Sunday, May 31, 2009

Niall Ferguson Smashes Paul Krugman

The NYT columnist and Nobel Prize winner, Paul Krugman, has been body slammed by historian Niall Ferguson. Writes Ferguson at NYT:

Most commentators were unnerved by [the recent increase in long term Treasuery rates]... coinciding as it did with warnings about the fiscal health of the US. For me, however, it was good news. For it settled a rather public argument between me and the Princeton economist Paul Krugman...

A month ago Mr Krugman and I sat on a panel convened in New York to discuss the financial crisis. I made the point that “the running of massive fiscal deficits in excess of 12 per cent of gross domestic product this year, and the issuance therefore of vast quantities of freshly-minted bonds” was likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. I predicted a “painful tug-of-war between our monetary policy and our fiscal policy, as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year”.

De haut en bas came the patronising response: I belonged to a “Dark Age” of economics. It was “really sad” that my knowledge of the dismal science had not even got up to 1937 (the year after Keynes’s General Theory was published), much less its zenith in 2005 (the year Mr Krugman’s macro-economics textbook appeared). Did I not grasp that the key to the crisis was “a vast excess of desired savings over willing investment”? “We have a global savings glut,” explained Mr Krugman, “which is why there is, in fact, no upward pressure on interest rates.”

Now, I do not need lessons about the General Theory . But I think perhaps Mr Krugman would benefit from a refresher course about that work’s historical context...

Of course, Mr Krugman knew what I meant. “The only thing that might drive up interest rates,” he acknowledged during our debate, “is that people may grow dubious about the financial solvency of governments.” Might? May? The fact is that people – not least the Chinese government – are already distinctly dubious. They understand that US fiscal policy implies big purchases of government bonds by the Fed this year, since neither foreign nor private domestic purchases will suffice to fund the deficit. This policy is known as printing money and it is what many governments tried in the 1970s, with inflationary consequences you do not need to be a historian to recall.

No doubt there are powerful deflationary headwinds blowing in the other direction today...But the price of key commodities has surged since February. Monetary expansion in the US, where M2 is growing at an annual rate of 9 per cent, well above its post-1960 average, seems likely to lead to inflation if not this year, then next. In the words of the Chinese central bank’s latest quarterly report: “A policy mistake ... may bring inflation risks to the whole world.”

The policy mistake has already been made – to adopt the fiscal policy of a world war to fight a recession. In the absence of credible commitments to end the chronic US structural deficit, there will be further upward pressure on interest rates, despite the glut of global savings. It was Keynes who noted that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist”. Today the long-dead economist is Keynes, and it is professors of economics, not practical men, who are in thrall to his ideas.
If anyone wants to stand up for Krugman's side in this debate, put your retirement money in long term Treasury securities. Go ahead, I dare you.


  1. Hi Robert -

    Interesting face-off there.
    Ferguson has been writing about US deficits and debt for a while...

    I think the spike in yields last week overshadowed the fact that Treasury auctions last week were rather well-bid. I don't know whether that is "less bad news," as some think it is..or not an indication of anything at all.

    But you're right. We're caught between inflationary and deflationary fears. Since there's a lag between when something happens and when it's perceived as having taken place, expect the kind of back and forth we've been having (commodity spikes followed by sell-offs).

    But if that's the case, then the next down-leg in the housing and consumer markets (loan resets, commercial, credit card and so on)
    should set off another sell-off in commodities.

    What do you think?

    Rogers suggests a take-down in gold price to the 700, but recently gold has looked very strong (if over bought) to the upside.

  2. Hi Lila,

    I tell you what I am watching very closely is Bernanke's actions with the money supply. I have never seen such roller coaster activity. One minute he is flooding the markets with money the next minute he is slamming on the breaks from late September to about mid-March moneu groeth was oveer 12%, now he has it down to 6%.

    Thuis has to cause whipsaw action in the markets. Buckle your seat belt.