There have been other dubious winners of the Nobel Prize.//The average American's only hope against his government's largesse to those who profit from the bailout, is thrift. THRIFT. SAVINGS.// When Sinclair Lewis got his call from a Swedish newspaper informing him of his Nobel Prize for literature he thought it was a prank so he mimiced the accent as a joke.
On Nov 11, 6:51 pm, Travis <[EMAIL PROTECTED]> wrote: > From: Travis > Subject: Consumers Don't Cause Recessions > Date: Tuesday, November 11, 2008, > > Consumers Don't Cause Recessions > > *Daily Article* by Robert P. > Murphy<http://mises.org/articles.aspx?AuthorId=380>| Posted on > 11/11/2008 > There's one saving grace about Paul Krugman's column at the *New York Times > *: when an Austrian economist wants to explain how mainstream economics > leads to ruin, he can always trust Krugman to set up the target in a clear, > concise manner. This saves us a lot of work, because we don't have to first > build up the position before knocking it down. > Even the casual reader of the financial press knows that it is dominated by > Keynesian "demand-side" thinking. For example, during the debate over the > stimulus checks earlier in the year, the main objection was that taxpayers > might use some of their rebate to pay down credit card bills, rather than > blowing the whole thing at the mall. But the reader will never see a > careful, step-by-step exposition of the worldview that generates such crazy > notions. > Enter Paul Krugman. In a recent piece, "When Consumers > Capitulate,"<http://www.nytimes.com/2008/10/31/opinion/31krugman.html>the > newest Nobel laureate spells out the method behind the madness. Let's > take the opportunity then to show just why this focus on consumer spending > is not only mistaken but downright dangerous. > "The Paradox of Thrift" Krugman first tells us the (allegedly) bad news: > "The long-feared capitulation of American consumers has arrived…[R]eal > consumer spending fell at an annual rate of 3.1 percent in the third > quarter; real spending on durable goods (stuff like cars and TVs) fell at an > annual rate of 14 percent." > Now let's stop for a moment. Many left-leaning writers—including > Krugman<http://query.nytimes.com/gst/fullpage.html?res=9A0CE0DB133DF935A15750...>—have > been warning for years that the US trade deficit was too high, and that the > national savings rate was too low. So one would think that a drop in > consumer spending would be a good thing. Ah, not so fast: Krugman tells us > that "the timing of the new sobriety is deeply unfortunate….For consumers > are cutting back just as the U.S. economy has fallen into a liquidity trap." > And now to the actual theory behind all these musings. Krugman writes, > > [O]ne of the high points of the semester, if you're a teacher of > introductory macroeconomics, comes when you explain how individual virtue > can be public vice, how attempts by consumers to do the right thing by > saving more can leave everyone worse off. The point is that if consumers cut > their spending, and nothing else takes the place of that spending, the > economy will slide into a recession, reducing everyone's income. > In fact, consumers' income may actually fall more than their spending, so > that their attempt to save more backfires — a possibility known as the > paradox of thrift. > > My friend Bill Anderson actually derives sustenance from his hatred of Paul > Krugman<http://www.forbes.com/2008/10/13/krugman-nobel-economics-oped-cx_wla_...>; > at lunch one time, Bill skipped a sandwich and instead just bought a *New > York Times*.[1] <http://mises.org/story/3194#note1> Now one of Bill's > frequent remarks is, "Paul Krugman is not an economist." When I first heard > that, I thought Bill was being unfair in order to score a funny point. But > the above excerpt from Krugman changes all that. > The most central lesson of economic science—going back further than Adam > Smith's "invisible hand" metaphor at least to Mandeville's 1732 *Fable of > the > Bees*<http://oll.libertyfund.org/?option=com_staticxt&staticfile=show.php%3...>—is > that in a system based on private property, private vices can actually be > harnessed for the benefit of the public at large. Specifically, a market > economy steers greedy businesspeople into staying up all night, thinking > about how best to satisfy their customers. > Besides this truth (discovered relatively recently in human history), people > have always known that a wise person refrains from possible consumption in > order to accumulate savings. The reason humans in the 21st century are so > fantastically wealthy compared to those in the 11th century is *not* merely > a matter of technological innovation. It is also the result of the growing > inventories of machines, tools, and equipment (i.e., "capital goods") that > have been bequeathed from generation to generation. "Everybody knows" that > thrift leads to prosperity, while prodigal spending leads to ruin. There's > even a famous story in the Bible on this topic. > It is truly shocking to learn that Krugman not only tells his students the > exact opposite—namely that private virtue leads to public vice, and that > saving makes the community poorer—but that he actually *relishes* the > demonstration. Fortunately for one's sanity, we can uncover the fallacies > pretty easily. > The Misleading "Circular Flow" Model In a nutshell, the problem with > Krugman's Keynesian analysis is that it is static, meaning that it doesn't > involve the passage of time, and consequently it can't begin to grapple with > the capital structure in a modern economy. The "circular flow diagram" > illustrates the way Krugman views the economy: > <http://www.people.eku.edu/ruppelf/Eco230/circularflow.gif> > So during a recession, Krugman thinks that (for some reason) consumers freak > out and start spending less. This reduces the revenues earned by firms from > the sale of goods and services. But then this means firms have less money > with which to hire factors of production (natural resources, labor hours, > and capital equipment). That means the income earned by the owners of these > items—i.e., everyone in the economy—goes down. But with less income, people > in their role as consumers can't spend as much on goods and services, so > business receipts fall even further, and so on until the decentralized > market economy crashes into a major depression. To repeat, Krugman thinks > the free market can't solve this problem, because individuals rationally > respond to the onset of the crisis by increasing their cash balances, which > only makes the crisis worse. > According to Krugman, in order to escape from this vicious cycle, the > government must coax consumers to start spending again, perhaps by cutting > interest rates or giving tax refunds. But sometimes (as in the present > situation) those remedies are inadequate, and then it is the duty of the > politicians to be the adults and spend tens of billions in borrowed money to > do a Control-Alt-Delete on the economy. > There are so many problems with Krugman's thinking that it's hard to know > where to begin. For starters, if government pump-priming can boost firm > revenues, which raises national income, which allows further business > expansion, etc. etc., then why employ this technique only during recessions? > Why not recommend that the government *always* engage in deficit spending, > in order to create jobs and boost GDP? > "Well," the Keynesian would say, "in a state of full employment, further > additions to aggregate demand wouldn't allow firms to hire more workers. The > new demand for products and services at that point would serve merely to > push up prices, not increase real output." > Ah, now we're getting somewhere. With all the talk of consumer spending and > national income, we often forget that *actual production* must occur before > people can consume anything. It doesn't matter how many green pieces of > paper are in your wallet; you can't "demand" a TV set unless the store has > an actual unit on the shelf. Pushing it back one step, no matter how many > customers are lining up outside his store, the manager of Best Buy can't > stockpile his shelves with TVs unless the manufacturer has previously > assembled them. And of course, the manufacturer can't do so—regardless of > how much money he is offered by the Best Buy manager—unless he can find > enough workers, and enough of the relevant parts, to actually make the TVs. > We now see why the circular-flow diagram above is a very misleading model of > the economy. It leads us to think that output of finished consumer goods can > immediately rise and fall with "spending." This framework would hold if > there were no capital goods, meaning that all consumer goods and services > were produced immediately, as workers took gifts of nature and produced the > finished item on the spot. > For example, in an economy composed of masseuses and jugglers, the > circular-flow diagram might be useful. If someone wanted a massage and had > the cash, the masseuse could go right to work. The only physical constraint > on output in the "massage sector" would be the number of masseuses, and the > fact that they needed to sleep at some point. Besides the input of the > masseuse's labor, the only other item involved is a table, and the same > table can be used in the production of thousands of massages before needing > to be replaced. > Things are different with most of the goods and services produced in a > modern economy. In almost every sector, the workers show up and rely on > tools and equipment that greatly magnify their productivity. Moreover, the > overwhelming majority of workers don't apply their tools directly to raw > natural resources. Instead, they use their tools to transform materials that > are shipped to them from *other* firms. > [image: There are so many problems with Krugman's thinking that it's hard to > know where to begin.]It's useful to take a step back and just consider what > happens every day in the worldwide market. There are billions of humans > scattered over the planet. Some of us work on oil rigs, pulling up barrels > of crude. Some of us work on farms, gathering wheat. Some of us work on oil > tankers or drive tractor trailers, bringing the (somewhat) raw materials to > others. As consumers, we only see the tail end of a "pipeline" that could be > traced back many years. The finished goods you buy at the store are made of > components that passed through probably thousands of different hands, in > dozens of countries, before all coming together into the item you throw in > your grocery cart. > Once we grasp the stunning complexity of the true "economic problem"—how all > of this interlocking human activity is coordinated so that production flows > smoothly and predictably—we see the absurdity of Keynesian pump-priming > remedies. During a recession, it's not as if *all* output in *all* sectors > falls by the exact same percentage. On the contrary, some sectors shrink > more than others. This is because some sectors suffered huge losses, and > they need to release some (or all) of their workers and other resources to > more profitable sectors. This reshuffling takes time, especially because > critical intermediate goods need to be produced so that operations further > down the "pipeline" can resume. (In this article<http://mises.org/story/3155>, > I tell a quick story describing this process for a hypothetical island of > 100 people.) > The Keynesians are right that in a condition of "full employment," their > proposals won't cause more physical TVs and pickup trucks to roll off the > assembly lines. But even in a state of widespread unemployment, the > Keynesian solutions don't help. To repeat, this is because we *can't* simply > increase activity in all sectors by, say, 1% to raise output back up to > pre-recession levels. Generally speaking, this is physically impossible. No > matter how much money consumers or the government throw at it, Ford can > produce 1,000 more Rangers only if it can purchase 4,000 more of the > appropriate tires. And the tire producer in turn can only meet Ford's > request if it can buy the appropriate amount of extra rubber. And the rubber > producer can only do this if…and so on. > When the recession is the result of a central-bank-induced artificial boom > (such as the recent housing boom <http://mises.org/story/2936>), the > downturn is a period of readjustment, when misallocated resources are > channeled back into more appropriate lines, consistent with consumer > preferences and technological realities. When the government steps in and > tries to prevent this readjustment, it simply maintains an unsustainable > deployment of scarce resources. Bottlenecks occur in the millions of > different "pipelines" tracing the flow of natural resources through millions > of different workers' hands and onto the store shelves. > There Is Nothing Paradoxical About Thrift In closing, it will be useful to > spell out exactly what happens in a market economy when consumers decide to > save more of their income. The first thing to realize is that people do not > decide to "spend" or not; rather, they decide whether to spend *in the > present* versus *in the future*. For example, imagine that thousands of > couples in a large city one day decide to skip their weekly restaurant > outings in order to save up for a summer cruise. At first, it seems that > this would hurt the economy. After all, local restaurants see their sales > drop, and so they buy fewer items from their suppliers and lay off some > workers. The suppliers and workers in turn have less income to spend, and so > sales are hurt elsewhere too. > However, so long as the entrepreneurs involved in the cruise industry > anticipate the eventual increase in demand for their services, they will > exactly offset the above effects when they hire more workers and other items > in preparation for the busy summer months. The new savings (which were > previously spent on restaurants) drives down interest rates, perhaps > allowing the cruise operators to borrow money and pay for an additional > liner. Thus the decision to save more doesn't reduce total income or > employment, once everyone adjusts to the new spending patterns. It is really > no different from a scenario where thousands of people become health > conscious and decide to spend their money on vegetables rather than fast > food. > Now it's true, in the present circumstances of our financial panic, consumer > spending has fallen because of fear, not because of a fundamental shift in > the desired timing of consumption. But still, the point remains that people > cut back on present consumption in order to be able to "spend money" in the > future. The difference between our present situation and the cruise-liner > story above is just that people right now aren't sure exactly when, and on > what, they will be spending this extra savings. > Even so, the best solution is still for the government to mind its own > business and let people work things out voluntarily. The uncertainty isn't > phony; people really *don't* know what's going to happen next month. In this > situation, it is entirely appropriate for humans to stop cranking out so > many iPods and designer clothes, allowing a temporary build-up of the > resources that go into the production of these nonessential items. > What is especially ironic in all of this is that even on his own terms, > Krugman's recommendations make no sense. That is to say, even if we put > aside all of the real, physical readjustments that must occur to revamp the > economy in light of the unsustainable housing boom, it would still be the > case that the government ought to do nothing. If the present crisis really > were largely the result of irrational panic and hoarding then government > activism would only make people *more uncertain* about the future. In > particular, no one has any idea what Paulson & Bernanke will announce next > regarding financial companies and mortgages. If we're trying to reassure > consumers that everything is normal, why would we resurrect tools from the > New Deal playbook? > > <http://www.mises.org/store/Politically-Incorrect-Guide-to-Capitalism-...> > There is one more contradiction we should mention. The essence of the > paradox of thrift and the liquidity trap is the insight that businesses > won't expand operations if there is no demand for their product. But if > Krugman and other pump-primers can see that the interruption in spending is > only temporary, then so can the business owners involved. And to the extent > that it is *not* temporary—for example, homebuilders are seeing much lower > sales, and this isn't simply due to irrational hoarding—then government > spending to "fill the gap" only screws things up even more. > For long-run sustainable output, businesses want to have finished products > emerging from the pipeline just when consumers want to buy them. Market > prices and the profit-and-loss system provide the best means of allowing > entrepreneurs to make these forecasts. If the government starts buying, say, > office copiers even though it doesn't really need them, that might provide > jobs temporarily in a few firms, but the owners know that they can't trust > this demand because it is subject to political whim. Thus the government's > efforts will simply confuse entrepreneurs who are trying to configure their > capacity to meet future demand. > Conclusion In his discussion of the "paradox of thrift," Paul Krugman proves > that he is not an economist—or at least, not a very good one. His policy > recommendations are based on a Keynesian model bereft of time and the > capital structure of production. Recessions are rooted in misalignments in > this unbelievably complex structure, and there needs to be a period of > below-normal output as these pipelines are fixed. Most important, consumers > are doing the right thing when they increase their saving during a downturn. > If solving a recession really were as simple as getting people to spend, > then we wouldn't keep experiencing them. > [VIEW THIS ARTICLE ONLINE] <http://mises.org/story/3194> > _________________________ > Robert Murphy runs the blog Free Advice > <http://consultingbyrpm.com/blog/>and is the author of > *The Politically Incorrect Guide to > Capitalism*<http://www.mises.org/store/Politically-Incorrect-Guide-to-Capitalism-...>. > Comment on the blog <http://blog.mises.org/archives/008926.asp>. > Notes [1] <http://mises.org/story/3194#ref1> Okay you got me: I made up > that anecdote. But I *have* been to lunch with Bill, and I'm pretty sure he > has bought a *New York Times*. And I know that he hates Krugman. > *Join the Mises Institute* <https://www.mises.org/donate.asp>* **Mises.org > Store* <http://www.mises.org/store> > > *Home* <http://www.mises.org/>* | **About* <http://www.mises.org/about.asp>*| > **Email List* <http://www.mises.org/elist.asp>* | > **Search*<http://www.google.com/u/Mises> > * | **Contact Us* <http://www.mises.org/contact.asp>* | > **Periodicals*<http://www.mises.org/journals.asp> > * | **Articles* <http://www.mises.org/articles.asp>* | **Games & > Fun<http://www.mises.org/fun.asp> > * > *FAQ <http://www.mises.org/fun.asp> | > **EBooks*<http://www.mises.org/StudyGuideDisplay.asp?SubjID=117> > * | **Resources* <http://www.mises.org/scholar.asp>* | > **Catalog*<http://www.mises.org/catalog.asp> > * | **Contributions* <https://www.mises.org/donate.asp>* | **Freedom > *<http://www.mises.org/calendar.asp> > You are subscribed as [EMAIL PROTECTED] > EasyUnsubscribe<http://mises.biglist.com/do/unsub/article/87556804/s265y83c20/1456>(by > email <[EMAIL PROTECTED]>) | > Settings<http://mises.biglist.com/do/acct/article/87556804/s265y83c20/1456>| > Report > Abuse <http://mises.biglist.com/do/abuse/article/87556804/s265y83c20/1456> > > -- > *~@):~{> --~--~---------~--~----~------------~-------~--~----~ Thanks for being part of "PoliticalForum" at Google Groups. For options & help see http://groups.google.com/group/PoliticalForum * Visit our other community at http://www.PoliticalForum.com/ * It's active and moderated. Register and vote in our polls. * Read the latest breaking news, and more. -~----------~----~----~----~------~----~------~--~---
