Generally, Paul Krugman is a punching bag around here for his ‘bailout this, bailout that’ attitude. He gets beaten less here than at other websites … say … Mish’s; nevertheless, Krugman embodies a truth;
Krugman’s current anti- gold crusade is right on the money:
Peter Temin has argued that a key cause of the Depression was what he calls the “gold-standard mentality.” By this he means not just belief in the sacred importance of maintaining the gold value of one’s currency, but a set of associated attitudes: obsessive fear of inflation even in the face of deflation; opposition to easy credit, even when the economy desperately needs it, on the grounds that it would be somehow corrupting; assertions that even if the government can create jobs it shouldn’t, because this would only be an “artificial” recovery.
if you get your opinions from, say, The Wall Street Journal’s editorial page, you’re told that the falling dollar is a terrible thing, a sign that the world is losing faith in America (and especially, of course, in President Obama). Something, you believe, must be done to stop the dollar’s slide. And in practice the dollar’s decline has become a stick with which conservative members of Congress beat the Federal Reserve, pressuring the Fed to scale back its efforts to support the economy.
We can only hope that the Fed stands up to this pressure. But there are worrying signs of a misguided monetary mentality within the Federal Reserve system itself.
In recent weeks there have been a number of statements from Fed officials, mainly but not only presidents of regional Federal Reserve banks, calling for an early return to tighter money, including higher interest rates. Now, people in the Federal Reserve system are normally extremely circumspect when making statements about future monetary policy, so as not to step on the efforts of the Fed’s Open Market Committee, which actually sets those rates, to shape expectations. So it’s extraordinary to see all these officials suddenly breaking the implicit rules, in effect lecturing the Open Market Committee about what it should do.
This parallels, ‘scare stories’ in the media/blogosphere and the gold- bugs running amok like cockroaches on the kitchen counters.
You cannot argue with these people, they’ve got ‘religion’.
A great way to watch gold- buggery in action is to read the October 8, 2009 lecture notes from J. Bradford DeLong,
Golden Fetters: The Great Depression in Europe
Countries without massive gold reserves that wanted to play by the rules of the gold-standard game did not have the luxury of even attempting to expand their economies, at least not until they abandoned the gold standard, let their exchange rates float freely, and so cast off their “golden fetters.” A government that wished to stimulate demand in the Great Depression would seek to inject credit and bring down interest rates to encourage investment. But additional credit would mean higher imports, and lower interest rates would encourage domestic investors to invest abroad. The result would be a balance-of-payments gap: economic expansion at home was inconsistent with gold convertibility. And few countries wished to abandon the gold standard at the start of the Great Depression.
There were exceptions that proved the rule. Scandinavian countries cast off their golden fetters at the start of the Great Depression, pursued policies of stabilizing nominal demand under the intellectual influence of the Stockholm School of economists, and did relatively well. In Japan fiscal orthodoxy and budget balance were abandoned in 1931, when Korekiyo Takahashi became Minister of Finance. Industrial production in Japan in 1936 was half again as much as it had been in 1928; in Japan the Great Depression was over by 1932.
Meanwhile, countries attempted to adhere to the international gold exchange regime.
The Credit-AnstaltAustria’s major bank, the Credit Anstalt, was revealed to be bankrupt in May 1931. Its deposits were so large that freezing them while bankruptcy was carried through would have destroyed the Austrian economy, hence the government stepped in to guarantee deposits. The resulting expansion of the currency was inconsistent with gold-standard discipline. Savers liquidated their deposits and began to transfer funds out of the country in order to avoid the capital losses that would have been associated with a
devaluation.
The opportunity to confine the crisis to Austria existed for a short time, but politics and resistance to leaving aside the perceived ‘benefits’ of gold backing prevented timely action;
Perhaps investors would then have begun returning gold to central banks in exchange for interest-bearing assets, would have begun to shrink down their demand for liquidity, and would have begun to boost worldwide investment. The Economist’s Berlin correspondent thought that it might well have done the job:It was clear from the beginning… that such an institution [as the Credit- Anstalt] could not collapse without the most serious consequences, but the fire might have been localized if the fire brigade had arrived quickly enough on the scene. It was the delay of several weeks in rendering effective international assistance to the Credit Anstalt which allowed the fire to spread so widely…
We do not know because it was not tried. The substantial loan to Austria was not made. Speculators continued to bet on devaluation, investors continued to hoard gold, the preference for liquidity continued to rise, and investment continued to fall.
The substantial loan to Austria was not made because French internal politics entered the picture. At the beginning of his political career French Premier Pierre Laval had styled himself a politician of the left: the Clarence Darrow of France. But by the early 1930s he was shifting to the position of a strong nationalist. He blocked the proposed international support package for Austria, insisting that if France was to contribute France had to get something out of it. The price that Laval demanded was made up of a series of diplomatic concessions, most important of which was the renunciation of a prospective customs union with Germany. To Laval, playing the nationalist card in French politics, nothing that benefited Germany could be allowed by France.
The Austrian government refused to make the required political
concessions fast enough for negotiations to be completed in time to be of use. Austria lost: the support package collapsed, and the Austrian economy abandoned the gold standard and went into recession. In the long run France lost too: what might have been a chance to moderate the Great Depression was lost. The ultimate consequences for France were dire. The rise of Adolf Hitler in Germany is inconceivable in the absence of the Great Depression. Nine years after the Credit-Anstalt crisis the French government surrendered to the Nazis.Pierre Laval was not greatly inconvenienced at first by the Nazi conquest of Europe. He discovered that he was not a leftist at all but a Fascist. He became the second most powerful figure, and the true focus of decision making, in France’s wartime collaborationist Vichy government. He was executed for treason after the end of World War II.
Gotta love that gold. Another easy, bad idea in a world full of them.
Another bad idea that doesn’t go away is the attempt to support high prices in a deflationary context. In a way, the support attempt is a soft form of ‘hard- currency’. Instead of a gold/dollar or gold/yuan relationship linked for all time, it is dollar/real estate or dollar/retirement benefits. Defending these linkages requires a large diversion of productive output … to no positive end.
Meanwhile, the various state governments are going broke trying to maintain the pay and benefit levels that were associated with the bubble times. To avoid pension routs, the states are cutting education; where the dead hand of the past reaches into and impoverishes the future, definitely a bad idea.
Just to prove that all economists aren’t dickheads, there is this paper by Ravi Jagannathan, Mudit Kapoor, Ernst Schaumburg for National Bureau of Economic Research;
Globalization has brought a sharp increase in the developed world’s labor supply. Labor in developing countries – countries with vast pools of underemployed people – can now more easily augment labor in the developed world, without having to relocate, in ways not thought possible only a few decades ago.
We argue that the large increase in the developed world’s labor supply, triggered by geo-political events and technological innovations, is the major underlying cause of the global macro economic imbalances that led to the great recession. The inability of existing institutions in the US and the rest of the world to cope with this shock set the stage for the great recession: The inability of emerging economies to absorb savings through domestic investment and consumption due to inadequate national financial markets and difficulties in enforcing financial contracts; the currency controls motivated by immediate national objectives; and the inability of the US economy to adjust to the perverse incentives caused by huge money inflows leading to a breakdown of checks and balances at various financial institutions. The financial crisis in the US was but the first acute symptom that had to be treated. A sustainable recovery will only occur when the natural flow of capital from developed to developing nations is restored.
China’s trade advantage is its cheap labor not cheap money. Even if its currency was allowed to float and become temporarily more valuable than the dollar or euro, it would still have cheaper labor than either America or Europe. The incentive has been for America and Europe to use more energy. Fuel- guzzling automation has become a substitute for even the cheapest labor and consumption the prime mover of GDP. This is because production is uneconomical and adds in the end to overcapacity.
This ‘solution’ is a terrible idea. Better to move away from a machine- centered industrialized approach to a high- human skill craft approach. Machines and import labor is good at ‘cheap’. Humans are best at ‘craft’. Goods made by skilled labor cannot be substituted for with unskilled labor or machines. There are no cheap labor substitutes for Ferraris – or Picassos – copies only, never the original.
Part of the solution is more and better education – away from management and ‘high tech’ approaches and more toward craft skills. Emphasising craft skills would give more people something useful and interesting to do. There is certainly no shortage of jobs needing doing. The country needs fewer advertising directors and more master stone masons.
Krugman’s bad idea is to add more credit to a finance system that already has all the credit it needs and more. In fact, the credit system makes its own credit! What Krugman doesn’t realize is the finance system is doing very well; its only business is creating liquidity, the outcome now is more likely to be hyperinflation within finance; another bubble in stocks or in derivative securities.
This expansion of ‘funny money’ dollars in the finance- shadow banking ambit is what is behind the dollar decline. The stock market (and other dollar markets as well) are driving down the dollar by lending ever more of them into existence – rather than the other way around. The expansion of dollar- derivative market balance sheets is amplifying the process. The Dow may go to 20,000 or more, but the dollar will lose more and more value – unless the bubble extends to other currencies. If US equities become hyper- inflated, look for markets in other currencies to hyperinflate along with them. This would support the dollar at a lower level, not low enough to do anyone in the physical economy any good but sufficient to create a FOREX trade.
The trade to pay attention to is dollar/crude. A breakout over $78 a barrel will bring an end to this finance- inflation nonsense. (A breakout over $78 is not necessarily a done deal, oil over $70 means generalized ‘Main Street’ inflation is not going to happen. The high price reallocates capital toward energy and away from other capital- and operating requirements, reducing aggregate transactions and stifling money expansion.)
A good finance idea would be to tax all financial transactions – a Tobin Tax. Since finance won’t go away, let the government skim a take off the top and bring its own finances in order. If the government is to bail with one hand keeping finance players in business, let it ignore the costs of the bailouts and aim instead to tax the financial systems ‘products’.
The real estate industry’s bad idea is the world needs more developed real estate. Good grief! We need less development and a return of many areas to nature to support natural services without which human life itself becomes questionable! Watersheds and forest cover areas are needed, not more office buildings and parking lots. The surplus of developed real estate is weighing the market, the subsidies that add more capacity are counterproductive. In a previous article I noted that business activities support themselves in a fiat system by generating their own liquidity; this cannot happen when high prices constrain the overall number of transactions. Better to let prices drop to a level where organic demand arises. The increase in transactions will consequently allow for a subsequent rise in prices. This is already happening in some areas where prices for real estate have declined such as San Diego and Phoenix.
Labor’s bad idea is that certain groups deserve high wages (and the rest can become unemployed). High wages – and benefits – are found in finance … and in General Motors. High pension levels – set during the bubble years – are bankrupting counties, cities and states. The costs are unsustainable. The Federal government can run an ongoing deficit, the rest of the country cannot.
The better idea is to assure the country that no one will be destitute and all will share in the sacrifice. This requires more than one or two municipalities declaring bankruptcy and voiding contracts. It needs a national political effort. A compression of wage levels needs to be made; between investment bankers and teachers, between athletes and laborers, between those on the bottom in the US and those on the top.
The municipalities’ bad idea is that education can be sacrificed for ‘other’ priorities. What other priorities?
Part of the problem is the shrinking of the tax base. Solution; A GASOLINE TAX! How about $2 a gallon to start? Every state has money problems and problems; every state has the opportunity to add two dollars to the price of gas and solve the tax base problem. I personally have no problem spending $4.50 a gallon for gas.
This revenue should be directed toward education only, pensions not at all. It would encourage conservation. It would help to end the control producers have over the oil market. It would lighten traffic and reduce wrecks – and save lives. It would provide an incentive to shift from autos to transit and bicycles. It would indicate a turn in the current crisis. It would be the most productive foreign policy measure in the Middle East and elsewhere.
Soon enough, conservation will take place, it will be imposed upon us by circumstances. Allowing this to happen is the ultimate bad idea.