Paul Krugman’s Dishonesty

One should not expect honesty from Paul Krugman, but this blog post takes the price.

Krugman starts out by trying to be funny:

One line I’ve been seeing in various places, including comments here, is the claim that the real way to deal with Wall Street is laissez-faire economics: no more bailouts! On this view, policy makers should raise their right hand in the air, place their left hand on a copy of Atlas Shrugged, and swear in the name of A is A that they will never again step in to rescue failing banks. And all will be well with the world.

And then goes on:

First of all, bank regulation is important even in the absence of bailouts. Don’t trust me, trust Adam Smith. Scotland invented modern banking; it also invented modern banking crises; and Smith, having witnessed such a crisis, favored bank regulations.

And then quotes Smith as follows:

Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.

Krugman doesn’t supply a page reference for this quote, and with good reason. If people read this quote in its context, they would quickly see through Krugman. (If anyone wants to look it up, it is on p. 308 of the Cannan edition of Wealth of Nations.)

If one bothers to read the whole chapter, or at least the surrounding paragraphs, one would know what kind of restrictions Smith has in mind: they are all about restraining the issue of paper money! What view of paper money could be farther away from Krugman’s views on this subject?

So what does Smith say? This is the very next paragraph in Wealth of Nations:

A paper money consisting in bank notes, issued by people of undoubted credit, payable upon demand without any condition, and in fact always readily paid as soon as presented, is, in every respect, equal in value to gold and silver money; since gold and silver money can at any time be had for it. Whatever is either bought or sold for such paper, must necessarily be bought as cheap as it could have been for gold and silver.

In simpler words: Bank notes with 100% gold or silver backing are as good as gold or silver. What about notes with less than 100% backing? One paragraph later:

It would be otherwise, indeed, with a paper money consisting in promissory notes, of which the immediate payment depended, in any respect, either upon the good will of those who issued them; or upon a condition which the holder of the notes might not always have it in his power to fulfil; or of which the payment was not exigible till after a certain number of years, and which in the mean time bore no interest. Such a paper money would, no doubt, fall more or less below the value of gold and silver, according as the difficulty or uncertainty of obtaining immediate payment was supposed to be greater or less; or according to the greater or less distance of time at which payment was exigible. [“Exigible” is an old word which, according to my dictionary, means “able to be exacted; demandable; requirable”.]

Again in simpler words: Bank notes with less than 100% backing (or where the gold/silver backing for some reason is uncertain) are not as good as gold or silver.

So how can modern Keynesians – who dismiss gold as a “barbarous relic” – invoke Adam Smith and pretend he was on their side? Krugman is simply counting on his readers’ ignorance.

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It is a fashionable game among “social liberals” to quote Adam Smith out of context in order to insinuate that he was in favor of interventionist measures. Here is another example, which I routinely encounter in Sweden. They take the following quote (from p. 128 in the Cannan edition):

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

This sentence is taken to mean that Adam Smith was well aware of “market failures” and would approve of such interventions as price controls and anti-trust laws. But in this case, they do not even bother to ignore some earlier or later paragraphs in Smith’s text; they ignore the very next sentences in the same paragraph:

It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though they cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. [Emphasis added.]

Smith then goes on to describe in some details how such assemblies are rendered necessary. But the main point here is that Smith advocates less government intervention, not more.

(Scandinavian readers may read this essay of mine on this subject from 1982.)

Late update (April 6, 2012): Stuart Hayashi blogged on this subject on the same date this was published with a link to this post. I didn’t see this until today.