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Krugman Touts Austrian Theory! (Sort of)

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Paul Krugman, who tells us that assets and capital are homogeneous when it comes to economic policy, suddenly claims that there were malinvestments during the boom! (Actually, he does not use the M-word, as he would not know what it means, but I digress.)

The Great One writes:

Financial firms, we now know, directed vast quantities of capital into the construction of unsellable houses and empty shopping malls. They increased risk rather than reducing it, and concentrated risk rather than spreading it. In effect, the industry was selling dangerous patent medicine to gullible consumers.

His next quote is true, but then his analysis (as always) goes south:

And Wall Streeters have every incentive to keep playing that kind of game.

I always am glad when “elite” economists “discover” moral hazard, but, unfortunately they assume that the banking and financial system MUST be cartelized (regulated, actually, but the meaning is the same) and then regulated. In one breath, Krugman seems to understand the dangers of the federal financial “put”:

I won’t try to parse the competing claims about how much direct benefit Goldman received from recent financial bailouts, especially the government’s assumption of A.I.G.’s liabilities. What’s clear is that Wall Street in general, Goldman very much included, benefited hugely from the government’s provision of a financial backstop — an assurance that it will rescue major financial players whenever things go wrong.

However, before one thinks that Krugman has converted to the Austrian way of thinking, he adds this:

You can argue that such rescues are necessary if we’re to avoid a replay of the Great Depression. In fact, I agree. But the result is that the financial system’s liabilities are now backed by an implicit government guarantee.

Now the last time there was a comparable expansion of the financial safety net, the creation of federal deposit insurance in the 1930s, it was accompanied by much tighter regulation, to ensure that banks didn’t abuse their privileges. This time, new regulations are still in the drawing-board stage — and the finance lobby is already fighting against even the most basic protections for consumers.

Thus, in Krugman’s ideal world, the system would be both cartelized and regulated, with the government guarantees of rescue behind it. It never seems to occur to Krugman that maybe, just maybe, we would not see these huge malinvestments and reckless behavior if we had free-market finance.

The reason is simple. Krugman has no understanding at all of a system of profits and LOSSES. To him, it all is about the Keynesian “animal spirits” and nothing else. Yeah, real economic analysis.

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