Nobel Prize-winning economist Paul Krugman, in his NYT column (12-18-09), entitled “The Curse of Montagu Norman” reiterates the advice he gave the central bank of Japan to end its decades-long recession that began in the 1990s. Simply put, he urged the Japanese to create inflationary expectations by inflating the currency. It was simplistic advice then and it is the same simplistic advice that he is giving Bernanke now. His argument is:
Right now, real interest rates are too high, on a PPE basis (that’s Proof of Pudding is in the Eating): the economy is clearly operating far below capacity due to insufficient demand. … While real interest rates are too high, however, the short-term nominal rate is as low as it can go. So there are only two ways real rates can be reduced. Either the Fed has to buy long-term assets, driving down the wedge between short and long rates . . . or it needs to raise expected inflation. Or it could and probably should do both.
Simplistic? Yes, indeed. We have no objection, indeed we encourage the Fed, to raise the only rate of interest it controls, the rate of interest it charges banks. It is almost zero, thus enabling the banks to borrow at little or no cost and make tons of money buying U.S. Treasury bonds and notes. This raises the prices of treasuries and lowers the rates of longer-term bonds and notes. Charging the banks a higher rate of interest would encourage them to make more loans to businesses.
But we are not great believers in the importance or usefulness of interest rates as a recovery mechanism. As Keynes wrote, reducing interest rates is like "pushing on a string." There is little demand by businesses for funds for new factories and equipment. What is required to recover from this recession is increased private investment in factories and equipment. That would increase the demand for loans and restore some of the lost industrial jobs.
What long-term assets would Krugman have the Fed buy? Long-term treasuries, corporate bonds, General Motors stock, all of the above? As a matter of fact, that is what the Fed and the banking system have been doing and all that it did so far was to cause a bear-market rally. It created no increased demand for goods and consequently did little to arrest the enormous increase in unemployment and underemployment.
Moreover, it contributed nothing to reduce the trade deficits. Indeed, the decline in our industrial sector continues and unemployment grows. Our companies are investing abroad which is good for employment in China and India, and possibly Brazil, but not the United States.
Prof. Krugman is a Keynesian; he believes in government spending its way out of the recession. So far, all that that has done was to stabilize the banks and investment companies (TARP), increase the number of government employees, and pay for earmarks to supporters, with no increase in employment! Its subsidies to the automobile industry (buying “klunkers”) proved ephemeral. Its subsidies to alternative sources of energy will inflate electrical energy prices, and will cost more jobs than it creates. A study by Gabriel Calzada, economics professor at Madrid's King Juan Carlos University, calculated that Spain lost 2.2 jobs in other industries for every government-subsidized green job that was created.
There is no relationship of Fed Policy and Montagu Norman’s adherence to the gold standard as head of the Bank of England in the 1930s. We have flexible exchange rates not a gold standard. But a system of flexible exchange rates requires that every major country allow its currency to fluctuate. China, Japan, and others have pegged their currencies to the dollar. Keeping the yuan low in relation to the value of the dollar has been of inestimable value to China, not us, facilitating the growth of China’s exports worldwide.
Nor has Prof. Krugman, to my knowledge, advanced any proposals other than inflation as the way to stimulate demand. Inflation doesn’t create demand. It just makes for another stock market bubble and ends in a recession.
So far, Prof. Krugman, an expert in international economics, has made no recommendation respecting U.S. trade policy which would help balance trade except to argue that China’s trade surplus, if it continues to grow, will have disastrous consequences for the world. We’ve been saying that since 2003 and in our book, Trading Away Our Future (2008). Price and wage inflation in the U.S. would reduce our exports and increase our imports and worsen our trade balance.
So far the real loser is the American industrial worker. Every month records a continued decline in industrial employment. The trade deficit in goods in 2008 amounted to over $800 billions, equivalent to 8 million jobs and equal to Pres. Obama’s economic stimulus plan.
Prof. Krugman has not even made mention of environmental economic policies that prevent our drilling for oil and gas on public lands, notwithstanding our continued dependence on oil imports.
Investment in restricting carbon dioxide emissions, Pres. Obama’s latest proposal to create jobs, is much like digging holes and filling them up again. Hundreds of physicists, the unchallenged elite among scientists, are now arguing that CO2 emissions have little to do with global warming. It is the sun’s emissions and rate of cosmic ray influx that cause global warming and cooling. The world is likely to find after spending trillions of dollars and euros that climate change has been unaffected.
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