Published May 04, 2012

Paul Versus Paul

Dear Reader,

Vedran Vuk here, filling in for David Galland. Today's issue is full of good stuff, including some observations on what may end up being the monetary-policy throw-down of the year, some alarming debt statistics from one of our newest analysts, and of course, some Friday Funnies. Let's get started.  

Lessons from the Paul vs. Paul Debate

By Vedran Vuk, Senior Analyst

A few days ago, Bloomberg held the debate many readers have been wanting for a long time: Paul Krugman vs. Ron Paul. To be fair, Ron Paul didn't have a slam-dunk debate moment – but neither did Krugman. Still, the fact that a medical doctor from Texas armed with a little Austrian economics and a lot of common sense can stand up to a Nobel-Prize-winning economist is impressive. If the roles were reversed and the conversation was on medicine, Krugman would have likely sounded like a village idiot in the discussion. In case you haven't already seen it, click on the frame below for the video.

What was more amazing than Ron Paul's performance was the number of times Paul Krugman shot himself in the foot. Honestly, Ron Paul didn't need to say much; Krugman's own logic make him look bad enough. Let's look at some of his blunders play-by-play style:

Early on in the debate, Krugman says, "You know you can't leave the government out of monetary policy .... The central bank is always going to be in the business of managing monetary policy. If you think that you can avoid that, you're living in some – you're living in the world as it was 150 years ago."

No matter the topic of the argument, a typical defense is to accuse your opponent of being stuck in past. However, in this case, it doesn't make sense. Consider the timing of the last two biggest US recessions: the Great Depression over 80 years ago and the current recession still in the works. Since the enlightened economic policies over the past century have performed so poorly, is it so bad to look upon other time periods favorably?

Krugman goes on: "And look, history tells us that in fact a completely unmanaged economy is subject to extreme volatility – subject to extreme downturns. I know that there's legends that people, probably like you Congressman, have, that the Great Depression was somehow caused by the government  – caused by the Federal Reserve – but it's not true. The reality is that was a market economy run amok. Which happens. It happened repeatedly over the past couple of centuries."

Exactly which periods of "extreme volatility and downturns" are Krugman referring to? Two come to my mind – again, the Great Depression and the current crisis. However, neither is consistent with Krugman's statement. The Federal Reserve was around for both recessions; it's been in business since 1913. Furthermore, researchers including Dr. Christina Romer (the former head of Obama's Council of Economic Advisors) have debunked much of Krugman's volatility assertions. For an excellent comparison of the economy's performance before and after the creation of the Federal Reserve, see A Century of Failure by Dr. George Selgin of the University of Georgia.

Krugman's statements get even bolder: "Depressions are a bad thing for capitalism, and it is the role of government to make sure that they don't happen, or if they do happen, that they don't last too long." Sounds good, right? There's just one problem. The Federal Reserve failed to prevent the Great Depression, and it failed to avoid the current crisis as well. Furthermore, the Federal Reserve seems powerless to shorten the duration of the current recession. If the government's role is to prevent recessions, it has a horrible track record. Krugman is apparently lost in some strange hallucinogenic trip where the government prevented the crisis, and we swiftly arose from a brief recession.

Ron Paul goes at Krugman with a good comeback for the "150 years" statement by pointing out that the history of inflationary policies extends thousands of years, back to the Romans. Krugman responds that this isn't his policy stance. Well, how is it different? The Federal Reserve may use fancy phrases such as "quantitative easing," but it really comes down to same policy of debasing a currency. The techniques and methods may have changed, but the general idea has not.

Rather than explain his comment on the Roman debasement of the currency, Krugman clarifies his position by praising the monetary policies of the 1950s post-WW II period. Yes, that was a great period of growth; but a single decade of success is hardly long enough to be considered support. Monetary policy shouldn't be judged by the performance of one decade, but rather by a century-long track record. Everyone loves policies when they work; it's the policy failures which are the problem. And it's certainly the case that the US federal government has been wholly unable to stay with any one monetary policy for a full century.

Ron Paul's retort mentions the spending cuts after WW II. To dodge Paul's good response, Krugman changes topics to an unconnected point about Milton Friedman. Then Ron Paul answers Krugman with his own unconnected point about competing currencies, to which Krugman mumbles, "I have no idea what that's about."

Next, the conversation switches to the national debt level. The host points out that the national debt as a percentage of GDP has reached near 100% and asks how much further the debt level can be extended. Krugman admits, "I don't have a fixed number," but he suggests that the debt level should be raised an additional 30 points to 130% of GDP, if that could get us out of the recession. In my opinion, this comment is the bazooka shot into Krugman's own foot. Earlier in the debate, Ron Paul criticized the arbitrariness of the Federal Reserve's interest-rate policies. He mocks the Fed by saying, "The interest rate should be one percent instead of three percent because we are so smart."

And here, Krugman completely verifies the validity of Paul's criticism. It's impossible for central planners to figure out the perfect interest rate. Similarly, Krugman doesn't know what the limit to the debt should be. And I don't blame him for having a tough time – who does know the solution to these problems? Maybe our national debt as a percentage of GDP can reach 200%, 150%, or maybe it's approaching Armageddon at 130%. It's impossible to say for sure. In the same way, it's impossible for the Federal Reserve to set an appropriate interest rate. Is zero too low for inflation? Is raising it to 4% too high? What are the consequences to finding some middle ground?

These are truly unanswerable questions. Without the Fed, the market would find the interest rate itself. You can fill a whole room with Nobel-Prize-winning economists, and they still won't be able to figure out what the market would do with interest rates. If they knew, most would be millionaires and running their own hedge funds – not employees of quasi-governmental agencies and universities.

Unfortunately, a lack of knowledge doesn't stop economists from making policy decisions much like what Krugman advocates. He admits to not knowing the limit to our national debt, but at the same time advocates pushing the debt to 130%. What if that's too high and the result is the start of a final death spiral for the US economy? "Whoops; sorry America."

This is the general problem with the Fed and all central planners. They try to guide the economy, but more often than not, they create the very recessions that the system is supposed to prevent. The Federal Reserve either leaves rates too low for too long, or it raises them so high as to create an economic slowdown of its own. The Federal Reserve isn't the wonderful safety net economic idealists imagine. Instead, it's much closer to driving a car while blindfolded. Unfortunately, people like Krugman are more than willing to take the keys knowing full well the dangers of driving blindfolded. And when these Fed economists inevitably crash into a brick wall, it is the passenger – the American worker – who gets creamed.

"Eat Your Vegetables, Greece!"

By Vedran Vuk

When most of us were kids, our parents force-fed us vegetables… and of course, most kids hated it. We yelled, screamed, and protested, but eventually we swallowed. Sure, this is one way to introduce your kids to healthy eating, and sometimes it might result in a lifelong commitment to a healthy diet. But unfortunately, there's no guarantee such a tactic will result in a healthy lifestyle. Sure, it might push the kids in the right direction – and it's better than feeding them nothing but chicken nuggets and French fries for 18 years – but it won't magically make them fitness superstars. As adults, they must decide for themselves their health choices.

In many ways, the PIIGS in Europe are being force-fed their vegetables. A few of them are making some serious changes with austerity plans. However, the pressure to change bad policies isn't coming so much internally as externally. The European Union is pushing its policy prescriptions onto them in hopes of the PIIGS adopting a long-term healthy economic outlook. However, what's more likely to happen is that as soon as the EU turns its back on these countries, they're going to spit out their veggies and run for the nearest chocolate chip cookie or brownie.

For a long-term improvement, the policy changes must come from within countries such as Spain and Greece. No one can force the governments to change policy; it has to be endogenous movement. In the 1980s, there was an almost-worldwide movement away from more socialist programs in reaction to economic problems. Think Margaret Thatcher and Ronald Reagan (both imperfect, but in comparison to today's fools running the show, they were great), and even the fall of the Berlin Wall. Economic turmoil brought about those changes in leadership. However, the new directions in leadership arose organically. The changes were not appeasement in exchange for a desperately needed bailout package, for example.

If the people truly can't stomach austerity reforms, nothing good will come of them. The voters will keep demanding the same destructive policies, and will drag their countries down. If popular support is missing, the reforms won't seem credible for the long term.

Imagine this scenario: The Greek crisis ends, and the country has some room to breathe. There's no crash coming for at least the next five years. Would you be comfortable enough with the new austerity measures and the political climate in Greece to start a business there? It doesn't have to be a huge business, anything from a shipping company to a bakery to a café. Personally, I wouldn't do it. Looking at the political environment there, I just don't see a Greek population committed to a long-term path of fiscal responsibility. If I open a business in the period of normalcy, trouble will again brew in a matter of years.

For businesses to start expanding, people have to feel confident in the long-term vision for the country. We have the same problem in the US. When the monetary and fiscal policies are constantly in a state of emergency, it's difficult to plan for the future. What Greece, Spain, and even the United States needs is a firm stand on the future direction of the country. When entrepreneurs can have a clear vision of their country's prospects twenty years from now, they can start planning today for the future. But at the moment, no one should trust the political commitments of the PIIGS which are being force-fed policies by the rest of Europe.

Numb3rs (The Debt Edition)

By Adam J. Crawford, Analyst

The United States' projected debt load ten years from now, according to The Hill's Congress Blog.

The total tab that may be funneled across the pond (via the Fed) to help bail out the debt-ridden Eurozone. Anthony Sanders was the purveyor of the good news, in testimony provided to the Congressional Oversight Committee.

The newly projected yearly shortfall created by the Affordable Care Act. I'm reminded of a quote from P.J. O'Rourke: "If you think health care is expensive now, wait until you see what it costs when it's free."

Lenny Dykstra's reported total debt according to a recent bankruptcy filing. Post-retirement, the former star center fielder befriended Jim Cramer. Cramer even made Dykstra a featured columnist on Then things took a turn for the worse.

Dykstra squandered most of his loot on the typical "necessities": a Rolls Royce, a Gulfstream jet, and a lavish mansion. His $17.5-million mansion was eventually foreclosed on. He ran into some legal trouble and was forced to downsize.

No word yet on whether the self-proclaimed "financial phenom" will still provide investment advice to the masses via his stock-picking newsletter from the California State Pen – where Dykstra is currently serving a three-year stint for grand theft auto and providing a false financial statement.

It's a dark period for Highland Park, Michigan. Literally. The town voted to remove a thousand streetlights in order to cover budget shortfalls.

The number of streetlights that survived the budget cuts.

Percent chance Portugal will be declared in default (per Standard & Poor's) by December 31, 2012 midnight EST, according to prediction site Intrade. So buy a share for $1.36 and the payout is $10 if S&P gives Portugal a "D" rating by year's end. If not, kiss the $1.36 goodbye.

This is particularly interesting given that the prediction markets currently view Portugal as the most troubled country in the Eurozone – even more so than Greece.

The number of historic landmarks the city of Baltimore is considering putting up for sale to cover the city's budget gap. Headlining the list of historic sites is Shot Tower – the nation's tallest building… in 1828.

The average interest rate for a 30-year fixed rate mortgage. The rate is hovering slightly above historic lows. Yet there are still few takers new home sales actually decreased in March.

Just think how robust housing demand will be when interest rates rise.

Americans' personal savings rate. The lowest percent of disposable income socked away since August of '09.

Battery life left on my computer.
Until next time.

(Adam Crawford spends most of his time searching for the very best investments for Casey subscribers. He recently wrote an excellent piece on why the gold price should be much higher than it is today.)

Friday Funnies

The Obama campaign has a new cartoon out called The Life of Julia. Essentially, the cartoon shows how government policies help the character Julia throughout each age in her life from Head Start Programs as a seven-year-old to free health care later on to retirement in old age. A timeline showing government in every phase of one's life is pretty Orwellian and scary in my opinion, but thankfully people are already making some good jokes from the "Julia" cartoon. Here are some tweets on "Julia" from Politico:

And now for some cartoons:

This last one should really have Krugman holding the buck and throwing in another 30% of GDP to the sharks:

That's it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Senior Analyst