Blame it on the lender

The Krugman diatribes, episode #2xx-

Mr. Bernanke cited “the depth and sophistication of the country’s financial markets (which, among other things, have allowed households easy access to housing wealth).” Depth, yes. But sophistication? Well, you could say that American bankers, empowered by a quarter-century of deregulatory zeal, led the world in finding sophisticated ways to enrich themselves by hiding risk and fooling investors.

And wide-open, loosely regulated financial systems characterized many of the other recipients of large capital inflows. This may explain the almost eerie correlation between conservative praise two or three years ago and economic disaster today. “Reforms have made Iceland a Nordic tiger,” declared a paper from the Cato Institute. “How Ireland Became the Celtic Tiger” was the title of one Heritage Foundation article; “The Estonian Economic Miracle” was the title of another. All three nations are in deep crisis now.

I will grant one thing – the banksters sure did fool a lot of people, themselves first, and then the hundreds of regulators who were present in spite of the “deregulatory zeal.” In fact I am not aware of a SINGLE case where regulators have ever prevented any scam. Like the police in our Bollywood movies, they come and lock the stable doors after the horses have bolted. They do one thing however – they enter and prevent the market from punishing the perpetrators, and then call it “market failure.”

I don’t trust Keynesians; their guru, the great JM Keynes was an immoral (“In our opinion, one of the greatest advantages of his [Moore’s] religion was that it made morals unnecessary….We repudiated entirely customary morals, conventions and traditional wisdom. We were, that is to say, in the strict sense of the term, immoralists.”), unprincipled (“A preference for truth or for sincerity as a method may be prejudice based on some aesthetic or personal standard, inconsistent, in politics, with practical good”; “I am afraid of ‘principle’”), fascist falsifier of evidence and (willful) mis-characterizer of other people’s positions. So I read the “Nordic tiger” CATO report (pdf; ~75kb) Krugman refers to. And this is what it says-

Iceland’s most dramatic reforms are in corporate taxation. The corporate income tax rate is 18 percent, which is among the lowest in the industrial world. The corporate tax rate has been cut steadily from 50 percent in the late 1980s, to 33 percent by the mid-1990s, and to just 18 percent by 2002. The rate cuts have created a powerful increase in investment incentives and boosted economic growth. Rather than creating a revenue loss for the government, Iceland’s corporate tax cuts have coincided with rapidly rising corporate tax revenues.

[...]

In addition to the flat tax for individuals and dramatic corporate tax rate reductions, Iceland has made other important reforms. It reduced its estate tax rate to 5 percent, implemented a flat tax of just 10 percent on capital income, repealed a turnover tax on business, and abolished a wealth tax.

Another economic reform was the creation of private property rights for fisheries, a policy that is being adopted by other nations. Iceland also granted independence to its central bank to create a stable monetary policy, and it has privatized numerous businesses.

All these reforms have helped Iceland climb from 26th to 9th in the Economic Freedom of the World rankings between 1990 and today. Greater economic freedom has created large benefits for average citizens of Iceland. According to the World Bank, Iceland is now one of the world’s richest nations, ranking in the top 10 using either of two different methodologies. Unemployment in Iceland is almost nonexistent, dropping to less than 2 percent in 2006, according to the International Monetary Fund.

The Organization for Economic Cooperation and Development also has a positive report. It notes that “Iceland’s economy and per capita income have grown at an impressive pace since the mid-1990s, making the country one of the most prosperous in the OECD.” In particular, Iceland’s “real GDP has grown by 4 percent per annum, significantly bettering OECD growth over that period … [and] making the country the fifth-wealthiest in the OECD on that benchmark.”

The report is on tax rates and privatization. It is not on the fractional reserve banking practiced by Icelandic banks – which were the ones that torpedoed the country’s financial system. It mentions the central bank. But “deregulatory zeal” means the central bank must cease to exist. Did it? Unless its Krugman’s position that privatizing fisheries and reducing tax rates were responsible for the financial crisis in Iceland, this report shouldn’t have found a mention. Why didn’t he mention this one – a twenty page analysis as against a two page report, by the same author a full nine months after “Nordic tiger”?

Selective quotations do have their uses though – you can tar laissez faire by mentioning CATO and Heritage reports. I don’t think the NYT’s readership even bothers about the fact that the report goes by the title – “Iceland Joins the Flat Tax Club.” And the jumbling up of cause and effect is a trademark of every irrational economic theory including Keynesianism. Paradoxes do not exist – their existence proves that those who see the paradox are prize idiots. Just like there is no “paradox of value,” there is no “paradox of thrift.” Anyone who says that “excess savings” are to blame for the crisis should first empty his bank account and then start preaching that sermon-

One way to look at the international situation right now is that we’re suffering from a global paradox of thrift: around the world, desired saving exceeds the amount businesses are willing to invest. And the result is a global slump that leaves everyone worse off.

Krugman says this right at the beginning of the article – “world [was] awash in cheap money, looking for somewhere to go.” The law of demand and supply applies as much to capital as it does to everything else. The money is not cheap just like that. Excess money (savings) competing for limited investment opportunities pull down interest rates. There always will be some kind of equilibrium. What governments have been doing for the past century or so, on the basis of disastrous advice from dodos, is tampering with the price signals – fiddling with interest rates. And that makes things worse.

Yes, the Asians are to “blame.” The poor Chinese, and Indians, and Indonesians…work sixteen-hour days at low wages and their governments park trillions of dollars earned that way in US government treasuries and in “guaranteed” investments like instruments issued by Fannie and Freddie. They were providing cheap credit to Americans, and that money will have to be repaid. The solution does not lie in borrowing a few trillion dollars more to have a blast. And that is precisely what the US government is about to do. As Halligan said last year,“Yes siree, the mighty US government could default.” One of these days, it might just happen.

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