Why Dumb Bankers Love Keynesianism

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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.

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Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 31-volume series, An Economic Commentary on the Bible.

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