Keynesians always say that public debt does not matter because the government can issue all it needs and has unlimited taxation power. It is simply false.
Governments cannot issue all the debt they need to finance their deficit spending. They have three clear limits:
Crises are never caused by building excessive exposure to high-risk assets. Crises can only happen when investors, government bodies, and households accumulate risk in assets where most believe there is little to no risk.
The 2008 crisis did not occur due to subprime mortgages. Those were the tips of the iceberg. Moreover, Freddie Mac and Fannie Mae, state-owned entities, guaranteed a sizable portion of the subprime mortgage packages, which prompted numerous investors and banks to invest in them. Nobody can anticipate a crisis stemming from the potential decline in the Nvidia share price or the value of Bitcoin. In fact, if the 2008 crisis had been created by subprime mortgages, it would have been absorbed and offset in less than two weeks.
The only asset that can really create a crisis is the part of banks’ balance sheets that is considered “no risk” and, as such, requires no capital to finance their holdings: government bonds. When the price of sovereign bonds swiftly declines, the banks’ balance sheet rapidly shrinks. Even if central banks conduct quantitative easing, the spillover effect on other assets leads to the abrupt destruction of the money base and lending.
The collapse in the price of the allegedly safest asset, government bonds, comes when investors must sell their existing holdings and fail to purchase the new supply issued by the states. Persistent inflation consumes the real returns of previously purchased bonds, leading to the emergence of evident solvency problems.
In summary, a financial crisis serves as evidence of the state’s insolvency. When the lowest-risk asset abruptly loses value, the entire asset base of commercial banks dissolves and falls faster than the ability to issue shares or bank bonds. In fact, banks are unable to increase capital or add debt due to the declining demand for sovereign bonds, as banks are perceived as a leveraged bet on government debt.
Banks do not cause financial crises. What creates a crisis is regulation, which always considers lending to governments a “no-risk,” “no capital required” investment even when solvency ratios are poor. Because the currency and government debt are inextricably linked, the financial crisis first manifests in the currency, which loses its purchasing power and leads to elevated inflation, and then in sovereign bonds.
Of course, Krugman’s confident dismissal of those Biden-hating doomsayers blew up in his face, as CPI inflation kept ratcheting higher and higher. In a December 2021 NYT column, Krugman threw in the towel and admitted he had been wrong, but in his own special way (again, with my bolding):
The current bout of inflation came on suddenly…. Even once the inflation numbers shot up, many economists—myself included—argued that the surge was likely to prove transitory. But at the very least it’s now clear that “transitory” inflation will last longer than most of us on that team expected…
Everything is transitory. The only thing that never changes is change.
The government’s latest report puts the twelve-month official consumer price inflation rate at 8.5 percent, the highest since December 1981:
As economists debate the causes of, and cure for, this price inflation, it’s worth recounting which schools of thought saw it coming. Although individuals can be nuanced, generally speaking the Austrians have been warning that the Fed’s reckless policies threaten the dollar. In contrast, as I will document in this article, two of the leaders of the Keynesian and market monetarist schools didn’t see this coming at all.
My Worst Professional Mistake
Before diving into it, I need to address a problem: my hands-down worst professional mistake occurred during the early years of the Fed’s “QE” (quantitative easing) programs, when I made bets on (consumer price) inflation with two economist colleagues. I ended up losing those bets and thereby gave Paul Krugman the opportunity to lecture me on my intellectual dishonesty because I clung to my (ostensibly falsified) Austrian model even after my prediction blew up in my face. Indeed, if you check out my Wikipedia entry, you’ll see that apparently my life story is that I was born, got my PhD, and lost an inflation bet—in that order. (For those interested in the details, I summarize the episode with relevant links in this postmortem blog post. I also participated in a 2014 Reason symposium along with Peter Schiff and others, commenting on the lack of inflation.)
Ever since the rounds of QE failed to yield surging consumer price inflation at the scale some of us warned of, the Keynesians and market monetarists understandably ran victory laps, saying that they were to be trusted over those permabear Cassandra Austrians. (To be sure, the market monetarists were far more civil about it than the prominent Keynesians.) So it is not with gloating or vindictiveness that I write the present article, but rather I do it to set the record straight and document for posterity that the leading Keynesians and market monetarists totally missed this bout of price inflation.
The Keynesians Camp: Paul Krugman and Klaus Schwab
Let’s do the fun one first: Paul Krugman has not fared well in light of our current inflationary experience. As late as June 2021, Krugman wrote an article in the New York Times titled “The Week Inflation Panic Died.” Here are some key excerpts, with my bold added, and keep in mind that when Krugman wrote this, the most recent Consumer Price Index (CPI) inflation rate was only 4.9 percent:
Remember when everyone was panicking about inflation, warning ominously about 1970s-type stagflation? OK, many people are still saying such things, some because that’s what they always say, some because that’s what they say when there’s a Democratic president….
But for those paying closer attention to the flow of new information, inflation panic is, you know, so last week.
Seriously, both recent data and recent statements from the Federal Reserve have, well, deflated the case for a sustained outbreak of inflation … [T]o panic over inflation, you had to believe either that the Fed’s model of how inflation works is all wrong or that the Fed would lack the political courage to cool off the economy if it were to become dangerously overheated.
Both beliefs have now lost most of whatever credibility they may have had….
The Fed has been arguing that recent price rises are similarly transitory … The Fed’s view has been that this episode, like the inflation blip of 2010–11, will soon be over.
In contrast was Rubin. At 14:00, he announced: “I’m quite enthused about the world right now.” About what? This: “There’s a new world coming on the horizon” (14:07). It is a world in people will be able to work where they want because of telecommuting. He offered a 30-second sermon on liberation. He said: “This is still America.” Yes, it is. He had admitted that there is a problem with the suppression of information, but he makes it clear that he does not believe that this is a technological imperative, nor does he believe that it is a political imperative.
I don’t watch Fox News, but I watch Carlson’s verbal editorials several times a month.
He has a gift for public speaking. He discusses things rationally. He also has a gift for rhetoric. He doesn’t just state the facts. He interprets them and then gives people encouragement to resist some of the trends of our day. There are a lot of really bad trends in our day. But, then again, there always are.
Recently, he came up with this term: “flu d’tat.” Anyone who could do this is my kind of guy.
He writes his own editorials. No one else could. Then he delivers them verbally.
This video is worth watching. It is worth watching because he skewers some leftists who really deserve to be skewered, including the ever-petulant Mark Zuckerberg. Second, he made a major error that needs to be nipped in the bud.
This is an almost flawless editorial. He showed a clip from the suppressed YouTube video by the physicians. He showed a clip from a YouTube spokeswoman defending the removal of the video. He showed a clip from Zuckerberg on Facebook’s suppression of inconvenient ideas.
He did this to present his case that we are facing a totalitarian movement. We have moved to a new phase of American history.
There was a major flaw in this editorial. You may have missed it. This flaw calls his editorial into question. Did you spot it?
The flaw was the man he interviewed. That man has it right. Carlson has it wrong.
The man was polite. He didn’t call Carlson’s thesis into question. Carlson seemed unaware of the fact that the man was overturning his case for the editorial. His name is Dave Rubin. He has written a book: Don’t Burn This Book (2020).
Rubin is a technician. He is trying to set up alternative sources of online communications to challenge YouTube and Facebook. I don’t think he’s going to be successful in this, but I certainly approve of the attempt. If he can make a profit doing it, so much the better. If he doesn’t make a profit, then it’s a futile effort.
Rubin did not use the word “totalitarian.” He used the word “authoritarian.” This distinction may not seem to be important, but, conceptually speaking, it is the heart of the matter.
Carlson kept bringing up the word “totalitarian.” This was a mistake. It made for a riveting editorial. It was a persuasive rhetorical term. But it made for bad analysis.
Because Rubin is correct, at the end of the interview, he displayed remarkable optimism. It is this optimism that we should adopt. But, before we do this, I must discuss definitions.
GETTING OUR DEFINITIONS RIGHT
Totalitarianism is a very specific kind of political order. It is an order in which the central government not merely undermines but actively destroys voluntary organizations. These organizations possess legitimacy. People trust them to deliver certain benefits in their lives. These organizations therefore possess authority. They are independent of the central government. The central government has to either destroy them or take them over by force. This is what was done in the Soviet Union. It is what was done in Communist China. It is what is done in North Korea.
In contrast, authoritarians recognize that they need the support of independent organizations. They know that they cannot stamp them out entirely. Therefore, they attempt to influence them indirectly. They may even subsidize them. They grant carrots, but there are sticks attached to the carrots. They buy off the leaders of these decentralized agencies of authority. Sometimes, they outlaw certain activities of these organizations, but they do not attempt to stamp them out. The authoritarian recognizes that he needs the support of decentralized organizations that possess legitimacy.
If you want a familiar example of this, consider tax exemption. It is granted by the Internal Revenue Service. This is a tremendous benefit to nonprofit organizations. Donations are tax-deductible. So, more money comes in for the causes. But, in order to get this grant of exemption, the organizations must not indulge in political activity. They can sometimes lose their tax exemption if they pursue certain policies that are considered politically incorrect by the nation’s bipartisan leadership. The threat of the loss of the tax exemption pressures the leaders of these organizations to toe the line on certain issues, but certainly not on all issues. The granting of tax exemption is not a mark of totalitarianism. It is a mark of authoritarianism. There is a difference.
Two generations ago, Hannah Arendt wrote a book: The Origins of Totalitarianism (1951). There is a Wikipedia entry on the book. It is one of the most important books of the 20th century. Wikipedia offers an extract, which is representative. She discussed the character and intellect of totalitarian leaders.
Intellectual, spiritual, and artistic initiative is as dangerous to totalitarianism as the gangster initiative of the mob, and both are more dangerous than mere political opposition. The consistent persecution of every higher form of intellectual activity by the new mass leaders springs from more than their natural resentment against everything they cannot understand. Total domination does not allow for free initiative in any field of life, for any activity that is not entirely predictable. Totalitarianism in power invariably replaces all first-rate talents, regardless of their sympathies, with those crackpots and fools whose lack of intelligence and creativity is still the best guarantee of their loyalty.
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