The “Traction” Fallacy by William Anderson

Today’s article of the day comes from Campaign for Liberty:

In his recent book, The Return of Depression Economics, Paul Krugman makes a rather amazing claim when he says that almost any problem in the U.S. economy can be “solved” simply by printing money. Elsewhere in his semi-weekly column in the New York Times and in his blog, Krugman has called for “a credible commitment to fairly high inflation” as a means of economic recovery.

Now, in the country where I live, one generally does not need the government to “commit” itself to inflation. Indeed, governments will do that all on their own and don’t even need approval from economists and especially Krugman.

But while it might seem that calling for inflation is absurd on its face, I believe that I should try to explain the economic strategy that is behind the call for more inflation. The term Krugman and others have used is “traction,” but instead of being an appropriate analogy, I would say that this is a “strategy” to run the economy off the road altogether and impoverish much of the United States.

If I am going to use such harsh language, however, I need to be sure that I can explain why Krugman and others have used that analogy, and why they believe it will work. It won’t, of course, but nonetheless I should be able to explain why on both counts.

I live in a place that receives a lot of snow each winter, and our house is halfway up a steep hill. We used to have a rear-wheel-drive van and in order to be able to make it to our driveway when the snow was falling, I had to gain speed just before we hit the hill, or the van would slide back.

Because not everyone here expertly drives in snow, once in a while someone goes off the road or is stuck in a snow bank. One way to help that person to drive out is to throw dirt or ashes under the tires in order to give the vehicle traction. After throwing down the material, people then push the car from behind. Once the car has some forward momentum, it usually can get out of the snow on its own.

Likewise, Krugman and others like him (too many like him, as far as I am concerned) believe that the problem with the economy today is that people just are not spending enough money, and in their reluctance to spend, they have created a “liquidity trap.” Since the Keynesian construct of the “liquidity trap” has it being a self-perpetuating problem, the only way to steer the economy out of its present “snow bank” is to have an outside force — the government — give it a push or throw money under the wheels (instead of ashes) and then watch the economy take off again.

In the case of the present downturn, creating new bank reserves will not provide much of a push since new money cannot be created if banks are not making loans, and a period of economic uncertainty is not going to result in a surge of new lending. Thus, if the economy is to be given “traction,” the only way is for government to spend in a way that floods the economy with new money, forcing up prices through inflation. People will face the hard choice of holding onto their money and watching its value deteriorate, or spending in and enabling the economy to “take off.”

As people continue to spend, the spending sends signals to producers to make more goods, and then the economy is off to the races. And all it takes is a friendly shove from the government along with a blizzard of new dollars.

If the economy really were a circular flow and if there were such a thing as a “liquidity trap,” and the economy worked just as Keynesians claim, then perhaps such a strategy would make sense. (I am not endorsing inflation, but rather am giving Krugman and others their argument in an imaginary economy.)

However, as I have pointed out before, the economy is not a circular flow mechanism. It is not some sort of perpetual motion mechanism. It is an entity with real fundamentals, a real structure of production, and these are things that matter. If an economy were simply a blot into which people throw whatever they wish and out pops what we see today, that would be one thing; but it is quite another when capital matters, when the relationship of factors of production to each other and to consumer good matters.

In the Krugman/Keynesian view, production is an automatic thing. In fact, it does not even matter who or what entity is producing something. In Krugman’s world, a government-owned and operated economy will operate just as well as one based on private property and maybe even better, since governments are legally permitted to print money.

However, if ours is a world scarcity, a world in which prices tell us something about the demand for and the relative scarcity of all goods, be they producers’ goods, consumer goods, or our labor, then throwing a big pile of money into the mix will not give an economy “traction” any more than pushing the car further into a snowy ditch will enable it to pull out. In fact, a burst of inflation (or, better, a government “commitment” to debasing our money) only will further the malinvestments that now plague our political economy.

My sense is that the powers that be will listen to the Krugmans of the academic and political world instead of listening to people like Ron Paul. After all, they are the ones with the honors, they are the ones who populate the “elite” economics departments, and they are the ones who are laying out real-live “plans of action” by which the political classes can make it look as though they are doing something. Those of us who advocate the government stepping back and not “helping people” are seen as reactionaries and worse.

But even if Paul Krugman is popular and has his face on the cover of Newsweek, that does not mean he is correct. His argument that inflation will give the economy “traction” is clever and might even resonate with the political classes and the media, but even though his is a cunning argument, nonetheless it still makes no sense. An economy is not a blob, it is not a “circle of life,” and it is not even something that needs “traction.” Our economy is something that has been badly damaged precisely because of all of these clever policies of inflation and malinvestment that have benefited the political classes, and the only way that it can get any real traction is for the political classes to go back to ribbon cuttings and hanging out at the bars in the Beltway and stop trying to fix things.

Published in: on June 2, 2009 at 6:41 pm  Leave a Comment  
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