Krugman vs. Greenspan on "That ’30s Feeling"; Calculated Risk Sides with Krugman, I Side with Greenspan

Courtesy of Calculated Risk here are a pair of articles, one from Krugman and another from Greenspan on the limits of debt.

That ’30s Feeling

Paul Krugman has That ’30s Feeling

Suddenly, creating jobs is out, inflicting pain is in. Condemning deficits and refusing to help a still-struggling economy has become the new fashion everywhere, including the United States, where 52 senators voted against extending aid to the unemployed despite the highest rate of long-term joblessness since the 1930s.

Many economists, myself included, regard this turn to austerity 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 Brüning, 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.

What’s the economic logic behind the government’s moves? The answer, as far as I can tell, is that there isn’t any. ....

How bad will it be? Will it really be 1937 all over again? I don’t know. What I do know is that economic policy around the world has taken a major wrong turn, and that the odds of a prolonged slump are rising by the day.

U.S. Debt and the Greece Analogy

In sharp contrast to Krugman's position, Alan Greenspan compares the US to Greece in U.S. Debt and the Greece Analogy

An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon. Perceptions of a large U.S. borrowing capacity are misleading.

Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

How much borrowing leeway at current interest rates remains for U.S. Treasury financing is highly uncertain.

We cannot grow out of these fiscal pressures. The modest-sized post-baby-boom labor force, if history is any guide, will not be able to consistently increase output per hour by more than 3% annually. The product of a slowly growing labor force and limited productivity growth will not provide the real resources necessary to meet existing commitments.

Only politically toxic cuts or rationing of medical care, a marked rise in the eligible age for health and retirement benefits, or significant inflation, can close the deficit. I rule out large tax increases that would sap economic growth (and the tax base) and accordingly achieve little added revenues.

It is little comfort that the dollar is still the least worst of the major fiat currencies. But the inexorable rise in the price of gold indicates a large number of investors are seeking a safe haven beyond fiat currencies.

The United States, and most of the rest of the developed world, is in need of a tectonic shift in fiscal policy. Incremental change will not be adequate.

I do not believe that our lawmakers or others are aware of the degree of impairment of our fiscal brakes. If we contained the amount of issuance of Treasury securities, pressures on private capital markets would be eased.

Fortunately, the very severity of the pending crisis and growing analogies to Greece set the stage for a serious response. That response needs to recognize that the range of error of long-term U.S. budget forecasts (especially of Medicare) is, in historic perspective, exceptionally wide. Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis. Our policy focus must therefore err significantly on the side of restraint.

There is much more in the article including a discussion of interest rate swap spreads which Greenspan says indicates upward pressure on 10-year treasury yields.

Calculated Risk Weighs in with Krugman

I believe Greenspan is flat wrong - just as he was in 2001 when he Greenspan spoke of 'an on-budget surplus of almost $500 billion ... in fiscal year 2010'.

I believe the focus right now needs to be on jobs, jobs and jobs.

I Side with Greenspan

Greenspan is seldom right and so is Krugman. In this case it is not even close. Greenspan wins by a mile although he does miss a point when he states "I believe the fears of budget contraction inducing a renewed decline of economic activity are misplaced. The current spending momentum is so pressing that it is highly unlikely that any politically feasible fiscal constraint will unleash new deflationary forces."

Deflationary forces will be with us as long as we have this debt overhang and I see no policy decisions to reduce that debt overhang at any level (personal, corporate, municipal, state, federal).

Moreover, Japan has proven that countries can get away with reckless spending for longer than most realize. However, that does not make Japan's policy a wise on.

Japan now has debt to GDP of close to 200% and no realistic way of financing it. Quite literally, high debt is all Japan has to show for Keynesian stimulus that Krugman is arguing for. Japan simultaneously tried Monetarist intervention and Quantitative Easing but that did nothing either.

Let's Play a Little Game of Q&A

Q. Do we need to stimulate housing?
A. No we have a glut of housing. We have massive shadow inventory on top of that.

Q. Does housing typically lead every expansion out of recession?
A. Yes, it does. So we do not need to add to the housing glut.

Q. Do we need more commercial real estate?
A. No, and we do not need any more Pizza huts, Home Depots, Lowes, Restaurants, strip malls, nail salons or any other such projects banks normally lend to.

Q. Do we need more public workers at the city, state, or municipal level?
A. No, we surely do not. Public pension plans and public union salaries have bankrupted cities, counties, and states. We need to get rid of public workers and reduce benefit levels to match private sector.

Q. Do we need more roads programs?
A. Didn't we just try that? It did not work either, did it? All it produced was a flurry of activity that died as soon as the handouts stopped. Just as with housing, there is a limit to how much demand can be brought forward.

Q. Did we get our money's worth for those programs?
A. Absolutely not. Money was thrown around without regard to cost, instead focusing on how quickly it could be spent. Much of the money was wasted.

Q. Are we going to "Drill Baby Drill"?
A. Hardly

Q. Does making schools and government buildings more energy efficient make any sense?
A. Of course not. The expected payback on those programs is negative.

Challenge to Krugman and Calculated Risk

If you want jobs, name a jobs program that makes fiscal sense.

I suggest it cannot be done. Yes, demand can be brought forward, but only for so long. Housing starts indicate housing is headed back to the gutter. Thus those housing tax credits were a waste of money.

The problem is debt, at every level (personal, corporate, government). Worse yet, that problem comes at a time when boomers have not saved enough for retirement and pensions promises are coming to the forefront.

Rising taxes to pay for those public pensions is not the answer. Moreover, students fresh out of college with no job and hundreds of thousands of dollars in debt are delaying family formation, and family formation is one of the keys to economic expansion.

Those clamoring for "jobs, jobs, jobs" never bother to explain what happens when the stimulus runs out. It ran out in the 1930's as well. Krugman mistakenly blames that small amount of tightening for sinking the US back into deflation.

The reality is stimulus money always runs out and priming the pump is nonsense. Japan has proven that in spades. What brought the US out of deflation was WWII.

This may sound like the "broken window fallacy" and it is in aggregate. However, the US was the one country that did not have its productive capacity destroyed in the war, and that coupled with the start of the baby boom, led the world recovery.

Those who claim we can grow our way out of debt now because we did it after WWII fail to understand boomer dynamics. Baby boomers and their kids supported growth for decades. Unless we have another baby boom it will not happen again.

In fact, because of peak oil and because of consumer debt coupled with global wage arbitrage, it's not possible to spend our way to prosperity this time, even with another baby boom.

Besides, WWII was one hell of a price to pay. Let's all hope it does not take war to solve the issue this time.

In the meantime, the problem is debt and as Japan has shown, and Greece after that, with more countries like Spain waiting on deck, it is impossible to spend one's way out of a debt problem.

Japan shows it is possible to get away with deficit spending for a long time, but Greece clearly shows what happens when time runs out.

Fix the Structural Problems

Instead of "jobs programs" per se, we need to fix the structural problems: Unsustainable pension promises and government wages, debt at every level, corporate tax policies that encourage jobs to move overseas (deferral of taxes on profits held overseas and excessive corporate taxes in the US), and the entire tax and spend structure at every level, especially the public level.

If we address the structural problems, jobs will eventually take care of themselves.

Krugman is on the wrong side of this debate while Greenspan is mostly right. However, no one will pay any heed to the now discredited Greenspan who ironically was worshiped for all the things he got wrong and ignored the few times he ever said anything that made any sense.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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