A Kind Word for Paul Krugman
Jude Wanniski
September 17, 2002


Memo To: Supply-Siders
From: Jude Wanniski
Re: "Stocks and Bombs"

In Bob Bartley's WSJournal column Monday, "A Monetary Bubble?," he takes a shot at NYTimes columnist Paul Krugman, who moonlights as a Princeton professor of neo-neo-Keynesian economics. In his September 13 column, "Stocks and Bombs," Krugman continues to make fun of supply-siders, as the Bush administration has done everything many of the supply-siders have asked him to do big tax cuts and lots of interest-rate cuts by the Fed. And still the economy stinks. Now Bartley and his troops at the WSJ editorial page are trying to turn a war with Iraq into a supply-side war, arguing that it will be just great for the economy as soon as it is over, and that meanwhile we should have another tax cut because interest rates are getting too low.

As you fellow supply-siders well know, I have been telling Bartley and the rest of you since the beginning of the Bush administration that no amount of tax cuts or interest-rate cuts will prevent the stock market from declining and the economy from going into a ditch. Tax cuts will only increase the demand for liquidity, which will result in monetary deflation as the Fed will not supply the liquidity to meet the demand. The Fed does not have the operating mechanism to make that happen as long as it is targeting something other than gold/commodities. When my advice was not taken by supply-siders last year, the Bush admin. went ahead with tax cuts and now supply-siders are being blamed for the deficits, and we are defenseless. Krugman can sit back and laugh at us. The only way to get out of this box is for those who resisted the deflation arguments to acknowledge they were in error. Our attention should now focus on persuading Greenspan and Bush to fix the dollar to gold at a price that would not require further declines in wages and prices to accommodate a lower dollar/gold numeraire.

Gold at $317 is better than gold at $265, but how it got there is not so good. The corporate governance legislation makes it more difficult to do business. This lowered demands for liquidity, and the weak economy has produced fiscal deficits at all levels of government, increasing future taxation or forcing higher tax rates. As we warned at Polyconomics, parts of the deflation have been offset by the forces of contraction -- entirely different than the forces of deflation. Our best guess is that gold should go to $350 before the deflation pressures on the economy end. It can get there in a good way or in a bad way. I also disagree with Bob that the function of monetary policy is to "mind the price level." It is to maintain the monetary standard, a fixed unit of account. I don't mean to single out Bob, but he did go public with his views Monday. Most supply-siders, as far as I can tell, have drifted away from the early consensus we had on gold -- with the Gipper, by the way -- and have only made the whole of the supply-side philosophy vulnerable to attack.

When I see Krugman taking a shot at Larry Kudlow, a supply-sider on alternate Tuesdays, I have to applaud: "Way back in June, the CNBC pundit Larry Kudlow published a column in the Washington Times with the headline "Taking Back the Market By Force." In it he argued for an invasion of Iraq to boost the Dow." The Kudlow argument was ridiculous in June and it is even worse when the WSJ officially puts its imprimatur on the idea that war with Iraq will be a good tonic for us all.

Where I would quibble with Krugman is his Keynesian argument that World War II had "positive economic effects," in that it ended the Great Depression via spending. If that were true, the Great Depression would have returned in 1945 when the war ended and spending dropped like a stone. Indeed, Keynesians at the time predicted a return of the Depression unless massive government public works programs were instituted. The economy flourished instead, as a result of the Bretton Woods monetary agreement of 1944 that put the world on a gold standard, ending the competitive devaluations of the Thirties. And the international trade that had conflated as a result of the Smoot Hawley Tariff Act of 1929-30 went into a boom, as tariffs everywhere were lowered bilaterally in the interests of financing the reconstruction of the war zones. As I contended in a recent lesson for my Supply Side University students, a family or a nation can buy its way out of a recession by spending from existing resources or borrowing against future incomes. But there is only so far running down savings and running up debt can go.

Just as Bartley and other supply-siders slip into demand-side economics from time to time (when they have lost their way), Krugman now and then slips into the supply model, which he hates to admit. Bartley and the WSJ "supply-side hawks" should be honest and admit that a war with Iraq, even if it was a cakewalk, would cost a fortune that nobody would help us pay, as other nations did the last time around. It would produce deficits as far as the eye could see, destroy any chance of addressing the coming bankruptcies of the nation's retirement programs, and lead to a succession of demand-side Democratic Presidents and Congresses. When capitalism breaks down, socialism takes over.