Krugman Makes Me Laugh

Confidence fairy remains stubbornly out of sight

I often complain, with reason, about the state of economic discussion in the United States. And the irresponsibility of certain politicians - like those Republicans claiming that defaulting on US debt would be no big deal - is scary.

But at least in America members of the pain caucus, who claim that raising interest rates and slashing government spending in the face of mass unemployment will somehow make things better, get some pushback from the Federal Reserve and the Obama administration.

In Europe, by contrast, the pain caucus has been in control for more than a year, insisting that sound money and balanced budgets are the answer to all problems. Underlying this insistence have been economic fantasies, in particular belief in the confidence fairy - that is, belief that slashing spending will actually create jobs, because fiscal austerity will improve private-sector confidence.

It is now clear that Greece, Ireland and Portugal cannot and will not repay their debts in full, although Spain might tough it out.

Realistically, then, Europe needs to prepare for some kind of debt reduction, involving a combination of aid from stronger economies and ''haircuts'' imposed on private creditors, who will have to accept less than full repayment. But realism appears to be in short supply.

On one side, Germany is taking a hard line against anything resembling aid to its troubled neighbours, even though one important motivation for the current rescue program was an attempt to shield German banks from losses

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While the last comment of Krugman's is realistic, his overall approach is filled with sophistry. A definition of sophism from Merriam-Webster dictionary follows:

- an argument apparently correct in form but actually invalid;
especially : such an argument used to deceive

Krugman has written similar articles before, lamenting the reduction in public spending and move toward deficit reduction in Europe and the U.S. He even mockingly calls those who would reign in spending the "pain caucus". Tax, spend and borrow Krugman fails to understand that the value of a currency must be protected, not continuously debauched. If our currency, our "money" is not a store of value, than it fails to meet the definition of money. This is one reason why gold continues to rise in dollar terms because it cannot easily be debauched.

Consider this fact - gold pays no interest or dividends, yet it rises in face of an interest bearing dollar (& pound & yen & euro).


The interest paid on fiat currencies, through the bond market, is not enough to compensate the investor for the growing risk of fiscal recklessness that often ends in default.

While cutting spending is unlikely to create jobs in the short term, in the intermediate to longer term real growth will result. The present path of QE and deficit spending did create some jobs, but the $600 billion spent to do so means the job cost approaches $1,000,000 each. Clearly this is utterly unsustainable.

We are in a period of deflation, meaning that leverage is coming out of the economic system. The Fed and fight it, but it will ultimately lose. Whether their fight ultimately ends in a severe inflation or hyperinflation once the leverage is squeezed out of the financial system remains to be seen.

What should be quite entertaining is to see, soon, Adam Smith's invisible hand give Mr. Krugman and more than a few banks, a swift smack on the backside.