Blinded by Theory

Paul Krugman shoots himself in the foot yesterday with his own rhetoric and doesn’t even know it. He utterly destroys his own Keynesian theory in “The Icelandic Post-crisis Miracle,” and seems to think that he has proven the validity of what he has been proposing for months, that we should pour more money into our failing economy and all will be well. The man is so blinded by his own theories that he cannot even see reality when he writes about it himself.

As an immediate reaction to the economic crash, every nation in the world went all Keynesian and created stimulus spending to “restart their economies” except Iceland. That country did, out of necessity since they had no money to spend for stimulus, what non-Keynesian economists suggest, which is to write off their bad debt and make the ones holding that debt take the loss.

You may recall that almost started a war between Iceland and England, since the English were mostly holding the Icelandic debt and they lost all of their money and were really, really pissed off about it.

The Keynesian countries, like the US, used taxpayer money to prop up and maintain the debt, and incurred even more debt in the form of stimulus spending. Krugman overlooks that part, he says those countries are “trying to rehabilitate themselves through austerity and deflation,” which sounded somewhat gratuitously snide to me.

Another way of looking at it would be that they tried stimulus spending and, seeing that it wasn’t working, are now trying something else. Yet another way would be that they have run out of money and credit and cannot any longer continue stimulus spending and are forced into “austerity and deflation.” Yet a third alternative would be that they got so freaked out by the amount of debt that they were running up…

Anyway, the situation is that those countries are out of money and have a large debt load. Iceland on the other hand, while it doesn’t have much in the way of money, also has no debt and its economy is rebounding and generating income. It is recovering far better than any other nation on Paul Krugman’s chart in every respect.

All of which proves that Keynesian economics is nonsense, or at least part of the time it is, a conclusion that Krugman manages to avoid completely.

The moral of the story seems to be that if you’re going to have a crisis, it’s better to have a really, really bad one. Otherwise, you’ll end up taking the advice of people who assure you that even more suffering will cure what ails you.

The point, Paul, which you miss, is that Iceland put the hurt on the people who were holding the debt and had been enriched by it, not on their own taxpayers. By refusing to impose pain on our enriched debt holders, we have put that pain onto our taxpayers; and the longer we refuse to harm the holders of the debt, the more badly we wind up harming our own taxpayers. Iceland didn’t have a uniquely bad crisis; unlike the rest of the world, they just had the right kind of crisis.