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Desperately Seeking Something — Anything!


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Donald L. Luskin

It’s not easy being Paul Krugman these days. He’s got a new book coming out, and he’s trying his damnedest to push it. He’s all over the talks. He even did an interview with Rolling Stone last week — he’s got a cover line sandwiched between “Eminem vs. Jarule: An Underground Rap War Heats Up” and “All-Girl Smackdown: Inside the World of Pro Catfighting.” But the timing just isn’t working. His book is called The Great Unraveling, but right now most things seem to be raveling. I’m thinking remainder bins.

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Think, for a moment, about how good things have been lately, and how hard a catastrophist like Krugman has to work to make them seem bad. The U.S.-led invasion of Iraq was a brilliant victory (Krugman: ” … it did the terrorists a favor … “). President Bush signs into law today an historic pro-growth tax bill, enacted thanks to the support of cross-over Democrats (Krugman: ” … the administration … actually wants a fiscal crisis … “). Even the crisis in corporate malfeasance seems to have been overcome (Krugman: ” … they can get away with even more self-dealing than before … “).

The thing that actually seems to be unraveling these days is Krugman’s home base, the New York Times, which is sinking ever deeper into the Jayson Blair maelstrom (Krugman: deafening silence). Krugman has also had his own taste of scandal in recent weeks, thanks to some relentless fact-checking on behalf of The Conspiracy to Keep You Poor and Stupid and the Krugman Truth Squad here on NRO.

But America’s most dangerous liberal pundit is not retreating. Instead, he’s finding safe harbor in the one realm he believes no one can seriously challenge him: economics.

Atypically for Krugman the economist, his column in last Saturday’s New York Times was actually about economics. And it was a big one — over 1,500 words, about twice the length of his usual op-ed for the Times.

The column centered on two economic concepts: deflation and the “liquidity trap.” As you might expect, Krugman tried to make it seem that imminent cataclysmic catastrophe is looming. But of course, only he and a few other really smart people can see the danger.

Krugman began with deflation. He introduced the concept using one of his favorite rhetorical tricks: pump up the importance of an issue, then try and make your take on it legitimate by citing the recent comments of a big-time authority figure — one who happens to agree with you. In this case, he cited “a rather ominous report” on deflation issued by the International Monetary Fund. The report, Krugman wrote, has Alan Greenspan “worried” because it shows Germany joining Japan as the next deflation victim.

Krugman cited the report five times. He included shock jargon like “adverse dynamics” and “deflationary spiral” — he even proudly mentioned that the report “draws on my work on the subject.”

But hang on — who says the IMF is an authority on deflation? In the past, Krugman himself has called the IMF “chumps,” has said it operates “like medieval doctors who insisted on bleeding their patients, and repeated the procedure when the bleeding made them sicker,” and has derided their ideas as being based on “bankers’ orthodoxy, not textbook economics.”

What is deflation, anyway? According to Krugman, it’s “a general fall in the level of prices.” Okay, simple enough. Now can Krugman tell us what causes it? Yep — the “liquidity trap.” Krugman wrote, “Once an economy is caught in such a trap, it’s likely to slide into deflation.” Now, can Krugman tell us what’s so bad about deflation? Yep: ” … the most important reason to fear deflation is that it can push an economy into a liquidity trap.”

Whoa. How’s that again? Liquidity traps cause deflation and deflation causes liquidity traps? This is why parents pay the big bucks to send their kids to Princeton?

Okay, let’s get our money’s worth and ask the professor what a “liquidity trap” is. As Krugman explained, ” … what if the economy is in such a deep malaise that pushing interest rates all the way to zero isn’t enough to get the economy back to full employment? Then you’re in a liquidity trap: additional cash pumped into the economy — added liquidity — sits idle, because there’s no point in lending money out if you don’t receive any reward. And monetary policy loses its effectiveness.”

With interest rates already at zero, Japan would be said to be in a liquidity trap because the Bank of Japan can’t lower rates any further. Krugman stated that, in the United States, “with the overnight interest rate down to 1.25 percent, the Fed has almost run out of room to cut.”

Of course all this rests on the Keynesian economic orthodoxy to which Krugman proudly subscribes. Krugman and fellow Keyensian travellers expect that a central bank like the Fed can and should rescue the economy from occasional slowdowns by stimulating borrowing activity with artificially low interest rates. Krugman once described it as “the Keynesian compact” that allows brutal free-market economies to operate: “Oh, there are recessions now and then,” he wrote. “However, when they occur, everyone expects the Fed to do what it did in 1975, 1982, and 1991: cut interest rates to perk up the economy.”

The liquidity trap actually describes a failure of the Keynesian theory of the role of the central bank. It proves that it doesn’t work. In most sciences, this would be sufficient to throw out the theory. But Keynesian economics is not a science, it’s an orthodoxy — and failure is not an option among the orthodox.

So, evidence of the orthodoxy’s failure is given a technical name — the liquidity trap — and itself becomes a part of the orthodoxy in a new, more elaborate version, one that’s intensely studied by cultists like Krugman with even more single-minded solemnity than the original. Oddly, John Maynard Keynes himself first described the liquidity trap — but then again Keynes was never so orthodox a Keynesian as his latter-day followers.

If you don’t believe the orthodoxy that a central bank is supposed to (or be able to) turn recessionary lead into expansionary gold by lowering interest rates, then that leaves it with a pretty simple mission in life: to preserve and keep stable the value of the currency. This includes preventing events such as deflation, correctly and simply described as “a general fall in the level of prices.”

Such a mission consists of little more than printing the correct amount of money to meet the commercial demands of the economy — print too much and you get inflation, print too little and you get deflation. As Milton Friedman said, “Inflation” — or, for that matter, deflation — “is everywhere and always a monetary phenomenon.”

With that simple view of the Federal Reserve’s mission, I give you economist David Gitlitz, a new Krugman Truth Squad member and my colleague at Trend Macrolytics. Gitlitz correctly argues that the liquidity trap “is akin to an urban legend,” and that deflation is nothing to be especially feared just because interest rates are near zero. He wrote in a client report yesterday,

As Fed Governor Ben Bernanke observed in a speech last fall, the Fed has an important tool at its disposal — the monetary printing press — that would allow it to directly inject essentially unlimited quantities of liquidity into the financial system if need be. Fed Chairman Alan Greenspan has reiterated on several occasions that the central bank could easily provide liquidity by jettisoning the rate-targeting regime and focusing its open market purchases on longer-term maturities.

But Krugman knows this. He’s recommended that very solution as a fix for Japan’s deflation. And he knows Bernanke’s views intimately: Earlier this month he bragged on his personal website about “Princeton — where the Fed’s Ben Bernanke was department head until a few months ago … ”

So here’s the lesson. Just follow the money when Krugman writes things like, “those of us who worry about a Japanese-style quagmire find the global picture pretty scary” or “the risks look uncomfortably high” or deflation “will be very hard to reverse.” As new Krugman Truth Squad member Caroline Baum put it in her Bloomberg.com column yesterday, “the Schadenfreude was palpable.” That’s because Krugman is desperately seeking something — anything! — that’s unraveling (other than the New York Times). He’s got books to sell.



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