Paul Krugman Should Issue A Heartfelt Apology

Paul Krugman issuing an apology would be a true man-bites-dog story, but an apology is certainly due.

Having earned the top economics prize in the world, the New York Times columnist has now taken it upon himself to bestow “The Worst Economist in the World” award on a regular basis.

But apparently not much to his chagrin, Krugman rode his high horse into an oil slick right out of the gate.

It turns out that the first winner of Krugman’s booby prize, Wall Street Journal reporter Mark Whitehouse, was making sense. Rather, it was the Nobel Prize winner — as a number of devoted readers pointed out in the comments — whose logic was a bit fuzzy.

Here is the explanation that inspired Krugman’s wrath:

When one country devalues its currency, others tend to follow suit. As a result, nobody achieves trade gains. Instead, the devaluations put upward pressure on the prices of commodities such as oil. Higher commodity prices, in turn, can cut into global economic output. In one ominous sign, the price of oil is up 8.7% since August 27.

Now here’s Krugman’s reaction:

(A) fall in the dollar tends to raise the price of oil in dollars — but it also tends to reduce the price of oil in euros. A fall in the euro tends to raise the price of oil in euros, but reduce it in dollars. . . . (t)he reality is that my depreciation is your appreciation, and vice versa; we can’t all devalue at the same time.

Krugman expresses befuddlement: “So what would devaluations that raise commodity prices in terms of all currencies look like? I have no idea.”

Perhaps he should have asked Pimco CEO Mohamed El-Erian, who is more or less predicting a competitive devaluation of currencies around the world that results in a stalemate of sorts. Here’s what he told CNBC earlier this month:

The reality is there are a lot of people who want to depreciate their currencies. There are very few people who want to appreciate their currency. And in that context, the only thing that happens is everybody depreciates against commodities.

While Krugman may or may not be right in terms of outcomes, he is on shaky ground when he casts doubt on the possibility that currencies across the globe could depreciate against commodities in response to more money printing.

If other nations were to follow the Federal Reserve and engage in central bank money printing of their own, then the global increase in currency float would be expected to result in higher commodities prices across a range of currencies.

IHS Global Insight Chief Economist Nariman Behravesh allows that such a broad depreciation of currencies vs. commodities but not each other is “possible,” though that’s not what he expects. Other countries, he says, aren’t fully resisting appreciation; rather they are trying to contain it.

UniCredit Global Chief U.S. Economist Harm Bandholz sees a chance of something reasonably similar to the scenario described by El-Erian playing out, driven by portfolio flows into commodities.

The prospect of more quantitative easing has investment dollars flowing to emerging markets in a search for higher returns and bidding up commodities prices, he notes.

Investors anticipating higher inflation also are turning to commodities, Bandholz said. “Everything that has real value is some kind of inflation hedge.”

In other words, extra liquidity and investment flows could push up the prices of commodities against all currencies, even if they rise more against the dollar than against, say, the euro.

One Krugman reader, after explaining how depreciation of all currencies against commodities might work, commented:

I don’t believe what I am doing. I am answering a simple economics question raised by a Nobel Laureate in economics.

Amazing. But the brilliant Krugman seems to have slipped on his own banana peel once again in bestowing his second world’s-worst-economist award.

Again, the issue was commodities and quantitative easing. In this case, Krugman took aim at an International Monetary Fund official who expressed concern that quantitative easing could inflate commodities prices, derailing the recovery.

Krugman argued that commodities price increases couldn’t hurt the recovery because they could only rise in real terms if quantitative easing is successful in boosting demand.

The feared commodities price increase may turn out to only modestly offset the stimulative effects of quantitative easing — that’s what Behravesh expects. But there’s no reason why commodities price increases couldn’t, in theory, have a net negative impact.

Now any jump in commodities prices that reflects QE-driven liquidity and portfolio shifts if it curbs demand won’t be sustained, but there’s no reason it couldn’t act as a bump in the road to recovery.

Krugman introduced his first booby-prize post with the subtitle, “First in a possibly continuing series.”

Here’s a vote for bringing down the curtain after the second act.

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