Tuesday, May 1, 2012

Paul Krugman's dollar debasement lunacy and what will cure unemployment

Mish Shedlock has an excellent post about today's debate on Bloomberg between Ron Paul and Paul Krugman.

On Krugman's justification for continued Fed money printing, namely, that:
The reckless thing is to allow mass unemployment to continue.
Mish comments:
Although the Fed does have a dual mandate on employment and inflation, as I have pointed out on numerous occasions, the Fed's Dual Mandate Is Mission Impossible.

Here's the deal.

1. The Fed can control money supply but it will have no control over interest rates (or anything else).

2. The Fed can control short-term interest rates, but then it would have no control over money supply (or anything else).

That is the full and complete extent of the Fed's "control". Note that neither price stability nor unemployment is in either equation. The reason is the Fed controls neither.

The result of all the recent Fed printing is a big yawn, otherwise known as excessive reserves as the following chart shows.

Excess Reserves of Depository Institutions

Does that chart look like the Fed is in control? If so, control of what?
Excess Reserves Then and Now

The above "Mission Impossible" snip was written August 27, 2009. Excess reserves now look like this.

Mish continues the piece to explain why more money printing will likely increase, not decrease, unemployment. 

If Sound Money Does Not Cause Unemployment, What Does?
Unemployment result from one of two causes: minimum wage laws that set wages above the value of the labor of the least productive workers, or welfare provisions that make unemployment preferable to employment.

Both factors contribute to today's high US and European unemployment. In the US, the Federal Minimum Wage of $7.25 is five to ten times the rate for industrial labor in the Third World economies with which the US now competes without protection.

In Europe, generous welfare schemes make unemployment more attractive for many than the inconvenience of minimum-wage menial labor. 

What Western Governments Are Doing to Eliminate Unemployment?
To eliminate welfare and lower Western wages to the level of the Third World would eliminate mass unemployment in the West, but at horrendous cost.

Living costs are higher in America and Europe than in Asia, which means that an abrupt reduction in Western wages making them competitive with those in the Third World would reduce tens of millions to the grimmest poverty and malnutrition, while creating conditions conducive to violent insurrection.

The unacknowledged solution that has been adopted by Western elites to achieve convergence of Western and Third World wages is to undertake a gradual debasement of currencies, during which nominal wages are held more or less constant, thereby causing real wages to fall. During the process, it must be assumed, living costs will adjust downward in line with wages.

The problem is that wage convergence achieved this way will take years during which time the labor of millions will be wasted, labor force skills will be lost, capital will be exported, and the productive capacity of the West will be severely diminished.

Moreover, the effectiveness of the program has been limited by the readiness of Third World nations, particularly China, and also Japan, to run trade surpluses with the West, thereby preventing rapid devaluation of Western currencies. As a result, the desired fall in real wages in the West has been delayed.

A Better Solution
 Leaving aside the option of protectionism, and assuming that global free trade is here to stay, the steps needed to eliminate high Western unemployment without massive social disruption are clear.

First, for those able to work, the receipt of welfare must be contingent on employment. This can be achieved by creating a market for government-funded wage subsidies. Employers would bid in a competitive auction for subsidies of limited duration that would be equal in value to the minimum wage. Depending on the price bid, employers would then be able to pay the minimum wage at a cost net of the subsidy somewhere between the minimum wage and nothing.

As discussed elsewhere, the cost of such a scheme would be minimal, and would be offset by the elimination of multiple existing welfare programs and other unemployment-related costs including unemployment-related costs of crime, prison incarceration, mental illness, and the loss of workforce skills.

Second, the cost of living in the West must be lowered to that of the Rest. Among other things, that means a massive reduction in the cost of government and the burden of taxation that it imposes on workers: the exact opposite of the policy Krugman advocates.

Third, conditions for employment-creating investment in the West must be improved by insuring a level playing field globally in workplace health and safety standards and environmental regulation. Because the Third World should upgrade their standards not the First World dismantle theirs, Western nations must be free to impose tariffs on goods produced in non-compliance with Western standards for worker and environmental protection.

Fourth, corporation taxes in the West should be no higher than in the Third World. Logically, since all taxes are ultimately paid by people, corporation tax should be abolished, the burden transferred to shareholders, which would eliminate the incentive for investors in the West to transfer capital to low tax jurisdictions abroad.

One can rest assured that none of the above proposals will be adopted and that the West will continue is decline into poverty, internecine conflict and ultimate military defeat and incorporation into a despotic Asiatic empire of one variety or another.

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