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To those who agree with Paul Krugman's ideas, oft
repeated on this list, careful reading of the
following by Michael Hudson (possibly related to
me a few generations ago!) would be useful.
Although I agree with Hudson's diagnosis as far
as it goes, I happen to think that neither he nor
Krugman have got anywhere near to the heart of
the matter, this being: "What on earth caused the
huge rise in credit from the 1980s onwards?".
This -- now in the form of debt (governmental,
banks', personal) that can never be repayable --
is what saddles us now and which the recent
pathetic G8 Washington summit was totally unable to get to grips with.
My view is that the wall of credit arose out of
desperation, albeit never articulated, that the
economic growth of the last 300 years should run
on unabated. The personal computer (and its
junior consort, the mobile phone) was the last of
the great chain of consumer goods that
incentivized Europe and America. We are now
locked into what is likely to be a long period of
adaptation until a new family of technologies
come along (the first three being 1. flint
scrapers and points, 2. plant and animal
cross-breeding, 3. steam and electrical power). I
happen to think that the next family will be
biological. If so, then the full extent of its
complexities are only now beginning to be
explored. It's likely to be generations before
the next era can be anywhere near adequately described. But that is by the way.
Keith
Paul Krugmans Economic Blinders
Michael Hudson
Paul Krugman is widely appreciated for his New
York Times columns criticizing Republican demands
for fiscal austerity. He rightly argues that
cutting back public spending will worsen the
economic depression into which we are sinking.
And despite his partisan Democratic Party
politicking, he warned from the outset in 2009
that President Obamas modest counter-cyclical
spending program was not sufficiently bold to spur recovery.
These are the themes of his new book, End This
Depression Now. In old-fashioned Keynesian style
he believes that the solution to insufficient
market demand is for the government to run larger
budget deficits. It should start by giving
revenue-sharing grants of $300 billion annually
to states and localities whose budgets are being
squeezed by the decline in property taxes and the general economic slowdown.
All this is a good idea as far as it goes. But
Mr. Krugman stops there as if that is all that
is needed today. So what he has done is basically
get into a fight with intellectual pygmies. Thus
dumbs down his argument, and actually distracts
attention from what is needed to avoid the
financial and fiscal depression he is warning about.
Heres the problem: To focus the argument against
Austerian advocates of fiscal balance, Mr.
Krugman hopes that economists will stop
distracting attention by talking about what he
deems not necessary. It seems not necessary to
write down debts, for example. All that is needed
is to reduce interest rates on existing debts, enabling them to be carried.
Mr. Krugman also does not advocate shifting taxes
off labor onto property. The implication is that
California can afford its Proposition 13 the
tax freeze on commercial property and homes at
long-ago levels, which has fiscally strangled the
state and led to an explosion of debt-leveraged
housing prices by leaving the site value untaxed
and hence free to be pledged to banks for larger
and larger mortgage loans instead of being paid
to the public authorities. There is no hint in
Mr. Krugmans journalism of a need to reverse the
tax shift off real estate and finance (onto
income and sales taxes), except to restore a bit more progressive taxation.
The effect of Mr. Krugmans suggestions is for
the government to subsidize the existing
financial and tax structures, leaving the debts
intact and ignoring the largely regressive,
unfair and inefficient system of taxation. It is
unfair because the profits of the rich and even
worse, their asset-price (capital) gains are
taxed at lower rates and riddled with tax
loopholes and giveaways. The wealthy benefit from
the windfall gains delivered by the public
infrastructure investment advocated by Mr.
Krugman, but there is not a word about the public
recouping this investment. Governments are indeed
able to create their own money as an alternative
to taxing, but some taxes above all, on
windfall gains, like locational value resulting
from public investment in roads or other public
transportation are justified simply on grounds of economic fairness.
So it is important to note what Mr. Krugman does
not address these issues that once played so
important a role in Democratic Party politics,
before the Wall Street faction gained control via
the campaign financing process even before the
Citizens United case. For over a century,
economists have recognized the need for financial
and fiscal reform to go together. Failure to
proceed with a joint reform has led the banking
and financial sector along with its major
client base, the real estate sector to scale
back property taxes and free the economy with
taxes so that the revenue can be pledged to the
banks as interest to carry larger loans. The
effect is to load the economy at large down with private and public debt.
In Mr. Krugmans reading, private debts need not
be written down or the tax system made more
efficient. It is to be better subsidized mainly
with easier bank credit and more government
spending. So I am afraid that his book might as
well have been subtitled How the Economy can
Borrow its Way Out of Debt. That is what budget
deficits do: they add to the debt overhead. In
Europe, which has no central bank permitted to
monetize the deficit spending, this pays interest
to transfers to the bondholders (and their
descendants). In the United States, the Federal
Reserve can monetize this indebtedness but the
effect is to subsidize domestic debt service.
Mr. Krugman has become censorial regarding the
debt issue over the last month or so. In last
Fridays New York Times column he wrote: Every
time some self-important politician or pundit
starts going on about how deficits are a burden
on the next generation, remember that the biggest
problem facing young Americans today isnt the future burden of debt.
Unfortunately, Mr. Krugmans failure to see
todays economic problem as one of debt deflation
reflects his failure (suffered by most
economists, to be sure) to recognize the need for
debt write-downs, for restructuring the banking
and financial system, and for shifting taxes off
labor back onto property, economic rent and
asset-price (capital) gains. The effect of his
narrow set of recommendations is to defend the
status quo and for my money, despite his
reputation as a liberal, that makes Mr. Krugman a
conservative. I see little in his logic that
would oppose Rubinomics, which has remained the
Democratic Partys program under the Obama administration.
Many of Mr. Krugmans readers find him the
leading hope of opposing even worse Republican
politics. But what can be worse than the
Rubinomics that Larry Summers, Tim Geithner, Rahm
Emanuel and other Wall Street holdovers from the
Democratic Leadership Committee have embraced?
Perhaps I can prod Mr. Krugman into taking a
stronger position on this issue. But what worries
me is that he has moved sharply to the
Rubinomics wing of his party. He insists that
debt doesnt matter. Bank fraud, junk mortgages
and casino capitalism are not the problem, or at
least not so serious that more deficit spending
cannot cure it. Criticizing Republicans for
emphasizing structural unemployment, he writes:
authoritative-sounding figures insist that our
problems are structural, that they cant be
fixed quickly.
What does it mean to say that we
have a structural unemployment problem? The usual
version involves the claim that American workers
are stuck in the wrong industries or with the wrong skills.
Using neoclassical sleight-of-hand to bait and
switch, he narrows the meaning of structural
reform to refer to Chicago School economists who
blame todays unemployment as being structural,
in the sense of workers trained for the wrong
jobs. This diverts the readers attention away
from the pressing problems that are genuinely structural.
The word structural refers to the systemic
imbalances that neoclassical economists dismiss
as institutional: the debt overhead, the legal
system especially unfair and dysfunctional
bankruptcy and foreclosure laws, regulations
against financial fraud, and wealth distribution
in general. In 1979, for example, I juxtaposed
economic structuralism to Chicago School
monetarism in my monograph on Canada in the New
Monetary Order. I have elaborated that discussion
in my textbook on Trade, Development and Foreign
Debt (new ed. 2010). The tradition is grounded in
the Progressive Eras reform program. Correcting
such structural and institutional defects,
parasitism and privilege seeking free lunches
is what classical political economy was all about
and what the neoclassical reaction sought to
exclude from the economic curriculum. But from
the perspective of neoclassical writers through
Rubinomics deregulators, the problem of massive,
unpayably high debt expanding inexorably by
compound interest (and penalty fees) simply disappears.
So the great problem today is whether to stop the
siphoning off of income and wealth to financial
institutions at the top of the economic pyramid,
or reverse the polarization that has taken place
over the past thirty years between creditors and
debtors, financial institutions and the rest of
the economy. I realize that it is more difficult
to criticize someone for an error of omission
than for an error of commission. But the
distinction was erased a month ago when Mr.
Krugman got lost in the black hole of banking,
finance and international trade theory that has
engulfed so many neoclassical and old-style
Keynesian economists. Last month Mr. Krugman
insisted that banks do not create credit, except
by borrowing reserves that (in his view) merely
shifts lending savings from wealthy people to
those with a higher propensity to consume.
Criticizing Steve Keen (who has just published a
second edition of his excellent Debunking
Economics to explain the dynamics of endogenous
money creation), he
wrote<http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/>:
Keen then goes on to assert that lending is, by
definition (at least as I understand it), an
addition to aggregate demand. I guess I dont get
that at all. If I decide to cut back on my
spending and stash the funds in a bank, which
lends them out to someone else, this doesnt have
to represent a net increase in demand. Yes, in
some (many) cases lending is associated with
higher demand, because resources are being
transferred to people with a higher propensity to
spend; but Keen seems to be saying something
else, and Im not sure what. I think it has
something to do with the notion that creating
money = creating demand, but again that isnt right in any model I understand.
Keen says that its because once you include
banks, lending increases the money supply. OK,
but why does that matter? He seems to assume that
aggregate demand cant increase unless the money
supply rises, but thats only true if the velocity of money is fixed;
But velocity is just a dummy variable to
balance any given equation a tautology, not
an analytic tool. As a neoclassical economist,
Mr. Krugman is unwilling to acknowledge that
banks not only create credit; in doing so, they
create debt. That is the essence of balance sheet
accounting. But writing like a tyro, Mr. Krugman
offers the mythology of banks that can only lend
out money taken in from depositors (as though
these banks were good old-fashioned savings banks
or S&Ls, not what Mr. Keen calls endogenous
money creators). Banks create deposits
electronically in the process of making loans.
Mr. Krugman then doubled down on his assertion
that bank debt creation doesnt matter. People
decide how much income they want to save, or
decide how much to borrow to buy goods that their
stagnant wage levels no longer enable them to
afford. Everything is a matter of choice, not a
necessity (price-inelastic is the neoclassical euphemism) said Krugman:
First of all, any individual bank does, in fact,
have to lend out the money it receives in
deposits. Bank loan officers cant just issue
checks out of thin air; like employees of any
financial intermediary, they must buy assets with funds they have on hand.
So how much currency does the public choose to
hold, as opposed to stashing funds in bank
deposits? Well, thats an economic decision,
which responds to things like income, prices,
interest rates, etc.. In other words, were
firmly back in the domain of ordinary economics,
in which decisions get made at the margin and all
that. Banks are important, but they dont take us
into an alternative economic universe.
As I read various stuff on banking comments
here, but also various writings here and there -
I often see the view that banks can create credit
out of thin air. There are vehement denials of
the proposition that banks lending is limited by
their deposits, or that the monetary base plays
any important role; banks, were told, hold
hardly any reserves (which is true), so the Feds
creation or destruction of reserves has no effect.
Not only do banks create new credit debt, from
the vantage point of their customers but in the
absence of government spending and regulation
along more progressive lines, this new debt
creation is the only way that the economy has
avoided a sharp shrinking of consumption as real
wages have remained stagnant since the late
1970s. The banks offer is one most people cant
refuse: Take out a mortgage or go without a
home, or Take out a student loan or go without
an education and try to get a job at McDonalds.
In other words, Your money or your life. It is
what banks have been saying throughout the ages.
The difference is that they can now create credit
freely and as Alan Greenspan has pointed out to
Senate committees, workers are so debt-burdened
(one check away from homelessness) that they
are afraid that if they complain about working
conditions, ask for higher salaries (to say
nothing of trying to unionize), they will be
fired. If they miss a paycheck their credit-card
rates will soar to about 29%. And if they miss a
mortgage payment, they may face foreclosure and
lose their home. So the banking system has cowed
the population with its credit- and debt-creating power.
Mr. Krugmans blind spot with regard to the debt
overhead derails trade theory as well. If Greece
leaves the Eurozone and devalues its currency
(the drachma), for example, debts denominated in
euros or other hard currency will rise
proportionally. So Greece cannot leave without
repudiating its debts in todays litigious global
economy. Yet Mr. Krugman believes in the old
neoclassical nonsense that all that is needed is
devaluation to lower the cost of domestic
labor. It is as if he is indifferent to the
suffering that such austerity imposes as Latin
American countries suffered at the hands of IMF
austerity plans from the 1970s onward. Costs can
"be brought in line by adjusting exchange rates."
The problem thus is simply one of exchange rates
(which translates into labor costs in short
order). Currency depreciation will (in Mr.
Krugmans trade theory) reduce labors cost and
other domestic costs to the point where
governments can export enough not only to cover
their imports, but to pay their foreign-currency
debts (which will soar in depreciated local-currency terms).
If this were the case, Germany could have paid
its reparations debt by depreciating the mark in
1921. But it did so by a billion-fold and even
this did not suffice to pay. Neither neoclassical
trade theorists nor Chicago School monetarists
get the fact that when public or private debts
are denominated in a foreign (hard) currency,
devaluation devastates the economy. The past
half-century has shown this again and again (most
recently in Iceland). Domestic assets are
transferred into foreign hands including those
of domestic oligarchies operating out of their
offshore dollar or Swiss-franc accounts.
Blindness to the debt issue results in especial
nonsense when applied to analysis of why the U.S.
economy has lost its export competitiveness. How
on earth can American industry be expected to
compete when employees must pay about 40 percent
of their wages on debt-leveraged housing, about
10 percent more on student loans, credit cards
and other bank debt, 15 percent on FICA, and
about 10 to 15 percent more in income and sales
taxes? Between 75 and 80 percent of the wage
payment is absorbed by the Finance, Insurance and
Real Estate (FIRE) sector even before employees
can start buying goods and services! No wonder
the economy is shrinking, sales are falling off,
and new investment and hiring have followed suit.
How will the government running a larger deficit
cope with todays dimension of the debt problem
except by taking Mr. Krugmans suggestion to
enable states and localities to spend marginally
more revenue and avoid further layoffs, while the
military industrial complex steps up its
Pentagon capitalism? So far, the great increase
in recent government debt has been to bail out
the banking sector, not to help the real economy recover.
Increasing the debt burden of European nations
has the same dire consequences. Germany balks at
bailing out Greece unless Greece moves to
streamline its bloated government and inefficient
bureaucracy, stop tax evasion by the wealthy,
clean up corruption and, in a word, be more
Germanic. The U.S. Austerian budget cutters
whom Mr. Krugman criticizes likewise can point to
wasteful government spending, failing to
distinguish positive infrastructure investment
from pork-barrel roads to nowhere and tax
loopholes promoted by Congressional politicians
whose campaigns are sponsored by special
financial interests, real estate and monopolies.
But I fear that Mr. Krugman is being drawn into
the gravitational pull of Rubinomics, the
Democratic Partys black hole from which the
light of clarity dealing with the debt issue and
bad financial and legal structures simply cannot
escape. The only variables he admits are
structure-free: The federal government can indeed
spend more and reduce interest rates (especially
on mortgages) so that the higher mortgage debt,
student debt, personal debt and corporate debt
overhead can be afforded more easily. No need to
write any of these debts down. That seemingly
obvious and sensible structural solution lies
outside the scope of Mr. Krugmans neoclassical
economics. He fails to recognize that debts that
cant be paid, wont be. This is the immediate
problem facing the U.S. and European economies
today and the way in which it is resolved will shape the coming generation.
The problem with Mr. Krugmans analysis is that
bank debt creation plays no analytic role in Mr.
Krugmans proposals to rescue the economy. It is
as if the economy operates without wealth or
debt, simply on the basis of spending power
flowing into the economy from the government, and
being spent on consumer goods, investment goods
and taxes not on debt service, pension fund
set-asides or asset price inflation. If the
government will spend enough run up a large
enough deficit to pump money into the spending
stream, Keynesian-style the economy can revive
by enough to earn its way out of debt. The
assumption is that the government will revive the
economy on a broad enough scale to enable the
individuals who owe the mortgages, student loans
and other debts and presumably even the states
and localities that have fallen behind in their
pension plan funding to catch up.
Without recognizing the role of debt and taking
into account the magnitude of negative equity and
earnings shortfalls, one cannot see that what is
preventing American industry from exporting more
is the heavy debt overhead that diverts income to
pay the Finance, Insurance and Real Estate (FIRE)
sector. How can U.S. labor compete with foreign
labor when employees and their employers are
obliged to pay such high mortgage debt for its
housing, such high student debt for its
education, such high medical insurance and Social
Security (FICA withholding), such high
credit-card debt all this even before spending on goods and services?
In fact, how can wage earners even afford to buy
what they produce? The problem interfering with
the circular flow between producers and consumers
(Says Law) is not saving as such. It is debt
payment. And unless debts are written down, the
U.S. economy will shrink just as will the
economies of Greece, Spain, Portugal, Italy,
Ireland, Iceland and other countries subjected to
the Washington Consensus of neoliberal austerity.
Michael Hudsons new book summarizing his
economic theories, The Bubble and Beyond, will be
available in a few weeks on Amazon.
Keith Hudson, Saltford, England http://allisstatus.wordpress.com
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