Krugman claims that the Republican argument for the importance of job creation relies too heavily on the “heroic entrepreneur,” rather than recognizing that “successful companies — or, at any rate, companies that make a large contribution to a nation’s economy — don’t exist in isolation.” For Krugman this means there’s plenty of help from government. Although I can’t speak for all Republican politicians, I can say that Krugman’s view of the argument for free markets is utterly mistaken.

The argument for the market is based precisely on the fact that the entrepreneur exists in a social context that helps to determine how effective her actions will be. The most heroic entrepreneur imaginable cannot be very productive if she is shackled by government regulations or is trying to operate in a society with ill-defined or poorly enforced property rights. As Ludwig von Mises recognized as far back as 1920, this is the same reason that successful entrepreneurs fail miserably when they try to run government agencies like businesses: What gives the entrepreneur the ability to succeed are market signals, which are necessary to determine what people might want and how well it was provided. Even the smartest person can’t learn if a teacher uses black chalk on a blackboard in a dark room. No entrepreneur can succeed in isolation.

The Hard Task

More important, though, is that both Krugman and politicians from both parties are much too concerned about job creation when they should be concerned about value creation. Creating jobs is easy; it’s creating value that’s hard. We could create millions of jobs quite easily by destroying every piece of machinery on U.S. farms. The question is whether we are actually better off by creating those jobs — and the answer is a definite no. We want labor-saving, job-destroying technology because it creates value by enabling us to produce things at lower cost and thereby free up labor for more urgent uses.

A century ago 40 percent of Americans worked in agriculture; today it’s less than 2 percent. The former farm workers didn’t all go unemployed. The wealth created by higher farm productivity and lower prices enabled us to demand all kinds of new products that in turn created many more jobs than were lost in agriculture. This is the story of innovation everywhere.

So rather than talking about job creation, let’s focus on value creation. The case for freeing markets is that such freedom best enables individuals to find ways to use their knowledge and skills to create value for others and thereby create wealth for themselves. The more wealth that value creators can keep, the more likely they are to continue to create it. Even if a value-creating innovation destroys jobs in the short run, the increased wealth will bring a great deal of job creation in its wake.

Ancillary Jobs

Krugman tries to criticize Apple by pointing out that the “heroic” Steve Jobs has only created about 43,000 Apple jobs in the United States (though around 700,000 overseas). But this misses the point: The real job-creation number that matters here are all the ancillary jobs created through the invention of the Mac, iPod, iPhone, and iPad. Those inventions, along with every other technological innovation, have created tens of millions of jobs in programming, web design, app design, hardware maintenance, and more.

Krugman also takes a swipe at fans of Ayn Rand by referring to “the John Galt, I mean Steve Jobs-type ‘job creator.’” But Krugman is blind to the error of his own joke: John Galt’s innovative motor took static electricity out of the air and turned it into useful energy, which would have been a huge job destroyer! Again, the triumph of entrepreneurial innovation is not in creating jobs, but in creating value. Galt’s motor would have freed up a lot of labor to be devoted to new wants made possible by the cheap source of energy. Krugman can’t even see that his own example undermines his argument.

The next time anyone starts talking about job creation, stop listening. Jobs come into existence when entrepreneurs are free to create value. Aiming directly at job creation is a recipe for waste and poverty. Set people free to use their talents to create value for others and the jobs will follow.

Even if it managed to squeak through and survive—aided by massive taxpayer infusions along the way—the euro’s vulnerability underscores the folly of a political currency. More so than any other currency in history, the euro has been a creation of technocrats working for modern nation-states. That the euro may well be on its deathbed hardly a decade after its birth demonstrates the futility of central planning. A durable monetary system, free from recurring crises, can only emerge spontaneously from voluntary exchanges in the marketplace.

The European Union and euro were officially created by the Maastricht Treaty in 1993. In addition to the political and cultural objectives, the EU and the single currency, which went into circulation in 2002, were significant steps in the effort to turn Europe into a unified economic zone patterned after the United States.

Before the introduction of the euro, a large business based in France that, say, had a factory paying workers in Italy and which bought machine parts from Germany would be vulnerable to shifts in the exchange rate between the franc, lira, and mark. But with a single currency the firm could focus on its customers and product lines, rather than worrying about the foreign-exchange market. This stability across the continent would (supposedly) give European businesses the same advantages that U.S.-based firms enjoy, since Americans in all 50 states use the dollar.

Because a currency’s ability to facilitate transactions only increases as more people use it, at first we might expect that the nations adopting the euro would want as many of their neighbors as possible to join. Yet in reality there were formal rules (called the Maastricht criteria, also the “convergence criteria”) that new applicants needed to satisfy before adopting the euro. The rules set standards for countries’ inflation rates, budget deficits, government debt, exchange rates, and long-term interest rates.

At first glance it seems odd that the developers of a new currency would want to restrict its usage. To repeat, the whole point of a currency union is to reduce transaction costs among the individuals using it. Thus it would seem that these benefits would only increase as the group grew.

Yet there are other factors at work, which the designers of the euro understood (if only imperfectly). In particular the euro is a fiat currency, meaning that the printing press could be used to achieve political ends. This explains why governments already using the euro are reluctant to admit relatively spendthrift governments into their club: There is a danger that the more profligate members will hijack monetary policy directly, or that they will require a monetary bailout (as we are seeing in practice).

Benefits of a Commodity Standard

Notice that these potential problems would be nonexistent under a fully backed commodity standard. For example, suppose that the creators of the euro, rather than reading the work of mainstream monetary theorists such as Robert Mundell, instead had studied the proposals of Ludwig von Mises in The Theory of Money and Credit. In this alternate universe the authorities in Brussels would stand prepared to issue new paper euros to any individual or institution (including governments and central banks) that handed them a fixed weight of gold.

Under this Misesian scheme the monetary authorities would maintain 100 percent gold backing of the currency; there would be the required weight of actual gold sitting in the vaults in Brussels backing up every paper euro in existence. In this scenario the authorities in Brussels wouldn’t care about the creditworthiness or the spending habits of the institutions applying for new euros. So long as the applicants handed over the correct amount of physical gold, the authorities would be happy to print up the appropriate number of euros.

The reason for this nonchalance is that the various users of the euro—if it were backed 100 percent by gold—couldn’t affect the euro’s purchasing power because they couldn’t affect future “monetary policy” regarding the currency. If the people in Region A used the euro, they wouldn’t be affected by (say) a default on bond payments by some government in Region B that also used the euro. The euros in existence, as well as the ones to be issued in the future, would have a constant redemption rate in gold, regardless of the fiscal solvency of a particular user of the euro.

In case the Misesian thought experiment is too fanciful, we have a much more pedestrian (if imperfect) example: U.S. state governments and their use of the dollar. If the California or Illinois state governments default on the billions of dollars in outstanding bonds that they have issued, no one is worried that this will lead to a collapse of the dollar itself, or that the relatively frugal states (such as Idaho) will elect to leave the “dollarzone” and adopt their own currency.

Thinking through the logic of the situation, it becomes clear that the reason for the difference is that the Federal Reserve (at least in the past) wouldn’t bail out insolvent state governments. To be clear, the people in Idaho might be affected by a default on California state bonds, but not because both areas used dollars as their currency.

However, if the Fed did start bailing out insolvent state governments, then the various states in the “dollarzone” might sit up and take notice. People in Idaho would realize they were paying higher prices because the Fed was creating billions of new dollars out of thin air to prop up the market for state bonds. In this environment a coalition of frugal state governments might demand that their profligate peers adopt austerity measures or else the frugal states would indeed abandon use of the dollar.

As this thought experiment illustrates, we can imagine a situation analogous to the crisis in Europe right here in the United States. All it would take is a Federal Reserve willing to issue extra dollars because member governments ran irresponsible fiscal deficits. We don’t currently link state government finances and the fate of the dollar because the Fed thus far hasn’t altered its policies based on state spending. Under a fully backed commodity standard, this independence of monetary and fiscal policies would be more absolute and would have prevented a crisis like the one now unfolding in Europe.

Those who have followed the mainstream economists’ handling of these issues know that gold convertibility is hardly touted as a solution to the euro crisis. In fact Paul Krugman recently blamed the crisis on the attempts to foist a “nouveau gold-standard regime” on European countries.

This is quite an extraordinary spin. How in the world could Krugman take a fiat currency, explicitly designed from day one by technocrats and without even a historical connection to a commodity money, and denounce it as a modern-day gold standard?

The answer is that Krugman is relying on the mainstream theory of optimal currency area. This theory tries to outline the optimal jurisdictions for different fiat currencies. In this approach the downside of having too large a region using the same currency is that the “optimal” amount of inflation might differ within the region, leading to unnecessary economic pain and hence political conflict.

In the present crisis Krugman and many others think the “obvious” solution would be for Greece to devalue its currency. This would make it easier to repay its debts and would make Greek exports more competitive, thus boosting economic growth.

Alas the problem (according to people like Krugman) is that Greece is not the master of its own economic destiny. Since it adopted the euro it is now powerless to inflate its way out of trouble. Thus the Greeks are condemned to suffer from fiscal austerity and a painful deflation of wages and prices (also known by the misleading term “internal devaluation”).

Now we can understand the (tepid) connection that Krugman and others are drawing between the current situation in Europe and the classical gold standard. Under the latter, if one country printed too much money its domestic prices would rise faster than those of its peers. The country would experience a trade deficit as its own exports became relatively expensive. The outflow of gold from the country would force officials to tighten monetary policy until wages and prices had fallen (if not in absolute terms, at least relative to the levels of other nations) and international competitiveness had been restored. Under the classical gold standard each nation’s currency was pegged at a fixed exchange rate to gold, so that no country could gain an advantage by devaluing its own currency. All adjustments to ensure sustainable trading patterns had to occur through changes in relative prices and wages, not through fluctuations in exchange rates.

Further Integration

The mainstream theory of optimal currency area sheds light on another (alleged) lesson being drawn from the present crisis: the need for fiscal union among the eurozone states. For example, Mario Draghi, the incoming head of the European Central Bank, recently said Europe needs to “make a quantum step up in economic and political integration.” Mainstream theory shows that it is suboptimal to have a single currency covering areas with governments enacting different fiscal policies, and hence the “obvious” conclusion is that the European governments must be brought under the control of a single agency.

As usual one intervention leads to another. After historically co-opting and then suppressing the market-chosen monies (gold and silver), the European governments in recent years upped the ante by creating a new fiat currency. Even though the ostensible safeguards failed miserably—Greece and several other participating governments have come nowhere near obeying the Maastricht criteria—the alleged solution is the creation of even more centralized power, with even less control by the people being so ruled.

The people of Europe are being conned. They do not need to sacrifice even more political sovereignty to a group of international bureaucrats and bankers. The dream of the euro—an integrated economic zone with a stable currency—can be achieved through the classical-liberal tenets of free trade and sound money. Continued experiments with fiat money regimes will lead us through a perpetual series of crises, until we are left with a single global fiat currency, the issuer of which has zero accountability to the hapless citizens forced to use it. According to many cynical observers, this after all may be the ultimate plan.

Economics and business reporter David Warsh is getting much attention for suggesting that F. A. Hayek, far from being one of the two most prominent economists of the 1930s – the other being Keynes – is rather more like the woman who was thought to have won the Boston marathon in 1980 when in fact she had joined the race, mostly unnoticed, a half-mile from the finish line.

Hayek’s fans “have jumped a caricature out of the bushes late in the day and claim that their guy ran a great race,” Warsh writes. “. . . But the fact remains that Hayek just didn’t contribute very much to the development of technical economics,” he continues.

Warsh, whom we may judge by the fact that he calls The Road to Serfdom “an embarrassment,” nonetheless does have some positive things to say about the 1974 Nobel Prize laureate: “With the publication of ‘The Use of Knowledge in Society’ in the American Economic Review in 1945, he essentially won on the ‘calculation debate,’ conducted with Ludwig von Mises and Oscar Lange, concerning the possibility of central planning.”

Considering how many respectable economists favored central planning – essentially the abolition of spontaneous competitive markets — until fairly recently, that would seem to be no mean feat. And there’s more:

[I]t is pleasing to think that Hayek himself may yet turn out to have been a very great economist after all, far more significant than [Gunnar] Myrdal or [Joan] Robinson, when seen against the background of a broader canvas.  The proposition that markets are fundamentally evolutionary mechanisms runs through Hayek’s work. [Bruce] Caldwell, of Duke University, notes that, starting with the Constitution of Liberty, “the twin ideas of evolution and spontaneous order” become prominent, especially the idea of cultural evolution, with its emphasis on rules, norms, and decentralization.

These are today lively concepts in laboratories and universities around the world. ‘It could have been that Hayek was running a different race, and the fact that he didn’t do well in the [mainstream] Walrasian race was that he wasn’t running in it — he was running in the complexity race,’ says David Colander, of Middlebury College. Hayek may yet enter history as a prophet of evolutionary economics, a discipline dreamt of since the days of Thorstein Veblen and Alfred Marshall in the late nineteenth century but not yet forged, whose great days lie ahead. [Emphasis added.]

In other words, maybe Hayek’s critics judge him by an inappropriate standard. We’ll get back to this.

Krugman Pile-on

As Jacob T. Levy surmises, not everyone eager to dismiss Hayek as a lightweight read Warsh’s post to the end. Take Paul Krugman, ever ready to trash anyone who doubts that Keynes was the fount of all wisdom:

David Warsh finally says what someone needed to say: Friedrich Hayek is not an important figure in the history of macroeconomics.

These days, you constantly see articles that make it seem as if there was a great debate in the 1930s between Keynes and Hayek, and that this debate has continued through the generations. As Warsh says, nothing like this happened. Hayek essentially made a fool of himself early in the Great Depression, and his ideas vanished from the professional discussion. . . .

[T]he Hayek thing is almost entirely about politics rather than economics. Without The Road To Serfdom — and the way that book was used by vested interests to oppose the welfare state — nobody would be talking about his business cycle ideas.

Hayekians Strike Back

The Hayekian wing of the blogosphere (which really has nothing to do with the right wing) has responded in force, and properly so. A common theme is that Hayek furnished the grounds for a proper skepticism about macroeconomics, the branch of economics launched by Keynes that treats large statistical aggregates (demand, unemployment, and so on) as though  they were concrete entities that interact with each according to fixed quantitative rules rather than historical “summations” of individual purposeful actions in a particular institutional context. As Hayek wrote,  “Mr. Keynes’ aggregates conceal the most fundamental mechanisms of change.” (See Steven Horwitz’s “Mr. Keynes’s Aggregates.”)

George Mason University professor (and FEE trustee) Peter Boettke at Coordination Problem wrote:

Hayek’s influence in modern economics is ubiquitous, even if sadly modern economics is not as Hayekian as I would like it to be.  Information economics, theories of dynamic competition, equilibrium theory of the business cycle, and complexity theory all owe a debt to Hayek’s economic contributions.  The work on legal origins owes a debt to Hayek’s work on law and political-social philosophy as well.  Hayek impacts the DNA of economics and political economy to such an extent that many are unaware of the pervasive influence. . . .

The final problem I have with both Krugman and Warsh is that they don’t actually consult the historical record and the accounts of those who were there in the 1930s when the battle was engaged or the direct citation evidence from post-WWII thinkers. . . . Instead they rely on impressionistic accounts from their education and discourse communities, and cherry pick from recent journalistic histories of economics.

Back with a Vengeance

And there’s this from GMU professor Alex Tabarrok at Marginal Revolution:

It is true that many of Hayek’s specific ideas about business cycles vanished from the mainstream discussion under the Keynesian juggernaut but what Krugman and Warsh miss is that Hayek’s vision of how to think about macroeconomics came back with a vengeance in the 1970s. . . .

Hayek was an important inspiration in the modern program to build macroeconomics on microfoundations.

Tabarrok notes that “in an interesting exercise David Skarbek finds that Hayek is cited by other Nobel laureates in their Nobel talks more than any other Nobel laureate with the exception of [Kenneth] Arrow.”

GMU’s Russ Roberts responded this way at Café Hayek:

Was Hayek an important macroeconomist? I would argue that the macroeconomic skepticism of the later Hayek is more valuable than the macroeconomic theorizing of the early Hayek. But he wasn’t an important macroeconomist in the mainstream sense of the title. So what? That’s a badge of honor. He was merely a great economist, without any prefix.

Rejecting the Rules

There are others, but I will close with a post from New York University’s Mario Rizzo at ThinkMarkets, one of the most perceptive people I know. Remember the remark above that “It could have been that Hayek was running a different race”? That’s Rizzo’s take.

I think the real issue is this. Hayek’s approach attacks, root-and-branch, the macroeconomic way of thinking. It is not simply a challenge to a particular theory of the determinants of mass unemployment, inflation, business cycles and the like. Hayek is not accepting the rules of the game or the parameters of the sub-discipline of modern macroeconomics. . . .

In short, he does not want to focus on aggregate spending and aggregate consequences. Hayek’s approach says: Let us pierce the veil of aggregates and look at the distortive effects on relative prices and relative output produced by boom-time credit expansions. Let us look at the distortive effects that booms leave us as we work our way through a recession. . . .

Suffice it to say this greatly erodes the intellectual capital of a field of economics – although one not noted for its successes. It mocks the claim that Keynes was a true revolutionary in economic thought. It opens the possibility that he was muddled, inconsistent and unaware of the contributions to monetary and business cycle theory made by the “classical economists” on the eve of the General Theory.

(By cutting out many details, I have not done these blog posts justice. Follow the links for the particulars.)

Hayek was important politically for demonstrating the practical social necessity of individual freedom. But he is just as important for what he taught us about markets: namely, that they provide the only way for human beings to overcome their individual deficiencies in knowledge, which would otherwise keep them from flourishing through social cooperation and the division of labor.

That’s right: Despite record federal spending and unprecedented Federal Reserve intervention, the economy remains depressed. Beyond stating the obvious about the nonrecovery Krugman frets about the long-term implications of the stubbornly sour labor market. He also notes that consumers are “still burdened by the debt that they ran up during the housing bubble,” which, to my Hayek-schooled mind, sounds an awful lot like the drawn-out bust phase of a credit-fueled business cycle.

Rather than concluding that deficit spending and printing money are the wrong cures for what ails us, Krugman complains that government is not doing enough. Citing the tea-party Republicans’ “deficit obsession,” Krugman complains that government has been “pulling back [rather than] supporting the economy in its time of need.” He also cites lassitude at the Fed, claiming it’s been “intimidated by the Ron Paul types” into overreacting against potential inflation. Krugman argues the federal government should be doing much more, and its top priority should be creating jobs, not reducing the deficit.

While Krugman avoids the specifics of what such grandiose federal jobs programs would entail, he’s on the record supporting massive New Deal-style public-works spending, which would employ “armies of government workers.” Krugman also favors more monetary stimulus by the Fed to boost spending throughout the economy. In brief Krugman is saying we have not yet begun to fight the Keynesian battle of stimulus on either the monetary or fiscal fronts.

Let’s review the figures. Since September 2008 the Fed has more than tripled its balance sheet, printing roughly $2 trillion in new bank reserves, monetizing around $900 billion of U.S. government debt, and lending over $3 trillion to U.S. and foreign banks. As for federal spending—the real growth engine, in Krugman’s mind—it increased by 40 percent (29 percent in real terms) from 2007 to 2011 to a record $3.8 trillion, with half that increase coming in the recession year 2009 alone. “Stimulus” spending by itself has amounted to $666 billion so far, and federal bailouts have racked up at least $150 billion in taxpayer costs. Since 2007 gross public debt has increased from 64 to 103 percent of GDP.

And Krugman’s argument again? Government is not printing and spending enough. This fetish for unlimited spending juxtaposes strangely against a backdrop of perhaps the most fiscally profligate decade of American history, but I’ll give Krugman credit for boldness. However, the figures themselves, shocking as they are, mask the real question: Can more government spending actually encourage productive employment that promotes overall economic welfare?

Stimulus enthusiasts like Krugman are sure it can. And their first big task for the new labor armies is to go forth and fix America’s broken infrastructure. Haven’t you heard? America’s roads, bridges, sewers, airports, and more are in total disrepair—so says the infrastructure lobby. But these folks—an assortment of large construction, manufacturing, and transport companies, and their unions—have been carping about infrastructure being underfunded for the last 30 years. No surprise here: like any special-interest group, they want a continued and enlarged flow of federal funding. Hence my Public Choice nerves twitch at every mention of “crumbling infrastructure.”

But let’s concede that they’re right: that our infrastructure is in a sad state and more federal spending would be a wise investment. Using the infrastructure lobby’s figure of 18,000 new jobs for every $1 billion in government spending, doubling federal infrastructure spending would reduce the unemployment rate to 8.3 percent. And this ignores the matter of timing, as infrastructure projects require years of planning and regulatory hurdle-jumping before they’re “shovel-ready.” Nonetheless, even the most unrealistically generous assumptions about infrastructure spending indicate that if you want to get the economy back to full employment, it’s going to take a lot more than just public works.

But stepping back from labor army fantasies, there’s something absurd about using infrastructure “investment” as a jobs program. To the extent that federal funding of infrastructure is economically advisable, “good government” would require minimum expenditure (read: minimum employment), lest said public works turn into a black hole of rent-seeking—public spending to enrich private interests.

Infrastructure spending is not immune to the institutional inefficiencies that beset all government programs. But questioning the value and efficiency of public works is only half the matter. Call me a conservative stick in the mud, but the little question of how the government is going to pay for all this largess strikes me as relevant these days.

Krugman of course sees no problem here. He is on record favoring larger deficits, seeing historically low interest rates as a go-ahead for even more federal borrowing. Oddly enough, others in the economy, such as Standard & Poor’s, see a quite large problem with continuing government debt growth. It’s called insolvency: If you have too much debt and you can never pay it off, bad consequences ensue. (I wonder if Krugman would advise a family with $325,000 in credit card debt on an income of $50,000 a year to go ahead and open up a new credit card account simply because it came with a 0 percent teaser rate?) While Krugman, with his stale brand of vulgar Keynesianism, appears increasingly oblivious to it, other recent events have revealed in stark fashion what our real economic problem is—excessive government debt, a direct consequence of excessive government spending.

The fixation on ever-bigger government stimulus programs to “fix the economy” reveals the basic fallacy with Krugman and the Keynesians. They view “the economy” and “the government” as distinct entities—as if poor little Johnny Economy would be just fine if only rich, stingy old Uncle Sam would open up his wallet and give Johnny a job! The reality is that the economy is us—the government exists within the U.S. economy, not apart from it. To “support” the economy the government must take resources from the very same economy. This can only confer a net increase in productive activity if government bureaucrats and politicians a) are truly benevolent, suppressing their representation of private interests in favor of “the general welfare” and b) know better than individual entrepreneurs throughout the country how to wisely invest scarce resources.

Since the days of Hume and Smith, economists have rightfully heaped skepticism on such assumptions. Politicians and bureaucrats are neither angelic nor omniscient; simply increasing their ability to print and spend is not a formula for prosperity. The fact that the United States is currently suffering the lingering effects of a complex recession and government debt crisis does not change these lessons, but confirms them. To adapt a phrase from a president who understood this (even if he couldn’t quite enact it): In our present crisis government spending is not the solution to the problem; government spending is the problem.

For the full story see this blog post by Mary Theroux of the Independent Institute.

Let’s concede for argument’s sake there is something unattractive about viewing patients as consumers. Krugman writes, “Medical care, after all, is an area in which crucial decisions—life and death decisions—must be made. Yet making such decisions intelligently requires a vast amount of specialized knowledge.”

All true, but not necessarily decisive in answering Krugman’s question—because if we reject the patient-as-consumer model, we must then ask: What’s the alternative?

I believe the answer is this: If the patient is not a consumer he or she will be a ward of the State or a government-empowered insurance company. If the choice is between consumer and ward of the State, consumer doesn’t look so bad after all.

To see what ward status means, ponder Krugman’s thoughts on the Independent Payment Advisory Board, Obamacare’s Medicare cost-cutting apparatus:

“About that advisory board: We have to do something about health care costs, which means that we have to find a way to start saying no. In particular, given continuing medical innovation, we can’t maintain a system in which Medicare essentially pays for anything a doctor recommends. . . .

“And the point is that choices must be made; one way or another, government spending on health care must be limited” (emphasis added).

Much of what Krugman says here is correct. Resources are finite. Choices must be made. No matter how medical care is paid for, spending will be limited—regardless of what demagogues imply. But under Krugman’s patient-not-as-consumer model (which is largely in effect today), government experts make all the important decisions. Bureaucrats will have a global budget for medical spending, and it will be their job to stick to that budget. They will not be the patients’ agents. Advocates of this scheme insist the quality of medical care will not be cut along with costs. They assure us they will prohibit only “unnecessary” and “wasteful” procedures. But how objective are those categories? And why should we trust unaccountable bureaucrats and “experts” to make the right decisions, as though there were one-size-fits-all answers in medicine?

The upshot is that anyone who has his or her medical bills paid by the taxpayers will ultimately be at the government’s mercy. If you’re not a consumer you’re a ward of the State.

But won’t private medical coverage also have restrictions? The difference is that if medical coverage were offered in a freed market—no privileges, no licenses, no protectionism—the environment would be competitive. When government is in charge competition disappears or is vastly constrained to the point where it hardly matters. In a competitive environment entrepreneurs seek to discover what services best satisfy their customers’ requirements. Note well: This environment includes nonprofit solutions, such as mutual-aid societies, which through “lodge practice” managed to provide decent medical coverage to people of modest means in earlier times (tinyurl.com/cjca68).

Competition is a discovery process (Hayek). Government is the habitat of bureaucrats who pretend they know it all already.

Krugman cautions, “[B]ear in mind that we’re not talking about limits on what health care you’re allowed to buy with your own (or your insurance company’s) money. We’re talking only about what will be paid for with taxpayers’ money.” This is disingenuous.

After being taxed all their lives, how many elderly people are in a position to forgo Medicare in favor of private insurance? Government creates dependence, then exploits that dependence to justify its power.

* * *

Even if the flawed Consumer Price Index isn’t quite showing it yet, there is talk of inflation in the air. What exactly is going on? One of our sharp economy watchers, Warren Gibson, doesn’t like what he sees.

Advocates of government expansion have not found the Constitution a terribly formidable barrier. Could a better-written preamble have helped? James Payne thinks perhaps it would have.

Schools run by state and local governments are bad enough, but how about a single national school system run from Washington, D.C.? The best-kept secret these days is the Obama administration’s moves toward a national curriculum. Neal McCluskey has the unpleasant details.

H. L. Mencken famously suggested that fear among the people is the government’s best friend. James Bovard finds ample empirical evidence for Mencken’s thesis.

Why are markets, despite their palpable benefits, morally tainted in so many people’s eyes? F. A. Hayek thought it’s because markets don’t embody the nurturing morality of the family that we first learn as children. Dwight Lee endorses Hayek’s explanation and points out that we wouldn’t like the results if great societies were run like families.

After a natural disaster the high-profile first response leaves the impression that no alternative to a centrally planned recovery is available. Peter Boettke says that’s a failure to look more closely.

Labor unions continue to be at the center of controversy. Despite appearances, Wendy McElroy writes, government-backed unions limit workers’ ability to organize in their own interest.

Just because two things are called by the same name is no reason to assume they are actually the same. Take the case of private-sector and government investment. Adam Summers does just that.

Our columnists’ inquiring minds have produced a smorgasbord of provocative fare: Thomas Szasz ponders the legal status of suicide. Stephen Davies looks at Japanese commercial virtues. John Stossel thinks police making arrests have no right to privacy. David Henderson says no particular person can say how much manufacturing Americans should engage in. And Gary Chartier, encountering a newspaper columnist’s claim that opposing military intervention indicates indifference to suffering, responds, “It Just Ain’t So!”

Books on the mistreatment of taxpayers, economics, and an infamous automobile catch the fancy of our reviewers.

In recent months – or has it been years? – Paul Krugman and Brad DeLong have been saying, in effect, “We told you so – the stimulus was not enough. Look at the sluggish economy and high unemployment rate.”

They are arguing that the problem with the fiscal stimulus is that it was not enough. The idea was right but the quantity was wrong.

Let it pass that at ThinkMarkets it was predicted that this is what the stimulus advocates would say in the event that the economy did not improve as much as they wanted.

The basic problem with the quantitative claim is that it skirts some real problems in the analysis.

The rest is here and definitely worth reading.

Over the past few years China’s “currency manipulation” has been a particularly hot-button issue. Pundits claim the Chinese government, by artificially suppressing the value of its currency, unfairly subsidizes Chinese exporters while destroying American jobs. Although there is truth to this claim it overlooks the benefits to American consumers from the Chinese policy. Americans should stop fretting about the Chinese currency.

To get a sense of the accusations leveled at the Chinese, we don’t need to scour letters to the editor written by economic illiterates. We can turn to Paul Krugman, who won a Nobel Prize for his work on international trade theory. Krugman has been leading the charge for punitive action against China—including retaliatory tariffs unless its government changes its ways. In a particularly bellicose column last year, “Taking on China,” Krugman wrote:

China’s policy of keeping its currency undervalued has become a significant drag on global economic recovery. Something must be done. . . . This is the most distortionary exchange rate policy any major nation has ever followed. . . . [I]f sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action—except that this time the surcharge would have to be much larger, say 25 percent.

Before continuing we should clarify Krugman’s charges: The Chinese government uses some of its revenues in its own currency (collected from taxation, State-owned enterprises, and so on) to augment its stockpile of foreign currency reserves. In other words, in addition to spending its (yuan-denominated) revenues on tanks, bombers, and infrastructure, the Chinese government also spends some on acquiring more dollars, euros, and other currencies.

Just as the Chinese government’s purchases of, say, gasoline for its military equipment would tend to push up the yuan-price of gasoline, its efforts to buy dollars with yuan will push up the yuan-price of a dollar. By having more yuan chase U.S. dollars in the foreign-exchange market, the Chinese government’s purchases tend to make the dollar appreciate against the yuan.

Because China’s currency is weaker than it otherwise would be, Chinese exports are cheaper: The stronger dollar allows Americans to buy more Chinese goods, and so they will favor Chinese over domestic producers. On the other hand, Chinese consumers will view American goods as more expensive because they ultimately are priced in dollars and it takes more yuan to buy one dollar at the (allegedly) distorted exchange rate.

Consequently countries with overvalued currencies (such as the United States) tend to export less and import more, while China—having the supposedly undervalued currency—tends to export more and import less. This disturbs some people because it enlarges the trade imbalance between China and the United States.

Even if we classify the Chinese government’s policies as nothing but a pure subsidy to its exporters, they benefit Americans on net. The harm imposed on U.S.  exporters is more than offset in dollar terms by the benefits to U.S. importers and consumers.

The standard arguments for free trade apply, even in cases where foreign governments give money directly to their exporters. For example, rather than using their revenues to prop up the dollar in the foreign-exchange market, suppose instead that the Chinese government told major Chinese exporters that they could cut their prices to foreign customers and it would make up the shortfall with tax-financed subsidies.

Note that this policy too would “destroy American jobs” in particular sectors—namely, the ones competing with the subsidized Chinese exporters—but it would generally make Americans richer. To see why, consider the extreme case, where the Chinese government used its tax receipts to buy TVs, cars, and computers from its own producers, then sent the goodies to the United States for free. This would be an unambiguous gift to the American people. If the policy persisted, the U.S. economy would adapt itself to the new reality. Particular producers might be worse off, but Americans would clearly be richer in general, just as surely as if brand new cars magically fell from the sky. The American workers who previously made the goods that we could now obtain for free would be available to produce other items, increasing the total amount of consumption possible from the same amount of labor and other resources.

So if we analyze Chinese currency policies as merely a hidden subsidy to exporters, the standard arguments for free trade show that the U.S. government can only hurt Americans by retaliating (by, for example, imposing tariffs on Chinese imports). This doesn’t mean the Chinese policy is efficient on a global scale. On the contrary, the Chinese are poorer because the losses imposed on them as taxpayers and consumers are higher than the gains to the Chinese exporters, as measured in terms of material output. But it is simply wrong to conclude that “China” is hurting “America.”

In fairness, Krugman has a sophisticated Keynesian twist to the accusations, whereby the “classical” analysis I’ve conducted here breaks down because the whole world is stuck in a “liquidity trap.” I’m going to ignore this subtlety of his argument, largely because most of the people complaining about the Chinese don’t rely on it.

Now that we’ve established that the “worst case” scenario is nothing to fear, we can introduce some further complications. In the first place, the Chinese haven’t made their own currency fall against the dollar, but have merely pegged the one currency to the other, so that the yuan/dollar exchange rate was constant (for long stretches).

As the graph  indicates, from 1995 through 2005 the yuan/dollar exchange rate was roughly constant, and this peg was maintained by Chinese, not U.S., officials. If the yuan started to appreciate against the dollar the Chinese would sell yuan to buy dollars. On the other hand if the yuan started falling against the dollar Chinese officials would sell dollars to buy yuan and restore the exchange rate to the desired target.

To maintain their peg the Chinese needed to have a large stockpile of dollar-denominated assets. The safest such asset has been U.S. Treasury securities. To convince international investors that it is safe to put their money in China—especially after the wild currency fluctuations during the “Asian contagion” of the late 1990s—China quite understandably needed to accumulate more and more Treasury securities.

The Dollar Standard

The situation for China was analogous to when the United States was on the gold standard. To reassure investors of the integrity of the dollar, the government for a long period pegged it to gold at a constant “exchange rate” of $20.67 an ounce. To back up the peg U.S. authorities obviously needed to accumulate large stockpiles of gold. If there had been only one country in the world that exported gold, the United States every year might have sent over tangible goods in exchange for the gold.

A similar analysis holds for China, with its “dollar standard.” To build up its reserves of foreign currencies—a perfectly sensible defensive move after the aforementioned Asian problems—the Chinese wanted to buy more foreign assets collectively than the rest of the world wanted to invest in Chinese financial assets. This is referred to as a “capital account deficit.”

As a matter of simple accounting, if a country (such as China) runs a capital account deficit, then it must simultaneously run a current account surplus (which is a broader category than the more familiar “trade surplus”). Intuitively, if the Chinese want to acquire financial assets (on net) from the rest of the world, then the Chinese must export goods (on net) to pay for them. After all, it is a valuable asset to have an IOU from the U.S. Treasury promising to send future streams of dollars, and a purchaser has to give up something valuable in exchange for it.

Referring back to the graph, it’s important to note that since 1995 the Chinese currency has either stayed the same or strengthened against the dollar. (When the line goes down it means the dollar buys fewer yuan; that is, the yuan appreciates against the dollar.)

When Krugman and others complain about the Chinese keeping their currency “artificially weak,” what they really mean is that the Federal Reserve—under both Alan Greenspan and Ben Bernanke—has been out-inflating the rest of the world. Under those circumstances the dollar ought to be sinking against other currencies. (Indeed, from February 2001 to February 2011, the dollar fell 31 percent against a trade-weighted basket of currencies.) In this context, if the Chinese stubbornly refuse to let the dollar weaken against their own currency, they are accused of “manipulation” to benefit themselves at the expense of the world.

To add yet more irony to the situation, notice that since June 2010 the Chinese have in fact been allowing their currency to steadily strengthen against the dollar. (This is the falling squiggly line at the end of the chart.) This has gone hand in hand with their slowdown in purchases of new debt issued by the U.S. Treasury. Yet rather than praising the Chinese for creating American jobs, most analysts are fretting over the fate of the dollar and U.S. interest rates if the Chinese don’t resume financing more of Uncle Sam’s deficits! If U.S. officials really want to eliminate an “overvalued dollar,” they should tell Bernanke to stop printing so many dollars.

I know that some people find this hard to understand — perhaps because they don’t want to understand — but people like me have never claimed that fiscal expansion is always and everywhere the right policy, even in response to recession….  All of the unorthodox policy recommendations and conclusions are contingent on the economy being in a liquidity trap, in which short-run nominal interest rates are up against the zero lower bound and can’t go lower.

And liquidity-trap conditions are rare; in fact, they’ve only happened twice in US history. Unfortunately, we’re living in one of those episodes right now.

Well, are we in a liquidity trap? And does the present situation require constant bursts of government spending?

Of course, Keynesians believe the answer to the first question is a resounding yes. The answer to the second logically would follow from the first: If Keynesianism really is true, only monetary policy and fiscal policy are available, and economic conditions determine their use.

The Government Alternative

Under the Keynesian paradigm, if monetary authorities cannot stimulate private spending by forcing down interest rates, then the only other avenue is for the government to borrow and create new money, and spend on its own projects. If the first option does not work, the second, by definition, must.

But in America’s Great Depression, Murray N. Rothbard said there is no liquidity trap:

Keynesians claim that “liquidity preference” (demand for money) may be so persistently high that the rate of interest could not fall low enough to stimulate investment sufficiently to raise the economy out of the depression. This statement assumes that the rate of interest is determined by “liquidity preference” instead of by time preference; and it also assumes again that the link between savings and investment is very tenuous indeed, only tentatively exerting itself through the rate of interest. But, on the contrary, it is not a question of saving and investment each being acted upon by the rate of interest; in fact, saving, investment, and the rate of interest are each and all simultaneously determined by individual time preferences on the market. Liquidity preference has nothing to do with this matter.

Rothbard continued that the very things Keynesians claim will worsen an economic downturn – including falling wages and prices and liquidation of capital – actually are necessary to speed up the readjustment. The Austrian-Keynesian divide is fundamental on this point;  Austrians not only reject the liquidity-trap paradigm, but also hold that the problem is boom-induced malinvested capital rather than idle capital.

Idle or Malinvested?

The distinction is important because Austrians say the economy cannot recover until the malinvested capital is transferred to other uses, liquidated, or abandoned altogether. Keynesians, on the other hand, claim that if government can spend enough money, the same capital that Austrians say is malinvested will be returned to full employment.

In other words, Keynesians hold that capital (as well as other factors of production) is homogeneous. An economy is like a cake mixture: Stir in water (money) and an economy appears. The only important ingredient is spending, and lots of it.

Austrians in contrast believe that an economy consists of heterogeneous assets that are directed by consumer choices. Thus attempts by government to drive this process only result in resources being directed to unsustainable purposes. Furthermore, Austrians hold that the current situation is not in a special case; instead, the government is justifying its actions using bad theory. Governments can neither fool Mother Nature nor violate the laws of economics.

Frédéric Bastiat exposed the fallacy more than 150 years ago, and yet many people who should know better apparently never got the memo. One of the latest examples of “the blessings of destruction” analysis comes from Paul Krugman, the 2008 Nobel winner in economics:

[T]he nuclear catastrophe could end up being expansionary, if not for Japan then at least for the world as a whole. If this sounds crazy, well, liquidity-trap economics is like that — remember, World War II ended the Great Depression.

So Japan is hit with three catastrophes, a massive and powerful earthquake, a tsunami, and radiation-spewing meltdowns at a nuclear power plant — and this is considered “expansionary”? If one wishes to understand the intellectual bankruptcy of modern macroeconomic thinking, Krugman provides material.

Krugman Not Alone

However, what the great Walter Williams calls “economic lunacy” is not limited to Krugman. Others are following suit, claiming that the destruction of property in Japan actually is a positive thing, economically speaking. Williams first points out what other “respected” economists have written:

Economic lunacy abounds, and often the most learned, including Nobel Laureates, are its primary victims. The most recent example of economic lunacy is found in a Huffington Post article titled “The Silver Lining of Japan’s Quake” written by Nathan Gardels, editor of New Perspectives Quarterly, who has also written articles for The Wall Street Journal, Los Angeles Times, New York Times, and Washington Post.

Mr. Gardels says, “No one – least of all someone like myself who has experienced the existential terror of California’s regular tremors and knows the big one is coming here next – would minimize the grief, suffering and disruption caused by Japan’s massive earthquake and tsunami. But if one can look past the devastation, there is a silver lining. The need to rebuild a large swath of Japan will create huge opportunities for domestic economic growth, particularly in energy-efficient technologies, while also stimulating global demand and hastening the integration of East Asia…. By taking Japan’s mature economy down a notch, Mother Nature has accomplished what fiscal policy and the central bank could not.”

Harvard University’s Professor Larry Summers, former Obama economic adviser and Bill Clinton’s Treasury secretary, said the disaster “may lead to some temporary increments, ironically, to GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”

Williams quotes Bastiat:

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Williams then asks:

Would the Japanese economy face even greater opportunities for economic growth had the earthquake and tsunami also struck Tokyo, Hiroshima, Yokohama and other major cities? Would the 9-11 terrorists have done us an even bigger economic favor had they destroyed buildings in other cities? The belief that society benefits from destruction is lunacy.

Impeccable Logic

Williams’s logic is impeccable, yet time and again such wisdom is overlooked in favor of the folly of Keynesian “logic” on the alleged benefits of spending. As we have seen from those supposedly most learned in economics, formal graduate study of the discipline in some of our most august academic institutions is no guarantee that sound economics will be learned.

No, Japan is not experiencing the blessings of destruction. The Japanese people are going through sheer horror. To spin this tragedy into economic triumph is not just bad economics; it’s an obscenity.