.Close them all down and allow the savings accrued be spent by the general consumer on something of real utility to him or her.
Should be "...a childless homosexual." Keynes, that is, not Krugman.
ReplyDelete--Senor Doug
This whole bubble thing reminds me of my hillbilly cousins back in Illinois. They raised coon hounds. One of them would trade one of his hounds to the other. The first dog would be valued at $2950. The other dog would be valued at $3000. $50 would actually change hands. At that point, though, one of them had a hound worth $30000 and the other one $2950, established by the market. Some suckers would eventually buy the dogs for between $2000 and $2500, and think they were getting a real deal. The bursting of that bubble didn't cause much of an uproar in the financial market, but my cousins did end up with a lot of rich people's money. Sort of like the whole MBS fiasco. A few people got very, very rich.
ReplyDeleteHere we are in 2010, a couple of years after I posted this piece, and the Echelon complex is still sitting there with nothing happening on it. The owners announced in 2009 that it would be 3 to 5 years before it opened.
ReplyDelete