Krugman and the pied pipers of debt
Investors are celebrating an incipient “recovery,” but the interventions responsible are sowing the seeds of a more violent contraction down the road. The problem, quite simply, is debt. We’ve accumulated record amounts, yet many economists tell us we need more.
Leading the charge is Paul Krugman. He exhorts us to borrow our way back to prosperity, but he doesn’t acknowledge that his brand of Keynesian economics ignores debt’s consequences. If you look at a chart of America’s total debt burden, he’s leading us over a cliff.
(Click chart to enlarge in new window)
The problem begins with the flawed way Krugman and other economists measure well-being. Primarily, they look at measures of activity, like GDP. These tell us how much people spend, but say nothing about where we get the money.
Every so often, we overextend ourselves, buying too much useless stuff with too much borrowed money. So we cut back, dumping the third family car and swapping the McMansion for a townhome.
But this is problematic for Krugman and other economists. Less spending means falling GDP. It means “recession.”
They ride to the rescue with two blunt instruments — monetary and fiscal policy — that encourage more borrowing and thus more spending. More spending equals “growth” so economists congratulate themselves for engineering “recovery.”
But if recessions never happen, bad businesses and unpayable debts are never washed away. They grow like cancer inside the system.
Since the mid-1980s, we’ve intervened whenever the economy hiccuped, so sectors that should have shrunk sharply — like housing and finance — never did. Feasting on easy credit, these sectors have exploded as a percentage of the economy.
Now, since individuals and corporations refuse to borrow more, the only way to grow spending is for the government to borrow.
According to George Cooper, author of The Origin of Financial Crises, “what is missing from today’s debate is recognition that previous growth rates were artificially supported by an unsustainable credit binge, itself the result of the misapplication of Keynesian policy.”
Cooper counts himself a Keynesian but says Keynesian policy has become “dangerously distorted.”
“We should be using Keynesian stimulus only to arrest the rate of credit contraction not to reverse it. The harsh truth is that our economies desperately need a recession.”
That’s because they desperately need to de-lever. As you can see in the first chart, debt relative to GDP is at record highs.
If we want sustainable growth, spending that drives it must come from savings, not more borrowing. To get there, we must first pay old debts. And that means recession.
Krugman is clearly aware of the consequences of excessive borrowing.
“I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits,” he wrote in 2003, citing a $1.8 trillion 10-year deficit projection from the Congressional Budget Office.
Fast forward six years, total debt has jumped 70 percent relative to GDP and optimistic projections put the 10-year deficitat $9 trillion.
This time, however, Krugman dismisses deficit “hysteria,” arguing that we can grow our way out of debt. “We did it during the Clinton administration,” he told me when he visited Reuters last week.
But we didn’t. While Clinton balanced the federal budget, Americans plowed through their savings. We kept growing because, in the aggregate, we were still accumulating debt.
(Click chart to enlarge in new window)
Krugman has also argued that we can handle larger deficits because we have in the past. After all, public debt peaked at 118 percent in 1945 compared with 65 percent today.
Two problems. First, the argument ignores tens of trillions of unfunded obligations for Medicare and Social Security, debt Krugman loudly lamented in his 2003 column.
It also ignores the higher private debt burden facing us today. According to economist Steve Keen, “Private sector debt accumulated in the 1920s was wiped out by the Depression, so in 1945 the private sector’s debt burden was only 45 percent of GDP. In that situation it was easy to wind down public debt from levels reached to finance WWII.”
Today, private debt is a suffocating 300 percent of GDP, making more public debt that much harder to pay down.
We know how this movie ends. Look at California — or Argentina.
We chortle from afar — “how did their budget get so out of whack?” — yet our own profligacy puts us squarely on that path. Like them, we’ve shown no political will to deal with debt. And so it will deal with us.
But we can print our own currency, you say. If all else fails, the United States can inflate its way out of debt.
Nonsense. If we try, our foreign lenders will cut us off.
As Krugman warned in 2003: “My prediction is that politicians will eventually be tempted to resolve the (fiscal) crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”
Yet today Krugman is leading the march, arguing that we can borrow indefinitely as long as deflation remains a threat.
Tell that to the Chinese.
What happens when they stop buying our bonds? To Cooper’s point, we’ll need government intervention to cushion the blow of de-leveraging. But there’s a difference between cushioning the blow and reinflating the bubble, which is what we’re doing, wasting trillions propping up housing and banking.
The risk is that we’ll have nothing left when we really need it, when the Great Leveraging becomes the Great De-Leveraging.