Does Paul Krugman Have Any Clue What He’s Saying?

by JDH on October 27, 2012

I do not generally comment on the work of others. I write this blog purely for my own edification and amusement (although I am pleased that a few of you stop by every week and read my ramblings). Today, however, I will make an exception and comment on the ramblings of Paul Krugman. For those who don’t know of him, Paul Krugman is an Economics professor at Princeton who won the Nobel Price for Economics in 2008. He is also an op-ed columnist for The New York Times, which is where the story gets interesting.

Back on September 30, 2012 Mr. Krugman wrote a piece called The Real Referendum, where he argued, yet again, that a federal deficit really isn’t that big a deal. He says there are three reasons why the deficit is not a problem:

First, despite years of dire warnings from people like, well, Alan Simpson and Erskine Bowles, we are not facing any kind of fiscal crisis. Indeed, U.S. borrowing costs are at historic lows, with investors actually willing to pay the government for the privilege of owning inflation-protected bonds. So reducing the budget deficit just isn’t the top priority for America at the moment; creating jobs is. For now, the administration’s political capital should be devoted to passing something like last year’s American Jobs Act and providing effective mortgage debt relief.

Second, contrary to Beltway conventional wisdom, America does not have an “entitlements problem.” Mainly, it has a health cost problem, private as well as public, which must be addressed (and which the Affordable Care Act at least starts to address). It’s true that there’s also, even aside from health care, a gap between the services we’re promising and the taxes we’re collecting — but to call that gap an “entitlements” issue is already to accept the very right-wing frame that voters appear to be in the process of rejecting.

Finally, despite the bizarre reverence it inspires in Beltway insiders — the same people, by the way, who assured us that Paul Ryan was a brave truth-teller — the fact is that Simpson-Bowles is a really bad plan, one that would undermine some key pieces of our safety net. And if a re-elected president were to endorse it, he would be betraying the trust of the voters who returned him to office.

Consider, in particular, the proposal to raise the Social Security retirement age, supposedly to reflect rising life expectancy. This is an idea Washington loves — but it’s also totally at odds with the reality of an America in which rising inequality is reflected not just in the quality of life but in its duration. For while average life expectancy has indeed risen, that increase is confined to the relatively well-off and well-educated — the very people who need Social Security least. Meanwhile, life expectancy is actually falling for a substantial part of the nation.

Interesting. We are not facing any kind of fiscal crisis. The budget deficit isn’t the top priority; creating jobs is.

So how is it possible that we don’t have a fiscal crisis, but at the same time our number one priority is to create jobs? The answer, of course, is that the economy is not producing enough jobs because we are in a fiscal crisis.

The government has tried the Paul Krugman “print money like crazy” approach for the last many years. Bush tried it. So has Obama. After four years of trillion dollar federal deficits, the official unemployment rate in the U.S. remains around 8%. If that isn’t a fiscal crisis, I don’t know what is. What’s the solution? Spend an extra two trillion a year?

Paul Krugman doesn’t see federal deficits as a problem because, as he said back in January Nobody Understands Debt. To quote him again:

Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments.

This is, however, a really bad analogy in at least two ways.

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.

But isn’t this time different? Not as much as you think.

It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.

Wow. And he actually put that in writing. Even though he admits that you and I have to pay back our debt, governments don’t, because they can grow their way out of it, just like we did after World War II! It worked before, let’s do it again!

This is an easy claim to refute. In 1940, near the start of the war, the U.S. population was 132 million. As a result of the post war baby boom, it continued to grow:

  • 1940 – 132 million
  • 1950 – 151 million – 14% growth
  • 1960 – 179 million – 18.5% growth
  • 1970 – 203 million – 13% growth
  • 1980 – 226 million – 11% growth
  • 1990 – 249 million – 10% growth
  • 2000 – 281 million – 12.8% growth
  • 2010 – 309 million – 9.9% growth

Do you see the pattern here? At the height of the baby boom bulge the population grew almost 20% in a 10 year period. Now, for the first time since the 1930 to 1940 period (during the Great Depression, when the population only grew by 7%), the U.S. population grew by less than 10% in a ten year period.

How can you grow your way out of deficits when you aren’t growing?

You can’t.

I remember when I got my first job out of university, many years ago. Two years later I borrowed a lot of money and bought a house. Seven years later I sold that house for less than I paid for it. There were only two reasons the debt didn’t kill me: First, I got married to a woman who was much smarter financially than I, and second my pay at my job increased 500% over a ten year period, so I was able to service the debt. High debt didn’t kill me.

Other than the marriage part, that’s exactly what happened to the U.S. in the 50 years after the war. The population continued to grow, so there was increasing tax revenue to service the debt.

Today, it’s the opposite. The population is aging, and the population is not growing as fast, so the tax base is not growing as fast as the debt obligations.

We are in a golden debt age: the U.S. is still a superpower, so they can hold interest rates low, and continue to borrow, but that won’t last forever. The Chinese already know they are holding worthless paper, and they are doing what they can to convert worthless paper into tangible assets, like gold, and shares in U.S. companies, and real estate. At some point they won’t take our worthless paper, and the game is up.

And that’s why I agree with Becky Quick’s response in Fortune to Paul Krugman’s nonsense in her article this week A call for frank talk about our debt from Bill Clinton (and me). She notes that we have a $1 trillion deficit each year, and we are spending $258 billion on interest payments. Social Security will run dry in 2033. Which is why Ms. Quick says “That’s why Krugman’s claim that there is no fiscal crisis isn’t just laughable, it’s downright dangerous.”

She’s right that it’s laughable, but I don’t think his thoughts are dangerous, because despite what the Huffington Post says, I don’t think there are very many people remaining who take Mr. Krugman seriously. It’s just common sense. You can’t spend more than you make forever. It’s just not possible.

I don’t expect the elections to change anything. Whoever wins will continue to spend like a drunken sailor, so we may survive for a while yet. But, inevitably, we will have to pay the piper.

So my advice is to keep a gold coin or two in your jeans, and fasten your seatbelts.

Thanks for reading; see you next week.

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