Today, the champion—the uncontested champion of Orwell’s “truth”—is Paul Krugman, the 2008 Nobel laureate, Princeton professor, and New York Times columnist. For those who read his twice-weekly column or glance at his blogs and commentary elsewhere, it is like reading the latest pronouncements from the “Ministry of Truth,” and, like in Oceania, it seems that the masses believe the nonsense.

Had I not read Krugman’s column, I never would have known that Jimmy Carter, who began the modern deregulation movement, was a right-wing Republican, or that the solution to almost all our economic ills is for the government to raise taxes, borrow, and print more money. However, his latest missive has managed even to outdo the Ministry of Truth itself. Big Brother would have been ecstatic.

There is not enough byte space in the universe to refute Krugman’s latest pronouncement completely, but a couple of the most glaring holes can be discussed here.

As most readers know, the U.S. Dollar has been falling fast against other currencies and members of OPEC are balking at continuing to price crude oil exclusively in dollars. Instead, they have suggested a “basket” of currencies, as they realize that our government’s policies are likely to turn the USD into something like the Zimbabwean Dollar.

Enter Professor Krugman, who writes:

The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters, helping us make the transition away from huge trade deficits to a more sustainable international position.

Not so fast.  The USD is falling because the rest of the world understands that the USA no longer is a “safe haven” and investors looking elsewhere. When super investors like Jim Rogers tell us to get out of this country altogether, people need to listen. Rogers does not have a Nobel to his credit, but he is no crackpot and he fully understands (unlike some American Ph.D.s) that the U.S. Government does not create wealth with the printing press.

While it is true that a falling dollar does make U.S. exports cheaper, the question is what can we export other than commodities. The government’s environmental policies alone continue to raise the cost of manufacturing and we are being forced by the political classes to divert productive resources into failed enterprises like General Motors and the zombie financial institutions on Wall Street.

Alas, Krugman does not stop there. No, he claims that what our economy “desperately” needs is—get this—more “easy credit.” That is right; the very thing that gave us massive malinvestments and brought the U.S. economy to near-ruin is what we “desperately” need. As I have written elsewhere, this is like claiming that the best way to deal with alcohol addiction is to imbibe even more.

For all the talk that the government’s policies of bailouts, printing money, and borrowing at record rates have “prevented” a second Great Depression, the truth is that all the government has done is to give the illusion of recovery while setting us up for an even worse Day of Reckoning. By keeping the zombie entities afloat, the government continues to force even more malinvestments at a time when liquidation is the order of the day.

The Keynesian propositions of printing money and borrowing might be popular to the political and intellectual “elites” of this country, but they are utterly destructive in the real world. Unfortunately, we are being fed Orwellian “truths” at a time when what we need to hear is the unadulterated truth.

The mercantilists of the 1600s raised this error to the pinnacle of national policy. Always bent upon heaping up hoards of gold and silver, they made war on their neighbors and looted their treasures. If England was richer than France, it was, according to the mercantilists, because England had more precious metals in its possession, which usually meant in the king’s coffers.

It was Adam Smith, in The Wealth of Nations, who exploded this silly notion. A people are prosperous to the extent they possess goods and services, not money, Smith declared. All the money in the world—paper or metallic—will still leave one starving if goods and services are not available.

The “money is wealth” error is the affliction of the currency crank. From John Law to John Maynard Keynes, great populations have hyperinflated themselves to ruin in pursuit of this illusion. Even today we hear cries of “we need more money” as the government’s monetary authorities crank it out at double digit rates.

The good economist will recognize that money creation is no short-cut to wealth. Only the production of valued goods and services in a market which reflects the consumer’s wishes can relieve poverty and promote prosperity.

Those words are still true, if only because our political and financial “leaders” want us to believe that they can end the current recession if the Federal Reserve System creates “liquidity.”  Thus, we see the Fed doing whatever it can to push more money into the economy.

One reason that the “money is wealth” fallacy has thrived for so long is that many people – including academic economists – fall prey to another fallacy, the fallacy of composition (discussed last week).  In the case of money, it is especially pernicious.

Assume, for example, that I had a printing press in my house which could crank out undetectable counterfeit money.  I could print huge amounts and purchase whatever I pleased.  No doubt, I would be better off (as long as the authorities did not discover what I was doing), but others would be made worse off.

First, and most important, is the nature of money.  Money is a good that is used to trade for other goods, and by making trade easier (and more abundant), it is a productive asset.

However, as Adam Smith understood, money itself is not wealth; instead, it is a good that we use in order to obtain wealth.  (Pieces of government-produced green paper do not qualify as historical “money.”  Government’s monopoly on money has led to its debasement.)

Second, money follows the same economic laws that govern all other goods.  The more money created, the less its marginal value.  (In other words, money is subject to the Law of Decreasing Marginal Utility.)  Many economists have missed this point.

In typical academic classes, money is described as a quantity variable.  Double the amount of money and the “price level” doubles as well, but the monetary increase has brought about no real harm.  Other academic models note that an increase in the amount of money will increase the amount of wealth (call it “Gross Domestic Product”), even if it also raises the “price levels.”

While such models are easy to teach (and to use for solving math problems), nonetheless they are inaccurate at best and dangerous at worst.  They do not demonstrate what really happens when the amount of money in an economy is increased.  If the process of creating more and more money by fiat (called inflation) goes on unchecked, as it did during the past decade, then not only does the value of money on the margin fall, but its growth triggers an unsustainable boom that ultimately collapses in a bust.

This process has repeated itself time and again, which demonstrates that most policy makers do not understand that money is not wealth.  The lesson still has not been learned.

Next Week: The Fallacy of Production for its Own Sake