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Myths of Austerity - A Rebuttal

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July 02, 2010 – Comments (13)

Today, our friend Krugman of the NY Times wrote an op-ed entitled "Myths of Austerity" (which you can read here). I'd like to post this rebuttal.

Krugman states that those arguing for austerity are "speculating" and "imagining" that the bond vigilantes will come take down America's Treasury Bonds and with it the U.S. financial system.  His argument is that we are not Greece, and he goes on to state that Ireland has and even WORSE economy than the spend thrift nations.

The facts seem to be getting in the way of Krugman's arguments.  In fact, one could say his article should have been called the "Myths of Keynesiests".  On the list of the 20 biggest debtor nations (based on debt/GDP owed to EXTERNAL finaciers), Greece is ranked 16th, the United States is 20th (click here for the CNBC Slideshow ).  Ireland is ranked #1 with a WHOPPING 1,312% of their GDP being owed to foreigners.

How convenient for Mr. Krugman to use as his example the most heavily indebted nation on the face of the planet, whose recent austerity isn't based on the mindset of the TEA Party, but rather on the REALITY that without austerity the ability to roll over their debt would be eliminated and the entire economy would collapse to the stone age.

Worse than that, Krugman FAILS to explain that austerity will cause TEMPORARY pain and hardship.  Not because austerity is bad, but because you must pay for the sins of your spend thrift past.  Once your financial condition is back in order your economy will once again flourish.  Krugman, on the other hand, believes in fairy land, that more spending will create a vibrant economy, where we can then slow the spending and reap the rewards of more tax revenue to pay back the debt we incurred.  In essence, Krugman believes you can go into great debt, have a stock market crash/correction, jack up spending and go into greater debt, and come out clean as a whistle on the other side.

The greatest advocates for huge debt LOVE to point to World War 2.  Let me say, if you can guarantee we willl go to war and destroy nearly every factory that both our allies and enemies use, I too will guarantee America will have a very prosperous economy for the next 20 years.  Not only do I find such a scenario a long shot with a lot of risks, I find it just a tad unethical as well.

13 Comments – Post Your Own

#1) On July 02, 2010 at 7:16 AM, whereaminow (< 20) wrote:

FM, 

Excellent post! 

Two things at work here.

One, the Keynesian story of the Great Depression doesn't work unless you believe that massive World War is healthy for an economy.  You also have to ignore the fact that the government slashed spending by close to 80% 1946-1947.  It's combining the Biggest Broken Window Fallacy in history with cognitive dissonance.

Two, the current monetary order is a race to the bottom and Krugman is cheering because we're farther from Hell than Greece. And he despises any notion that we should change direction.

David in Qatar

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#2) On July 02, 2010 at 9:54 AM, Dow3000 (< 20) wrote:

I have recently decided that Paul Krugman is a terrorist trying to destroy us all...someone please alert the feds so they can take him away.  At least Bernanke knows he is wrong and just plays politics.  This jackass actually believes the crap he says...I think...or is it all on purpose??????

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#3) On July 02, 2010 at 2:11 PM, JakilaTheHun (99.93) wrote:

Take a look at Ireland's Debt-to-GDP from the mid '00s.  Or Spain's.  Or Greece's.  All of these nations that are now on the verge of default had very low government debt not that long ago. 

The problem is that the Euro creates structural trade imbalances.  Think of the Euro like a giant 16-nation currency peg (which it actually is in a technical sense).  The Euro artificially strengthened the currency for the PIIGS.  It artificially weakened the currency for the Northern European nations (Netherlands, Germany, Finland, Austria).  France and a few others are kind of in the middle. 

When the economic downturn hit, this situation was exacerbated.  Spain, Ireland, and Greece got slammed.  It also harmed Portugal and Italy significantly.  

 

Until these nations can improve their own economic situations, they are doomed to default one way or another.  Austerity isn't going to achieve a damn thing, except lower GDP even more. Moreover, austerity would actively harm the business environments in these nations since they are required to raise taxes.  

I've never seen any austerity-proponents effectively address the reasons why Ireland's austerity programs resulted in more government debt.   If austerity works, why isn't it working in Ireland?  You might cite it as an "extreme"; but in actuality, Ireland looked like Greece and Spain not that long ago. 

 

The US is not Greece, Spain, or Ireland.  Ireland is simply the frontrunner for the Euro's problems.  Greece will be there next.  Then Spain.  Then Portugal.  Unless the Eurozone fixes its structural problems, they're all pretty much doomed to default at some point. 

 

The US has no analogous situation.  It is a sovereign issuer of its own currency.  It can't default, by definition.  It can, of course, create inflation, but its ability to do that is somewhat limited, as well, as the current environment displays. 

 

So Krugman is right.  Austerity won't fix anything.  However, I'm not sure that increasing government expenditures will do all that much good either.  For the Eurozone nations, it might help maintain GDP somewhat, but at a huge long-term economic cost.  Essentially, they are in an ugly situation where the only way to improve economically is to watch the government sector take over the economy. Which will be inefficient in the long-run.  That's why the Euro needs dramatic reform or it needs to be dissolved. 

For the US --- we have a spectacular record of wasting government resources.  The better solution for the US is to cut income taxes. This will pump more credit back into the economy.  Interest rates will rise, economic activity will improve, and banks will be able to repair their balance sheets slowly.  Over the long-run, GDP will increase, as well, which will alleviate the deficit.

Austerity is the absolute worst solution:

Lower spending + Higher taxes = Lower GDP = Higher Debt-to-GDP

The government is able to borrow at 3% right now, so it doesn't even make sense to cut spending.

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#4) On July 02, 2010 at 2:14 PM, JakilaTheHun (99.93) wrote:

I should amend my statement some.  I do think the US government should cut entitlement spending.  But "austerity" almost never results in major entitlement cuts.  It is mostly aimed at government employees.

The US should lower entitlement and defense obligations.  It should not lower government employees in non-defense sectors.

The states should cut spending, because they have no choice.  Most of the states in serious budget trouble are there becuase of wasteful spending anyway.  

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#5) On July 02, 2010 at 2:19 PM, whereaminow (< 20) wrote:

JakilaTheHun,

I've never seen any austerity-proponents effectively address the reasons why Ireland's austerity programs resulted in more government debt.

Because they spent more than they earned.  That's not austerity.

If you can't do the math on that, why would the other 10,000 words of nonsense you've written here mean anything to me?

David in Qatar

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#6) On July 02, 2010 at 2:23 PM, whereaminow (< 20) wrote:

JakilaTheHun,

Let me try to explain it in words even a sixteen year old shopaholic would understand?

Dad: "Last month, you spent $4,000 on clothes, but you only made $800. What austerity programs are you going to implement to rectify this."

Shopaholic:"I'm going to the outlet store, where I can get the same clothes for only $1200!"

Dad: "That's a start, but you're still going to go $400 further in debt."

Shopaholic: "Austerity failed me!!!!"

David in Qatar

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#7) On July 02, 2010 at 2:37 PM, rofgile (99.41) wrote:

whereaminow:

 That's a bad example, because when a country commits austerity, their earnings (GDP and tax base) would also decrease. 

 Comparing a company or a person to a country that creates currency is silly.  Those three things are three different animals.

 A currency producing country can:

  -Default on debts, 

  -Inflate the currency,

  -Increase or decrease earnings based on policy changes that improve tax collection, decrease expenditures, and grow business.

---

  A company can increase or decrease earnings by increasing sales, increasing margins, making new products, and cutting costs.

---

 A person can increase or decrease earnings by getting a better job, and cutting spending.  A person and a company are not altogether dissimilar in terms of earnings.

 Both people and companies differ from countries in that they do not collect taxes (and choose tax rates) with effects on future business growth.  They don't make the rules judging business unlike a country.  They also cannot change how much currency is in circulation.

 Ie. don't compare countries to people, David!

 -Rof 

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#8) On July 02, 2010 at 2:40 PM, rofgile (99.41) wrote:

Jakila the Hun, #3 is a very nice comment - you should turn that into a blog.

 -Rof 

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#9) On July 02, 2010 at 2:41 PM, whereaminow (< 20) wrote:

rofgile,

He asked why their debt went up.  That's a pretty basic question and it requires a basic answer.  They spent more than they earned.  But since Jakila, as usual, had to add in that "no austerity supporter could explain it," I figured that must be a difficult concept for him and I broke it down further.

David in Qatar

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#10) On July 02, 2010 at 2:45 PM, whereaminow (< 20) wrote:

One more thing, deficits are a tax on future generations.  That's part of the problem. That's part of how we got here.  Spending other people's money. Spending our children's money after our parent's spent ours.  Cutting taxes without cutting spending increases deficits.  So naturally, debt will rise even more. 

In essence, a person who advocates deficit spending is a tax hiker, but just wants to pass the buck to the next generation.  Where have I heard that concept before?

Great comment though, Jakila. Real insightful, You should definitely turn that into a blog.

David in Qatar

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#11) On July 02, 2010 at 2:53 PM, whereaminow (< 20) wrote:

rofgile,

I hope you are not advocating that the rules of addition and subtraction don't apply to governments.  Btw, Jakila's solution was Reagan's supply side economics - which of course created another bubble that crashed in 1987, and vastly expanded the size of government.  I didn't take you for a Reagan guy, although the size of government thing is right up your alley so maybe it makes sense.

David in Qatar

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#12) On July 02, 2010 at 9:00 PM, devoish (96.28) wrote:

Over the long-run, GDP will increase, as well, which will alleviate the deficit.

But I don't want to increase "GDP". I want to increase "DFT".

"Devo's Fishing Time".

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#13) On July 05, 2010 at 10:04 AM, ETFsRule (99.92) wrote:

"Worse than that, Krugman FAILS to explain that austerity will cause TEMPORARY pain and hardship"

It sounds like you are the one who has failed to explain this idea. The reason Krugman didn't make this point, is because it isn't true.

As Krugman points out here, the people calling for austerity are the cowards. They are using the "long-term" as an excuse for ignoring the very serious problems that we are facing right now.

Unemployment? Forget about it, let everyone lose their jobs. They'll get another job later - all that matter is paying down the national debt. This is the logic of idiots and cowards.

It seems that the only thing that you've "rebutted" is Krugman's use of Ireland as an example. That's all you've got?

This is typical of the intellectual laziness of Libertarians (I'm not sure if you are one, but you sure sound like it). They show up at a discussion, call people idiots, make some quick points, and assume that they've somehow won the argument. It's incredible.

For starters, how about reconciling this with your points?

Watch out, the invisible bond vigilante boogeyman is coming for us!

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