Fund Your Utopia Without Me.™

04 January 2013

The Krugman Zone

M2RB:  The Church

Sometimes when this place gets kind of empty
Sound of their breath fades with the light
I think about the loveless fascination
Under the Milky Way tonight

The Orson Welles’ ‘War of the Worlds’ Paul Krugman Edition Stimulus Programme:

"If we discovered that space aliens were planning to attack, and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months.”
- Paul Krugman, theorising how a manufactured crisis about how an alien invasion threat would bring a worldwide recovery

 By Greg Mankiw

I often disagree with Paul Krugman, but I usually understand him. Lately, however, I have been puzzled about his view of the bond market. In a recent post, he takes President Obama to task for believing that the failure to deal with our long-term fiscal imbalance might cause a spike in interest rates:

America can’t run out of cash (except politically, if Congress refuses to raise the debt ceiling); it basically can’t experience an interest rate spike unless people see an increased chance of economic recovery and hence a rise in short-term rates. And the people who have been predicting an interest rate spike any day now for four years shouldn’t have any credibility at this point.

But back in 2003, when the fiscal imbalance was much smaller (It was $377.6 billion – Sophie), he wrote:

With war looming, it’s time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits….

How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

And as that temptation becomes obvious, interest rates will soar. It won’t happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.

I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that ”a fiscal crisis threatens our future standard of living” — investors still can’t believe that the leaders of the United States are acting like the rulers of a banana republic. But I’ve done the math, and reached my own conclusions — and I’ve locked in my rate.

I am having trouble reconciling these points of views. Has Paul changed his mind since 2003 about how the bond market works? Or are circumstances different now? If anything, I would have thought that the fiscal situation is more dire now and so the logic from 2003 would apply with more force. I am puzzled.

Professor Mankiw asks:

“Or are circumstances different now?”

Yes, “the one that we’ve been waiting for” is now in the White House…so, it’s all good! 

Under The Milky Way Tonight - The Church

Sometimes when this place gets kind of empty
Sound of their breath fades with the light
I think about the loveless fascination
Under the Milky Way tonight

Lower the curtain down in Memphis
Lower the curtain down all right
I got no time for private consultation
Under the Milky Way tonight

Wish I knew what you were looking for
Might have known what you would find

And it's something quite peculiar
Something that's shimmering and white
It leads you here despite your destination
Under the Milky Way tonight

Under the Milky Way tonight

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