By Bill Wilson — Leave it to the New York Times’ Paul Krugman to find a tautological rationale for never cutting spending. Writing March 11 on the €105 billion default of Greece, Krugman warns U.S. policymakers against “trying to reduce deficits too quickly, while the economy is still deeply depressed”.
Krugman is resisting the often-made comparison between the United States’ trillion-dollar annual record deficits and Greece’s own predicament. It has been suggested that, through our profligacy here, the default there is an outcome we are inevitably risking.
“Not a day goes by without some politician or pundit intoning, with the air of a man conveying great wisdom, that we must slash government spending right away or find ourselves turning into Greece, Greece I tell you,” Krugman mockingly reflected.
Austerity, Krugman maintains, is the reason Greece has been unable to pull out of its current debt-induced economic malaise. He warns that “trying to eliminate deficits once you’re already in trouble is a recipe for a depression.”
Instead, he proposes that Greece and other troubled sovereigns “have no good alternatives short of leaving the euro, an extreme step that, realistically, their leaders cannot take until all other options have failed”.
On that count, we actually agree with Krugman. A default followed by debt restructuring in a new currency was always the optimal solution to Greece’s self-imposed fiscal troubles. All the current bailout regime achieves is transferring the risk of issuing debt from European banks to stronger countries in the euro system, the European Central Bank (ECB), and the International Monetary Fund (IMF), which U.S. taxpayers fund.
But, default could be avoided, Krugman says, if Germany and the ECB would just take action “by demanding less austerity and doing more to boost the European economy as a whole”. In other words, if Berlin and Frankfurt (where the ECB is headquartered) would only agree to perpetually print as much money as is necessary to finance the deficits of Greece, Spain, and others, there would never need to be any need to cut spending.
This is where we part ways with Krugman. Borrowing more money from markets than could possibly be sustained was how Greece got into this mess in the first place, something Krugman is forced to acknowledge: “running deficits in good times can get you in trouble — which is indeed the story for Greece”.
So, to follow Krugman’s logic, spending and borrowing too much money actually can become a drag on the economy. Yet, once it has extended its grip, spending cannot be cut because then it will cause a depression. At that point, the only options are to print annually as much money is needed to refinance existing debt and to issue new debt, or default.
The problem with debasing the currency to refinance the debt, obviously, is inflation, which too becomes a drag on economic output. It also can create asset bubbles, which, when they pop, are lethal to a nation’s economic health. Once the vicious cycle of credit expansion gets too out of control, after a collapse, the economy cannot fully recover, leaving high unemployment in its wake.
To be fair, Krugman is actually alluding to a larger problem that debt-addled countries face. The more debt is issued, the less of an impact it has on economic growth, a topic Americans for Limited Government has covered recently. And then once a nation is in a debt crisis, it is true, austerity will be quite painful. No nation attempting to get its fiscal house in order should harbor any illusions.
To cover up the deficiencies of the present model — which never contemplates repayment of the debt — Krugman would simply continue to flood the system with unlimited financing. He notes we are not in a Greek style crisis yet because interest rates are very low. He’s right. 10-year treasuries only go for about 2 percent right now. In Greece they top 36 percent.
What he fails to note is that the reason is because the Federal Reserve has substantially increased its share of the national debt — now $1.65 trillion, over 10 percent of the debt — more than any creditor, including China. But that is no solution.
At best, printing money to refinance the debt is a stopgap measure. Even Krugman would have to acknowledge that the moment the Fed turns off the easy money, interest rates will rise. And then, all bets are off. Of course, such forward thinking is beyond the purview of Krugman.
He claims it is those who would cut spending that would turn the U.S. into Greece: “it’s the people demanding that we emulate Greek-style austerity even though we don’t face Greek-style borrowing constraints and thereby plunge ourselves into a Greek-style depression.”
But if we do not face Greek-style borrowing costs, and a debt-induced downturn can be averted before interest rates rise by balancing the budget and reducing the debt, shouldn’t we be acting now? Therein lays Krugman’s contradiction. If “running deficits in good times can get you in trouble”, then the solution always is to avoid driving off the cliff by stopping before it’s too late.
Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.
