Tag: economics

2010: the economic situation

As the new year kicks off, I’ve been trying to think of a way to explain the present economic situation in a simple and graphical manner that would not only illustrate the precarious nature of the US economy, but also explain my negative perspective on its prospects as well as the positive GDP reports and expectations on the part of mainstream economists. After wasting a fair amount of time poring over the usual BEA and BLS reports, I realized that because my analyses are primarily predicated upon debt, the only thing that made sense was to go back to the Fed’s quarterly Z1 report and look more closely at the sector data.  I have to confess that when the third quarter report came out a few weeks ago, I was surprised it did not show more contraction in the third quarter; total credit market debt only declined a further $113 billion from the revised Q1 2009 peak of $52.9 trillion.  The net contraction to date has only been 0.53%, which seemed weirdly small when the 8.7% contraction in commercial bank loans over the same period was taken into account.

But a look at the various credit sectors usefully clarifies this apparent dichotomy.  As the chart below shows, household debt reached its peak in the third quarter of 2008 and is down 1.75% since then.  The financial sector began reducing its outstanding debt a quarter later than the households, but is deleveraging much faster as its debt has fallen 5.93% from the Q408 peak.  Corporate debt has remained essentially flat since 2008, but the Federal government has, for the time being, been able to fill in the entire credit gap by increasing its outstanding debt by nearly one-third, 30.1%, in the four quarters since Q308!  State and local government debt has also increased, but by close to an order of magnitude less at 3.25%.  So, the reason we have not yet seen any significant effects of the debt-deleveraging in the household (-$242.8 billion) and financial (-$873.7 billion) sectors in the wider economy is because the Federal government has taken on an additional $1,743.4 billion of debt plus another $72.4 billion from the state and local governments to counter that contraction of credit.

So, the questions raised by this analysis are:  a) can the various levels of government continue to increase their outstanding debts faster than household, corporate, and financial debts decline, b) how long can the various levels of government continue to increase their debts, c) when will household, corporate, and financial debt stop contracting?  As of today, January 1st, 2010, the answers appear to be: a) No, the disparity of debt levels renders this impractical, if not impossible, especially since the early data indicates that household and financial debt is still declining. b) Probably not beyond the second quarter of 2010.  State and local tax revenues fell precipitously in 2009, many state and local governments are already on the verge of bankruptcy and the White House is already talking about attempting to reduce the 2010 deficit. c) given the growing number of mortgage and credit card payments reaching 60 and 90 days late, there is no sign of this happening in 2010.  In fact, much of the 2009 contraction that should have happened due to foreclosures and defaults has not yet been recorded on the books thanks to the extend-and-pretend policy presently in place.

The White House and the Federal Reserve are gambling that the contraction of household and financial sector debt will end before time runs out on their ability to increase Federal debt enough to compensate for that contraction.  But despite a panoply of credit-creation programs, changes to accounting laws, and regulatory easing, they are running out of time and there are still no signs of any further appetite for debt on the part of consumers or financial institutions.  The brief uptick in total bank loans from the middle of October to the middle of November has already given back its gains; TOTLL was still down 8.01% as of the most recent report on December 16th.  Therefore, I conclude that the White House already knows it lost its credit gamble, which is why it is now preparing the $4 trillion SuperTARP bill known as HR 4173.

Calculated Risk’s readers would appear to share my pessimism regarding the 2010 outlook, as 57% expect the economy to fall back into contraction. 

WND column

2010: The Year Ahead

While the Great Depression is considered to have begun with the great stock market crash of 1929, the first mention of the words “great depression” was in a speech given by Herbert Hoover in late 1931. The first specific and titular reference did not occur until 1934, when British economist Lionel Robbins published a book titled “The Great Depression.” This would neither be the first nor the last time economists influenced by the Austrian School would be the first to identify a major economic downturn in the making or to point out that the policies of the fiscal and monetary authorities were guaranteed to exacerbate it.

What then, are the prospects of enduring recovery? It is clear that they are not bright. It is quite probable, if there is no immediate outbreak of war on a large scale, that the next few months may see a substantial revival of business. If the exchanges are stabilised and the competition in depreciation ceases, there is a strong probability that the upward movement, which began in the summer of 1932, will continue. If the stabilisation were made permanent and some progress were made with the removal of the grosser obstacles to trade, it is not out of the question that a boom would develop. There are many things which might upset this development. The basis of recovery in the United States is gravely jeopardised by the policy of the Government.
– Lionel Robbins, “The Great Depression,” Page 195

UPDATE I – In the column, I neglected to specifically point out that if the present situation follows the historical precedent, public figures should first begin to recognize the existence of the Great Depression 2.0 two years after it began. This would indicate the fourth quarter of 2010.

UPDATE II – We are amused. Yesterday, I wrote this: “While some of the wiser economists are hedging their bets by stating that they expect growth to be “sluggish” with “downside risks,” there are no more expectations of market crashes, financial collapse or widespread economic contraction than there were at the beginning of 2008.” At the same time, Paul Krugman was anticipating his need to engage in the customary CYA of the mainstream economist: “Yeah, its a reasonably high chance [of economic contraction in the second half of 2010] – it’s less than 50/50 odds – but we have now a recovery that … is being driven by fiscal stimulus which is going to fade out in the 2nd half of next year….”

Reasonably high. Less than 50/50. Remember, that’s the finest that mainstream economics has to offer. Now, I don’t believe in feigning accuracy by assigning meaningless numbers that hint at nonexistent probability calculations, so I will simply say that 100 > 50/50. So speak up now, every doubter, anklebiter, and would-be critic. How many of you dare to publicly declare that all the mainstream economists are correct about the prospects for continued “economic recovery” in 2010 and that I am therefore wrong? Is anyone actually willing to go on the record and state that my rejection of the expert consensus is incorrect or not?

I’ll even provide some hard metrics and predict that by the end of 2010:

1. The BLS will report U-3 unemployment to be in excess of 11 percent. The actual number of unemployed workers will be much higher.
2. The BEA will report at least one quarter of negative GDP growth. The GDP figures for Q309 and Q409 will be revised downward. Again.
3. The Federal budget deficit for 2010 will exceed the projected $1.17 trillion.
4. More than 200 banks will be seized by the FDIC. Their deposits will represent more than two percent of all U.S. bank deposits.
5. Commercial bank loans and leases (TOTLL) will fall below $6.3 trillion.
6. All sectors credit market instruments excluding corporate equities and mutual fund shares liability, which is published in the Fed’s quarterly Z1 Flow of Funds Accounts, will fall below $52 trillion.
7. The national median existing-home price will not rise four percent from $172,600 to $179,500 as predicted by NAR’s lead economist Lawrence Yun. It will fall instead to a level I will attempt to estimate before the next NAR release.

These seven specific predictions are all directly contrary to what almost all mainstream economists are presently predicting for 2010; I am presently compiling a selection of economic predictions from all the usual suspects for future comparison.

Picture of a rally

I realize that many market analysts think Elliott Wave theory is akin to technical witchdoctery. But regardless of what you think of the theory, it is very hard to look at this image from Barry Ritzholtz without Waves 1 and 2 leaping out at you. As I’ve shown on the chart, the subdivisions are perfectly clear. Furthermore, the implications for the market happen to correlate almost perfectly with my current debt calculations for the economy.

Mailvox: from RGD to TIA

SS has three questions about The Return of the Great Depression:

I’ve been meaning to write for some time about your book, The Return of the Great Depression. First things first- it’s a great book, and I’d like to heartily congratulate you for writing a very valuable resource for those of us who are relatively new to Austrian economics. (The pricing for the Kindle edition helped too, even though I know you’re not exactly a fan of the proprietary .azw format.) I was particularly interested in your explanation of the Austrian Theory of the Business Cycle; it was simple, straightforward, and easy to understand. It’s become very clear to me over the last few years that most of what I learned about mathematical economics in London is simply wrong and needs to be discarded; the only coherent and empirically tested theory of the business cycle that seems to work is the one put forward by the Austrian School, in my experience. That said, I have a couple of questions for you regarding specific issues raised in the book.

First, you seem to argue (I believe it is in Chapter 9, but could be wrong) that the imposition of the Smoot-Hawley tariffs in 1930 weren’t actually much of a problem relative to the Hoover-FDR interventions. Yet in FDR’s Folly, Jim Powell specifically argued that unemployment peaked at 9.6% in January 1930 and was heading back down towards 6% by June; after Smoot-Hawley was passed, unemployment hit 14% by year-end. This is backed up in Gene Smiley’s Rethinking the Great Depression. Therefore, I am quite curious as to why you think that trade wasn’t a major causal factor of the collapse that followed between 1930 and 1933. Or have I misinterpreted your writing?

Second, in Chapter 11 you argue in point 6 that the Gramm-Leach-Bliley Act should be repealed. That Act removed the barriers between investment banking and commercial/personal banking that had existed since the days of the Glass-Steagall Act. Yet Jim Powell showed in his book that when Glass-Steagall was passed, one of its most immediate results was to significantly weaken the healthiest banks in the country. J.P. Morgan & Co. was particularly affected, as it had to divest its investment banking arm to create Morgan Stanley. I have no sympathy for the Masters of the Universe who messed up so badly, but it seems to me that weakening the banks yet further would be contraindicated at this point.

Third, it didn’t look like you raised any arguments for or against a return to an explicit hard-money standard in the US (again, I could be wrong). I see that you have argued in favour of auditing the Fed (which I strongly support), but why not go the whole distance and argue in favour of restoring the gold standard….

Finally, I’d just like to state that your work in RGD was more than enough to convince me to download The Irrational Atheist. As an atheist who has read The God Delusion and found its writing to be sub-par and its arguments to be vague, I look forward to reading your dissections of Dawkins, Hitchens, Denning, et al. Thank you again for the excellent work on RGD; I look forward to reading many more of your comments and works in the future.

SS is very welcome, of course. It’s encouraging to hear that those whose academic background is in economics also feel they have been able learn something from RGD. In answer to the first question, while I have not read their books, both Howell and Smiley would appear to be making an incorrect assumption about an intrinsic correlation between the timing of the passage of the tariff and the subsequent rise in unemployment. I can only conclude that they did not look at the more relevant import and export statistics for that historical period, (See International Transactions and Foreign Commerce, Series U 1-186, US Colonial to 1970), for as I did indeed mention in Chapter 9, the annual percentage decline in exports was smaller from 1929 to 1933 than it was from 1920 to 1922. Since that was insufficient to clarify the matter, I will point out that in 1929, US exports were 5 percent of GDP at $5,441 million, down 37 percent from the $8,664 million they had been in 1920. They declined another 16.7 percent to $4,013 million, or 3.6 percent of 1929 GDP, in 1930. So, it’s simply not credible that this one-year decline in exports, much less precipitous than the 1921 decline and equal at most to 1.4 percent of GDP could possibly be the culprit in producing such high levels of unemployment, especially given the equally large 26 percent decline in imports. (Non-economists, remember that a reduction in imports is GDP positive and the idea behind a tariff is to encourage the substitution of domestic goods and services for foreign ones.) The fact that exports began increasing again in 1934, long before the tariff was relaxed in 1937, shows that the tariff did not have the trade-limiting effects it is conventionally supposed to have had, as does the subsequent decline in international trade in 1937 and 1938.

In fact, after the tariff was CUT by two-thirds in 1937, exports dropped 9 percent in 1938. And the 26 percent decline in exports from 1929 to 1930 was nearly doubled by the 47 percent collapse in them from 1920 to 1921 which occurred nine years prior to Smoot-Hawley. So, while Smoot-Hawley may not have helped the unemployment situation, it is not credible to assert that it was the primary causal factor in the high level of 1930s unemployment.

Second, the fact that investment banking may have once helped strengthen a historical US bank does not change the fact that investment banking brought all the largest banks in the USA to their knees last year. The point of separating the functions of depository institutions and investment institutions is to permit the latter to take outsized risks and fail without destroying the stability of the former. It’s not a question of weakening the banks, but rather refusing to permit them to cut their own throats, then live on life support at the public’s expense. The historical example is simply irrelevant because modern investment banking, with all its default swaps and derivatives, now represents a weakness, not a strength.

Third, regarding monetary standards, I think that subject would merit a book in its own rights and there is no way I could have done justice to it in what would have been the very limited space provided. Moreover, because I do not feel that I have a sufficient grasp on all the various complexities of the concept of money and modern currency, that is a book I am unlikely to write. Despite my certainty about the unsustainable nature of the present debt-based system, I would be very hesitant to make any case for a return to the gold standard or any other hard money standard without doing considerably more research on the topic than I have done. Unlike most economics writers, I’m not even certain about the $57 trillion question regarding inflation/deflation, although as is clear from the book, I tend to lean towards the latter.

Finally, I am pleased that SS has reached the logical conclusion that a writer who is capable of credibly analyzing complex economic matters may have something reasonable to say about other subjects. I am, of course, dismissive of the notion that expertise in one subject necessarily grants any in another, unrelated subject, but it is ridiculous to assert, as some have, that anyone who has demonstrated the ability to knowledgeably discuss economics at this level could be incapable of contemplating science or making valid points in the atheism/religion discussion. One tends to suspect that those making the assertion simply don’t know enough about economics to understand that the issues involved tend to be considerably more complicated than those customarily disputed in the usual evolution, morality, and existence of God debates.

Given SS’s pertinent questions, it should be interesting to learn his opinion of TIA. Assuming, of course, that he manages to make it past Mount Chapter IV and finish the book without being inspired to seek employment in a house of ill repute in Southampton.

A Christmas surprise!

Actually, it’s about as surprising as seeing Santa at the mall. I suppose you can imagine how shocked I am to be proven correct – again – about downward revisions to the Q309 GDP report that has been keeping the markets afloat for the time being:

Economists React: GDP Revision “Surprisingly Large”
Economists react to the larger-than-expected downward revision to third quarter gross domestic product (GDP), to 2.2% annualized growth from 2.8% previously and 3.5% originally reported.

This isn’t really a surprise, obviously, or I could not have predicted it. And even though this is supposed to be the second and final revision to the third quarter GDP number, (at least until the next comprehensive National Income and Product Accounts revision in 2014), I fully expect that it will be revised downward again in a “surprise” unscheduled revision sometime in 2010. Notice that despite being revised downward itself, the Cash for Clunkers debt-creation program now accounts for 66 percent of the remaining GDP “growth”, up from 47 percent in the initial report.

This is an error of $185 billion, which you will note is both a) larger than the $152 billion Bush stimulus package of 2008 and b) smaller than the average $245 billion variance in quarterly reports. Of course, that latter average takes into account two additional revisions, so as subsequent unscheduled revisions are quietly made, we can expect the Q309 variance to increase. If the first two revisions are a correct indication, it will surpass the average.

There is no growth. There is only debt.

UPDATE: It’s always a little startling to come across references like this when you’re making your daily reading rounds: I sure as heck get more data, which I can view an analyze myself, on individual websites like this one, Mish, Zero Hedge, Vox Popoli, and discussion boards, than I find in the mainstream media. I’ve come to the conclusion that many journalists are not even capable of analyzing the subjects they are meant to be covering. And if they are, they will not be allowed to present their analysis if it conflicts with the agenda of their overlords.

Speaking of that data, here’s a link to the 2007-2009 GDP Variance Chart updated with the most recent revisions.

A rational metric

Karl Denninger proposes one at the Market Ticker:

[T}his is where government and regulatory interests align to the detriment of economy stability: Governments want to see big GDP increases, and increasing leverage (amount of borrowing outstanding in the economy for a given GDP level) is one way to do this.

The best way to control this trend would be to mandate (by law) that GDP be adjusted to reflect leverage changes in the economy – that is, if debt goes up by 4% of GDP then the 4% has to come off the reported GDP numbers.

The reason this isn’t tenable, of course, is that it would make it clear that we’re well into the economic contraction of massive proportions that is beginning to become visible despite the best efforts of the governments and banks to statistically obfuscate.

Explaining debt-deflation

This article should help explain why “printing” money is not necessarily inflationary in a monetary system where most of the money is created through fractional-reserve lending:

The following chart shows that bank reserves held at the Fed have increased 100-fold over the past 14 months — from around $10B in August of 2008 to around $1000B ($1T) today. It is important to understand that while this explosion in the reserves of US depository institutions has rightfully prompted much discussion and consternation, it hasn’t directly added to the total supply of US dollars (bank reserves are not counted in monetary aggregates such as M1, M2, M3, MZM and TMS). The reason that bank reserves aren’t added to the money supply is that they do not constitute money available to be spent within the economy; rather, they constitute money that could be loaned into the economy or used to support additional bank lending in the future.

If even bank reserves can’t be counted as money, it should be obvious that mere Federal Reserve printed notes can’t be counted either. The money has to go into the system before it can be spent; this is why increased bank reserves are considered to be deflationary. This does not mean, however, that the Fed can simply force the banks to force lending, as some have suggested. Mike Shedlock explains why:

1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely “fictional”.
4) Banks are capital constrained not reserve constrained.
5) Banks aren’t lending because there are few credit worthy borrowers worth the risk.

Krugman defends

Or, at least, tries to defend himself.

Oy. Rajiv Sethi tries to make sense of the arguments of Bryan Caplan and Tyler Cowen. So I went and looked — and what’s immediately clear is that Caplan, at least, is simply assuming that a rise or fall in nominal wages is equivalent to a rise or fall in real wages.

This was exactly Keynes’s starting point: as he said, by taking it for granted that the bargain over nominal wages sets real wages for the economy as a whole, classical economists had “slipt into an illicit assumption.”

And look: if you work through my little AD/AS exercise it should be immediately clear that in the case I was concerned with, changes in W lead to equal changes in P, so that real wages don’t change. Simple microeconomic logic doesn’t help here at all.

The problem with Dr. Krugman’s defense here is that a) microecnomic logic is not relevant, and b) he has committed his own illicit assumption, for as he stated: “in liquidity trap conditions, the interest rate isn’t affected at the margin by either the supply or the demand for money – it’s hard up against the zero bound.”

But this means that even if one accepts his AS-AD model, it is obvious that he was incorrect to state that economy in the 1930s was hard up against the zero bound. As proof of this, he cites historical interest rates on 3-month Treasury bills as being 0.14%, and forgets that present interest rates on 3-month T-bills are around 0.005%. Moreover, his own calls for quantitative easing indicate that the zero bound cannot be the firm barrier that his model requires them to be.

On a less theoretical level, it is simply not credible to assert that a lower minimum wage is going to magically cause the Fed to raise interest rates. Japan’s highest minimum wage is lower than the U.S. federal minimum and this has obviously not caused Japanese interest rates to increase in 20 years.

Correcting Krugman

I completely understand if some people think I’m attacking strawmen rather than Krugman’s actual arguments. Except I’d create more convincing strawmen:

It seems that more and more Serious People (and Fox News) are rallying around the idea that if Obama really wants to create jobs, he should cut the minimum wage.

So let me repeat a point I made a number of times back when the usual suspects were declaring that FDR prolonged the Depression by raising wages: the belief that lower wages would raise overall employment rests on a fallacy of composition. In reality, reducing wages would at best do nothing for employment; more likely it would actually be contractionary.

Here’s how the fallacy works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?

First, a reduction in the minimum wage doesn’t mean that EVERYONE’S PAY is going to get cut. There aren’t a lot of surgeons and computer programmers who are suddenly going to face competition from those whose labor is worth less than 7.25 per hour. Second, there are two ways that a general cut in wages could lead people to buy more in the aggregate. If labor costs are reduced, then the price of consumer goods are reduced. The Law of Supply and Demand states that there will be more demand for those lower-priced consumer goods… as well as more demand for the lower-priced labor. Also, it is an established fact that higher-income people save a greater portion of their income and spend less of it than lower-income people. Therefore, creating a larger pool of people making less money on average is going to cause people to buy more across the board.

Please note that I do not agree with the Keynesian aggregate perspective nor do I believe it is the responsibility of government to micromanage the economy, I am merely showing that Krugman is incorrect even from his chosen perspective.

Now, Krugman attempts to evade the obvious criticism in his subsequent post by stating: “the whole point is that reducing all money wages doesn’t necessarily reduce real wages. And for what it’s worth, the little AS-AD analysis I linked to is Econ 101, at least if you use a good textbook.”

This argument against reducing the minimum wage boils down to the possibility that cutting the minimum wage will cause interest rates to rise. That is simply not credible in the current monetary policy environment, as the 20-year example of Japan should suffice to demonstrate. Krugman rests his case on asking us to “suppose that the AD curve is vertical“, but a request for a supposition is a very long way from demonstrating that the AD curve actually is vertical. And even if Krugman’s simplified model had been correct, once one considers the fact that the U.S. Treasury auctioned 3-month bills at 0.005 percent in December 2008, it becomes obvious that America was not liquidity trapped at 0.14 percent in the mid-1930s as Krugman imagines, but actually had room for expansion by an order of magnitude… 28x to be precise.

Deficits: the Keynesian perspective

This is a very informative piece by Paul Krugman which accurately describes how the Keynesians regard budget deficits. I’d intended to post on it prior to the spending/income equivalency discussion, but as it happens, the two are tangentially related so this will make for a nice step into the deeper examination of why Keynesians place such importance on what I assert to be a false simplicity that is the result of them practicing the Ricardian Vice:

Broadly speaking, there are two ways you can get into severe deficits: fundamental irresponsibility, or temporary emergencies. There’s a world of difference between the two.

Consider first the classic temporary emergency — a big war. It’s normal and natural to respond to such an emergency by issuing a lot of debt, then gradually reducing that debt after the emergency is over. And the operative word is “gradually”: it would have been incredibly difficult for the United States to pay off its World War II debt in ten years, which Jim apparently thinks is the right way to view debts incurred more recently; but it was no big deal to stabilize the nominal debt, which is roughly what happened, and as a result gradually reduce debt as a percentage of GDP.

Consider, on the other hand, a government that is running big deficits even though there isn’t an emergency. That’s much more worrisome, because you have to wonder what will change to stop the soaring debt. In such a situation, markets are much more likely to conclude that any given debt is so large that it creates a serious risk of default.

Now, back in 2003 I got very alarmed about the US deficit — wrongly, it turned out — not so much because of its size as because of its origin. We had an administration that was behaving in a deeply irresponsible way. Not only was it cutting taxes in the face of a war, which had never happened before, plus starting up a huge unfunded drug benefit, but it was also clearly following a starve-the-beast budget strategy: tax cuts to reduce the revenue base and force later spending cuts to be determined. In effect, it was a strategy designed to produce a fiscal crisis, so as to provide a reason to dismantle the welfare state. And so I thought the crisis would come.

In fact, it never did. Bond markets figured that America was still America, and that responsibility would eventually return; it’s still not clear whether they were right, but the housing boom also led to a revenue boom, whittling down those Bush deficits.

Compare and contrast the current situation.

Most though not all of our current budget deficit can be viewed as the result of a temporary emergency. Revenue has plunged in the face of the crisis, while there has been an increase in spending largely due to stimulus and bailouts. None of this can be seen as a case of irresponsible policy, nor as a permanent change in policy. It’s more like the financial equivalent of a war — which is why the WWII example is relevant.

So the debt question is what happens when things return to normal: will we be at a level of indebtedness that can’t be handled once the crisis is past?

And the answer is that it depends on the politics. If we have a reasonably responsible government a decade from now, and the bond market believes that we have such a government, the debt burden will be well within the range that can be managed with only modest sacrifice.

Krugman’s reference to the “classic temporary emergency” is a reference to Samuelson’s explanation of the difference between internal and external debt in Chapter 18 of Economics, entitled Fiscal Policy and Full Employment Without Inflation. In creating his example, Samuelson concocts a scenario which posits a) present day munitions are necessary (true), b) there is no outside nation to lend goods (unlikely), c) Congress is unwilling to raise taxes enough to balance the budget (usually true), d) price-control and rationing laws are necessary (irrelevant, as Samuelson himself points out). And Samuelson makes an unintentionally important point when he mentions, offhand, that “Fortunately, the United States has come out of the most costly war in all history with little impairment of capital equipment and internal debt.”

(Sorry, had to do an interview there.)

Now, Krugman begins by posting a somewhat misleading distinction. There is no reason why a temporary emergency cannot be the result of fundamental irresponsibility. In fact, since the present political system is now built on the concept of the permanent campaign and the permanent crisis, one can quite reasonably ask if the idea of a “temporary emergency” is an oxymoron when modern government is taken into account. But if, for the sake of argument, we accept the distinction, it is fairly reasonable to subsequently accept the idea that a big war in which the survival of the nation is at stake would a) trump budgetary concerns, and b) not represent a permanent outlay.

However, it has to be kept in mind that this cannot be applied to all wars or all emergencies. The war has to pose a real threat to the nation’s survival, since losing the war renders future interest payments irrelevant. There is no point in going into massive debt for war if you’re going to have to pay it off regardless of the outcome; losing the war has to represent a worse fate than going into debt. Therefore, the equation varies depending upon whether you are being attacked by killer cannibals from Papua New Guinea or Victoria’s Secret Army. The war has to be short-term, and it also has to favor the odds of not destroying your capital base. Needless to say, this pretty much eliminates every shooting war in which the USA has engaged since, well, WWII.

The next problematic point made by Krugman is that the present crisis is NOT the result of irresponsible policy and that it is temporary. This is, to put it bluntly, incorrect and arguably insane. Numerous books, including RGD, have been written to explain how the present crisis is the direct and predictable result of irresponsible monetary and fiscal policies. Moreover, since total credit market debt grew from $37.8 trillion in 2004 to $52.9 trillion in 2009, there is absolutely no reason to believe that the crisis is temporary either; it will likely take decades of debt-deleveraging and economic contraction to reduce debt/GDP from its present 3.7 to the sustainable long term level of 1.5.

Finally, the Bush tax cuts were not “a strategy designed to produce a fiscal crisis, so as to provide a reason to dismantle the welfare state”. Bush actually expanded Federal entitlements and never made any effort to reduce, let alone dismantle, the welfare state. The tax cuts were actually straight out of the Keynesian playbook, being an expansionary contracyclical policy enacted during the economic slowdown of 2000-2001. Krugman not only fails to support his case here, but provides an argument that is ludicrously easy to disprove.

Therefore, it is downright laughable to attempt to claim that the $450 billion deficit in 2003 was more troublesome than is the $1.8 trillion deficit in 2009. The economic crisis is not the financial equivalent of war because it does not threaten the nation’s survival, it obviously does not represent a fate worse than debt, it is not temporary, and it is the result of fundamentally irresponsible policies.