For Civilization, it is Mises or Bust

For those who may be new to Austrian Economics, to better understand the ideas presented below, please first take a look at this web comic on capital theory from my series Human Action Comics

Probably what most sets the Austrian School apart from mainstream economics is the Austrian School's careful analysis of the structure of production. When an Austrian economist considers the structure of production, he doesn't just dwell on crude aggregates, such as the total number or total value of capital goods in an economy. Rather, h considers how long (or how "roundabout") a given structure of production is. He asks, "How many steps are there in the production process between the extraction of raw resources and the actual output of consumers' goods?" He also considers how any given society with a given structure production can improve its productivity.

Capital Accumulation and Social Progress

Any change in the structure of production obviously must either involve (A.) an increase of, (B.) a decrease of, or (C) a maintenance of its length. Improvements in productivity which involve less or equally roundabout production processes will tend to be adopted very quickly because they tend to require fewer resources. Therefore, all that is required for their adoption is their discovery. For example, it won't take long for a hunting society to realize that the hard, sharp obsidian in the area is better for skinning animals than the fragile, blunt pumice stones they may have tried to use first.

But once a society has plucked all the low-hanging fruit of "no-brainer" productivity improvements, what then can its members do to improve productivity? Obviously the only thing left to do would be to adopt improvements in productivity which involve more roundabout methods of production.
For example, a hunting society might try the more roundabout (but more productive) method of making and using bows and arrows for hunting to replace the less roundabout (but less productive) method of making and using crude spears. This is an investment in more productive capital goods. However, since making bows and arrows take more time, and perhaps more resources, the hunters and their investment must be sustained by an adequate stock of food and other materials, since, even though the bows and arrows will yield a greater bounty, they will only do so after a longer period of time. Thus, savings are an indispensable prerequisite for increases in productivity which involve lengthening the structure of production.

Or, as Ludwig von Mises explained in Human Action, chapter 18, section 3:

As soon as those present wants are sated the satisfaction of which is considered more urgent than any provision for the morrow, people begin to save a part of the available supply of consumers' goods for later use. This postponement of consumption makes it possible to direct action toward temporally remoter ends. It is now feasible to aim at goals which could not be thought of before on account of the length of the period of production required. It is furthermore feasible to choose methods of production in which the output of products is greater per unit of input than in other methods requiring a shorter period of production. The sine qua non of any lengthening of the process of production adopted is saving, i.e., an excess of current production over current consumption. Saving is the first step on the way toward improvement of material well-being and toward every further progress on this way.

This "further progress" is possible due to the fact that more bountiful production methods mean more goods, which in turn mean a greater capacity for savings. The new saved goods can be used, not only to maintain the new, longer structure of production (by replacing bows and arrows as they are spent), but can also be used to support an even longer and more bountiful structure of production (say, in the case of the hunters, building and using extensive traps). The savings made by possible by the second productivity-enhancing lengthening of the chain of production can then in turn be used to for a third such lengthening, and so on. In a free market, this virtuous cycle of capital accumulation can go on in perpetuity, thus engendering an upward spiral in the well-being of mankind.
But as Mises wrote later in the same section, no matter how high up the spiral we may be, we always owe the propitious opportunities at hand to the capital accumulation of those who came before us.

Every single performance in this ceaseless pursuit of wealth production is based upon the saving and the preparatory work of earlier generations. We are the lucky heirs of our fathers and forefathers whose saving has accumulated the capital goods with the aid of which we are working today. We favorite children of the age of electricity still derive advantage from the original saving of the primitive fishermen who, in producing the first nets and canoes, devoted a part of their working time to provision for a remoter future. If the sons of these legendary fishermen had worn out these intermediary products--nets and canoes--without replacing them by new ones, they would have consumed capital and the process of saving and capital accumulation would have had to start afresh. We are better off than earlier generations because we are equipped with the capital goods they have accumulated for us.

It is just such an upward spiral as mentioned above that the western world experienced during the Industrial Revolution. And as Mises further elucidated in chapter 18, section 4, the rapid rise in western living standards during that time was a function of capital accumulation.

To have capital goods at one's disposal is tantamount to being nearer to a goal aimed at. An increment in capital goods available makes it possible to attain temporally remoter ends without being forced to restrict consumption. A loss in capital goods, on the other hand, makes it necessary either to abstain from striving after certain goals which one could aim at before or to restrict consumption. To have capital goods means, other things being equal, a temporal gain. As against those who lack capital goods, the capitalist, under the given state of technological knowledge, is in a position to reach a definite goal sooner without restricting consumption and without increasing the input of labor and nature-given material factors of production. His head start is in time. A rival endowed with a smaller supply of capital goods can catch up only by restricting his consumption.
The start which the peoples of the West have gained over the other peoples consists in the fact that they have long since created the political and institutional conditions required for a smooth and by and large uninterrupted progress of the process of larger-scale saving, capital accumulation, and investment.

Of course what ultimately matters for the well-being of society is the actual degree to which our wants are satisfied, and therefore the actual usefulness of goods. Of course we can only know the actual usefulness of goods in hindsight. Acting man, therefore, must rely on his anticipation of the actual usefulness of goods. Of course, man is not prescient, so he will often err in his anticipations. The more he errs, the more he will adopt structures of production that are either (A.) not as long (and productive) as he could have afforded, or (B.) longer than he can sustain and see through to completion. As an example of (B.), a hunter who incorrectly measured the length of rope in his possession might embark on building a kind of trap which required more rope than he actually had. He would, of course, be unable to finish the trap, and any of the rope that was cut into lengths that were unusable for anything else will have been wasted.

Central Banks and Social Retrogression

The Austrian Business Cycle Theory, first formulated by Mises in 1912, teaches us that in a developed economy, artificial expansions of the supply of money and credit (which now are the exclusive prerogatives of central banks) temporarily lower the rate of interest which leads to mass error. It causes people to think, like the hunter with poor rope-measuring skills, that they are wealthier than they truly are, which leads them to over-consume, and invest in production processes which are too ambitious given the capital goods available.

Let's say a hunting society using crude spears is at Level 1 of capital accumulation. Bows and arrows are used at Level 2, and traps at Level 3. Using such a scale, an industrial society would have to be characterized as several orders of magnitude above these levels. So let's use a different scale for such societies. Let's say in the early phases of its first industrial revolution, a given society was at Level A, and, through capital accumulation, it subsequently advanced to Level B, then C, and so on.
Now let's say that the society at some point is cursed with a central bank. At the time of the central bank's first expansion of money and credit, the society is at Level Q. Again, artificial expansions of the supply of money and credit make the members of society think they are at a more advanced level than they really are. It makes them think they have sufficient capital goods to see through longer, more productive production processes, when they really don't. And so let's say the monetary expansion is sufficient to make the members of the society think they are at Level R, instead of Level Q. They make Level-R-appropriate investments which are simply unsustainable; they are going through an economic bubble. The reality of the situation will eventually reveal itself to the members of society. That is the moment of the "bursting of the bubble".

Now you might think it would then simply be a matter of reallocating the capital to Level-Q-appropriate production processes. But that presupposes capital as an amorphous blob, like a mass of clay, which can be divided up and merged together to any purpose. But just as the shaft of a curved bow makes a wretched spear, and much of the materials of a animal trap are useless for the production of bows, most of the investments made during a bubble are simply lost. As Jim Fedako has beautifully put it:

The standard view is that capital is clay, ready for the potter to reshape it in a moment's time. In contrast, the Austrian view takes the current structure of capital as a given, something that the entrepreneur must take into consideration when formulating his plans. If an entrepreneur wants to change the current structure of capital, he will wield dynamite and dozer, not water and wheel.

And so, having squandered resources, our hypothetical society which was acting as if it was at Level R, is more likely to find itself taking two or more steps back, not one, and may, at best, need to adopt Level-P-appropriate methods of production.

That is of course, unless the central bank expands money and credit even further, making them think Level Q is still viable. Then it will just continue to squander resources, and continue to drop level after level until the central bank finally leaves bad-enough alone.

And of course it is not just how long the central bank fosters malinvestment that matters, but how intensely it does so. The greater the degree to which the central bank expands money and credit, the worse will be the resulting malinvestments. It should be obvious that an unsound production process adopted by a businessman who thinks he's three times as wealthy as he really is will squander more resources than one adopted by a producer who thinks he's only two times as wealthy as he really is.

Our Present Crisis of Interventionism

What does this mean for us in our present situation? The longevity and the intensity of the monetary and credit expansion embarked upon by the Federal Reserve since the beginning of Alan Greenspan's term at its helm has been unprecedented. Compared even with the levels of monetary and credit expansion during the 20s and 30s, what Greenspan did after the dot-com bubble burst, and what Bernanke is doing following the bursting of the housing bubble has been stratospheric. In the space of months, Bernanke doubled the Fed's balance sheet. Through engendering massive capital consumption, these measures have destroyed prodigious amounts of wealth, and continue to do so today.

Regarding the true wealth of society, nobody can say exactly how many "alphabet-levels" we've fallen, or will fall. But it is will very likely be enough to result in a calamitous long-term plummet in the living standards of the average person. This will very likely bring us to the climax of what Mises called the "Crisis of Interventionism".

Before the rise of liberalism made continuous capital accumulation possible across generations, the common man held a gross underestimation of what his own species was capable of. He simply took it for granted that economic stagnation across millennia was simply an inevitable fact of life. He had no inkling that human society was capable of enormous strides in the standard of living within a single decade. If the average man had any notion of it at all, he would have shrugged at the fact that his own standard of living was not much different from that of the average man a dozen generations before him, or, for that matter, from an even more ancient forebear 1,000 years prior. And if the ruling caste lived high on the hog while the bulk of the populace remained mired in squalor, well that was just a fact of life, too.

But that has irreversibly changed. The phenomenal increases in the well-being of man of the past centuries have exploded such lies. The common man knows he and his fellows are capable of wondrous achievements.

And so, years from now, after the ceaseless and prodigious capital consumption engendered by the Federal Reserve and other government measures has reduced society to squalor again, the common man will not accept it. The ruling caste may insist to him that The New Squalor is simply a product of circumstances brought on by the recklessness of certain private individuals, and that the maintenance of its own power and position are necessary to keep things from getting even worse (as the Fed is doing even now as it is confronted with but a mild curtailment of its powers). But the common man will not believe them. He will not accept a return to the old order. He has already tasted the fruits of capital accumulation. He knows civilization is capable of more than this, and that somewhere there must be a wrench in the gears of society: a problem too fundamental to be explained by just the reckless investing or heedless consumption of certain private individuals at a certain point in time. He will desperately look for this wrench, even if it means abandoning some of his most firmly-held beliefs about government and society. He already knows from history that the students of Marx can't help him find it. And he will come to realize after a string of failed economic rescue attempts that the students of Keynes and other mainstream economists don't know where it is either.

But, if he survives long enough, and if society does not descend into barbarism first, the common man might find the answer to his conundrum in the writings of Ludwig von Mises and his students. And he will learn from Mises that the wrench in the gears of civilization is nothing else but the interventionist state. He might then even find the will and the nerve to yank out the wrench for good.

Or he might not, and all will be lost.

As the state brings the world deeper into the Crisis of Interventionism, civilization itself is nearing a fork in the road. It will be Mises or bust.

A Rather Politically Convenient "Rethinking" on Cancer Screening

The Journal of the American Medical Association, the labor-restricting guild that is largely responsible for the high cost of health care published an editorial, the thrust of which, in the words of its lead author Laura Esserman (who by the way donated a cool thousand to Obama's presidential campaign), is that, "The benefit [of cancer screening] is not nearly as much as we hoped and comes at the cost of overdiagnosis and overtreatment..." And the American Cancer Society, although they've since backpedaled a bit, has voiced support for this position.

The mainstream media is all over this "rethinking" on screening. The New York Times headline runs, "Benefits and Risks of Cancer Screening Are Not Always Clear, Experts Say" Sharon Begley in Newsweek: cites the editorial while opining about, "Why there's more reason than ever to be skeptical about cancer screening."

Esserman has been quoted and interviewed extensively in the past couple of days. In her interviews on the News Hour and on San Francisco's KQED she protests profusely that the "rethinking" she is pushing for is not about restriction of care, but is about "tailoring care" and "making care better."  In the KQED interview, in a soppy, "caring" tone, she professes her concern for patients worrying over cancers which they do indeed have, but which aren't necessarily dangerous.

I highly suspect that all this is basically a ham-fisted attempt at consent-engineering purposed toward softening the blow for future government-mandated restrictions on screening. Unless we fight back, we may well be on our way toward centrally-rationed health care. And that's not scare-mongering, but simply a sensible analysis of political trends.

Ben Bernanke Was Wrong: YouTube Mashup

Somebody did a cool "mashup" (defined in Wikipedia as "a digital media file containing any or all of text, graphics, audio, video and animation drawn from pre-existing sources, to create a new derivative work") of my Mises.org article on Ben Bernanke's embarrassing prognostications.

This is a neat example of "Web 2.0" (distributed, participatory media on the internet) actually doing some good.

"PaulWilliamsWorld" painstakingly found the most telling footage of Bernanke's wretched economic forecasting and spliced them together.

Then, I transcribed the video and added Austrian analysis.

And now "confederalsocialist" has redone the original video, splicing in a reading of my analysis following each relevant Bernanke clip (see below).

The three of us are complete strangers and none of us are members of the media establishment, yet we have spontaneously collaborated to progressively add value to each other's products, and have thereby spoken truth to power and have spread that truth to thousands of people.

Individuals don't have to rely on the corrupt mainstream media anymore.  With the internet, the ideas of freedom can, to some degree, get around establishment gate-keepers and spread by virtue of their truth-value.  This new possibility is a ray of hope shining through the darkness of the rising state.

[View:http://www.youtube.com/watch?v=QLnRns75TRI]

Ben Bernanke Was Wrong: Featured on Mises.org

My piece Ben Bernanke Was Wrong is a Daily Article today on the Mises Institute web site.  Here is the article and the comments page.  I've fleshed out my commentary on the transcription to make it more of an actual article.  I've also updated the article here on Summa Anthropica.  One of the things I added was the following bit at the end:

But even the most powerful and sequestered bureaucrat is not completely invulnerable. The Federal Reserve Transparency Act and the End the Fed movement have ruffled the Fed's feathers enough that Bernanke actually felt the need to address the public in a "townhall forum" to be broadcast on the News Hour. According to NPR,

after the forum was over, a Fed employee passed out souvenirs, an unintended metaphor perhaps for what some fear Bernanke's aggressive policies may eventually do to the currency: shredded cash.

The Fed employee, who apparently suffers from a defective sense of irony, was even recorded saying, "Here, you want money?" and, "Here's some free shred folks, thanks for coming by, we appreciate it,"

No, no, thank you and your boss, Mr. Fed employee. Within the space of days, we've been provided, courtesy of the Fed itself, with footage that perfectly distills the complete failure of Fed forecasting and planning, and audio that encapsulates splendidly the only thing that the Fed actually accomplishes: the destruction of money.

The Second Coming of Keynes: Featured on Mises.org

My article "The Second Coming of Keynes" (originally posted here) has been published today as a front-page Mises Daily.  Here's the article and the comments page.
Best.  Mises.org.  Image.  Ever....

Ben Bernanke Was Wrong

 We now have the diametrical opposite of the famous "Peter Schiff Was Right" video (a compilation of 2006 and 2007 clips in which Schiff, a financial expert who subscribes to Austrian economics, predicted the deep recession that would follow the bursting of the housing bubble).

The new, opposite video is a compilation of the 2005–2007 prognostications of Federal Reserve Chairman Ben Bernanke. In it, Bernanke is shown to have been just as embarrassingly wrong as Schiff was uncannily right.

Could their differences in economic understanding have anything to do with this remarkable dichotomy? I have transcribed most of the video, and offer my own comments interspersed with it.

July 2005
INTERVIEWER: Ben, there's been a lot of talk about a housing bubble, particularly, you know [inaudible] from all sorts of places. Can you give us your view as to whether or not there is a housing bubble out there?
BERNANKE: Well, unquestionably, housing prices are up quite a bit; I think it's important to note that fundamentals are also very strong. We've got a growing economy, jobs, incomes. We've got very low mortgage rates. We've got demographics supporting housing growth. We've got restricted supply in some places. So it's certainly understandable that prices would go up some. I don't know whether prices are exactly where they should be, but I think it's fair to say that much of what's happened is supported by the strength of the economy.

This is not only wrong in hindsight; it's a complete misunderstanding of the issue. Bernanke said that the housing boom was fine because it was supported by, among other things, growth in jobs, incomes, and in the economy in general. But that very growth itself was supported by the housing boom! For example, most of the job growth was in the housing sector. Witness Bernanke's amazing levitating economy: its housing sector is held up by economic growth, which is held up by its housing sector. And it's just as ridiculous that he denied the existence of a housing bubble by pointing to low mortgage rates. The low rates were a chief cause of the housing bubble, and were a direct result of his actions as Federal Reserve chairman.

July 2005
INTERVIEWER: Tell me, what is the worst-case scenario? Sir, we have so many economists coming on our air and saying, "Oh, this is a bubble, and it's going to burst, and this is going to be a real issue for the economy." Some say it could even cause a recession at some point. What is the worst-case scenario, if in fact we were to see prices come down substantially across the country?
BERNANKE: Well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though.

As Peter Schiff pointed out in his speech "Why the Meltdown Should Have Surprised No One," while it is true that up until the housing crash, house prices hadn't gone down on a nationwide basis, it's also true that they had never risen so precipitously before either. Bernanke's argument is akin to getting someone drunk for the first time, putting them in a car, and then saying, "He'll be fine; he's never been in a car accident before."
That interview continued:

INTERVIEWER: So would you agree with Alan Greenspan's comments recently that we've got some areas of that country that are seeing froth, not necessarily a national situation, but certainly froth in some areas?
BERNANKE: You can see some types of speculation: investors turning over condos quickly. Those sorts of things you see in some local areas. I'm hopeful — I'm confident, in fact, that the bank regulators will pay close attention to the kinds of loans that are being made, and make sure that underwriting is done right. But I do think this is mostly a localized problem, and not something that's going to affect the national economy.

Bernanke's Fed itself created the false signals that led to vast disruptions in the housing market. Speculators try to see through those disruptions and anticipate how prices will change as valuation mistakes are corrected in order to profit from them. In fact, their speculation is part of the correction process. If their speculation is on the mark, it speeds up the price-correction process. If it's wrong, then the consequences are on their heads. Speculation is nothing but high-uncertainty entrepreneurship; and entrepreneurship is how optimal prices are found and markets clear. It was the Fed under Bernanke himself, and his predecessor Alan Greenspan, that created the price disruption and high uncertainty that made speculation profitable in the first place.

November 2006
BERNANKE: This scenario envisions that consumer spending, supported by rising incomes and the recent decline in energy prices, will continue to grow near its trend rate and that the drag on the economy from the [inaudible] housing sector will gradually diminish. The motor vehicles sector may already be showing signs of strengthening. After having cut production significantly in recent months, in response to the rise in inventory of unsold vehicles, automakers appear to have boosted the assembly rate a bit in November, and they have scheduled further increases for December. The effects of the housing correction on real economic activity are likely to persist into next year, as I've already noted. But the rate of decline in home construction should slow as the inventory of unsold new homes is gradually worked down.

Here we have the Keynesian fallacy (which I have written about here) that consumer spending, in and of itself, creates general increases in wealth. And note the irony in Bernanke applauding the boost in automotive production: the products accumulated during that boost turned out just to be more malinvestment to be liquidated or bailed out when Chrysler and GM collapsed.

February 2007
BERNANKE: We expect moderate growth going forward. We believe that if the housing sector begins to stabilize, and if some of the inventory corrections still going on in manufacturing begin to be completed, that there's a reasonable possibility that we'll see some strengthening in the economy sometime during the middle of the new year.
Our assessment is that there's not much indication at this point that subprime mortgage issues have spread into the broader mortgage market, which still seems to be healthy. And the lending side of that still seems to be healthy.

For Bernanke, healthy lending is the same thing as "a lot of lending." This dovetails with his statement in the first interview, hailing low mortgage rates as a self-evidently good thing. He has no conception of an equilibrium interest rate determined by society's average time preference, so bubbles will always surprise him. For more on this calamitous gap in Bernanke's understanding, see "Manipulating the Interest Rate: a Recipe for Disaster" by Thorsten Polleit.

July 2007
BERNANKE: The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards, and the recent increase in mortgage interest rates. Sales should ultimately be supported by growth in income and employment, as well as by mortgage rates that, despite the recent increase, remain fairly low relative to historical norms. However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further, as builders work down the stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth in coming quarters, although the magnitude of the drag on growth should diminish over time. The global economy continues to be strong, supported by solid economic growth abroad. U.S. exports should expand further in coming quarters. Overall, the U.S. economy seems likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend.

Strengthening in 2008? Perhaps the biggest confirmation ever of Rockwell's Law: always believe the opposite of what government officials tell you.
Bernanke's own words, in light of how the crisis developed, are a testament to much more than his own personal failings as a forecaster and policy maker. They demonstrate the complete inadequacy of mainstream macroeconomics in its present state, devoid as it is of the essential insights of the Austrian School. They also reveal the folly of the very idea of giving a single man and his institution the power to centrally plan the most important price in the economy: the rate of interest. Make no mistake: the present economic crisis was brought on by central planning. It is unsettling to think that the fellow in the new video who so badly misread an economy on the brink is arguably the most powerful central planner in the world.
But even the most powerful and sequestered bureaucrat is not completely invulnerable. The Federal Reserve Transparency Act and the End the Fed movement have ruffled the Fed's feathers enough that Bernanke actually felt the need to address the public in a "townhall forum" to be broadcast on the News Hour. According to NPR,

after the forum was over, a Fed employee passed out souvenirs, an unintended metaphor perhaps for what some fear Bernanke's aggressive policies may eventually do to the currency: shredded cash.

The Fed employee, who apparently suffers from a defective sense of irony, was even recorded saying, "Here, you want money?" and, "Here's some free shred folks, thanks for coming by, we appreciate it,"

No, no, thank you and your boss, Mr. Fed employee. Within the space of days, we've been provided, courtesy of the Fed itself, with footage that perfectly distills the complete failure of Fed forecasting and planning, and audio that encapsulates splendidly the only thing that the Fed actually accomplishes: the destruction of money.

The Second Coming of Keynes

Paul Krugman wants to be our savior.  Moreover, he wants to be a specific kind of savior: a magus of the scientific age, a blackboard prophet.

The roots of this curious ambition can be seen in his recent profile in Newsweek:

Krugman says he found himself in the science fiction of Isaac Asimov, especially the "Foundation" series—"It was nerds saving civilization, quants who had a theory of society, people writing equations on a blackboard, saying, 'See, unless you follow this formula, the empire will fail and be followed by a thousand years of barbarism'."

Now here we are at an economic zero hour for the American empire, and perhaps for modern civilization itself, and many in the global urban elite think this establishment triathlete with his Princeton professorship, his New York Times column, and his Nobel Prize, has the equation for salvation.  So what is Krugman's formula?  What commandments for us, his plebian flock, does the magus have scrawled on his blackboard?

To understand that, one must understand Krugman's intellectual heritage, such as it is.

Paul Krugman is a devotee of John Maynard Keynes.  He's such a hard-core disciple that he was Keyensian when Keynesianism wasn't cool: the period between the 1970's stagflation, which seemed to disprove Keynesian doctrine, and now, when it is groundlessly renascent due to our society's stunted memory span.  He himself proudly admits his devotion to Keynes.  He has written such headlines as "The Greatness of Keynes" and "Why Aren't We All Keynesians Yet?"  But what does it mean to be keen on Keynes?  What diagnosis does Krugman's Keynesian economics have for the economic crisis, and what remedies does he prescribe?

The Keynesian Diagnosis: A Deadly Case of Frugality

The Keyensian culprit in the whodunit mystery of depression economics is nothing other than savings.  That's right, savings: that necessary precondition for all capital development, and thereby all gains in productivity, and thereby all increases in general human prosperity.

The Keynesian story of depressions in a nutshell is that 1) excessive savings leads to 2) underconsumption which leads to 3) unemployment.  Unemployment engenders even more dread savings, completing the loop of a vicious cycle.  This theory was a spit in the face of hundreds of years of progress in economic thought.  Economists before Keynes painstakingly, analytically, and progressively built up a mighty edifice of knowledge and truth, all of which centered around how markets find optimal prices and equilibrate in response to changing situations.  Keynes blithely dismissed it all as "orthodoxy" and falsely characterized the market as an inherently dysfunctional mechanism that tends to seize up into permanent depression without intervention from the wise government.

Paul Krugman completely buys the Keynesian story.  He wrote recently:

one of the high points of the semester, if you're a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.

So to Krugman, the road to economic hell is paved with the good intentions of frugality.  This "underconsumption theory" is basically what he's talking about whenever you read Krugman warning ominously about "saving gluts", the "paradox of thrift", "consumer capitulation", "insufficient aggregate demand", etc, etc.  It's all just adult jargon dressing up a childish theory.  As Gary North wrote, underconsumption theories

...speak of saving as if it were a system for hiding paper currency under a mattress. They refuse to answer this crucial question: What does the bank do with the money that a consumer deposits instead of spending? Put another way: What analytical or conceptual difference does it make whether a saver deposits a dollar his bank, which the bank will lend, or whether he spends it, enabling the seller to deposit the dollar in his bank, which his bank will lend?

And even if saving were a matter of greenbacks and mattresses, any particular amount of such "hoarding" would not lead to underconsumption, as Murray Rothbard showed in his economic treatise Man, Economy, and State, but merely "an increase in the real value of their cash balances and of the monetary unit."  This would depress business revenues in nominal terms, but it would lower business costs as well, leaving businesses just as profitable in real terms as before.

The Keynesian Remedy: Spend Your Way to Riches

With such an backwards diagnosis of depressions as Krugman's, it should be no surprise that his Keynesian remedies would be equally wrong-headed, and disastrously destructive besides.  The Keynesian prescription to ward off depression is government stimulus.  This is what Krugman is talking about whenever he calls for "priming the pump".  Keynesian stimulus comes in two forms: monetary and fiscal.  With monetary stimulus, a central bank (like the Federal Reserve) greatly increases the money supply, which dramatically lowers interest rates, which in turn stimulates spending.  This is the "pro-bubble" side of Krugman's economics, which I've written about here and here.  His now-notorious prescription of an induced housing bubble was to be accomplished (and was actually accomplished) via monetary stimulus.  Krugman said in an interview with Lou Dobbs:

Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. (Emphasis added.)

This was his prescription for the recession in 2001.  The rest is housing bubble history.

The ironic thing is that monetary expansion, Krugman's cure for depressions, is the very poison that causes them in the first place.  According to the Austrian Business Cycle Theory, which was first expounded in 1912 by Ludwig von Mises, the great Austrian economist who predicted the Great Depression, monetary expansion misdirects resources, causing excessive investment in stages of production that are more removed from the final products.  This lengthening of the chain of production is unsustainable, given the actual amount of savings available for continuous investment. Eventually businesses realize this fact, and that the malinvestments need to be liquidated and resources reallocated toward sustainable projects.  Further monetary stimulus (or any government intervention for that matter) only serves to retard that reallocation process and to prolong the depression.  For a nice primer on the true story behind business cycles, I recommend this article and this speech (video) by Tom Woods.

According to Krugman's assessment of the current state of the economy, monetary stimulus has done pretty much all it could do (thank God for that!), and we are now coming upon a Keynesian "liquidity trap", which, as he characterizes it, is "a situation in which conventional monetary policy loses all traction. When short-term interest rates are close to zero..."  What does Keynesian doctrine prescribe in such situations?  It calls for massive fiscal stimulus: government spending intended to fill the hole in aggregate demand that underconsumption has left.  This is how Krugman himself characterized it in February, according to a University of Pennsylvania e-newsletter:

With monetary policy a non-starter, "That leaves nothing but government spending" to prime the pump, Krugman said. "That's pure Keynes."

Krugman estimated that the "spending hole" in the U.S. economy is $2.9 trillion dollars.  Because of that, he complained, President Obama's stimulus package should be over three times its present size!

"It's helpful, but it does not cover even one-third of the gap, so it's disappointing," Krugman said. Out of the $789 billion approved, only about $600 billion adds real stimulus, in Krugman's opinion. "So you've only got $600 billion to fill a $2.9 trillion hole."

The only hole that needs filling is the one in Krugman's understanding.  As we have already seen, the notion that stimulus does any good by moving money out of mattresses and bank vaults is fallacious.  And as Ludvig von Mises wrote:

a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity. 

This leads to the question of whether government spending and investment does more good than private spending and investment.  Sound economics answers this question with a resounding "no"; yet we don't even need to consider the question in regards to Krugman's Keynesianism.  This is because ultimately Keynesian fiscal stimulus is not even about the goods and services produced by the additional spending (infrastructure, welfare, etc).  You see, the fiscal stimulus might as well be literally filling holes, as well as figuratively, since according to Keynes' ridiculous understanding of how an economy works, it doesn't matter what the government spends money on.  Even digging up holes just to refill them would qualify as beneficial stimulus.  You might think that this must not be literally true: "Keynes may have been wrong on some things, but no economist as prominent as he was would believe something so foolish!"  Read the man's words for yourself:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines 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.

The above passage was not some off-hand note written to a colleague in a fit of academic speculation.  It was written in his chief contribution to economics, upon which his reputation rests: The General Theory of Employment, Interest, and Money.  I don't care how prominent, credentialed, or "accomplished" an economist is.  If he says that burying cash in the ground can be a boon to society, then he should be immediately dismissed from public and academic discourse.

The simple fact that Krugman regards such a fellow as an exemplar of economic scholarship would be highly telling by itself.  "Okay," you might think, "Keynes was a bit extreme.  But Krugman himself wouldn't go so far as to believe something like that."

Wrong again.  In April, Krugman actually bemoaned the fact that Obama's stimulus projects were under budget.

President Obama hails the fact that stimulus projects are coming in ahead of schedule and under budget. Yay — but boo.

Ahead of schedule is good. Under budget — well, ordinarily that’s a good thing. But the point of the stimulus is to increase spending!

That's right, Krugman would, all other things being equal, prefer government stimulus spending to be inefficient.  He then goes on to favorably quote the very same ridiculous passage from Keynes' General Theory, which I quoted above.  And the title of the piece in which he made this complaint?  "Time for Bottles in Coal Mines."

I told you he's hard-core.

This brings me to a side point I'd like to make.  One might think that in writing in such, let's say "direct", language, I'm needlessly vilifying both Keynes and Krugman.  I certainly wouldn't write this way about just anyone I happened to disagree with.  But, as should now be evident, Keynesians are special.  Their economic doctrines are so fallacious, and their policies are so destructive that, for the sake of truth and humanity, one cannot be too forthright in denouncing them.

Conclusion

Paul Krugman wants to be our savior.  Like a savior, he would perform a miracle for us: that of turning consumption into wealth.  But who would accept a messiah with such a "John the Baptist" harbinger as John Maynard Keynes, who proclaimed that credit expansion could perform the “miracle... of turning a stone into bread”?  In any case Krugman is a curious kind of savior: one more interested in seeming brilliant than in actually helping people.  In the Newsweek profile, he said of his policy advocacy:

"I am not overflowing with human compassion. It's more of an intellectual thing."

Indeed, there is something almost calculated in the unblinking wrong-headedness of both Keynes and Krugman.  You're not likely to get much notoreity as a public intellectual advocating common sense.  What's more, you can't express common sense in calculus, which is actually useful in the natural sciences, but which only provides a fallacious veil of obscurity and elitism over the social sciences.  In other words, sound economics just doesn't make for a cool-looking blackboard.  And without a cool-looking blackboard, how would Paul Krugman be the "quant nerd saving civilization"?  John Maynard Keynes reveled in the ballyhoo over his bold "new economics", even though his doctrines were merely age-old inflationist fallacies dressed up in mathematical jargon.  When confronted with the fact that his solutions would never work in the long run, he would dismissively say, "In the long run, we're all dead."  Keynes' short run was long enough for him to live the rest of his life as the scholarly savior who turned economic stone into bread.  But as Murray Rothbard used to say, now Keynes is dead, and we're all stuck living in his "long run"  (See Rothbard's essay on Keynes the Man.)  For our own sake, let's hope Paul Krugman's tenure as an influential economist, as well as the current renascence of Keynes he represents, is a mercifully short-run affair.

Krugman's Rearguard Apologists: Featured on Mises.org

My article Krugman's Rearguard Apologists (originally posted on Summa Anthropica), which follows up my Krugman's Intellectual Waterloo Mises Daily (also orginally posted on Summa Anthropica) has been published today as a front-page Mises Daily.  Please check it out and contribute to the comments.

My sincere thanks again to Jeffrey Tucker and BK Marcus.

Here's an excerpt...

This brings us to the key point that all the Krugman apologists egregiously ignore: namely that it would be surprising if such an arch-Keynesian economist as Krugman (he's written extensively on what he has called "the greatness of Keynes") didn't adovocate a housing bubble to replace the dot-com bubble, since doing so would dovetail perfectly with basic Keynesian doctrine. As a Keynesian, Krugman should have wanted lower interest rates (as he actually did want, as is revealed by the previous quote). To quote Keynes himself,

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. (General Theory, p. 322; emphasis added, but the exclamation point is Keynes's own.)

To be true to his Keynesian principles, Krugman ought to have to welcomed the housing bubble, since to him

1. it was a good way to achieve his coveted "soaring household spending", and
2. it was the likely result of Keynesianism-prescribed lower interest rates.

Krugman's Rearguard Apologists

As most readers will know, a collection of damning quotes has surfaced recently, exposing Paul Krugman, the doyen of the economic left, as having been completely backward on the most material economic event in our generation: the housing bubble.  My recent article on the subject, Krugman's Intellectual Waterloo, has elicited some pretty heated rearguard apologetics, which, in the present article, I'd like to sum up, and knock down.

The first quotes which surfaced are from a 2002 editorial by Krugman.  This was followed by a cluster of even more damning 2001 quotes collected by Mark Thornton.  The first editorial could be twisted, if one was inclined to twist, into something seemingly benign.  The second wave of quotes is much harder to mischaracterize (which is not to say Krugman ditto-heads don't try).  The laziest tactic of the Krugman apologists is to only address the more stretchable 2002 editorial, and completely ignore the 2001 quotes.  But, not even that approach, if accepted, helps Krugman' case, since the 2002 editorial is damning enough on its own, once the benign interpretations of Krugman's apologists are shown to be nonsense.

One protestation offered has been that a quotation offered in my "Waterloo" piece which read...

To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

...omits the context which shows that Krugman was "merely" quoting someone else.  The last sentence quoted reads in full:

And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

"Disingenuous partisan misquoting!" the apologists cry, "It was this Paul McCulley fellow who said that, not Krugman!"  But lets pull the lens back even further, and add even more context by including the whole paragraph, and the one preceding it.

A few months ago the vast majority of business economists mocked concerns about a ''double dip,'' a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I've repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever.

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. (Emphasis added.)

So the first paragraph introduces the "double-dipper iconoclasts", and then clearly states that he, Krugman, agrees with them.  The second paragraph then outlines the "basic point" of the double-dippers, which again, he agrees with.  And the basic point in question is that to "fight this recession the Fed...needs soaring household spending."  Krugman then continues to say how the Fed would need to accomplish this goal, which again, he supports; he says that the recession needs to be fought with soaring household spending, which Alan Greenspan needs to induce by creating a housing bubble to replace the Nasdaq bubble.  By writing, "as Paul McCulley of Pimco put it", Krugman is not "merely" quoting another person; he is using someone else's phraseology to express his own opinion.

Another protestation is that Krugman was saying the housing bubble won't work, since later in the editorial he wrote:

Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman's crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging.

But this protestation completely ignores the fact that when Krugman wrote in the editorial...

Despite the bad news, most commentators, like Mr. Greenspan, remain optimistic.

and...

But wishful thinking aside, I just don't understand the grounds for optimism. Who, exactly, is about to start spending a lot more? (Emphasis added.)

...he was clearly characterizing a housing bubble as an object of optimism, whether or not he thought it was possible.  In other words, at best, Krugman could be interpreted as saying that it would be great if Greenspan could pull off a housing bubble, but that he, Krugman, doubts whether he'll be able to accomplish such a worthy feat.

So it should be clear that the Fed causing a housing bubble in order to bring about "soaring household spending" was Krugman's optimal situation, whether or not he thought it was do-able at the time.  Given the consequences of the housing bubble that did ultimately happen, that alone should be enough cause for the public to stop listening to this fellow. 

Another question is, how did he see the Fed bringing about his optimal situation?  He answered this question himself in a 2002 interview with Lou Dobbs (which can be found here, though not at the page originally linked to in Thornton's collection):

Low interest rates, which promote spending on housing and other durable goods, are the main answer. (Emphasis added.)

This brings us to the key point that all the Krugman apologists egregiouslly ignore: namely that it would be surprising if such an arch-Keynesian economist as Krugman (he's written extensively on what he has called "the greatness of Keynes") didn't adovocate a housing bubble to replace the Dot Com Bubble, since doing so would dovetail perfectly with basic Keynesian doctrine.  As a Keynesian, Krugman should have wanted lower interest rates (as he actually did want, as is revealed by the previous quote).  To quote Keynes himself,

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest!  For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. (Font emphasis added, but the exclamation point is Keynes' own.)

John Maynard Keynes, The General Theory of Employment, Interest, and Money, p. 322

To be true to his Keynesian principles, Krugman ought to have to welcomed the housing bubble, since to him (1) it was a good way to achieve his coveted "soaring household spending", and (2) it was the likely result of Keynesianism-prescribed lower interest rates.

Now let's take a look at some more recent and more directly damning evidence of Krugman's pro-bubble economics.  In my recent article, I pointed out that in Krugman's 2001 editorial, he implicitly agreed with the Onion's facetious call for a new bubble to replace the old one.  In a brilliant comment left in Krugman's own blog (which you can still read until it gets "moderated" (purged), as is the fate of many critical comments there), one "M Ingelmo" reveals, in a most devastating manner, that in 2009 Krugman explicitly agreed with the Onion piece.

Mr. Krugman,

I don’t know if you were on the grassy knoll, too, but you certainly were in Spain in March, chatting with that most fervent of your admirers, Prime Minister Mr. Zapatero, and interviewed in the Spanish public TV channel.

Since these days a video is worth a thousand words, allow me to quote you and say: “guys, watch it for yourselves”. The program is about other things, innovation, and in Spanish (sorry), so go straight to the 35 seconds in the interview after minute 2:50. Under the Spanish translation I’m sure you’ll be able to hear the English original. Quite enlightening:

“To be honest, a new bubble now would help us out a lot even if we paid for it later.  This is a really good time for a bubble…

There was a headline in a satirical newspaper in the US last summer that said: “The nation demands a new bubble to invest in” And that’s pretty much right.”

http://www.rtve.es/mediateca/videos/20090502/innovar-para-salir-crisis-informe-semanal/495712.shtml

Not a piece of policy advocacy? Just economic analysis? Will it look like it to all your defenders and commentators here? Personally I am delighted with the words “pay for it later”; are we paying right now for the last one, advocated in 2002, or maybe not enough yet, Mr. Krugman?

If governments follow your “not-a-piece-of-policy-advocacy-just-economic-analysis”, (as it seems certain at least with ours), when that new bubble thus inflated eventually bursts, and we are “paying for it” in a few years time, what will you write in your blog then, Mr. Krugman?

But perhaps the most instructive lesson out of all this is that, implicit in Krugman's quotes, there is a big fat finger of blame pointed directly (and correctly) at the Federal Reserve.  Krugman himself would only admit to blaming other factors for our present crisis.  But, if...

1. as any sane person will recognize in hindsight, the housing bubble was disastrous for the economy
2. as Krugman himself stated, the Fed can induce such a bubble by lowering interest rates, and
3. as the public record shows, the Fed did drastically lower interest rates in the time leading up to, and in the thick of, the housing bubble,

...then according to the vanishingly few economic principles Krugman actually gets right, he should blame the Fed for the present crisis.  Although somehow I doubt, he'll be supporting the Audit the Fed campaign, or Ron Paul's Federal Reserve Transparency Act anytime soon.

As it turns out, Krugman's apologists shouldn't demand more context for his notorious quotes, since it only shines even more light on his confused backwardness as an economist.

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Krugman's Intellectual Waterloo: Featured on Mises.org

My piece  Krugman's Intellectual Waterloo has been made today's Daily Article on Mises.org.  Check out the hilarious "Krugman-as-Napoleon" image they put together.  My thanks to Jeffrey Tucker for selecting it, to BK Marcus for editing it, and to nirgrahamUK on the Mises boards and anyone else who passed it on to others.

 I consider the Mises Institute web site to be the greatest source for truth and wisdom on the web.  So it's an honor to have something I wrote featured on its main page, and it's a kick to see my name in the list of Mises Daily Authors, along with the names of a great many of heroes.

I hope my characterization of Krugman's twisting in the wind will be convincing to people and that this piece will help spread the word regarding the damning quotes that Lew Rockwell and Mark Thornton have discovered.  If I could help soften the ground under Krugman's pedestal and cause it to sink just one inch, I would feel I have truly done good in the world.

Please join the assault on neo-Keyneseanism by contributing a comment to the article's entry on the Mises Blog.

Krugman's Intellectual Waterloo

On Monday evening, Lew Rockwell, from a tip by someone named "Travis", posted this damning quote of Paul Krugman's from a 2002 New York Times editorial:

“To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

Krugman.  2002.  Calling for a housing bubble.

What's more, by explicitly calling for a new bubble to replace the recently burst one, he anticipated by 6 years the Onion's hilarious "report" that "demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income."  Except Krugman was being SERIOUS.

The quote caught on in the blogosphere, to such an extent that Krugman actually responded in his New York Times blog Wednesday morning:

Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.

So with a deft little two-step, Krugman paints himself as a doctor who gave an excellent diagnostic, and not a disastrous prescription.  One of his ditto-heads posted on his blog that saying Krugman advocated or caused the housing bubble was:

Like saying Nostradamus caused the rise of European fascism.

At the same time, with his headline of "And I was on the grassy knoll, too" he paints his critics (especially the Austrians) as conspiracy theorists, akin to the Lone Gunmen (the Kennedy assassination theorists from the X-Files TV show).  Just like with the matter of Jekyll Island and the events leading up to the creation of the Fed, an OBVIOUS conclusion from a matter of PUBLIC RECORD is portrayed by establishment sophistry as unmoored crankiness.  And once again, it works: another ditto-head dismissively remarked,

"no need to reason with those folks."

Even economist Arnold Kling bent over backwards to interpret the column in a benign light:

He was not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur.

Krugman thanked Kling for his "gracious, sensible explication".  I can just imagine Kling running around his office in glee at having been nodded at by a celebrity Nobel Laureate, exclaiming, "He likes me!  He likes me!"

Mark Thornton on the Mises blog followed up with a devastating collection of 2001 Krugman quotes clearly documenting his support for inducing a housing bubble.  The most damning of this batch is the following from a 2001 interview with Lou Dobbs:

“Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment.  Low interest rates, which promote spending on housing and other durable goods, are the main answer.”

How the hell can anyone spin THAT as a purely academic musing, and not a policy recommendation for artificially inducing housing spending?

Ignoring the other quotes for a moment, and just judging from the 2002 column, did Krugman support pumping up a housing bubble or not?  Given that, even in his recent blog defending himself, he explicitly stated his belief that "the only way the Fed could get traction would be if it could inflate a housing bubble", there are only two possibilities:

1. He DID NOT support inducing a housing bubble, and wanted the Fed to NOT FIGHT THE RECESSION.
2. He DID support inducing a housing bubble.

Anyone even somewhat familiar with Krugman's attitude toward Fed activism should know that proposition #1, that Krugman supported a do-nothing policy, is preposterous.  So, especially after bringing back in the quotes gathered by Mark Thornton, the case for proposition #2 is overwhelming.

And what about his strawman protests that he didn't cause the housing bubble, much less the Enron scandal or Kennedy's assassination?  The man is willfully missing the point.  What is damning about these quotes is NOT that he necessarily caused ANYTHING.  What is devastating about them is that they expose the intellectual bankruptcy of his economic principles.  Those who look up to him like the second coming of Adam Smith should realize that the neo-Keynesian principles that lead him to advocate aggressive interest rate cuts and mammoth public spending NOW, are the very same principles that led him to advocate inducing a housing bubble THEN.  He would himself affirm that his economic principles haven't fundamentally changed since then.  So the conclusions and policy prescriptions he infers from them are just as wildly wrong now as they were then.

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Krugman's Rearguard Apologists

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