Friday, August 9, 2013

Is Paul Krugman right?

Okay, so I'm taking a clue from Yahoo Finance and putting a Nobel prize winner name in the headline to attract attention.  I truly am sorry.

Paul Krugman is Right, It Turns Out, About ‘Uncertainty’

I suppose that depends on your perspective.  The so-called "experts" of the world thrive on twisting ideas to make them fit reality, gaining fame and wealth for themselves in the process.  So, with that in mind, let's take a look at this article, piece by piece.
New York Times columnist and Nobel-prize winning economist Paul Krugman is taking on the role of mythbuster: in his latest column "Phony Fear Factor" -- he claims to have already blown up the following economic myths:
  • Monetary expansion needn't cause hyperinflation.
  • Budget deficits in a depressed economy don’t cause soaring interest rates.
  • Slashing spending doesn't create jobs.
  • Economic growth doesn't collapse when debt exceeds 90% of G.D.P.
First, let me say this: The article has actually reversed the supposed myths.  For example, "Monetary expansion needn't cause hyperinflation" is not the myth.  It is the reality, while the myth, if there is one in there, is that monetary expansion always causes (hyper)inflation.  The others are similarly backwards, so I'll be referring to the myths as they should apparently have been worded.

The first myth is that monetary expansion causes hyperinflation.  Of course it doesn't always, and anyone who believes that monetary expansion always has some predictable result probably needs to go back to school, or, perhaps should just leave the thinking to someone else.  To use economic terminology, monetary expansion leads to inflation, ceteris paribus, or all other things equal.  But if the velocity of money slows down while the currency base expands... well, it depends on exactly how much of each change there is.  It isn't inconceivable that there would be deflation even with monetary expansion.  I'm not sure that this was ever a myth at all.  Did some people believe that the current Fed expansion of the monetary base might lead to hyperinflation?  Of course they did.  Look what happened to gold prices over the last few years.  This time, those people appear to have been wrong.  but to assume that they will always be wrong would be a huge mistake.

The second myth is that budget deficits in a depressed economy cause soaring interest rates.  In a true market economy, interest rates would have risen, maybe enough to be referred to as "soaring."  But this isn't a true market economy and interest rates are being held artificially low by the Fed.  The Federal Government is free to borrow as much as it wants because the Fed is willing to loan as much as the Federal Government wants to borrow.  But in a free market economy, the scarcity of loanable funds would force the government to pay ever higher interest rates.  With the Fed, there is no scarcity of loanable funds.  The Fed will just print more, and interest rates stay low.

The third myth is that slashing spending creates jobs.  No.  I don't know anyone that thinks this.  Slashing spending and cutting taxes proportionately could have the effect of spurring job creation.  But the idea that simply cutting spending will somehow create jobs is ludicrous.  So, if all consumers just decided to not spend any money, we're well on our way to 4% unemployment, I guess.  Of course not.  It isn't spending cuts that creates jobs; it's the tax cuts that should go along with those spending cuts that will give consumers more money to spend.  But if consumers don't spend that money, then even tax cuts won't do any good.  Another way to look at this is to realize that the best thing government can do to spur job growth is to butt out.

The final myth is that economic growth collapses when debt exceeds 90% of G.D.P.  Now, think about this for just a second.  Let's say I'm going to make $100,000 this year, so I go out and borrow $90,000 payable in 1 year at 0% interest that I can just roll over into new loans every year.  Is my economic standing doomed?  Not so long as my interest rate is 0%, and actually, I might be able to manage at as much as 10% or more.  I realize that this isn't exactly the case for the government.  Their interest rate isn't 0%.  I used that example to show that the collapse is not so much dependent on the dollar amount of debt as it is dependent on the interest rate.  As far as the dollar amount of debt compared to G.D.P. goes, it is dependent on whether anyone wants to loan the government money with a debt level that high.  Of course, in our artificial world, the Fed stands willing to loan however much the government wants to borrow, so even that isn't an issue, at least not at the moment.

But the article I'm addressing isn't really about Mr. Krugman.  I think maybe they put his name in the headline just to get attention.  Reference a Nobel prize winner and suddenly people are interested.  On the other hand, mention me and at best people will say, "Who?"  before moving on to the funny papers.

No, this article is about uncertainty.  More specifically, it is about something called the Economic Policy Index "which has plunged to levels not seen since 2008. 'Uncertainty has improved,' says Newman."  Um, no.  Regardless of how people feel about the uncertainty of the future, it is always uncertain.  The future is never more certain, or less certain.  It is always uncertain.  However, people may feel more, or less, certain, but in reality they are still just as uncertain as ever.  Nobody can know what the future holds, no matter how certain they are of the future.

Now, it might be useful to know how uncertain people feel about the future.  In fact, if people in general are more certain about what the future has in store for them, then they will act with increasing confidence, and that is a good thing, at least when the economy is recovering from a big, bad recession like the one we've just experienced.  Confident people spend more, and this in turn leads to increasing demand and job creation, which in turn make people even more confident.  Eventually, though, that confidence turns to overconfidence, and that's where it appears we are right now, at least that's the impression I get when I read this article even though that wasn't the impression I think I was supposed to get.

The part of the video that struck me the most was when the participants started talking about how "all the tail risks are behind us."  Um, no.  Only the ones we expected, which are really the risks to be least worried about.  It is the unexpected risks that can really wreak havoc.  Those risks are still there.  They didn't go away because we somehow muddled through our problems.
Krugman brings it full-circle: "The truth is that we understand perfectly well why the recovery has been slow, and confidence has nothing to do with it. What we’re looking at, instead, is the normal aftermath of a debt-fueled asset bubble..."
He's right, you know.  Unfortunately, he probably doesn't care much (and neither do many people) whether I agree or not.  The main thing, though, is I don't think we're out of the woods yet.  I don't think anything has been "proven" here.  We still don't know if the economy is going to finish the collapse that was started in the financial crisis.  There is still significant uncertainty in the world despite people thinking it's all behind us, and that thinking is what will make those unseen tail risks all the more destructive should they arise.

If we assume, then, that people in general really believe that those bad "tail risks" are all behind us, then it is likely time to head for the fallout shelter, in a metaphoric sense at least.  The time to be defensive is when everyone else believes "the worst is over."  Of course, it may be some time before the really bad, surprising tail risk hits us, so it probably isn't really time to move completely into that fallout shelter.  But I do think it's time to start building a defensive position, and at least open the door to that shelter.

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