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Krugman Ignores His Own Theory and Misses An Important Piece of European History

This whole “what danger is there for a country issuing its own currency?” argument is really slippery. First of all, what these people really mean is, “What danger is there for a country issuing its own currency and in which most of its debts are denominated in this currency?” I.e., even on their own terms, it’s not enough for a country to issue its own currency. I believe this extra hoop is how they rule out things like Russia defaulting on its bonds and causing a bit of a ruckus, as you may recall.

When you think about it, there are only a handful of countries for which this concept even applies, and even then it only really works from 1971 onward. But anyway, let’s put aside that objection and consider Krugman’s latest:

What [a critic of the fiscal scaremongers] doesn’t note, however, is that the problem with bond vigilante scare tactics runs even deeper than that — because it’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionaryeffect?

Yes, I know, Greece — but Greece doesn’t have its own currency. What’s the model under which a country that does have its own currency and borrows in that currency can experience a slump due to an attack by bond vigilantes? Or failing that, where are the historical examples?

This is really amazing. Krugman is acting like it’s not even theoretically possible to imagine this kind of thing. But sure it is. Here’s a theory of it:

So suppose that we eventually go back to a situation in which interest rates are positive….with the government still running deficits of more than $1 trillion a year, say around $100 billion a month. And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates.

So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So? …

Does this mean 400 percent inflation? No, it means more — because people would find ways to avoid holding green pieces of paper, raising prices still further.

I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation…

At this point I have to say that I DON’T EXPECT THIS TO HAPPEN — America is a very long way from losing access to bond markets, and in any case we’re still in liquidity trap territory and likely to stay there for a while. But the idea that deficits can never matter, that our possession of an independent national currency makes the whole issue go away, is something I just don’t understand.

So there you have Paul Krugman himself, explaining how a bond strike on Treasuries would either force the government to balance its budget, or risk hyperinflation itself. If Krugman is now admitting that he can’t even come up for a theoretical basis for his objections to the MMT guys (that was the context of the above quotation), then he should send an apology to James Galbraith.

But let’s go back to Krugman’s recent post. It gets better:

The closest I can come to anything resembling the danger supposedly lurking for America is the tale of France in the 1920s, which emerged from World War I burdened by large debt, and which did in fact face an attack by speculators as a result. Yet the French story does not, if you look at it closely, offer any support to the deficit scare talk we keep hearing.

So Krugman walks through, and shows how France followed Krugmanian advice and let the franc depreciate, inflating away the real value of its post-war debt. Krugman claims that everything was great, and points to a table showing French unemployment. Only thing is, in 1927 it jumps up to 11 percent. Yikes! That’s pretty bad. So does it prove that running up a humongous debt can lead to bad consequences? Of course not! Krugman explains:

But what about the brief but nasty slump in 1927? That wasn’t caused by spiking interest rates; it was, instead, caused by fiscal austerity, by the measures taken to stabilize the franc.

So even when we look at the closest thing I can find to the scenario the deficit scolds want us to fear, it doesn’t play out at all as described.

Everyone see what’s going on here? Krugman points to France as the only example of a bond vigilante attack he can think of, on a nation issuing its own currency. (I guess he’s not counting the gold standard as being binding here; I’m not sure when France went back on. Remember in those 1930s charts of industrial output that the Keynesians like to point to the idiot French as hurting their economy by clinging to gold far longer than other countries.)

So here’s the progression:

(1) The French emerge from World War I with a debt of about 240% of GDP. (That was its value in 1921, which was a big jump from 1920. I’m not sure what was going on there.) Of course the reason the French government has such a massive debt, is that it ran massive budget deficits during the war years (and went off gold).

(2) What did the French do in the early and mid-1920s to deal with the problem? Did they run massive budget surpluses? Nope, Krugman himself says, “How did France achieve that big drop in debt after 1925? Basically by inflating it away.”

(3) Krugman admits that the bond vigilantes saw this depreciation coming, and so interest rates spiked.

(4) The French authorities eventually reversed course to stop the plunge of the franc. Krugman acknowledges that this led to 11% unemployment in 1927.

(5) Krugman says this pain was avoidable, because the French authorities shouldn’t have tightened in 1927.

So, it seems to me we need to think of an historical example of a country that did just what Krugman suggests, in order to test out his recommendations. So let’s see: Can anybody think of a major industrial power that emerged from World War I with a huge debt, but that issued its own national currency the way the French issue francs, and that turned to the printing press but without looking back? In other words, can anybody think of a European power that followed the French pattern, except stuck to Krugman’s advice by continually depreciating rather than a foolish move to stabilize its currency?

(Don’t worry Keynesians, there’s no danger here. Even when an Austrian in the crowd thinks of the answer, Krugman will just point out, “Ah, but they ate a lot of sauerkraut. Hardly relevant for the US today.”)

Noah Pinion Shows Yet Again That Economists Will Be Strung Up Right After Investment Bankers

[UPDATE below.]

I knew right off the bat that Noahpinion was doing something wrong in this patronizing post on inflation, but it took me a minute to figure out where the error was creeping in. But don’t worry, I finally got it. Here’s Noah:

Inflation is one of those things that almost nobody who isn’t an economist seems to understand…

Or the other day, someone on Twitter asked me: “How is it possible for inflation to help debtors when wages are going down? If wages are going down, doesn’t inflation just make it harder for people to pay off their debts?”

The answer is no. Here’s why. Suppose you make $50,000 a year and you have $50,000 in debt. Your debt-to-income ratio is 1. Also, just for convenience, let’s say the general price level starts out at “1″.

Situation A: -50% real wage growth, 100% inflation.
In this case, the new price level is 2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 2 = $50,000. Your debt is still $50,000. Your debt/income ratio is still 1.

Situation B: -50% real wage growth, 0% inflation.
In this case, the new price level is 1. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1 = $25,000. Your debt is still $50,000. Your debt/income ratio is now 2.

Situation C: -50% real wage growth, 50% deflation.
In this case, the new price level is 1/2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1/2 = $12,500. Your debt is still $50,000. Your debt/income ratio is now 4.

So as you can see, even if your real wage is going down by 50%, it’s better to have inflation than no inflation if you are a net debtor. Inflation erodes the value of your debt no matter what is happening to your real wages.

So what’s going on here? Why do so many people misunderstand inflation? Maybe it’s a form of “Stockholm Syndrome”. Inflation-hawkish economists have been bellowing, so loudly and so vehemently, that inflation is Satan – this goes back at least a hundred years – that non-economists just can’t help believing it. People end up trying to think up reasons why inflation must be bad after all. When you offer them freedom – when you tell them that sometimes inflation can erode debt, relieve balance sheet recessions, and help stimulate the economy – they don’t want to take it. , and they come up with more brilliant ways to identify with their captors. Or something like that.

My reply in the comments:

Mr. Pinion, in my humble opinion you have totally overanalyzed the Twitter question and ended up speaking nonsense. The guy wasn’t asking you about real wages, he was asking about actual nominal wages.

So his point was something like this:

“Hey Noah, I get how if all prices double, including my hourly nominal wage rate, then it becomes easier for me to pay off my fixed debt. But if I’m having trouble making ends meet and keeping up with my loan repayment plan, then my employer actually cuts my nominal paycheck, and then on top of that the price of food and health insurance goes up, how in the world does that make me better off?!”

It doesn’t. By interpreting your Twitter guy to be speaking of real wages, you completely dodged his simple question.

Why is it that so many economists can’t understand simple questions about inflation? Must be political.

UPDATE: So in the comments, it turns out that not 1, not 2, but 3 of my clever critics think I’m missing Noah’s “point.” OK watch this. I’m going to paste Noah’s 3 scenarios, and then add one more that is done in exactly the same style, but with a 200% 300% (price) inflation rate. Watch what happens:

Suppose you make $50,000 a year and you have $50,000 in debt. Your debt-to-income ratio is 1. Also, just for convenience, let’s say the general price level starts out at “1″.

Situation A: -50% real wage growth, 100% inflation.
In this case, the new price level is 2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 2 = $50,000. Your debt is still $50,000. Your debt/income ratio is still 1.

Situation B: -50% real wage growth, 0% inflation.
In this case, the new price level is 1. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1 = $25,000. Your debt is still $50,000. Your debt/income ratio is now 2.

Situation C: -50% real wage growth, 50% deflation.
In this case, the new price level is 1/2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1/2 = $12,500. Your debt is still $50,000. Your debt/income ratio is now 4.

[Added by RPM:] Situation D: -50% real wage growth, 200% 300% inflation.
In this case, the new price level is 4. Your new real wage is $25,000. Your new nominal wage is $25,000 x 4 = $100,000. Your debt is still $50,000. Your debt/income ratio is now 1/2.

Wow, I just proved Noah’s point even more so, right? Look at that, the guy’s debt/income ratio dropped from 1 down to 1/2. So clearly 200% 300% inflation is even better than 100% inflation. Noahpinion FTW!

Oh wait a minute. By using Noah’s technique, and picking an inflation rate of 200% 300% rather than Noah’s (completely arbitrary) 100%, now I’m making the guy get a pay increase from his employer. This is clearly NOT what the Twitter guy had in mind, proving that Noah is answering a different question.

This is really simple, everyone: If I am struggling to pay my bills, including fixed-rate debt payments, and then you’ll tell me prices are going to go up by 10% next year, I don’t care what happens to this particular fraction called “debt/income.” What I want to know is, will my nominal paycheck go up by 10% as well? If so, then I’m golden. If it goes up, but by less than 10%, I conceivably could still be better off–it depends how big a fraction my fixed-rate debt payments originally are of my total budget.

But under NO CIRCUMSTANCES would I want to see prices go up, if at the same time you tell my wages are going to go down too. Instead of that outcome, I would rather see prices stay the same.

Putting it another way: For a given nominal wage and nominal debt payment, I am better off if prices go down. Duh. I don’t care if that raises the “real burden of my debt.”

If you want to say this guy’s question doesn’t understand basic price theory, and that it’s kind of goofy to assume prices could rise while leaving blue collar workers in the dust, OK…but that’s the narrative progressives have been telling about Ronald Reagan-George W. Bush’s America. I actually think that’s what prompted the Twitter guy’s question. He was having cognitive dissonance on why the Keynesian heroes were simultaneously championing inflation to help debtors, but also worrying about income gains accruing largely to the fat cats.

If We Had Massive Economic Failure in the US, Would You Be Prepared?

You are invited to attend John Michael Chambers’ presentation,

“The True State of the Economy… Solutions For an Escalating Crisis”

Hosted by the Evergreen Tea Party & Liberty On The Rocks

When: Monday, June 13, 6:30-8:30 p.m. (pre-meeting “Beer Summit” @ 5 p.m.)
Where: Evergreen Country Day School | 1093 Swede Gulch Rd, Evergreen, CO
What: Discussing Solutions for an Escalating Economic Crisis

RSVP on Facebook

We are not in an “economic recovery”. In fact we are trillions upon trillions of dollars in debt with increased unemployment approaching the great depression levels. The economies, global financial systems and currencies around the world are collapsing. The U.S. Dollar is on life support. Something must be done. Something can be done! Our personal freedom is tied to our economic freedom.

So says John Michael Chambers, Founder of the Save America Foundation, a not for profit 501(c)(4). He is the Executive Director of the Economic Advisory Council, the founder of JMC Productions and the Asset Preservation Institute. John is an entrepreneur, author, songwriter, public speaker; and producer and host for the radio program “Freedom…it’s up to U.S.”

In Washington DC, John attended meetings held by members of Congress on Social Security Reform, Tax Reform and Homeland Security. Acknowledging his business leadership, entrepreneurial spirit and contributions made to the growth of local and national economies, he was twice awarded the Businessman of the Year Award for the state of Colorado by the Presidential Business Advisory Council of Washington DC in 2004 & 2005.

Earlier this year, John organized and hosted the three day, Save America Convention in Tampa. Speakers at the event included Judge Andrew Napolitano, Author G Edward Griffin, (Creature From Jeckyl Island), Rep. Tom Tancredo, (CO.), Stewart Rhodes, (Oathkeepers), Frantz Kebreau, Gov. Gary Johnson, (NM), Sheriff Richard Mack (AZ), Brandon Smith, (Neithercorp Press & Alt-Market), and Joe Farah of World Net Daily, to name a few.

Arrive early The Evergreen Tea Party hosts a pre-meeting “Beer Summit”, or “High Tea” hour at the nearby Smugglers Tavern (29017 Hotel Way in Evergreen). Join us from 5-6 p.m. before the event for food, drinks and great conversation (No Host Bar)! Also, be sure to get to Evergreen Country Day School by 6:15 p.m.for cookies & bottled water, and to ensure you do not miss a second of the presentation!

Duration: 90 minutes with additional Q/A afterwards

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