Paul Krugman and the New Keynesians

I just had read Paul Krugman’s book – End the Depression Now - for the second time. Everyone regardless of political philosophy should read this book. Even though Paul Krugman has become the top spokesman for Keynesian economics, he writes clearly, succinctly, and intelligently for an economist. Perhaps, Paul Krugman should rewrite Keynes’s book. Unfortunately, the world’s two most famous economists, Maynard Keynes and Karl Marx, are incredibly long-winded writers as every sentence overflows with superfluous words, and sentences stretch across pages.

Paul Krugman is correct in many ways but errs in other ways. The world continues to struggle from the Great Recession that struck the world in 2007. Something seriously happened to the U.S. economy, and many people do not get it. Paul and I get it, and I understand why most people do not get it. Everyone grew up during the prosperous times when the U.S. economy plowed ahead and created millions of jobs while the U.S. military and U.S. businesses dominated the world. If someone wanted to work, the person would simply fill out several job applications and wait for the phone call. Then this person had a job. Then this person could apply for other jobs while working, and gradually transition themselves into better positions.

Nevertheless, something had changed. After the 2007 Great Recession, the U.S. economy has become stuck like a truck spinning its tires in the mud. Jobs had become scarce while the unemployment rate gradually falls towards the 5% rate, which we consider normal. However, many smart people know something had broken in the U.S. economy.

Many politicians and leaders view the falling unemployment rate as a barometer on the economy’s health. However, a falling unemployment rate masks two problems. First, the U.S. government does not count discouraged workers as unemployed. Discouraged workers want to work, but they stopped searching for employment because they believe they can’t find a job in the economy. Second, some people found part-time jobs after being laid off during the 2007 Great Recession. However, some of these people want to work full time and not part time.

What had happened? Something struck the economy like the Ebola virus coursing through a healthy person’s body. Of course, I argue the transition from a manufacturing economy to a service-oriented one had replaced many good-paying, full-time jobs with low-paying, part-time jobs. Then we add an overbearing, all-controlling government that further damaged our economy. Now, we arrive at the first rule - just like the socialists and communists, Keynesians accurately describe the poor’s plight and misfortune.

Rule 1: The Keynesians, Socialists, and Communists can accurately describe the plight of the poor and misfortune in our society.

Paul Krugman correctly assessed Europe’s plight. European leaders have fallen into the austerity trap - governments must increase taxes and reduce government programs. If people picked up an elementary economics textbook, they would discover austerity would be a disastrous policy. During recessions, government should increase government spending and/or reduce taxes because the government injects money into the economy, raising consumers' incomes and spending. Similarly, the government could reduce taxes, allowing taxpayers to keep more income, so they can increase their spending and help expand the economy.

Paul Krugman, however, has missed the point. The European countries never used Keynesian economics correctly, which becomes Rule 2. Governments should use austerity during economic expansions that would slow the economy. Austerity helps create budget surpluses to reduce the government’s debt and strengthens a government’s finances. Then during a crisis or recession, government can boost its spending and lower taxes to expand the economy. Unfortunately, European governments reduced taxes and boosted government spending during the economic expansion, weakening their financial resources. As European governments tried to increase government spending during the 2008 Financial Crisis, investors became leery, pessimistic, and fearful. They stopped investing in Greek, Spanish, and Irish bonds. Investors believed these governments had issued too much debt, and the governments would experience troubles repaying the bonds with interest. We know this became true. Remember the Greek haircut? Euphemism for forcing the bondholders to take a 50% loss on their Greek bonds.

Rule 2: For pure Keynesian economics, government reduces spending or raises taxes during economic booms and boost spending or reduces taxes during recessions. Thus, government strengthens its finances to handle downturns in the economy.

Keynesians are biased towards government spending, which becomes Rule 3. Don’t get me wrong. I understand the concept well. Every economy has four broadly defined sectors: Consumers, businesses, governments, and exports-imports. During a recession, consumers and businesses become fearful and pessimistic about the future. Consumers reduce their spending, buy fewer imports, and boost their savings. As businesses sell fewer products or services, companies lay off some of their labor and reduce their investments. Meanwhile, if the recession had spread to a foreign country, then foreigners buy fewer exports from us. Consequently, our economy takes a huge hit from lack of spending. Consequently, government becomes the only entity that can defy the recession and can boost its spending to overcome society's lower spending.

Rule 3: Keynesians have a bias towards government spending. Nevertheless, government can reduce taxes to expand the economy and raise taxes to slow the economy down.

Many Keynesians discourage businesses, government, and consumers from saving, leading to Rule 4. They must spend all their incomes in the economy to buy goods and services, and keep the economic machine turning. Since everyone becomes fearful and saves more during recessions, people remove money from the economy. Thus, Keynesians are correct if people hide their savings under their mattresses while business and government store their money in vaults. On the other hand, if companies and people deposit their funds into banks, then banks can lend out their funds. Consumers borrow to buy houses, cars, and appliances while companies borrow to invest in buildings, machines, computers, and equipment. This explains why the Asian tigers - Hong Kong, Singapore, Taiwan, and South Korea - grew phenomenally. Asians are phenomenal savers who deposit their savings into banks. Then banks could grant loans to businesses that invest in their economies that fuel their extraordinary economic growth rates.

Rule 4: Keynesians are against businesses, government, and consumers from saving. They must continually spend to prop up the economy.

Here is where Paul and I begin to diverge. Keynesians pick certain periods to show Keynesian economics works, which becomes Rule 5. They always point to a particular time such as the U.S. government preparing the U.S. economy for World War II. The U.S. federal government ramped up spending to build ships, trucks, weapons, and supplies for soldiers. U.S. manufacturing went into overdrive and stomp on the economy’s accelerator. Many young men joined the armed forces while many factories hired women to work in the factories. No question, Keynesian economics had worked.

Rule 5: Keynesians choose their times well to show Keynesian economics works. Then they neglect other times when Keynesian economics had failed.

Everyone forgets Franklin Roosevelt, who started his presidency in 1932. The president boosted government spending during the 1930s by creating numerous alphabet soup agencies and sponsored massive public works projects. Did the U.S. economy recover? No - the U.S. economy had entered a recession in 1937. Of course, the U.S. government also raised taxes, which the government should never do during a recession, and the U.S. government encouraged companies to keep paying high wages to the workers. The high wages ensured the workers retained their purchasing power. Unfortunately, people increase their savings during uncertain times and reduce their spending.

Let’s say the Great Depression was an anomaly. I can find another significant failure of Keynesian economics. Japan entered its two-decade malaise starting in the early 1990s. Japan also used Keynesian economics since the 1990s as the Japanese government amassed a public debt to GDP ratio of 200%. Consequently, the Japanese economic engine continues sputtering and struggling along since the 1990s. What makes Japan unique is the Japanese government bonds are held within Japan, and thus, Japan has little risk of foreigners triggering a financial crisis, which I explain later in this blog.

Returning to our side of the world, the U.S. federal government has dumped trillions of dollars into the economy since the start of the 2008 Financial Crisis, and we have witnessed the weakest recovery ever. Of course, Paul Krugman said, if Keynesian economics does not work, then government must scale up its spending, which becomes Rule 6. Using Paul’s analogy from his book, the broken economy represents a car with a defective battery. The government must only replace the battery to get the car running again. Well, the government has spent $700 billion to bail out the financial institutions and another $831 billion for the American Recovery and Reinvestment Act of 2009. Then the Federal Reserve, our central bank, lent about $2 trillion to bail out the banks. Replacing the battery has become expensive while that damn car still won’t start. The U.S. economy measures about $16 trillion, so if government continues boosting its spending, it will dominate and control our society, similarly to the Soviet Union, where the bureaucrats controlled the entire economy.

Rule 6: Communists and Keynesians only differ in their scale of the government's planning.

I do agree with Paul Krugman – government should never decrease government spending or boost taxes during a recession. Nevertheless, I must add one caveat - government must have strong finances to weather the downturn. In his book, Krugman cites Minsky, an unknown economist. Minsky expounded a simple idea. A company with low debt can expand quickly by taking out bank loans, which we call leveraging. The company continues doing well and keeps expanding while banks keep granting the company more loans. Then a crisis happens, and banks start examining their loans. If banks believe the company has too many loans, the bank cuts the company off, which imposes hardship onto the company. The company begins deleveraging by cutting back on spending and repaying its loans. If a financial crisis strikes the company, then the company may nosedive while the bankers, stockholders, and bondholders panic. Subsequently, the company accelerates towards bankruptcy.

For example, Lehman Brothers bankrupted in October 2008. It began with a leverage ratio of 26 to 1 in 2003 that surged to 39 to 1 in 2006. Consequently, Lehman Brothers borrowed $39 for every $1 it had in equity. Equity measures a company’s financial strength by taking its assets and subtracting its liabilities. Investors want a low leverage ratio because they want to recoup their investments if the company bankrupts. Unfortunately, Lehman Brothers borrowed to buy expensive real estate at the height of the housing bubble.

Did you catch the irony? The U.S. federal government has a leverage ratio too. We know the U.S. government has accumulated $17 trillion dollar debt, but we do not know the government’s equity. Although the U.S. government spends about $3.5 trillion per year, this does not represent equity. We must add all the government’s assets, such as military bases, equipment, government buildings, and other assets and subtract its liabilities. I bet the government's current leverage ratio tilts towards the high side. If a government debt becomes too high, investors will stop buying the government bonds, triggering a financial crisis. Then government must deleverage by paying down its debt and selling off its assets. Unfortunately, the U.S. government holds many assets that it cannot sell, such as military bases, weapons, and so on.

Paul Krugman argues the U.S. government could ramp up its spending that would push the U.S. debt to new records. Although a high debt could trigger a financial crisis, a government does not have to deleverage if it experiences financial trouble. A government could force its central bank to buy government bonds. Thus, the central bank prints money to cover a government budget shortfall. However, printing money leads to inflation and weakens a currency. (The Greek, Irish, Italian, and Spanish governments have no control over the central bank. They only have the power to tax, spend, and borrow. Since investors do not want to buy these government bonds, these governments cannot expand government spending or reduce taxes during a recession.)

Here is where Paul Krugman stumbles in his book, which becomes Rule 7. The U.S. federal government cannot weaken the U.S. dollar by forcing the Federal Reserve to buy U.S. bonds because people around the world hold U.S. dollars to save their purchasing power. If the U.S. government weakens and depreciates the U.S. dollar, people will stop holding U.S. dollars. Then many countries will stop investing in U.S. government securities. For example, China holds roughly $1 trillion in U.S. securities. If the Chinese believes the U.S. government will depreciate the U.S. dollars, then those U.S. government bonds and U.S. dollars plummet in value. Thus, China will dump those dollars and bonds that would trigger a financial crisis. Then the world rushes to unload the U.S. dollars and U.S. government securities, and we Americans will truly experience hard times.

Rule 7: Government cannot debase its currency if the world uses the country’s currency as the world’s transaction currency. Thus, the Eurozone and United States cannot devalue their currencies to jump start exports.

I am not anti-Keynesian, and I do not object if a government builds and expands roads, hospitals, schools, and infrastructure during a recession to create jobs. Nevertheless, the government must possess good finances, which becomes the most important rule – Rule 8.

Rule 8: The politicians have butchered Keynesian economics. Most governments did not raises taxes or reduce government spending during good times, so they could reduce their debts and strengthen their finances. Then governments would have the resources to combat the downturns in the economy.

Thomas Piketty, Income Inequality, and the Wealthy

Thomas Piketty, the new red-hot French economist, has taken the world by storm by writing his bestseller – Capital in the Twenty-First Century. He studied income inequality for many nations and summarized them in his book.

Thomas concluded family dynasties control the economy and not the new wealthy. Furthermore, the rate of return on capital exceeds the economy's growth rate. What does this mean? Everyone takes a slice of the economic pie by working and spending in the economy. A growing economy expands the economic pie, so, in theory, everyone in society can take a larger slice. However, the wealthy earn incomes from owning the capital. Thus, their share of the pie grows faster than everyone else. Thus, the rich are becoming richer while the poor are getting poorer. Dr. Piketty has recited Karl Marx with the same twist, which leads to Rule 1.

Rule 1: Every society has a wealthy or privileged class.

Name a society that eliminated their wealthy and made everyone equal? The Soviet Union! Although Vladimir Lenin and his gang seized all the capital – land, buildings, machines, and equipment, they created a new privileged class – the members of the communist party. They called them apparatchiks – the Russian root meaning apparatus. They became the devices of the state, cogs in the bureaucratic machinery, to carry out the communist philosophy. This system had failed.

As the Soviet Union was disintegrating, the top ranking communist party members grabbed the state's assets and became the new businessmen in Russia.

If countries adopting communism are so great, why do these countries imprison their citizens behind barb wire and walls? The military guards and patrols the borders, preventing its citizens from escaping. Communist governments also form large prison camps and incarcerate any dissident or citizen with the slightest inkling of dissent. Reading the wrong book at the library could trigger a life sentence in a political prison camp.

Communists held another tenant - everyone must work. Although the communists freed the workers from the capitalists, the workers became slaves to their new masters – the state via the communists. Societies can achieve great things with slave labor such as building the pyramids of Egypt or harvesting the cotton fields in the southern United States during the hot, humid summers.

That brings Rule 2. China, Cuba, Russia, North Korea, and Vietnam have tried Communism, and all of them had failed. All these countries except North Korea started incorporating market economics and capitalism into their systems. Communism in its pure form does not work and will never work.

Rule 2: No country has ever adopted and used Communism successfully.

As Deng Xiaoping regained power and became president in China, he said, "I have two choices. I can distribute poverty or I can distribute wealth." Then he gradually opened China to free markets. Starting in the late 1970s, he began deregulating the agricultural markets and allowed people to grow and sell their own food. Then he allowed entrepreneurs to start and manage small and medium size businesses. However, the communist party of China still controls the large-scale enterprises.

The communists claim these countries took shortcuts and never adapted Communism correctly. Experts are right. A communist government never adopted the ideas of Communism correctly. If countries cannot adopt it correctly, then why try it? On the other side, if we did adopt communism, whom do you think will be the new communist party members? The same politicians, we have elected into office.

I have read Karl Marx. He never said everyone should earn identical wages, and everyone should receive equal pay. He stated workers should earn the value they contribute to a good. For example, if a worker contributes $500 to a product, then he or she should receive $500 in wages for that work. However, the owners of capital siphon away the worker's contribution and pay the worker a fraction of his or her contribution. Marx never said all workers should earn the same wages.

Then Piketty added the rich inherit their wealth. Did he have to tell us that? Everyone already knew this. How many millionaires and billionaires donate all their wealth to charity after their death? Only a handful of the wealthy such as Bill Gates, Warren Buffet, and Mark Zuckerberg donate large sums to charity. Piketty is correct – the wealthy garner larger shares of the capital, which leads to Rule 3.

Rule 3: Wealthy can easily maintain, expand, and propagate their wealth.

For example, Bill Gates founded Microsoft that successfully copyrighted the software for an operating system. Since then, Microsoft has not developed innovated products. However, when the company sees something new, it buys and assimilates the company into Microsoft. This has been occurring in the U.S. economy during the 20th century. In the early 1900s, the industries for tobacco, cars, beer, soda, and so on had dozens or more companies operating in the market. One hundred years later, two or three large corporations dominate these markets.

Wealth carries a dangerous side effect. Most people do not realize a country with a good legal system and private property rights will protect owners of the property. The wealthy will use the state to help protect them. For instance, I start a new company and introduce a new operating system. People like it and people begin switching from Microsoft's Windows to my system. Subsequently, Bill Gates contacts his friends in Washington, D.C. – the politicians whom everyone hates. The politicians can sic the tax authorities and regulators on me. With the numerous laws and regulations, they will find severe violations and use them to close me down or bankrupt me with massive fines. That leads to Rule 4.

Rule 4: In capitalistic countries with free markets, the government establishes institutions to protect private property. Then the state protects the wealthy who hold and own the property.

Piketty and others clamor a wealth tax or want government to impose more taxes on businesses. He is from France, and France imposes high taxes on everyone. Moreover, it had passed a wealth tax in 2006. Some of the wealthy fled France and moved their wealth to other countries. Although the French government raised $2.6 billion per year in new taxes, France lost about $125 billion in capital as the wealthy fled the country. Thus, all countries must pass the same wealth tax to stop the wealthy from fleeing. Of course, several countries will hold back such as Hong Kong, Monaco, and Singapore, giving the wealthy a haven to flee to.

I have liberal friends who criticize our political leaders. Then they turn around and want the government to tax the rich. Thus, the liberals want the politicians whom they despise to determine how to spend the tax money, leading to Rule 5. Politicians controlling more money can control and manipulate more things in society. As an illustration, just examine President's Obama's Healthcare Plan and the mess it has created.

Rule 5: A tax only expands the state's power and gives the government more control over the economy.

Paul Krugman, an advocate of Thomas Piketty, won the noble prize in economics in 2008. Sometimes, he can be brilliant and raise a good point in his blog and writings while, other times, I wonder if this guy came from a different planet. Sometimes he goes off the deep end, and I wonder if anyone takes Paul Krugman seriously anymore? Hey, hold on. He did propose the U.S. government should use Keynesian economics to build a defense against a Martian invasion. This brings us to Rule 6. Economists isolate themselves from society, and sometimes, they develop policies and recommendations that deviate far from reality.

Rule 6: Most economists come from the upper middle class and higher. If they teach or do research in a university, then they isolate themselves from the world and its problems.

Although I am not a Keynesian and do not want the government to expand taxes, I am also not a Republican. The Republicans can be scarier than their democrat counterparts. After the 2008 Financial Crisis, they began calling the wealthy the job creators. They cleverly spun a new twist on an old word, which becomes easy to dispel. In the last 20 years, what kind of jobs has the wealthy created? The good-paying jobs continue disappearing and being replaced with part-time, low-wage jobs.

I know because I remember growing up in Michigan. When I was a boy, many people worked in the factories producing cars and products for the nation and the world. Factory workers joined unions and earned high wages with excellent benefits. When I entered the workforce, these union jobs had disappeared - the first causality of international trade.

I am not bitter at the wealthy. Who cares about the rich? People who cannot find good-paying jobs should be allowed to create their own jobs, which becomes Rule 7. True capitalism lets anyone become entrepreneurs to create income for themselves. During the last three economic expansions, small and medium size businesses created the most jobs while large corporations created few jobs. As the economy expands, local and state governments also create jobs, hiring regulators to control the economy – the state's apparatchiks. Unfortunately, governments at all levels in the United States must control and regulate businesses.

Rule 7: A society with a good legal system should encourage its citizens to become entrepreneurs. Successful entrepreneurs establish growing prosperous companies that hire workers.

For example, Thailand has a poor legal system, but the Thai government lets its citizen work and support themselves. I walked by a street corner several times with a space of 10 feet by 20 feet on the sidewalk along the curb. In the morning, the entrepreneurs sold t-shirts. Then they transformed this space into an outdoor restaurant in the afternoon and a bar at nighttime. Imagine how many rules and regulations this business would violate in the United States if an entrepreneur tried to do this on any street corner in any U.S. city.