I have been telling you for months there is going to be a double dip in the economy. Nobel Prize Winning economist Paul Krugman also thinks the economy is so bad we need to keep on stimulating the economy. In a New York Times Op-Ed piece last week, Krugman said, “. . . somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed.” In short, cut backs, or austerity, is not what the economy needs right now. (Click here for the complete NYT Op-Ed from Krugman.)
In a nutshell, Mr. Krugman thinks America will do no harm in the short term if the U.S. government prints money to prop up the economy until it can stand on its own. He thinks it is a myth to believe in “invisible bond vigilantes” who financially attack countries with sky high debt. Krugman wrote, “Bond vigilantes are investors who pull the plug on governments they perceive as unable or unwilling to pay their debts. Now there’s no question that countries can suffer crises of confidence (see Greece, debt of). But what the advocates of austerity claim is that (a) the bond vigilantes are about to attack America, and (b) spending anything more on stimulus will set them off. What reason do we have to believe that any of this is true? Yes, America has long-run budget problems, but what we do on stimulus over the next couple of years has almost no bearing on our ability to deal with these long-run problems.”
What evidence does Krugman give that America can keep printing money until things get better? Interest rates on government debt are staying low. For example, the 10 year Treasury is paying around 3%. Krugman said, “Far from fleeing U.S. government debt, investors evidently see it as their safest bet in a stumbling economy. Yet the advocates of austerity still assure us that bond vigilantes will attack any day now if we don’t slash spending immediately.”
What Krugman glosses over is the government has spent trillions keeping rates down and the economy going. The Fed has bought at least $1.25 trillion in mortgage backed securities with money printed out of thin air. There has been “quantitative easing” (code for money printing) to the tune of at least $300 billion to buy, what else, government debt. Congress has raised the debt ceiling to more than $14 trillion. That helped fund an $862 billion stimulus plan and a $700 billion TARP bailout for the banks. (Part of TARP has been paid back, but taxpayers are still owed around $296 billion.) Now, the Fed is considering ways to head off another plunge in the economy. A recent Telegraph UK story said, “Fed watchers say Mr. Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam. . . .Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed’s balance sheet from $2.4 trillion . . .to uncharted levels of $5 trillion.” (Click here for the complete Telegraph UK story.)
There is also evidence the government is buying its own debt from hedge fund manager Eric Sprott. In December of 2009, Sprott took a hard look at who was buying Treasuries. Sprott discovered a sector the Treasury Department calls “Households” that bought $528 billion in government debt by the third quarter of 2009. The Sprott report said, “We must admit that we were surprised to discover that “Households” had bought so many Treasuries in 2009. They bought 35 times more government debt than they did in 2008. Given the financial condition of the average household in 2009, this makes little sense to us. With unemployment and foreclosures skyrocketing, who could afford to increase treasury investments to such a large degree? . . . -who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report.” (Click here for the Sprott report.)
In June of 2010, according to a CNN story, “Households” held nearly $800 billion in Treasuries. This “phantom” buying has people like Eric Sprott thinking, “It makes us wonder if it’s all just a Ponzi scheme.” Are “Households” and the world really flocking to the safety of Treasuries? Or is the Fed becoming a buyer of last resort? I think it is probably both. When the government buys its own debt, it creates false demand and artificially depresses interest rates.
The idea that interest rates are being magically held down by extreme demand for our ballooning debt is the real myth. Krugman fails to recognize any downside of all this money printing. Maybe he has fallen victim to his own prejudices. As Krugman says in the beginning of his Op-Ed piece, “Much of what Serious People believe rests on prejudices, not analysis. And these prejudices are subject to fads and fashions.
Milton Freidman, another Nobel Prize winner in economics, summed up the result of a loose monetary policy in his famous quote, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” If the country takes the path Mr. Krugman is suggesting, we might not have a double dip in the economy, but we will have some very big inflation because you just can’t have it both ways.