I will dissect this article paragraph by paragraph so the article finds its justly spot, tossed onto an ash heap.
This is paragraph 1 from Krugman's piece, Hangover Theory:
A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle—a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking—not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.Notice the vicious launch, "I regard [Austrian Theory] as being about as worthy of serious study as the phlogiston theory of fire".
Interestingly, it was the great Austrian economist, Ludwig von Mises, who taught that one should study all economic theories so that one could argue and point out the faults in weak theories. Apparently, Krugman has a superior method of understanding so that he does not even have to study a theory before he dismisses it. This nonsensical start by Krugman is enough to toss the paper. But, let us do something he claims he does not need to do, let us review arguments contra to our own thinking, that is, let us give the rest of his article full hearing.
He then writes: "the incident set me thinking—not so much about that particular theory as about the general worldview behind it". This is twisted cleverness if there ever is such a thing, because for the rest of the article he does nothing but discuss the theory, with one subtle deviation, when he attempts to force Austrian Business Cycle Theory ("ABCT") into a subtle box as a moral quasi-religious theory, as opposed to the well reasoned economic theory that it is.
He then begins discussing the theory, "Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion."
There are a couple things that need to be pointed out here. First,in debus ex machima fashion, he begins the theory with the boom already in place. In ABCT, how the boom starts is integral to an understanding of the theory. ABCT holds that central banks create an artificial boom by printing money that ends up in the capital goods sector.
Thus, not all booms will cause the negative consequences of a bust. An increase in productivity can cause a roaring boom that every ABCT theorist would agree has no reason to end in recession.
And notice the deceiving use of the word "punishment". Nowhere do ABCT theorists use the word. It has the connotation that ABCT is some moral theory about those who party too hard getting their just desserts, in a moral sense. This is pure twisted evil Krugman. He is much too good a wordsmith not to know the deception he is spinning here.
On to paragraph 2:
The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.Ah yes, the use of the word "punishment" now sets the reader up for this poppycock paragraph about a "morality play" , hubris and downfall. Thus, the evil Krugman digs the deception deeper. And, notice the use of the word "seduction", for a theory that has perhaps 1.0% of the followers of Krugman's Keynesian religion.
Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded.Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less. Nor is this merely an academic argument:Notice the sly Krugman here, this “seductive” ( which accounts for 1.0% of trained economists) morality play (A morality play which is a strawman, created by Krugman's twisted and deceiving use of the word "punishment") "must be resisted."
The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.
Krugman then goes on to remarkably blame the Austrians for the Great Depression, a period during which FDR instituted more controls on the country than ever seen before. UCLA economists Harold L. Cole and Lee E. Ohanian have shown that FDR drove up wages and prices and was responsible for extending the length of the 1930s economic downturn by years.
The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity—of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes—investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.This is simply another twisted paragraph . Now it appears that Krugman has slyly changed the debate. He is no longer discussing ABCT, but all "hangover theories", and whatever happened to discussing ABCT's "worldview"?
Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles. Anyone who has watched the ups and downs of, say, Boston's real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life. But let's ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole? Don't say that it's obvious—although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them. And in fact the key to the Keynesian revolution in economic thought—a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles—was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines because(sic)the whole economy to slump.Again we have Krugman using a loaded term, the supposed ABCT view of the "virtue" of recessions. ABCT theorists see recession as the readjustment period necessary from a previous central bank inspired boom. Krugman wants to keep his near-religious “morality play” going, so he uses the word “virtue". As for arguing that Keynes has made ABCT theory obsolete, by simply stating such, that’s as strong an argument as my saying, Henry Hazlitt made Keynes obsolete. But at least there is a book by Hazlitt, The Failure of the New Economics, that did make Keynes obsolete.
Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?So much for not discussing ABCT, and to just look at some worldview. Of course, the person that gets laid off does not automatically find a job the next hour, a search for a new job must take place. Further, Keynesian unemployment programs extend the unemployment! Since why should anyone rush to find a job when they are being paid not to work?
Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction—also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when every industry—not just the investment sector—normally contracts.Notice the viciousness, “supposedly deep Austrian theorists “.
As for as Krugman’s question as to why there isn’t a rise in unemployment during the boom part of the cycle , this clearly demonstrates his lack of a deep understanding of ABCT. Before a boom starts, the economy can be said to be in equilibrium between the consumer goods production and capital goods production. When a central bank then pumps in new money, new demand is created for labor in the capital goods sector causing bidding for labor away from the consumer goods sector. Thus, there is no point where rising unemployment would be a factor in this part of the cycle. However, during the downturn part of the cycle, it is not a case that the central bank is pumping money into the consumer sector. What is occurring, instead, is that a transfer of money is taking place from the capital goods sector to the consumer goods sector. It is this money drain from the capital goods sector that causes the unemployment. During the central bank induced boom, money isn’t being drained from anywhere.
As for every industry being impacted by a recession, Krugman just doesn’t get what a capital good is. What I have identified as Wenzel’s Observation # 2 states that you need to know the purpose a good is being put to, to know if it is a capital good or consumer good, as I explained recently with regard to NBA tickets and how some purchases are consumer good purchases and other purchases are capital good purchases. Likewise, a hot dog sold on a summer day in a park is different from a hot dog sold at a construction site.
Thus , the “supposedly deep Austrian theorists” are much deeper on this topic than Krugman.
Here Krugman wants to become an inflationist. He decries an economy wide demand for cash, but wants to pump money through the banking sector, which benefits debtors at the expense of savers. If it is an economy wide increase in the demand for cash, why not just let the new lower price structure settle on the economy? Why would an increase in the demand for cash cause “good productive capacity to be left idle” unless ABCT is correct?
As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?
The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present. Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can't stand the thought that positive action by governments (let alone—horrors!—printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. And some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors. But moderates and liberals are not immune to the theory's seductive charms—especially when it gives them a chance to lecture others on their failings.“The hangover theory, then, turns out to be intellectually incoherent,” writes Krugman, This again from a man who says at the start of this article that he is not gong to examine the theory but the “worldview”. It is not the ABCT that is incoherent, it is Krugman’s article.
Then , he is back to the “emotional” appeal of ABCT. He then goes on to tell us the reasons that “some” are attracted to ABCT. This is very close to a Marxian view of class logic, again all subtlety slipped in.
Few Western commentators have resisted the temptation to turn Asia's economic woes into an occasion for moralizing on the region's past sins. How many articles have you read blaming Japan's current malaise on the excesses of the "bubble economy" of the 1980s—even though that bubble burst almost a decade ago? How many editorials have you seen warning that credit expansion in Korea or Malaysia is a terrible idea, because after all it was excessive credit expansion that created the problem in the first place?
“Moralizing on the region’s past sins”? Again another attempt to make ABCT sound as though it is a religious moral theory , and not a theory based on sound principles and reasoning.
And the Asians—the Japanese in particular—take such strictures seriously. One often hears that Japan is adrift because its politicians refuse to make hard choices, to take on vested interests. The truth is that the Japanese have been remarkably willing to make hard choices, such as raising taxes sharply in 1997. Indeed, they are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a
recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct. Keynes had it right: Often, if not always, "it is ideas, not vested interests, that are dangerous for good or evil."
Raising taxes in the middle of a recession was a hardly smart move by the Japanese. Keynes was right, though, about ideas that can be dangerous for good or evil. And as can be seen in this article, Krugman’s ideas are evil in their tone and they attack ABCT in a twisted, and deceiving manner. But, at this point, the Austrian economic analysis must stop and the other Austrians, lead by the foundational thinking of Sigmund Freud, must take over to explain what would cause a mind to write the twisted deceiving article that Krugman did.