Thursday, March 27, 2014

Paul “Contrafactual” Krugman: The Laureate of Keyneisan Babble

by David Stockman

If you are not Professor Paul Krugman you probably agree that Washington has left no stone unturned on the Keynesian stimulus front since the crisis of September 2008. The Fed’s balance sheet started that month at $900 billion–a figure it had accumulated mostly in dribs and drabs over the course of its first 94 years. Bubbles Ben then generated the next $900 billion in 7 weeks of mad money printing designed to keep the tottering gambling halls of Wall Street afloat. And by the time the “taper” is over later this year (?) the Fed’s balance sheet will exceed $4.7 trillion.

So $4 trillion in new central bank liabilities in six year. All conjured out of thin air. All monetary vaporware issued in exchange for treasury and GSE paper that had originally financed the consumption of real labor, material and capital resources.

And if $4 trillion of monetary magic was not enough, the action on the fiscal front was no less fulsome. At the time in March 2008 that Goldman’s plenipotentiary in Washington, Secretary Hank Paulson, joined hands with the People’s Tribune from Pacific Heights, Speaker Nancy Pelosi, to revive Jimmy Carter’s infamous $50 per family tax rebate, hoping America’s flagging consumers would be induced to buy a flat-screen TV, dinner at Red Lobster or new pair of shoes, the public debt was $9 trillion. It will be $18 trillion by the time that the current “un-ceiling” on the Federal debt completes its election year leave of absence next March.

Yet $9 trillion of added national debt in six years is not the half of it. Even our Washington betters do not claim to have outlawed the business cycle, and we are now in month 57 of this expansion. Given that the average expansion during the ten “recovery” cycles since 1950 has been 53 months, it might be argued that we are already on borrowed time fiscally. That is, we have already used up the forward area on Uncle Sam’s balance sheet that is supposed to be available to absorb the predictable eruption of red ink that will occur during the next recession or financial bubble collapse or China melt-down etc.

In fact, peering at the future through its Keynesian goggles, the CBO assumes that the US economy will accelerate to  nearly 3.5 percent average GDP growth until it reaches “full employment” around 2017, and then will remain in that beneficent state for all remaining time, world without end!  Yet even then it projects a cumulative deficit of nearly $10 trillion under “current policy” (i.e. bipartisan can-kicking of expiring tax and spending giveaways) over the next decade.

Given the self-evident economic headwinds both at home and abroad, however, it  would not be unreasonable to set aside CBO’s Rosy Scenario 2.0—a delusion I have some personal familiarity with, having invented the original version 33-years ago to the day. Indeed, a more prudent 10-year macroeconomic scenario might be simply “copy and paste”. That is to say, take the average growth rate of GDP, jobs, income and investment over the past decade and assume that the inevitable macroeconomic bumps and grinds of the next decade will average out about the same.

To be sure, some pessimists might note that more than 27 million working age citizens have dropped off the employment rolls since 2000; that presently 10,000 more are retiring each and every day; and that the ingredients of future growth have been radically short-changed, given that real investment in business fixed assets has averaged less than 1% annually for the past 14 years. So “copy and paste” might be hard to achieve in the real world ahead, but even then the added cumulative Federal deficit would total $15 trillion over the next decade under current policy.

In other words, until the sleepwalking denizens of the Washington beltway “do something” about a fiscal doomsday machine that has been put on auto-pilot since the 2008 crisis, the nation is likely to end up with upwards of $35 trillion of national debt by the middle of the next decade, while a “copy and paste” growth rate of nominal GDP (2000-2013= 4.0%) would end up at $25 trillion. In short, what is built-in to our fiscal future right now is a Big Fat Greek debt ratio of 140%.

Now comes Professor Krugman proposing to “do something”:

…. we should aggressively reverse the fiscal austerity of the last few years, getting government at all levels spending several points of GDP more to boost demand…. let’s say for the sake of argument that the right policy is two years of fiscal expansion amounting to 3 percent of GDP each year, plus a permanent rise in the inflation target to 4 percent. These wouldn’t be radical moves in terms of Econ 101 — they are in fact pretty much what textbook models would suggest make sense given what we have learned about macroeconomic vulnerabilities…

In short, Krugman wants to double-down on the lunacy we have already accomplished. His 4% inflation target is just code for re-accelerating the Fed’s money printing machine, thereby keeping real interest in deeply negative terrain for even more years beyond the seven-year ZIRP target the Fed has already promised. And while the Wall Street gamblers who prosper mightily from the free money carry trades enabled by this insult to honest financial markets might not even appreciate the favor, its possible that millions of Main Street households not “indexed” to Krugman’s beneficent 4% inflation target might will notice its impact.

The math is not promising. Under Krugman’s inflation RX, today’s median household income of $51,000 would compute out to $33,000 in constant dollars a decade hence—taking it back to pre-Korean War levels. But do not be troubled, of course, because right there in Krugman’s Dynamic Stochastic General Equilibrium Model (i.e. DSGE) it shows that every Wal-Mart shift supervisor will get at least a 4% wage increase each year, and that all retirees with a decent bundle of lifetime cash savings will earn at least a 4% annual return by investing in Dan Loeb’s hedge fund.

If you do not understand the DSGE, however, you might say good luck with that. And you might say that wantonly adding another $1 trillion to the national debt over the next two years, as Krugman has also prescribed, amounts to carrying “bathtub economics” to a downright absurd extreme.

At the end of the day, Professor Krugman and his Keynesian acolytes believe in a mysterious economic ether called “aggregate demand”.  And through the wonders of their DSGE models they can measure the precise shortfall between aggregate demand under the nirvana of  ”full employment” and the actual level of aggregate demand ( i.e GDP or spending”) generated by 150 million workers and 300 million consumers struggling to make ends meet in today’s real world.  The whole point of fiscal and monetary ”stimulus”, therefore, is to insure that America’s economic bathtub is filled right up to the brim with aggregate demand, thereby insuring maximum growth of jobs, GDP and societal bliss.

Except that “aggregate demand” is a Keynesian fairy-tale that has now been playing for more than a half-century. In fact, spending or GDP cannot be conjured by the fiscal and monetary tricks of the state. Spending can only come from current income, which is the reward for current production; or it can come from borrowing, which is a claim on future income that will reduce borrowing capacity tomorrow  in order to have more spending today.

In fact, four decades of fiscal and monetary stimulus have essentially layered spending from a one-time credit expansion on top of spending from current income. Unfortunately, we are presently nigh onto “peak debt”; that is, the balance sheets of households, business and the public sector have been used up after the great debt party (i.e. national LBO) since 1980 has taken the US economy’s historic leverage ratio (total credit market debt to GDP) from 1.5 turns to 3.5 turns.

That’s evident even in the specious GDP numbers from Washington’s statistical mills. If you set the aside short-run stocking and destocking of inventories in the quarterly GDP figures, the year-over-year gain in final real sales for Q4 2013 was 1.9%; and that’s also close enough for government work to the 2.5% gain ending in Q4 2012; the 1.8% rate in Q4 2011; and the 2.0% gain in Q4 2010.

In short, there is no “escape velocity” because the Fed’s credit channel is broken and done. Going forward, the American people will once again be required to live within their means, spending no more than they produce.

By contrast, Professor Krugman’s destructive recipes are entirely the product of a counter-factual economic universe that does not actually exist. He wants us to borrow and print even more because our macro-economic bathtub is not yet full. And that part is true. It doesn’t even exist.

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