David Angelo

Economics can be confusing.
Paul Krugman isn't helping. I make sense of his nonsense and refute his claims - one post at a time!

Krugman on QE and Money Markets

Just a few comments on two recent Krugman posts.

In “How Could QE Work?” Krugman suggests:

…we actually can hope that the Fed’s new policy will boost housing as well as operating through other channels, and therefore that it can act more like conventional monetary policy in fostering recovery.

So, ideally, Fed policy can create a housing bubble.  Use your own recent memory and powers of deduction to decide if that’s the best solution.

———

In “Ron Paul on Money Market Funds,” Krugman flexes his academic skills by destroying multiple straw men.  He first presents Ron Paul as being against “fractional reserve banking” and, therefore, must be at odds with money market mutual funds.  

How do the Austrians propose dealing with money market funds?

I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government intervention — but that at the same time it demands that the government step in to prevent the free market from providing a certain kind of financial service. As I understand it, the intellectual trick here is to convince oneself that fractional reserve banking, in which banks don’t keep 100 percent of deposits in a vault, is somehow an artificial creation of the government. This is historically wrong, but maybe the actual history of banking is deep enough in the past for that wrongness to get missed.

Well, no, not quite.  I’m not a certified ”Austrian” - so I won’t speak for them - but I’ll give my opinion.  

Fractional reserve banking, while not the creation of government, has triumphed in the market precisely because of government deposit guarantees.  I think this is the point Ron Paul is making as well.  From his website:

Banks should no longer have a government backstop of any sort in the event of failure. Banks, like every other business, should have to face the spectre of market regulation. Those banks which engage in sound business practices, keep adequate reserves on hand, and gain the confidence of their customers will survive, while others fall by the wayside.

True believers in free markets don’t expect or want the government to “step in to prevent the free market from providing a certain kind of financial service.”  We’d simply like the government to stop favoring certain financial services. (for more, look up “moral hazard in banking”)

Krugman continues:

But consider a more recent innovation: money market funds. Such funds are just a particular type of mutual fund — and surely the Austrians don’t want to ban financial intermediation (or do they?). Yet shares in a MMF are very clearly a form of money — you can even write checks on them — created out of thin air by financial institutions, with very few pieces of green paper behind them.

Well, I’d argue that shares in MMF are not “very clearly a form of money.”  Like all shares, they are equity claims - and, as such, have no specific value defined in terms of “money.”  It’s true that MMF shares are highly liquid and treated like money, but - again - this quality is influenced by government involvement in money markets.  At the first hint of concern in money market mutual funds during the 2008 crisis, the government immediately stepped in to guarantee against losses. So, yes - MMF accounts can be effectively treated just like FDIC insured bank accounts; but not because of the inherent nature of money markets - which would implode if the government could no longer pay back debt by issuing new debt.  So this example is not exactly “the free market” at work.

Krugman concludes:

One of the key lessons of the 2008 crisis was precisely that banks are defined by what they do, not by what they look like, and there are a whole range of financial arrangements that in economic terms act a lot like fractional reserve banking. So would a Ron Paul regulatory regime have teams of “honest money” inquisitors fanning across the landscape, chasing and closing down anyone illegitimately creating claims that might compete with gold and silver? How is this supposed to work?

Well, again, in the Ron Paul system, there would be no need for “inquisitors” (why does Krugman never use that term to describe other government regulators?).  The market - free of politically motivated distortions - should regulate itself much more efficiently.

OK, I don’t expect a serious answer. But it’s scary that this has become the more or less official doctrine of the GOP.

Well, that’s my attempt at a serious answer.

I think I understand how Austrians deal with money market funds.  At least, I know how I reconcile free market principles with opposition to forces that distort money markets and fractional reserve banking…

…the bigger question is how does Paul Krugman propose dealing with money market funds?

If MMF shares are “clearly money,” and MMFs can create credit with Treasury bonds and high-quality debt - all while offering low risk to shareholders - then why do we need The Federal Reserve system?

I certainly don’t expect a serious answer.

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