Sunday, September 5, 2010

The Bloom is Off the Rose of Keynesian Economics

Sometimes Paul Krugman manipulates the truth to try and make his neo- Keynesian theory work and other times he just ignores reality and lies. In his ‘The Real Story” article, he makes the ludicrous statement “ inflation always falls during sustained periods of high unemployment and this time should be no different.” Apparently he forgot the Carter Administration where high unemployment and inflation was so rampant that they had to make up a new word for it (Stagflation). You may also remember that I said (Germany Proves Keynesians and Obama Wrong) Krugman would try and spin Germany’s rebound that resulted from its austerity measures; 9% raise in GDP and a drop in unemployment in a single quarter. This was after this remark in his Op-Ed piece “That 30’s Feeling;
"Many economists, myself included, regard this turn to austerity (Germany’s) as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession. And here in Germany, a few scholars see parallels to the policies of Heinrich BrĂ¼ning, the chancellor from 1930 to 1932, whose devotion to financial orthodoxy ended up sealing the doom of the Weimar Republic. But despite these warnings, the deficit hawks are prevailing in most places — and nowhere more than here, where the government has pledged 80 billion euros, almost $100 billion, in tax increases and spending cuts even though the economy continues to operate far below capacity.

Well this was his statement in his Sept 5 Op-Ed, “The Real Story;”
Oh, and don’t tell me that Germany proves that austerity, not stimulus, is the way to go. Germany actually did quite a lot of stimulus — the austerity is all in the future. Also, it never had a housing bubble that burst. And with all that, German G.D.P. is still further below its pre-crisis peak than American G.D.P. True, Germany has done better in terms of employment — but that’s because strong unions and government policy have prevented American-style mass layoffs.

There is simply no way to reconcile his forecast and the180 deg spin. Paul Krugman is running scared.

What Krugman continues to harp on however is a lack of inflation as the US borrowed itself into an additional $12 trillion hole over the last 10 years; $4 trillion in last two years alone. Krugman is so sure of his neo-Keynesian belief that inflation cannot occur with sustained unemployment, that he is willing to bet the farm (aka the US and world economy) on it. The reason however, that the US economy has not experienced any inflation is mainly due to reasons that have nothing to do with unemployment, but are nonetheless very well known by real economists; the first being the cause of the Carter years of stagflation. Here was a classic example of a Neo-Keynesian refusal to do as John Maynard Keynes said to do when situations change, “I change my mind; what do you do?” The reason is centered on the price oil and how its sold. During the Carter years the US was mired in a recession and suddenly oil prices increased, resulting in inflation. The reason is simple and obvious and still very true today. The world buys and sells oil in US dollars. This leads in many ways to the tail wagging the dog; resulting in the price of oil determining the value of the dollar. As long as oil prices are stable and low, the US will dollar will tend to stay stable with low inflation. But if oil starts to spike, then inflation will set in. In the summer of 2008 the US suffered from oil prices spiking to over $4 @ gal. The result was an immediate increase in inflation from 3% to 5.6%, which fell off as soon as oil went down to its previous prices.

Next you have the Fed keeping interest rates artificially low. This can only continue as long as the US Treasury can keep selling low yield Treasury securities. One reason the Treasury securities market continues to stay relatively healthy is that Europe is 10 years closer to the Keynesian “end point” than the US, so even the small yield Treasury securities seem a better investment then those based on the Euro; but that is starting to change. Recently the Fed has announced they are going to buy more Treasury securities themselves, which will increase monetization and eventually lead to increased inflation. Another obvious issue is as the US goes deeper into the debt, the less stable the dollar becomes. Sooner or later, there will be a demand for higher yields from US Treasury securities to cover the increased risk that the added debt will bring upon the economy on which they are based . Once the Federal securities yields go up, you won’t be able to stop inflation with 40% unemployment.

Last, but certainly not least you have China. For years now, China has continually devalued its currency so it can sell its products a lower prices. This has especially helped to pump up the value of the dollar. There has been criticism of this from the other world markets, but China knows on what side it’s toast is buttered on and continues to prop up the currency of it’s biggest trading partner. China has also been one of Washington’s biggest critics for it’s Keynesian deficit spending and has periodically sold off a percentage of its US Treasury securities, of which it holds about $840 billion worth, to goad the US to reduce its debt. A higher valued Yen would certainly lead to inflation.

The world wide opinion of Keynesian economics and it’s debt fueled spending programs has not produced the results it promised, and the realization it has finally reached it’s "end point." As I wrote in another blog article It Wasn't All Bush, Keynesian economics has caused us, particularly since the 1980s, to continually borrow prosperity from our grandchildren and great grandchildren. When Reagan became president in 1981 the debt was $700 billion, when he left 8 years later it was $3 trillion; in today’s money that’s an increase of $5.75 trillion. “Since the 1980s, Americans have consumed more than they produced—and they have made up the difference by borrowing. Two decades of easy money and innovative financial products meant that virtually anyone could borrow any amount of money for any purpose.” (www.newsweek.com). Like the gangsters after prohibition, the bankers and the Keynesian will try and put the smoke back in the box, but is over. It is time to get back to being responsible again and to go out and make an honest dollar.

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