Krugman’s Solution – Nitro

Interesting read by Krugman in the Times today. He makes the clear case for some quarters of negative growth in the future, but his view is that a double dip is irrelevant. I agree with him.

While it may be hard to forecast a double dip it is now a slam-dunk that we are going into a longer period of sub par growth. That outlook is even worse than two quarters of negative growth followed by six quarters of anemic recovery. If we go two years with growth around 1% our fiscal books will be in the tank. We would be so far off on the critical issues of total debt, debt service to GDP, debt to GDP, deficit to GDP, employment and unemployment that I can’t envision how we could dig ourselves out of that hole. If we don’t grow we die.

Krugman says that we should throw everything we have got at the problem. It was clear that he was angry at the lack of action at the Fed and the Administration. I got a sense of trepidation in his words. Here are his suggestions of what should be done:

The Administration can use Fannie Mae and Freddie Mac, the government-sponsored lenders, to engineer mortgage refinancing that puts money in the hands of American families.

Mr. K we are doing that. The Agencies are 95% of the lending. One can still get a 96-1/2% LTV loan for heavens sake. QE-1 and now QE-2 have killed savers and brought mortgage rates to 50-year lows! With HAMP and HARP nearly anyone who has a chance of landing on their feet can get a trial modification. The FHA is lending $50k to people in default at zero interest and the loan is non-recourse and subordinated. What the hell is that?

Mr. K wants to turn up the dial on this? The only way to do that would be to drop lending standards. The stupidest thing that we could do. Bad lending got us into this mess. Bad lending is not going to get us out it. It will only ensure our demise.

The Fed can buy more long-term and private debt.

Private debt? Who’s private debt? GE’s? BP’s? Citi’s? AIG’s? This is over the top in my opinion. We have already socialized big parts of the financial system. Now Mr. K wants everything to be owned by the government. This is not an idea that will sell in America. There has already been too much intervention. If the Fed starts buying Wal-Mart bonds America is finished. And heaven help us if the buy common stocks. Japan started doing that 20 years ago. Their market is down 70%.

The Fed can raise its medium-term target for inflation.

What does that mean? Does the Fed come out with a statement that says, “Our old target for inflation was 2%, we have changed it to 4%”? There is only one way to achieve that goal. The Fed would have to print money. Trillions of it. The fed balance sheet would go to $5T. To me this is assured destruction. I don’t think we would get to $5t. The financial system would implode before we got there. America would look like Argentina in the 1980’s.

Treasury can finally get serious about confronting China over its currency manipulation.

I’m sorry but just shut up with this Mr. K. In the past 24 months the US has intervened and supported financial markets at levels never before seen in history. The Federal Reserve bought $1.75 trillion of fixed rate paper! Have you looked at the tape lately Mr. K? The yields you’re seeing are in no small part due to those POMO operations. And he wants to do trillions more? Talk about a double standard. When America actually stops the intervention in the global credit market it can then sit down with the Chinese and talk turkey. Before that it is the pot calling the kettle black. And Mr. Krugman knows it.

These steps are big gambles. The downsides are enormous, the upsides questionable. Krugman acknowledges this:

Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.

No one wants to see “workers suffer”. I think this use of words was a cheap shot. The fact is the steps Mr. Krugman is advocating could very well destroy most of the things we consider important.

Friday evening. The markets are up big. The weather is perfect. But there are big storms in the Atlantic and I am worried that we are dead either way.