Krugman or Paulson: Who You Gonna Bet On?

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Krugman, by contrast, sees darker forces at work. He argues that the market has already ratified his belief that fiscal tightening will smother the recovery, pointing to widening bond spreads in Greece and Ireland, where huge cuts loom. About Ireland, Krugman recently wrote on his Times blog, "All that savage austerity was supposed to bring rewards...But the reality is that nothing of the sort has taken place: virtuous, suffering Ireland is gaining nothing." The markets have been kinder to Spain, he says, because leaders there have cut less.

The heart of the matter, for Krugman, is unemployment. As long as it remains at such elevated levels, he says, more and more people remain out of work for so long they become unfit to hold jobs.

It's hard not to marvel at Krugman's conviction about how all the pieces fit together, why it's essential to mankind that Germany start spending and China let the value of its currency appreciate. If the world economy had a cockpit, Krugman exudes the confidence of a man who could climb in there, flip all the right switches, and get this sucker airborne.

Paulson has a simpler view: Americans are starting to spend again, in ways not terribly dissimilar to the ways we did before, buying suburban homes and stuffing our Social Security checks into slot machines. There are pitfalls. As we work our way back to the old normal and demand picks up, the years of superlow interest rates will come back to smack us, fueling inflation that Paulson sees possibly reaching into the double digits within a few years. That's why, in addition to Florida property, Paulson is heavily invested in gold.

As Gregory Zuckerman described in The Greatest Trade Ever, Paulson rose from obscurity by exploiting the age-old tendency of investors in flush times to blithely assume risks they don't understand, like buying the other side of his bespoke CDOs. Now he has flipped, betting that investors are so gun-shy they can't quantify the potential for upside. Recent tremors in the stock market bring flashbacks of fall 2008 and the nerve-racking question: Is this the big one?

The debate over the economy can be thought of as a trade—Paulson taking one side, Krugman the other. Paulson's got real money on the table, but for both men, the main risk is reputational. Is Paulson another Wall Street one-hit wonder? Is Krugman another too-smart-for-his-own-good academic with no feel for animal spirits? Paulson may have an edge because he is just playing the market. Krugman is playing history, which is quite a bit trickier.

Additional reporting by John Glover and Sapna Maheshwari

Lindgren is an Executive Editor for Bloomberg Businessweek.

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