Barron’s asks a famous Nobel Prize—winning economist:

"What’s the stupidest thing you’ve heard said about the current economic crisis and how to solve it? What’s the smartest?"

He answers

"…whichever mind-numbingly stupid thing I’ve just heard, like [U.S. House of Representatives] Minority Leader [John] Boehner’s statement that we shouldn’t u2018reward’ Fannie and Freddie by increasing their resources (he apparently doesn’t understand the meaning of u2018government owned’) But I guess the statements from many players that the Obama plan is a spending bill, not a stimulus bill — when spending is the whole point — top the list."

This person is not part of a conspiracy to create business cycles so as to enrich certain players, including himself. He is not making recommendations that might prolong the depression on purpose in order to create a totalitarian state. His statements are the product of error, ignorance, and bias.

He erroneously thinks that Fannie and Freddie are not to blame for the housing fiasco (with numerous Congresses behind them). But they are. I quote Robert Prechter:

"The ultimate source of all the bad credit in the U.S. financial system is Congress. Congress created the Federal Reserve System and many privileged lending corporations: Fannie Mae, Freddie Mac, Ginnie Mae, Sallie Mae, the Federal Housing Administration and the Federal Home Loan Banks, to name a few. The August issue [of The Elliott Wave Theorist] cited our estimate that the mortgage-encouraging entities that Congress created account for 75 percent of all U.S. debt creation with respect to housing. For investors in mortgage (in)securities, the ratio is even greater. Recent reports show that these agencies, which have been stealing people blind by taking interest for nothing, account for a stunning 82 percent of all securitized mortgage debt. Roughly speaking, the government directly encouraged the indebtedness of four out of five home-related borrowers. As noted in the August issue, it indirectly encouraged the rest through the Fed’s lending to banks and the FDIC’s guarantee of bank deposits. These policies allowed borrowers to drive up house prices to absurd levels, making them unaffordable to people who wanted to buy them with actual money. Proof that these mortgages are artificial and the product of something other than a free market is the fact that while Germany, for example, has issued mortgage-backed securities with a value equal to 0.2 percent of its annual GDP, the U.S. has issued them so ferociously that their value has reached 49.6 percent of annual GDP, a multiple of 250 times Germany’s rate, and that is not in total value but only in value relative to the U.S.’s much larger GDP. (Statistics courtesy of the British Treasury.)"

This famous economist says that spending is the same as stimulus or that government spending produces stimulus. This is a fallacy. If each federal building were painted and re-painted 10 times, most of the work would be pure waste. It is uneconomic to spend resources now without getting a payback in due time. Capital has a cost.

This economist, a self-described [non-classical] liberal, is biased toward believing that government can and will select spending projects that have a large enough payback to create wealth. He ignores the facts of history that range from housing projects to veterans’ hospitals or to the 70-year trials in the USSR. He is ignorant of these facts, does not accept them for what they are, and maintains his position out of pure bias. He knows no better than to believe in fallacies.

There is no conspiracy here, only a combination of error, ignorance, and bias.

Barron’s asks

"You’ve written that the gap between the economy’s potential shortfall in production over the next three years — $2.9 trillion — and the $800 billion in economic stimulus is a big problem. Why does this gap between production and bailout matter so much?"

The economist answers

"My big concern here is that the economy digs itself into a deflationary hole, which is what can all too easily happen if you have a large, sustained output gap. Once prices start falling, and people start to expect continuing deflation, the balance sheet problems will become much worse than they already are, and much harder to resolve."

Mr. Krugman believes what he is saying. By his own account, he reads and re-reads Keynes, who emphasizes animal spirits and the state of long-run expectations. It takes a theory to beat a theory. A conspiracy theory beats nothing. It is an acknowledgment of no theory. It is a self-defeating non-theory that poses as a real theory that explains real phenomena.

It is a fact that prices of wholesale commodities have fallen sharply. Last July, imports and exports both began to plunge dramatically. It was as if a large tariff barrier had sprung up among nations. What is the result? Prices plunged. If a large tariff barrier had existed and were removed, those prices would rise. I quote a question and answer put to Jesse Livermore in 1932 when high tariffs were a factor impeding recovery. Livermore was a top-notch speculator in commodities:

"If you woke up tomorrow and found the tariffs down so that Europe, including Germany, could send us manufactured goods, and you wanted to make some money out of that, what would you do?"

Livermore’s answer

"Well, I might buy some German bonds. No. I’d buy commodities. I’d buy the ones they have to have [for manufacturing and export] and the ones they would be buying in that situation. I’d buy copper. I’d buy lard. I’d buy cotton. I’d buy wheat."

Even without tariffs as a cause, in 2008, copper fell from $4.00 a pound to $1.27 a pound in 5 months. This reflects the depression and trade interruption. This is not a price deflation due to Keynesian animal spirits. It is not so much due to a change in expectations as it is to a drop in demand. That drop in demand is not due to a sudden burst of thrift. We did not suddenly get plunged into depression because people stopped buying. The reverse is more nearly the case. The boom economy produced goods that people did not want to buy at prices that cover costs. The depression economy is the inevitable result, because businesses will not continue to produce goods that can’t be sold at prices high enough to cover costs.

Imagine that nearly everyone is put to work for a month by businesses that build high-priced houses induced by government stimulus. While that is happening, fewer people are employed baking bread. At the end of the month, people try to buy bread and find that there is not enough. Meanwhile, they do not want to buy the high-priced houses. There are too many of those. Home prices fall. Bread prices rise. (Consumer goods prices rose 0.3 percent in January.) The workers in homebuilding are laid off. Home prices decline. Lenders find their home loans going bad. The economy goes into an adjustment that is a recession in order to correct the imbalance. The economy needs more bread factories and bread makers. Left to its own devices, the adjustment will occur. The possibility of making profits by making bread will see to that. The losses in homebuilding will see to it that fewer homes are built.

But suppose that the government steps in with a stimulus bill and hires labor to pave roads. The adjustment toward bread making is delayed. At first overall production seems to improve, counting the money spent on roads. But eventually there is a surplus of paved roads and not enough bread. The bread makers try to hire labor. They compete with the road pavers. Wages rise. The economy sees price inflation. It still does not have the bread it wants.

There is much more to it, of course. But this is the idea. Deflation in prices is not a problem. It is part of the solution.

There is no conspiracy to bring totalitarianism to America. It may be happening, but not because of a conspiracy directed by certain cunning individuals united in a cabal. Economists are not put through a secret training school where they learn fallacies like the above. They are not given diplomas when the schoolmasters determine that they have their propaganda stories down pat. The processes of life are more subtle than conspiracies directing all bad outcomes. And if one succumbs to the conspiratorial kind of thought, one will end up sitting on one’s hands, blindly waiting for one’s fate, and not trying to understand and then interrupt and alter the processes that are leading to totalitarianism.

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