Friday, June 11, 2010

Krugman Refusal To Accept The Consequences Of Deficits

The debt panic in Southern Europe has prompted not only countries like Spain, Portugal and Greece to undertake fiscal austerity measures, but also countries with falling borrowing costs like Germany, Holland and France to reduce government spending and raise taxes.

The crisis has brought attention to the potential perils of deficit spending even to governments that can now borrow cheaper than ever.

A predictable result of this will be a strengthening of the aggregate current account balance of the euro area, with the current small deficit being turned into a surplus. Germany's surplus could rise even as the deficits of Spain, Portugal and Greece will likely fall.

This angers Paul Krugman who after repeating his earlier call for a trade war between the U.S. and China (failing to note that the weak euro means that his earlier case for Chinese revaluation has collapsed (not that it was ever valid)) goes on to hint that America should start a trade war with Germany too to punish them for trying to pursue sound fiscal policies:

"Meanwhile, Europe is going wild for fiscal austerity. Angela Merkel says that budget cuts will make Germany more competitive — but competitive against whom, exactly?

You know the answer, don’t you? Yep: everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi. Oh, and while they rely on US demand to make up for their own contractionary policies, they’ll lecture us on how irresponsible we’re being, running those budget and current account deficits.

This is not going to work — and the United States has to take steps to protect itself.....

....And it’s also important to send a message to the Germans: we are not going to let them export the consequences of their obsession with austerity.

Nicely, nicely isn’t working. Time to get tough."

Krugman refuses to accept the undeniable fact that if the government dissaves, then this will lead to a bigger trade deficit. The only way to prevent this from happening is really to pursue a North Korea-style autarky with no trade with the outside world (it is true that if there is perfect Richardian equivalence then the trade deficit won't increase, but that is unrealistic and would at any rate defeat the purpose of deficit spending). But that would create a far deeper economic crisis than what we've seen so far.

Krugman doesn't go that far (yet), but his trade war proposals would still create deep problems and would fail to prevent the fact that a higher budget deficit would ceteris paribus increase the trade deficit.