Mises Daily Articles
Booms, Busts, and "Krugpot" Economics
In a recent column, Paul Krugman tries to explain the "Bush bust." Instead of clear, cogent economic theory, we are fed a mass of contradictory ideas, a bit of political partisanship, and explanations that simply make no sense.
When one attempts to apply economic theory in order to explain certain events, one is reminded of Carl Menger's dictum: "All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary."
Austrian economists hold that there are certain principles which can be understood and which are based upon immutable laws of human action. Unfortunately, in Krugman's world, events happen with no real explanation.
For example, he writes,
One of the underemphasized keys to the Clinton boom, I'd argue, was the way the cost disease of health care went into remission between 1993 and 2000. For a while, the spread of managed care put a lid on premiums, encouraging companies to expand their work forces.
But premiums surged again after 2000, imposing huge new burdens on business. It's a good bet that this played an important role in weak job creation.
Why did they surge, and how would lower health-care costs help create a boom? Those are questions that demand answers. First, and most important, the boom of the Clinton years was centered in the stock market, yet health insurance premiums operate across the board. Furthermore, while the increase might have been slower during that time, nonetheless those costs did rise. Second, a slower rise in health-insurance premiums automatically leading to a boom in the stock market is a non sequitur — or at least Krugman does not connect the dots.
Another cause of the present downturn, Krugman notes, has been soaring prices. He writes,
What about raw materials prices? During the Clinton years basic commodities stayed cheap by historical standards. Since then, however, food and energy prices have exploded, directly lopping about 5 percent off the typical American family's real income, and raising business costs throughout the economy.
Why has this happened? According to Krugman, it is because Congress did not give President Bill Clinton enough power:
Much of this pain could have been avoided.
If Bill Clinton's attempt to reform health care had succeeded, the U.S. economy would be in much better shape today. But the attempt failed — and let's remember why. Yes, the Clinton administration botched the politics. But it was Republicans in Congress who blocked reform, as Newt Gingrich pursued a strategy of "coagulation" designed to "clot everyone away" from Mr. Clinton.
As for high food and fuel prices, they're mainly the result of growing demand from China and other emerging economies. But oil prices wouldn't be as high as they are, and the United States would have been much less vulnerable to the current price spike, if we had taken steps in the past to limit our oil consumption.
Again, we are given the non sequitur. How do we know that Clinton's "reform" would have lowered medical costs? The imposition of Medicare more than 40 years ago was the turning point in driving up medical-care costs. How would this "reform" have resulted in lower real costs to the economy? Krugman does not say how, other than to tell us that those Big Bad Republicans want medical care to cost a lot of money.
In dealing with food prices, one has to wonder if food imports to China and elsewhere have skyrocketed or if caloric intake in Asia is growing. In other words, we are supposed to believe that because the Chinese economy has been growing, the rank-and-file Chinese have been pigging out.
What kind of "steps" would have limited oil consumption? Mandatory rationing? Forcing everyone to purchase high-mileage vehicles? Assume that the government had done these things. It is unclear what opportunity costs would have been imposed by measures that would have made transportation of goods and people more difficult to attain, but one can surmise that such heavy-handed regulations would have made us poorer — and much less free.
Furthermore, I do not know how further restrictions on the oil industry — which I am sure Krugman has in mind — would have lowered oil prices and made Americans less vulnerable to price spikes in petroleum. Again, we are dealing with claims that do not pass Menger's standards of cause and effect.
Oil is bought and sold in markets that span the world. The only way to separate the effects of world prices and US prices is to set up trade barriers and trade the US-produced commodity in separate markets. That is already done with sugar, where US growers are "protected" from lower-priced sugar grown elsewhere; the price of US sugar is, on average, about three times the world price. So, if Krugman believes that a similar program would lower oil prices, perhaps he needs to review the price-theory class he took at MIT.
If there is a cause-and-effect pattern in this article, it is based solely upon who occupies the White House, according to Krugman. Now, one might expect such talk from the heads of the two main political parties, but a Princeton economist is supposed to operate by higher standards than what prevail in pure, partisan politics.
Can we blame Bush for what is happening and still be intellectually honest? Yes, but one must understand cause-and-effect in economic analysis if one wishes to affix blame that has more explanatory power than "Bush is a Republican and Clinton is a Democrat."
To understand the current about-to-bust, however, we must look back eight years at the end of the Clinton term. Despite Krugman's partisan rants, it was clear that the Federal Reserve System had actively pumped up stock values, leading to a dangerous bubble that finally broke toward the end of 2000. By the time Bush took office in January 2001, the NASDAQ was on its way to losing half of its value, and the Dow Jones and S&P 500 indices were in freefall as well.
No doubt, the Bush administration would have loved to try to pump up the markets, but by then it was clear that stock prices had been way out of kilter in relation to fundamentals, and the markets were not going to heed the word of a president or anyone else. Thus, the administration turned toward the moribund housing market.
Following the 9/11 attacks, the Fed lowered interest rates to near one percent and began to push housing. Accompanying the Fed's push was the "ownership society" mantra that came from the White House and the Heritage Foundation and Cato Institute, which put a "free enterprise" cover over what was essentially financial socialism.
Not only did we have the Fed forcing down interest rates to below their "natural" levels, but the government and its quasi-government corporations, Fannie Mae and Freddie Mac aggressively hawked their mortgage securities, with the implicit agreement that the government (read that, "taxpayers") would "guarantee" those securities in case they lost value. They lost value anyway.
While Krugman has recognized the bubble and, indeed, recognized it before most other commentators (except the Austrians, of course), his explanation for it is steeped in partisan politics and just plain faulty analysis. The bubble occurred, he claims, because Ronald Reagan mesmerized the country into "believing in free markets," which led to less regulation, which ultimately led to the financial bubbles. The solution? Re-regulate everything.
One hates to break it to this perennial candidate for the Nobel Prize, but the problem is not "unregulated free markets." For one, financial markets are heavily regulated by government. Second, the real problem has been the belief that government can act as the backstop for every financial failure. In fact, the various guarantees, bailouts, loans, and the other measures taken by the government to prop up failing markets have served not only to lengthen the coming recession, but also to block the recovery. One cannot simultaneously have free and wide-open financial markets and government guarantees to back failures, which economists recognize as a moral hazard.
The government's idea (and too many people are buying into this nonsense) is that if it can prop up the failing markets (like housing) and every brokerage house and fund that was fueled by mortgage securities, then somehow, the crisis will pass and the economy will recover. Those holding to Austrian theory, however, know better.
First, and most important, there is a reason the housing market has tanked; the boom was not sustainable. People with middle-income jobs could not reach into their pockets and continue to make payments for houses that had sold at multimillionaire prices. The malinvestments (a distinctive Austrian term) were too massive and the economic fundamentals (there is that word again) simply did not match the go-go housing market.
Second, to prop up the unhealthy, malinvested markets, governments must cannibalize the healthy markets in order to find the needed cash to transfer the wealth. Thus, over time, not only do sick markets fail to recover, but formerly healthy ones also fall into trouble, which is exactly what happened from 1930–1933.
Thus, we move into that territory where Krugman fails to tread: inflation. The Fed has attempted to perform its so-called "bailout magic" by monetary creation, known to the ancients as inflation, which is defined not by rising commodity prices per se, but rather by the unwarranted creation of new money.
Ultimately, why are oil prices rising madly? Certainly, there are supply fundamentals that play a role, but the quick decline of the dollar is mostly to blame. The tipoff has been the subsequent rise of all other commodities, which generally tends to happen in the last stages of inflation. (The earlier stages tend to be concentrated in specific financial markets before moving to commodities and consumer goods, as we are seeing now.)
Krugman, to his credit, has opposed the Iraq war from the beginning, but he also believes that it has been a boon to the economy. (All true Keynesians believe war is good for the economy, although they believe that "massive public works" are even better.) Austrians, however, recognize that the huge federal budget deficits are largely caused by the war and are financed with government paper that will surely lose large amounts of its value soon enough.
(At least the Clinton administration was able to target the stock market, so the wave of sales also meant a spike in capital-gains-tax revenues, which played a major role in balancing the federal budget. Housing sales, however, do not provide the same high-tax returns, which meant that while there was a huge amount of financial activity, the tax proceeds from this bubble were not as high as they were during the Clinton bubble.)
So, can we blame Bush for what is currently happening and what will surely happen in the next year? Absolutely, and we can do it with great relish and authority.
Nonetheless, if we are going to criticize this president, one hopes that we do not fall to the Big Lie that George W. Bush believed in those free markets that utterly failed him and the country. Krugman seems to have done so, and judging from what we hear from Congress and the media, it seems that the loudest voices in this crisis are also the voices that are just plain wrong.