Paul Krugman, the Cassandra* of our era, is getting ready to delcare “The Third Depression”, a long interval of @ 10% unemployment and slow US economic growth. He says our only hope is ongoing stimulus and massive deficits over the next five years.
Alas, a coordinated stimulus isn't going to happen. Bruce Bartlett gives one example why …
Debt Default: It Can Happen Here
… As of right now, outstanding debt subject to limit is a little over $13 trillion and the debt limit is $14.3 trillion. At the rate the Treasury is borrowing, it can continue for about 10 months before the debt limit must be raised again…
… to be sure, the debt limit has always been raised in time to prevent a default, although Treasury sometimes had to push the limits of the law to move money around to pay the government’s bills. However, I believe the game has changed …
… a growing number of conservatives have suggested that default on the debt wouldn’t be such a bad thing. It is often said that default would lead to an instantaneous balanced budget because no one would lend to the U.S. government ever again. Therefore, spending would have to be cut to the level of current revenues. Writing in Forbes last month, the Cato Institute’s John Tamny was enthusiastic about the prospects of default…
… Tamny is not an isolated crackpot; reputable conservative economists have been writing sympathetically about the idea of default for decades...
Other prominent conservatives who have been favorable, even enthusiastic, about debt default include Murray Rothbard, Dan Pilla, Jeffrey Rogers Hummel, and Christopher Whalen. In 1995, then House speaker Newt Gingrich publicly warned the Public Securities Association that he was prepared to default on the debt unless Bill Clinton acceded to Republican demands for budget cuts. “I don’t care what the price is,” Gingrich said.
..Last year, The Economist’s Greg Ip wrote an article in the Washington Post saying that financial markets were placing the risk of default at 6 percent over the next 10 years. “Default is unlikely,” he said. “But it is no longer unthinkable.”…
So even if Krugman is right, the American people don’t have the wisdom to apply his recommendations.
Is there some way, however, that Krugman could be wrong?
It seems unlikely, his record is very good. Still, it is a bit peculiar that the Euro crisis seems to have arisen from somewhat different economic roots than the American crisis. Yes, Krugman and others argue that the economic fundamentals are identical, but I think I see some unspoken anxieties in their conclusions.
So if these crises aren’t really of the same root causes, why should they occur together?
Perhaps we’re simply seeing an economic form of the sort of synchronization that may cause earthquakes to occur close in time. Or perhaps there are root causes beyond traditional economic modeling.
That’s one way in which Krugman could be wrong. He’s unlikely to be wrong within the framework of economics, but what if our economies have drifted into turbulent domains where linear economic models no longer apply? A whitewater world, in other words.
What if the root cause of our crises can't be found in traditional economic models, but in deeper causes such as the technological discontinuity of networked computers and the historic discontinuity of a resurgent China and India? What if these two shocks are stressing every aspect of the world's economic infrastructure?
If we accepted those twin revolutions as root causes, then we might imagine they would manifest differently in different economic settings. In each case the "machine" would come apart at its weakest point. In the US that would be our insanely complex Finance operations, in Europe it would be the strains of a single currency for Greece and Germany, and in China it will be ...
If we take these as the root causes, then traditional economic stimulus might get the machine going again -- but it might blow up in a different direction. The focus would need to be on managing and ameliorating disruptions, while perhaps sprinkling a bit of sand in the gears of an overheating engine. Managing China's bubble economy, including currency value changes, would become a great US priority.
It's not a great change from what Krugman recommends, save for less focus on spending and more on management for the long haul - including stripping benefits (health care, etc) from employment. There's also in this model more room for surprises -- meaning we may do better than another Long Depression. Or we might do worse ...
* Cassandra as in always depressing, always right, always ignored.
Update 6/29/10: I really don’t think Paul K and Kevin Warsh are reading Gordon’s Notes, but I do think I’m tuning a meme.
From PK’s blog post this am we read Warsh saying “unanticipated, nonlinear events can happen” and Krugman responding
So it’s these “unanticipated, nonlinear events” that are “more certain” than the direct effects of fiscal policy?
Of course that’s only a bit of the blog post, which mostly consists of Krugman reframing a few of Warsh’s statements and ripping them up (he’s very good at that, maybe too good).
Still, the “nonlinear events” bit is interesting. Krugman’s rebuttal is also interesting. He doesn’t actually say it’s rubbish to contemplate nonlinear events that might move us outside of current economic modeling, instead he says they’re relatively speculative compared to the direct effects of fiscal policy.
I think Krugman is wrestling with the possibility that we’re outside model bounds.
Incidentally, I should be clear (fwiw) that I’m not joining up with the austerity group. I’m in the squishy middle ground. I’d be more of a full Keynesian if I believed humans were capable of running surpluses in good times.
