When libertarian economist Javier Milei was elected as Argentine president to fix the results of decades of mismanagement, he proposed a series of economic reforms dubbed by his critics as “shock therapy" – including slashing government spending, cutting bureaucracy, and devaluing the peso.

Critics warned these measures would be disastrous, and many took it for granted that the remedies would deepen Argentina’s recession. But as Jon Miltimore explains in this guest post, a year on and it's becoming clear that the reverse has happened ...

Did Javier Milei Just Lift Argentina Out of Recession? 

by Jon Miltimore

During his first year as president, Javier Milei has been waging a bitter but largely successful campaign against inflation.

Now, Argentines received more welcome news: their economy is growing again.

“Economic activity rose 1.3 percent from April, above the 0.1 percent median estimate from analysts in a Bloomberg survey and the first month of growth since Milei’s term began in December,” Bloomberg reported on July 18. “From a year ago, the proxy for gross domestic product grew 2.3 percent.”

The positive economic report, based on data from the Argentine government, is a surprise to many.

The 2.3 percent year-over-year increase defied expectations of a decline of similar magnitude, Bloomberg reported. As Semafor notes, the Argentine economy was projected to have the least economic growth of any country in the world in 2024, according to the International Monetary Fund.

A ‘Wrecking Ball’?

Argentine economists I spoke to said that the numbers are encouraging, but the country’s economy is far from being out of the woods.

As most people know, Milei inherited an economic mess decades in the making. When the self-described anarcho-capitalist assumed office in December, Argentina was suffering from the third highest inflation rate in the world—211 percent year over year. The poverty rate was north of 40 percent, and Argentina’s economy was declining.

With his country’s economy in a full tailspin from decades of Peronism, Milei proposed a series of economic reforms dubbed “shock therapy” that consisted primarily of three components: slashing government spending, cutting bureaucracy, and devaluing the peso.

Critics warned that these measures would be disastrous, and many took it for granted that the remedies would deepen Argentina’s recession.

The former head of the International Monetary Fund’s Western Hemisphere Department, Alejandro Werner, said Milei’s strategy could tame inflation, but at great cost.

“A deep recession will also take place,” Werner wrote, “as the fiscal consolidation kicks in and as the decline in household income depresses consumption and uncertainty weighs on investment.”

Felix Salmon, the chief financial correspondent at Axios, concurred, comparing Milei’s policies to “a wrecking ball.”

“Milei’s budget cuts will cause a plunge in household income, as well as a deep recession,” wrote Salmon.

Despite these warnings, Milei delivered his “shock therapy” plan in the first few months of his presidency. Tens of thousands of state workers were cut as were more than half of government ministries, including the Ministry of Culture, as well as the Ministries of Labor, Social Development, Health, and Education (which Milei dubbed “the Ministry of Indoctrination”). Numerous government subsidies were eliminated, and the value of the peso was cut in half.

Even before Milei’s policies were given a chance to succeed, many continued to attack them.

“Shock therapy is pushing more people into poverty,” journalist Lautaro Grinspan wrote in Foreign Policy in early March. “Food prices have risen by roughly 50 percent, according to official government data.”

Yet the official government data Grinspan cited was a report from December 2023, before Milei had even assumed the presidency.

Contrary to the dire predictions, the results of Milei’s policies have been better than even many of his supporters had dared hope.

During the first half of 2024, inflation cooled for five straight months in Argentina, the Associated Press reported in July. Though consumer prices were up 4.6 percent in June from the previous month, that’s down from a 25 percent month-over-month increase in December, when monthly inflation peaked in Argentina. Meanwhile, in February the government saw its first budget surplus in more than a decade. And just days ago, an economic report was published showing a massive decline in poverty in Argentina.

Many doubted that these successes were possible, and the conventional wisdom said that wringing inflation out of the economy and slashing government spending could only be achieved at great cost: a deepening recession.

Escaping Recession?

The data suggest that, contrary to what so many people predicted, Argentina may not be slipping deeper into recession following Milei’s shock therapy. Instead, its economy is healing.

“Argentina is officially out of recession after 7 months of Javier Milei’s economic reforms,” Daniel Di Martino, a University of Columbia student pursuing his PhD, tweeted. “Remember, the economy was in recession since mid-2023, half a year before he got into office.”

Others, however, warn that it’s premature to say that Argentina is out of its recession.

“I will be careful of claiming ‘out of the recession,’” Nicolás Cachanosky, a native of Argentina and Associate Professor of Economics at the University of Texas at El Paso, told me. “Maybe the Argentine economy is getting out of a recession. Maybe not. All I’m saying is that it is too early to confirm, given these numbers.”

Cachanosky notes that interannual figures can be misleading, and that the data in question are relative values and not technically growth rates. While it’s still unclear where Argentina’s economy will go from here, it bears exploring why so many people, including many economists, doubted that its economy could be growing again already. There are two primary reasons, one of which is legitimate.

The first reason is a legitimate concern that sharp reductions in government spending will likely result in short term pain, even though it’s a necessary step toward economic healing.

“The government spends a bunch of money and keeps people employed,” one economist I spoke with told me. “When that slows down, you’re going to be able to measure the impact of that.”

This is why some free-market economists I spoke with expressed doubts that Argentina had already escaped recession. Cutting tens of thousands of jobs, even unproductive ones, and slashing hundreds of millions in subsidies is bound to have an impact on economic activity. Long term that impact will be positive because it will result in a more efficient allocation of resources, but it’s not unreasonable to assume it will first result in economic pain.

A second reason is a poor understanding of economics.

In the Keynesian school of economics, it’s taken as gospel that government spending fuels economic growth. This is why you’ll find so many Keynesians who argue that even destructive phenomena like war and hurricanes are actually good for the economy, because they stimulate government spending.

This was the argument economist Paul Krugman made several years ago when he said that an alien invasion, real or fake, would be good for the economy, since it would mobilise a massive amount of military spending, similar to World War II.

The idea is simple: government spending is good even if it’s producing goods that are unnecessary, such as weapons created for an alien invasion that is not even real.

The idea that Argentina would be slashing government spending during a recession runs counter to Keynesian orthodoxy, which teaches that recessions are precisely when “fiscal stimulus” is needed the most, since negative economic conditions often result in a predictable market failure: a decline in spending.

Broken Windows and Economic Growth

In other words, Argentina is flipping the macroeconomic script. In a world in which government spending hikes are deemed “a perfect solution in battling recessions,” Milei is providing the opposite: he’s slashing government outlays.

Yet a Mercatus Center study conducted by Tony Caporale and Marc Poitras, titled “The Trouble with Keynesian Stimulus Spending,” points out the obvious problem with such stimulus schemes:

[The Keynesian] approach fails to account for several significant sources of cost. Besides the cost of waste inherent in government spending, financing the spending requires taxation, which entails an excess burden, the reduction in output resulting from workers’ reduced incentive to work. Furthermore, the employment of even previously idle resources involves lost opportunities to invest in alternative uses of these resources.

Caporale and Poitras are talking about an elementary economic concept: opportunity costs. These costs refer to what one foregoes or gives up to purchase a good or service, an idea the economist Frédéric Bastiat explored in his famous “broken window” parable. Economist Jonathan Newman offers a tidy summary of the story, which appeared in Bastiat’s 1850 essay 'That Which Is Seen, and That Which Is Not Seen.'

It goes like this: a boy throws a brick at a baker’s window and a crowd gathers to discuss the economic consequences. They console the baker by pointing out that glass-repair companies need business, too, so it isn’t all bad news. After further reflection, they conclude that total employment and spending in the community has increased because of the broken window, and that this little spark of spending by the baker to repair the window sets off a chain reaction of spending. Now the glazier has extra cash to spend on various items, and the people who sold him those things now have extra income, and so on.

The crowd draws the conclusion that destruction is beneficial for the economy because it stimulates spending and employment.

Does this sound absurd and too good to be true? Well, it is. Bastiat’s parable revealed the absurdity of Keynesian economics before Keynesian economics existed.

Bastiat was challenging readers to see the unseen. Economists shouldn’t focus solely on the glazier’s profits that resulted from the rock thrown at the baker’s window, any more than they should focus solely on the jobs created by military spending. They must also focus on the costs of these actions, too.

This is the flaw that has long plagued Keynesians, and it helps explain why so many took it as gospel that slashing government spending in Argentina would deepen its recession.

When it came to Milei’s reforms, critics and prognosticators were focusing on the seen: tens of thousands of lost jobs, and billions in reduced spending. On one hand, this is perfectly rational. These cuts will come with easily measurable costs, and are likely to reduce economic activity in the short term. On the other hand, whether they are seen immediately or not, there are countless opportunities created by Milei’s reforms, which are dismantling the least productive parts of Argentina’s economy: its bureaucracy.

Whether Argentina’s burst in economic activity in May was a blip or the beginning of a long-term trend of economic recovery is something only time will tell. (Data indicate there was a sharp increase in agricultural production, which could be explained by favourable seasonal conditions or some other factor.)

It’s certainly possible that, after decades of economic pain from Peronism and mass money-printing, Argentina has more work to do before its economic recovery arrives. Yet Adam Smith once noted that the formula for prosperity is surprisingly simple, and it doesn’t contain government “stimulus”: just “peace, easy taxes, and a tolerable administration of justice.”

Milei knows this, fortunately. And he is showing no signs of relenting in his campaign to crush inflation and government spending to return Argentina to prosperity.

“What [is] the alternative?” he told the BBC. “To continue to print money like the previous administration that generates inflation and ends up affecting the most vulnerable?”

* * * * 

Jonathan Miltimore is the Managing Editor of FEE.org and a Senior Writer at AIER. His writing/reporting has been the subject of articles in TIME magazine, The Wall Street Journal, CNN, Forbes, Fox News, and the Star Tribune.

His article first appeared at the FEE blog.

Pointing out the Climate-Mastery Denialists

"'We are typically taught that whatever the benefits of fossil fuels or other forms of energy are, they always come at the expense of our environmental safety and health.
    "'But the history of climate safety shows that fossil-fueled machine labour makes us far safer from climate— a phenomenon I call 'climate mastery....'

 

"What has allowed humanity to reduce climate-related deaths by 98% over the last century is Climate Mastery. '[O]ver the last century, as CO2 emissions have most rapidly increased, the climate disaster death rate fell by an incredible 98 percent. That means the average person is fifty times less likely to die of a climate-related cause than they were in the 1920s.... not only does our knowledge system ignore the massive, life- or- death benefits of fossil fuels [illustrated so well by this one], but it has a track record of being 180 degrees wrong about the supposedly catastrophic side-effect of climate danger — which has dramatically decreased...'

    "'Knowing that our knowledge system consistently denies [this] temperature mastery is crucial context to keep in mind whenever we hear claims about 'catastrophic' temperature changes in the future; there is a very good chance those claims are based on climate mastery denial, and that without such denial catastrophe would be implausible....'
    "'As [climate-mastery denialist Paul] Krugman puts it [for example], 'We can see the damage now, although it’s only a small taste of the horrors that lie ahead.' '
    "'But the idea that climate danger is bad and getting worse, overwhelming our mastery abilities, is completely false....'
    "'[I]f we look at the universally acknowledged history of climate and life on this planet, we inevitably come to the conclusion that rising CO2 levels leading to an unliveable planet is literally impossible — because the planet was incredibly liveable for far less-adaptable organisms, with much in common with us, when CO2 was at levels that we could not come close to even if we wanted to....'
    "Given all of the horrors of nature that humanity has already mastered, humanity can clearly master some more. Yes, we can imagine worst-case scenarios that overwhelm our abilities. Imagination, after all, is infinite. But that doesn’t show that such scenarios are likely enough to worry about.
    "As I’ve argued before, our default should that worst-case scenarios are highly unlikely. After all, humanity already got this far. If specialists with a long track record of hyperbole warn us of doom, we should ignore them. Unless, of course, specialists with a long track record of calm, measured thought chime in, 'For once, the doomsayers are right.' Show me these specialists, and I’ll read them."

~ Alex Epstein, with comments interpolated by Bryan Caplan, from Caplan's post 'The Meaning of Climate Mastery'

"Putin is losing the economic as well as the military war."

"Russia’s military failure in Ukraine has defied almost everyone’s predictions. First came abject defeat at the gates of Kyiv. Then came the incredible shrinking blitzkrieg, as attempts to encircle Ukrainian forces in the supposedly more favourable terrain in the east have devolved into a slow-motion battle of attrition.
    "What’s important about this second Russian setback is that it interacts with another big surprise: The remarkable — and, in some ways, puzzling — effectiveness, at least so far, of Western economic sanctions against the Putin regime, sanctions that are working in an unexpected way....
    "As soon as the war began there was a great deal of talk about bringing economic pressure to bear against the invading nation. Most of this focussed on ways to cut off Russia’s exports, especially its sales of oil and natural gas. Unfortunately, however, there has been shamefully little meaningful movement on that front....
    "As a result, Russian exports have held up, and the country appears to be headed for a record trade surplus. So is Vladimir Putin winning the economic war?
    "No, he’s losing it. That surging surplus is a sign of weakness, not strength — it largely reflects a plunge in Russia’s imports, which even state-backed analysts say is hobbling its economy. Russia is, in effect, making a lot of money selling oil and gas, but finding it hard to use that money to buy the things it needs, reportedly including crucial components used in the production of tanks and other military equipment.
    "Why is Russia apparently having so much trouble buying stuff? Part of the answer is that many of the world’s democracies have banned sales to Russia of a variety of goods — weapons, of course, but also industrial components that can, directly or indirectly, be used to produce weapons....
    "The effect of sanctions on Russia offers a graphic, if grisly, demonstration of a point economists often try to make, but rarely manage to get across: Imports, not exports, are the point of international trade.
    "That is, the benefits of trade shouldn’t be measured by the jobs and incomes created in export industries; those workers could, after all, be doing something else. The gains from trade come, instead, from the useful goods and services other countries provide to your citizens. And running a trade surplus isn’t a 'win'; if anything, it means that you’re giving the world more than you get, receiving nothing but i.o.u.s in return.
    "Yes, I know that in practice there are caveats and complications to these statements. Trade surpluses can sometimes help boost a weak economy, and while imports make a nation richer, they may displace and impoverish some workers. But what’s happening to Russia illustrates their essential truth. Russia’s trade surplus is a sign of weakness, not strength; its exports are (alas) holding up well despite its pariah status, but its economy is being crippled by a cutoff of imports.
    "And this in turn means that Putin is losing the economic as well as the military war."

~ Paul Krugman (yes, that Paul Krugman), from his op-ed 'How the West Is Strangling Putin’s Economy'

Krugman: Deregulate housing

Paul Krugman makes far more sense when he talks microeconomics. Here he is explaining how housing inequality can be cured by housing deregulation:

Rising demand for urban living by the elite could be met largely by increasing supply. There's still room to build, even in New York, especially upward. Yet while there is something of a building boom in the city, it's far smaller than the soaring prices warrant, mainly because land use restrictions are in the way.
    And this is part of a broader national story. As Jason Furman, the chairman of the White House Council of Economic Advisers, recently pointed out, national housing prices have risen much faster than construction costs since the 1990s, and land-use restrictions are the most likely culprit. Yes, this is an issue on which you don't have to be a conservative to believe that we have too much regulation.

If possible, the story is more urgent in Auckland!

Hat tip to David Henderson at EconLog, who has a nice story about inequality, chainsaws, and Lyndon Baines Johnson  …

Keynesianism, market monetarism & Austro-classical compared [update 2]

Paul Krugman has a new post he says “summarises” Keynesian economics:

1. Economies sometimes produce much less than they could, and employ many fewer workers than they should, because there just isn't enough spending. Such episodes can happen for a variety of reasons; the question is how to respond.
2. There are normally forces that tend to push the economy back toward full employment. But they work slowly; a hands-off policy toward depressed economies means accepting a long, unnecessary period of pain.
3. It is often possible to drastically shorten this period of pain and greatly reduce the human and financial losses by "printing money", using the central bank's power of currency creation to push interest rates down.
4. Sometimes, however, monetary policy loses its effectiveness, especially when rates are close to zero. In that case temporary deficit spending can provide a useful boost. And conversely, fiscal austerity in a depressed economy imposes large economic losses.

Scott Sumner does the equivalent for market monetarism. “It might look something like the following,” he says:

1. Economies sometimes produce much less than they could, and employ many fewer workers than they should, because there just isn't enough spending. Such episodes occur because monetary policy is too contractionary, causing NGDP to fall relative to the (sticky) wage level.
[As an aside, economies can also produce too little due to real shocks, such as higher minimum wages. That's also true in the Keynesian model.]
2. There are normally forces that tend to push the economy back toward full employment. But they work slowly; a hands-off policy toward depressed economies means accepting a long, unnecessary period of pain.
[Notice this one is identical.]
3. It is often possible to drastically shorten this period of pain and greatly reduce the human and financial losses by "printing money", using the central bank's power of currency creation to boost M*V, i.e. NGDP, via the "hot potato effect."
4. Monetary policy remains highly effective at the zero bound. As a result, demand-side fiscal policy is mostly ineffective in countries with an independent monetary authority---offset by monetary policy. Fiscal actions that shift the aggregate supply curve, however, can be effective.

Rather than directly challenge either, I figured it might simply be interesting to compare Austro-classical position on their points. (I have added a point ‘zero’ however since, as Hayek used to say, before you can talk about how things go wrong you first have to understand how they go right, something about which both Keynesian economics and so-called “market monetarism” are all too silent ) :

0. The economic system is driven by production, not consumption or “aggregate demand” (consumption is the final cause, but production is the efficient cause that makes it possible.) Production happens and people are employed because entrepreneurs and capitalists advance capital from previous production into long-term value-adding production plans. Capital spending comes from saving; it is productive consumption.

1. Economies sometimes produce much less than they could, and employ many fewer workers than they should, because malinvestment has increased, production plans have got out of whack, and capital spending has consequently diminished.

2. There are forces that tend to push the economy back toward fuller investment and greater employment. Government intervention however increases uncertainty, and monetary intervention encourages capital consumption.

3. It is often possible to drastically lengthen this period of pain and greatly reduce the human and financial losses by pumping out counterfeit capital: reducing interest rates (which discourages saving, and so reduces the ability of destroyed capital to be rebuilt), discouraging wage and price reduction to fit reduced economic circumstances and encouraging consumption (which increases unemployment and human misery) and encouraging consumption instead of saving. There is no choice about the pain of a correction, only about how long it takes. With more intervention it can take years; without it, just months. [Compare, for instance, the 1920/21 depression with that beginning in 1929.]

4. Monetary pumping and credit creation create confusing and destructive price movements and bubbles—and is the primary driver of the business cycle. Government spending crowds out private investment; deficit spending shifts already-diminished capital from investment into consumption.

UPDATE 1: The blurb for the just-released revised and updated edition of Mark Skousen’s modern Austrian classic The Structure of Production goes some way to explaining what the mainstream don’t see that Austroclassicals do:

The almost total inability of economists of the mainstream to make sense of the macroeconomy is because they look only at final demand. To them, the rest of the economy is a black box about which they know next to nothing. And emphasising how little they even understand about what they need to know, the most important statistic for the past seventy years has been the national accounts which measures how much final output is produced. It is why there are still economists who think that our economy is 60% consumption, when that part of the economy is around 5% at best. The rest is that vast hinterland of productive efforts that move resources from the ground and the forest through various stages of processing to the distributors and then, but only then, to retail outlets for final sale. The man who has done the work of Hercules in overturning this shallow and narrow approach is Mark Skousen. Do you wish to know more about this approach and how better to understand how an economy works, this is the go-to book, now released in its third edition.
Mark Skousen, The Structure of Production. New York University Press
Third revised edition, 2015, 402 pages. $26 paperback. Available on Kindle.

Naturally, the book goes a long, long long way to explaining the difference …

UPDATE 2: Another major difference that you might add as Krugman’s fifth point …

‘Oh! What a Lovely Pestilence!’: Why Governments Love Destruction (and Always Fail to Act)

Paul Krugman and Joseph Stiglitz must be prancing around like excited schoolgirls about Ebola, say Chris Campbell & Daniel Oliver in this Guest Post.

We’ve given Ebola a lot of thought this weekend.  And how different this crisis would be without the government getting in the way.
    Despite the insanely underwhelming (yet typical) response from the government, most people can’t imagine that we could deal with any type of crisis without government intervention.
    Most are inundated with the idea that we need government in our lives for crises like these.  We know this simply isn’t true. It’s when the government gets out of the way that the magic happens.

How effectively would the private sector act if the state got out of the way?
    While pondering this, we came across the same question on the inquiry website Quora. (Quora, if you haven’t been, is a place where people can ask questions and let others vote on the answers. It’s a great research tool. Highly recommended.)
    The question was, how would a non-interventionist state respond to the Ebola crisis?
    The answer, of course, is they wouldn’t have to.
    Here’s a screenshot of the original question…

And here’s the highest-voted answer from one user, Rob Weir:

I’m puzzled about what part of the state’s lacklustre response you would hold up as a shining example of what only an interventionist state could do?

In any case, a libertarian response would include things like:

Paul Krugman disgraced?

Which of these following statements is true:

a.Paul Krugman is a Nobel Prize winner.
b. Paul Krugman called for a housing bubble to fix the economy in 2002, and fro a space aliens to fix the economy in 2011.
c. Paul Krugman is the most prominent economist today calling for massive money printing and government over-spending .
d. Paul Krugman is leaving Princeton university in “quiet disgrace.”

Actually, that’s a trick question. If a report coming out of the States today is correct, all of the above statements are true. The report asks, Is Paul Krugman Leaving Princeton In Quiet Disgrace?:

Professor Paul Krugman is leaving Princeton.  Is he leaving in disgrace?

Not long, as these things go, before his departure was announced Krugman thoroughly was indicted and publicly eviscerated for intellectual dishonesty by Harvard’s Niall Ferguson in a hard-hitting three-part series in the Huffington Post, beginning here, [part 2 here, part 3 here] and with a coda in Project Syndicate, all summarized at Forbes.com.  Ferguson, on Krugman:

Where I come from … we do not fear bullies. We despise them. And we do so because we understand that what motivates their bullying is a deep sense of insecurity. Unfortunately for Krugtron the Invincible, his ultimate nightmare has just become a reality. By applying the methods of the historian – by quoting and contextualizing his own published words – I believe I have now made him what he richly deserves to be: a figure of fun, whose predictions (and proscriptions) no one should ever again take seriously.

Princeton, according to Bloomberg News, acknowledged Krugman’s departure with an extraordinarily tepid comment by a spokesperson. “He’s been a valued member of our faculty and we appreciate his 14 years at Princeton.”

Not the rousing send-off you’d expect when your flagship academic departs your hallowed walls, especially not when “the revered Paul Volcker, himself a Princeton alumni,” kicks him in the arse as he’s heading out:

To the Daily Princetonian (later reprised by the Wall Street Journal, Volcker stated with refreshing bluntness:

The responsibility of any central bank is price stability. … They ought to make sure that they are making policies that are convincing to the public and to the markets that they’re not going to tolerate inflation.

This was followed by a show-stopping statement:  “This kind of stuff that you’re being taught at Princeton disturbs me.” Taught at Princeton by … whom? Paul Krugman, perhaps?  Krugman, last year, wrote an op-ed for the New York Times entitled  Not Enough Inflation.  It betrayed an extremely louche, at best, attitude toward inflation’s insidious dangers. Smoking gun?

Volcker’s comment, in full context:

The responsibility of the government is to have a stable currency. This kind of stuff that you’re being taught at Princeton disturbs me. Your teachers must be telling you that if you’ve got expected inflation, then everybody adjusts and then it’s OK. Is that what they’re telling you? Where did the question come from?

Is Krugman leaving in disgrace? Krugman really is a disgrace … both to Princeton and to the principle of monetary integrity.

The sad news is, he will continue writing nonsense at The New York Times.

It apparently starts with Ayn Rand [updated]

To say Paul Krugman has jumped the shark would be to confuse this one shark for several dozen earlier varieties.

Krugman’s latest is that a) we’re all gonna die (You now, crop failures; ice caps falling on us; polar bears taking their revenge; all that sort of thing), and b) anyone who denies we’re all gonna die has been deluded by Ayn Rand.

He writes this for America’s paper of record. Not as satire, but as serious analysis.

James Delingpole is excited for this new turn in the former Nobel-Prize winner’s career. See:

I'm personally very excited for Professor Krugman too because I think it could mark the beginning of a successful new career as an amateur pop psychologist. Next week, he could maybe tell us why racism is caused by listening to Lynyrd Skynyrd; then, in a subsequent column, which I especially look forward to reading, he could explain why all the firm breasts and heaving buttocks in Game of Thrones are responsible for the worst outbreak of sexism in Western history.
    What's certain is that Krugman badly needs a career change. He trained, I believe, as an economist but what's palpably clear when reading his article is that he doesn't really understand his subject at all.
    Let me give you some examples of what I mean…

You can, if you care to, read on.

UPDATE: From the other direction, Reason magazine decided they might ridicule Rand for liking cats.  For liking cats! Timothy Sanderfur fires back on cats, objective value, and more. Read: ‘Ayn Rand believed in the objective value of cats? How silly!...oh wait, she was right.’

Peter Schiff on David Stockman

Peter Schiff talks about the impact and arguments of former Reagan Budget Director David Stockman, and his new book The Great Deformation: Corruption of Capitalism in America.  Because it was written by a former insider, it’s been making waves, Stockman’s critics “shooting the messenger” rather than dealing with his severe criticisms …

In reference to an op-ed piece by Stockman in the New York Times, for example, “Corruption of Capitalism in America,” Krugman dismissed the ex-congressman as a "cranky old man" without even reading the book.

Actually, I was disappointed in Stockman’s piece. I thought there would be some kind of real argument, some presentation, however tendentious, of evidence. Instead it’s just a series of gee-whiz, context- and model-free numbers embedded in a rant — and not even an interesting rant. It’s cranky old man stuff…

Naturally, Stockman fired back.

Quote of the Evening: Sun Tzu refutes Keynes (& Krugman) [updated]

"What is essential in war is victory, not prolonged operations. No nation has ever benefited from a prolonged war." - Sun Tzu

UPDATE: Let's compare and contrast the common sense and sound reason of Ludwig von Mises to the dangerous hyperbolic fantasies of the Super-Krugman and his mentor Keynes (to whose intellectual influence virtually every politician and every mainstream journalist are slaves, whether they know it or not).

Mises:

"In proportion as armaments increased the sales of munitions plants, they reduced the sales of all other industries.” [writing in Omnipotent Government]
"All the materials needed for the conduct of a war must be provided by restriction of civilian consumption, by using up a part of the capital available and by working harder. The whole burden of warring falls upon the living generation.” [writing in Human Action]
"At the breakfast table of every citizen sits in wartime an invisible guest, as it were, a G.I. who shares the meal. In the citizen’s garage stays not only the family car but besides, invisibly, a tank or a plane. The important fact is that this G.I. needs more in food, clothing, and other things than he used to consume as a civilian and that military equipment wears out much quicker than civilian equipment. The costs of a modern war are enormous." [Writing in Defense, Controls, and Inflation]

Krugman, on CNN this week:

"I mean, probably because you want to put these things together, if we say, 'Look, we could use some inflation,’ … which is, of course, anathema to a lot of people in Washington but is, in fact, what the basic logic says. It's very hard to get inflation in a depressed economy. But if you had a program of government spending plus an expansionary policy by the Fed, you could get that. So, if you think about using all of these things together, you could accomplish, you know, a great deal.
If we discovered that, you know, space aliens were planning to attack and we needed a massive build-up to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren't any aliens, we'd be better." (http://bit.ly/nqrXjO)

Keynes, in his General Theory:

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing."

[Hat tip I bet Ludwig von Mises can get more fans than John Maynard Keynes]

“Austerity” versus “stimulunacy”—with a Krugmanite twist!

The whole economic world is now debating “austerity” versus “stimulunacy,” with every variant of alleged economist on either side, with every variant of what those two words might mean—including Paul Krugman, who is famously still telling the world that the US (on its knees after a world-historical scale  borrow-and-spend binge) has to endure its government borrowing and spending on a Biblical scale  if it’s ever to get back on its feet.

This is, of course, like the prescription your Dr Feelgood likes to give you: more of the same drug that got you hooked in first place, and in ever vaster quantities.

Krugman at least has the virtue of consistency on his side.  He was offering the same batshit crazy prescription when the Asian Financial Crisis hit in 1997, famously insisting in his book Return of Depression Economics that unless Asian governments whacked up their deficits to similarly eye-watering heights, the whole world was in for a swift come-down.

Famously, of course, he was wrong, for reasons pointed out by economist Kenneth Rogoff (who was by then chief economist to the IMF) in a letter to Krugman ally, George Siglitz—reasons which have now become as topical as they were then, as you’ll see.  Said Rogoff:

Governments typically come to the IMF when they are having trouble finding buyers for their debt, and when the value of their money is falling.  The Stiglitzian[/Krugmanite] prescription is to raise  … fiscal deficits, that is, to issue more debt and to print more money.

And so it is!

You seem to believe [Rogoff continues, warming now to his theme]  that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Stiglitz and Krugman were both wrong.  Fortunately, nobody outside Japan listened to them then. Rather than splurge on a new Keynesian investment line of deficits and stimulunacy, as Stiglitz and Krugman insisted, predicting disaster all round if they didn’t, Asian governments (outside Japan) instead balanced their books and let their economies re-tool, reallocate and recover—and rather than relapse into depression, they instead returned swiftly to rapid growth.  Unlike Japan of course, which followed the prescription of Drs Stiglitz and Krugman, and is still even now in the Recovery Ward.

Just another world-historical lesson that you might consider remembering today, as you listen to the same debate again. Same debate, even one of the same con-men, just slightly different protagonists.

PS: On a somewhat related note, since he’s taken to criticising the “Hayekian” solutions  currently characterised under the label of “austerity,” it’s now apparent that the alleged economist Paul Krugman doesn’t even know his Hayek from his hat-stand.  Just one of the inconvenient truths pointed out to him in the replies to his latest column by (among others) Jonathan M. F. Catalan, Richard Ebeling, Bob Roddis, and Richard Ebeling again.

So what happened to all those ‘green shoots,’ fellers? [update 3]

The recovery has stalled. 

Obvious enough to anyone actually on the ground trying to do business, this news would be a surprise only to a mainstream economist, or to anyone who listens to one. Like NZIER’s Principal Economist Shamubeel Eaqub, for example, who is surprised to have to announce that, “The recovery may be stalling. The outlook is still fragile.”

No kidding.

But just imagine how all the mainstream economists must feel. Every economy in the world followed their advice and threw trillions of stimulus dollars against the wall, hoping that some of it would stick--and the result worldwide may be summarised in NZIER’s assessment of NZ’s last quarter: “The recovery may be stalling. The outlook is still fragile.”

So why are the mainstreamers (and those who take their advice) so surprised? Because, according to their lights, throwing out all those trillions to “increase aggregate demand” must have had some effect.  And of course, they’re right, it did.  It lit up some fireworks for a while, but at the cost of delaying any real recovery.

“The problems are not over [summarises Jim Rogers]. If you pump lots of money into an economy, it looks better but essentially it’s artificial. We are going to see more problems in the US over the next year or two.”

Nobel Prize winner and stimulus loon Paul Krugman reckons however that the problem is not too much stimulus, but too little. If we’re going to raise world demand properly, says this modern reincarnation of the Great Idiot Keynes, then Obama and The Fed (and, by extension, everyone else in the G-20 and beyond) needs to be thinking—not about austerity packages—but in terms of trillions of dollars more stimulus. If we’re going to successfully “raise demand,” then the world’s governments needs higher deficits, he says, not lower.

That he says this in the face of the near bankruptcy of several European governments for running the very deficits he applauds should tell you one thing about his favourite nostrum: that it’s really the height of irresponsibility.

But what it won’t tell you is why he wants governments to be so irresponsible.

The answer to that, however, is very simple. At least, I’ll try to make it simple. The reason he wants to boost government spending is because he thinks that will boost demand; and by boosting demand he thinks we can all boost GDP. It’s a simple idea, but it’s wrong as hell. (“If you pump lots of money into an economy, it looks better but essentially it’s artificial.”)

Let me explain why.

Imagine a very simplified economy consisting of only you and your one-hundred closest friends. An economy based on beer. (I told you it would be simple.) Twenty of you grow the hops and barley. The next twenty brew it into beer. The next twenty package it and sell it. The next twenty are your partners, who like to stay home and drink. And the next twenty work for the government, and they like to use their parliamentary credit cards to buy your beer out of the mini-bar.

So there’s your basic economy. 80 people devoted to making and drinking beer, and 20 devoted to getting the hell in their way. (Oh, did I mention that the first sixty get the pleasure of paying the credit card bill for the annoying bastards consuming the mini-bar?)

Now in the way of conventional economics, the formula for GDP has been cunningly contrived to measure only what the drinkers do, and not what the other sixty get up to. Here’s the formula for GDP (which has here been given the title of ‘Baloney.’)

C is Consumption, i.e., all the drinking done by all your twenty drinking partners.

G is Government, i.e., all the drinking done by all the twenty grey ones from the mini-bar.

And I … now that’s “Investment.”  And that’s a bit trickier, because it’s not total investment but only nett investment. Essentially this figure measures the difference between the six-packs of beer we sixty producers pay out to get things done, and the six-packs of beer we get back when we do things for others. So (to oversimplify a great deal) if our profit is ten percent, then only the work of six of us are measured in the GDP/Baloney figure.

If that sounds ridiculous, it’s because it is—yet that’s how ridiculous the GDP delusion is. It doesn’t measure production, it measures consumption. Rather than measure economic activity, what it does is bury the bulk of economic activity (i.e., the production of those other fifty-five folk) under this contrived figure of I, and then it contrives to ignore all fifty-five.  (As a measure of just how much it ignores, US GDP in 2006 was $13.4 trillion, whereas total business spending was $31 trillion, meaning businesses were spending $4.30 for every $1 spent on personal consumption. Policy-makers take note.)

It’s by this utterly contrived means then that alleged economists like Mr Krugman can talk about “raising GDP” through the “stimulus” of shopping subsidies (or as his mentor Keynes did, by the “stimulus” of building pyramids)—it’s because all that GDP really measures is what gets spent in the shops, and not hardly at all what goes on in the mines, factories and warehouses that makes all that spending possible.

And it’s the homage paid to this ridiculous economic equation that allows him to get away with it, and is so economically destructive--as you’ll see when we take another look at our simplified economy in recovery mode.

Let’s imagine our simplified consumers have all just had a party. A big blow-out. A boom. And now it’s the morning after. (What a bust.) There’s still hops a’pickin’ and still beer a-brewin’ in the vats, but your packaging and production cycle has got a bit out of whack, and the livers of your drinking partners are all feeling a bit tender.  Demand has gone down (and they’re starting to beg for the invention of some basic pain-killers), but in a short time production will be back on track and things ticking along again.

Then along comes Mr Krugman, and all he sees is calamity!  “Look!” he cries.  “Your “C” is way down. And your GDP/Baloney/Spending figure is flat! We’ve got to boost demand!”  And of course, he’s right. It is.  But it wouldn’t be right simply to print drinking vouchers so the twenty parliamentarians can raise “G” at the mini-bar, while ignoring the sixty producers who were trying to get things back on track, and whose production would have to pay for it (but whose total production has been “netted out,” i.e., minimised, in that figure for “I”.

Because their spending has to be paid for.  That demand must come from production. And if you start “stimulating” the economy simply by overstocking the mini-bar, without ever getting anything back for it, then you’ll wake up one day soon and find you’ve got no more six-packs set aside to pay for more hops and more barley. Which means no more beer at all.

And just because that bogus GDP equation allows alleged economists like Paul Krugman to ignore that, it doesn’t mean that you should.

Because as the great economist Ludwig Von Mises used to say, it’s not just the next generation who pays for deficits, it’s this one.  And the way we pay is by having our resources diverted today from all the good productive activity that the GDP equation ignores, into all the unproductive consumption that it picks up.

Which helps explain why the Paul Krugmans of this world (and their sophistic, simplistic equations) have helped make the recovery less likely, rather than more.

So to end this wee post, here’s economist Bob Murphy’s tribute to his favourite Keynesian moron, Paul Krugman (sung very badly to the tune of The Buckinghams’s Susan).

UPDATE 1: More good, related reading at The Cobden Centre: “Short sharp shock –'the Irish Route' or Keynesian Malaise?”

UPDATE 2: I’ve rewritten an old Q&A (from January ‘09) to help explain the point:

Stimulus: Because all economies have performance issues

Q: What is the point of running deficits?
A: Because it’s demand that drives an economy, and we have to keep demand up to keep the economy going.  So when consumer demand drops, the government has to pick up the slack. That’s it’s job.

Q: By borrowing?
A: By borrowing, by printing money, by any way you can do it.

Q: But aren’t most business-to-business payments paid for out of real savings, not faked up demand?
A: Well, yes…but we can try to fool them for a while.

Q: For how long?
A: Long enough. Another three years if we need to.

Q: Until we turn into Greece?
A: Um…

Q: So does borrowing or printing money bring any new resources into existence?
A:  Well, no. In the first case it transfers existing resources, and in the second it just dilutes existing savings. But it does create new demand.

Q: But doesn’t your demand have to be paid for with real resources?
A: Well …

Q: So what you’re relying on is using your new bits of paper to redistribute existing resources in ways the original owners wouldn’t have otherwise agreed to.
A: They need to spend!!

Q: And at the same time you’re denuding the existing pool of real savings.
A: They need to stop saving and start spending!!  We need to run deficits to make up for the money that savers have withdrawn from the economy by their hoarding. 

Q: But how can you say savings are being hoarded when most business-to-business payments are paid for out of real savings?
A: Well…

Q: How is running deficits going to rebuild that shattered pool of real savings?
A: Um…

Q. Okay, let’s move on. What is an Economic Stimulus Payment?
A. It is money the government distributes to some taxpayers to boost demand, and stimulate economic activity.

Q. Where will the government get this money?
A. From taxpayers.

Q. So the government is giving me back my own money?
A. Only a smidgen.

Q. What is the purpose of this payment?
A. The plan is that you will use the money to purchase a High definition TV set or a new computer, thus stimulating the economy.

Q. But isn't that stimulating the economy of China?
A. Um.

Q: Well, how on earth does it stimulate the one whose taxpayers are paying to be stimulated?
A: It's all about the "multiplier."

Q: The "multiplier"?
A: Yes, the "multiplier." Every dollar the government "injects" into the economy creates an even larger increase in national output -- a multiple up to one-and-a-half times the original spend-up. The money the government is giving away goes to retailers, which then goes to producers, which then goes to other producers and so on. The net result of the spend-up, as the theory goes, will be new jobs and an overall increase in the nation's income.

Q: So the government is giving me back a smidgen of my own money, and this smidgen is multiplied several times to create a "stimulus?
A. You've got it.

Q: And it keeps prices up?
A: We hope so.

Q: But don't the prices  that producers pay need to fall in a recession to get real production going again?
A: Well, yes.

Q: And it's not even backed by real demand, is it?
A: Well, no.

Q: So how long can such an artificial stimulus last, then?
A: Um, the theory is that it's only temporary at best.

Q: But you’ve been advocating running deficits and printing shopping subsidies to fix the economy now for nearly three years!
A: They haven’t been over-spending enough!!

Q: Well, what sort of stimulus would it have created if you hadn’t taken it off me, abd I'd been able to keep that money myself, and either spend it or save it?
A: Well . . .

Q: Or if producers had been able to keep their own money?
A: Um . . .

Q: So it would be fair to argue that "not only does the increase in government outlays not raise overall output by a positive multiple; but, on the contrary, [it actually] leads to the weakening in the process of wealth generation in general.”
A: But . . .

Q: And this is the whole theory? This is all you economists can come up with?
A: Well, that's about it, yes.

Q: So it's a bit like when "a carnival magician produces a quarter from behind a child's ear," isn't it. "The 'magic' of the multiplier is mere illusion."
A: Hush your mouth. People are listening.

Q: No answer?
A: Sorry, we're a bit busy right now shovelling money out the door.

* * * * Stimulus: Because all economies have performance issues * * * *

 

UPDATE 3: Economic historian Niall Ferguson talks “austerity” vs “stimulus” (and Paul Krugman)—making an important point about what so-called austerity really has to mean…

KRIS SAYCE: How Will Heads of Government Departments Cut Regulatory Costs?

More wisdom from`Kris Sayce at Money Morning Australia.

* * * * *

We couldn’t help but laugh at the front page of yesterday’s Australian Financial Review (AFR):

“Tanner takes razor to red tape”

Apparently, “The Rudd government will increase the powers of its red-tape regulator in a bid to prevent any unnecessary rules from stifling economic growth…”

Red-tape regulator!

Anyway, it goes on,

    “Finance Minister Lindsay Tanner will subject new legislation and regulation to greater scrutiny while also forcing the heads of government departments to take greater personal responsibility for finding ways to cut regulatory costs.”

Sounds good doesn’t it? Heads of government departments cutting regulatory costs. Hmm, how will they do that we wonder?

But that’s the trouble, they can’t. It’s impossible. There’s no market mechanism for them to benchmark against. It’s not as though federal government departments can send spies out to see what that other Australian federal government is doing, because there isn’t one.

And even the idea that it can benchmark against other departments’ costs is false. Without a motivation to make a profit, and fully knowing that any shortfall can be covered by increased taxes or public borrowing, governments can’t know whether it is saving money.

Besides, hapless public servants will inevitably fall for the old, “costs have increased due to inflation” trick.

They’ll see any cost increase in-line with price inflation or just below price inflation as a ’saving.’ Their other trick will be to claim the rate of cost increases is lower than in previous years.

Either way, there won’t be any savings.

But back to the AFR. The bit that really tickled us was this:

    “Mr Tanner has finalized orders that would empower an independent agency to decide whether a department needed to report on the economic cost of a new regulation, taking the decision out of the hands of the department itself. The change gives the Office of Best Practice Regulation (OBPR) greater authority to scrutinize laws and rules proposed by departments…”

Ah, only in government. You can imagine the conversation when this OBPR department was set up:

Pen-pusher 1: I’ve had a great idea of how we can cut red tape.

Pen-pusher 2: Really, how?

Pen-pusher 1: It’s simple, we’ll set up a brand new department, staffed by tens, even hundreds of people to handle all the red tape and then it can make the cuts.

Pen-pusher 2: You’re a genius.

Pen-pusher 1: I know.

Only a chump would think that creating a whole new government bureaucracy in some way reduces bureaucracy. One step forward, two steps back.

However, that wasn’t the most ridiculous thing we read yesterday. That honour goes to Nobel prize winning economist Paul Krugman for his column in the New York Times.

As we’ve written before, not only is it sad that a supposedly well-educated man like Krugman could get so much wrong, but it’s even sadder that so many people read and truly believe what he has to say.

And even sadderer is that the chumps in government largely follow his advice.

Take this bit of babble:

    “Most of the world’s large economies are stuck in a liquidity trap – deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero.”

Doesn’t something seem terribly wrong with that argument? If low interest rates was the solution to excessive debt then surely interest rates near zero would already have solved the problem.

Wouldn’t the fact that it hasn’t solved the problem not make you think that perhaps, just perhaps, low interest rates aren’t the solution at all?

Perhaps when you keep doing the same thing – cutting rates – and it keeps causing the same problems – excessive credit – the answer is to do something else. Such as not letting the ‘excessive credit genie’ out of the bottle in the first place.

Not according to Krugman. With interest rates near zero, he and his Keynesian mates are in a bind. They’ve got no more ideas apart from closing their eyes and wishing really hard that it will all go away.

Actually, that’s not strictly true because –- wait for it -– Krugman does have a cunning plan.

But before I reveal his dastardly deed to solve the world’s woes, there is a point he makes about what would happen if China started to dump US dollars. Something we covered in yesterday’s Money Morning.

Krugman asks:

    “What you have to ask is, What would happen if China tried to sell a large share of its US assets? Would interest rates soar?”

No need to bother yourself by thinking of an answer, Krugman’s got that sorted:

    “Short-term US interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down.”

Is that possible? Let’s think about it. Let’s look at the transaction from the both sides.

If the Chinese did dump US dollars then they’re doing so because they believe something else represents better value. Either they’re selling US dollars to buy another currency to hold, or they’re selling US dollars to buy a physical commodity or some other asset.

Either way, the seller is selling because it values the US dollar less than the currency or item it’s buying.

But what about the buyer of the US dollars? If the buyer is a firm that’s sold a commodity or other good to the Chinese then the buyer of the US dollars will either keep the dollars to invest or it too will trade them in for something else –- another currency maybe, or more supplies for the business.

Again, the business makes a decision about which is more valuable or useful to it –- the US dollars or what can be bought using US dollars.

So, to avoid lengthening this example, let’s assume the firm intends on saving whatever proceeds it has. Its first choice is to keep the money in US dollars and earn only a fraction of a percent in interest.

That’s not much of a return. But the firm must really believe that’s the best investment for them when all things are considered. If it wasn’t it wouldn’t make the investment.

But that’s a firm buying and selling stuff. Let’s also consider a big global investing firm. In both instances the investors that need to get a return for their clients. Is holding US dollars such a great idea?

It certainly isn’t a good idea if you’re concerned that a big holder of US dollars –- China –- plans on selling lots and lots of the little Greenbacks.

The reason it’s not a good idea for the investor is this: when any asset is sold down, the price tends to fall. It’s the same for shares, property, bonds, and even currencies.

If that happens then, relative to other currencies, those investors that continue to hold US dollars would see the value of their US dollar assets fall. The knock-on effect is that investors would anticipate a further sell-off and therefore look to sell their US dollar positions first. It would be the proverbial rush for the exit. Unless…

What’s the one thing that could discourage an investor from selling a depreciating asset? One thing would be an increase in the income flow from retaining the currency. In other words, a higher rate of interest.

If as an investor you’re offered a higher rate of interest, you may view this as an acceptable trade-off to counteract the falling value of the dollar. This could make you less likely to sell your US dollars.

But if there is no interest rate incentive it’s only natural an investor would look to sell out before other sellers pushed the price down.

With no comparable increase in the interest rate, the investor isn’t getting paid for holding on to the currency.

And furthermore, if the investors knew in advance that interest rates would not rise then why hang around waiting for something that’s not going to happen. And investors must be pretty certain interest rates won’t go up because the US Federal Reserve tells them so:

“…warrant exceptionally low levels of the federal funds rate for an extended period.”

OK, “low” doesn’t necessarily mean zero, but it clearly doesn’t mean 2% or 3%.

But the typical response to that is, won’t the ‘free market’ automatically adjust interest rates higher? Correct, a ‘free market’ would do that. But don’t forget, whenever there is a central bank a free market in the truest form doesn’t exist.

Besides, as Krugman ingeniously points out:

    “Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.”

That’s right, the Fed will keep interest rates low by just buying up all the bonds. Bond sellers will get a bail-out and receive top dollar rather than suffer losses from falling bond prices. And buyers who may have bought bonds at a lower price (when bond prices fall interest rates rise) won’t get a chance to benefit from a lower bond price and higher interest rate because the Fed will just print money to try and support the bond price at a higher level and therefore maintain low interest rates.

That means investors who may have been tempted to keep hold of their US dollars in order to invest in lower priced bonds with a higher yielding interest rate will now have no incentive to do so.

I mean, seriously, can it really be true that a Nobel Prize winning economist thinks it’s a good idea for the Fed to create money from thin air to pay off debts? It’s just not logical.

Think about it, if it was such a good idea why don’t all governments do it? Then there would be no government debt at all and we could all start from scratch. Better still, why not let all private individuals do the same thing?

Krugman and the dopes at the Fed must surely know that monetizing debt by just creating more money to pay it off is a bad idea.

But just in case you need confirmation of why it’s a bad idea, it’s simply this. It’s an appalling inflationary tactic that harms everyone. The only short-term beneficiaries are the government as it doesn’t need to suffer the wrath of the electorate by either cutting services, raising taxes, or defaulting on debt.

Everyone else is a loser.

Naturally Krugman wraps up his sorry tale with another fallacy:

    “It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.”

We can only think he’s got in mind that old saying: “If you’re in debt to the bank for a million dollars and you can’t pay it back, you’re in big trouble. But if you’re in debt to the bank for a billion dollars and you can’t pay it back, the bank is in big trouble.”

It’s a nice saying. Very twee. Trouble is, it’s not true in the case of the individual, and it’s not true in the case of China. Although, granted, for different reasons.

Although it’s true that the obligations the US has to China is little more than the ‘promise to pay the bearer’ a gazillion dollars, the reality is that the US doesn’t have China over a barrel at all, far from it.

As we pointed out yesterday, China is probably already resigned to losing a big chunk of its US dollars. That’s why it’s building skyscrapers instead of building piles of Greenbacks.

According to Krugman, China has around the equivalent of USD$2.4 trillion of reserves. Of which, according to the US Treasury, USD$889 billion is held in US treasury securities.

In other words, about 37% of China’s reserves are in US dollar bonds.

So, if China did dump all of its bonds and US dollars, what would the impact be? Well, we’ll assume the bonds and dollar isn’t going to fall to zero – we’ll assume that because Krugman seems confident the Fed would backstop it by buying up these securities!

Therefore, the Chinese may take something of a hit, but unless we’re talking hyper-inflationary money printing by the Fed – which is possible – then the Chinese will still get something out of it.

But even if we are talking hyper-inflation, so what. China has 63% of its reserves that aren’t denominated in US dollars. That’s 63% of its reserves which would increase in value relative to US dollars. What it loses in US dollar terms it gains in all other terms – China has a hedged exposure.

The losers would be America not China. A terminally weakened currency and massive debt which no one would want to buy. Not until hyper-inflation had run its course anyway.

A nation that would be unable to afford to import goods and services. The only possible savior for the US is its massive holding of gold – providing it’s all accounted for! But even so, that doesn’t necessarily give it a get-out-of-jail-free card. Having a store of gold is fine, but unless the US could do a quick about-turn and reinvigorate its formerly productive economy, then the gold would slowly but surely be exported in exchange for consumer goods.

Let me put it this way. The picture Krugman paints is a world where everyone pays off their own debt by creating money out of thin air, and where the economically successful economies play second fiddle to the weak and desperate.

It’s a world that doesn’t and cannot exist. It only exists in the child-like minds of mainstream economists who fail to understand the real consequences of harmful government and central bank policies.

Don’t get us wrong, we think the whole China story is a bubble waiting to pop. But the idea that the US is playing this perfectly and holds the upper hand is completely and utterly false.

Cheers.
Kris.

NB: Meanwhile, in completely unrelated news to Australia’s announcement of a “red-tape regulator” to stimulate economic growth, here at home in New Zealand, Finance Minister Sir Double Dipton and “Regulatory Reform” Minister Rodney Hide have announced the creation of “a Productivity Commission” to help boost New Zealand’s economic performance . . .