Bubbles

Once again, Paul Krugman is arguing that, despite encouraging signs, the economy is not recovering and will not recover without more government stimulus spending.

First, according to accepted standards, we are out of recession. What Krugman is worried about is a "double dip" recession where the recovery is cut short by a second recession. He never says this, though. He is too busy making parallels with 1937. According to Krugman, the government cut back on spending in 1937 and that lead to a recession which prolonged the Great Depression. Other economists have pointed out that economics in 1937 were much more complicated than Krugman's version so I will dispense with the 1937 parallels. The real question is if the government can spend its way into prosperity?

The current recession is so bad because so much of the economy was debt-driven during the last decade. Housing values, stock prices, and financial assets were valued too high and everyone involved was borrowing against the paper value of these assets. When prices fell, people started defaulting on loans and stopped buying in general.

The easiest way to get things moving again is to get everyone to act like the crash never happened and go back to spending. That isn't going to happen. People are being a lot more cautious with their money and are paying their debts down. In the long-term, this has to happen for a healthy economy. In the short-term, it slows the recovery to a crawl.

What Krugman is proposing is for the government to mimic what individuals were doing and spend without regard for consequences. The hope is that people will start spending again and the economy will heat up enough to stand on its own without the need for government support.

The paradox here is that FDR did just that for years. He spent like crazy and only slacked off when it looked like the economy was finally recovering on its own. If several years of government spending was not enough to restart the economy in 1937, then how much does Krugman think would have been enough (the quick answer is the amount spent during WWII but I addressed that fallacy weeks ago)? Also, how do we know when we have spent enough and can scale back? Krugman does not address this. He doesn't know how much is needed, he just knows that we are not spending anywhere near enough.

Krugman also ignores the biggest issue - by engaging in massive debt-backed spending, the government is creating its own bubble. This may restore the bubble-based economy but it is still a bubble and cannot be sustained. Following Krugman's advice will eventually cause a new bubble-induced recession as deep as the current one but with a government too cash-strapped to help.