If Paul Krugman Hates It, How Bad Can It Be?

I probably don’t know enough to have an intelligent opinion about this, either, but I think the administration’s new version of cash for trash shows improvement.  I would prefer to see more funding from the private sector; indeed, I would prefer 100% private funding.  But if by hypothesis the government has to take the leading role, perhaps the small amount that will be required from private bidders under this program will work like economic pixie dust and make it all fly.

Paul Krugman hates it, and so does Joe Stiglitz.  And by  a freakish coincidence, I learned of their disapproval just after reading a section of Niall Ferguson’s The Ascent of Money that mentions them both.

Ferguson is discussing the so-called “Washington Consensus,” a package of ten big-picture economic policies that the International Monetary Fund has historically tended to require of developing economies before committing any resources to an aid package.  The idea is that economies that can’t implement these policies are extremely unlikely to make it with or without aid, so why waste it?  In case you’re curious about the ten policies, Ferguson summarizes them this way:

1.  Impose fiscal discipline; 2. Reform taxation; 3. Liberalize interest rates; 4. Raise spending on health and education; 5.  Secure property rights; 6. Privatize state-run industries; 7. Deregulate markets; 8. Adopt a competitive exchange rate; 9. Remove barriers to trade; 10. Remove barriers to foreign direct investment.

A little more detail on each of the policies is available here.  It looks to me like we’re doing alright on 4, 8, 9, and 10, but we’re otherwise moving in all the wrong directions.  Reasonable minds can draw their own conclusions.

But that’s not why I’m posting this.  I’m posting because Ferguson happens to mention in his book (pp. 310-13) that Krugman and Stiglitz both criticized the IMF’s attachment of these conditions in Asia in the late 1990s.

Yet neither Stiglitz nor Krugman offers a convincing account of how the East Asian crisis might have been better managed on standard Keynesian lines, with currencies being allowed to float and government deficits to rise.  In the acerbic words of an open letter to Stiglitz by Kenneth Rogoff, who became chief economist at the IMF after the Asian crisis:

Governments typically come to the IMF for financial assistance when they are having trouble finding buyers for their debt and when the value of their money is falling.  The Stiglitzian prescription is to raise . . . fiscal deficits, that is, to issue more debt and to print more money.  You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable.  You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes.  We at the —  no, make that we on planet Earth — have considerable experience suggesting otherwise.  We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably . . . The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Let me quickly add that Stiglitz and Krugman are both Nobel laureates, which is impressive, even if it’s not as impressive as it used to be.  And when Krugman discusses the current state of affairs with other economists, I’ve been impressed with his balance and fairness; he seems much more candid in that context about the weakness of the case for Keynesian stimulus than when he writes for the New York Times.

Time will tell, of course.  But for now, I’m still with the earthlings.

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5 Responses to “If Paul Krugman Hates It, How Bad Can It Be?”

  1. Timothy Peach Says:

    After Gore got the Nobel prize for Peace instead of Fiction, I think of Nobel prize winners in the same way I think of winners of “Most Popular Incorrect Spelling” contests. These stupid prizes are based on political allegiance now, not achievement.

    I could not agree more with the heading of your post, Granulous. Reminds of what McCain’s campaign manager said — “When in doubt, we try to figure out what David Gergen would do, and then do the opposite.”

    The editorial page of the New York Times basically serves as a daily seminar on how to burn down your own house. I’m surprised they still bother to print it in English.

  2. Ken Rynne Says:

    I also probably don’t know enough to have an intelligent opinion on this but I enjoyed your post Mark. When you suggest as part of The Washington Consensus that we are moving in the “wrong direction” with market deregulation, would that mean that we should continue deregulating? If so, we’ll need a whole lot more economic pixie dust. We’re gonna need a bigger boat.

    • Mark Grannis Says:

      Nice to hear from you, Ken. At the risk of using ridiculously broad brush strokes, yes, I think we need less regulation. I would not even go so far as to agree with the implicit premse that on the whole we’ve been deregulating in the recent past; mostly I think we’ve just been replacing some regulations with others. To pick an example I know a little about, telecom deregulation has been an incredibly regulation-intensive process. It’s been going on for almost 15 years, and while lots of old regulatory barriers have fallen, lots of new constraints have risen in their place. The new constraints are in many cases unambiguously less constraining than the ones they replaced, but at some level the point is that one dursn’t try to run a telecom company without a lot of legal advice.

      I think it would be fascinating to harness the power of the Internet and tell people they have 30 days to e-mail their Representative in Congress and name five federal regulations that are really valuable. Then repeal everything that no one in the whole country mentions. My guess is that the Code of Federal Regulations would shrink significantly.

  3. Ken Metcalfe Says:

    I too generally hate to post comments whole cloth from another, but Bonner, in today’s Daily Reckoning, had a few, I think, great paragraphs summarizing the “Geithner plan”, as follows:

    “But let’s focus on the big news: the Geithner Plan.

    The gist of the story is that the government will create a public- private fund to buy up to $1 trillion in the banks’ mistakes. These assets will be auctioned off – in a market sustained and supported by public money. This is a “win – win –win” situation, says Bill Gross of PIMCO, the world’s largest bond fund. We didn’t see the rest of his analysis so we’ll have to guess. It’s a win for the banks because they get to clean out their refrigerators. It’s a win for investors because they get to buy the throwaways at huge discounts – with government guarantees – and then they’ll discover that some of them don’t have fuzz all over. And it’s a win for the government, because it finally gets rid of that nasty odor coming from the kitchen.

    We have neither the time nor the stomach to look closely at this program. But we don’t have to; even from a distance, it stinks.

    Why? Because there’s not that much ‘win’ to share out. The assets are worth what they’re worth. By all accounts, they’re worth a lot less than the banks thought they were worth originally. In a better world, the bankers would take their losses, admit their mistakes, and blow their brains out…or at least change careers. In fact, we have a suggestion: they should go into government; there they can make as many mistakes as they like and no one will notice.

    But this is not a better world; it’s a world that is full of sin and sorrow…one with a fool on every corner…and an ace up every sleeve.

    There won’t be three winners from Mr. Geithner’s plan. There will only be one. Whatever the toxic assets are worth, they will be sold for either more or less than that amount. If they are sold for less, investors will realize a profit. The banks – and their government backers – will lose because they will have given up an asset for less than it was really worth. On the other hand, if the toxic assets are sold for more than they are worth, it is investors who will lose.

    Investors’ objective is clear: they want to make money. And they won’t invest unless they think they’re getting the assets for less than they are worth. Bankers’ and the government’s motivations are more complex. Mostly, they just want the problem to go away. So, we’ll put our money on the buyers of the toxic assets, not the sellers. Most likely, they will be the only winners. They will buy the more palatable pieces of meat at good prices; they’ll leave the most toxic pieces for the government. Most likely, the government will be an even bigger loser than it is now.

    But the government will lose twice. First, it will lose money in the poker game with private investors. Then, it will lose again when its expensive flimflam fails to restart the economy.

    The banks will be better off once they’ve cleaned out their cupboard. No doubt about it. They will be ready to lend again, right? But to whom?

    The problem the bank bailout is designed to fix is only a piece of the larger problem…and not the essential piece. Banks have had plenty of money to lend – despite their own toxic assets. The Fed has been willing to give them the most elastic line of credit in history. The problem was not that they didn’t have the money to lend, it was that they didn’t have a creditworthy borrower to lend to.

    Take the case of mortgage lending. In their vaults, they have billions of dollars’ worth of mortgage-backed assets. They know that those assets are ‘toxic’ because homeowners can’t pay their mortgages and the value of their collateral is going down. So, those mortgage-backed assets are getting marked down to what investors think they might really be worth.

    But what bank wants to take on more mortgage debt? Housing prices are still falling. And homeowners are still in trouble. Toxic assets are being marked down in ANTICIPATION of the poor homeowner going broke. He still has to go broke…and get back on his feet…before he’s a good credit risk. And that logic applies to the entire economy. Businesses, homeowners, and investors need to clean out their cupboards too, before the credit cycle can turn up again. And that is a very long process….”

  4. George Peacock Says:

    I read and listened to many responses to the latest sortie from Geitner & Co. and I found the response by Charles Calomiris the most interesting. “This is a pretend plan. It’s not a game-changer at all,” said Charles Calomiris, a finance professor at Columbia Business School. “The result of this plan will be lot of money managers getting rich by buying assets cheap with government funding. It doesn’t help the banks recapitalize. In fact, it makes it harder.”

    There was a nice 10 minute interview with Calomiris on Bloomberg Surveillance today. He also comments about another financial shock headed our way from Europe. http://www.bloomberg.com/tvradio/podcast/surveillance.html

    Maybe we’ll find that the government navigated this whole mess perfectly, but shy of perfection, so much intervention seems like it’ll miss entirely. It just doesn’t seem like we’ll get it “right enough.” Is that a fat tail I see?


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