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Krugman's Arrogance

Updated: May 20, 2022

I'm delighted that I have no formal training in economics as it means I can enjoy it as a keen amateur. Economics, it seems, is about predicting how people will behkriave under certain circumstances. How something as complex as human behaviour can be predicted is beyond me. Physics can tell us very precisely how long it will take an object to fall to the ground and chemistry what happens if we mix zinc with sulphuric acid, but to predict how I will behave at some point in the future is, frankly, absurd.

Indeed the absurdity of the so-called science is evidenced by the fact that two economists can come up with two, or sometimes three, different answers to the same puzzle. This was Isaac Asimov's point when he wrote in 1991 that he could not understand "the dismal science" nor did he believe did anyone else. "People may say they understand it and economists even win Nobel Prizes, but I think it's all fake", he wrote. While natural sciences have made extraordinary progress, economists are still arguing over whether the earth is round or flat.

Asimov told of a bet between two economists about the future of commodity prices. One said the cost of certain key metals would rise over the next ten years, because he felt that rising population and the declining availability of resources would make that necessary. The other said that the cost would decline because of advancing technology and because the higher the population the better-off the world would be. Asimov was “naturally” on the side of pessimist and was shocked to find that he’d lost the bet. To him it was obvious that a steadily rising population is deadly. “If basic commodities are going down in price, what is it that’s going up and drowning them out?” he asked. Recently, I have been reading The Accidental Theoritst by (Nobel Prizewinner) Paul Krugman. Krugman does not hide his arrogance, laying into William Greider and his book The Manic Logic of Global Capitalism early on. Now I am not suggesting that Greider's logic is correct (I'm not an economist) but his uncontroversial conclusion is that there are severe flaws in the market system. Krugman writes "Greider's view, if I understand it, is that [the boom of the 80s and 90s] is just a reprieve - that any day now the whole economy will start looking like the steel industry." Well whadyaknow, Paul, it just did! Where am I going with this? OK, here goes. It is increasing wealth and income inequality that, when it cannot get any greater, results in a big bust. Simple as that. But nowhere in Keynesian literature does one find reference to such inequality being a problem (for that, we have the Austrian school to thank). To Keynesians like Krugman economic slumps can be cured with money. "It is deeply implausible" he writes "to suggest that the cause of so much suffering can be something as trivial, technical, and fixable as the failure to print enough money. Indeed there would be no reason to believe such a silly story, except that it happens to be true." If, as I contend, it is extreme wealth and income inequality that is the root of the problem - since there is a point at which the poorer half of society, on whom the other half relies, gets so stretched that it cannot spend any more - how does printing money solve this? The answer is, it doesn't. I have found it useful to think of people as companies, each with their own income and assets (or not as the case may be) and debt. Viewed this way let me, or rather David Cay Johnston (winner of the Pulitzer Prize and author of Perfectly Legal: The Covert Campaign to Rig our Tax System to Benefit the Super Rich - and Cheat Everybody Else), tell you where we are today, and you decide if it's healthy. Here are the facts:

  • The richest 1% of "companies" (people) own almost half the US's financial assets

  • The richest 15% own nearly all of the financial assets

  • The richest 1% earned 21% of total "profits" (income)

  • From 1970 to 2000, average profit for the poorest 99% of companies rose 8% from $32,763 (inflation adjusted) to $35,473, during which time real GDP per capita rose 89%

  • From 1970 to 2000, average income for the richest 0.01% rose 558% from $3,641,285 to $20,328,482

Imagine if you will a society composed of just two people, let’s call them Thrifty and Scrounger. For whatever reason, Thrifty’s output is higher than Scrounger’s, meaning that the real value of what Thrifty produces every day is higher than what Scrounger produces (this is a fair reflection of reality, in which some, because they are more skillful or have greater opportunity, are more productive than others.) Part of their output they consume themselves and part of it they give - or sell - to the other, but Thrifty, because he produces more, always gives more to Scrounger than Scrounger gives to Thrifty. To keep track of this imbalance, Scrounger writes IOUs to Thrifty, promising to do a certain amount of work some time in the future in lieu of Thrifty’s "excess" work. But Scrounger must pay a price for consuming more than he produces and for having to write IOUs. Thrifty says that an hour of Scrounger’s work that is deferred is worth less than an hour of work carried out today (the IOUs wouldn't be worth much if Scrounger were to drop dead), and so demands that Scrounger pays ‘interest’, at regular intervals, on the IOUs for as long as they remain outstanding. At first Thrifty is careful to make sure that he receives this interest in the form of extra work carried out by Scrounger, rather than in more IOUs. But of course Thrifty is still the more productive of the two, and thus both wants to and can do more for Scrounger than Scrounger does for him. Anyway, likes IOUs, they make him feel rich, and he wants as many of them as he can get his greedy hands on. But there comes a point where Scrounger cannot do any more for Thrifty. He’s working flat out and, anyway, there’re only so many shoes that Thrifty can wear or so many yachts that he can sail. But it’s OK, Thrifty agrees that Scrounger can start paying his interest with new IOUs, instead of with work. Thrifty thinks that is better than nothing. But of course Thrifty is charging interest on these new IOUs which are in lieu of interest on the old IOUs, in other words charging interest on the interest, and so the amount of IOUs keeps on going up without Scrounger actually doing any more work! In the meantime, Thrifty has been trying to use some of the IOUs he has accumulated to buy back from Scrounger the things that he made for him in the past. He’s got to do something with them, and it gives Scrounger a chance to cancel out some of his debt. But, thanks to interest, the IOUs, the debt, keep piling up. Then one day, Thrifty goes to Scrounger to see what else he can buy off him. And Scrounger says, “Sorry, I’ve got nothing left! You’ve bought it all! I’ve got no assets and I’m hugely indebted to you.” “Oops”, says Thrifty, who’s still sitting on piles of IOUs. It dawns on him that these IOUs are effectively worthless bits of paper and perhaps it wasn’t so clever to have accumulated so many of them after all. Thrifty’s “Oops” is also known as a Minsky Moment, named after renowned economist Hyman Minsky, at which it suddenly dawns on a society that the amount of debt owed by one part of it to the other is so huge that it could never be fully repaid, or not during either’s lifetime. And this is where we are today, or rather where we were two years ago. Under our fractional reserve banking system, most of the money in circulation (bank deposits) is debt money, backed by future work of the borrower, not by an existing, income-generating asset. The system works just fine until lenders want to cash in their IOUs, which of course they can't. In other words, it is the ultimate Ponzi scheme. How wealthy we are influences our spending, and lower spending by lower income households, seeking to rebuild balance sheets, will result in economic stagnation for many years. Thanks to the collapse of the housing bubble, many are now in a negative net wealth position that will take years of frugality, declaration of bankruptcy, or debt relief to resolve. It must be remembered that one person's debt is another's asset, so the inevitable debt deflation will go hand in hand with asset deflation. The more wealthy stepping in to fill the spending hole would go some way to addressing the problem, but sadly this is not what tends to happen. It is hard for someone already consuming as much as they need or want to consume any more. Anyway, right now, the wealthy are preparing for increases in their taxes to fund massive government budget deficits. Don't get me wrong, I believe in the free market. But throwing money at the problem isn't the solution. Until such time as human beings are all equally productive, only time can heal.

Published on The Centilliard

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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