Guest Post: Paul Krugman's Dangerous Misconceptions

Tyler Durden's picture

Via Pater Tenebrarum of Acting-Man blog,

How to Deal with Economic History

In a recent article at the NYT entitled 'Incredible Credibility', Paul Krugman once again takes aim at those who believe it may not be a good idea to let the government's debt rise without limit. In order to understand the backdrop to this, Krugman is a Keynesian who thinks that recessions should be fought by increasing the government deficit spending and printing gobs of money. Moreover, he is a past master at presenting whatever evidence appears to support his case, while ignoring or disparaging evidence that seems to contradict his beliefs.

Among the evidence he ignores we find e.g. the 'stagflation' of the 1970's, or the inability of Japan to revive its economy in spite of having embarked on the biggest government deficit spending spree ever in a modern industrialized economy. Evidence he likes to frequently disparage is the evident success of austerity policies in the Baltic nations (evident to all but Krugman, one might say).

As readers of this blog know, we are generally of the opinion that it is in any case impossible to decide or prove points of economic theory with the help of economic history – the method Krugman seems to regularly employ. This is why we listed the evidence he ignores or disparages: the fact that there exists both plenty of evidence that contradicts his views and a much smaller body of evidence that seems to support them at an unreflected first glance, already shows that the positivist approach to economic theory must be flawed.

An economist must in fact approach things exactly the other way around, but then again it is a well-known flaw of Keynesian thinking in general that it tends to put the cart before the horse (examples for this would be the idea that one can consume oneself to economic wealth instead of saving and investing toward that goal, or that employment creates growth; it is exactly the other way around in both cases).

So how must one approach the 'evidence' of economic history? As we have shown on numerous occasions, an especially dumb method is to look at prices in financial markets and then conclude that these markets 'know' something about the future. The proper method is to have a tenable, causal-realist economic theory first, and then employ that in interpreting the facts of economic history. Most historians, even so-called economic historians, have failed in this task. The reason why one must use this approach is that economics is not like physics: there are no repeatable experiments one could conceivably conduct to 'test' a hypothesis.  Human beings are not rocks, they have minds and volition, they pursue goals and must employ scarce economic means to attain them.  One therefore requires a theory of human action before embarking on the task of interpreting economic history.  Every incidence of economic history is unique, and subject to a myriad of disparate factors that are interlocking and producing the outcomes observed. It is not even possible to isolate all these factors with precision. And yet, underlying each episode are undoubtedly the laws of praxeology and economics – they constrain both our interpretations of the past as well as our forecasts of the future.


What Do Financial Markets Know?

As noted above, financial markets really don't 'know' anything. It is certainly true that their prices convey signals to actors in the economy, but given the fact that money is centrally planned by a bureaucracy, these signals are more often than not grossly distorted and misleading.

In his article Krugman discusses the fact that both the UK and the US currently  have very low government bond interest rates – and complains that some observers ascribe the UK's low level of interest rates to 'austerity'. If that's the case, so Krugman asks, then why are they also low in the 'non-austere' US? Of course the whole point of the exercise is to disparage fiscal restraint. Krugman already  makes a major misstep by taking it as a given that there is actually 'austerity' in the UK. In reality, there is only talk about austerity; the thing as such doesn't yet exist. Here is for instance a recent Bloomberg report entitled: “UK Deficit Unexpectedly Swells on Spending Gain”. We read there:

Worse-than-expected public sector borrowing in October has put the pressure back on the chancellor,” Robert Wood, an economist at Berenberg Bank in London who was advising Bank of England policy makers until earlier this year, said in an e- mailed note. “Stalling growth means the deficit is likely to overshoot official forecasts this year, while the growth forecasts in the last budget are likely to be scaled back.”

(emphasis added)

Does this strike anyone as an example of 'austerity'? In the UK is has never been more than a hollow phrase, a political slogan. The reality has so far failed to live up to it.

Krugman also cavalierly omits the not insignificant fact that the Bank of England has bought some £375 billion of outstanding UK gilts, almost 30% of the long term government debt in issue. Could it be that this might have had an effect on their interest rates? Similarly, in 2011, the Fed bought some 60% of the treasury debt issued that year in the course of 'QE2'. With 'Operation Twist' it has continued to remove long term debt from the market.

However, Krugman does of course mention that possession of the printing press is an advantage in these matters. Let us look at what he writes:

“There’s an interesting mix of contrast and similarity between the policy debates in Britain and the United States right now. In both countries — as in every country that retains its own currency and has debts denominated in that national currency — interest rates are near record lows.


“However, Very Serious People tell very different stories in the two nations. In the United States, we supposedly have low borrowing costs despite our budget deficit — and if we don’t implement Bowles-Simpson immediately, the bond vigilantes will attack. Really! This time we mean it!


Meanwhile, in the UK, the official line is that the low rates are a reward for all that fiscal austerity — and VSPs get upset and abusive if someone well-informed points out that a much better explanation is that investors expect the economy to remain weak, and hence for short-term rates to remain very low, for a long time.


Let’s unpack this a bit. It’s very hard to come up with any reason why either the US or the UK might default, since they can simply print money if they need cash. And given the absence of real default risk, long-term interest rates should be more or less equal to an average of expected future short-term rates (not exactly, because of maturity risk, but that’s a fairly minor detail).


So if you expect the US and UK economies to be depressed for a long time, with the central bank keeping rates low, long rates will be low too — end of story.


But won’t that money printing cause inflation? Not as long as the economy remains depressed. Budget deficits could lead people to expect higher inflation down the road, once the slump finally ends — but that would be a good thing for the economy in the short run, discouraging people from sitting on cash and weakening the exchange rate, thereby making exports more competitive.


The point, then, is that the whole “credibility” argument is incoherent.”

Let's for the moment leave aside the absurd contention made at the end of his post that 'inflation' (here meaning rising prices of goods and services) and a depreciating currency are somehow 'good'.

First, here are a few things we agree with:

Krugman is correct that expectations regarding the economy's future performance play a role in keeping interest rates low. It would be more precise to state that the associated 'inflation expectations' (i.e., the market's estimate of the future rate of change of CPI) are affecting long term interest rates. Moreover, there is the fact that a large group of investors has been scared of investing in assets deemed risky since the 2008 crisis. This can be seen by looking at yields on highly rated government bonds everywhere. Since 2008 there has also been a growing shortage of highly rated debt, which plays an important role as collateral in repo markets. This is yet another reason why such debt is being bid up. Some countries even enjoy negative nominal interest rates on the short end of the maturity curve. So rates are kept low  not only due to the fact that central banks are shrinking the supply of debt with quantitative easing.  Krugman is also correct that 'austerity' isn't what keeps UK interest rates low, not least because there simply is no 'austerity' in the UK.

However, he then commits a grave error: for one thing, he concludes that the markets 'know' something, and that therefore one shouldn't worry about how big the public debt mountain becomes, especially not if the country concerned has its own money printing press at its disposal.

To this we would counter: 5 year credit default swaps on Greek government debt sold for 35 basis points in 2007. Four years later, Greece defaulted and the same CDS had soared to more than 26,800 basis points. What did the market 'know' in 2007? It 'knew' that no sovereign debtor in the developed world would ever default. What did it know four years later? That Greece would default with absolute certainty.

It is the same story with the ultra-low interest rates on the government debt of countries that is currently rated AA or AAA. Today, the markets 'know' that this debt is 'safe' . This fact per se tells us precisely nothing about future states of knowledge. A few years hence, the markets may 'know' decidedly otherwise.


Defaults and the Printing Press

However, so Krugman would counter, taking a leaf from the chartalist 'State Theory of Money' (today called 'MMT'), Greece didn't have control over the printing press! Surely it would never have defaulted if it did!

We would say that depends on one's definition of 'default'. In all likelihood, given the size of Greece's debt and the intractable corruption and inefficiency of its administration, it would have inflated its currency into oblivion. That would effectively have been a default as well, even if not a 'formal' one. The bonds would still have been repaid; only with money worth perhaps one tenth of what it was worth when the debt was contracted. For bond holders it makes no practical difference if they get 10 lepta on the drachma after a 'formal' default or after the value of the drachma has been destroyed.

Krugman then compounds his error by asserting that there is an 'absence of default risk' in the rest of the developed world (ex the European periphery, one presumes). That is a big leap of the imagination; in fact, if nothing is changed about the 'mandatory' portion of government spending on future entitlements, default – one way or the other – seems all but certain.

Not content with making such sweeping pronouncements about an unknown future, Krugman then asserts that “But won’t that money printing cause inflation? Not as long as the economy remains depressed”.

As Kyle Bass noted in a recent letter to investors in Hayman Capital, this entire train of thought – that governments who have their own printing press won't default and that there can be no inflation in a depressed economy – may be one of the most dangerous misconceptions of our time.

Leaving aside that every single housewife in America and Europe would gape at Krugman's statement about inflation in recessionary times with incredulity (after all, just because the effects of inflation on prices don't show up in government's 'CPI' statistics does not mean that such effects are not noticeable), Krugman seems to have completely forgotten that Keynesians said the same thing in the 1950s and the 1960s, and then found themselves completely unable to explain the 'stagflation' of the 1970s. In fact, this episode almost buried the Keynesian dogma for good. It is no coincidence that people like Milton Friedman and Friedrich Hayek rose to prominence during the decade. Krugman has conveniently forgotten it ever happened.

However, if one thinks things through properly, one should realize that a weak economy is by no means a 'guarantee' for tame 'price inflation', given that central banks indeed print a lot of money whenever the economy weakens. Assume for instance that the credit boom preceding the bust has weakened the economy's pool of real funding to such an extent that it is no longer possible to divert resources toward various bubble activities. The production structure will have to be shortened then, no matter how much additional money is thrown into the economy, as the real resources necessary to keep the existing length of the structure intact simply won't be there. As Ludwig von Mises reminds us (in Human Action, ch. XX, 6 ):

“However conditions may be, it is certain that no manipulations of the banks can provide the economic system with capital goods. What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media.”

By necessity this will over time lower the economy's output. Then, at some future point, there will arise a situation when fewer goods are chased by a massively grown wall of money. In short, recessions actually have an inbuilt long term tendency to negatively influence the purchasing power of money both from the monetary policy side as well as from the goods-induced side.

Moreover, one thing that Krugman always completely ignores are the highly variable and often very large lag times involved (another reason why today's low interest rates tell us absolutely nothing about the future).

After all, we know for a fact that the true broad US money supply stood at $5.3 trillion on January 1 2008, and stands at nearly $9 trillion today. There has already been massive inflation.

As Ludwig von Mises writes about the manner in which inflation and its effects on the purchasing power of money proceed (in Human Action, ch. XVII, 8):

The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation.


There are still people in the country who have not yet become aw-are of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.


But then finally the masses wake up. They become suddenly aware  of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The  crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”

(emphasis added)

Clearly, we are at the point in time where only the prices of 'some commodities and services have risen', the 'first stage that may last for many years'. The demand for cash balances still remains high, and there is therefore in theory still time for the monetary authority to abandon the inflationary policy before things get out of hand. It should be obvious though that the rate at which government debt increases will influence the decision making of the monetary authority, regardless of its nominal 'independence'. Once public opinion about the inflationary policy changes – i.e. the point in time when the Fed's vaunted 'credibility' goes up in smoke because the 'masses wake up' – it will be too late.

Krugman is certainly correct that the government will then not necessarily formally default on its previously contracted debt; but the holders of the debt will get paid in 'scrap paper'.


Paul Krugman – coming to wrong conclusions about the future on the basis of cherry-picked slices of the recent past …

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TruthInSunshine's picture

Already having a shitty day, then BOOM!...Tylers hit me with this crazy bastard's face while pinky lifting a flute of champagne.

You're sick, Tylers...

crusty curmudgeon's picture

One cannot blame this idiocy/insanity on Keynes.  It would be hard to think less of Keynes than I do, but even he merely advocated temporary government spending.

Krugman is an insanity all to himself.

TruthInSunshine's picture

I agree and have pointed out that Keynes, regardless of one's opinion of him, would sue Krugman for slander/libel if he were alive today.

There's crazy....and then there's KRUGMAN LEVEL BATSHIT CRAZY!

Krugman calls for space aliens to fix U.S. economy. - YouTube
falak pema's picture

amen, and poor Keynes. 

Not that this shill on ZH is the real K; he can't be, he sounds as delusional as I make him out to be! 

So Close's picture

His picture makes me want to punch him in the face.

Hedgetard55's picture

Yes, a well compensated worker bee for the globalist hive.

XitSam's picture

A flying monkey for the Buffoons of Banking.

Gene Parmesan's picture

Paul Krugman is a cottonheaded ninnymuggin.

Tsunami Wave's picture

As Hugh Hendry said in a TV interview (it goes something like): "I meet these champagne socalists in first class... and they're all the same!!!"

James-Morrison's picture

Have a little perspective.

Krugman will end up on the dungheap of history.

Don't the Greeks have a saying:

"He who jumps many poles will eventually get one up his ass."

EnslavethechildrenforBen's picture

Bernanke's pole is up Krugman's...

MillionDollarBogus_'s picture

What does he care what anyone thinks about his writing..??  The guy owns a Puliter Prize for his economic ideas.

Sure he's going to say Bernanke needs to print until the ink runs out.  At this point in time what other option is there..??

Cost cutting never happens when times are good, which means it will never happen when times are bad. 

Dick Cheney was right when he said 'debt doesn't matter'.  If its not your debt, it doesn't matter.

Interest rates will stay near zero and the Fed will keep buying debt.  There is no other real option.


monogratis's picture

Thus:  Buy Gold and Silver and perhaps even some Yuan.

EnslavethechildrenforBen's picture

Do anything but go to sleep while you are holding assets valued in Dollars. By the time you wake up in the morning, your net worth will be one half what it was when you fell asleep

EnslavethechildrenforBen's picture

 I pissed in his glass when he wasn't looking

ACP's picture

"Gaack! Is this the one laced with cyanide?"

"Sir, it's ALL laced with cyanide."

TruthInSunshine's picture
A refresher on how badly Krugman tortures Keynes posthumously:

J.M. Keynes on inflation in The Economic Consequences of the Peace (p. 235-6):

[T]he best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some."


"The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.


"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

economics9698's picture

Inflation in the 20s started the Jew hatred that led to Hitler in the 30s.

blunderdog's picture

    Inflation in the 20s started the Jew hatred that led to Hitler in the 30s.

Uh, no.  There was PLENTY of Jew-hatred in Germany before 1920.  The inflation, and the concerted effort to blame it all on the Jews, just helped exacerbate things.'s picture




Zionism Promotes Anti-Semitism


Theodor Herzl (1860-1904), the founder of modern Zionism, recognized that anti-Semitism would further his cause, the creation of a separate state for Jews. To solve the Jewish Question, he maintained “we must, above all, make it an international political issue.”


Herzl wrote that Zionism offered the world a welcome “final solution of the Jewish question.” In his “Diaries”, page 19, Herzl stated “Anti-Semites will become our surest friends, anti-Semitic countries our allies.


Zionist reliance on Anti-Semitism to further their goals continues to this day. Studies of immigration records reflect increased immigration to the Zionist state during times of increased anti-Semitism. Without a continued inflow of Jewish immigrants to the state of "Israel", it is estimated that within a decade the Jewish population of the Zionist state will become the minority.

EnslavethechildrenforBen's picture

A 3 year old child can understand economics better than this Paul Krugman Prostitute.

He even makes Peter Schiff look intelligent.

RopeADope's picture

And here I thought the hatred toward Jews was caused by their anti-Keynesian attitudes and refusal to risk their capital assets on state mandated malinvestments that were undertaken to  provide job entitlements to the politician's constituents.

crusty curmudgeon's picture

Ironically, that's one of the best quotes in all of economics!  That's why I hope there's a special place in hell for people like Keynes...who had the intellect to understand just how destructive his "general theory" (1936) was.

F.A. Hayek described Keynes as "a man of great intellect but limited knowledge of economic theory, who ultimately succeeded in rehabilitating a view long the preserve of cranks with whom he openly sympathised."

I suspect Hayek would not have so kindly described our nobel-prize-winning, champagne drinking fool.

Clueless Economist's picture

I am NOT insane!

"The only solution to the debt problem, is more debt"

--Professor Krugman

DaveyJones's picture

I thought your only solution Mr. Krug was to listen to "very serious people." Ironic, coming from a clown.

John Law Lives's picture

Could I borrow that champagne flute for a second?  I'll give it right back.  Trust me.  I won't spike the contents.  Just don't be alarmed if the champagne has a little wang to the taste afterward...


pemdas's picture


One tip. If you want to be head of the world bank hold your champaign glass by the stem, not the bowl.  The europeans are scoffing at you.

TruthInSunshine's picture

Speaking of Champagne, this place is Krugman's favorite watering hole:


Urban Roman's picture

How you gonna "grow" the economy with peak oil in the rearview mirror, and the bulk of our "money supply" now demonstrably based on real estate fraud?'s picture

How was the problem of peak whale oil solved?

A Nanny Moose's picture

It's absurd to think that innovative responses to all the seemingly insurmountable challenges throughout history, lie firmly behind us. What a bleak outlook, given the evidence.

Surely the question of the say in the mid 19th c was, "Who will pick the cotton, if we free the slaves?"

RopeADope's picture

Most of those innovative responses were about externalizing costs off the P&L or creating off balance sheet liabilities. Guess what...the auditor has found them.'s picture

Man went from stone to bronze to iron without auditors having anything to do with it.

chubbar's picture

How the fuck can anyone take price signals from bonds when the gov't is in the market buying them hand over fist?

TruthInSunshine's picture

Krugman has said and still maintains that sovereign bonds (yes, the U.S.', as well) is efficiently priced in terms of yield based on market forces.

Yes, I could google for proof and link said claims of Krugman's, but am not adequately motivated at present.

RopeADope's picture

Rates are low because there is no economic profit to pay a yield. Krugman excels at being accidently not incorrect.

monogratis's picture

As long as morons like Krugman are allowed to spew that crap in the NY Times, then Gold is a sure bet.

slaughterer's picture

The above-pictured poorly-bred douche does not even know that one holds a flute BY THE STEM to avoid heating the champagne with the heat of ones hands on the bowl.'s picture

These nouveau moochers have so little class.

EnslavethechildrenforBen's picture

If he had any class at all he would be drinking out of the fucking bottle like most rich fucks do.

Daily Bail's picture

Good Times - 1970s TV Series

Blame it on the Federal Reserve

R_J's picture

Paul Krugman is another perfect candidate for my AddBlockFilter, it does save some agro...

falak pema's picture

why blame Krugman when he is just the invisible shroud?

The reality is the banksta cabal, the most potent threat to civilization. Why revile the King's buffoon when its the Emperor who is naked?

Have we come to mistaking the shadow for the real wild boar? 

ZH is becoming a blogsite for beating the wrong Masai drums. Its not the Masai delusional warrior who is the fool, its those who rape King Solomon's mines for their own lousy good.

Masai warriors don't understand the modern world. 

john39's picture

the sleeping masses use krugman's propaganda as an easy deflection to anyone who claims that debt is a problem.  which no doubt is why he is where he is despite being ridiculed by anyone who actually pays attention to what is happening.

DaveyJones's picture

More than the enabler, like any other criminal, bankers only do as much damage as the "government" allows. For something to go on this long, this deep, for former prosecuting experts like William Black to be ignored and silenced, for Goldman to be allowed to run the joint, government is more than the enabler, it is a co-defendant. 

Krugman and his ilk are more conmen than misconceivers

Optimusprime's picture

Brandeis is forever bemirched by two things:

1) The manner of his nomination (blackmail of Wilson by a former Princeton mistress)

2) His providing the specious rationale for US declaration of war against Germany in WWI.