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A Bender of an Era: Krugman Sees the oncoming train

Stirling Newberry's picture

[Welcome, Ian Welsh readers! Welcome, Crooks and Liars readers! --lambert]

Part II here.

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:

  1. The effects of the bursting of the bubble in stocks will fall primarily on the rich.
  2. The rich will be bailed out with tax cuts.
  3. 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.
  4. This bubble will burst because it is pure consumption.
  5. The result will be a much larger recession than forseen, the way the 1975 recession was much sharper than the 1969 recession.
  6. 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.
  7. 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.

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Submitted by lambert on

"assert it in 2002"? Anything online?

* * *

Awesome post! I think this para has a typo:

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 by 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.

And I don't understand this:

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.

"Much less" and "much more"? What is much, and why the polarization? Leverage?

Stirling Newberry's picture
Submitted by Stirling Newberry on

Was I think the first time I wrote about it online.

Submitted by jawbone on

Get the people to sing?

Tricoteuses unite?

How do we get the people to unite? To fight? To act in their own best interests?

How do we fight this?

Do you hear the people sing?
Singing a song of angry men?
It is the music of a people
Who will not be slaves again!
When the beating of your heart
Echoes the beating of the drums
There is a life about to start
When tomorrow comes!

Will you join in our crusade?
Who will be strong and stand with me?
Somewhere beyond the barricade
Is there a world you long to see?

Then join in the fight
That will give you the right to be free!!

Do you hear the people sing?
Singing a song of angry men?
It is the music of a people
Who will not be slaves again!
When the beating of your heart
Echoes the beating of the drums
There is a life about to start
When tomorrow comes!

Will you give all you can give
So that our banner may advance
Some will fall and some will live
Will you stand up and take your chance?
The blood of the martyrs
Will water the meadows of France!

Do you hear the people sing?
Singing a song of angry men?
It is the music of a people
Who will not be slaves again!
When the beating of your heart
Echoes the beating of the drums
There is a life about to start
When tomorrow comes

nihil obstet's picture
Submitted by nihil obstet on

Over the past three decades, average wages have deteriorated and personal economic insecurity has increased. All the benefits of growth have gone to the top. During the lost decade in Japan, people still had food, housing, medical care, reasonably secure employment, and pensions. They were better off by some measures than most Americans are.

So if we get economic stagnation in the U.S., how does it change things? The problem is still political -- who has reasonably secure access to sufficient resources for a decent life. Given the elites' increasingly rapacious looting of the country, will lack of real or bubble growth have a big effect on most people? Fear of Japanification has started sounding to me like belief in the wondrous effects of free trade.

Tony Wikrent's picture
Submitted by Tony Wikrent on

in the sense that the "Lost Decade" in Japan was a loss only to the financial predators. While Japan's economy in the last 20 years was supposedly stagnating, Toyota and Nissan managed to capture the luxury car market with their Lexus and Infiniti brands against competitors who had been building their brands for decades. What DID stagnate in the "Lost Decade" were the financial games and profits of speculators and usurers.

I discuss this more, including my own remembrances that the Japanese real estate and stock market bubbles were both created and popped by Wall Street after Japan was forced to open its financial markets, What really caused Japan's Lost Decade?

okanogen's picture
Submitted by okanogen on

Huge post.

For a long time now I have been saying that the driver towards alternative energy is (or should be viewed as) the replacement of commodity pricing for energy to a capital investment.

In the context that (our policy makers have) that U.S. wages are what drive U.S. inflation ("Cheap Chinese goods sold by Walmart help our economy by keeping prices down") the actual fact that the increased global demand for resources (especially energy) is what is REALLY driving price instability means we are not just selling the rope to hang ourselves with, it means that we are selling it as a conscious policy decision. If it takes 5 Chinese workers using 60% (for example) of those commodities apiece to match the productivity of 1 U.S. (or European) worker producing the same flat-screen TV, that means 5 * .6 or three times the energy is needed. Demand for energy is three times higher, driving pricing for energy upwards by a multiplier globally. This creates "inflation" here, which leads our policy makers to call for more regressive taxation and downward pressure on wages (to protect the investor classes assets), meaning goods need to be produced more cheaply to be affordable, which drives production to low wage countries overseas, which leads to increased energy demand, which leads to..... A vicious circle!

By contrast, a wind turbine, hydro power, or solar panel has a fixed installation cost which can be capitalized and amortized, unaffected by commodity price spikes, by demand, by accident, or by collusion. In this case, capital is actually a solution, as is increased energy efficiency (a capital investment), and automation, a capital investment which increases worker productivity and reduces commodity/energy usage.

As long as our policies support commodity priced energy over the alternative of capital investment and energy efficiency, it will be a race to the bottom, with workers and the middle class losing as we pay more for less, while being forced to work for less.

Oh, and then there are the wars and stacks of dead bodies we need to maintain access to the cheap labor and cheap energy. Let's not forget that.....

Submitted by lambert on

That example explains the argument very clearly.

All this doesn't just feel like doubling down, then; it is doubling down.

okanogen's picture
Submitted by okanogen on

China leads the world in ramping up to renewable energy production. Unlike us, they understand that global demand for commodity energy (oil, gas, coal) can be avoided by capital investment on renewable energy projects.

It has nothing to do with their wanting to be "green", they could give fuckall about that.

okanogen's picture
Submitted by okanogen on

I'm starting to think there is a useful and important distinction to make between "rent", where someone charges to recoup the initial cost and maintenance of a capital investment (house, apartment, etc.) that they own and someone else uses, and "skim" where someone charges for the use or maintenance or access to what someone else owns (pension, insurance, retirement account, savings, investments, government airwaves, the interwebs).

The fundamental difference I see is that in the first case (that of "rents"), something of value is created which serves an actual purpose (it provides shelter, provides food, provides energy, provides transportation) and needs to be paid for. Plus, if many people can share in the use of a capital expenditure by paying just a part of it as "rent", doesn't that give lower-income people more access to capital intensive things which improve their lives at a cost that corresponds to their use fo this thing? In this case, I would include the capital improvements paid for through taxes as well (bridges, roads, hospitals (one day), etc.).

In the second case (that of "skims"), nothing of value is created, the supposed "need" is based on the manipulation of a governmental or financial system to forcibly extract money for a service which wouldn't need to exist, except to protect you from other aspects of the governmental or financial service which are trying to forcibly extract money from you. Basically, it is a protection racket. "Nice little life you have here. Be a shame if anything happened to it.....".

The existence of "skims" (which I would call "bad") pulls money and effort and energy from the creation of things where we would charge "rents" (which I would call "good" in many ways).

Yet another vicious circle.

And that is why the decision to bail out banks, rather than directing money to capital improvement projects, alternative energy projects, energy efficiency projects, etc. is going to ring down the curtain on the U.S. economy.

par4's picture
Submitted by par4 on

doesn't appear to be working. P.S. That's where I first read your and some others work.

ScentOfViolets's picture
Submitted by ScentOfViolets on

With all due respect, while the Japanification thesis seems correct, I think you're wrong to fault Krugman, in particular given this:

The problem, to Krugman, is that more people like Krugman weren't being listened to.

Iow, you are faulting Krugman the economist for not being Krugman, the insightful politician. You are entirely correct about people who were not mainstream economists seeing this one coming from a long ways off, but it seems that the people who were right on this got to be that way on the basis of political, and not economic analysis.

Of course surreptitiously refinancing a large banks by giving them interest-free loans which they are not obliged to pass on while they accrue interest from reinvesting that money into safe securities is just about the worst way to handle the problem. (economic)

Of course that's exactly what is going to happen. (political)

Stirling Newberry's picture
Submitted by Stirling Newberry on

for following certain patterns which had inherent economic contradictions, which would lead directly to where we are now. Bush merely accelerated the process by a decade, but it was almost inevitable that it would happen, since we were not going to have a moderate party in perpetual government the way the Japanese have.

The key economic problem is the limitation of the monetary era itself: what happens when the interest rate low enough to sustain the economy, is too low to attract savings? The answer is brutal: two monetary regimes are created, a low interest rate one to sustain credit, and a higher one to sustain the flow of savings from the wealthy.

It is mathematically impossible for such a system to be pareto optimal.

ScentOfViolets's picture
Submitted by ScentOfViolets on

But if the policy prescriptions favored by Krugman were the ones enacted rather than the strategy that was actually pursued, would this scenario still have inevitably played out?

I think the difference here is that you and Krugman seem to be at cross-purposes; as an economist he's giving his best advice (and I agree with him there). What you seem to be saying is that in the real world (and I certainly agree with you on this one), the chance of this advice actually being followed is so close to nil as to make no difference.

Stirling Newberry's picture
Submitted by Stirling Newberry on

It's inevitable, because profit comes from volatility, and volatility comes from being close to the critical point. The necessity of a neo-liberal system is near price stability combined with high financial volatility and extreme concentration of profitability.

To make money in this environment involves making 50/50 bets, and doubling down each time you lose. A strategy called "a martingale." Eventually a run that is bad enough will come along, even if the table isn't otherwise rigged. The rule of exponential growth is simple: doublings get expensive very quickly. But this isn't the turn of cards, the runs are correlated. People tend to lose their houses in clusters, because of the way marginal value works: a slight move exposes a great deal more people to risk than before.

It would be like trying to fly a 747 loaded with passengers and explosives at just stall speed across the US nape of the earth. It might seem OK over Kansas, but as soon as you hit the rockies, you aren't in Kansas any more.

ScentOfViolets's picture
Submitted by ScentOfViolets on

As always, of course, there is nothing new under the sun. Galbraith back in the 50's made a big deal about "countervailing power" and how it had to be taken into account in any sort of economic analysis. And he was far from the first to do so.

And again as always, a punchy metaphor helps clarify the thought: the current situation is a lot like having men with bullets putting guns to the heads of both the populace and the nominal heads of state (all quite legally of course), and who use the power of the gun (power of a purely destructive sort) to push policies for more bullets. With these sorts guys and the way they tend to think, things don't usually change until they run out of ammo.

Accordingly, a prediction: this won't change until the age of peak oil is passed. Resources that could have eased the transition for everyone will be squandered on excess for the few while most suffer under the lash (by the ancient maxim, "The Thin starve before the Fat suffer.") Once the oil power is gone however, the worm will turn with a vengeance. Even the paid-for bullyboys and the bought politicians will be in on the kill, once they realize the last time money changed hands under the table was the last time. These sorts of arrangements aren't the sort that fosters good relationships, or makes friends and allies. Not after the money runs out.

Stirling Newberry's picture
Submitted by Stirling Newberry on

Repays reading again and again.

"Financial genius, is leverage and a rising market."

Stirling Newberry's picture
Submitted by Stirling Newberry on

The problem with what JKG called "the dubious magic of monetary policy" is that the best it can do, is get to the best you can get to. Fiscal policy, and only fiscal policy, can get to places that are better than where the market can reach.

In econospeak, the market for the future is incomplete. Or to put it in old Yankee terms "you can't get theah from heah" if all you are doing is making it easier for people to do, what they can already do.

Joseph Cannon's picture
Submitted by Joseph Cannon on

By making regulation -- the rule of law -- ideologically impermissible in the financial sphere, Libertarianism has inflicted more human misery than did Communism.

Stirling Newberry's picture
Submitted by Stirling Newberry on

but it is probably leading in the career actives list.

Marxism and Libertarianism are, in fact, sibling ideologies, in that the parlay a few insights into human behavior into a logical apparatus.