Rise of the Free-Market Zombies

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For his Sunday
column, Paul Krugman wrote a piece titled "When
Zombies Win.
" Krugman claims that "free-market fundamentalists"
– including Ron Paul – have been successful politically,
despite being thoroughly discredited by recent events. As we’ll
see, it’s a good thing that these ideas of shrinking government
refuse to die, no matter how often Krugman attacks them.

Zombie Thesis

The opening
paragraph explains the title given to Krugman’s article:

When historians
look back at 2008–10, what will puzzle them most, I believe,
is the strange triumph of failed ideas. Free-market fundamentalists
have been wrong about everything – yet they now dominate
the political scene more thoroughly than ever.

Before moving
on to Krugman’s specific claims, we need to stop and remark on just
how warped the above opening really is. For one thing, "free-market
fundamentalists" have not been wrong about everything.
It is true – as we’ll get to shortly – that many opponents
of fiscal stimulus and quantitative easing were warning of high
interest rates and price inflation. Those threats have not materialized
(at least yet), and on that score Krugman understandably can pat
himself on the back.

But the free-market
fundamentalists were certainly correct when they said that
the Obama stimulus package would not pull us out of recession. It
was not just Austrians but many Chicago School economists who were
reminding the public of basic observations such as "the government
can only spend what it first takes from the private sector."

At the time,
Keynesians such as Brad
and Krugman
went ballistic at such crude thinking, but if anybody has been vindicated
by what happened to employment and GDP in the last two years, it
has been those who said the Obama stimulus would just make things

It was not
merely Christina
Romer who famously predicted
that unemployment without
the stimulus wouldn’t rise as much as it in fact did with
stimulus. It was also Mark Zandi (whom Krugman later
for his wonderfully accurate Keynesian models) who
predicted in November 2008 (see page 21 of this pdf) that real GDP
without stimulus would fall by 2.2 percent in 2009. Then,
with the Obama stimulus, the economy
in fact
fell by 2.6 percent that year.

As far as the
free-market fundamentalists dominating the political scene "more
thoroughly than ever," I suppose Krugman is right, in the sense
that two French poodles could dominate a pit bull more than one
French poodle could. But as the Fed discloses its cumulative $9
in backdoor loans, as the FBI
raids hedge funds
, and as federal
spending as a share of the economy
is at its highest level since
World War II, I hardly think that DC is being overrun by laissez-faire
shock troops.

Krugman versus
Ron Paul

To prove that
free-market fundamentalists have seized power, Krugman’s Exhibit
A is Ron Paul:

How did that
happen? How, after runaway banks brought the economy to its knees,
did we end up with Ron Paul, who says "I don’t think we need
regulators," about to take over a key House panel overseeing
the Fed?

Of course,
if we look at the actual
of what Paul is saying, we find that he means it is
foolish to trust government regulators to nip asset bubbles in the
bud, while the Fed and other government programs do their part in
fueling such bubbles. Ron Paul was not saying, "Let
the banks do whatever they want," instead he was saying that
we shouldn’t be bailing them out when they screw up. Instead,
let them go bankrupt just like any other business would after making
horrible investment decisions.

In his article,
Krugman has some good examples of "right wingers" who
made predictions that, in retrospect, made them look foolish. But
it’s not as if the conventional Left is lacking in this category,
even if we focus just on the housing bubble and bank crisis.

For example,
and Ben
himself denied that there was a housing bubble.
Barney Frank – hardly a Jedi Knight of libertarianism –
infamously defended
the solvency of Fannie and Freddie
up until their seizures.

And let us
not forget Paul Krugman himself, who – it must be admitted
– did indeed recognize the housing bubble before many others
did. But, ironically, he praised Greenspan for creating it.
Many people have pointed to Krugman’s
2002 call for Greenspan to create a housing boom
, but not as
many saw Krugman endorse it after the fact, as this October
2006 exchange
with one of his readers illustrates,

AMRITSAR, INDIA: Mr. Greenspan has done a disservice to the nation
by creating the housing boom. As a layman-observer, that’s the
lingering thought I’ve had. Your article reaffirms it.

The question
I have is this: Did he do the right thing – acting morally
by engineering a housing boom, more as a bridge loan, until something
else showed up at the horizon to shore up the economy – because
he didn’t have a choice, or did he undertake a path of mere political
expediency? And, that’s a question that’s nagging me for a while.

Would appreciate
it if you could shed some light.

As Paul McCulley of PIMCO remarked when the tech boom crashed,
Greenspan needed to create a housing bubble to replace the technology
bubble. So within limits he may have done the right thing. But
by late 2004 he should have seen the danger signs and warned against
what was happening; such a warning could have taken the place
of rising interest rates. He didn’t, and he left a terrible mess
for Ben Bernanke.

Turning from
monetary policy to other government efforts to spur the housing
boom, Krugman’s story – in which he tries to exonerate Freddie
and Fannie, and pin the blame entirely on private-sector villains
– keeps changing, as others constantly correct his facts. Raghuram
Rajan gives the blow-by-blow account here.

Finally, regarding
bank bailouts, many Austrian economists (not so many among other
free-marketeers, unfortunately) were vehemently
to them, as the issue was being debated.

In contrast,
Krugman was for
the bailouts
(though of course they were not the textbook ideal,
in his opinion). Interestingly, when Krugman recently
tried to argue
that he and his heterodox peers were in favor
of letting the Iceland banks go under, while the orthodox fuddy-duddies
were in favor of bailing out Ireland’s banks, this caused such cognitive
dissonance among Krugman’s readers (who remembered his support for
TARP) that he had
to explain
his way out of the contradiction.

In sum, regarding
the worldviews of Ron Paul versus Paul Krugman, here’s what we can

Ron Paul thought
it was a terrible mistake for Greenspan to fuel the housing bubble,
for government agencies to encourage banks to lower their lending
standards, and then for the Treasury (as well as the Fed) to bail
out the big banks from their mistakes.

Krugman, in
contrast, recommended that Greenspan blow up the housing bubble,
and his only criticism was that Greenspan began raising interest
rates to quell it, rather than simply jawboning the speculators.
Krugman continues to downplay any role that the government had in
encouraging reckless lending. Further, Krugman was in favor of bailing
out the banks, who he thinks acted recklessly.

So if we are
going to look at the current, dismal economy and blame somebody’s
policies for it, surely we can acquit Ron Paul. That doesn’t by
itself prove that Ron Paul’s views are correct, but it certainly
casts doubt on Krugman’s constant claims that he himself has been
a beacon of clarity over the years with his accurate Keynesian modeling.

Interest Rates
and Price Inflation

Finally, let’s
turn to the one legitimate point Krugman makes in his article:

It’s also
worth pointing out that everything the right said about why
Obamanomics would fail was wrong. For two years we’ve been warned
that government borrowing would send interest rates sky-high;
in fact, rates have fluctuated with optimism or pessimism about
recovery, but stayed consistently low by historical standards.
For two years we’ve been warned that inflation, even hyperinflation,
was just around the corner; instead, disinflation has continued,
with core inflation – which excludes volatile food and energy
prices – now at a half-century low.

It is true
that many opponents of massive deficits and money printing gave
warnings of interest rates and price inflation that at best were
premature; I myself fall
into this group. This is unfortunate, because our mistaken warnings
now give Krugman a convenient target when trying to distract people
from the failure of Keynesian pump priming.

To tackle this
issue would require another article in itself. For now suffice it
to say that there are indeed plenty of signs that the Fed’s inflation
is distorting the economy, not least of which is the record price
of gold. Even using the government’s own numbers, producer
prices are rising in proportion
to how far removed they are
from the unemployed, debt-ridden consumer. I have been a faithful
reader of Krugman over the last two years, and I don’t remember
his predicting in early 2009 that oil
would double in 15 months.


Paul Krugman
is speaking nonsense when he argues that the last two years have
demonstrated the failure of free-market policies. Despite his claims,
it is encouraging to watch the growing respect given to Ron Paul
and others espousing small-government rhetoric. If these rising
stars of the liberty movement be zombies, we can only hope they
have enough brains to get the job done.

from Mises.org.

24, 2010

Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism
Human Action Study Guide
and The
Man, Economy, and State Study Guide
His latest book is The
Politically Incorrect Guide to the Great Depression and the New

Best of Bob Murphy

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