Keynes, Bernanke, Krugman

There’s no doubt that the big question for markets this week and next is whether Bernanke will crank up the printing-press and purchase more US debt, in a so-called QE3. And from my point of view the answer is very easy: yes, he will. Bernanke’s academic career is characterised by him publishing papers on novel ways for government to stimulate the economy. And while he didn’t directly announce a program of easing, he did extend the next Fed policy meeting to two days, possibly to build consensus on the tools and the exact methodology that will be deployed. And with “highly-influential” investment bank Goldman Sachs foreseeing a program of great easing going into 2012  who am I to disagree?


Of course, there is a political dimension to this, too. Washington has taken on a rather hawkish austerity mood. Rick Perry — crony capitalist, philistine and stimulus recipient — recently said that people in Texas would “treat Bernanke pretty ugly” if he printed any more money before the 2012 election, as that would be “playing politics“. Some Fed governors are increasingly hostile to an easing program that they see as having had few or no positive effects. But the real political issue is that of bondholders — particularly the Chinese and Russian governments — becoming increasingly tepid  at the prospect of what they see as greater devaluation. So it is no surprise to me at all that Bernanke’s approach is characterised by subtlety, caution and consensus building, even if the academic Bernanke once told Japan to show some “Rooseveltian resolve” on very much the same issue. Of course, none of these signs is enough for arch-Keynesian agitator Paul Krugman:

John Maynard Keynes:

“But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”

Ben Bernanke:

“These are tempestuous times, but when the storm is long past the ocean will be flat again.”

There is one thing that pollicy makers can do to get the money flowing more easily: in 2008 the Fed took the decision to pay interest on excess bank reserves. This was ostensibly to prevent banks from running into leverage woes: the more reserves they held, the less likely they were to go bankrupt. But look at what has happened since the Fed took that decision:

That’s right: hoarding cash. If Bernanke wants to focus on getting cash flowing, they should stop paying interest on excess reserves. All it is doing is raising net real rates, which are clearly still high enough (even with the zero-interest rate policy, and all of the QE) to make cash and low-interest bonds attractive to risk-averse, cash-rich institutional investors, and banks. Of course, unleashing all those excess reserves might have a huge inflationary impact.

But back to Krugman — there are two models of thought here: Krugman believes that the problem is a negative demand shock fuelling a liquidity trap, and that the only way out is to pump what he calculates to be a sufficient level of stimulus. He believes this extra spending will get money circulating, banks lending, and people investing again. The other model of thought — as proposed by Thomas Hoenig, and myself, among others — is that no amount of stimulus would be sufficient, as the underlying problems are structuralOn the 25th of August I wrote:

Those troubles are non-monetary — they are systemic and infrastructural: military overspending, political corruption, public and private indebtedness, withering infrastructure, oil dependence, deindustrialisation, bailout culture, systemic fragility, and so forth

As an investor, why would you choose not to invest money? Is it likely to be because even with a zero-interest rate policy, the Fed not printing enough money, and government spending is not high enough? Or is it more likely to be because of deeper infrastructural, socio-political and geostrategic factors? The death of the dollar as the world’s reserve currency, the rise of China, the potential for an oil shock, etc? In my view, no amount of stimulus or easing can make the real problems go away — all they do is massage the situation a little, and buy time for policy makers to fix the real problems.

So, as much as I believe Krugman is wrong, clearly, we do need to test Krugman’s calculation. Otherwise he (and his intellectual descendants) will just yak on and on about how he was right. So — isn’t it time Obama ditched Geithner and offered the job of Treasury Secretary ’til the end of 2012 — and a blank stimulus cheque — to Paul Krugman? After all, we would get a definitive answer as to whether or not the problems are structural — as I believe — or soluble by stimulus, as Krugman believes.

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46 thoughts on “Keynes, Bernanke, Krugman

  1. Well that’s all well and good, Aziz, but don’t you think that Krugman would just revise-up his “necessary stimulus” figure when his program inevitably fails? He doesn’t seem like the kind of person who is open to having his views and doctrines proven wrong by evidence… To Krugman models are Gods. And maybe you’re wrong about him not being able to cause much more damage — more debt is more damage. You think that the damage to his reputation would be enough to offset the damage to the nation? I’m skeptical. But I would love to see him proven dead wrong.

  2. TJ, I highly doubt that Obama will appoint Krugman. It is next to impossible — Krugman is happy to stay as NYT agitator, and Obama doesn’t want someone like PK in his administration. Even with the Enron connection, he’s not Wall Street enough. But yes — I think testing (and probably discrediting) Krugman’s theory would be worth every penny of additional debt.

    • And if we’re talking about a few lunches with Enron in the 1998 as being a talking point on the issue of Krugman, what of Ron Paul’s frequent and enduring connection to the John Birch Society?

      These guys are about as close to fascist nationalists (and racists) that mainstream political organizations get. They are similar to your BNP’s, only much more ingrained in the tradition of American politics. Conspiratorial, irrational, and GROTESQUELY pro-militancy.

      • Jonah: For me, conspiracy theories, even Bircher conspiracy theories, are part of a healthy discourse. They encourage transparency and accountability, at least. If there weren’t large, powerful and secretive groups who behaved secretively (and probably quite manipulatively) then there would be far, far less conspiracy talk. Obviously a lot of conspiracy theories are wrong. But a lot of free speech is wrong. That’s the nature of reality. And I am very dubious that conspiracy theories fuel terrorism like Janet Napolitano says: I’d say that’s straight out of the G.W. Bush playbook on stifling dissent.

        So I will give them some credit — in recent years (certainly not the 60s or 70s or 80s, but post-9/11) the Birchers are very much anti-war. Their biggest bugbear is that there is a huge conspiracy to promote world government. Well why is that view such a problem? Eventually humanity is going to have to have a debate about world government. I am personally largely against it now, and in the future, but I come to the debate with an open mind and an open heart.

  3. I don’t think Krugman giving a few speeches at an Enron retreat is going to show on the map.

    I would love to see Krugman proven wrong, or right, as the case may be. I don’t think he would disagree on you that systems are flawed. If “buying some time” means “putting people to work right now on things that REALLY need to get done” than I’m all for Krugman.

      • > Putting people to work on things that really need to get done is the solution, more or less.

        No it isn’t. Not at all. The right solution is to let the free market decide. The free market is deciding that if production = borrow to consume and consumption = debt and debt is saturated, then we need by all means to STOP PRODUCTION. The free market is saying that GDP needs to be lowered, NOT raised. People need to STOP consuming (and consumption = production (thank you Mr. Keynes)).

        The only way to solve this problem is to destroy GDP. Period. Why? Because GDP = borrow to consume = debt.

        You all remember Keynes’ equation: “C + I + G + X − M = Y(GDP)”.

        Does CONSUMPTION = PRODUCTION like Keynes says? Or is the pretty much the lie – that and “G” (government spending (ie, BORROW to SPEND))?

      • And one more point – I despise the term “putting people to work”. Why not say “forcing people to pay for work to be done”. It’s like the government saying “we CREATED jobs”, or “we need to CREATE (or save) jobs”. That task is physically and mathematically impossible since government can not create production – it always creates 1/production (ie, DESTRUCTION) just as printing money does not create wealth, but rather printing money creates 1/wealth (ie, POVERTY).

  4. A couple weeks ago your post “Jobs Creation 101″ stated that a potential solution to this whole debacle is getting investors like Buffet to fund useful projects for energy dependence, greenhouse emissions reduction, etc. Wouldn’t the government also work as a potential investor for projects like these? While adding to the deficit in the short-run, you made the point that these would be profitable endeavors, which would reduce the deficit long-term… This seems like the more “Rooseveltian” solution, to use the Bernank’s vernacular.

    • Right. I don’t really care where the money comes from. As Adam Smith put it the state should have the role of creating “certain great institutions” — although just what that means is up for debate. Where I diverge from Krugman is he seems to believe that this is pure demand shock/liquidity trap and can be fixed purely by pumping money to create full employment and lower net rates.

      My position is that this is a structural problem that is the factor creating the demand shock/liquidity trap. I’ve identified most of what I believe to be the structural issues. I don’t really care where the money come froms to fix them. The big problem with government is probably that it is so sold-out to special interests that it would be very difficult getting X, Y and Z through, whereas with investors you usually have to just convince one guy.

      The reason I really became interested in economics to the extent where I spend all day researching and writing about it was because how pissed I was about TARP and QE, because the government has the spending power to fix many of the structural problems, but just won’t for whatever reasons (corruption, myopia, paralysis) and instead wastes money saving the most excessive and destructive businesses out there — full-service global megabanks that are fundamentally too big not to fail.

      So while I am hopeful that government can rise to some of these challenges, Government in recent years does not exactly have the greatest record on the block.

      • Yeap, you pretty much drilled it. I have no doubts that the American government will not handle any of the structural issues threatening our economic system until there are ABSOLUTELY no more ways of deferring (see debt ceiling negotiations).

        By the way, Aziz, your posts are the most thoroughly informative and entertaining economic discussions on the internets. Keep up the good work-

  5. The Government does have a role in the economy. IF IT IS FOCUSSED, EFFICIENT AND NOT JUST FOR VOTES.

    The Government, through Sovereign debt raising, can raise funds at a lower cost of capital than any corporate or individual. For example Berkshire Hathaways, Warren Buffet would pay a higher rate on its Bonds to raise capital for “Future Projects” Ones that will benefit the economy in the “New World Economy” for example Solar generators.

    If these funds were raised and channelled into an efficient project, the Government would be prudent in taking on more debt for short term pain in order to improve the national economy in the long run.

    But they don’t, because it costs more, as Government workers are lazy and inscure about their abilities. That is why they are in Government jobs.

    In Australia, the Governments outsourced public infrastructure projects to the private sector (See the Macquarie Bank Model) As a result, the public pays a higher cost for using Toll Roads, than what they would if the Government undertook the venture (As efficiently as a a Private Company)

    The Karl Mark Model works in theory, but not in practice, because humans don’t act for the national good. Humans are inately selfish, and Communism causes waste and corruption. Look at the failure of the Soviet Union and the Divide between rich and poor in China.

    Therefore, a Corporatised method of Government is required, where all Government departments are based on a service model with KPI’s for all staff and projects. Any person working for this department who does not meet the KPI benchmark is culled as ruthlessly as in the Private sector. That way the Government can use it financial clout to buy resources in bulk, improve projects for the greater good and have a “Hybridised model” for the efficient delivery of projects and services.

    However in a Democratic Model, this would see Political interference, Union strikes and other self interest interfering in the efficient use of government funds. A strong Constitution is necessary to check power. I am an Australian and I can see the benefit of the US Constitution. But it needs to be reworked to ensure the economic KPI’s can not be altered by Political interfrence.

    As a result, economic collapse is inevitable and Dictatorial methods adopted. It seems this is the natural order of things. As a result it is prudent for private individuals to save for a rainy day, and by saving this means assets that can not be seized in the event of a Dictatorial regime emerging, and can be liquid if need be. I do see the value in Gold as it is internationally recognised. It could buy food, bribe a policeman, obtain a ticket to freedom, in a world of chaos.

    The question is: Is the world headed for collapse, outright war, requiring the flurry into gold we are seeing? Time will tell.

  6. “But they don’t, because it costs more, as Government workers are lazy and inscure about their abilities. That is why they are in Government jobs.” Uh… this is a truly ridiculous and unfounded statement that weakens any argument you might be making in the body of your post.

  7. Anonymous:

    Haven’t you considered that the free market puts people to work? Obviously the point of a free market is that stuff that people want and need gets done. I am hugely in favour of letting the market have a much bigger role than it has under today’s corporatism, but again — as Adam Smith noted — certain great institutions are out of reach of the market. Things like NASA. And right now I’d say alternative energy is high on the list — the market will get around to it eventually (probably an oil shock), but why should we wait for the market when government can do it now? I have no problem with that so long as government is run in a transparent, democratic, legitimate and accountable way.

    I don’t know what your view is on climate change (I myself am agnostic) but something that is out of reach of the free market that the government could provide as an insurance policy against climate change are arrays of carbon scrubbing trees to return CO2 to the pre-industrial range. That would not only be a great insurance policy, but would also create a whole lot of employment, and prosperity. Especially if the climate scientists are right (nobody knows for certain if they are). The same goes for alternative energy to stanch the peak oil believers.

    When it comes to stuff people need, I don’t care if the government delivers it or the market, so long as it is actually what people need and want. I know government is presently behaving extremely badly, and unaccountably, but who else is going to build roads, bridges, and maintain the commons? Some government is necessary.

    As for Keynes’ equation, well yes I agree GDP is not the appropriate equation to measure the health of an economy. And I agree that consumption and production are not the same thing (although Keynes definition of “product” is total circulation — not production). But my case is not for more production — my case, like Dwight D. Eisenhower — is for fulfilling wants and needs. And I am sure you will agree endless war, bailouts, etc is something we all need less of.

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  9. On my way to work last Friday, I passed a caterpillar sitting on top of a two story tall mushroom smoking out of a hookah. None of us even looked up or gave him second thought.

    When crazy is normal, watch out!

    You are right to point out that the excess bank reserves held at the FED (earning at crazy awesome .25%) as part of the problem. A curious man would ask, “Why?” But we all know the answer! Those million dollar bonus bankers can’t find anything or anyone to invest in. I’m sure they also know how big the black holes of crap loans are on their books are and assume that everyother bank has the same problem.

    All we are really doing now is waiting for the “Great Crash of 2011 or 2012 or whenever.”

    Commenting on one of your past posts about how to stimulate the economy, I must point out that, unfortunately, no amount of additional debt can save our bacon. Why? Simple, the marginal productivity of government debt is now negative (Its been negative since 2006, so all additional debt added by the Federal Government since then has been a waste.) It is a mathmatical certainity (100%) that no amount of additional government deficit spending can dig us out of our current hole. Now I agree that the stimulus we tried was poor and misguided, but until we either pay-off our past debts or default on them, any additional debt will just pull forward our hyperinflationary destiny.

    On a personal note: We economists took more math classes in college then we care to remember and now it seems that none of us can add and subtract any more. I still struggle (I feel much like you) on how so many mainstream economists can’t or don’t use basic math to support or refute their claims. How our current economic leaders have been wrong for so long and still have jobs and influence policy is beyond my mental capacity. End my struggle and the world shall be yours or (atleast my unyielding devotion!)

    • Welcome back, FO SHO.

      That was a breath of fresh air. I will do a blog tomorrow or this week on the negative marginal productivity of government debt. I believe the problems, are structural, and high debt is one of those structural problems, and I really want to flesh that position out a bit.

      I would love to hear more of your thoughts on where you think we’re going. Great Crash of 2011/12 followed by default and new, organic growth? Or Great Crash of 2011/12 followed by trade war with China, regional conflicts, World War 3? Or something else?

  10. Aziz,

    I wish I could add more substance/proof/flesh to my Great Crash 2011/012 predictions, but alas, I am human and prone to errors in logic and hyperbole.

    I firmly believe that we are currently in the last innings of the great world debt bubble. World central banks are printing money hand over fist and not only is not helping (it never does), its making things worse! For me, Egypt is a perfect example of future problems coming down the line. I doubt that inflation in food and fuel prices were the only things that caused the Egyptian Revolution, but they sure helped. Now, current dictators/presidents are becoming aware of the problem and most likely the solutions as well. (i.e. All the world currencies are being debased and if they want to stay in power, they will have to protect their citizens from the flood of fiat inflation. How could they do this? Well world governments could go out and buy the actual commmodities their citizens need. Subsidizing the necessities of life is one way to stay in power, see Kuwait and Saudi Arabia.)

    Now, the question has to be, if everyone starts chasing commodities when does the negative feedback loop stop? And where exactly will broke governments get the money to buy the commodities? They will print money of course! Hyperinflation is the end. Soon, it will be every country for themselves and if we in the USA think that it can’t happen here, well you now the answer to that.

    Now predicting big picture events after a hyperinflationary episodes (or just a serious currency devaltion) is much harder. It so hard infact, that I go out of my way to try and NOT predict what will happen. But if I were pressed, I can’t help to to think that the Middle East will be the battle ground, but who and when is not something I think I have the ability forecast.

    PS Stock markets crash up during hyperinflation.

    • I personally believe we have a whole gauntlet of deflationary depression to run before the hyperinflation really kicks in… It will hit just as Peter Schiff and Gonzalo Lira become objects of ridicule. As we worked out before, it’s a non-monetary phenomenon, so the quantities of goods, and the oil infrastructure are the keys. For me, the solution is better commodities creation/infrastructure. And I think governments and individuals will eventually cotton onto that. I just fear we’re going to have to go through WW3 before they do…

      • I constantly struggle with and go back and forth between a deflationary depression first and then hyperinflation or just straight to a hyperinflation episode. We shall see.

        Thanks for the reply!

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  13. I don’t think banks are holding excess reserves because they want to. It’s because their capital positions are f#&%ed. All those excess reserves can’t go anywhere until the housing bubble is unwound (years and years of ZIRP). Now we have the EU sovereign debt crisis putting a hurting on their capital (look at PD exposure to EU debt). It’s risk management for the banks.

    Wouldn’t dropping the rates to zero just cause a huge inflationary spike as those reserves flood the market?

    Printing excess reserves is how the fed ‘saved the system’ while not having a massive inflationary ascent.

    There is no demand shock, ‘demand’ is killed. Our societies are too damn efficient now with important exceptions to infrastructure/energy inputs/commodities management as you eluded to. Krugman’s plan to print money to dig ditches and fill them back up doesn’t help humanities problems, rather it merely massages the numbers and pacifies us with the game of life while the banks profit.

    It’s unfortunate our financial system requires eternal growth, because wisdom in life teaches you that more isn’t always better.

  14. I think it’s a mixture of the two: there is genuine fear that lending won’t get paid back, and there is massive PD exposure to many things, including EU debt.

    But this is biflation — and for those with proportionately lower necessities spending that means it is a deflationary environment, and cash and treasuries are genuinely attractive to banks — including the non-PDs.

    The notion of paying interest on excess reserves is an entirely new one, coming into being in 2008 as a response to the liquidity problems of the time. What really concerns me is that this essentially a transfer of wealth from the public to the bankers — not only has QE caused devaluation, but now we are paying interest on that devaluation.

    Ultimately, the only way to soften the blow of all this crushing debt is to fix the problems in infrastructure/energy inputs/ commodities management. In theory, the market should sense many of these things — and with commodities and energy priced high, should gravitate toward them. Alongside people like Roubini and Taleb talking about global robustness, I would hope that opening the floodgates to the excess reserves would trigger investment that we actually need, and not just more pork belly speculation and forex arbitrage.

    If the super-crash is unavoidable then it’s unavoidable. But we need to do everything we can to cushion the blow beforehand.

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