Krugman was on British Television, [https://www.youtube.com/watch?v=_r-AKruzmkk] explaining that if we all try to “slash” spending at the same time, meaning both the private sector and the govt, then there will be trouble.

If the private sector feels it has too much debt, and so does the govt, well then we run up against the fundamental fact that

We Are Not a Household, We Are an Economy.

And that your spending is my income. And my spending is your income. And if we both try and do the slashing at the same time what we end up doing is producing a depression. That leaves us worse off.

And then he quotes the great Irving Fisher [the guy who predicted there would never be a depression again, right before the Great Depression happened] that…

…in such a situation “The more people try to save, the more they owe.” We’re actually worsening the debt problem by not having the govt act as the flywheel, the stabilizing factor, when the private sector is engaged in this ferocious deleveraging.

Well, isn’t he right? If we all stop spending, won’t we all go broke? Won’t we all lose our jobs if no one is hiring? Won’t the stores all have to close if no one is buying? If the silly private sector is foolishly and selfishly trying to pay its debts, shouldn’t the wise govt look at the big picture and borrow even more money to make sure we all get our paychecks?

Devil’s Advocate: Well, Dave, the Nobel Prize Winner got you this time. All your Austrian Economics has just been poured down the drain by his brilliant yet simple explanation. I have a great deal on a John Maynard T-shirt you could wear as a sign of penitence.

Smiling Dave: Just explain one little detail, then I’ll buy the T-shirt.

DA: Shoot.

SD: When that foolish private sector pays its debts, what does it do exactly?

DA: They take a pile of money and give it to the bank that lent it to them.

SD: And the bank then incinerates it.

DA: Of course not. They lend it or spend it.

SD: So by paying my debts, although I spend less, the bankers will spend more by exactly an offsetting amount?

DA: Of course, what do you think? Paying your debts is not destroying the money, just handing it over to someone else to spend.

SD: So when I pay my debts, how is there less spending?

DA: Dave, you forget that there is no guarantee the banks will spend the money they get in return. Look how they have been hoarding money these past few years.

SD: Let’s raise a more general question. If A buys something from B, what is to guarantee B will spend the money he got? Maybe B is a sink for the money. And yet, Krugman is not worried about that, just assumes that he will spend it and everything is fine.

It’s only when B gets the money as the repayment of a debt that suddenly Krugman is worried. Why?

First of all, not all loans are taken from banks. So if B is not a bank, there is no reason to assume some strange thing, that if B got the money from selling something, he will spend it, but if he got it because he lent it long ago to A, then he won’t.

As for banks, they will always lend money. How else will they stay in business? It’s like a football team deciding not to play football. How will it generate income?

Now some people may argue that banks have not lent money these past few years, but there is a govt meddling that created that. [Do a search for “banks not lending money”]. Take away the meddling and of course they will lend.

DA: You know you are contradicting yourself, Smiling Dave. You have been arguing the Austrian position all over this blog, that there is nothing wrong with saving money, that it’s a good thing. Now you turn around and explain that Krugman can sleep nights, we will have plenty of spending, like it’s a good thing.

SD: Good catch there, Devil. I still hold to the Austrian position, that saving is a blessing, and even so called hoarding does no damage. The point of this article is to show that Krugman, even if we grant him for the sake of argument that spending is important, has no justification to cheer lead for govt meddling in the economy, and borrowing money to spend it just because the private sector is being responsible and paying its debts. Whoever gets the money from those repaid debts will spend it, or lend it. Relax, Nobel Prize Winning Krugman.

DA: Dave, how can you be so impertinent as to contradict a Nobel Prize Winner?

SD: I’ll see your Nobel Prize Winner Krugman, who won a prize for his stuff on international trade, and raise you Nobel Prize Winner Hayek, who got his prize for explaining recessions. You know, the topic of this very article. Krugman is talking outside his area of expertise. He should read some Hayek, or better yet my blog.

DA: I have one last question, and I think it will shoot you down in disgrace, Dave. 90% of the “money” lent is created from checks with no cash backing. So that when a person repays his debt to a bank, the money disappears. So it is incinerated.

SD: Devil, when that money disappears, the bank is now allowed to write a new check for an equal amount. The way it works is that the govt only allows banks to write checks for about ten times the cash they have. And they use that privilege to the max. So when $1,000 of “money” disappears because someone returned a loan, that gives the bank the right to create new fake money, in the form of a check with no backing, in the sum of $1,000, and lend it right back to someone else.

Bottom line, maybe the money disappeared, but it popped right back into existence two minutes later.

DA: Could I interest you in a von Mises T-shirt?

SD: You might want to read these articles, too, my son.

http://smilingdavesblog.wordpress.com/2013/10/27/when-people-repay-their-debts-money-disappears-will-that-hurt-the-economy/

http://smilingdavesblog.wordpress.com/2013/12/01/is-money-destroyed-when-a-bank-collects-a-debt/

End of article.

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