Deficits Matter, Paul Krugman Doesn’t

Okie dokie. So, I awoke somewhere around 4:15 am to finish tearing into Krugman’s latest drivel, when I discovered that Bill Mitchell beat me to the punch. Good deal. I’ve spent some time this morning re-writing my article so that Krugman takes a hit on two fronts: Mitchell knocks him down, and I kick him while he’s down. Frankly, this last epic neoliberal drool-fest of Krugman’s, to me, represents the end of his career; or at least it should given the plethora of political BS and veritable dearth of macroeconomic reality. So, let me proclaim it loud that all might hear:

Labour unions, progressives, people of the world – hear me: Stop listening to Paul Krugman. The man is a charlatan; a political hack; a snake oil salesman.

Fig. 1 Paul Krugman

In his latest anti-knowledge drivel of January 9, 2017, Count Krugula apparently decided that he wants to make a total fool of himself in public yet again. Only this time, he wants it to be a sort of career-ending effort. As I said, in that effort, Paul Krugman has succeeded. Krugman opines:

“Not long ago prominent Republicans like Paul Ryan, the speaker of the House, liked to warn in apocalyptic terms about the dangers of budget deficits, declaring that a Greek-style crisis was just around the corner. But now, suddenly, those very same politicians are perfectly happy with the prospect of deficits swollen by tax cuts; the budget resolution they’re considering would, according to their own estimates, add $9 trillion in debt over the next decade. Hey, no problem.”

Right, so first of all, let’s make some things clear. Politics is always a problem, because both Republicans and Democrats use a false economic narrative to push their particular political agenda. Both sell a narrative of fear concerning federal deficits, taxes and debt which have absolutely no footing in reality, and if the economic narrative isn’t fear-based, they cannot sell their politics. The difference between the two? Republicans sell that narrative only when they aren’t in charge. Democrats sell deficit terrorism 24/7.

Adding $9 trillion in debt over the next decade is not a problem; in fact, it would be a god send were it to represent spending for full employment and the public purpose. Unfortunately, that won’t be the case. Nevertheless, adding $9 trillion to the debt is meaningless, because the national debt is just a bunch of savings accounts. It isn’t an actual debt.

What is termed the “public debt” is a bunch of numbers on spreadsheets sitting at the Fed. These numbers were originally issued by the US Government during prior deficit spending initiatives, the dollars were obtained by private entities, and then used to purchase treasury bonds, which the US Treasury issued to defend a positive target interest rate set by the Federal Reserve. The dollars which purchased the bonds were then shifted from one spreadsheet called a “reserve account” to another spreadsheet called a “securities account”, both spreadsheets held at the Fed where the numbers sit unspent, earning interest. Put simply, the debt is a bunch of harmless savings accounts that pay interest.

Something else that Krugman doesn’t realize, or doesn’t wish to because he is a market-oriented type of guy, is that the US Government controls the amount of interest it will pay, and can do so across the entire yield curve. The market simply isn’t in charge here.

Also, there are thingies called primary dealers which are obligated to bid on treasury bonds. The New York Federal Reserve maintains a list of these dealers here.

So, point one is that the US Government will not ever find itself in a position where it cannot sell its bonds. Point two is also the fact that the Federal Reserve can easily buy up all treasury bonds issued. Point three is that treasury bonds are an anachronism. They are utterly useless devices in the modern day and serve no financing function for the US Government, regardless of what Krugman says. Need proof? We have two different ways to prove Krugman incompetent. Firstly, interest on reserves.

As I mentioned, the US Treasury issues bonds that pay interest to defend a positive target interest rate set by the Federal Reserve. In terms that the public can understand, bonds conduct monetary policy, not fiscal policy. Banks who find themselves deficient of required reserves would rather not obtain the reserves from the Fed’s expensive discount window. So, they head to the interbank market where banks with excess reserves are willing to lend to those who are deficient. This competition for excess reserves drives down the overnight rate, threatening the Fed’s target interest rate. If the Fed does not intervene to halt that competition, it will lose control over monetary policy.

The Fed intervenes by removing the excess reserves, replacing them with a bond and the interest paid induces the bank to accept and hold onto the bond. Competition is halted. The positive target rate is defended. This very same condition can be achieved by paying interest on reserves.

The Fed simply offers to pay interest on reserves, and banks with excess will be induced to hold onto their reserves rather than lend them on the interbank market. Thus, there is no competition which would threaten the Fed’s target rate. Instead of the national debt sitting in securities accounts at the Fed, the debt would sit in reserve accounts at the Fed. At this point, treasury bonds would not have to be issued, because they would be redundant.

Secondly, the Fed could be ordered to maintain a zero interest rate policy. In doing so, competition for excess reserves would drive the overnight rate down, but because the Fed’s target rate is set to zero, a fall in the overnight rate doesn’t threaten the target rate. In other words, there’s nothing to defend, the national debt would not exist at all, and so, treasury could simply stop issuing bonds altogether.

So, actual debt?


Is the market in charge?


The US Government is always in charge.

Krugman is incompetent.

“Those apocalyptic warnings are still foolish: America, which borrows in its own currency and therefore can’t run out of cash, isn’t at all like Greece. But running big deficits is no longer harmless, let alone desirable.”

In his big effort to end his career, Krugman prepares us with this statement for another foray into the fictional world of loanable funds theory. How do we know this? The last sentence: “But running big deficits is no longer harmless, let alone desirable.” Let me show you why. Follow me here for a few more paragraphs. Kruggles goes on to say:

“The way it was: Eight years ago, with the economy in free fall, I wrote that we had entered an era of “depression economics,” in which the usual rules of economic policy no longer applied, in which virtue was vice and prudence was folly. In particular, deficit spending was essential to support the economy, and attempts to balance the budget would be destructive.”

Now then, ever notice how Krugman always sets himself up as the all-wise, all-knowing, all-insightful macroeconomic equivalent of Nostradamus? He is stunningly accurate too when he reverses himself after the fact – a condition we call “Ex Post Rationale Syndrome”:

“This diagnosis — shared by most professional economists — didn’t come out of thin air;”

Stop. Firstly, Krugman’s ego train is about to derail at high speed and it’s making me sick, frankly. He’s claiming that first, thus spake “Paul Krugman the Wise”, then afterwards most professional economists said, “Krugman is wise. Let us follow him”. Secondly, this sentence fragment is highly misleading. It needs a re-write:

‘This diagnosis — shared by most professional astrologers — didn’t come out of thin air;’


“it was based on well-established macroeconomic principles.”

As though these principles are anything but total fantasy. The truth is that these well-established macroeconomic principles that Paul alludes to are really well-established religious rituals, entirely based on how so-called “economists” want the economy to work, not how it actually does work.

“Furthermore, the predictions that came out of those principles held up very well.”

Man, you smell that? That’s some stank. Rancid stank. Hell, even Queen Elizabeth II knew it was stank post-global financial crisis when she said that orthodox economists like Krugman had no idea what they were doing, and that’s saying quite a lot there. The economy entered the free fall that Paul talks about, precisely because orthodox economists sent the economy into a free fall. None of these New Keynesian jackwagons could see the financial crisis coming; a crisis of their own doing, and now, Krugman wants to sell an unwitting public the snake oil story that these same well-established macroeconomic principles held up very well post-GFC. They cannot hold up at all, because DSGE is bullshit, IS-LM is total horseshit, the zero lower bound is a mythical monster that eats peoples’ shoes, banks don’t lend out reserves and deficits do not crowd out private investment. Given the fact that the orthodox view is total fantasy, these “well-established macroeconomic principles” can only be correct strictly by accident. Let me demonstrate what I mean for the benefit of laypersons and the general public.

Say Krugman tells you that his “well established principles” demonstrate that too much sneezing is why automatic garage door openers fail. You laugh at him and leave his office. On the way home, you sneeze, but when you arrive at home, the garage door opens and shuts. For the next year, you sneeze here and there many times. Then, suddenly one morning, your automatic garage door opener fails. You meet Krugman for lunch and make the offhand comment that your automatic garage door opener failed that morning.

Krugman declares that his “well-established principles” held up pretty well.

Understand me?

“In the depressed economy that prevailed for years after the financial crisis, government borrowing didn’t drive up interest rates, money creation by the Fed didn’t cause inflation, and nations that tried to slash budget deficits experienced severe recessions.”

We’re getting close to kicking Paul in his macroeconomic shins now. I wish to direct your attention to this statement by Krugman: “money creation by the Fed didn’t cause inflation”. Simply put, Krugman is claiming that he knows QE isn’t inflationary. That’s another lie.

Krugman fancies himself a Japan success story even though he was wrong, since it was fiscal policy and not monetary policy that lifted Japan out of the doldrums. Krugman believed that QE would get Japan going again:

“But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.” – Krugman, December 1999

In other words, in 1999 Krugman claimed that money creation efforts by the Federal Reserve would create inflation.

The guy flip-flops more than a fish out of water.

“How do we know that we’re close to full employment? The low official unemployment rate is just one indicator. What I find more compelling are two facts: Wages are finally rising reasonably fast, showing that workers have bargaining power again, and the rate at which workers are quitting their jobs, an indication of how confident they are of finding new jobs, is back to pre-crisis levels.”

Bill Mitchell handles Krugmagnon man’s errant discussion of full employment, so I won’t delve into it except to say that the actual U6 unemployment rate is still above 9% and Krugman doesn’t give a damn about working men and women.

Labour unions, take note!

Anyway, let’s instead push on to the loanable funds nonsense:

“What changes once we’re close to full employment? Basically, government borrowing once again competes with the private sector for a limited amount of money. This means that deficit spending no longer provides much if any economic boost, because it drives up interest rates and “crowds out” private investment.”

And there it is! Easily predictable. Mr. Ex Post Rationale flip-flops back to loanable funds once more. Talk about waffling. I’m about to change my pet name for Krugman to “Eggo Man”.

How Banks Lend

In the real world, banks operate on the credit creation model where a bank lends regardless of its reserve position. When a bank lends, it creates its own IOU which it then denominates in the unit of account. Doing so makes the IOU acceptable to satisfy any tax liabilities to the state. At the same time the loan is made a deposit is made which consists of these IOUs. When the borrower spends the deposit, reserves shift from the lending bank’s reserve account to the seller’s bank’s reserve account and so, the IOUs behave as money in the private sector. Once the loan is paid off, the IOUs are destroyed. What all this means is that the central bank doesn’t control the money supply. The money supply is determined by demand for bank credit, which means it is “endogenous”. So, when loans are made, the money supply expands and when loans are paid off, the money supply shrinks.

Krugman, on the other hand, insists that banks are intermediaries and lend out customer deposits:

“First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.”

Krugman also claims that the central bank controls the money supply:

“That’s the bottom line: the Fed controls credit conditions, except when we’re in a liquidity trap and it’s pushing on a string. Everything else — all the talk about banks creating money, and yes, all the gotchas my critics think they’ve found in what I’m saying — is irrelevant to the actual economic discussion.”

The above statements from Paul in 2012 were his responses to Steve Keen’s challenge of Krugman’s claim concerning banking operations. Most of us outside of the mainstream (along with the Bank of England) know that Krugman’s claim of banks being intermediaries is entirely false as well as his claim that the central bank controls the money supply, which it doesn’t since it sets the target interest rate.

Furthermore, as to the money supply issue, Krugman’s conditional liquidity trap: “the Fed controls credit conditions, except when we’re in a liquidity trap”, highlights that he possesses a deep, fundamental confusion as Scott Fullwiler demonstrates quite effectively:

“What he [Krugman] fails to understand is that it is only when the Fed sets its target rate equal to the rate paid on reserve balances (which will mean t-bills earn roughly the same as reserve balances—Krugman’s liquidity trap) that the Fed can actually target the quantity of reserve balances and by extension the monetary base. And even then, it must be sure to provide at least as many reserve balances as banks desire at the target rate to achieve its target rate in the first place. The key point here is that “under normal circumstances” the monetary base’s size would be determined endogenously based on the public’s demand for currency and banks’ demand for reserve balances at the Fed’s target rate; the Fed or any other central bank can only control the size of the monetary base directly by creating “liquidity trap” conditions that set interest on reserve balances equal to interest on t-bills.”

In the face of damning evidence to the contrary, Krugman refused to admit that his claims were false, ending the conversation before the public as a whole could discover that he had no idea what he was talking about.

And so, that’s how science works, right?

A few years down the road when his errant views on banking and central bank operations actually began falling out of favor, or in Krugmanese, his views became rather “wonkish”, and a decent opportunity arose, Krugman reached into his bag of tricks, pulled a fast one and unwonked himself claiming that he’s always been an endogenous money sort of guy and that he’s always said the central bank doesn’t control the money supply:

“Basically, it was an application to asset markets, including the role of intermediates, of an approach similar to IS-LM: general equilibrium, yes, but with an ad hoc if plausible treatment of aggregate behavior. This approach told you right away that the volume of bank deposits, which are the non-cash component of broader money aggregates, was determined not by some mechanical multiplier but by incentives –and that in a liquidity trap just swapping monetary base for zero-interest securities would have no effect on these incentives, and hence no effect on deposits. Oh, and this wasn’t an ex post rationale: it’s what those of us who knew the golden oldies were saying in advance. Me in 2009: ‘Central banks don’t control the money supply, they only control the monetary base.’”

And so, there goes Ex Post Paul once again – First he’s a loanable funds type of guy, then he claims to have always been an endogenous money type of guy, and now, on January 9, 2017, he’s back to loanable funds theory again. Why is he doing this, you might ask? Simple really. Paul is merely crafting bullshit arguments to support his political agenda and his deep love for the Democratic neo-liberal establishment. Nothing more than that.

Paul Krugman is grossly incompetent.

You can read more about this saga of stupid in my article “You Need to Know Your Tobin – Ex Post Nonsense

Look, here’s the truth, Krugman’s economics works on two very simple premises: Firstly, he asks, “What are the Republicans saying today?”, and then Krugman says the exact opposite.

Because that’s how we do science, right?

Yes, you see, every morning Neil deGrasse Tyson rises early to greet the new day, makes a pot of coffee and begins to do science by asking, “What’s Stephen Hawking saying about black holes today?”, and then Tyson whips out his MacBook Pro, fires up Word and says the exact opposite of what Hawking said.


The second premise is something Mitchell pointed out in his article (See the section – “Blowing in the Wind). Krugman changes his position on deficits with the political winds. In other words, Krugman’s position on deficits entirely depends on which party controls the White House.

Behold! Science!

Eggo Man continues his pursuit of retirement thusly:

“… they’re [Republicans] going to blow up the deficit mainly by cutting taxes on the wealthy. And that won’t do anything significant to boost the economy or create jobs.”

Outside of the ignorant phrase “blow up the deficit”, which actually means “increase the private sector’s income”, Paul is correct. Tax cuts on the wealthy will do absolutely nothing significant to boost the economy or add more jobs. The problem with Krugman’s thinking?

After eight wasteful years watching Obama slash the deficit, resulting in the slowest recovery in US history, it’s always a good time to blow up the deficit – just not the way Republicans blow up the deficit. It is a guarantee that when they are in charge of things, Republicans will increase the deficit. However, being backwards-assed by nature, Republicans direct deficit spending at things which have no hope of creating prosperity and full employment, namely military expansion, tax cuts on the rich, and corporate welfare.

Democrats like Krugman prefer some good old deficit slashing, starving the economy of much needed dollars, and filling the spending gap with private debt, using the false narrative that banks lend out reserves to convince the public that it is in their best interests. The end result is greater Wall Street profits, greater income inequality, and an indebted populace that eventually contracts its spending, business income then falls, and unemployment rises resulting in a recession.

Folks, don’t worry, because Krugman assures you that today banks lend out customer deposits, even though in September of 2016 he was all about endogenous money, and should any recession occur because of New Democrat economic policy, Paul will simply claim that the recession is actually the result of GOP meddling, or something. Nothing to do with Democrats.

Because that’s how we do science, right?

Puerile nonsense. Loanable funds doesn’t exist. Paul Krugman doesn’t know what the hell he is talking about.

“But back to deficits:”, says Eggo Man, “the crucial point is not that Republicans were hypocritical. It is, instead, that their hypocrisy made us poorer. They screamed about the evils of debt at a time when bigger deficits would have done a lot of good, and are about to blow up deficits at a time when they will do harm.”

Why does Eggo Man make such an asinine statement? Because Eggo Man doesn’t understand deficits, and for a guy who drives the national economic debate from his perch at the New York Times, that’s a dangerous lack of knowledge.

A federal budget deficit is errantly defined by the mainstream as when the government spends more than its income. This is simply not true, because, at no point in time, does the federal government have an income. Factually, a federal budget deficit is the difference between the number of US Dollars manufactured and spent by the US government and the number of US Dollars destroyed afterwards through taxation in any given fiscal year. Mathematically, we can express a budget deficit as (G – T > 0), where government spending (G) minus taxation (T) is greater than zero.

On a daily basis, the federal government is crediting bank accounts with newly manufactured US Dollars (federal spending), and it is also removing US Dollars from reserve accounts (federal taxation) that the US government previously manufactured and spent. All federal spending comes before federal taxation; not the other way around. If the number of US Dollars manufactured and then disbursed into the economy are greater than the number taxed out of the economy, then a federal budget deficit exists. Operationally, the reality is that a federal budget deficit is income for the private sector. In order to demonstrate this reality, we come to the point in our discussion where we must clarify sectors and familiarize you with the difference between the US private sector and the rest of the world. The point of what follows is not to inundate you with math, but to demonstrate to you that we aren’t dealing in guesswork and thus, we can clarify the reasons why the monetary system works in the opposite way than that which the mainstream tells you. Do not panic. You won’t be asked to calculate anything.

Sectoral Balances

There are three major sectors to the US economy:

(G – T) = the government sector

(S – I) = the US domestic private sector (you, me, Walmart)

(X – M) = the external, or foreign sector (the rest of the world)

that when assembled, take a form of what is known as the Sectoral Balances equation:

(G – T) = (S – I) – (X – M)

Federal spending is the depositing of US Dollars into the economy and taxation is the withdrawal of US Dollars from the economy. If the US government runs a budget deficit, depositing more US Dollars into the economy than it withdraws, then what remains is a net savings for the non-government sector. A way of looking at this concept is to consider deposits and withdrawals from your personal bank account. When you deposit and then withdraw money from your savings account, if the total amount deposited is greater than total withdrawals, then the remainder is a savings, or (D – W > 0), where deposits (D) minus withdrawals (W) are greater than zero. If less than zero, (D – W < 0) the result is a deficit. Similarly, the federal government makes deposits and withdrawals into/out of the US economy, except, in this case, the federal government is the income source for the entire US economy, as demonstrated by the reality that the US government issues all US Dollars and by sectoral balances equation.

[(S – I) – (X – M)] is 100% financially supported by (G – T) and, thus, entirely dependent upon (G – T) manufacturing US Dollars, and then giving it those new US Dollars.

So, when we discuss federal budget deficits, what we are actually discussing is a stream of income (flows) into the US private sector that will result in US private sector savings (stocks). The US government itself cannot have an actual deficit in terms of US Dollars, because it never has an income in US Dollars. It manufactures all of the US Dollars.

When we discuss federal budget surpluses, what we are actually discussing is the withdrawal of US Dollars from the non-government sector that will result in US private sector deficit. The foreign sector (X – M) plays a crucial role here.

Because international trade exists, the US both exports its own goods and imports foreign goods. When the US government manufactures US Dollars and spends them, some of those dollars flow out of the US and into the rest of the world (X – M) through imports. Imports means that the US is buying foreign-made goods and paying for them with US Dollars, because the rest of the world is selling its goods to the US. If imports (M) exceed exports (X), then there exists what we call a “current account deficit” for the US. So, if China has $3 trillion, then the US has $3 trillion worth of Chinese goods. Since $3 trillion flowed into Chinese hands, that is exactly $3 trillion that the US domestic private sector cannot spend in order to decrease unemployment. If there is a current account deficit, more US Dollars are flowing out into the hands of the rest of the world than are flowing back into the US, and so, the US government simply cannot run a budget surplus without causing a recession in the US domestic private sector.

As budget deficits are income for the US domestic private sector, then if there is a current account deficit in conjunction with a federal budget surplus, US Dollars are flowing out of the US domestic private sector in two directions:

1.) into the rest of the world through imports

2.) back to the US government through taxation

The result, then, is that the total amount of US Dollars circulating in the US domestic economy is shrinking and the US government would be forcing the US domestic private sector to run a deficit in order to prop up a large economy. What this means, is that the domestic private sector must rely on bank credit to continue spending, which will result in the increasing indebtedness of the domestic private sector. When the US domestic private sector can no longer take on more private debt, consumers will reduce their spending. When this occurs, businesses will begin losing income. As businesses lose income, they will lay off workers, unemployment will rise and a recession will occur. When the unemployed seek assistance from welfare and unemployment insurance because few jobs are available, the federal budget surplus will automatically become a federal budget deficit.

In very simple terms, the reality is that the federal government’s deficit is not the US private sector’s deficit and a federal budget surplus is not the US private sector’s surplus. Since there exists a current account deficit, then at all times, to ensure persistent full employment and a stable economy, the federal government must run budget deficits targeted at full employment. Expanding federal budget deficits are necessary up to the point of full employment, which is the point of maximum production capability; a condition we call “macroeconomic efficiency”. If federal deficits persistently exceeded the real production ability of the US economy, then inflation would occur.

Simply put, deficits that are too high can be inflationary and deficits that are too low result in unemployment. That being said, if the US is running a current account deficit, importing more than it is exporting, then deficit reduction prior to the real production ability of the US economy will sustain unemployment and in conjunction with private debt expansion, will result in a recession.

Now you know more than Paul Krugman, and you also know why Paul Krugman is totally incompetent. Krugman doesn’t matter – drop him like a bad habit.

Krugman’s grip over the progressive economic narrative is all over bar the shouting, folks.