Tuesday, February 10, 2015

You are Missing the Point, Mr. Krugman

The New York Times columnist and Keynesian apologist Paul Krugman has been on a tear this week with not one but three pieces explaining debt to us. There are a couple of blog posts: "Debt is Money We Owe Ourselves" and "Debt: A Thought Experiment," followed by a full-dress oped: "Nobody Understands Debt."

Naturally, everyone wants to get in on the act, including Steve Keen at Forbes with "Nobody Understands Debt -- Including Paul Krugman," so why shouldn't I join in the fun?

In "Debt is Money We Owe Ourselves" Krugman cranks up a chart of UK National Debt -- also available here at ukpublicspending.uk -- and says that, hey, after the Napoleonic Wars the Brits had a National Debt of 250 percent GDP and what harm did it do them?
Britain did not emerge impoverished from the Napoleonic Wars; the government ended up with a lot of debt, but the counterpart of this debt was that the British propertied classes owned a lot of consols.
True. But suppose the Brits had lost the Napoleonic War and defaulted on the debt? Then all the British propertied classes would have been a "foul way out." And suppose they didn't have the industrial revolution helping out?

Then Krugman returns with a hypothetical:
Here’s a thought experiment that may clarify matters (or alternatively make the usual suspects even more enraged.) Suppose that for some reason the government were to decree, arbitrarily, that every American whose last name begins with the letters A through K now owes $100,000 to a special government agency; meanwhile, every American L through Z is given a $100,000 bond to be paid by that agency.
The net balance is zero, he explains:
Clearly, the overall level of debt in the U.S. economy has suddenly increased (actually by about $1.6 trillion). But has the nation become any poorer?
The answer is: not unless the government defaults on the debt.

So later on, Krugman writes his usual oped about debt and austerity. In "Nobody Understands Debt" he keys off a McKinsey Global Institute report that not much deleveraging had taken place since 2008 to complain that, in fact, savage retrenchment had taken place, and it hadn't helped.
 But we have, in fact, had unprecedented austerity. As the International Monetary Fund has pointed out, real government spending excluding interest has fallen across wealthy nations — there have been deep cuts by the troubled debtors of Southern Europe, but there have also been cuts in countries, like Germany and the United States, that can borrow at some of the lowest interest rates in history.

All this austerity has, however, only made things worse — and predictably so, because demands that everyone tighten their belts were based on a misunderstanding of the role debt plays in the economy.
 Foolish people say that all this debt is robbing our grandchildren. No it isn't, writes Krugman. "Families who run up debts make themselves poorer... the world economy as a whole owes money to itself." So, if the peripheral countries needed to tighten their belts, the Germans needed to loosen theirs.

Forbes' Steven Keen faults Krugman for not seeing the difference between "peer-to-peer" lending and bank lending. But I have a different beef.

My point is that Krugman is wrong about debt. When families "run up debts" they don't necessarily make themselves poorer; they are just making a bet on the future. They are betting that they will have the income to service those debts. The same with the Brits in the Napoleonic War; they were betting that they would win, and to the victor the spoils. There is no problem if the bets pay out. But if the bet fails, then we have a different story.

And so we return to a piece of wisdom told to me by a communications engineer. The interesting case is not the successful transmission of data, he said. The interesting case is what you do when things go wrong.

When a debtor fails to service a loan, it is because he is poorer than he expected; his bet on the future has not panned out. But then the question is: who is going to pay for his mistake? The answer is: everyone. The debtor must surrender his collateral, such as it is, and the creditor most likely must take a haircut. Everyone is poorer.

That's what might have happened at the end of the Napoleonic Wars. If the Brits hadn't won, or if the industrial revolution hadn't come along and flooding the nation with wealth and the government with revenues, well then the British propertied classes wouldn't have been sitting on their £1,000 a year, they would have been sitting on a lot less and would have had to get out and get a job, like Charles Dickens, son of a bankrupt.

Nobody understands debt. Least of all Paul Krugman. Every investment is a bet on the future. With debt, I say that if I can invest money in a project right now I can make enough money to service the debt and pay it off, and if there are any profits then I get them all. With equity, I say that if I can invest money in a project right now I will share the profits, if any, with my partners.

If the bet pays off, then we are all winners. If the bet goes bad, then we are all losers.

The problem with the world right now is that we are arguing about who is going to take the losses from the bubble of the 2000s. Should it be the Greeks? The Germans? Krugman's "usual suspects?" The minority homeowners who got loans on a "dream house" that went south? (Yeah. Did you know that minority homeowners were hardest hit in the mortgage meltdown?)

The problem for the Paul Krugmans of the world is that the liberal ruling class made all kinds of promises to all kinds of people: vote for us and we'll give you loot -- pensions, subsidies, jobs, health care, you name it -- and they paid for the loot with debt. Now they can't pay out on the promises. What to do? Blame greedy bankers, blame "austerity," blame the rich, blame the Germans.

So what do they want to do? They want the rest of us to pay for their blunders.

The whole point of Keynesian economics is to avoid the truth, that government screwed up and pumped up the economy with easy money, and now we will all have to pay the piper.

That's one thing that government can never admit: it's time to pay the piper.

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