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Jeremy R. Hammond


Subtitle: Austrian vs. Keynesian Economics in the Financial Crisis, Jeremy Hammond, 2012, 104 pgs., index, endnotes.


The author correctly selected former Congressman Ron Paul and NY Times economist Paul Krugman as current representatives of the two opposite theories about economics and its manifestation in the role of government; The Austrian School believes in a real 'free market' and minimum government interference, while the Keynesian school believes that government should manage the economy and have an even greater control. The madding thing about this is that while government manipulates the market and prevents the existence of a free market the progressives continually blame the results right back on this non-existing free market and lack of even more government control. The two opposing theories were given a practical test in the course of the financial crisis of 2007-2009: both with respect to their contrasting predictions and recommended government 'solutions.' For this purpose the author has compiled a very extensive data base consisting of numerous speeches and articles published by the two authors, that he then presents directly in context with each other. Thus the author's quotations from and commentary about the recent public statements of the two surrogates about this real, dramatic financial crisis provide a text that should be easily digested by the public. But I warn the reader that eventually the very tone of Krugman's alternating between failed predictions and subsequent excuses and vicious attempts at blame shifting onto those who actually did make accurate predictions becomes worse than tiresome. In a brief summary and review I cannot but extract a few quotations from this densely argued text. They fill page after page of published statements clearly selected from a much larger corpus of authorship. I highly recommend that everyone interested in reality read the full book, it is worth the pain. It should be read along with Krugman's book - Return of Depression Economics, Lawrence White's The Clash of Economic Ideas and Alan Greenspan's The Map and the Territory as well as other books focused on the 2008 financial crisis. The author could have selected many other references and public speeches and writing, but no doubt Ron Paul and Paul Krugman are two of the most articulate and widely known and read representatives of the two diametrically opposed theories and practices. Moreover, while Ron Paul's correct analysis, predictions, and warnings were ignored, Paul Krugman's advice was adopted ( or rather he was advocating the policies establishment politicians promoted anyway) and his predictions turned out to be false. Therefore, the book is not simply an academic exercise, but a record of government failure which continues today. It is a warning about the further failures that are coming now.


Introduction: The author places the usual explanations (causes) of the housing bubble and financial crisis into two categories: the cause was unregulated free markets, or the cause was government intervention in to that market. The opposite recommendations for future action flow from these - either more or less government intervention and control. Therefore a correct response and adoption of one of these policies requires an accurate determination of the real causes. The author decided to examine this subject via the public records of to individuals who made predictions and offered policies. He notes that former Congressman Ron Paul was (and is) an outspoken claimant that it was the government (its laws and regulations) that caused the crisis. And Nobel prize winner Paul Krugman was ( and is) an advocate of expanded government control. But these two gentlemen are representative of broader groups of economic theoreticians: the so called "Austrian School" and the Keynesian school. His objective then, he states, is to evaluate which position is the better in terms of which conformed more to the results that took place. He cites the Bible is full of the predictions of prophets and receipt for separating real from false prophets. The true prophets are those whose predictions come true. Moreover, in general the true prophets were ignored by their listeners while the false prophets gave speeches that were more popular because of being more reassuring that all was well.
Thus the author narrows his subject to comparison of the public record he compiles of predictions and comments the two authors made relating to the housing bubble and subsequent financial crisis.


The Dot-Com Bubble:
The author begins this chapter with Ron Paul's warning in 1997 about the government plan for HUD to subsidize housing. The result would be misallocation of resources and a distorted market for capital as predicted by Austrian School economists. Plus, the program benefited the wealthy rather than the poor. Moreover, this was but one of the errors resulting from the FED monopoly over and manipulation of interest rates. FED policies distorted the critical signals prices give to the market and create artificial booms. Then politicians desperately attempt to prevent the boom from going bust.
At the same time, the author notes, Krugman was arguing the opposite. He quotes extensively from Krugman's newspaper articles. Krugman recommended that the FED keep interest rates low. While Ron Paul was continuing to warn throughout 1998 about the artificial boom and coming world-wide financial crisis, Chairman Alan Greenspan followed Krugman's advice and kept interest rates artificially low. The author quotes Ron Paul "Price fixing of interest rates contradicts the basic tenets of capitalism." When the FED then 'rescued' the big financial firms from the collapse of LTCM, Krugman claimed that the collapse was due to 'deregulation' and 'aggressive speculators are able to leverage themselves'. This is a typical Krugman ploy to divert blame from the real causes. Hammond points out that Krugman's argument ignores the question of why a company would destroy itself on purpose. LTCM was merely responding to the financial environment created by the FED.
In a House speech Ron Paul argued that not only had the FED created the environment but also had further created 'moral hazard' by its intervention and bail out. Hammond continues his citations of Krugman and Paul into 1999. Krugman even noted that the high level of consumption was unusual but claimed it was good for producers and jobs. (Right out of the Keynesian play book.) While Ron Paul was increasingly warning about the coming burst of the market bubble. Krugman continued to ignore the role of the FED and assure the public that all was well.
Come January 2000, after the stock market crashed Krugman wrote about investors not being entirely rational and that 'stocks surge and plunge for no good reason'. The article was another Krugman effort to absolve himself from his prior writings. He continued in like vane into February, as Hammond, quotes him extensively. Hammond continues, "Even after the NASDAQ began to plummet, Krugman could still write that 'the U.S. economy has cheerfully broken all the old limits' with 'almost every fresh economic statistic' having been a 'cause for celebration.' Hammond writes. "While Krugman was predicting continued growth, Ron Paul was telling his fellow Congressmen that the coming recession could not be prevented." The author fills three more pages with damming comparisons between Krugman's unreal assessments and Ron Paul's explicit evaluations of the actual causes of the crisis that was taking place right before their eyes.


The Housing Bubble:
The chapter begins with Krugman's comment in January 2001 "that the soaring NASDAQ had been 'a classic bubble' which raised the question of why he had failed to recognize it at the time." Hammond continues the contrast. "While Krugman was convinced that his prescribed medicine was working to cure the economy (that is lower interest rates) Ron Paul continued to characterize that same policy as poison." In 2001 Ron Paul was warning about the coming new bubble in housing prices. While Krugman continued to claim no recession was to be expected because, 'The Fed can easily and quickly cut interest rates as much as necessary, for as long as zero is low enough.' The contrasting story continued right through 2001. By then Krugman was attacking Paul and the Austrian theory of business cycles. As Hammond, points out, 'But Krugman was once again begging the question. If the Austrian theory of the business cycle was correct, and artificially low interest rates had caused those 'bad investments', in the first place, how could cutting interest rates to encourage even more spending also be the solution?' Hammond continues: "As the market continued to plunge, Krugman commented, 'It goes without saying that the Fed must cut interest rates next week....' And on 2 May 2001, "Krugman again dismissed the Austrian business cycle theory, which he this time called 'a sort of crime-and-punishment theory of recessions.' And, "Financial bubbles, which be attributed to 'irrational exuberance' , did not need to be followed by a recession, he repeated.' Hammond follows with a lengthy quotation from Krugman dated July 2001 in which he repeated the slogan that everyone now is a Keynesian. Unfortunately that is almost true, at least within the academic circles of Ivy League universities. Three more pages of this regurgitation of Krugman nonsense becomes disgusting, but I imagine it might sway the opinion of some Krugman acolytes.
Hammond continues, "On September 6, 2001 Ron Paul warned that the monetary policy Krugman was advocating was creating a housing bubble that would inevitably require a correction.' He continues with lengthy quotations from Ron Paul about the results of the FED actions in credit and interest rates. In contrast to Krugman's alternating wishful thinking and blame-his-critics rants, Ron Paul's speeches describe exactly what was taking place in the real world and predicting what results would follow - as they in fact did follow. Then, on September 14 2001 we have Krugman's assessment of the recent attack. "Ghastly as it may seem to say this, the terror attack - like the original day of infamy, which brought an end to the Great Depression - could even do some economic good.' Hammond remarks,' Krugman thus repeated the old 'broken window' fallacy identified by Frederic Bastiat a century-and-a-half before.' And he repeated the same error in the NYT later in September. But Hammond fails to note that Krugman was actually admitting that the New Deal Keynesian massive policies during the 1930's had failed to end the Great Depression.
The author continues with more quotations from Krugman in which the NOBEL prize winner blamed faulty economic advice on 'conventional wisdom' when in actuality he was himself a leading spokesman for that very 'conventional wisdom.' The reader has to wonder how Krugman continues to get away with such stuff. And so it continued through 2001 and on into 2002 - Krugman urging more government intervention and lower FED interest rates, while Ron Paul repeatedly warned about the building bubble in building of houses. From Ron Paul, "It is precisely too much government, and especially manipulation of credit by the Federal Reserve, that precipitated the economic downturn in the first place. Increasing that which caused the recession can't possibly, at the same time, be the solution...' He continued to warn that 'government intervention in the market was creating a housing bubble that would lead to a financial crisis and bailouts that would fall on the backs of taxpayers.' Hammond provides another lengthy quotation from Ron Paul that concludes with this, "To condemn free-market capitalism because of anything going on today makes no sense. There is no evidence that capitalism exists today. We are deeply involved in an interventionist-planned economy that allows major benefits to accrue to the political connected of both political spectrums....'' Hammond fills 15 more pages with these contrasting quotations published through 2005.


Crisis and Response:
In this chapter we arrive at January 2006 when Krugman wrote 'In spite of record home prices, housing in most of America remains surprisingly affordable, thanks to low interest rates.' But, Krugman, advised, yes housing prices in at least some markets were into a bubble, but the problem was not artificially low interest rates creating this bubble but instead that rates could not get much lower in order to expand the market further. He was beginning to face reality when noting that sooner or later the housing boom would end, but continued to advocate lower interest rates from the FED in order to encourage yet more borrowing and spending. In February Ron Paul commented that the FED's printing paper money was 'nothing short of counterfeiting'. And he expanded his impact area globally by noting that with the U.S. dollar being the world reserve currency the coming financial crisis would generate an impact on American imports paid for by borrowing from China and other countries. And it would have an impact on oil prices due to payments in dollars. Hammond continues with lengthy quotations from Ron Paul warning throughout 2006. He notes that, "Paul Krugman, by contrast, continued to dismiss any concerns arising from the Fed's inflationary monetary policy.' After yet more quotations from Krugman, Hammond summarizes and critiques his many contributions with five specific fallacies.
By March 2007 Krugman was admitting that there had been already a collapse in the housing market and that this extended into the broader financial markets. He wrote, "In retrospect the complacency of investors on the eve of the crisis seems puzzling. Why didn't they see the risks? Well, things always seem clearer with the benefit of hindsight." Such brazen CYA - yet he gets away with it. He, himself, was a leading voice in creating that complacency. By summer, Krugman was blaming the rating agencies and regulators. Hammond again fingers Krugman. "The origins of this crisis, he said, 'lies in the financial follies of the last few years, which in retrospect were as irrational as the dot-com mania'. Thus, although Krugman understood the housing bubble to be a predictable consequence of the Fed's low interest rate policy, he was at the same time attempting to deceive his readers into believing that there was just no rational explanation for it. He begged the question.' He refused to admit the cause had anything to do with Keynesian economic theory in practice. Then, in October 2007, Krugman pulled off a typical blame game. "He asked, "Why was nothing done to head off this disaster?' His answer was that it was a consequence of 'the laissez- faire ideologues ruling Washington' and the belief' that government is always the problem never the solution, that regulation is always a bad thing'. This is simply unbelievable, since it certainly is not due to ignorance. To view him as incorrigible is not enough.
Meanwhile Ron Paul was providing the exact opposite assessment. He noted that the bubble was not due to an unregulated free market, "For years the federal government has made it one of its prime aims to encourage home ownership among people who otherwise would not be able to afford homes." The entire chain of financial institutions involved in the mortgage market is highly regulated.


Know them by their fruits:
Hammond begins this chapter with Paul Krugman's responses to critics in June 2009. Typically, he claimed the critics were loony and delusional. He went on to twist the context and content of his previous writing as well as the comments of some critics. Critics noted that Krugman failed to predict the housing bubble and had advocated the policies, such as minimal interest rates, that enabled it. In response he first claimed that his critics had accused him of CAUSING the house bubble and then claimed he was only providing 'economic analysis'. Of course no critics had accused him of CAUSING the crisis. Hammond remarks, "By conjoining the spurious charge that the bubble was his 'fault' with the legitimate criticism that he had called for it, he could create the strawman argument that since he hadn't personally created the bubble therefore his critics were not only wrong, but so bizarre in their criticism that they must be delusional." Hammond continues, "The fact is that Krugman did advocate a policy of creating a housing bubble to replace the dot-com bubble, his disingenuous protests to the contrary notwithstanding." And, "Krugman continued to deflect blame away from the policy course he himself had advocated in the aftermath of the financial crisis, and thus away from the role the Fed had played in creating the housing bubble." He continued to claim that 'most' economists had failed and moreover that was due to most economists being 'blind' because they believe in capitalism. Hammond again, "His fallacies were glaring, and it is highly ironic that he could attribute to any other economists a 'blindness' and willingness to 'turn a blind eye' due to adherence to ideology.' "Again on April 5, 2010 Krugman attempted to exonerate himself and obfuscate his own record, writing in his blog that people were taking his earlier remarks calling for a housing boom, 'out-of-context.'"
There is much more, on into 2011, but we eventually tire.


Hammond devotes a single page to the question: "So who was the true prophet, and who the false? Whose predictions came true?"
"While Paul Krugman advocated a monetary policy of maintaining artificially low interest rates in order to manufacture a boom in housing, Ron Paul correctly predicted that this policy would create a housing bubble that would pose a threat not only to the U.S,. but to the global economy when it burst, as it ultimately must do.'
There is just no contest. Krugman was continuously wrong, and Ron Paul was consistently correct."
"In as much as each man represents an opposing school of economic thought, the further corollary seems incontrovertible that the financial crisis has shown Keynesianism to be a thoroughly bankrupt school of economic thought. It has at the same time vindicated proponents of the Austrian school and attested to the cogency of its business cycle theory."


Warnings for the Future: Hammond continues with further quotations from Ron Paul and discussion of his comments about the FED and government policies that create 'moral hazards' due to intervention in markets. Paul in particular cites the problems that come from government guarantee of Fannie Mae and Freddie Mac. He argues that it is government 'solutions' to crisis that were themselves the causes. The 20 pages are filled with mostly lengthy quotations that repeat Paul's warnings and criticisms of government monetary policy. There is no mention of Krugman in this chapter. Thus, this chapter is the author's own warning about the future of American finance based on his conclusion that Ron Paul's analysis and predictions are still not being accepted by the political establishment.


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