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Engineer, blogger, and student of the Austrian school of economics who seeks to apply its principles to investing.
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  • Repression, Krugmerican Style 0 comments
    Jun 13, 2012 2:27 PM

    In a recent article called "Repression, Chinese Style," Paul Krugman correctly analyzes China's negative rate of return as on deposits as "a giant engine of kleptocracy," yet fails to see that his critical observation of China demonstrates why his own policy prescriptions for the US are exactly the same as what he correctly calls repression. He writes,

    "Hempton basically argues that China has turned financial repression - controlled interest rates on deposits, which ensure a negative real rate of return - into a giant engine of kleptocracy. The banks extract rent from depositors, transfer those rents on to state-owned enterprises in the form of cheap loans, and then the Party elite essentially embezzles the money."

    The article might as well be entitled "Repression, Krugman Style," because that's exactly the policy Krugman supports via Zero Percent Interest Rates, aka ZIRP, in the US.

    Let's rephrase his statement to demonstrate:

    "The Federal Reserve Bank has turned financial repression - controlled interest rates on deposits, which ensure a negative real rate of interest - into a giant engine of kleptocracy. With interest rates below the inflation rate, the Federal Reserve extracts rent (aka steals) from depositors, transfers those rents on to state-connected banks that can belly up to the discount window and borrow at the Fed Funds Rate of 0%-.25% interest, with the Democrat and Republican elite essentially lavishing the rest on the interests best represented by lobbyists."

    Steals from depositors? That sounds inflammatory, but it's true. If you earn less interest than the rate of inflation on your savings, the spending power of your savings is consequently reduced. That spending power ends up elsewhere: the Fed's balance sheet expansion and government spending. Or, as blindered, myopic Krugman can only see when looking at China, a "giant engine of kleptocracy."

    As explained during the Congressional Testimony of James J Rickards, Senior Managing Director of Tangent Capital Partners, at a hearing called "Retirement (In)security: Examining the Retirement Savings Deficit" on Wednesday, March 28, 2012,

    "Lost purchasing power. Zero rate policy deprives retirees and those nearing retirement of income and depletes their net worth through inflation. This lost purchasing power exceeds $400 billion per year and cumulatively exceeds $1 trillion since 2007."

    Krugman is all for this. Writing about Greece on March 12th of this year, Krugman said,

    "But the main point is that America does have an alternative: we have our own currency, and we can borrow long-term at historically low interest rates, so we don't need to enter a downward spiral of austerity and economic contraction.

    So it is time to stop invoking Greece as a cautionary tale about the dangers of deficits; from an American point of view, Greece should instead be seen as a cautionary tale about the dangers of trying to reduce deficits too quickly, while the economy is still deeply depressed."

    In that statement, Krugman argues that further borrowing at low long term rates are a "historic opportunity" brought on by the Fed's Zero Percent Interest Rate policy.

    Yet on Feb 26th, Krugman wrote:

    "The policy problem is that for whatever reason - in current conditions, mainly the deleveraging taking place after an era of debt complacency - the interest rate that would match savings and investment at full employment is negative. Unfortunately, that's not possible, because rather than lend at a loss people can just hold cash. So we have an "incipient" excess supply of savings, which is eliminated not via a fall in interest rates but via a fall in income, i.e., a depression.

    Now, the figure above may look familiar from microeconomics; it's more than a bit like the standard analysis of a price floor that creates a persistent excess supply of a good, such as the way European price floors on agricultural products created butter mountains, wine lakes, etc."

    Krugman blindly ignores that that Zero Percent Interest Rates which are responsible for the "historically low rates" he urges borrowing at are a price floor. Even the IMF calls this policy a "Zero Interest Rate Floor." Borrowing at artificially low interest rates as Krugman is promoting creates a money mountain, aka bubble, aka inflation. Krugman mocks butter mountains, but promotes money mountains - he wrote of increasing inflation in April as the equivalent of moving to a real interest rate below 0%.

    In discussing the distinction without a difference argued in a debate between Ryan Avent and Matt Yglesias, he ultimately takes Avent's side, promoting inflation, and admits albeit indirectly that this policy is designed to hurt savers:

    "The shared starting point here is that we are in a situation in which the Fed would clearly cut rates if it could; based on historical relationships between unemployment, inflation, and policy rates, the Fed funds rate "should" be something like -4 percent. But the Fed can't do that. What it could do, however, is try to reduce real interest rates by raising expected inflation.

    Avent is right in saying that raising the inflation target would, in economic terms, be very much the same thing as cutting rates. He then argues that this says that the real constraint on policy is political, not technical, and hence that the Fed is engaging in malfeasance."

    Repression, American Style

    Let's revisit the "Repression, Chinese Style" article. Krugman agrees that

    "China has turned financial repression - controlled interest rates on deposits, which ensure a negative real rate of return - into a giant engine of kleptocracy."

    There are two possibilities: either Krugman doesn't understand what he's talking about, or he is supporting "Repression, American Style" by promoting continued borrowing at "historically low interest rates."

    To Krugman, when China does it, it's "repression."

    When the Federal Reserve does it, Krugman argues it is to prevent a "downward spiral of austerity and economic contraction."

    Sorry Krugman, it's still kleptocracy and repression.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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