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  
Tags: , , , ,

While we all lose money, the Fed makes money?

This from the Economist:

“Last year the central bank reported a whopping $43 billion in operating income. That was more or less the same level as in 2007, but meanwhile short-term interest rates had plummeted, ending the year near zero. That should have clobbered Fed income, as rate cuts did in the early days of the last recovery in 2002-04 (see chart).

But it did not, for two reasons. First, to shore up financial markets the Fed has pumped up its balance-sheet—its total assets were $2.2 trillion on December 31st, more than double their level of a year earlier. Second, it has been trading in low-risk, low-return Treasury debt and buying higher-yielding private debt—discount loans to banks, commercial paper, and mortgage-backed securities, for example.”

Are you kidding me? Not only the Fed can debase our currency, print as much money as it wants, cause booms and busts at will, but they also make money on the recession. Tell me if this makes any sense! Oh wait, they can print as much money as they want, so how can they ever lose money?


Published in: on June 2, 2009 at 12:38 pm  Leave a Comment  
Tags: , , ,

Book Review: The Revolution by Ron Paul

Since Congressman Ron Paul’s Presidential Campaign, he has recieved a large amount of support from the public. Not enough support to boost him as a party nominee but enough to get on to major news channels. Ron Paul is a good political entrepreneur. He has seized upon this and written a book that every American should read, whether you agree with him or not.

Much like Conscience of a Conservative by Barry Goldwater it is a small book that spans many issues. This gives a person enough information to allow them to run with it and do their own research. Unlike Goldwater’s book Paul cites many great figures throughout the book and at the end he includes a recommended reading list with these people in it. Some of them include Ludwig von Mises, Thomas Jefferson, Fredreic Bastiat, F.A. Hayek, and Murray Rothbard.

In the media Ron Paul often comes off as rash or harsh. Arguing for Capitalism can be harsh. Some people are turned off from him because he does not have the speaking skills or the good looks that most Americans care about in politicians. Politicians should be picked upon policy and not personality, but that is neither here nor there. This book is a very rational well thought out logical book. This digs deeper into some of the rhetoric that he speaks and would help with those who find him to be harsh.

One particular argument I found interesting was his one of healthcare and linking it to inflation. Paul argues that “The health costs tend to rise faster than other costs because of the distribution effects of inflation: wherever government spends its new money, that is where higher prices will be most immediate and evident.” The second part of this argument is correct, but if we use debt and such that would not be inflation. It would still bid up the cost all the same but it may be interesting to look into whether or not programs are funded by debt or inflation. Of course, if the result is the same this may not matter.

Overall rating 4/5


The Harding Way by Thomas E Woods Jr.

Today’s article of the day comes from The American Conservative:

When Barack Obama urged passage of his so-called stimulus measure in February, he claimed that only bold government action would prevent the economy from slipping into a deep depression. In making that argument, he was only repeating the conventional wisdom, according to which markets are not self-correcting—except in the very long run—and state intervention is necessary to revive economic activity.

Economic theory can tell us why these claims are incorrect and why, in fact, even the appearance of prosperity that those measures can produce causes still greater damage and leads to a more severe correction in the long run. But we can also refer to the testimony of history. In particular, the depression of 1920-21, which most people have never heard of, is an example of the resumption of prosperity in the absence of government stimulus, indeed in the face of its very opposite. If economies cannot turn around without these interventions, then what happened in this instance should not have been possible. But it was.

During and after World War I, the Federal Reserve inflated the money supply substantially. Once the Fed finally began to raise the discount rate—the rate at which it lends to banks—the economy slowed as it started readjusting to reality. By the middle of 1920, the downturn had become severe, with production falling by 21 percent over the next 12 months. The number of unemployed people jumped from 2.1 million in 1920 to 4.9 million in 1921.

From 1929 onward, Herbert Hoover and then Franklin Roosevelt tried to fight an economic depression by making labor costlier to hire. Warren G. Harding, on the other hand, said in the 1920 acceptance speech he delivered upon receiving the Republican nomination, “I would be blind to the responsibilities that mark this fateful hour if I did not caution the wage-earners of America that mounting wages and decreased production can lead only to industrial and economic ruin.” Harding elsewhere explained that wages, like prices, would need to come down to reflect post-bubble economic realities.

Few American presidents are less in fashion among historians than Harding, who is routinely portrayed as a bumbling fool who stumbled into the presidency. Yet whatever his intellectual shortcomings—and they have been grotesquely exaggerated, as recent scholars have admitted—and whatever the moral foibles that afflicted him, he understood the fundamentals of boom, bust, and recovery better than any 20th-century president. (more…)

Inflation is looming on America’s horizon By Martin Feldstein

The article of the day comes from the Financial Times:

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases. (more…)

The Threat of Hyper-Depression By Robert Murphy

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

In the Keynesian heydays of the 1950s and 1960s, most economists and policy makers believed in the “Phillips Curve,” which was the (alleged) tradeoff between unemployment and price inflation. The idea was that the Federal Reserve could cure a recession by printing money, or that the Fed could cure runaway inflation by jacking up interest rates. Each of these moves had its downside, of course, but the point was that the Fed could choose one poison or the other.

This Keynesian orthodoxy was shattered in the 1970s when the United States suffered through “stagflation,” which was high unemployment and high inflation. This outcome was not supposed to be possible, according to the popular macroeconomics models, and it left policy makers with no clear choice. If the Fed raised rates to stem the inflation, it would hurt the economy even more, but if the Fed cut rates (through printing more money) the inflation problem would worsen. The vacuum created by this crisis in both theory and policy was filled by the Reagan Revolution and supply-side economics.

At this stage nothing is certain, but the country is currently headed straight into a period of very rapid price hikes and a very bad recession. It would not surprise me at all if the national unemployment rate and the annualized rate of consumer price inflation both broke through into double digits by the end of 2009. Moreover, regardless of when it actually starts, I predict that things will get much worse before they get better, and that the United States will be mired in a malfunctioning economy for at least a decade, with price inflation in the double-digits (possibly higher) the entire time. We can call this condition “hyper-depression.”

As with stagflation during the 1970s, hyper-depression will blow up the prevailing “cutting edge” models of the macroeconomy. Back when he was an academic, Fed Chair Ben Bernanke was actually an expert on the Great Depression. Bernanke adheres to the (alleged) lesson taught by Milton Friedman and Anna Schwartz in their classic A Monetary History of the United States. F&S argued that Fed officials bore a large share of the blame for the Great Depression, because they did not pump in enough liquidity. The quantity of money actually declined by about a third from 1929-1933, as panicked customers withdrew cash from the banks. (In a fractional reserve banking system, when people withdraw deposits, the banks have to shrink their outstanding checking balances because of reserve requirements.) (more…)

Terence Corcoran: Is this the end of America?

The article of the day comes from The Financial Post:

U.S. law-making is riddled with slapdash, incompetence and gamesmanship

By Terence Corcoran

Helicopter Ben Bernanke’s Federal Reserve is dropping trillions of fresh paper dollars on the world economy, the President of the United States is cracking jokes on late night comedy shows, his energy minister is threatening a trade war over carbon emissions, his treasury secretary is dithering over a banking reform program amid rising concerns over his competence and a monumentally dysfunctional U.S. Congress is launching another public jihad against corporations and bankers.

As an aghast world — from China to Chicago and Chihuahua — watches, the circus-like U.S. political system seems to be declining into near chaos. Through it all, stock and financial markets are paralyzed. The more the policy regime does, the worse the outlook gets. The multi-ringed spectacle raises a disturbing question in many minds: Is this the end of America?

Probably not, if only because there are good reasons for optimism. (more…)

Senator Jim DeMint on Bailouts and Inflation

Via NetRightNation Jim Demint at CPAC mentions the upcoming inflation around 2:30:


Published in: on February 28, 2009 at 3:20 pm  Leave a Comment  
Tags: , , ,

The Keynesian-Krugman Problem of War

As most of us has heard, there is an ongoing debate about Keynesian economics and whether it is in fact a good idea for the government to run deficits pursuing fiscal stimuli. In a previous article, I wrote what the economic reasoning is behind all of this. Upon further research, I have discovered an important untold part of the Keynesian viewpoint. That is which is illustrated best by Dr. Paul Krugman in his recent article discussing “What will stop the pain?”:

“What, then, will actually end the slump?

Well, the Great Depression did eventually come to an end, but that was thanks to an enormous war, something we’d rather not emulate.”

If you ask even some normal people, you will receive the answer that World War II caused us to get out of the Great Depression. This is inherently false. In fact Cullen and Fishback at NBER made this observation, ” [They] find that in the longer term counties receiving more war spending per capita during the war experienced extensive growth due to increases in population but not intensive growth, as the war spending had very small impacts on per capita measures of economic activity.”

How could this be? Most people when they think of productivity they think of labor and employment. If this was the case then World War II would be a great success. In fact, war times in general would bring a large boost to any economy, as they are a fiscal dream. Why is this not true? The fact is that the goods that they are producing are purely military and are being sent off to be destroyed. This is called the broken window fallacy, which Krugman violated after 9/11 when he said:

“…the attack opens the door to some sensible recession-fighting measures. For the last few weeks there has been a heated debate among liberals over whether to advocate the classic Keynesian response to economic slowdown, a temporary burst of public spending. There were plausible economic arguments in favor of such a move, but it was questionable whether Congress could agree on how to spend the money in time to be of any use — and there was also the certainty that conservatives would refuse to accept any such move unless it were tied to another round of irresponsible long-term tax cuts. Now it seems that we will indeed get a quick burst of public spending, however tragic the reasons.”

It is obvious here that Krugman along with other Keynesians secretly (or not so secretly) find war and destruction to be a good thing for our economy. This begs the question, why doesn’t Dr. Krugman’s plan involve increasing production of anything and blowing it up in the desert? This would be no more productive than World War II. It would just avoid all the pain and suffering.

To simplify things a bit, imagine an economy where they go to war and the factories switch from cars and tractors to tanks. While these tanks are going off to Europe to be destroyed, the prices of cars are going through the roof as supply has stopped. Sure, the inflationary wartime spending has caused people to go to work but they cannot buy anything as prices skyrocket. We have to remember the three ways that you can raise money for this. They are higher taxes, borrowing money, or inflation. Let’s not forget FDR’s ban on gold thus setting up inflation, which Truman inherited. This just acts as a tax and causes a very unstable currency. The other possible method was borrowing, which is just future tax increases. This will not create productive growth.

Many uneducated people on the right cling to this explanation because they feel it’s the only argument they have against the liberals saying it was the New Deal. Both of these groups should wake up and smell the free-market roses. It is ridiculous to think that a centrally planned economy (war-time economy) where massive amounts of people (human capital) along with materials (physical capital) is being destroy and very little non-military goods were being produced (not to mention there was rationing), somehow “stimulated” us out of a recession.


Published in: on February 23, 2009 at 2:32 pm  Leave a Comment  
Tags: , , , , , , ,

I want my bailout money…


Published in: on January 21, 2009 at 11:39 pm  Leave a Comment  
Tags: , , , ,