Most of the reviews of my book Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis have been very positive. Every single Amazon verified purchaser gave it a five-star review. All reviews are either five-stars or one-star, the latter of which there are two. The first was the following:
It is not rocket science to see that the book has a political agenda to further libertarian views, and put forward a particular stance regardless of facts, and regardless of discussion. One sided reviews strong on Paul worship and Krugman-as-devil speak for themselves.
The reviewer thus makes it perfectly apparent that she never bought or read the book, but based her judgment of it solely on the product description and the other (five-star) reviews. Earlier this week, a second person gave it a one-star review, with the following comment:
Bias and Misleading
The author suggest he is putting forth a reasonable articulations of two schools of thought, but unapologetically builds strawman arguments throughout the book against Keynesian economics. I wanted to finish it, from the first five pages it was clear the author was not intending the book to be illuminating but rather contribute to idealogical propaganda. Waste of money.
Let’s just assume this person did actually buy the book (the review was posted to the Kindle edition, and yet it is clear that this person did not buy it in that format, since one must be logged in to one’s Amazon account to have done so, in which case this would have appeared as an “Amazon verified purchase”, which it did not). I replied to this review with the following:
Please provide a single example of one of these strawman arguments you allege to have appeared in the first five pages. Good luck with that. It’s funny you should [say] I “unapologetically builds strawman arguments throughout the book”–yet you didn’t even read more than the first five pages, so you couldn’t possibly know that. If you had actually read the book, you would, on the contrary, see that I merely let Paul Krugman’s words speak for themselves. If you wish to accuse Krugman of misrepresenting Keynes, by all means, suit yourself!
Here are the first five pages:
What caused the housing bubble that precipitated the 2008 financial crisis? Answers generally fall into one of two categories: those that assign responsibility to an unregulated free market, and those that point to government intervention in the market as itself being the problem. Proponents of the former view argue that the government should regulate and manage the economy, while proponents of the latter argue in favor of a free market. If a solution to the crisis is to be found, it must be based on a correct understanding of its primary causes. Thus, the question of how we are to know which view is the correct is crucial.
This book examines the records of two prominent individuals who have offered diagnoses and prescriptions. Congressmen and presidential candidate Ron Paul has perhaps become the most well-known advocate of the view that it was a government-created crisis and that what is needed is a free market. Nobel-prize winning economist and New York Times columnist Paul Krugman has been a prominent advocate of the opposing view that an unregulated free market was the cause and thus that greater government management of the economy is needed. Who is correct?
The question goes beyond the opinions of two individuals. It is really a question about two schools of economic thought. Ron Paul represents the Austrian school, whose luminaries include Ludwig von Mises, Henry Hazlitt, Friedrich A. Hayek, and Murray N. Rothbard, among others, while Paul Krugman represents the Keynesian school, which embraces the theories of British economist John Maynard Keynes. While the Keynesian school advocates that the government should manage the economy, the Austrian school advocates just the opposite: that government interference only creates more problems than it is ostensibly intended to solve. The most important contribution of the Austrian school to the field of economics is its theory of the business cycle, which is unique in offering a comprehensive and coherent explanation for why the economy goes through regular cycles of booms and busts.
So which school has offered a better diagnosis of the causes of the 2008 financial crisis and a better prescription for what to do about it? There is some ancient wisdom that can help to answer this question. The Bible is full of stories about the prophets, the political and economic analysts of their day, and offers a simple answer to the question of how one is to tell the true from the false prophets: those whose predictions come to pass are the true prophets, while those whose predictions do not, the false. There is also a consistent theme that the true prophets issued disturbing warnings that people generally didn’t want to here and were thus widely disdained, while the false prophets offered more reassuring messages about what the future had in store and thus were widely celebrated.
The purpose of this book is to review the records of Ron Paul and Paul Krugman on the question of the housing bubble. Who correctly predicted it? Who has offered the more reasonable explanation as to its cause? Who has offered the more sensible response to the bursting of the housing bubble and the financial crisis it precipitated? Most importantly, whose admonitions should we now be regarding as we move into the future? In short, who is the true prophet, and who the false?
The Dot-Com Bubble
In 1997, Congressman Ron Paul warned that the government’s policy of subsidizing housing, such as through the Housing and Urban Development (HUD) Agency, was causing a misallocation of resources that was distorting the market. He spoke out against the “transfer of wealth to government housing programs”, arguing that it wasn’t the poor but the wealthy who benefited most. “It is the rich beneficiaries, those who receive the rents and those who get to build the buildings [who] are the most concerned that this government housing program continues.” He also decried the Federal Reserve monetary system that “hurts the poor more than the rich”.
Elaborating on the role of the Federal Reserve (or “the Fed”), he warned against the government-enforced monopoly that it had over the supply of money and credit in the United States. “If we are concerned about repealing the business cycle,” he said, “we would have to finally understand the Federal Reserve and how they contribute to the business cycle.” The Fed’s “authority to manipulate interest rates” was “an ominous power” that caused the business cycle and was incompatible with the principle of a free market economy. Its means of doing so was an increase in the money supply, or inflation, which robbed the people of the purchasing power of their dollars. “In a free market,” he explained, “interest rates would be determined by savings…. If savings are high, interest rates go down; people then are encouraged to borrow and invest and build businesses.”
The Fed’s manipulation of the interest rate sent wrong signals to borrowers and investors that created artificial booms. The Fed, he said, “comes along and they crank out the credit and they lower the interest rates artificially, which then encourages business people and consumers to do things that they would not otherwise do. This is the expansion or the bubble part of the business cycle, which then sets the stage for the next recession.” But rather than understanding the business cycle and preventing artificial booms, economists and members of Congress were instead vainly focused on preventing the busts by applying more of the same policies that had created the bubble in the first place, thus setting the stage for the next, even greater, recession.
While Ron Paul was expressing these views on the Fed, Paul Krugman was arguing virtually the opposite. He also wrote in his column in the New York Times on August 30, 1998 that the “current craziness in world financial markets” could translate into “a global slump”, but the cause in his view would be governments raising interest rates, rather than having kept them artificially low for too long. He acknowledged that stock prices in the U.S. had been driven to “hard-to-justify heights”, but assured that the “real risk to the world economy comes not from bad fundamentals but from rigid ideologies”, such as “the belief that a strong currency means a strong economy, that stable prices insure prosperity.” In other words, the U.S. economy was fundamentally sound, and all that needed to be done to keep it that way was to inflate to keep interest rates low. “In the end,” he wrote, “a global slump is quite an easy thing to prevent.”
Ron Paul continued to warn against inflation, stating in September 1998 that the “worldwide financial crisis” then underway was a consequence of operating “with a fiat monetary system” that “has allowed the financial bubble to develop. Easy credit and artificially low interest rates starts a chain reaction that, by its very nature, guarantees a future correction.” The “boom part of the cycle lasts for unpredictable lengths of time”, but must be followed by a corrective bust. “Fiat money and its low interest rates cause malinvestment, over capacity, rising prices in one industry or another, excessive debt and over-speculation worldwide.” Furthermore, “Capitalism erroneously is being blamed. No mention is made that no country today is truly capitalist in following a sound monetary policy.” Government bailouts also compounded the problem, encouraging mismanagement of the economy.
He commented further that “the largest of all bubbles is now bursting”, reiterating that while “the stimulative effect” of having “central banks generously create credit out of thin air” was “welcomed and applauded as the boom part of the cycle”, the “illusions of wealth brought about by artificial wealth creation end when the predictable correction arrives.” The trouble was not limited to the U.S. “All countries of the world have participated in this massive inflationary bubble with the dollar leading the way” in its role as the world’s reserve currency. He again warned against the Federal Reserve artificially lowering interest rates in response to the financial crisis.
When the Chairman of the Federal Reserve, Alan Greenspan, announced that the Fed would follow the course advocated by Paul Krugman and lower interest rates, Ron Paul responded by saying that the Fed’s monetary policy, along with the longstanding government policy of bailing out troubled institutions, would “make the problems much worse.” He repeated that the “previous boom supported by the illusion of wealth coming from money creation is the cause of current world events”. He said that the resulting bust “cannot be prevented” and attempting to do so would only “prolong the agony”. He observed that “Price fixing of interest rates contradicts the basic tenets of capitalism” and concluded that “More Federal Reserve fixing of interest rates and credit expansion can hardly solve our problems when this has been precisely the cause of the mess in which we currently find ourselves.”
After the Federal Reserve orchestrated the bailout of the hedge fund Long-Term Capital Management LP, Paul Krugman argued that “deregulation” had helped to make markets “more `liquid'” so that “aggressive speculators are able to leverage themselves”, as Long-Term Capital Management had done. But this explanation begged the question of why a company would choose to put itself at such risk; after all, it is not in a business’s own self-interest to drive itself into bankruptcy.
Ron Paul offered some insights into that question in the House of Representatives. He brought up the “taxpayer-backed liability concerns raised by the involvement of an agency”-the Federal Reserve Bank of New York-“with the full faith and credit of the U.S. government” through the Federal Deposit Insurance Corporation (FDIC). The implicit promise of future intervention to bail out financial institutions created a “moral hazard” that could incentivize greater risk-taking with the knowledge that any losses would ultimately be incurred by the taxpayers. He urged the Congress to consider “the potential for systemic risk posed by any future episode that might involve the imprudent use of derivatives and excessive amounts of leverage.”
Can anyone find any strawman arguments in there? Get the paperback or Kindle edition to continue your search… (There’s currently a used copy available for $900, but I’d suggest going with the low, low price of $8.99 for a new one or the $4.99 to download it to your Kindle. I priced as low as I reasonably could without practically giving it away.)