Cap'n Transit on the Economy
Wednesday, September 14, 2011 | Charles Marohn One of our frequent readers, Cap'n Transit, wrote last month on his blog (Cap'n Transit Rides Again) about the difficulty in solving the short, medium and long-term problems of the economy, as well as the difficult challenge of knowing the difference. It was a very thoughtful piece and I have a passion for engaging intellectually with anyone who is coherent on this topic. Cap'n Transit has raised some good points and I wanted to take a little bit of time to go over them.
Here is the meat of the post from August 20:
Yes, it's true that we're facing the peak oil crisis and the climate change crisis, and Marohn is quite right that we have an additional crisis of overbuilt infrastructure that we don't have the financial ability to maintain. We may not even have the "real" ability to maintain it, in terms of resources like manpower, asphalt and energy, while still feeding ourselves and producing goods for export.
The fact is that those are all three long term problems. There are similar-looking short-term problems, but the solution to a short-term problem is not always the same as the first step of solving a similar long-term problem. For example, if it's cold in my apartment one day, I may want to turn on a space heater. If it's cold in my apartment all winter, I may want to replace my weatherstripping. The first step to replacing weatherstripping is to see if the hardware store is open, but that won't make my apartment any warmer in the short term. I may want to turn on the space heater and see if the hardware store is open. It may be a bit wasteful to run the space heater with leaky windows, but for a day it's not that big a deal.
This is what I think Marohn and Kunstler are missing when it comes to Paul Krugman, Matt Yglesias and their calls for Keynesian stimulus. Marohn and Kunstler criticize Krugman for not realizing the severity of the situation. Krugman may or may not realize the severity of the situation, but he knows that the economy has the short-term capacity to put most people back to work and bring tax revenues back up, if the government were willing to tolerate some inflation.
Let me point out the obvious first. If Paul Krugman and I are in a room together, only one of us has a Nobel Prize in Economics (hint: it's not me). That having been said, in the spirit of the blogosphere where everyone can pretend to debate a Nobel laureate, I will take issue with the Krugman advocacy of Keynesian stimulus, but try to juxtapose his views with those of other economic thinkers I enjoy.
Let's examine the cold apartment analogy presented by Cap'n Transit. (And by the way....I kind of enjoy writing the name Cap'n Transit. It has a super hero quality to it. Very cool.) The weatherstripping is bad and so the apartment is cold. We can't fix the weather stripping today, so we take some other short-term action instead, then fix the weather stripping tomorrow.
I agree that this is very logical. And certainly this is how I would handle that problem. But that is not how we as a society collectively act, or have collectively acted for decades. Society would turn up the space heater, get rid of the cold and then forget it was cold in the first place. Pretty soon we would have a space heater entitlement and it would be every elected official's duty to ensure that it was kept running. Whole space heater industries would spring up, complete with a massive lobby, to advocate for the continuation of solving this temperature problem with space heaters. Weather stripping would now threaten their jobs and, over time, the entire economy, so we would develop a weather stripping tax. A narrative would develop that it was space heaters that kept us warm all these years, that the poor, the children and the elderly would be hurt worst if there was a change in space heater policy.
As modestly uncomfortable as it would have been at the time, I'd rather society just spent one chilly night and then went out and took care of the problem itself the next day.
I believe that Paul Krugman is right, as is Robert Reich, in arguing that we could end this great recession with more stimulus. We could create jobs, etc. by spending more money. If we had no limit to what we could spend, we could create full employment.
As I wrote earlier this year after reading the book When Money Dies by Adam Fergussen, this is what Weimar Germany did in the 1930's 1920's. They couldn't decide between dealing with deflation or unemployment -- they had a political stalemate -- and the default setting was to print money and deficit spend (sound familiar). That is, until hyperinflation took over and they had no currency and no employment.
The problem with Krugman's approach, and modern Keynesianism in general, is that it looks at recessions as bad. I wrote about this last year in a piece, Only you can prevent financial fires (September 27, 2010) and used the analogy of a forest fire. In the 1950's and 1960's, we had a mentality that we could suppress the cycles of nature by suppressing forest fires as soon as they broke out. This had two devastating impacts. First, it built up what we now understand is an explosive amount of fuel within the forest (bad investment that should have been purged, in an economic sense, and now too-big-to-fail). Second, it encouraged people to disregard the impact of forest fires in choosing where to live (in financial terms, this is called moral hazard). As Jared Diamonds pointed out in his book, Collapse, this will not end well.
Recessions are not bad. Recessions are good. The key is that they should be minor and frequent. This is an embrace of the "break early" concept as opposed to the "too-big-to-fail" approach we have gotten ourselves into. Once you go so far down that Keynesian road, recessions are no longer the necessary pruning of the forest stand. They've been quashed until they become destructive, out-of-control, raging conflagrations. Welcome to 2011.
My favorite way to explain this is the circus and restaurant analogy used by Peter Schiff in his prescient speech to the Mortgage Bankers Association two years prior to the housing collapse. (Seriously that speech is a must watch). You own a restaurant. A circus comes to town. All of a sudden there are all these new people eating at the restaurant. You don't know it is from a circus, you misread the demand and decide to expand your restaurant. The circus leaves town and all of a sudden you are in a recession. You need to contract and rid yourself of this malinvestment. Schiff delivers this analogy at time marker 12:20.
In a Keynes/Krugman world, the problem is not the malinvestment but the lack of demand. The solution is for the government to intervene, prop up demand and keep the restaurant from having to contract. The hope is that at some point the market will grow and create the demand itself without the need for fiscal support.
The key for a healthy economy is to learn from your mistakes early. You want the ma and pa restaurant with the malinvestment to fail before it grows into a multinational chain. You want the mismanaged local bank to fail before it grows into Bank of America. You want the housing and tech bubbles -- both the product of artificial Fed stimulus -- to never happen. We purge these malinvestments early, or avoid them altogether, and the pain is much less. Lower stakes and more manageable.
This is the world envisioned by Nassim Taleb, my favorite economic thinker and perhaps the Patron Saint of Strong Towns thinking. He advocates for financial systems that are resilient, that can overcome human error. As we have pointed out numerous times this year (Our unfaithful partner / Downgraded), prolonged deficit spending creates tremendous reliance on forecasts of economic growth. Mess up the forecast (we're human, so we will) and the entire thing stops working. We need to create our systems to operate more like natural systems; resilient and adaptable.
This brings me to my central problem with Keynes, Krugman and really all things involving big hubris (I include national political parties here). While I will freely admit that Krugman is more intelligent than I am, I'll also point out that he knows only a tiny fraction of the knowledge amassed by humanity, which itself is but a tiny fraction of what is to be known in this universe. I'm very wary of economists who have the hubris to believe that they know THE solution, that somehow they have mastered this massively complicated, intertwined and ever-changing system of economics we have developed. Greenspan claimed to have ended the business cycle. Oops. I'm not willing to bet more and more of our future that Bernanke is any more prescient.
If we follow columnist Matt Miller's -- always the centrist -- advice, we would stimulate now and apply austerity later when the economy is growing again. That assumes that (1) the economy can actually grow and (2) we will have the discipline to be austere later. I like Matt Miller, but on the latter assumption I'll point out that we were profligate in the best times and profligate in the worst times. It's never a good time for austerity. On the former, I believe that without dramatic reform of our underlying development pattern, there will be no sustained growth.
I would argue that our economy departed from reality a long time ago. There is little question that the dollar has gone on its own trajectory since we left the gold standard in the 1970's. The tech bubble was not real and neither was the housing bubble that was brought about to solve the tech bubble. So go back to whatever point you like as your baseline: 1950, 1970, 1995 or 2002. Much of what we experienced since then was a growth illusion, so that is where we need to get back to before we can have real growth. At this point, there are very painful ways to do that and there are devastatingly painful ways to do that. Throw in the new reality of peak everything and I find this all to be a sad, sad tragedy.
My basic argument with Krugman et. al. is that they seem to deny the need for a reset. It is inevitable.
Thanks to Cap'n Transit for his post. I hope he follows this up on his blog and we can continue this conversation. Unlike Krugman, I know I'm wrong. Feel free to tell me where. I should also point out that, while I chat frequently with the others here at Strong Towns, the detailed nature of this post means that it likely veers from Jon and Ben's opinion on these matters. For the sake of discussion, assume they agree with you on whatever you disagree with me on.
Finance tagged Alan Greenspan, Ben Bernanke, Nassim Taleb, Peter Schiff 
Reader Comments (19)
Great examples Chuck, especially the space heater industrial complex that sounds so absurd, except it's exactly the kind of situation we're stuck in. I'm also glad you brought up Peter Schiff. He's one of the few people out there who seems to realize just how the macro economy works. His overarching point, that recessions are not the problem, bubbles are, is lost on most people. Recessions correct the mis-allocation of resources that happen during bubbles. Your forest fire analogy is excellent to relate to it. After stamping out so many small recessions (some before they even started), we're now trying to fight a full-on conflagration. Can we win? Who knows, but it's a very costly battle for sure.
The question about where our economy's baseline lies is a rather sobering one. Could it be you need to go back before World War I? After all, 1950 can't be a baseline as it's coming right off the heels of World War II. The post-war growth of the 1950s and 60s was artificially propped up not only by the pent up demand from WWII and the Great Depression, but also the lack of any meaningful competition from the rest of the world's markets. The suburban experiment really geared up in 1950 and continued all the way through to the present, so can any of the latter half of the 20th century be considered a stable baseline for the economy? Looking further back, WWII and the Great Depression were certainly unstable situations, as was the early suburbanization funded by debt in the 1920s. Then we're back to WWI. It seems that before then was the only time there was limited inflation, but there were plenty of financial panics and wild swings in unemployment and economic output.
Could it be that with such rapid change in modern times that establishing a baseline for economies is impossible? Standard operating procedure seems to be based on how to ride the various gimmicks of the time, whether that's railroad building, agricultural revolutions, computer technology, or suburban expansion. We've been doing it for so long that any "normal" state might just not exist anymore, and if we tried to get to such a state then we'd be crushed by others who take advantage of the current trends. It's like asking if you can figure out where sea level is when you're riding the waves on a turbulent ocean, and should you even care?
You make some good points. Who knows where the baseline is. It is likely that an attempt to truly find it would not only be devastatingly painful but would even perhaps over-correct. Not all gains since the Depression were phantom, but sorting things out and creating some type of equilibrium seems nearly impossible now.
And maybe that's the truth that Krugman knows that we don't. Maybe this is an illusion, he knows it but embraces it. If it crashes, we just reset the matrix, so-to-speak, and start over.
I've got CNBC on right now and they are talking about Jobs vs. Housing Recovery, a chicken/egg argument on which one comes first. This is silly because, without more economic meth, a housing recovery is impossible. A real housing recovery is totally impossible. Guess that means job growth, but when new jobs are nearly all based on either building houses or selling stuff, not sure how that happens either.
The feeling I have on this is most closely described as sorrow. This is all so very, very sad.
Chuck -
Stick to planning. When you talk about strong towns you are on the money. But this is just plain ideological nonsense. The Weimar Republic's problem was that it was paying reparations for World War I far in excess of its ability to produce. It has nothing to do with with the United States today. Its like saying a sniffle is the same as terminal pneumonia.
There is NO net cost to society in creating jobs for people who are otherwise unemployed.
Grand Rapids has hanging plants downtown. There is no aggregate cost of those plants to the community. They tax us to purchase the plants. In simplified fashion, they take the money I could have spent for a hanging plant in my backyard and buy one to hang downtown. This has a net benefit, since far more people will see the plant downtown than would have in my backyard.
But that plant downtown also requires maintenance. Someone has to water it and that provides jobs for the teenagers who do the watering. Again, I have to pay taxes to pay the teenagers. But the teenagers get my tax money, so there is no net aggregate cost to the community.
Of course I may be happier with my own plant in my own backyard. And I might be happier watering the plant myself and buying myself a latte with the money. Instead those teenagers are buying themselves lattes with the proceeds of the work. But lets be clear that isn't charity. Those teenagers worked for that money. Its now as much their money as it was mine.
In other words, this is a balance between MY interest in having my own plant and a latte and the general interest of everyone getting the benefits of plants downtown and the teenagers getting some pocket money. So long as we have people who are idle, any investment that puts them to work productively is likely to have a net benefit. It only stops being a benefit when the work they do lacks any value or when they would have done more productive work instead.
But there is a second problem, that heattanalogy is flawed. The real comparison is to a car that won't start. The longterm solution may be to buy a new car. But the short term solution, fixing the car enough to get it started, is essential if you are going to get to work to earn the money for a new car. Investments that put people back to work are like that. The short term fix actually makes solving the bigger problems easier.
Its really the question of how do you make ends meet. Cut back? Or get a better job or a second job? There was a time when Americans were the ones who who looked to fix their problems with optimistic solutions. But the baby boomers have now reached that point in life where they are just looking to hang onto what they have. And, as we did in every other stage of our lives, we are the ones setting the public agenda. Only now, we are setting an agenda that serves us as we wind our lives down, instead of serving the future.
Ross has convinced me a change needs to be made in voting eligibility. Once you hit retirement age you should not be allowed to vote.
;-)
Not to cater to Ross too much, but author of the book on the Weimar that I quoted went to great lengths to reiterate over and over that Germany's problems were NOT the reparations. It was their monetary and fiscal policy. Read the book and then we can have an informed discussion on that topic.
I'll go back to butterflies and daisies now.
-chuck
With all due respect Chuck, this is what you wrote:
"As I wrote earlier this year after reading the book When Money Dies by Adam Fergussen, this is what Weimar Germany did in the 1930's."
In fact, a new currency, the Rentenmark ,was introduced in Germany in 1923 and inflation virtually ended. You apparently are talking about the period before that, immediately after the war. And there is little doubt there was a direct connection between the printing of money and the requirement for reparations.
In any case, the comparison of the current situation in the United States to the Weimar Republic is as silly as comparing Adolph Hitler to Ronald Reagan, George Bush or Barack Obama. Its pure idelogical screed.
You are right, I should have said the 1920's. That is the time period I meant - will fix that.
Germany was required to pay reparations in gold. They did not print gold, they printed marks.
Chuck -
You are relying on an account written by a British conservative politician with an explicit agenda. According to this story, it became a cult hit on right-wing blogs after it was, falsely, claimed Warren Buffet had recommended it.
http://www.cnbc.com/id/38243922/Warren_Buffett_to_CNBC_Never_Heard_of_German_Hyperinflation_Book_Until_Report_He_s_Recommending_It
Reparations were not to be paid only in gold. In fact, they exceeded Germany's entire gold reserves.
http://en.wikipedia.org/wiki/Inflation_in_the_Weimar_Republic
"Beginning in August 1921, Germany began to buy foreign currency with Marks at any price, but that only increased the speed of breakdown in the value of the Mark.[17] The lower the mark sank in international markets, the greater the amount of marks were required to buy the foreign currency demanded by the Reparations Commission."
The printing of money was not done because of some conflict between avoiding deflation and unemployment. In fact, the new currency was a MASSIVE deflation, cutting 12 zeros off of prices according to the wikipedia article.
In short, the experience of the Weimar Republic has virtually nothing to do with the current situation in the United States. Its use as an example is just an exaggerated morality tale used to support pre-conceived ideological convictions.
Chuck and Ross both make very good points that hopefully aren't lost in the heated discussion of the Weimar's problems.
As a compassionate person, I believe that we (the people) need to do what we can to cushion the pain that recessions cause the least among us. If that means raising taxes on the employed so that we can put the unemployed to work, then I think we all ought to agree to do it. To gain a future benefit, those people should be put to work on those long-term problems -- energy efficiency, transportation improvements, infrastructure improvements -- install solar and wind power and wave power systems, smart grid, better rail lines (freight and passenger), improved air-traffic-control systems, improved ports, better schools, park improvements, etc. We probably won't all agree on what projects are most important, but let's put people to work. If we can afford 100-million-dollar airplanes but balk at extending unemployment insurance payments or healthcare for the poor, then we really have our priorities out of whack.
I share your frustration with anyone expecting the national political parties from acting rational. Remember that under President Clinton Congress did run a surplus (perhaps not entirely of their doing), but that was something that the Republican Congress did not do under President Bush (which pisses me off to no end, but I digress).
Let's see....we have a Republican blogger who advocates for Smart Growth, transit and livable communities. He writes an intelligent post with a very fair critique of the pitfalls of Keynesian economics while acknowledging at least twice that there are other rational lines of thinking.
And then he is branded an ideologue? Seriously? We wonder why there is no civil debate in this country.
I guess for Ross, "ideological nonsense" is whenever you don't agree with his dogma. Plus, I don't think Chuck actually called the U.S. "Weimar". He actually said that we could print and borrow as much money as needed but if we did we may end up as Weimar. That's a pretty fair observation.
This blog deserves a higher quality of comments, Ross.
JT
I agree with our last comment. Not surprisingly, I think it applies to your post. Because he neither said what you claim, nor is it true..
What he actually said was this:
"I believe that Paul Krugman is right, as is Robert Reich, in arguing that we could end this great recession with more stimulus. We could create jobs, etc. by spending more money. If we had no limit to what we could spend, we could create full employment.
As I wrote earlier this year after reading the book When Money Dies by Adam Fergussen, this is what Weimar Germany did in the (1930's) 1920's. "
That isn't what Weimar did and it is a far different assertion than this:
" He actually said that we could print and borrow as much money as needed but if we did we may end up as Weimar."
"That's a pretty fair observation."
Actually it would have been an equally ridiculous observation, had he actually made it. He didn't. The argument that we would need to create inflation on anything like the scale of Weimar in order to pay our bills has no basis at all.
Frankly, I am tired of ideological narrative on all sides, right, center and left. They are mostly arguing 19th century ideologies that do little to inform 21st century decisions.
I understand that Chuck is trying to make Smart Growth ideas attractive to ideological conservatives. But this isn't the way to do that.
Thanks, Chuck! Here's my latest, which is partly a response to this post.
At the risk of allowing him to divert all focus to craziness, is Ross arguing that it is a "ridiculous observation" to suggest that we could theoretically print enough money to cause hyperinflation, that essentially there is no limit to the amount we can create out of thin air? I don't even think Krugman has made that case.
In the original piece I indicated that, if we had no limits on what we could spend -- we could just create money out of thin air -- we could solve the unemployment problem for a time. That IS precisely what they did in Weimar Germany. I don't know why it is important to try and discredit a history book written in 1975 because its author later served as a conservative MP and people concerned about our monetary policy have recommended it to others. I don't try and discredit Krugman solely on the basis that he wrote "conscience of a liberal".
Now, I never suggested that the U.S. was Weimar. The major difference between the two is that we understand (at least some of us) what they did in Weimar. At the time, they didn't connect their hyperinflation with their monetary policy and the printing of money. They blamed the French, English and Swiss for manipulating their currency and driving up costs in Germany. Printing money was their solution to hyperinflation. We know today that it was actually the cause.
The advocates for a more inflationary policy today -- Krugman, Reich, Rogoff (he's a conservative, so he should be discredited) -- suggest that we should create inflation by deficit spending and having the Federal Reserve fund the deficit by expanding the money supply. I have no doubt that their intent is to target a higher CPI -- I think Rogoff has called for 4% instead of 2% -- but to stay well short of even what would be considered "high" inflation. We are not going to print so much money in the U.S. that it causes hyperinflation.
That having been said, my overall point here is that the die has already been cast. We've used a Keynes approach to suppress recession for so long that a huge conflagration is inevitable. The economy is not a car that won't start, like it's run out of gas or just needs a new spark plug. The 2005 U.S. economy was based on 60%+ consumption along with shuffling of Wall Street paper, building houses and strip malls and caring for the elderly. There is no spark that is going to be bringing those conditions back, except for the aging population.
Keynes has a lot to offer us, but his approach should not be a religion. The same with the Austrian school, although we've been Keynesians for so long that I do think there is more to be gained today from studying other schools of thought. Either way, I'd recommend that anyone that wants to argue historical facts as a way to make a narrow, political point read a book and not simply quote Wikipedia.
"That IS precisely what they did in Weimar Germany."
No, it is not even vaguely what they did. They printed money to pay off war reparations imposed on them, not to stimulate the economy, not to prevent unemployment and not because they had political paralysis.
"why it is important to try and discredit a history book written in 1975 "
For exactly the same reason someone invented the idea that a history book written in 1975 was recommended by Warren Buffet. Because silly ideologues will believe it and we will end up having silly debates completely unrelated to our current economic situation.
"they didn't connect their hyperinflation with their monetary policy"
And yet, in their ignorance, they solved the problem overnight in 1923 by changing their monetary policy.
That having been said, my overall point here is that the die has already been cast. We've used a Keynes approach to suppress recession for so long that a huge conflagration is inevitable.
No, the die hasn't been cast. And we haven't "used a Keynesian approach to suppress recession", there have been repeated recessions over the past 65 years since World War II.
Your "circus" analogy is a good example of what is wrong with this discussion. A restaurant expands to meet demand, not anticipating that demand will disappear in the future. The selection of a "circus' is designed to make it clear that it was obvious demand would disappear, but that isn't really true for the economy.
Moreover, the likely result for a restaurant that did that is not a "recession", but bankruptcy and closing. Now, if you are community faced with the loss of your only restaurant that may have consequences far beyond the owner of that restaurant. Folks now meet for coffee the next town over, and they use the drug store, the hardware store, the grocery store in that other community. People decide to attend the church in the next town over, since they have to drive their for dinner after church anyway. And they all use the drug store, market and hardware store there as well. The property values in town fall as people decide they want to live where there are better services and more jobs. Now, even if you find a new restaurant owner, the customer base is no longer there for them to make money.
The question for the small town is whether to invest some money to keep that restaurant open, given the stake everyone in the community has in it. I am not saying the answers to that question are easy, but that is the real life decision that is being made. And problems like these don't lend themselves to economic cookie cutter answers based on 19th century political ideologies.
But what ought to be clear, is that if we in the United States let the restaurant die. People can, and will, take their business elsewhere. You may accept that fate as the "die is cast", but I think most of us are looking for alternatives.
"...not even vaguely what they did."
Ross, you are ignorant on this piece of history. I'm not even "vaguely" right? Seriously, if you are not going to take the time to read about the topic you write about, at least read the article I wrote after reading a book on the topic.
http://www.strongtowns.org/journal/2011/7/18/when-money-dies.html
Chuck -
You really consider your account of right-wing journalist/politician's 1975 book about the Weimar Republic the basis of a discussion of the current economic situation? Even the brief number of facts you have used here don't check out.
And that's right. Its not vaguely correct. The situation that the Weimar republic was struggling with is almost completely unrelated to our current situation. No matter what you read in a book from 1975 written as part of the political debates over the proper response to 1970's inflation.
I don't know Ross but "almost completely unrelated" sounds a lot like "vaguely correct". Are you ever wrong?
I'm not a Republican or "right wing" by a long ways but am turned off by how you automatically dismiss someone's work because they are. Would you accept it if all "right wingers" simply dismissed Krugman and Keynes without bothering to read and consider their work? Is there nothing redeeming in the book at all? No single valid point made?
I'm sure they won't but I wish this site would block you from commenting. This is one of the best places on the Internet for serious cross partisan discussion. You detract from that with your talking points and knee jerk flaming.
IMHO
-JT
JT -
As far as I can tell, I haven't "flamed" anyone, only their ideas. And I haven't dismissed anything solely based on its source, but because it is an inaccurate portrayal of what actually happened. And I don't think considering the ideological motivation of a source is inappropriate. Particularly, when that ideological motivation is not clear in the original post.
If 35 years from now someone were to have read only Paul Krugman's current critique of US economic policies during the Great Depression, I would not take that very seriously. But even that isn't really a fair comparison, since he has a Nobel laureate in economics. A more accurate comparison would be a current "history" of the Depression written by a Wall Street Journal, Huffington Post, Fox or CNN news commentator drawing parallels to our current situation.
I think this is a great place to hear about and discuss Smart Growth, especially as it applies to small towns in rural areas. That is is a non-partisan issue. I think ALL partisan discussion detracts from it. Which is why I challenge ideological BS when I see it. Whether the Weimar Republic printed money to pay reparations or to stimulate the economy or to prevent unemployment or as a negotiating tactic is frankly irrelevant to decisions about Smart Growth. Far from clarifying the issues, it just muddies the waters.
Just thought I'd throw out a link to the intriguing blog <A HREF="http://theautomaticearth.blogspot.com/">The Automatic Earth</A> for a discussion on inflation, HI, and deflation.