In his blog yesterday, Paul Krugman wrote about how it isn’t the financial sector calling for QE3, because printing money to keep interest rates down isn’t beneficial to the banks, and how claims to the contrary are Orwellian because it is really the people calling for more inflation at the expense of the financial institutions, because we understand how inflation good for us. And if that narrative sounds completely whack to you, then you are obviously just unenlightened.
He didn’t put it exactly like that, but that’s the gist of it. Let’s break it down. Krugman begins:
These past few years have been lean times in many respects — but they’ve been boom years for agonizingly dumb, pound-your-head-on-the-table economic fallacies. The latest fad — illustrated by this piece in today’s WSJ [Wall Street Journal] — is that expansionary monetary policy is a giveaway to banks and plutocrats generally…. What’s wrong with the idea that running the printing presses is a giveaway to plutocrats? Let me count the ways. First, … the actual politics is utterly the reverse of what’s being claimed. Quantitative easing isn’t being imposed on an unwitting populace by financiers and rentiers; it’s being undertaken, to the extent that it is, over howls of protest from the financial industry. I mean, where are the editorials in the WSJ demanding that the Fed raise its inflation target?
What’s wrong with Krugman’s arguments? Let me count the ways. First of all, this is just ahistorical. Let’s not forget the Fed was the product of the bankers to begin with, going back to its origins at the secret meeting at Jekyll Island where Morgan, Rockefeller, Schiff, Warburg, et al, met to scheme how they would get the legislature to pass a bill that would give them a total monopoly over the supply of money and credit in the country. As Murray Rothbard illustrates in his book A History of Money and Banking in the United States, the whole purpose of the Federal Reserve, like the First and Second Bank of the United States before it, was to enable the banks to inflate together in a coordinated manner (“to provide … an elastic supply of money” as the Fed puts it, by “enabling member banks to effect orderly adjustments in their asset positions in response to changes in over-all reserve availability”). We are supposed to not know this. Such facts are for the memory hole.
Second, notice that Krugman is saying that it isn’t true that inflation is “being imposed on an unwitting populace” by “the financial industry”, but “the reverse” is true; ergo, according to Krugman, inflation is being imposed on the financial institutions against its “howls of protests” by the American people. As evidence of this, he points to a lack of “editorials in the WSJ demanding that the Fed raise its inflation target”. But by that logic, one could just as well ask, “Where are the editorials in the WSJ demanding that the Fed stop printing money?” This is an equally valid question, according to Krugman’s logic, but he doesn’t provide any examples of such to his readers. In fact, he doesn’t provide any evidence at all that there are “howls of protest from the financial industry”. You are just supposed to take his word for it.
He likewise offers no public opinion polls or any other evidence showing that the American people are just begging for more inflation, much to the annoyance of the nation’s moneyed interests.
Krugman then comes to his second argument for why “running the printing presses is” not “a giveaway to plutocrats”:
The naive (or deliberately misleading) version of Fed policy is the claim that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff, usually short-term government debt but nowadays sometimes other stuff. It’s not a gift.
So Krugman sets up a strawman argument to combat. Who says the Fed literally just gives money to the banks and isn’t just using this as a figure of speech? As Krugman rightly points out, the Fed doesn’t literally give money away, but extends credit to the banks in the form of an advance secured by acceptable collateral (i.e., “usually short-term government debt but nowadays sometimes other stuff”). But notice by rightly refuting the assertion that the Fed gives money to the banks “as a gift”, he avoids having to confront the question of whether the Fed loaning money to the banks at low interest isn’t also beneficial to the banks. And, obviously, Krugman couldn’t possibly come out and try to argue that the Federal Reserve system itself is bad for the banks, so the reason the strawman argument is necessary becomes obvious.
But here’s where it gets really fun. Krugman argues:
To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre. I mean, what is the un-artificial, or if you prefer, “natural” rate of interest? As it turns out, there is actually a standard definition of the natural rate of interest, coming from Wicksell, and it’s basically defined on a PPE basis (that’s for proof of the pudding is in the eating). Roughly, the natural rate of interest is the rate that would lead to stable inflation at more or less full employment. And we have low inflation with high unemployment, strongly suggesting that the natural rate of interest is below current levels, and that the key problem is the zero lower bound which keeps us from getting there. Under these circumstances, expansionary Fed policy isn’t some kind of giveway [sic] to the banks, it’s just an effort to give the economy what it needs.
Where to begin? First, and most importantly, notice that Krugman here himself tacitly acknowledges that it would be “effectively a gift” to banks for the Fed to keep interest rates “pushed artificially low”, which in effect moots his otherwise already fallacious strawman argument. Notice Krugman makes no argument that artificially low interest rates are not a benefit to the banks. Rather, he argues that the Fed is not keeping rates artificially low, nor could it possibly, apparently, since the “natural rate” of interest is below zero.
Are you beginning to see why I titled this post “Paul Krugman Thinks You Are Stupid”? Truly bizarre indeed.
Well, let’s examine how he defines the “natural” rate of interest. He cites “Wicksell” and provides a link. If you follow that link, to the website of the Federal Reserve Bank of San Francisco, you’ll find this:
Over 100 years ago, Wicksell defined the natural rate this way: “There is a certain rate of interest on loans which is neutral in respect to commodity prices, and tends neither to raise nor to lower them.”
So how does Krugman go from the “natural” rate of interest being that rate at which commodity prices are neither raised nor lowered to it being the rate at which there is “stable inflation at more or less full employment”? When Krugman speaks of “stable” inflation, he is talking about price inflation, and the Fed itself sets a target rate of about 2% in terms of the government Consumer Price Index (CPI). So the definition Krugman provides wherein the “natural” rate accommodates a steady increase in commodity prices (i.e. “stable inflation”) is contrary to Wicksell’s definition of the natural rate of interest being defined as that which commodity prices remain unchanged over time.
In fact, the definition of the “natural” rate of interest Krugman provides isn’t Wicksell’s but the Fed’s own, provided at the same source, the FRBSF. In fact, immediately after providing the Wicksell quote, the FRBSF states: (emphasis added)
Since then, various definitions of the natural rate of interest have appeared in the economics literature. In this Letter, the natural rate is defined to be the real fed funds rate consistent with real GDP equaling its potential level (potential GDP) in the absence of transitory shocks to demand. Potential GDP, in turn, is defined to be the level of output consistent with stable price inflation, absent transitory shocks to supply.
So Krugman’s source is pretty clear in expressing that the definition for “natural” rate Krugman provides is not the same as that Wicksell offered over 100 years ago, but a different one. Of course, attributing this definition to “Wicksell” sells his argument better than if he just came out and admitted he was using the Fed’s own definition, which, needless to say, rejects the idea that the free market should determine interest rates.
A free market definition for the “natural” rate of interest would be the rate determined by the law of supply and demand: when savings rates are high and banks have large reserves, interest rates will be lower since the incentive would be for banks to attract borrowers rather than depositors; likewise, when banks need to attract depositors and limit loans to only those most able to afford the higher cost of borrowing, interest rates will rise. Of course, the Fed is keeping interest rates below the rate that the market would otherwise determine absent Fed intervention, and thus, from a free market perspective, interest rates are certainly “being pushed artificially low”, which Krugman’s own argument allows is “a gift” to the banks.
Obviously, if you think rates should be determined by the market rather than by government bureaucrats or Fed economists, then you are obviously just unenlightened, some kind of relic from the dark ages.
Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.
First notice his caveats, “probably” and “likely”. In other words, he is just guessing, offering his own speculative opinion, based on the argument that, effectively, it isn’t good for banks to loan at low interest, because they get less of a return on that loan.
Well, that is obviously true. It’s equally true that if the apple vendor lowers the prices of his apples, he will make less profit for each apple sold. But Krugman ignores the other side of that coin, the fact that by lowering his prices, he is going to attract more customers, which could just as well work in his favor as against. True, if he sets his prices too low, he will sell out his inventory and have to send customers away empty-handed when they would be perfectly willing to buy apples from him. But if his prices are too high, he will be unable to sell off his inventory and his apples will rot in his cart because too few customers will want to by his expensive fruit. The “natural” or equilibrium price would be that at which the vendor is able to both satisfy demand and sell off his inventory; it would be the price at which there are the same number of customers willing to pay that cost as there are apples in his cart. Thus, to simply argue that by lowering his prices, the apple vendor is “likely” to hurt his profit margin is completely meaningless, since one could just as well argue that raising prices is “likely” to hurt his profit margin. It obviously depends.
The law of supply and demand applies just as much to interest rates, the cost of borrowing money, as any other price. When Krugman argues that the Fed’s lowering of interest rates is “probably” not good for the banks, that this “likely” hurts them, he is clueing you in to the fact that he is really just bullshitting (something he’s really quite good at; read my book Ron Paul vs. Paul Krugman for a case study of his record on the housing bubble).
This goes back to the WSJ article, the central arguments of which Krugman makes no attempt to refute. The WSJ article notes that “monetary inflation is akin to counterfeiting, which necessitates that some benefit and others don’t”. Krugman has no answer to that. It argues that “the expansion of credit is uneven in the economy, which results in wealth redistribution”. Krugman doesn’t deny this, either. The WSJ op-ed argues that:
[The Fed] directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do. The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline…. The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged.
Krugman’s answer to this is:
Finally, how is expansionary monetary policy supposed to hurt the 99 percent? Think of all the people living on fixed incomes, we’re told. But who are these people? I know the picture: retirees living on the interest on their bank account and their fixed pension check — and there are no doubt some people fitting that description. But there aren’t many of them. The typical retired American these days relies largely on Social Security — which is indexed against inflation. He or she may get some interest income from bank deposits, but not much: ordinary Americans have fewer financial assets than the elite can easily imagine. And as for pensions: yes, some people have defined-benefit pension plans that aren’t indexed for inflation. But that’s a dwindling minority — and the effect of, say, 1 or 2 percent higher inflation isn’t going to be enormous even for this minority. No, the real victims of expansionary monetary policies are the very people who the current mythology says are pushing these policies. And that, I guess, explains why we’re hearing the opposite. It’s George Orwell’s world, and we’re just living in it.
Let’s break that down. First, notice that Krugman basically admits that inflation hurts people on a fixed income from their retirement savings or a pension. Okay, so no argument there. Rather, his argument is most retired Americans rather depend on Social Security checks that are adjusted for inflation. Okay, so even if this argument convinced us that it was totally cool—or at least really no big deal—to rob old ladies living off of their retirement savings, where does the money come from upon which the larger number of people who collect Social Security depend come from? Does it grow on trees? Ultimately, of course, it must come from the taxpayers, who have to pay more taxes so those checks can keep up with inflation while their own purchasing power declines, who are, like the old ladies living off of their retirement savings, being robbed. Krugman’s argument is thus just an example of the broken window fallacy (one of those “agonizingly dumb, pound-your-head-on-the-table economic fallacies”).
Notice also that Krugman makes absolutely no attempt to actually refute the argument that the privileged sectors that receive the newly counterfeited money first benefit because they are able to spend it before the resulting rise in prices, while the rest of us (the 99%) don’t receive such a benefit, but rather must suffer the disadvantage of having our purchasing power eroded. Notice that Krugman doesn’t actually deny this, presumably because he can’t, since it is an accurate observation. Instead, his argument, where it is actually valid, basically just boils down to saying that the detriment to the 99% isn’t “enormous”. Well, okay, choose your adjective, but a benefit to the financial elite is still a benefit and a detriment to the rest of us is still a detriment, and this does not exactly lead to the conclusion that it’s the poor banks (sob) that are the “victims” of the Fed’s inflationary monetary policy (boo hoo).
Putting aside all the sophistry, when you get right down to it, banks operate on a fractional-reserve basis, meaning that they can lend out many times more than they actually have in reserve. When people take out a loan, they are “borrowing” so-called “money” that the bank doesn’t actually have and doesn’t even exist until the loan contract is signed, at which point the bank simply creates it out of nothing by punching a few keys on a computer. When the borrower pays back the principle on that loan, those magical digits just disappear, back into the void from whence they came. Only now the borrower also has to pay interest on the loan. Where does the interest come from? Inflation, of course. Under the Federal Reserve monetary system, every single dollar represents debt. Every single dollar is borrowed into existence from banks that simply create “money” out of thin air and then charge interest for its use. Of course, that means to repay the interest in addition to the principle on all those loans, even more “money” has to be created out of thin air. Hence the Fed’s need for a constant, steady inflation. And, of course, if a borrower is unable to repay the principle plus interest, the bank will just take his or her property, thereby gaining something of real value in return for having lent “money” it never had in the first place (hence the Wall Street Journal article’s pointing out that banks are essentially legalized counterfeiting operations).
In what way is this monetary system, which was designed by bankers, not beneficial to the interests of the banks? In what way does it not benefit the 1% who receive the new money first and are able to spend it to purchase assets before the resulting rise in prices at the expense of the 99% who are robbed of the purchasing power of their dollars?
Krugman is right about one thing: it certainly is George Orwell’s world, and he is definitely a pro at newspeak, or, as we might better refer to it in this case, Fedspeak. He would make a great Fed Chairman.