Posted 10/3/2012 10:43:00 AM

Why Dumb Bankers Love Keynesianism

Gary North
Reality Check

Dumb bankers love government bailouts. So do Keynesians. Dumb bankers abhor negative economic feedback for stupid decisions. So do Keynesians. Dumb bankers love monetary inflation that leads to banking profits. So do Keynesians. Dumb bankers love national governments large enough to bail out large banks. So do Keynesians. Dumb bankers hate bank runs. So do Keynesians. Dumb bankers want tenure without personal liability. So do Keynesians.

Paul Krugman is the chief spokesman for Keynesianism in our time. He sees his job as making sure that taxpayers bail out large multinational banks. When taxpayers resist, he ridicules them for being short-sighted.

He conceals his position as a defender of banking interests by coming in the name of the workers. But big bank bailouts are the inescapable implication of his recommended policies. He is the multinational bankers' friend. So is his Princeton colleague, Ben Bernanke.

We can see this in his recent article calling for the German government and the International Monetary Fund and the European Central Bank to lend more money to Spain's government even though the government refuses to cut spending.

He wants the economy to avoid the cost of repaying loans from the North. There must be more loans to the government so there can be more payments to people on the dole, who will spend money, and get the economy rolling. Then this will let Spanish debtors meet their interest payments to German banks.

So, once caught in the trap of bad loans to deadbeats, bankers must make more bad loans. Why will they do this? Because the German government, the ECB, and the IMF will keep buying Spain's government's bonds.

If this sounds like Bernanke and Paulson in 2008, that's because they set the pattern.

Europe is entering into a recession. There is a continuing fiscal crisis in Greece, Portugal, and Spain, which is huge.

Germany has now moved into a recession. Great Britain probably has.

Krugman is appalled by the requirements of the IMF, the ECB, and Germany's politicians that reduced spending by PIIGS's governments must be a condition for receiving IMF aid and German aid. He is a Keynesian. He hates the idea of austerity, which means austerity for government bureaucracies. He wants more spending by governments.

It is always possible to get an article out of refuting one of his articles. He is of course anti-austerity, he is in favor of deficits.


He began his article with a summary of the European Central Bank's promise to keep governments solvent by purchasing their debt. This has been illegal in the past. But the ECB has broken the rules of the eurozone's treaty. This violation of the rules had "soothed" markets, he said. All a debtor nation had to do was ask for help, meaning bailout money.

Then strikes broke out in Greece and Spain to protest "austerity," meaning government budget cuts. It's very bad economically, he said. "With unemployment at Great Depression levels and with erstwhile middle-class workers reduced to picking through garbage in search of food, austerity has already gone too far. And this means that there may not be a deal after all."

He summarized the financial media, which thinks that the deadbeat nations will default anyway.

Much commentary suggests that the citizens of Spain and Greece are just delaying the inevitable, protesting against sacrifices that must, in fact, be made. But the truth is that the protesters are right. More austerity serves no useful purpose; the truly irrational players here are the allegedly serious politicians and officials demanding ever more pain.

This is pure Krugman. He never met a federal deficit that he didn't like. He never met a government labor union he didn't like.

He said that Spain is suffering because of the aftermath of its popped housing bubble. He said it caused a boom and forced up prices. He did not explain how. Why did housing prices rise? Low interest rates. Why were there low interest rates? Because northern European banks lent newly created money to Spanish government bonds. German banks were among them.

When the bubble burst, Spain was left with the difficult problem of regaining competitiveness, a painful process that will take years. Unless Spain leaves the euro -- a step nobody wants to take -- it is condemned to years of high unemployment.

Spain never had much competitiveness in the first place. That was the heart of the matter. But they borrowed at rates that applied to Germans, who are competitive. This was stupidity on the part of German bankers. Now they are loaded up on bad debt issued by a nation that was never competitive -- going back to the seventeenth century.

But this arguably inevitable suffering is being greatly magnified by harsh spending cuts; and these spending cuts are a case of inflicting pain for the sake of inflicting pain.

This is Keynesian rhetoric. The cuts are not being called for to increase pain for its own sake. The cuts are being demanded because Spain is running a huge deficit. Lenders want to be paid interest on time, and in euros.

He said that the government ran a small surplus until 2009. "Large deficits emerged when the economy tanked, taking revenues with it, but, even so, Spain doesn't appear to have all that high a debt burden."

Really? Then what happened? It's simple: dumb bankers in the North lend euros at low rates. When rates are held low by stupid bond investors, this forces down other long-rate debt. Mortgage debt soared. The bubble grew.

It's true that Spain is now having trouble borrowing to finance its deficits. That trouble is, however, mainly because of fears about the nation's broader difficulties -- not least the fear of political turmoil in the face of very high unemployment. And shaving a few points off the budget deficit won't resolve those fears. In fact, research by the International Monetary Fund suggests that spending cuts in deeply depressed economies may actually reduce investor confidence because they accelerate the pace of economic decline.

So, reduced government spending hastens economic decline. Why? Why is it unproductive to let the private sector keep this money? This is the heart of Keynesianism's error from the beginning.

In other words, the straight economics of the situation suggests that Spain doesn't need more austerity. It shouldn't throw a party, and, in fact, it probably has no alternative (short of euro exit) to a protracted period of hard times. But savage cuts to essential public services, to aid to the needy, and so on actually hurt the country's prospects for successful adjustment.

Think about what he is saying. Cuts are "savage." What is the evidence? What constitutes savage cuts? For a Keynesian, any cuts are savage.

He wrote that there will be "a protracted period of hard times." I agree. There are already very hard times. There is 50% unemployment for people in their early twenties. But why does Spain have no alternative (short of a eurozone exit.)


Now I must ask some decidedly non-Keynesian questions. First, why would Spain's departure from the eurozone keep away hard times? This is what Krugman indicates would be the case, but it is not self-evident to me as to why it should be the case. What is it about the euro, meaning the use of the euro within a free-trade zone, that has created such hard times?

A strong euro is creating hard times in Spain, because there is almost nothing that Spain can export that anybody in northern Europe wants to buy. So, Spaniards cannot get enough money in euros for the government to collect from the public to meet its payments on its debt.

In other words, the government sold its IOUs in the boom. The economy has collapsed. The economy has collapsed, because the inefficiencies of Spanish production do not enable it to compete effectively with economies in the North.

Why would leaving the eurozone help Spain? There would be some increase in exports, but only if the new currency unit, probably the peseta, will fall in value in relationship to the euro. Why would it do that? Because Spain's central bank would legally have the power to produce pesetas in large quantities. It would inflate the currency. That would lower the value of the peseta in relationship to the euro. So, Spain would get more exports. But, in contrast, Spain's citizens would not be able to afford to import very much from outside Spain. That would dramatically cut imports, which would raise domestic prices. The public would not be able to buy as many goods and services, precisely because the supply of services coming in from Germany in the North would be cut off.

The reduction of available goods from northern Europe would mean austerity for the public. It would mean that people would have to cut back on spending. There would be a real hardship among those people who still have jobs.

Some Spaniards would win by a departure. Others -- most people -- would lose. The only thing that Spain's government can do is redistribute the pain by leaving the euro, and it would distribute the pain in the direction of those citizens who like to buy high-quality goods from northern Europe. That would greatly benefit the inefficient producers who are members of Spain's trade unions, but it surely would not help Spanish customers.

Krugman wants to know why anybody would recommend austerity. Everybody seems to recommend it.

Part of the explanation is that in Europe, as in America, far too many Very Serious People have been taken in by the cult of austerity, by the belief that budget deficits, not mass unemployment, are the clear and present danger, and that deficit reduction will somehow solve a problem brought on by private sector excess.

He capitalizes "very serious people," because he thinks they are not economically intelligent people. They are merely serious. They are not Keynesians. They do not understand budget deficits are very good for economies.

My second question arises. What have the budget deficits got to do with pulling out of the eurozone? How is it that pulling out of the eurozone is going to enable the central government to restore the economy merely by running deficits? What is it about pesetas that will enable the government to overcome these economic woes by means of running deficits, when it cannot overcome these woes by running deficits as denominated in euros? In other words, what makes Keynesianism work effectively to reduce unemployment? The answer is clear, according to Keynesianism: the ability of the central bank to create massive amounts of fiat money to lend to the government. The government will then run massive deficits.

Next question. Where is the new-found productivity to come from? Why is running massive deficits in fiat money the way to escape the effects of the popped real estate bubble? He never discusses this. But it is the essence of the Keynesian system that there is such a relationship. Massive deficits funded by fiat money are the solution that Keynesians advise in every economic slowdown.


But this is not a good enough explanation for Krugman. He wants another explanation, in this case political. There seems to be an idea that is spread widely in Germany. It is unwise for German bankers to buy lots of new Spanish bonds at low interest rates. That is what they did, which is what created the housing bubble. The German voters think that lending more money to Spain is pouring taxpayer's money down a rat hole.

The German banks bought debt that was issued by Spanish borrowers, and now the borrowers cannot pay off the debt. Of course they can't pay off the debt. There was no way in the world that they could ever get their hands on euros in order to pay off the debt. They had nothing to export to Germany that would have enabled them to pay off the debt. That German banks never expected Spain to pay off the debt.

Now Spanish interest rates are rising. The market value of Spanish bonds held by German banks is falling, and the threat of a default is increasing. (Exiting the eurozone would be a partial default.) Surprise, surprise. Dumb bankers do dumb things, and Germans are tired of bailing out dumb German bankers. But this does not satisfy Krugman.

Beyond that, a significant part of public opinion in Europe's core -- above all, in Germany -- is deeply committed to a false view of the situation. Talk to German officials and they will portray the euro crisis as a morality play, a tale of countries that lived high and now face the inevitable reckoning. Never mind the fact that this isn't at all what happened -- and the equally inconvenient fact that German banks played a large role in inflating Spain's housing bubble. Sin and its consequences is their story, and they're sticking to it.

No, Dr. Krugman, it is not sin and its consequences that are the problem. Rather it was stupid German bankers who never figured out that the low interest rates they were getting when they bought Spanish debt involved a massive risk of default. Dumb German bankers did not indulge in sin, but rather economic stupidity. They believed that the PIIGS could repay their debts, meaning that the PIIGS had something valuable to export, which they didn't.

Worse yet, this is also what many German voters believe, largely because it's what politicians have told them. And fear of a backlash from voters who believe, wrongly, that they're being put on the hook for the consequences of southern European irresponsibility leaves German politicians unwilling to approve essential emergency lending to Spain and other troubled nations unless the borrowers are punished first.

The voters are indeed being put on the hook for the consequences. There is no question that massive wealth redistribution is going to take place, one way or the other. The government is going to provide a bailout for the German banks, at taxpayers expense. The only question is how: either directly or by lending money to Spain's government, which will pay interest with borrowed euros.

This will go on forever. Nobody is going to trust Spanish borrowers again unless German taxpayers are on the hook for Spain's debts.

Of course, that's not the way these demands are portrayed. But that's what it really comes down to. And it's long past time to put an end to this cruel nonsense.

It is neither nonsense, nor is it cruel. It is simply the outcome of irresponsible lending by German bankers to deadbeat enterprises and governments in the Mediterranean zone. The bankers have now lost hundreds of billions of euros, because the debts cannot be repaid, and the bankers want somebody to bail him out. After all, that is what bankers always want.

German taxpayers understand that they are going to be the sacrificial lambs to save the hides of German bankers. They don't like it. They would rather have the debts paid off by the Spaniards who borrowed the money. They think the Spaniards borrowed the money, so the Spaniards should pay it back. This outlook, of course, is radically anti-Keynesian. Debts are never supposed to be paid back in the Keynesian system. They only grow ever-larger.

Then comes the collapse of the bubble. Somebody is left with a mountain of worthless debt. This always means bankers, and in this case, it is German bankers.

If Germany really wants to save the euro, it should let the European Central Bank do what's necessary to rescue the debtor nations -- and it should do so without demanding more pointless pain. (


Here is the basic pitch of every Keynesian economist. Nobody should ever suffer pain for the bad decisions that they made previously. The bad decisions have turned out to be disastrous. Stupid German bankers can see this. They therefore resent anybody who says that there should not be more government loans, or more IMF loans, or more European Central Bank inflation to enable the Spanish debtors to make interest payments on the loans they can never afford to pay off. This will only increase the amount of debt they owe to the stupid German bankers.

This is why German voters want to call a halt to the process. It is not because they are sadists who want to inflict pain.

It all boils down to this. Everybody wants a bailout. Everybody who makes big money in a boom time wants a safety net, financed by others, when the boom turns into a bust.

In the Keynesian universe, there are never to be consequences for one's actions. There are never to be negative sanctions that impose losses on bankers who make stupid loans. There is not to be a negative feedback loop that reminds bankers that they made mistakes, and that the owners of the capital stock of the banks have got to suffer losses. The bankers didn't want this in the United States in 2008, and the German bankers don't want it in 2012.


Paul Krugman, as the Dean of Keynesian economists in our day, calls for the same old solutions: massive government deficits and massive monetary inflation. The game must go on. Those who made mistakes are not supposed to suffer for having made the mistakes.

It was stupid to have lent Spanish enterprises euros at low interest rates. The Keynesian solution to that stupidity is to make an endless series of loans at low interest rates to the same Spanish banks and Spanish enterprises. In other words, mistakes, once made, are to be bailed out by further bad mistakes. The idea is to throw good money after bad. This is the essence of Keynesianism.

Bankers therefore love Keynesianism.

Posted By: Paul Stark  

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