Krugman's intelligence has a limit
Shortly upon receiving his Nobel Prize, Andre Geim made the following entry in his blog titled "Conscience of a Physicist": "A heated body can only lose its heat through conduction or convection". At which point a fifth-grader named Joe Schmuck complained that they are giving away Nobel prizes to illiterate pretenders who don't even know about radiation.
OK, I made it up. The intelligence of all Nobel laureats in Physics and Chemistry is above suspicion. There is no chance any one of them could ever make such a stupid error. Such things only happen to Nobel laureats in Economics.
Let's look at the writings of our friend Krugman:
"The background to the world economic crisis is that we went through an extended period of rising debt. Now, one person’s liability is another person’s asset, so rising debt made the world as a whole neither richer nor poorer. It did, however, leave the borrowers increasingly leveraged. And then came the Minsky moment; suddenly, investors were no longer willing to roll over, let alone increase, the debts of highly leveraged players. So these players are being forced to pay down debt. The process of paying down debt, however, must obey two rules:
1. Those who pay down debt must do so by spending less than their income.
2. For the world as a whole, spending equals income.
It follows that
3. Those who are not being forced to pay down debt must spend more than their income.
So since the world economy can’t raise the bridge, it is lowering the water: without sufficient spending from those who can, the only way to make the accounting identities hold is for incomes to decline — specifically, the incomes of those not constrained by debt must decline so as to create a sufficiently large gap between their (unchanged) spending and their incomes to offset the forced saving of debtors. "
So Krugman sees just one way for the leveraged borrowers to pay down their debt: by spending less. (Corollary: to offset it, savers who wouldn't take on debt to spend more must be robbed through inflation). But could there be some other way which Krugman has missed? Let us help the Nobel laureate. Such a way exists. It is called transfer of assets from the borrowers to the lenders. These loans were collaterized for a reason. By relinquishing ownership of the collateral, borrowers can pay most of their debt without reducing their spending. This can be accomplished through foreclosures, liquidation of leveraged accounts, repossession of cars, or orderly sales of stocks, bonds, 401K plans and houses on the open market. Nota Bene: this is how capitalism was supposed to work in the first place, and a Nobel prize-winning economist should know this.
So how come Krugman appears to be so illiterate? Lack of cognitive skills? No, Krugman is not Baby Bush - it's not a two-digit IQ that is the problem. I have a simpler explanation. I think that, contrary to his claim, Krugman does treat economics as a morality play, and his brand of morality does not allow for the world in which irresponsible debtors can lose their assets. He feels that assets should fetch the maximum possible price and be transferred at that price to the most irresponsible bidder and that bidder should own the assets forever regardless of the price he paid. And therefore in his understanding, good economics should be like this: "Daddy, they just raised the price of alcohol. Does that mean you will now be drinking less? -No, it means you and your brothers will be eating less". Or, more to the point: "Hey, Stupid, you overpaid for that investment, you could only afford to pay half as much. Does it mean you will now sell it? -No, Mr. Responsible, it means you will now pay the other half".
With moral convictions that strong, Krugman is very limited in his consideration of possible options.