A Bender of an Era: Krugman Sees the oncoming train
Read this from Krugman and realize this is what happens when an era dies. 8 years ago, when I spoke with Krugman and others about "Japanification" the talk was dismissed. Yes, he and others were worried about a Japan style "lost decade" but there was the assertion that "our policy makers" were too smart for that. Some quotes stick in the mind, because when economists can't explain the facts, they turn to bad sociology, and when they can't see the future, they turn to bad politics. In Krugman's case, doubling down on Ben Bernanke, and later President Obama.
What is the Japanification thesis? Why did I, and others, assert it in 2002? Why was it ignored then, and is dawning now? This isn't a mistake, or disagreement on policy, it is the end of an era. The era of modern money, and late modern economics.
When you look at the important papers of the last 30 years in economics, a few names keep showing up over and over. Most working economists spend their time looking for proxies. They measure real things, and relate them to "the real economy" which is, in fact, a metaphysical entity where certain equations hold. The "nominal" economy is the one we see every day. The nominal number of dollars is different from "inflation adjusted" real dollars. Paul Krugman is one of the names. So is Larry Summers. The collegiality at the top of economics comes from the individuals involved. Zandi, former McCain advisor, co-authors a study with Alan Blinder, who is a New Deal Liberal at heart. Mankiw, Bush advisor, co-authored with Larry Summers, Obama advisor.
The era we are talking about is the era of monetary policy economics, which is rooted in both macro-economic thinking, but took firmer hold between 1965 and 1980, when the Mundell-Flemming model of open currency macro-economics, and shocks from oil prices combined to produce what can be described as the neo-liberal consensus in economics, which became "the Washington Consensus" in policy, though, of course, both reach much farther than these specific labels, in the same way that "romanticism," technically, applies to a sliver of writers from 1750-1840, but means a great deal more than that.
This consensus can be summarized as follows:
1. Monetary policy is better than fiscal policy which is better than regulatory policy, all other things being equal (ceteris paribus in econo-speak. Beware of economists speaking latin).
2. Markets distribute goods, even in shortage, better than governments.
3. Growth of GDP allows for both borrowing and social amelioration through taxation, and the most efficient transfer of wealth.
4. Macro-inflation is driven by wage push inflation: too much demand. Hence, all problems can be dealt with by raising regressive taxes on demand, lowering interest rates to spur consumption, and increasing information. Meaning raising prices so that people know what they are buying is expensive.
Hence, "downsize the government, deregulate commerce, cut taxes as the best fiscal policy for driving growth, and fight over the margins of welfare distribution."
The focus became on the actions of central banks, since central banks were seen as being populated by meritocratic technocrats who had a fundamental agreement on the models and their meanings, and could act "creatively" if need be to deal with large shocks. Also known as sidelining democracy. The result was that democracy became infantilized: it was about slicing a pie, not about the size of the pie, since relatively little that the fiscal authority did mattered, and if it started to, then the central bank would raise interest rates enough. And if it did not step in in time forcefully enough, the unelected central bank could. Thus congress was free to be more partisan, because it was really about who got what.
Thus the two arguments that run through much of the last 40 years in economics amount to what the band of equilibrium is where welfare can be distributed. Or how much can each group demand, without upsetting the apple cart. Economics then waged side arguments with what might be called "folk economics" and what is called "heterodox economics" over matters such as budget deficits and taxation.
Krugman recognized, relatively early, as did other liberal economists, that the Bush executive was violating the technocratic consensus as to how much discretion the political party in power had. However, he continued to have faith in the technocracy itself. The problem, to Krugman, is that more people like Krugman weren't being listened to. The conservative economists would never violate what might be thought of as the modern equivalent of what just was not done.
The tools of this era: monetary policy, tax cutting on income taxes, tax increases on consumption, deregulation, globalization, and incentivization, seemed for about 20 years to work well. More over, they stopped the inflation wave of the late 1960's and 1970's, which seemed miraculous. The price of commodities fell, which had been the driver of crisis, and there were, in the US, only two shallow recessions, or so they seemed, after the end of the double dip of 1980-82. It was the era of complacency. One can look at volatility of prices in numerous sectors and see that price stability seemed within reach. It seemed as if all problems were manageable. The neo-liberal era grew as arrogant, more arrogant, than the liberal Keynesian era before it, and made exactly the same mistakes: mistaking wealth, for a weight that allowed gardening the world down to the smallest details. Including failed colonial wars.
The Japanification Thesis
The japanification thesis can be summarized as follows:
- The effects of the bursting of the bubble in stocks will fall primarily on the rich.
- The rich will be bailed out with tax cuts.
- To keep the money that piles up in the hands of the oligarchic economies, such as Saudi Arabia and China, as well as the global rich, flowing, a secondary bubble, similar to Japan's land bubble, will be created.
- This bubble will burst because it is pure consumption.
- The result will be a much larger recession than forseen, the way the 1975 recession was much sharper than the 1969 recession.
- The banks will be bailed out, and they will then have to raise interest rates dramatically, while getting free money from the central bank. The economy will stagnate for a long period of time, as the vast amount of dead paper is paid off.
- There will be political stability for those in power afterwards, and thus no accountability.
This is what happened in Japan. The LDP led Japan into a devastating crisis, and remained in power, with only two breaks. It is not clear they will not win the next election, and the new government is not dramatically different in policy.
This thesis is rooted in the work of Minsky, Modigliani, Sen, Stiglitz, Akerloff, Nash ... and yes Krugman, Mundell and the other neo-liberals. What it asserts is something that would have been familiar to Kenneth Arrow: lack of moral hazard creates risk. Those that are better off in the worst case than any one else, have no reason not to risk the worst case.
Thus Japanification challenges not the fundamentals of post-war economics, though there are elements of the elaborated version of the thesis which do, more on this later, but as much the nature of who is a policy person in the post-war era.
Krugman recognized the potential for a Japan style trap, what he did not recognize is that a Japan style trap would be created, not prevented, but the class of people of which he is a member: those hired to figure out how to redistribute welfare from others, to those they work for, or have sympathy for.
The Economic Lesson
The reason economists are ill-tempered about this assertion, is because it contains the root of what they do to others, namely say that it does not matter what you intend to happen, the dynamics of the market place will force other outcomes. This is what happend with the Japan and with the US: policy makers seeking to avoid short term pain for their supporters, inflicted disproportionate long term pain. The steps that led to where we are now were not started under Bush, but under Nixon, and they were added to, not reduced, by Clinton, most importantly with financial deregulation.
This is because the essential competition is between rent collectors, who either have much less money than they need, because most of their costs are fixed costs, or much more, because most of their costs are fixed costs. Saudi Arabia sinks enormous amounts of money into its military, and into social control. These expenses largely do not change. China has an enormous population to deal with, the expenses the government incurs to stay in power largely do not change. Thus when they were kept on a short leash by neo-classical policies of constricting demand, their rents were reduced. During the great commodities depression, the price of oil finally fell in real terms.
However, the coming of China as the engine of labor deflation upset this balance, the more disinflationary pressure China created, the more profits for capital there was, largely financial capital. At first this seemed rosy, and it could have been made to work. However, that pile of money could be forced into holding dollars, and thus allow, for a brief period of time, people like Bush to engage in the devaluation tax to fund their own social engineering. Specifically, the creation of what I termed "Rove's Republic" where there was a permanent coalition to vote for subsidies that the state provided, in return for a gradual spiraling down of America. This too Krugman saw in "The Great Unravelling," as did, from a political perspective, Gov. Howard Dean, and Gen. Wesley Clark, both candidates for the Democratic nomination in 2004.
The reason this is important is that it unhinged keeping prices stable, from keeping resource prices down. In the neo-classical synthesis, lower labor prices mean lower demand, and that means lower prices. Inflation is cured by taking money away from people who would otherwise spend it, and low inflation mean financial profits, which could, in turn, be used to "finance" long term obligations. The fundamental folly is that one cannot finance real demand, with paper profits. Bankers do not find oil, they find copper, they do not make anything. One cannot "pay" for retirees with bonds, only with the real goods that retirees need, such as food and medicine.
Once unhinged, resource prices marked up to a peak of resource inflation. To combat this, wages had to stagnate further. Doing this drove more globalization, which meant more people with demand for cars, houses, and goods in the rest of the world. The problem is that a person who is just barely in the developed system uses a large fraction of the resources that someone who is solidly in it does. In fact, in some cases more, since they drive less efficient cars, and live farther from where they work. 10 Chinese people may make about what one US worker does, but they use similar amounts of raw materials. The average American home isn't 10 times as large as the average Chinese apartment, and a scooter uses one third. not 1/10th as much fuel. The marginal curve of resource consumption means a person jumps from out of the system to in it, and burns much more resources.
This jump was well recognized in the Depression, and in the 1950's. In the depression, when the price for goods dropped below the fixed cost of keeping the capital running, the capital was not slowed, it was idled. In the 1950's the drive for segregation in the south, was the drive to keep African-Americans out of the middle class life style, and thus fundamentally cheaper.
It was made in the other direction in China: in 1975 there were thousands of bicycles on Chinese roads, now there are cars. One bicycle is a hundred times more efficient at moving one person to work.
Thus the more disinflation from China that was used to offset resource inflation, the more pressure there was on resources. The system was broken, and playing with the quantity of money would not fix it, because the US was damned one way or another. The shift was no longer of control of the capital system from one group of wealthy to another, but from the US, to other countries, and all demand in the end, became demand for oil and other commodities.
Part II tomorrow.