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The Fable of the Krugman

Mises Daily: Thursday, March 25, 2010 by

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While Paul Krugman likes to present himself as being a Keynesian, in reality, his intellectual roots run back a few centuries to the mercantilists. If you wish to see the Krugman of 300 years ago, read Bernard Mandeville's The Fable of the Bees, first published in 1705, to see all of the same economic (and logical) fallacies that haunt Keynesianism and Krugman's columns.

Do you want the "paradox of thrift"? You can find it there. The idea of "underconsumption" and the emphasis upon spending has not changed in three centuries — at least when one reads Krugman's columns.

In his column "Taking on China," Krugman takes his mercantilist arguments to a new high (or low, which might be more appropriate), blaming, yes, China for the continuing economic depression in the rest of the world. It seems that China has been undervaluing its currency, the renminbi, and that forces the rest of the world into that infamous "liquidity trap." Here is Krugman in his own words:

[I]t's a policy that seriously damages the rest of the world. Most of the world's large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can't offset.

To understand Krugman's logic, first you must turn economic logic upside down. By undervaluing its currency, China is following a policy of exports first and in the process is amassing a lot of foreign reserves. This, by the way, was the very kind of practice that Adam Smith and other Classical economists railed against, as they successfully argued that such artificial trade restrictions made their own people poorer.

Furthermore, China has been building a huge surplus denominated in fiat currencies from abroad — mostly the US Dollar. However, Ben Bernanke and soon-to-be-his-partner-in-crime Janet Yellen are willing to turn the dollar into worthless paper that cannot compete with the infamous German mark of 1923, not to mention the fading Euro and Lord knows what else. Maybe we can throw some Bolivian money in the mix and some Argentine pesos from the Age of Juan PerĂ³n.

By pursuing this action, Chinese producers indeed are able to sell their goods more cheaply abroad than are Americans. This much is true. Conversely, this also means that China is willing to ship real wealth overseas and accept our worthless green pieces of paper in return. Yes, we have a situation in which the poorer Chinese are playing the role of philanthropist to the wealthy Americans and Europeans. Hmmm, exploitation, anyone? This is a better deal than colonialism.

Now, if one has a Keynesian, er, Mandevillian, view of the world, this is terrible. In the Keynesian view of things, spending not consumption — is the end of economic activity. There is a difference. From the Keynesian perspective, consumption and production are two unrelated things. People make products and then hope-to-goodness that they can "buy back" what they have just produced.

In this opinion, producers just "make things," and then the real reason for spending is to empty the inventories. That way producers can make more things, and when those things are cleared off the shelves, the process begins anew.

"Yes, this is the mercantilist world of Paul Krugman. Peaceful private exchange is an act of aggression, and aggression will deliver us from an imaginary 'liquidity trap.' Indeed, war is peace, freedom is slavery, and ignorance is strength."

This is not an economy; this is a cat chasing its tail. The only purpose I can see here is keeping people occupied. The purpose of "consumption" here is only to "buy back" what has been made; it does not and cannot go any farther.

No wonder that Keynesians emphasize the "circular flow" of the economy, as it fits within their circular logic. Israel Kirzner once parodied this whole set of nonsense with the following dialogue: "Why do you eat breakfast? So I can go to work. Why do you go to work? So I can eat breakfast."

Lest one thinks I am exaggerating or trying to present a caricature of Keynesianism as fact, take the following quote from Krugman, in which he praises Richard Nixon's 1971 decision to cut ties to gold, devalue the dollar (or, in real-life terms, engage in a default), and thus write a vital chapter in what would be a disastrous economic decade:

In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies.

Now, as a hardcore partisan Democrat, Krugman cannot utter the N-word, except in derision, yet he is praising what Austrians see as a dishonest approach to the real problem of runaway government spending, fiat currencies, and a mountain of government debt. To Krugman, all of the things I have mentioned are virtues, just as Mandeville praised profligacy as being virtuous and thrift as a vice.

I would pose a different scenario. Indeed, China should end its pegging of the renminbi to the US Dollar, but for different reasons. Chinese workers have toiled in factories, yet government policies are overpricing those goods at home. This is similar to what Japan did in the 1980s and we see how well that worked for the Japanese.

Yes, Walmart is full of Chinese consumer goods that are artificially cheap for us, and as long as we can keep this arrangement going, who is to complain? Krugman does not like it for all of the wrong reasons. To him, when he sees Americans buying something at Walmart (well, let's face it, I'm sure Krugman never lowers himself to step into a Walmart and mingle with the Great Unwashed), he sees trade imbalances. I see American consumption made possible by the philanthropic Chinese government acting to the detriment of the Chinese consumer.

Granted, one must understand Keynesian and Mandevillian logic. Domestic consumption, according to this "logic," is "buying back the product," but the real goal of American production should be to let someone in another country consume what Americans have produced. If that does not make sense to you, don't worry. It means you are thinking clearly.

Of course, this would work wonders at home. Americans, who are struggling to make ends meet, would discover that prices were shooting up and their dollars would purchase less than before. There would be international tensions and the dollar would become the worthless paper in a scenario that the Austrians have been predicting for a while.

Yes, this is the mercantilist world of Paul Krugman. Trade between Americans and Chinese, which not that long ago was nonexistent, now becomes something akin to an act of war. Indeed, war is peace, freedom is slavery, and ignorance is strength.