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Comment by mhartl | Hacker News Reader

Krugman proves that you can be a NY Times columnist, Princeton professor, and Nobel laureate, all without (apparently) understanding some very basic economics. Repeat after me:

  * Going into debt to buy foreign goods is bad.
  * Going into debt to buy domestic goods is bad.
  * Not going into debt to buy foreign goods is fine.
  * Not going into debt to buy domestic goods is fine. Hence
  * The "trade deficit" is entirely beside the point.  Moreover,
  * Consumer spending is not the cause of prosperity.
  * The collapse in consumer demand reflects people realizing they were spending beyond their means.
  * Having the government "stimulate" the economy with demand only postpones the inevitable, because
  * There are too many companies making too many consumer goods, and
  * This has to change.

Recession is the cure, not the disease. Why can't people understand that?

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Because the "cure" threatens to kill the patient. The current recession is deflationary - something we have not seen in the US since the Great Depression. Whereas monetary policy can rather easily counteract a typical recession - and be used to bring a recession on as in 1982 to "cure" the economy of persistent inflation - in a deflationary environment monetary policy has little or no traction. And today, without fiscal stimulus, we could realistically find ourselves in a deflationary spiral. Businesses and assets that are otherwise sound can get pushed down in a vicious circle of deleveraging and shrinking demand resulting from lower prices and lower wages.

This has already begun. We've effectively seen a run on the shadow banking system of investment banks, prime brokers, hedge funds, etc., as initial losses in subprime have forced firesales of other assets to meet margin calls. To be sure, the credit bubble extended far beyond subprime, and the deteriorating economic fundamentals support continuing write-downs and losses on Alt-As, option ARMs, prime mortgages, auto loans, credit card debt, student loans, etc. But the credit market's subsequent freezing has put everyone at risk, so that the recession could potentially far overshoot the "disease" of over-indebtedness and overconsumption. Absent the government stepping in and trying to make use of the wasted capacity in the economy, making up for lost private and business investment, this process could spiral on well beyond what the economic fundamentals justify, and past anyone's ability to predict as well.

Yes, this recession is the result of previous bad choices, but that doesn't mean we shouldn't try to ameliorate the worst consequences and prevent a negative feedback loop. Telling people that this is the "cure" without trying to end the cycle of loss smacks of neo-Hooverism.

No, it isn't deflationary. We had bubbles in housing, oil, food, and other commodities. Anyone remember the news articles saying "food prices are rising to levels not seen since 1998, gas prices too, the end is nigh?"

Those bubbles have burst, and prices are returning to their normal level. Over the short term, that looks like deflation (just as the bubble looked like inflation), but it's really very different from actual Japan-style deflation.

By the way, "shadow banking system" is just a scary term invented by Paul Krugman to describe non-S&L investors.

It doesn't just look like deflation. It is deflation, which is defined as a persistent increase in the value of money. Similarly with inflation.

How is it actually very different from Japan-style deflation? The problem is that as the credit bubble has popped, prices across the board are falling, and consumers are so scared that even relatively well-off people are cutting back on consumption.

And once deflationary expectations set in, it's very difficult to rid the economy of them. For example, if you expect housing prices to fall even more, it makes sense to wait a few months for them to do so. If enough people act this way, deflationary expectations become self-justifying, and prices could keep falling even beyond the fundamentals. And while individuals benefit from their dollars having increasing buying power, this is more than offset by the fact that in the face of falling demand, companies will have to slash payrolls, either through benefit reduction or layoffs. This is in turn lowers demand, deteriorating the business environment even more. And this is to say nothing of the fact that people's debts become larger in real terms during deflation, likely causing more defaults of all sorts.

The shadow banking system refers to financial institutions that act like banks - ie borrow short, and lend long, oftentimes in illiquid assets - but don't have the protections that banks do, most importantly depositor insurance. Consequently, institutions like investment banks or hedge funds can still experience the equivalent of bank runs. Bear Stearns was a perfect example of this.

Going into debt at all is bad? Since when has that ever been basic economics?

The stimulus package is about infrastructure. If the resulting payoff is greater than the debt, then absolutely it makes sense to go into debt. That's basic economics, and it has been for as long as the concept of debt has existed.

The point of the spending isn't because infrastructure has a positive ROI its to artificially create jobs to cushion the people suffering from the current economic collapse. Also, traditionally investment is repaid as a result of the investment activity, where in the US it seems to be repaid from increased borrowing. How long can that go on before it stops working?

"The point of the spending isn't because infrastructure has a positive ROI its to artificially create jobs to cushion the people suffering from the current economic collapse."

The reason why we're spending is to cushion ourselves from the economic collapse, yes. The reason why we're spending on infrastructure is because this is the only way to do it that isn't ultimately a waste, and we would have needed to do it at some point regardless of the state of the economy. No better time than an economic collapse to do so.

(This assumes that the infrastructure plans themselves are wise, of course. So far, they appear to be.)

Saying that investment in the US is traditionally "repaid from increased borrowing" has nothing to do with the rationality of spending on infrastructure (which eventually pays for itself by increasing GDP). A lack of responsible accounting and accountability causes US debt to be repaid with increased borrowing, not what the borrowed funds are spent on.

I omitted detail for brevity. Of course debt isn't always bad. But "too much" debt is. How much is "too much"? That's complicated. So I simplified. That being said, going into (mainly credit card) debt to buy TVs and iPods and widgets, which lots of people having been doing for years, is almost always "too much".

If the resulting payoff is greater than the debt, then absolutely it makes sense to go into debt.

I agree: if. But government lacks the proper incentives to ensure that the benefits justify the costs.

"Having the government "stimulate" the economy with demand only postpones the inevitable"

Since we're basically borrowing money from the future to attempt to smooth out a difficult transition in the present, I think a stimulus can make the problems less bad for some people.

That the money will be used inefficiently is probably the case, but the money is more valuable in the present, in a sense, than it is in the future -- because without the money now, a desirable future may not exist.

At the worst, the stimulus won't matter much.

At the best, it'll help a few million people.

The truth will probably lie somewhere in between those two extremes.

No, it is not only shuffling money from the future into the present; it is also shuffling problems from the present into the future. When we get to the future, as we must, we'll find today's problems and tomorrow's problems waiting for us, and we'll have fewer resources to tackle them.

Having the government "stimulate" the economy with demand only postpones the inevitable, because...There are too many companies making too many consumer goods

Rest assured, then, that the government stimulus will mainly benefit producers of steel beams and concrete rather than iPods and Laptops.

I am not sure it makes sense not to count laptops and lathes in the same category these days.

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