One More For the Road
I’m actually in a hotel room right now, and I need to stop hammering Krugman on the bond vigilante stuff. But I see Gene Callahan misunderstood the point of one of my recent posts, and so perhaps I need to step back and explain why this whole thing is so frustrating.
Krugman is saying that we need to show him a historical example of a country in exactly the same circumstances as the US today that suffered from a bond vigilante attack, before he’ll take the deficit scolds seriously. So this rules out all sorts of obvious examples of countries suffering from a bond vigilante attack, and arguably it rules out all examples. But Krugman’s rules for eligibility restrict things to a handful of countries during liquidity crises. Does someone want to come up with an estimate of the percentage of “country-years” for this eligibility? In other words, Krugman basically needs us to show him an example of the US, UK, Japan, and … ? suffering from a bond vigilante attack, at a time when interest rates were 0%, from 1971 onward, or during the interwar period when the major powers were still off gold. If we can’t come up with an example from this incredibly restricted sample of world history, we lose.
Beyond throwing out 99% (?) of the data, though, there’s something more insidious going on here: Krugman is telling us that a bond vigilante attack can’t harm us so long as interest rates are at 0%. Sure, once we leave the liquidity trap, then we might face hyperinflation–Krugman himself tells us this. But so long as we’re still in the liquidity trap, no problem. It’s not even theoretically possible that a bond strike can hurt.
Does everyone see why this is a really really bad argument? Remember that for Krugman, a liquidity trap is defined as a situation with high unemployment and 0% interest rates.
Uno Momento Por Favor, Senor Krugman
I am not going to bother employing my army of employees to fact-check this, but it looks plausible enough to quote and walk away… (HT2 somebody in the comments of an earlier post.)
Paul Krugman, May 2012:
Matt Yglesias, who just spent time in Argentina, writes about the lessons of that country’s recovery following its exit from the one-peso-one-dollar “convertibility law”. As he says, it’s a remarkable success story, one that arguably holds lessons for the euro zone.
I’d just add something else: press coverage of Argentina is another one of those examples of how conventional wisdom can apparently make it impossible to get basic facts right. We keep getting stories about Ireland’s recovery when there is, in fact, no recovery — but there should be, darn it, because they’ve done the “right” thing, so that’s what we’ll report.
And conversely, articles about Argentina are almost always very negative in tone — they’re irresponsible, they’re renationalizing some industries, they talk populist, so they must be going very badly. Never mind this…
After this text, Krugman posts a chart showing that Argentina’s real GDP is growing better since 2002 than Brazil’s.
Juan Carlos Hidalgo, November 2012:
Today La Nación of Buenos Aires reports [in Spanish] that Argentina will have the worst record in terms of inflation and growth in South America in 2012. The Argentine economy will barely grow 1% this year and inflation will be above 20%, while the rest of the region enjoys healthy growth and low inflation rates.
Ah but see, Argentina is in the Southern hemisphere, whereas the United States is in the Northern, Juan, so your argument is invalid.
Potpourri
==> David Beckworth says the Fed isn’t monetizing the debt, and has Tyler Durden destroy something beautiful. (Actually that joke fails on two counts, because it’s not Tyler Durden but a guest blogger, and it wasn’t Brad Pitt but Ed Norton who messed up the pretty boy’s face in the movie.)
==> Mark Spitznagel applies Austrian business cycle theory to the Obama reelection.
==> I’m on “expert” on climate economics. AOL said so.
==> Redmond Weissenberger is teaching a class on the politics behind global warming. Redmond is the founder of the Mises Institute in Canada, and he is very knowledgeable about these issues, though some of you would no doubt classify him as a “denier.”
==> Proving that His libertarian critics are right, God kills another 2.5 men.
==> NoahReadaFriedrich writes: “It was Robert Lucas and Edward Prescott who truly restored Hayekian “classical” economics to dominance in the macro field, with their models of frictionless economies and near-optimal business cycles.”
==> If any of you are bored, please go to this Scott Sumner post and figure out for me what the top marginal *income tax* (not including payroll tax) rate is, for someone making $275,000 in salary, but with $0 in investment income, in 2013. I am very fragile and can’t talk with those bullies in the comments anymore.
What’s Krugman’s Transition Vision?
Predictably, people reconciled Krugman’s two wildly divergent opinions on the dangers of the US inflating its way out of debt by saying we weren’t in a liquidity trap in 2003. Okaaaay, but can someone ask him politely (I don’t think he will listen to suggestions from me) to devote a future blog post to the transition? I.e., explain to me how there can be a worldwide strike by investors in US Treasuries that causes the dollar to depreciate and price inflation to spike, but then after we reach full employment suddenly investors are A-OK again with lending to Uncle Sam and interest rates go back to normal? And also, that this comforting of the investors won’t require painful austerity measures (the kind that sent unemployment in France to 11% in 1927, when they had to deal with stabilizing the franc after following Krugman’s advice two years earlier)?
I’m not being sarcastic. The CBO forecast of the US debt/GDP shows it going up and up. Everybody, including Krugman, admits there is a long-term fiscal imbalance. So I’m seriously wanting Krugman to spell out his vision for how this thing plays out, such that we get a bond strike that rescues us from the liquidity trap, but then turns on a dime so that we don’t run into the monetizing-the-debt-is-bad scenarios that Krugman himself spelled out so eloquently theoretically (when criticizing the MMTers) and as a real-world alarm (when criticizing the deficits of the Bush Administration in 2003).
An Oldie But Goodie
Reading Krugman’s op ed on the “fiscal phantom menace” I was struck by this assertion:
You’ve heard the story many times: Supposedly, any day now investors will lose faith in America’s ability to come to grips with its budget failures. When they do, there will be a run on Treasury bonds, interest rates will spike, and the U.S. economy will plunge back into recession.
This sounds plausible to many people, because it’s roughly speaking what happened to Greece. But we’re not Greece, and it’s almost impossible to see how this could actually happen to a country in our situation….
So let’s step back for a minute, and consider what’s going on here. For years, deficit scolds have held Washington in thrall with warnings of an imminent debt crisis, even though investors, who continue to buy U.S. bonds, clearly believe that such a crisis won’t happen; economic analysis says that such a crisis can’t happen; and the historical record shows no examples bearing any resemblance to our current situation in which such a crisis actually did happen.
If you ask me, it’s time for Washington to stop worrying about this phantom menace — and to stop listening to the people who have been peddling this scare story in an attempt to get their way.
Is it really possible that the same guy who wrote the above, also wrote this back in 2003?
…last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.
…we’re looking at a fiscal crisis that will drive interest rates sky-high….But what’s really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government’s solvency.
…How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.
We’ve known about that gem for a while now, but it’s absolutely astounding to read it again in light of Krugman now saying such threats are impossible according to economic theory. Did Krugman think US debt was denominated in yuan back in 2003? Or is it possible that today’s deficit scolds aren’t the idiots/liars-taking-money-from-Pete-Peterson that Krugman portrays?
Krugman’s Conversion to the MMT Side Is (Almost) Complete
There’s an interesting mix of contrast and similarity between the policy debates in Britain and the United States right now. In both countries — as in every country that retains its own currency and has debts denominated in that national currency — interest rates are near record lows…
It’s very hard to come up with any reason why either the US or the UK might default, since they can simply print money if they need cash. And given the absence of real default risk, long-term interest rates should be more or less equal to an average of expected future short-term rates (not exactly, because of maturity risk, but that’s a fairly minor detail).
So if you expect the US and UK economies to be depressed for a long time, with the central bank keeping rates low, long rates will be low too — end of story.
But won’t that money printing cause inflation? Not as long as the economy remains depressed.
I vaguely recalled a debt and inflation crisis in Great Britain from the 1970s, so I googled to get the details. Try this summary from the UK national archives:
Sterling devalued and the IMF loan
Devaluation of the poundThe left wing of the Labour Party defeated the Public Expenditure White Paper in the Commons in March 1976. Subsequently, Harold Wilson resigned and James Callaghan took over as Prime Minister. Around this time, investors became convinced that the pound was overvalued and that the government might devalue. A large-scale sale of sterling began, which rapidly lost value against the dollar.
In spite of further efforts to reduce inflation, the pound continued to lose value, reaching a record low against the dollar in June 1976….
The 3.9 billion dollar loan
As pressure on the pound continued, the government approached the IMF for a loan of $3.9 billion in September 1976. This was the largest amount ever requested of the Fund, which needed to seek additional funds from the US and Germany. The IMF negotiators demanded heavy cuts in public expenditure and the budget deficit as a precondition for the loan. Healey’s proposals for a cut of around 20 per cent in the budget deficit were hotly debated in Cabinet, particularly by Anthony Crosland and Michael Foot. Eventually they acceded, as it seemed likely that the refusal of the loan would be followed by a disastrous run on the pound. Healey announced the forthcoming reductions in public expenditure to the House of Commons on 15 December 1976.
Following the agreement with the IMF, the overall economic and financial picture improved. Interest rates were soon reduced and the pound quickly appreciated in value. By the end of 1977, partly as a result of new oil revenues, there were improvements in the balance of trade. Britain did not need to draw the full loan from the IMF. Nevertheless, the IMF crisis reinforced a change in policy orientation away from full employment and social welfare towards the control of inflation and expenditure.
I know, I know: The only reason anything bad happened, was that the people in the UK government, the US government, and the IMF were all nuts. Had they just let the pound continue to sink, everything would have been fine. Krugman’s medicine just needed a larger dose and more time to prove its efficacy.
Also, in the 1970s there was disco fever. That isn’t the case today. Clearly the British experience in 1976 has no relevance for our current crisis. Only those ignorant of basic economics and world history could possibly think huge debts pose a problem for a government with a printing press.
Thoughts on Marco Rubio and the Age of the Earth
Hold on to your hats, kids, I think I will alienate 95% of the blogosphere with this one (and without even cursing)…
Marco Rubio has been getting hammered in the blogosphere from both right and left for his coy answer when a GQ interviewer asked him about the age of the Earth. The irony is, the people I’ve seen complaining the loudest, don’t realize that they themselves don’t adhere to their commentary on the Rubio affair.
First, let’s set the context for those who didn’t see the exchange. Here’s the relevant excerpt from the December 2012 GQ:
GQ: How old do you think the Earth is?
Marco Rubio: I’m not a scientist, man. I can tell you what recorded history says, I can tell you what the Bible says, but I think that’s a dispute amongst theologians and I think it has nothing to do with the gross domestic product or economic growth of the United States. I think the age of the universe has zero to do with how our economy is going to grow. I’m not a scientist. I don’t think I’m qualified to answer a question like that. At the end of the day, I think there are multiple theories out there on how the universe was created and I think this is a country where people should have the opportunity to teach them all. I think parents should be able to teach their kids what their faith says, what science says. Whether the Earth was created in 7 days, or 7 actual eras, I’m not sure we’ll ever be able to answer that. It’s one of the great mysteries.
Now clearly, Rubio is giving a non-answer here: He’s skillfully acknowledging the controversy without trying to appear like a Bible-thumping hick, but also without offending fundamentalist Christians. After reading Rubio’s response, I know very little about his actual views except, “I would like to continue winning elections.”
Even so, I think much of the hysteria following the interview is misguided. For example, let’s look at Paul Krugman’s reaction. It should not surprise anyone to learn that he quickly pounced:
As I like to say, the GOP doesn’t just want to roll back the New Deal; it wants to roll back the Enlightenment.
But here’s what you should realize: when Rubio says that the question of the Earth’s age “has zero to do with how our economy is going to grow”, he’s dead wrong. For one thing, science and technology education has a lot to do with our future productivity — and how are you going to have effective science education if schools have to give equal time to the views of fundamentalist Christians?
More broadly, the attitude that discounts any amount of evidence — and boy, do we have lots of evidence on the age of the planet! — if it conflicts with prejudices is not an attitude consistent with effective policy. If you’re going to ignore what geologists say if you don’t like its implications, what are the chances that you’ll take sensible advice on monetary and fiscal policy? After all, we’ve just seen how Republicans deal with research reports that undermine their faith in the magic of tax cuts: they try to suppress the reports.
Beyond Krugman’s annoying haughtiness, is the more serious problem that this is what we do in economics education all the time, including Paul Krugman. When I was a professor at Hillsdale College, I spent an inordinate amount of time lecturing on the virtues of free trade. Now I could’ve just said, “This is a topic where economists from across the political spectrum agree. Lowering trade barriers raises just about everybody’s standard of living, in all countries.”
But I didn’t merely do that. Instead, I gave several different arguments to demonstrate how unfettered trade raises all boats, and I walked through several different critiques of standard “protectionist” arguments. I had the class read Bastiat’s famous “Petition of the Candlemakers,” I walked through a simple numerical example of trade flows and wages in the U.S. and Mexico, and I relayed Henry George’s famous quip that in wartime we blockade our enemies and do to them what we do to ourselves with tariffs in peacetime. I pointed out that as an employee of Hillsdale College, I had a massive trade surplus with the state of Michigan, but a massive trade deficit with Florida whenever I went on vacation. So did this mean my money was eventually going to all end up in the hands of Floridians? And so forth.
Now why did I spend so much time on this topic? Because I knew it was the single hardest thing for the layperson to grasp. Indeed, even after all of my efforts, I would still have students writing on tests that a trade deficit with Japan “sucked!” Even though the vast majority of economists for more than a century has thought it silly for governments to institute tariffs in order to “save domestic jobs,” nonetheless the general public endorses the idea. So it’s important for economists to try to educate their students on what is wrong with this notion, if that’s what the economists believe.
By the same token then, if a large segment of the U.S. population—so large that major politicians are afraid to cross them—doesn’t believe the standard neo-Darwinian synthesis on the origin of species, then it’s important for teachers to teach about these issues. Hardly anybody is suggesting that if someone wants to get a Ph.D. in microbiology from Harvard, that he should use Genesis as a text. Rather, what many parents are saying is that if their kids are going to be taught the general principles of biology, chemistry, and so forth, because these are supposedly important subjects for a well-rounded citizen, then teachers should at least acknowledge the fact that many of these kids grow up in households where they have strongly held views against some of the conclusions of these disciplines.
If Krugman wants to say this is a waste of scarce classroom time, on a topic on which the experts have little disagreement, then by the same token he should recommend that intro college courses on economics drop all mention of protectionism. Furthermore, I have to wonder why he spends so much time on his own blog, in his popular books, and on the Sunday talk shows, knocking down “zombie ideas” and other views advanced by his opponents. One almost gets the sense that Krugman feels it’s important for even a Nobel laureate to disabuse the general public of widely held economics fallacies.
Yet turning back to Rubio, there was another strand of criticism I saw, this time coming from atheist libertarians and Austrian economists. The complaint here was that if the Republican Party keeps catering to these nutjob Christians, then their message of smaller government and economic freedoms will get drowned out by the crazy social and religious dogmas.
These complaints were particularly amusing, because Austrian economists are the analog of the “Intelligent Design” scholars. Contrary to the aspersions of Krugman and others, there really are PhDs in various, relevant fields who challenge the “consensus” views on speciation, the origin of life, and the age of the earth. The fundamentalist Christians who believe in a Young Earth don’t merely say, “Well sure, all them pointy heads with their fancy equipment and big brains say one thing, but I’ve got my Bible so they must be wrong.” No, the fundamentalist Christian thinks the secular scientists have overrated the powers of their reason and are misapplying their scientific tools. The works of the academics in the Intelligent Design and Creationist fields (those are distinct concepts, by the way) are full of secular arguments. They give logical objections to carbon dating and geological evidence of an Old Earth. It’s not simply quoting Scripture.
In conclusion, it is entirely understandable that Paul Krugman and other icons in the economics establishment can laugh at the outcasts in both economics and other disciplines. But it is ironic indeed when Austrian economists—who think that the New Keynesian orthodoxy is rubbish—join suit.
Of course the two disciplines are different; it’s possible that the Austrians are right in their criticism of the mainstream “consensus,” while the Intelligent Design and/or Young Earth scientists are wrong in their criticism of their mainstream peers. But from a cultural or sociological perspective, the two situations are quite similar. Unless a particular Austrian economist also has an advanced degree in biology or geology, I don’t think he or she should be complaining too loudly about conservatives paying attention to “crank” scientists in other disciplines. If the conservatives heeded such advice, then they’d tune out the Austrian economists too.
Krugman Ignores His Own Theory and Misses An Important Piece of European History
This whole “what danger is there for a country issuing its own currency?” argument is really slippery. First of all, what these people really mean is, “What danger is there for a country issuing its own currency and in which most of its debts are denominated in this currency?” I.e., even on their own terms, it’s not enough for a country to issue its own currency. I believe this extra hoop is how they rule out things like Russia defaulting on its bonds and causing a bit of a ruckus, as you may recall.
When you think about it, there are only a handful of countries for which this concept even applies, and even then it only really works from 1971 onward. But anyway, let’s put aside that objection and consider Krugman’s latest:
What [a critic of the fiscal scaremongers] doesn’t note, however, is that the problem with bond vigilante scare tactics runs even deeper than that — because it’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionaryeffect?
Yes, I know, Greece — but Greece doesn’t have its own currency. What’s the model under which a country that does have its own currency and borrows in that currency can experience a slump due to an attack by bond vigilantes? Or failing that, where are the historical examples?
This is really amazing. Krugman is acting like it’s not even theoretically possible to imagine this kind of thing. But sure it is. Here’s a theory of it:
So suppose that we eventually go back to a situation in which interest rates are positive….with the government still running deficits of more than $1 trillion a year, say around $100 billion a month. And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates.
So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So? …
Does this mean 400 percent inflation? No, it means more — because people would find ways to avoid holding green pieces of paper, raising prices still further.
I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation…
At this point I have to say that I DON’T EXPECT THIS TO HAPPEN — America is a very long way from losing access to bond markets, and in any case we’re still in liquidity trap territory and likely to stay there for a while. But the idea that deficits can never matter, that our possession of an independent national currency makes the whole issue go away, is something I just don’t understand.
So there you have Paul Krugman himself, explaining how a bond strike on Treasuries would either force the government to balance its budget, or risk hyperinflation itself. If Krugman is now admitting that he can’t even come up for a theoretical basis for his objections to the MMT guys (that was the context of the above quotation), then he should send an apology to James Galbraith.
But let’s go back to Krugman’s recent post. It gets better:
The closest I can come to anything resembling the danger supposedly lurking for America is the tale of France in the 1920s, which emerged from World War I burdened by large debt, and which did in fact face an attack by speculators as a result. Yet the French story does not, if you look at it closely, offer any support to the deficit scare talk we keep hearing.
So Krugman walks through, and shows how France followed Krugmanian advice and let the franc depreciate, inflating away the real value of its post-war debt. Krugman claims that everything was great, and points to a table showing French unemployment. Only thing is, in 1927 it jumps up to 11 percent. Yikes! That’s pretty bad. So does it prove that running up a humongous debt can lead to bad consequences? Of course not! Krugman explains:
But what about the brief but nasty slump in 1927? That wasn’t caused by spiking interest rates; it was, instead, caused by fiscal austerity, by the measures taken to stabilize the franc.
So even when we look at the closest thing I can find to the scenario the deficit scolds want us to fear, it doesn’t play out at all as described.
Everyone see what’s going on here? Krugman points to France as the only example of a bond vigilante attack he can think of, on a nation issuing its own currency. (I guess he’s not counting the gold standard as being binding here; I’m not sure when France went back on. Remember in those 1930s charts of industrial output that the Keynesians like to point to the idiot French as hurting their economy by clinging to gold far longer than other countries.)
So here’s the progression:
(1) The French emerge from World War I with a debt of about 240% of GDP. (That was its value in 1921, which was a big jump from 1920. I’m not sure what was going on there.) Of course the reason the French government has such a massive debt, is that it ran massive budget deficits during the war years (and went off gold).
(2) What did the French do in the early and mid-1920s to deal with the problem? Did they run massive budget surpluses? Nope, Krugman himself says, “How did France achieve that big drop in debt after 1925? Basically by inflating it away.”
(3) Krugman admits that the bond vigilantes saw this depreciation coming, and so interest rates spiked.
(4) The French authorities eventually reversed course to stop the plunge of the franc. Krugman acknowledges that this led to 11% unemployment in 1927.
(5) Krugman says this pain was avoidable, because the French authorities shouldn’t have tightened in 1927.
So, it seems to me we need to think of an historical example of a country that did just what Krugman suggests, in order to test out his recommendations. So let’s see: Can anybody think of a major industrial power that emerged from World War I with a huge debt, but that issued its own national currency the way the French issue francs, and that turned to the printing press but without looking back? In other words, can anybody think of a European power that followed the French pattern, except stuck to Krugman’s advice by continually depreciating rather than a foolish move to stabilize its currency?
(Don’t worry Keynesians, there’s no danger here. Even when an Austrian in the crowd thinks of the answer, Krugman will just point out, “Ah, but they ate a lot of sauerkraut. Hardly relevant for the US today.”)
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