Why Paul Krugman is so wrong and his stance is dangerous

Paul Krugman is pushing for a rise of 25% in tariffs on Chinese goods.

http://www.nytimes.com/2010/03/15/opinion/15krugman.html?src=me


If history is a lesson to a Nobel Prize in economics, Paul Krugman should probably revisit the devastating impact the re introduction of tariffs had during the Great Depression with the implementation of the Smoot–Hawley Tariff Act of 1930.

Maybe Paul Krugman should read Wikipedia relating to the Smoot-Hawley Tariff of 1930:

"U.S. imports decreased 66% from US$4.4 billion (1929) to US$1.5 billion (1933), and exports decreased 61% from US$5.4 billion to US$2.1 billion, both decreases much more than the 50% decrease of the GDP."

http://en.wikipedia.org/wiki/Smoot%E2%80%93Hawley_Tariff_Act


"According to government statistics, U.S. imports from Europe decreased from a 1929 high of $1,334 million to just $390 million during 1932, while U.S. exports to Europe decreased from $2,341 million in 1929 to $784 million in 1932. Overall, world trade decreased by some 66% between 1929 and 1934."

"Although the tariff act was passed after the stock-market crash of 1929, some economic historians consider the political discussion leading up to the passing of the act a factor in causing the crash, the recession that began in late 1929, or both, and its eventual passage a factor in deepening the Great Depression.[16] Unemployment was at 7.8% in 1930 when the Smoot-Hawley tariff was passed, but it jumped to 16.3% in 1931, 24.9% in 1932, and 25.1% in 1933."

Why on Earth Paul Krugman thinks this time it is different?(the 5 most dangerous words in the world).

I am completely baffled by such a reckless statement from a Nobel Prize and I am not the only one concerned.

John Mauldin in his latest "Thoughts from the frontline" entitled "The Threat to Muddle Through" shares the same thoughts with his readers:

http://www.frontlinethoughts.com/article.asp?id=mwo032010

"Krugman and the Keynesians are right in this regard. If consumption falls, as it does in recession, then a corresponding increase in "G" helps offset that drop. But Keynes assumed that in good times government would run surpluses. It seems that we forgot that part."

As per above extract from John Mauldin's excellent letter, this is why Keynesian cannot work anymore in our current environment in Western Europe and in the US.

Keynes assumed government would be managing public finances in an efficient and responsible way.

Well Mister Paul Krugman, looks like Portugal, Spain, Italy, France, United Kingdom and of course Greece have been exactly doing that and the US as well!

The only efficient Keynesian policies which have been implemented in fact has been done by China! The main difference is that the Chinese have been managing much more effectively their economy so far!

http://en.wikipedia.org/wiki/China_economic_stimulus_program


"A statement on the government's website said the State Council had approved a plan to invest 4 trillion yuan in infrastructure and social welfare by the end of 2010. This stimulus, equivalent to US$586 billion, represented a pledge comparable to that subsequently announced by the US, but which came from an economy only one third the size. The stimulus package will be invested in key areas such as housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income-building, tax cuts, and finance.

China's export driven economy is starting to feel the impact of the economic slowdown in the United States and Europe, and the government has already cut key interest rates three times in less than two months in a bid to spur economic expansion.

The stimulus package was welcomed by world leaders and analysts as larger than expected and a sign that by boosting its own economy, China is helping to stabilize the world economy. World Bank President Robert Zoellick declared that he was ‘delighted’ and believed that China was ‘well positioned given its current account surplus and budget position to have fiscal expansion.'News of the announcement of the stimulus package sent markets up across the world."

It is up to the US to resolve their trade imbalances by being more competitive and to increase the amount of goods and services they export.

I agree with John Mauldin, should the US target as well Japan and Germany with higher tariffs?

Should all the countries with trade surpluses be targeted?

The importance of branding in economy in general and what it really means in particular

Branding Definition: "Entire process involved in creating a unique name and image for a product (good or service) in the consumers' mind, through advertising campaigns with a consistent theme. Branding aims to establish a significant and differentiated presence in the market that attracts and retains loyal customers."

Branding Definition in Economy as per this blog: "Entire process in creating a unique term for an economic policy or financial product in the consumers' mind, through consistent communication in the news." The best example to mind comes when you think about High Yield bonds, which should really be called Junk bonds, or more recently "Quantitative Easing" which should really be called printing money out of thin air...

Here is the link to Wikipedia about QE (Quantitative Easing):

http://en.wikipedia.org/wiki/Quantitative_easing

"Risks"
"Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if it is improperly used and too much money is created.

Some economists argue that there is less risk of such an outcome when a central bank employs quantitative easing strictly to ease credit markets (e.g. by buying commercial paper), whereas hyperinflation is more likely to be triggered when money is created for the purpose of buying up government debts (i.e. treasury securities) which in turn can create a political temptation for governments and legislatures to habitually spend more than their revenues without either raising taxes or risking default on financial obligations."

MV=PT as per Irving Fisher's equation. The Bank of England bought 200 Billions worth of long dated Gilts with QE. The BOE by pumping M (M4) is expecting T to rise and it is not really happening...
As a reminder: MV = PT. M is the stock of money in the economy,V is the velocity of circulation or the speed at which money flows around the economy. P is the price level and T the value of transactions, or gross domestic product (GDP). Hence by
increasing ‘M’, QE aims to increase ‘T’.

The main risk of QE was that the money pumped into the system would not result in higher
spending and economic activity. Banks are currently using all these additional funds to help repair balance sheets. Increased availability of credit is not resulting in more lending. Many companies and individuals do not want to increase borrowing during a period of economic uncertainty and this is the reason why savings are going up and people are trying to repay their debt.

Therefore the initial MV = PT equation means that a rise in ‘M’ leads in reality to a fall in ‘V’ leaving no net benefit.

As per my previous blog post in February, first we are seeing deflation then comes the big risk of hyperinflation which explains why so many famous hedge fund managers like Tudor, Soros, Paulson and others have fallen to the gold bug and have as well increased recently their holdings in Gold in size...

The results of QE will be an increase in inflation down the line.

This also bring us to the recent violent currency movements we have seen in the markets and particularly on GBP. The United Kingdom faces massive headwinds and with the risk of a hung parliament with the upcoming election, the prospect for GBP currency could not be bleaker. GBP will probably come under significant pressure and I can easily see GBP at parity with the Euro, not to mention that the coveted AAA of the UK is threatened.

Bill Gross from PIMCO in his latest market comment talks as well of the sovereign risks ahead of us:

http://europe.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Investment+Outlook+March+2010+Bill+Gross+Dont+Care.htm

The importance of looking at the Macro picture has never been more important than today.

You should look at safe harbors such as Australia, Canada, and developing countries like China, India, etc.

I also agree with Bill Gross comments:

"An investor’s motto should be, “Don’t trust any government and verify before you invest”."