4 votes

Perpetually Wrong; the positions of Paul Krugman

The theories of John Maynard Keynes have pervaded virtually all of America's educational institutions and plagued American political policy for a century. The policies advocated by the Keynesians have brought us to an era of diminished living standards and a world economy drowned in malinvestment. The state sponsorship of the Keynesian ideal is a predictable outcome if one understands human action in the Austrian tradition. The inflationist doctrines are little more than a pseudo-scholarly justification for government control over the value of currency. To maintain such a system in a society which owes its unprecedented standard of living to the accumulation of personal wealth made possible by laissez faire principles, takes an overwhelming propaganda mechanism.

This is where men like Paul Krugman earn their stripes with the political establishment. The problem is that current economic conditions, and every reputable Austrian scholar on the planet, prove Keynesianism wrong on an almost daily basis. Every student of economics has immediate access to countless sources proving the Keynesian school wrong. But Krugman and the like just continue on as if there could not possibly be dissention among scholars. Austrian economist Bob Murphy even recently presented a debate challenge to him. In an effort to convince Krugman to consent to a debate Murphy has started taking donations, all of which he will give to a New York City food bank if Krugman steps up to the challenge. The last I checked, Dr. Murphy had raised over $100,000. Below is a link to the donation site and a video on the status of the challenge.

The positions of Paul Krugman basically represent the epitome of the modern Keynesian. He preaches inflation and government spending blindly as the world falls apart around him. There are no original solutions, only a religious devotion to a school of thought that has proven disasterous for the savings accounts of Americans. There is not a position held by Dr. Krugman and the Keynesians that cannot be easily rebuted and proven false. I will attempt to break down each of these fallacies and compare them with the truths of the Austrian school.



Any time Professor Krugman, or any Keynesian scholar for that matter, makes any mention of the Austrian school it is always done in a very deceptive manner. They never allow for the entire position to be heard and most direct quotes are heavily paraphrased and edited in their favor. When Krugman wrote the piece below, on the Austrian Business Cycle Theory (ABCT), he essentially just scrapped the real theory, rewrote it and refuted himself.


Krugman attempts to disprove the Austrian Business Cycle Theory when he writes: “…As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa)… Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.”

Anyone familiar with ABCT must question whether or not Dr. Krugman even read it before rewriting it. Recessions do not occur because the investments of entrepreneurs just slow down, simultaneously, for some inexplicable reason. Unsustainable market booms occur first, as a result of an artificially increased money supply and low lending rates, leading to a level of investment exceeding real value in a particular sector. The inevitable correction comes as the market realizes that the low interest rates are not the result of an increase in market capital, but rather an artificial indicator of wealth which did not exist. This is the basic premise of the Austrian Business Cycle Theory.

It is the government intervention which follows the bust, in an attempt to stimulate "aggregate consumer demand", that sustains market wide unemployment. The bail-out programs switch the burden of the downturn to all market participants rather than the investors involved with the insolvent establishments. The high taxes and inflation of a government stimulus plan increase market uncertainty and restrict the accumulation of capital.

The market downturns of 1819, 1837, 1857, 1873, 1893, 1907 and 1920 were all perfect examples of ABCT playing out. All of these occured and corrected without Federal Reserve intervetion. A study of each example will reveal a predictable pattern; government spending, credit expansion, inflation, market boom, crash.

While those examples occured prior to the use of the Federal Reserve as a market stimulant, they can hardly be blamed on the operation of the free market. All occured as a result of government meddling in the market. They are, however, distinctly different from the depressions which occured after the Fed was allowed to intervene. The modern recessions and depressions are long lived and spare no sector of the market from hardship.

Krugman writes: “A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money?...”

Periods of increased demand for cash holdings do occur in the market. If the free market were allowed to operate without government hinderence this would hardly be cause for alarm. Deflation of a metallic currency would satisfy the demand for greater cash savings and society would grow more wealthy as a result. Today's investment slow downs are caused by uncertainty and the burden that government places on the market. They are the result of the boom and bust cycles which are the trademark of a centrally controlled currency.

It does not take years of economic study to understand the flawed logic in the call for currency inflation to satisfy the demand for greater wealth retention. The vast majority of market participants will be made poorer through the increase in the money supply. The new money does not enter the market through some perfect work of magic. The equations on Paul Krugman's chalk board fail to grasp the predictable corruption which accompanies a power as great as unchecked currency debasement.

Imagine the inefficiencies of currency allocation through any central authority. The recipients of money handed out by congress or the Federal Reserve are not chosen for being the most deserved or effective investors. The money is doled out based on political connections. Anyone paying attention can see the negative impact on competition this has in the market today. The lives of all Americans are influenced by state sponsored monopolies in areas like energy, produce and education. This is one of the most profound corollaries of the Keynesian doctrine.

In the article linked below this paragraph, Krugman predictably calls for more theft to get us out of our current crisis. He cites a couple of papers which study the market conditions during recessions. Somehow he claims that economic crises which occured before the Fed were worse than after the Fed was allowed to step in.


How about we compare the market crash of 1920 to the Great Depression of 1929? These were only 8 years apart and happened under comparable market conditions. In 1920, the Harding administration kept the Fed from stepping in with stimulus. The crash occured and the bad investment was allowed to liquidate. Investors and households were allowed to naturally rebuild their personal wealth and begin investing and producing soundly. Recovery was visible in the late summer of 1921 and unemployment was back down to 6.7 percent by 1922 and 2.4 percent by 1923. The recovery after the crash of 1920 was no isolated incident, all of the recessions prior to Fed intervention followed a nearly identical pattern.

Contrast this with what we all know happened from 1929 until the early to mid 1940's. During the Great Depression government was allowed to step in at unprecedented levels. The New Deal gave the power to more easily fluctuate the value of the dollar. Massive public projects and spending programs were enacted and all failed miserably. The depression continued, unemployment remained near and above 20 percent and sustained economic growth was not achieved until 1946. The pain was not eased until the liquidation finally occured under the Truman administration.

What Krugman and the authors of the studies he cited fail to adress is the fact that the recessions which happened prior to the Fed intervening ended. Not only did they end, but they ended much quicker than modern, post-Fed, recessions. They act as though the Federal Reserve has ended the prospect of a recession in America. The link below is an enlightening lecture by economist Tom Woods on the contrast between the depressions of 1920 and 1929.


The article linked below this paragraph is an example of the irrational fear of deflation held by Dr. Krugman and the economists of the Keynesian school. This is a particularly disturbing position when one considers the fact that deflation is the natural direction of a thriving free market. More efficient means of production and greater wealth in society tend to increase the purchasing power of a currency. It must be noted that we are not talking about the rapid deflation which occurs in a particular sector as a result of inflation leading to market crashes as explained by ABCT. Obviously the rapid loss of value in the assets of a substantial portion of the populace is going to have negative effects.


The idea that spending slows down to epidemic levels during times of deflation is completely unfounded. People do not stop their consumption as their wealth is increased. Economics in its entirety is driven by mankind's unceasing desire to increase material wealth. We see deflation all throughout the 1800's, during the industrial revolution. Under the international gold standard, economic growth and the wealth of western nations increased to levels which could not have been imagined prior.

The Keynesian school continues to be off base on the understanding of human behavior. The claim that all people will hold their savings because they predict lower prices in the future, ignores any observation of how people interpret market data. Krugman acts as though people will starve to death, with a mountain of cash soaring in value in the back room. One person may study the market conditions and conclude that prices will rise in the future, while another may expect them to continue to fall, while yet another will be certain that prices will remain the same. Anyone can observe the market today and the dissention among economic forecasters and understand that there are very few unanimously agreed upon conclusions for future economic conditions.

Krugman may not realize it, but he actually makes part of our argument for us when he admits the natural difficulty in lowering nominal wage rates. Opponents of Austrianism are always claiming that low income wage earners would suffer under the free market. But steady deflation, nominal downward wage rigidity and low unemployment are precisely why the people in the lower class improve their position and increase their standard of living much quicker than under any system of central planning.

In the link below, Robert Blumen does an excellent job debunking the fears of a deflationary death spiral. The Austrian argument for deflation is a defense of the market as the best arbitrator of prices. Deflation is the natural direction of a decentralized currency as a free economy tends to stay at full employment and maintains a robust rate of growth. There is no reason to believe that if there was a modern economy following the Austrian model that there would be any sustained levels of high unemployment under regular market conditions.


Below is a link to an article that proves Paul Krugman actually recommended the creation of the housing bubble.


It does not make much sense for Krugman to deny that he was in favor of inflating the housing bubble. Even if he was not serious about the term "housing bubble", which he clearly was, he unequivocally supported the interest rate suppression which caused the crisis. The inflationist economic doctrines can never bring about continued economic prosperity because they lack any acknowledgement of the importance of capital accrual in society. They have discarded the accumulated knowledge of the theories of capital in the market. It is capital which drives the market not aggregate consumer demand. An economist that does not understand the importance of the flow and accumulation of capital is like an auto mechanic that does not understand how the engine in a car works.


The link above this paragraph will take you to a televised mini-debate between Ron Paul and Paul Krugman. Possibly the most deceiving position of Krugman is the idea that the ideal Austrian economic model is one which was achieved 150 years ago. Even the moderator at one point chimes in with the ignorant assumption that Ron Paul is a proponent of the bretton woods agreement. Nothing could be more misleading. During the debate Dr. Paul points out the hypocracy in Krugman's argument, but the fallaciousness of his positions go far beyond simple hypocracies.

What was not brought up is the fact that the Austrian School is the highest level of achievement in the understanding of human conduct. What Austrian economists advocate is a system which has not been fully realized in the history of man. The writings of men like Mises, Hayek and Rothbard represent a level of understanding capable of bringing about a higher standard of individual wealth and liberty than humanity has ever seen.

The framers of the U.S. Constitution understood that limiting the power of government was necessary to maintain individual liberty. They new that the quality of life would improve under such a system. What they did not know was the level of technological and industrial growth that would occur as a result of limited state obstruction in the market. Austrian economists recognized the market and political conditions which allowed for the greatest growth and stability. They recognized the difficiencies in the constitution and where it left Americans vulnerable to government encroachments on liberty and market function.

Modern scholars like Ron Paul, Tom Woods, Lew Rockwell, Peter Schiff, Kevin Gutzman and Bob Murphy are pioneers. They are trail blazers for human progress. These are men willing to sacrifice power, fame and academic recognition to ensure that the truth is passed on. This is what makes interesting times a blessing for those who participate in them. Today we are at an important crossroads in human history. The writings of men today could prove invaluable to the future of liberty.


In no instance can Keynesianism stand up against Austrianism. Time will ultimately prove us right. The theories of Keynes and Krugman are incomplete. The collapse of the experiment has been foretold by Austrians since the dissolution of the Bretton Woods agreement in 1971.

The housing market collapse of 2007 was the beginning of a much bigger collapse to come. It was a direct result of the long term policies of low interest carried out by our government and Federal Reserve. Very little of the bad debt which had built up prior to the crisis was allowed to liquidate. The link below is to a video on Peter Schiff's predictions for the coming economic crisis.


I ask any person with market knowledge to contemplate the consequences of a rise in interest rates. There is already no possibility of our federal government paying its debts at the current levels. The real national debt carried by the US government greatly exceeds the GDP. Even though it is obvious that US debt is a lost cause, long term bond yields hover around all time lows. Unemployment remains high and the economy is showing negative growth, but we are reaching record highs in the stock market. People are paying ridiculously high prices for nearly worthless assets. The lower interest rates are also achieving their "desired effects" in raising the price of housing, but there has been no growth of value in the market.

Any moron can compare receipts from just a couple of years ago to those of today and come to the conclusion that we are experiencing higher price inflation than what the CPI is claiming. Interest rates must go up. But interest rates cannot go up much higher than 4 or 5 percent without burdening the federal government to a point of not being able to service its debt. When that happens there will be a crash that dwarfs that of 2007. There will be an immediate stock market decline and fall in housing prices. The sky will be the limit on treasury rates. The US financial market will crash.

The correct response of allowing the crash to play itself out will certainly not happen so long as the philosophies of Krugman are the standard of those in charge of monetary policy in America. This will mean that there will be massive monetization of the American financial market. Eventually, possibly quite quickly, the world will lose confidence in its reserve currency. Once the countries of the world stop using the dollar, the check on hyperinflation is gone and the burden of the crisis is dropped into the pocket books of the American citizen.

People need to know that the doomsday scenario can have a light at the end of the tunnel. The US economy could come out of the collapse in an exceptionally strong position. Today's level of world-wide communication could lead to an era of free trade which brings the living standards of the entire world to a new high. If the American economy were allowed to just liquidate its malinvestment and the Austrian theories were heard by the masses the problems we are in could be corrected. This may sound impossible, but this is the task that we are presented with. The only hope that we have is to publicly compare the theories of people like Paul Krugman to the logic of the Austrian model.

Trending on the Web

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.

On the other hand

von Mises explicitly warned that historical data cannot always prove or disprove economic laws. Austrians use logic, others use mathematics, statistics, "historical data", urgent human needs. Austrians use hand off approach, others use practical solutions available within the scope of their office mandate to produce perceivable satisfactory results for the electorate.

In this particular regard, economists use mathematics & historical data act as a religious person uses his mind - they accept axioms as a blind belief, then use rational faculty to rationalize the dogma. So, do not underestimate people who mostly operate on dogmas anyway. Should Bernanke rule as the Austrian today, he would be dismissed from the office by the outcry from the majority.

Ron Paul: "the FED is just facilitator, not the problem." People, who are not consistently rational and want free stuff or worry about "common good" are.

Mises' warning that historical data can be misleading

is not a refutation of the business cycle theory. The deification of central planners is a far more dogmatic economic recurrence than the call for a free market. The "mathematics, statistics, urgent human needs" are little more than an attempt to prove the supremacy of whatever leader happens to be in power over the volitility of the market. The "urgent human needs" have never been the goal of the Federal Reserve. All you would have to do is study the operation of FDIC to realize this.

The Ron Paul quote on the Fed not being the problem is ambiguous as well. To say that the Fed needs to be restrained back to its original, limited mandate is true. But this is only something that could carry on in transition. It is far too much to ask of anyone in power to keep the central bank from devaluing a currency beyond any limits placed on them. It is also far too much to ask people to not push the limits on what they can obtain for free.