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The Big Fail (of Keynesian Economics)

An image of Paul Krugman practicing Keynesian economics

Paul Krugman practicing his Keynesian economics…

In a recent (Jan. 6) NY Times column, The Big Fail, the esteemed Dr. Krugman suggests that a “triumph of bad ideas” is responsible for our failure to emerge from “the great slump.” And the bad idea in question? You guessed it: not spending hard enough. Apparently, my Dad never afforded Dr. Krugman his special brand of fatherly wisdom concerning stupid behavior of any sort: “Son, [stupid behavior X] is like hitting yourself on the head with a hammer – it feels great when you quit.” Unfortunately, we seem to be trading in the Keynesian hammer for an even more repulsive hammer – European-style fiscal austerity.

Dr. Krugman makes one accurate observation, “… in the economy as a whole, spending and earning go together: my spending is your income; your spending is my income. If everyone tries to slash spending at the same time, incomes will fall — and unemployment will soar.” This (largely accurate) observation lies at the heart of Keynesian economics, and is exactly the problem Keynesian counter-cyclical spending policy is intended to fix. The idea behind counter-cyclical spending is that government should tax and save during boom times to build up a surplus; then, during downturns, government should spend the surplus to stimulate the economy back to health.

On paper the theory of counter-cyclical spending looks great. Unfortunately, as the estimable Yogi Berra once noted, “In theory there is no difference between theory and practice. In practice there is.” Krugman, like Keynes, is blissfully oblivious to one critical fact: While the set of internally consistent theories is infinite, the set of theories that conform to reality is singular. Much like communism, Keynesian economics works great until you add people.

The savvy reader will have observed that we did not enter the great recession with a government surplus. Nope, we were already deeply in debt. To an existing national debt in excess of $10 trillion, Obama immediately added nearly a trillion more in Keynesian-style economic stimulus (the American Recovery & Reinvestment Act of 2009), and then gleefully proceeded to add trillion-plus dollar deficits in each of the first four years of his presidency, resulting in a total national debt in excess of $16 trillion, more than 100% of our Gross Domestic Product (GDP).

So if we don’t have the money to spend, where does it come from? Easy-peasy, lemon-squeezy: Quantitative Easing (QE1, QE2, QE3, Operation Twist, and QE4). Quantitative easing is basically a polite euphemism for printing money out of thin air. Don’t try this at home, gentle reader. The FBI calls this counterfeiting, and if they catch you doing it they’ll send you to the big house. But when Ben Bernanke does it, we call it economic stimulus. See? Beneath all the mud, there’s more mud still. Essentially, we have mortgaged the future earnings of our unborn descendants to pay for our current spending splurge. Yep, the grandkids are going love Ben Bernanke. Or maybe not. Maybe they’ll spit on his grave.

Artificially low interest rates and quantitative easing have been a yummy treat for the paper equity economy, hence the apparent (if somewhat illusory) health of the stock market. Unfortunately, it hasn’t done much for the real economy inhabited by real working Americans. All this fiscal chicanery hasn’t produced any real value. Real value (and real wealth) is generated by real people producing and consuming real goods and services. And that type of real economic activity continues to lag, dragged down by the very real negative side effects of deficit spending.

Runaway deficit spending is the real issue. It’s got to end, and ending it isn’t going to be pleasant. Krugman is right to blast European fiscal austerity, but he does so for the wrong reasons. Krugman decries the moderate spending cuts of European fiscal austerity, calling instead for continued spending. He doesn’t understand that continued deficit spending is like upping the dose for a heroin addict – it’s never enough. Cutting spending from a balanced federal budget merely transfers money from the public sector to the private sector, which by definition spends that money more efficiently. Cutting deficit spending is a different matter. Cutting deficit spending removes fake money from the economy, and just as with a heroin addict, the withdrawal symptoms are temporarily unpleasant. But failing to end the addiction is ultimately fatal, so for the long term health of the patient it has to be done.

Krugman is blind to the real problem with European fiscal austerity: increased taxation. Increasing taxes in a depressed economy takes real money out of real people’s wallets, causing real pain. Furthermore, that money has to come out of productive people’s wallets, and is typically transferred to unproductive people’s wallets, exacerbating the problem of lagging real economic activity. Hence the double dip recessions in Europe associated with European fiscal austerity.

Obama enjoyed crowing about the terrible, horrible, no good, very bad fiscal cliff deal. According to him, “… more than 98% of Americans… will not see their income taxes go up.” True, as far as it goes. However, come Jan. 15 every employed American will find their wallet a little lighter, as Mr. FICA will be taking a larger bite. In fact, as a result of the fiscal cliff deal taxes are going up on virtually all Americans. Perhaps we might want to ask the Brits how that’s working out for them.

Pass the heroin, gentle reader. And hold on to your hat – it’s going to be a bumpy ride.

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