Monday, June 28, 2010

Krugman goes there

Princeton Economist Paul Krugman uses the “D-word” in his regular column in today’s New York Times. “We are now, I fear, in the early stages of a third depression.” According to Krugman, this will be more like the so-called Long Depression of the 1870s than the Great Depression of the 1930s. But this is little consolation, he says, because “the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.”

Krugman has been traveling in Europe just as the German and UK governments announced deficit reducing austerity plans. In his view this is the worst possible policy at this time and will inevitably result in prolonging the economic downturn. Its affect here will be to substantially reduce European imports of American goods making our recovery that much more difficult. While in Germany Krugman very publicly made his views known and they were derisively dismissed by Germany’s finance minister. Obama expressed a similar but more moderate viewpoint at the G-20 meeting but it also fell on deaf ears.

A growing number of economists and financial advisers are warning that the US will head back into recession (a “double-dip”) in the 3rd or 4th quarter of this year. Krugman and many others warned that the stimulus package adopted last year was too small. While it would stop the economy’s free fall (which it did) it was insufficient to re-ignite the economy and start it growing.

Those predictions seem to be proving accurate. New and existing housing sales are falling and house prices are likely to follow. Retail sales are stagnant and unemployment has been stuck at about 10% for months. Perhaps most disturbing has been the fall in the money supply despite the nearly wide-open spigot of the Federal Reserve. The Fed’s money give away seems only to have fueled a run-up in the stock market but even that has finally sputtered out.

In short: the US economy is a mess, much more so than most people are aware. The same is true for much of the rest of the developed world so we’re not going to get any help from them. The picture Krugman is painting is of a long stretch of economic stagnation characterized especially by high unemployment and underemployment. Would new aggressive, massive government stimulus make a difference? It probably would but it’s also probably not going to happen for one simple reason: the people holding the economic/political cards are the ones who would have to pay for it.

A significant increase in government spending can be paid for by higher taxes or by massive borrowing leading to inflation, or some combination of the two. To cut to the chase, both of these will inevitably result in the rich taking a significant hit. Either their money will be taken via taxes or reduced in value via inflation. Republicans have essentially won the argument on both of these points, having demonized both higher taxes and deficit spending. Democrats have basically conceded the fight with the exception of a few lone voices.

The result is that we will see a few half-hearted efforts from time-to-time on both of these fronts but nothing large enough to make a real difference. As Krugman fears, the economy is heading into a long winter and spring is looking a long way off.

Update: And if you want an example of what Krugman is afraid of, check out this New York Times' story about Ireland. What a difference a recession makes.

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