Just Because You Have A Nobel Prize...

...doesn't mean that anything you say automatically makes sense.

Paul Krugman got his Nobel for working on economic geography. He deserves it because he did do some great work there.

Other than that, he's a polemicist for the Democratic Party, one who, according to the Ombudsman from the New York Times (where he has his column), has a rather ... liberal view of the truthfulness of the facts that he cites (i.e. for the clueless: is willing to twist the facts to fit his story).

Unfortunately for the state of US finances, he has the ear of the President and the Presidential Cabinet.

According to Krugman, the time is ripe for further, full-blown Keynesian pump-priming to "get the economy rolling," regardless of the effect that this has on finances.

Now, from a purely opportunistic political-economy viewpoint, this is right: if the government goes on a spending spree, the economy, in the short term, will pick up and hiring would resume from its still-stand today.

The problem is that Krugman and, by extension, the Obama Administration, severely underestimate the power of markets. Specifically, bond markets.

Let's run a scenario on what would happen if the Obama Administration were to follow the Keynesian path of those advising the Democratic Party (not only Krugman, but Robert Reich, for instance, as well):

1) The US government embarks on, say, a $2 tr "System To Utilize Productive Industry Domestically" or STUPID. STUPID takes government funds and buys domestic products (no imports or foreign-owned companies need to apply) for distribution to low-income cohorts, bypassing retail stores because there shouldn't be any profits made except for the industry (another reason to call this STUPID). The US debt ceiling is moved to $20tr from the current $14tr to accommodate this and other spending plans (since the current debt is $13tr and in order to spend more than that, the debt ceiling has to be moved);

2) This is financed by the sale of US government bonds;

3) With more and more dollars flooding the market and with US debt levels reaching Third-World levels, the bond prices start to fall, driving up the effective interest rate on US bonds. Rating Agencies do not down-rate the US because a) they know the repercussions for their business plans and b) they also fear criminal proceedings brought by the US Department of Justice if they dared to do so. The market, however, realizes that the US has, effectively, entered the Twilight Zone of government finances by exceeding 100% of GDP, and starts to decline to buy US government bonds because the yields are too low for the risk involved;

4) The US Treasury, in order to acquire the dollars needed for STUPID, accepts decreasing bond prices as a proxy for higher interest rates due to the increased perceived risk, and a run starts to develop on bond prices, given that existing holders see their assets start to show serious decline;

5) In order to ensure that there is not a run on US bonds, bond yields are raised;

6) Increases in bond yields percolate through the system, but everyone is happy because the increase in bond yields has now stabilized and the price run has been stopped;

7) The US government has to refinance older bonds and discovers to its dismay that effective interest rates are now 5%, not 0%;

8) STUPID kicks in (hard) and the economy starts to recover, with growth rates for 2011Q1 of 6%;

9) The US government discovers that in order to refinance older bonds, effective interest rates are now 7%, not 5%;

10) Rating agencies are losing all credibility by continuing to give the US government, whose debt now stands at 122% of GDP (despite STUPID), a AAA rating;

11) More US government bonds are refinanced;

12) More US government bonds are refinanced;

13) The amount of tax revenues used for financing US government debt on the bond market goes from currently ca 9.5% of total government spending (#4 position in the budget) to over 20% of total government spending, raising further warning flags for financial observers;

14) Growth in the US continues to increase strongly, 2010 ended up growing by 4% and 2011 looks to be 5%;

15) US government debt continues to accelerate despite increasing tax revenues, as the revenues lag debt growth;

16) More and more US debt issues are short-term as interest rates invert because fewer and fewer bond buyers believe that the US government has any long-term sustainability;

17) The US government discovers that in order to refinance older bonds, effective interest rates are now 12%, not 7%;

18) STUPID effects are over and the economy slows back to 3% growth rates;

19) In 2012, US government debt stands at 210% of GDP and interest servicing is now the largest single position in the US budget;

20) President Obama runs for re-election on a platform that STUPID was just the start, the economy will turn around with STUPID II;


At that point I will stop. The US government has blown its wad, shot off its munitions, gone the whole nine yards and has gotten so deeply into debt that it will be unable to finance the retirement of the Baby Boomers under any circumstances.

Keynesian pump-priming, if you bother to read Keynes, is only sensible when it is a one-time thing to get our of a business cycle hole and get people back to work. It must be accompanied with debt retirement when the business cycle is on an upswing.

It cannot and will not work if you are already heavily burdened with debt because the political class cannot understand that permanent deficit spending doesn't mean that you can permanently ratchet up government spending (permanent deficit spending means that it's not necessarily a good idea to have long-term government surpluses, as this means that government, unless it is actively retiring debt, is collecting too much in the way of taxes.

What Krugman believes, basically, is that if you are severely in debt because you have been consuming too much, then get another credit card, use it to pay off all the debt, and then keep on getting credit cards with higher and higher limits because if you have to repay, the whole house of cards falls apart and that means you'll never realize your dreams of utopia.


We can already see the face of what will happen if the Euro remains weak: Krugman, in today's Handelsblatt (German equivalent of the WSJ), says that Europeans will be amazed what Congress will demand from them if the Euro were to fall to parity.

He doesn't realize that the Europeans don't dictate the value of the Euro: financial markets do.

The fiscal policy of the Obama Administration is sell bonds and spend: their only solution is to continue to spend and damn the consequences. It's almost as if they know they will be trounced in 2010 and that President Obama will be a one-term wonder in 2012, leaving the grown-ups who come in (note I do not say Republicans...) a true fiscal ruin that will require some rather unpalatable changes in US fiscal policy, one aimed at getting the Democrats back into power in 2012.

Germany is supposed to give up its export surplus and start having their consumers spend like there is no tomorrow. It is the ultimate conceit of the misinformed and willfully ignorant that everyone is supposed to play the game according to their game plan.

The world is not America. Fiscal irresponsibility doesn't disappear "because I said it does."

Ye gods.