Three Schools of Economic Wizardry

Dear Readers,

Allow my to apologize for the length of today’s post. However, I believe everyone should read it to the end. It is, in essence, a simple reproduction of Mike Shedlock’s article on economic wizardry. The additional length comes from the reproduction of the articles he quotes in his missive. Although long, it is full of “truth” and it is quite entertaining. I guarantee a chuckle or two. I am rapidly becoming a big fan of Mr. Shedlock, whose articles are cogent and data driven. I have edited the original articles to reduce the length of my post as much as possible (and added emphasis in many places).

By the by, I am thinking about applying for Austrian citizenship.

Let us begin with another wordsmith, who in two simple sentences encapsulates everything that follows. Hats off to Mr. Yogi Berra.

Roy Filly

In theory there is no difference between theory and practice. In practice, there is.

Yogi Berra

Modern Day Fairy Tale of 3 Economic Wizards (Except It’s True)

Mike Shedlock

Once upon a time (today), in a land not so far away (USA), there lived a trio of economic wizards (economists), whose names shall remain anonymous (Paul Krugman, Greg Mankiw, Ben Bernanke). A fourth wizard, Murry Rothbard, is no longer among the living but resides in the netherworld. The above wizards seldom agree with each other because they come from competing schools of wizardry.

Three Schools of Economic Wizardry

1. Keynesian School of Fiscal Voodoo and Witchcraft

2. Monetarist School of Monetary Voodoo and Witchcraft

3. Austrian School of Sound Money, Sound Economic Principles and Common Sense.

“Dark Arts” Wizardry

The first two wizardry schools belong to a class of wizardry promoted to aspiring wizards as the “Dark Arts.”

Philosophical Beliefs

• Keynesian wizards believe governments can spend their way to economic health and although fiscal deficits may matter at some point in time, they never matter now, in practice.
• Monetarist wizards believe money will cure any and every problem if enough is dropped from helicopters and interest rates held low.
• Austrian wizards believe that economic problems are created by unsound money, haphazard loans, excessive debts, and government manipulations.
• Keynesian and Monetarist wizards believe in the voodoo principle “the problem is the solution if only you do more of it.” The former relies primarily on fiscal voodoo; the latter relies primarily on monetary voodoo.
• Austrian wizards do not believe “the problem is the solution,” no matter how many times it is repeated.

Grand Poobahs

1. Paul Krugman is the economic “Grand Poobah” of the Keynesian wizards.

2. The “Grand Poobah” of Monetarist Voodoo is Fed chairman Ben Bernanke.

3. Murray Rothbard, no longer alive, was the last great proponent of school of Sound Money, Sound Economic Principles, and Common Sense.

“Dark Arts” Schools Overflowing With Students

The “Dark Arts” are very enticing to modern day wizards-in-training because nearly everyone likes money from helicopters and deficit spending (even when they claim they don’t).

In response to demand for voodoo economists, the “Dark Arts” schools for voodoo economics are overflowing with young wizards all hoping to win a Nobel Prize in Voodooism with “fresh thinking” and new voodoo proposals.

Voodoo Proposal Example – Purposely Make Money Go Worthless

Aspiring Grand Poobah Greg Mankiw (Professor of Economic Wizardry at Harvard University) put forth a proposal that caused a stir in both the real world and the world of wizards (i.e., another economist that believes in “controlled inflation”).

Mankiw proposed that purposely making money go worthless over time would be of great economic benefit (Footnote 1).

No Demand for Common Sense

The average non-wizard, living in the real world, with an education level beyond 2nd grade, would quickly see the ridiculousness of making money go worthless.

However, at the highest political levels, there is virtually no demand for common sense, and shockingly high demand for voodoo wizardry.

For example, if you ever expect to make chairman of the president’s Council of Economic Advisers or become an economic adviser to Mitt Romney (Wizard Mankiw did both), then common sense must go out the window.

Aspiring wizards hoping for careers in politics better quickly learn that politicians never want to hear they cannot spend money. Instead, politicians want to hear economic voodoo.

“Dark Arts” Feuds

Given Keynesian and Monetarist wizards both believe in voodoo, one might think the two schools would get along reasonably well. One would be wrong.

There have been numerous public squabbles between Mankiw and Krugman but the mother of all verbal wizardry battles came when Krugman went so deep into fiscal voodoo theory that Bernanke called Krugman reckless (Footnote 2).

Ivory Towers and Academic Wonderland

Unlike non-wizards, modern-day economic wizards do not live in the real world, in real cities. Instead, they live in ivory towers in secret villages for wizards only, typically tucked away in obscure corners of major U.S. universities.

Collectively, these secret villages are known as “Academic Wonderland.”

“Academic Wonderland” is strictly off limits to non-wizards with the exception of “Dark Arts” wizards-in-training. It is even off limits to those few aspiring wizards who believe in Sound Money, Sound Economic Principles, and Common Sense.

Real World Experience

“Dark Arts” wizards of the Keynesian and Monetarist schools generally have never worked in the real world. Instead, they sit in their ivory towers and devise empirical formulas as to how they expect the real world to behave.

Occasionally the “Dark Arts” wizards surface in the real world, primarily to explain their mathematical formulas as to how the world functions.

It is seldom of concern to economic wizards if the real world does not follow their mathematical formulas.

Decision Making at Night

“Dark Arts” wizards are very concerned about such nebulous concepts as the “Decision Making at Night.” Here is set of equations from an aspiring wizard-in-training (this is “for real” – I encourage you to look at the following paper from the St. Louis Federal Reserve: http://research.stlouisfed.org/wp/2012/2012-012.pdf – RF).

“Decision making at night” is of course different from “decision making in the day.” Both are distinctly different than “decision making with no news.”

Voodoo Wizards Like Secrecy

The voodoo wizard-in-training making the above proposal is a big proponent of secrecy, believing that Grand Poobahs need to keep what they are doing a big secret lest it change real-world decision making processes of non-wizards during the day or night.

Austerity

No “Dark Arts” wizard worth his weight in salt would ever propose that any country live within its means.

For a recent example, Paul Krugman, the Grand Poobah of the Keynesian School of Fiscal Voodoo and Witchcraft (wrote an article entitled Estonian Rhapsody) (decrying Estonian restraint on government spending – you can reread my post on Estonia that discusses this article– RF)

Since Estonia has suddenly become the poster child for austerity defenders — they’re on the euro and they’re booming…

Estonia vs. Fantasyland

Estonia is not Nirvana. Estonia is not “Academic Wonderland” either.

In contrast, Krugman is in “Academic Wonderland”. The Grand Poobah clearly believes Estonia would be in better shape with helicopter drops of fiscal stimulus than a very nice partial recovery and no debt, in spite of the fact the eurozone in general is going to hell in a hand basket.

Debt Never a Problem

In modern-day ivory towers, with voodoo economics, debt is never a problem. The only thing that matters is GDP.

One might think that a Nobel prize winner would figure out that government spending will make GDP rise by definition (government spending is part of the equation) and the debt must be paid back. However, one would be wrong.

Bear in mind, Japan has tried both Keynesian voodoo and Monetarist voodoo for over 20 years. The result is a nearly unfathomable debt-to-GDP ratio of 220% and rising. Krugman would have you believe still more spending is the answer. Monetarists like Mankiw would propose making the Yen worthless.

Remember the Voodoo Motto!

Please remember the voodoo motto: If it doesn’t work, keep doing more of it, even if that is what got you in trouble in the first place!

Anyone with an ounce of common sense would realize that artificial stimulus will always end, but the debt will remain, hanging like the Sword of Damocles over the economy.

Sadly, these modern-day economic wizards do not have the common sense of the average 6th grader who inherently knows that you cannot keep spending what you do not have (or, as I like to point out, a person looking at their checking account and seeing red ink from top to bottom should not conclude, “I didn’t earn enough money last year.” The correct conclusion is that. “I am overspending” – RF).

Was Krugman a Housing Bubble Proponent?

In a 2002 New York Times editorial Krugman said “To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

Krugman claims “that wasn’t a piece of policy advocacy, it was just economic analysis.”

For further discussion please see Krugman’s Intellectual Waterloo (Footnote 3).

When wizards get into trouble they claim they were misquoted, someone did too much, someone did not do enough or any number of other excuses.

No, it was not “policy advocacy,” it was simply economic voodoo that Krugman condoned.

Moral of the Story

The average non-wizard non-union employee has long ago figured out the moral of this story. Those in ivory towers in “Academic Wonderland” have not, so I need to spell it out.

It is indeed possible to have a genuine economic debt-free recovery, along with austerity, as long as other sound economic measures are incorporated at the same time.

Yes, there will be some short-term pain (I keep warning my fellow Republicans that bringing the US fiscal house back to orderliness will be painful, but necessary – RF). However, any attempt to avoid pain via heaps of fiscal and monetary stimulus is nothing but voodoo economics and can-kicking witchcraft.

Thank you, Mr. Shedlock.

Roy Filly

Footnote 1

Please consider It May Be Time for the Fed to Go Negative.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to [make holding money less attractive].

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.

Mankiw’s idea is to generate inflation (in this case defined as rising prices), so that people will spend their money instead of holding on to it. Mankiw clearly thinks rising prices and borrowing no matter how much debt people have is a good thing. I will come back to that issue in a bit in a discussion about “inflation targeting” but first let’s take a look at this so called “clever scheme”.

Footnote 2

Bloomberg reports Bernanke Takes On Krugman’s Criticism Ignoring Own Advice

Federal Reserve Chairman Ben S. Bernanke took on Nobel prize-winning economist Paul Krugman yesterday and called his advice to reduce unemployment by boosting inflation “reckless.”

“The question is, does it make sense to actively seek a higher inflation rate in order to achieve” a slightly faster reduction in the unemployment rate, Bernanke said yesterday to reporters after a Federal Open Market Committee meeting. “The view of the committee is that that would be very reckless.”

Krugman, whom Bernanke hired at Princeton University in 2000 when he was chairman of the economics department, said in a New York Times Magazine article that the Fed should raise its 2 percent inflation target to cut unemployment. Such a policy shift would align with Bernanke’s comment in 2000 that the Bank of Japan (8301) should pursue faster inflation to escape deflation, he said. Japan’s consumer prices fell 0.2 percent that year.

“While the Fed went to great lengths to rescue the financial system, it has done far less to rescue workers,” Krugman wrote. “Higher expected inflation would aid an economy” because it would persuade investors and businesses “that sitting on cash is a bad idea,” Krugman said.

The chairman spoke in response to a reporter’s question referring to Krugman’s story, titled “Earth to Ben Bernanke,” published April 24. The article cited “the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done.”

Bernanke said pushing the increase in prices above the Fed’s 2 percent goal would risk undermining inflation expectations and erode the central bank’s credibility as a force for stable prices.”

“We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years,” Bernanke told reporters. “To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.”

Footnote 3

Krugman’s Intellectual Waterloo

Daniel James Sanchez

Last Monday evening, Lew Rockwell, from a tip by someone named “Travis,” posted this damning quote of Paul Krugman’s from a 2002 New York Times editorial:

“To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” Krugman. 2002.

Calling for a housing bubble.

What’s more, by explicitly calling for a new bubble to replace the recently burst one, he anticipated by 6 years the Onion‘s hilarious “report” that “demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income.” Except Krugman was being serious.

The quote caught on in the blogosphere, to such an extent that Krugman actually responded in his New York Times blog Wednesday morning:

“Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.”

So with a deft little two-step, Krugman paints himself as a doctor who gave an excellent diagnostic, and not a disastrous prescription. One of his ditto-heads posted on his blog that saying Krugman advocated or caused the housing bubble was “Like saying Nostradamus caused the rise of European fascism.”

At the same time, with his headline of “And I was on the grassy knoll, too” he paints his critics (especially the Austrians) as conspiracy theorists, akin to the Lone Gunmen (the Kennedy-assassination theorists from the X-Files TV show). Just like with the matter of Jekyll Island and the events leading up to the creation of the Fed, an obvious conclusion from a matter of public record is portrayed by establishment sophistry as unmoored crankiness. And once again, it works: another ditto-head dismissively remarked “no need to reason with those folks.”

Even economist Arnold Kling bent over backwards to interpret the column in a benign light:

“He was not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur.”

Krugman thanked Kling for his “gracious, sensible explication.” I can just imagine Kling running around his office in glee at having been nodded at by a celebrity Nobel Laureate, exclaiming, “He likes me! He likes me!”

Mark Thornton on the Mises blog followed up with a devastating collection of 2001 Krugman quotes clearly documenting his support for inducing a housing bubble. The most damning of this batch is the following from a 2001 interview with Lou Dobbs:

“Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer.” [emphasis added]

How the hell can anyone spin that as a purely academic musing, and not a policy recommendation for artificially inducing housing spending?

Ignoring the other quotes for a moment, and just judging from the 2002 column, did Krugman support pumping up a housing bubble or not? Given that, even in his recent blog defending himself, he explicitly stated his belief that “the only way the Fed could get traction would be if it could inflate a housing bubble,” there are only two possibilities:

• He did not support inducing a housing bubble, and wanted the Fed to not fight the recession.
• He did support inducing a housing bubble.

Anyone even somewhat familiar with Krugman’s attitude toward Fed activism should know that proposition #1, that Krugman supported a do-nothing policy, is preposterous. So, especially after bringing back in the quotes gathered by Mark Thornton, the case for proposition #2 is overwhelming.