By Dan McLaughlin, on February 18th, 2009
A recent Forbes article listed the ten “tallest cities”, those with the most buildings over 700 feet tall. The current record holder for tallest building is the Burj Dubai in the Arab Emirates, at 2684 feet, scheduled to open this fall. It is more than 1000 feet taller than the previous record holder, the Taipei 101 in Taiwan. There are plans to build a couple of skyscrapers over 3000 feet tall.
The article brings to mind a concept introduced in 1999 by Andrew Lawrence, called the “Skyscraper Index”. The index highlights a fairly strong correlation between new world record buildings and the onset of recession. While correlation isn’t causation, and tall buildings certainly don’t cause economic downturns, it is quite interesting and can help to shed some light on the workings of business cycles.
Business cycles can be more aptly described as banking or monetary cycles. They arise in conjunction with inflationary credit bubbles, the responsibility for which lies with the central banks and the fractional reserve banking system. The relative regularity of the bubbles is linked to the fact that the actions taken to mitigate the deflationary effects of an economic downturn, when the bubble bursts, actually plant the seeds for the next bubble.
The root of the matter is that central bankers use incentives to spur rapid economic growth. The interest rate is artificially reduced to below the market rates and the market is flooded with money. Fractional reserve banks greatly leverage the money supply, and it expands like an accordion. The banks use deposited money to make loans, and the leverage of fractional reserves transforms a billion dollars of new reserves into ten billion dollars of new money, created out of thin air.
When interest rates are artificially lowered, business ventures that might not make sense under normal conditions suddenly look profitable. The beginning of the bubble is actually the end of the previous bubble, so costs look favorable. The prior shakeout means that there are lots of resources available at cheap prices. Business really does look good, and entrepreneurs make rational decisions to start projects which look profitable. The money entering the system makes it appear that business is booming for everyone. High spirits and lots of cash stoke the fires for bigger and bigger projects. At times like this, record breaking skyscrapers start to materialize. The thesis of the Skyscraper Index is that when world record building projects get rolling, it is likely that the end of the bubble is near.
The problem is that real resources are limited in the short term. More money pouring into the system does not make any more steel, concrete or lumber available. It does not make more people available to do the work. As the market heats up, the limitation on real resources becomes apparent and costs of production are bid up far beyond expectations. It turns out that entrepreneurs have been fooled. Projects that once looked like big winners now become losers.
The downhill side of the bubble occurs when businesses and individuals can’t pay and the loans go bad. The accordion of fractional reserve banking starts to contract as the leverage is reversed. A billion dollars in bad loans will cause a contraction of 10 billion dollars, as money made from nothing disappears into the ether from whence it came.
As the bust progresses, the real productive resources are still there. Skyscraper owners may go bankrupt but deflation should make prices come down. Productive assets, or overpriced homes in the present case, should become more affordable and realistically priced. If that was allowed to happen, the efficient entrepreneurs would take over productive assets and prospective homeowners would finally be able to afford the homes that they were responsible enough to avoid when they were overpriced.
The reaction among politicians today is to flood the market with “stimulus” to prevent prices from falling and to prop up failed banks and businesses. Aside from the glaring moral hazard of supporting failing businesses and irresponsible homeowners at the expense of those who were responsible, the actions prevent the adjustment that is needed for the economy to become productive again. Skyscraper owners are bailed out, while Average Joe drowns.
Eventually, we may wake up to the reality that the present banking system is the problem. Real banking reform may make the bailout mentality obsolete. It is probably not a good idea to hold your breath waiting, though. Big banks and skyscraper owners with political clout have become addicted to bailouts.
By Moyo Mamora, on February 16th, 2009
By now, everyone is surely familiar with the measures that the Federal Reserve Bank and US Treasury (under the auspices of the US government) have unveiled to blunt the impact of the credit crisis. The accompanying debate, regrettably, has dwelled on matters of efficacy; in other words, are such measures adequate to stimulate the economy and prevent it from sliding into long-term recession? Only a few analysts have taken to pondering the long-term monetary implications of such policy-making. This is to be expected, since those who call for restraint have always been outnumbered by those favoring bold (and expensive) action. Besides, the Fed has always had critics, namely those who advocate a return to the gold standard. But perhaps this time is different. In recent memory, the stakes have never been so high, and the global economy has never been so imbalanced. Accordingly, the Fed and the Treasury must be careful that in treating the economic crisis, they don’t inadvertently damage the very foundation of the US economy.
History of the Fed
Without boring too deep into the history of the Federal Reserve, suffice it to say that it differs from a normal Central Bank in that its first priority is not necessarily to guard against inflation. In fact, the Fed was created in order to facilitate -rather than counter- inflation, albeit in moderation. “Under the Fed’s enlightened stewardship, the currency would become ‘expansive’. Accordion-fashion, the number of dollars in circulation would expand or contract according to the needs of commerce and agriculture.” To this day, the Fed’s mandate remains slightly murky; it is charged both with maintaining full employment and with managing inflation. Not only do these aims often conflict, but also the Fed’s notions of inflation are often dubious. For example, its approach to measuring inflation rests on consumer prices, rather than on the money supply. Two years ago, it even went so far as to stop publishing data on M3, which most experts reckon is the “most-inclusive measure of the growth of the U.S. money supply.” While the Fed argued ostensibly that such data was no longer relevant, some commentators believe its true motive was to downplay the risks that its easy monetary policy would contribute to long-term inflation. Meanwhile, the Fed has also refrained from utilizing even an informal inflation target. This contrasts with the European Central Bank, which uses 2% as an approximate guide.
Ben Bernanke, current Chairman of the Fed, is known for his especial complacency with regard to inflation. In fact, he earned the nickname “Helicopter Ben” by joking that if need be, Dollars could be dropped from helicopters in order to stimulate the economy. Bernanke has received backing in this view from prominent academics, including advisers to current president Barack Obama and former President George W. Bush. Greg Mankiw, one such advisor, recently asserted: “In particular, the overall level of prices a decade hence should be about 30 percent higher than the price level today…[and] the stance of monetary policy sufficiently accommodative to achieve that degree of inflation over the coming decade.”
Asset markets have ‘thrived’ under such a loose approach to monetary policy, with stocks, bonds, and commodities rising to record highs before collapsing spectacularly in late 2008. The sole protest could be found in the forex market, which is perhaps the most sensitive to changes in interest rates and inflation. In fact, the Euro’s steady divergence from the Dollar mirrors the contrasting approaches to monetary policy practiced by the Fed and the ECB, as well as the apparent indifference of the Bush administration towards fiscal responsibility. The Euro “soared against the greenback as the U.S. Federal Reserve made its historic mistake of flooding the world with dollars earlier this decade…[and] has climbed sharply again since Mr. Bernanke cut rates virtually to zero last month and signaled his new policy would be “quantitative easing” — i.e., printing as much money as it takes to revive the U.S. economy.”
The Fed’s “Liquidity Program”
The Fed’s response to the credit crisis has been to flood the markets with “liquidity,” through a combination of direct and indirect methods. The Fed began by attempting to stimulate lending indirectly by steadily lowering the interest rates that it charges member banks on overnight loans, not stopping until its benchmark Federal Funds Rate hovered slightly above 0.0%. As commercial banks failed to take the hint and continued to hoard cash, the Fed felt compelled to insert itself more directly into the markets, initially “announcing a program to buy $100 billion in the direct obligations of housing related government sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac and the Federal Home Loan banks — and $500 billion in mortgage-based securities backed by Fannie Mae, Freddie Mac and Ginnie Mae.” This was quickly followed by repurchase programs, lending facilities, investments in money market funds, and option agreements, all of which were designed to supplement its “traditional open market operations and securities lending to primary dealers.” The Fed’s efforts also worked to ease the liquidity shortage in credit markets abroad by entering into swap agreements with several foreign Central Banks suffering from acute Dollar shortages.
The end result was that “In just a few short months, the central bank has effectively become a substitute for banks and other lenders, especially in the commercial paper market and others that remain frozen to certain economic transactions. The Fed also stands ready to buy mortgage-related bonds, longer-term Treasury bonds, corporate debt and even consumer loans.” The only problem is that the Fed’s financial resources aren’t adequate to support such activity, necessitating steep leverage. In fact, “the flagship branch of the 12-bank system, the Federal Reserve Bank of New York, shows assets of $1.3 trillion and capital of just $12.2 billion. Its leverage ratio, a mere 0.9%, is less than one-third of that prescribed for banks in the private sector.” Only the brave are willing to ponder what would happen if any of these “investments” go sour.
Market Response
As previously stated, securities markets have reacted positively to the Fed’s policy prescription, since some of the liquidity will no doubt be used for asset speculation. Few economists share this sense of buoyancy, however: “The 2008 shock is so big that it cannot be shrugged off by households, like the 2001 downturn. With their wealth depleted, households will save: as a precaution in hard times, to make up for losses and try to regain their desired wealth path.” This increase in savings will not only negatively impact GDP, but could ignite a self-fulfilling deflationary spiral. The Fed is terrified of this possibility, because deflation and a lack of confidence in the Dollar would quickly reinforce each other, causing “the flow of money to speed up as individuals become desperate to exchange cash for real goods as fast as possible, producing hyperinflation.”
The Role of the US Treasury
The US Treasury Department, often acting on behalf of the US Federal Government, is also playing an increasingly prominent role in the policy response to the credit crisis. The previous six months have witnessed the poorly-managed $700 Billion TARP program, direct bailouts for failing companies in the automotive and banking sectors, as well as the far-reaching Obama economic stimulus plan, currently pegged at $825 Billion. Setting the substance of these programs aside, let’s instead focus on the fiscal impact. The federal government is now projecting a 2009 budget deficit of $1.2 Trillion, shattering the 2008 record of $455 Billion. The result is a (conservativative) estimate by the Congressional Budget Office that US government borrowings will increase by $3 Trillion over the next decade, which is not surprising given that the bailout could end up costing over $4 Trillion.
Unfortunately, “with the experience of the last eight years, the international financial community does not have too much faith in the ability of the United States government to act with appropriate discipline,” and may not be easily convinced to absorb this increase in debt. While still considered a low possibility by most analysts, speculation is in fact mounting that the US will default on part of its debt. In addition, Timothy Geithner, recently appointed Secretary of the Treasury, crassly provoked China- previously the most reliable purchaser of US Treasury securities- by calling attention to its dubious currency policy. In short, it is becoming ever-more likely that the the Treasury Department will be forced to turn to the Fed, which in turn will be forced to “monetize” the debt by literally printing the required currency necessary to make up the shortfall. This will spur inflation, and “increases the likelihood that foreigners will not only stop buying Treasuries, but that they will sell the ones they have, and will dump US dollar holdings out of a concern of dollar devaluation by the part of the Federal Reserve.” One editorialist offered a pithy summary of this dilemma: “If the Fed is going to create boatloads of depreciating, non-yielding dollar bills, who will absorb them?”
The World’s Reserve Currency?
The scariest prospect of all is that the Dollar will no longer function as the world’s reserve currency. In recent years, the Euro has steadily increased its share of Central Banks’ foreign exchange reserves, although it is still dwarfed by the Dollar. Since 2003, China has cut the portion of Dollars from 70% of its total forex reserves to 45%. In addition, several Middle East countries recently made headlines by announcing plans to abandon their respective currency pegs to the Dollar, because such was becoming increasingly costly, especially from the standpoint of opportunity cost. In other words, the Fed’s interest rate reductions have turned investing in short-term US securities into a losing proposition. The forex markets encapsulated this sentiment: “A day after the Federal Reserve adopted a near zero-interest rate policy to stimulate the economy, the Euro jumped as much as 4 cents against the Dollar, the largest single-day move since the euro’s birth in 1999.” Even ignoring yield, investors realize that they are being burned on the risk end of the equation as well, given both the dubious nature of the assets newly guaranteed by the US government, as well as the fact that a bubble appears to be forming in the market for government bonds. Ironically, if the Fed is successful in stimulating investor risk appetite, it could prompt a rapid flight away from low-yielding Treasuries. “Any exodus now could spark selling across the board. Foreign debt holders would likely repatriate their funds immediately to reduce the risk of being last to convert.”
Conclusions
In conclusion, we must accept that in the words of one commentator, “Washington’s policymakers have little choice as they aim to prevent America’s economy tipping into depression. But they need to be aware of the risks to the dollar. Zero interest rates, a contracting economy, a still large current account deficit and suspicious foreign investors are a potent combination that could lead to a rout of the currency.” Ultimately, the Fed and the US Treasury must bear in mind that their policies hinge on a crucial assumption: that there is only a limited link between money supply growth and inflation. If this turns out to be false, any US economic recovery would certainly be followed by tremendous inflation, in which case the implications for the Dollar are clear.
Courtesy http://www.currencytrading.net/ written by Adam Kritzer
By Stephan Zimmermann, on February 16th, 2009
As early as May, 2008, Libyan leader Colonel Muammar Ghaddafi suggested that his country planned to dismantle his nation’s political bureaucracy and would “hand out oil money directly to the country’s five million people.” (www.javno.com) Nearly three-fourths of Libya’s petroleum revenue is suspected of being illegally diverted.
In September of last year, the Arab Times reported that “Libyan leader Muammar Al-Ghaddafi has announced he will distribute all oil revenues directly to his people and will purge most state departments except the Defence, Interior, Foreign Affairs and Justice,” columnist Saleh Al-Ghannam wrote for Arrouiah daily. Ghaddafi attributes this decision to corruption in government departments which put the burden on the budget to the tune of $27 billion each year.” (www.arabtimesonline.com)
London’s Financial Times reported November 14, 2008 on an appearance by Ghaddafi on Libyan television. Among those discussing the issue were Farhat Omar Bin Guidara, central bank governor, and Al-Baghdadi Ali al-Mahmoudi, prime minister of Libya.
Arguments by leading members of the government against Ghaddafi’s revolutionary and unorthodox plan included anticipated major inflation and foreign currency problem in the country. Another suggested distributing shares in Libya’s manufacturing and telecommunications industries. Ghaddafi failed to be persuaded. According to The Financial Times, he charged officials with “clinging to the status quo to protect their privileges…so you can keep your positions.“ (www.ft.com)
The story was hardly reported in major American news media at the time. It was not until February 14, 2009 that the New York Times and Yahoo.com first reported the story from a Reuters dispatch.
The Socialist Islamic republic, which derives roughly a quarter of its annual GNP from the OPEC member’s petroleum revenues, was unlikely to be seen one of the first nations to try to adopt a direct libertarian political posture.
In his forty years since his successful and bloodless coup in 1969, Ghaddafi has at various times been both hailed and denounced as a visionary and a revolutionary.
In a 1986 raid on Tripoli by U.S. warplanes, he lost his infant daughter.
Proof of his complicity in the 1988 Pan Am flight bombing over Lockerby, Scotland was never legally established, although Ghaddafi and the Libyan nation accepted full responsibility and made financial restitution in 2006.
Previous U.N. sanctions, imposed in 1992, were lifted in 2003 and 2006.
Today, the Sunni Moslem country is a one-year member of the U.N. Security Council
It is estimated that there are roughly five million people in Libya. The nation produced a GDP of $57 billion. Some $32 billion annually would be distributed to the population.
Ghadaffi’s remarks should be favorably received by those advocating similar utopian ideals in the United States.
Libya is essentially a centrally ruled socialist autocracy with popularly elected local leaders. In 1977 Ghaddafi proclaimed Jamahiriyah (people’s republic). The unique governmental form combines religious aspects of Islam, economic mixture of socialism and capitalism, and populism.
While Ghadaffi holds ultimate power over major macro-economic decisions, he suggested that “You would fail to stop corruption as long as the state owns the oil wealth, makes contracts with companies to carry out projects, manages health care, education and other services and economic projects”
Particularly unusual for an autocratic ruler, Ghaddafi emphasized that “We are not afraid that people enjoy freedom on every street and every place, to appoint the officials of their liking, create associations, set up business and companies as they like. … This is their right and there is no debate about such an issue.”
Roughly twenty percent of Libyan’s are government employees.
Awaiting the outcome of the social experiment, American analysts ranging from the intelligence community to armchair pundits ascribe various motives to the sixty-seven year old leader. Ghaddafi is one of the longest-serving heads of state in the world, ruling since 1969. The king of Thailand, Bhumibol Aduljadej (1945), Sheik Saqr of Ras al-Khaima (1949), Queen Elizabeth II (1952) and Gabon’s Omar Bongo (1967) are the other leaders currently serving.
The convergence between capitalism and socialism and populism with strong central leadership should be closely monitored, whether in Libya or the United States.
By Cheryl Grey, on February 13th, 2009
Real gross domestic product (GDP) is the market value of all goods and services produced by a nation within a certain span of time, adjusted for inflation. It includes both the goods and services sold in the marketplace, such as a can of tuna at the grocery or server space leased from a website host, as well as those that are not, such as disaster relief provided by the Red Cross. Because this calculation is for what’s produced, it doesn’t include existing goods (re-sold homes, used cars) or those in transition (empty aluminum cans purchased by Coca-Cola to fill at a bottling facility). Nor does it include the value of stocks or bonds outstanding (although the sales commissions count), which is why the Dow Jones meltdown currently underway has not affected GDP estimates.
The adjustment for inflation is of primary importance. If an economy grew by 2.8% and inflation also rose by 2.8%, then the economy didn’t really grow. The same amount of goods and services were produced as before; only the prices increased. Economist Charles Wheelan calls it the equivalent of exchanging a $10 bill for ten $1 bills; your wallet feels fatter but there’s really no difference.
In the United States, the Bureau of Economic Analysis, a division of the Department of Commerce, keeps an index of inflation adjustments dating back to 1929, giving economists a stable means of comparison for U.S. economic performance across the years.
Nominal GDP has not been adjusted for inflation and is therefore merely raw data, which is why you don’t hear about it all that often.
Measuring GDP
GDP is measured in two ways: the raw figure, and the percent change from the previous time period. The U.S. real, inflation-adjusted GDP for the third quarter of 2008 reached $14,420,500,000,000.00, even if the economy is currently contracting rather than expanding. The sheer size of that number makes working with the raw figures rather cumbersome and also makes people’s eyes glaze over. It’s more easily understood if we simply say the U.S. economy contracted by 0.5% in the third quarter as compared to the second quarter of 2008, when it expanded by 2.8% over the first quarter.
Taking the real GDP figure and dividing it by that nation’s current population gives per capita GDP, another favorite economic scorecard, this one designed to compare economies by their average (not median) incomes and therefore standards of living. For example, Ireland’s 2007 GDP of $191,600,000,000.00, when divided by its population of 4,156,119, equals its per capita GDP of $46,600—higher than the $45,800 of the U.S.
If a nation’s population is growing, then its GDP must grow at least as quickly just to provide jobs for the new arrivals. An economic rule of thumb called Okun’s Law states that, in the U.S., GDP growth of 3% is required to prevent unemployment from rising. For every gain of 1% above that figure, the unemployment rate should fall by 0.5%. Although this pattern isn’t cast in stone, it’s been fairly consistent since the end of World War II, which unfortunately doesn’t bode well for job seekers through at least the end of this year, considering the current and expected fall in GDP worldwide.
Downsides to GDP
On average, GDP makes for a workable scorecard across economic borders; however, it does have its shortcomings. It doesn’t count values that aren’t easily transcribed into monetary figures, such as cultural, environmental, or historical values. An old-growth forest, in GDP terms, is worth no more than one planted for harvest by a forestry company (and it also doesn’t care what sort of owls call it home), while a building remains the total of its construction materials plus labor no matter who slept there.
GDP also doesn’t count work performed in the home unless it requires the purchase of cleaning materials or new siding. Nor does it count raising children as an investment for the future beyond braces and educational materials.
GDP also doesn’t include the “shadow economy,” constructed to avoid paying a tax or to bypass governmental regulations. The classic example is the waiter who doesn’t report his tips as income. Although it’s obviously difficult to calculate such things with any exactitude, a serious study performed by Friedrich Schneider of the Johannes Keppler Institute Linz claims that this shadow economy in the U.S. is approximately 7.9% the size of the official one, or around $1.14 trillion in 2007—larger than the official GDP of Australia.
By Erica Tesla, on February 12th, 2009
There have been more words written about the iPhone “phenomenon” than perhaps any other single piece of technology. So it might seem like another blog would be just one more for the pile.
But the iPhone presents a perfect example of technology making its mark on consumer behavior. A recent article in the LA Times discusses the overwhelming accessibility of information for iPhone users. The article primarily explores the possibility that this accessibility could become a social liability – the phone can “in seconds change a lighthearted conversation into the Pursuit of Truth”.
It is true that easy access to information via the iPhone may make it all too easy to beat a dead horse, but access to information has important – and interesting – economic consequences. A well-known problem in economics is that of asymmetric information. In a typical exchange of goods or services, one party will usually have more information than the other. In theory, this information would either cause the seller to demand a higher price for the item or the buyer to offer less.
Have you ever suspected you were being had by a used car salesman? Hand your iPhone over to your buddy to pull up Kelly Blue Book while you test drive. Not sure that first edition at the Rare Books Emporium is actually all that rare? Hop on Amazon and see if copies are going for three cents plus shipping. Can’t understand why on earth your friend would pay $80 for those shoes? Hop on Facebook and read her review, detailing her five years in the same pair.
Indeed, some say that social networking – the ability to see what people you trust think about something before you shell out cash – is the most powerful aspect of the iPhone. Jared Kelley-Hudgins, a design student from the Atlanta area, says the phone has opened up a “huge opportunity for people to check on a certain product, be it a pair of jeans, a computer, or car, with their peers.” Jared is holding out for the new iPhone, in particular for the expected 3G feature, which if introduced would make accessing the internet outside of Wi-Fi networks up to 10 times faster than speeds on EDGE networks.
For some people, it seems, almost instantaneous is not quite fast enough.
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By Antony Adolf, on February 11th, 2009
Poverty and affluence may be relative concepts, but they are absolute experiences. A striking and dangerous feature of the recent global economic downturn is the ways in which it has blurred, if not reversed, the relativity and absoluteness of these two historically imminent psychosocial and economic conditions on individual, corporate and international levels. The focus here is the first: the new economics of poverty and affluence on a personal basis.
Sharp declines in housing and stock markets, new lifestyle choices being made because of commodities and luxury prices coupled with unprecedented access to consumer credit and corporate capital, have it seems brought about a significant shift not only in what is meant by rich and poor, but also in every intermediary position on the spectrum.
What distinguishes the relationship between poverty and affluence today from those more recent and distant past? The new, evermore challenging senses of these two old states can be illustrated by their experiential dissociation both from their precedents and each other on the three interrelated levels put forth above. On individual or family scales as on the others, being rich or poor is no longer tantamount with feeling rich or poor — until it’s too late.
The thick black line creating the age-old dichotomy between rich and poor has, in the popular and academic imagination alike, been drawn between them in this way: First are the “haves” who possess the means, knowledge and connections to survive or thrive in nearly any given economic environment. Second are the “have-nots” who sometimes even in the most prosperous conditions find it difficult or impossible to survive due to lack of such resources, let alone thrive. Of course, we are far from in prosperous conditions now, which in theory should only accentuate, rather than revolutionize, the situations of haves and have-nots.
The French Revolution (1789), pitting rural peasants and urban poor against their well-to-do overlords, graphically exemplifies the differences and disasters the absoluteness of having and not having can cause when exacerbated by unusually difficult conditions and/or radical mindsets. Likewise, To Have and Have Not, Ernest Hemingway’s lackluster 1937 novel set during the Great Depression, dramatizes these differences by narrating the slippery slope slide of its main character from fearless fisherman to human trafficker as he and his family increasingly finds it difficult to make ends meet. Having or not having thus become ethical and/or moral in addition to socio-economic positions and problems. What of buying and not buying?
Having or not having as the defining, dividing line between poor and rich has recently been displaced by the power to buy or not to buy in developed economies such as that of the U.S. The key difference is that having depends upon resources that are already one’s own as means of subsistence and prosperity; on the contrary, buying can depend on resources that are borrowed or devalued and be either a means of further enrichment or a road to further destitution. Terrorist economies such as that of the present, whose perpetrators ought to be so charged, paradoxically expose this distortion and make it less visible by bringing much wider trends closer to home.
For example, according to the old paradigm of poverty and affluence, have-nots became rich by coming to have (that is, own in full) what they did not before: properties, luxuries, cash, investments, lifestyles, etc. Within the new economics of poverty and affluence, however, it is precisely by being able to buy what the poor and moderately affluent alike did not have before that they can become even poorer. The culprits, credit cards, store financing, lines of credit, first through third mortgages and other forms of consumer credit have turned have-nots into buyers, making them poorer in the process. But the same does not go for the haves.
In contrast, within the old paradigm the affluent could use what they have to survive even the severest recessions, whereas now those who can leverage their holdings can go so far as to increase their wealth during such periods by buying more for less than they could have in more prosperous circumstances. Foreclosures are traumatic events in the life of struggling families, but for indifferent investor they are wellsprings of profit. This is not to say that an ethical problem is poised on the part of such investors; rather, it arises with the original lenders to the families who enabled them to become buyers despite being have-nots.
In the past, loan sharks used to break your legs if you failed to pay a loan. Now, lenders have broken their own legs to lend you money, are running to the government for crutches, but both institutions are still expecting you to pay their medical bills. For those who have and have-not, the concepts and experiences of poverty and affluence are directly correlated; for those who buy and buy-not, they are inversely correlated, as illustrated in the following graph:
As the buying power of the poor goes up, their actual wealth goes down. As the buying power of the rich goes down, their actual wealth goes up. Credit crises like the current one or that of 1999 are in this way both corrections and continuations of a problem: the poor realize just how poor they have become (the correction) and the rich realize they have a rare opportunity to get richer even quicker, often at the expense of the poor (the continuation). Of course, these traits are to some extent perennial in socio-economic history, but recent and drastic augmentations in purchasing power and the cost of certain goods make it clear that their dimensions and degrees have been significantly intensified.
At the heart of the mortgage crisis was that lenders like banks, relishing in a criminal lack of regulation maintained in the name of free markets, turned have-nots and modest haves into nightmarish homebuyers in the name of the American Dream. To paraphrase an instigator of the French Revolution, Jean-Jacques Rousseau, markets are born free but are everywhere in chains — and it’s a good thing too, as our current crisis makes painfully clear. Another metaphor must now be added to that of “card houses:” paper mortgages. The buyers who suffer, and haves who profit, most from the mortgage crises are quite literally living in it. In the immediate present, the choice between buying groceries or a new computer doesn’t have to be made because, thanks to consumer credit, both can be done right now. But because of this very situation, it is those who buy not who end up being those who have, while those who buy end up being those who have not. Retailers, desperate for sales, have begun slashing the prices of luxury goods: good news for the haves, bad for the buyers, even if the latter may think otherwise for the time being. More so than in decades, it is possible to live it up by buying it down, and vice versa. The crown jewels of global markets, American consumers, have begun to lose their half-century long luring shine; whether they were faux to begin with has yet to be definitively determined, though the magnitude of our depression-in-denial is an indication.
Consumer credit, originally used to facilitate transactions on a temporary or emergency basis, has in becoming available on standing and widespread basis allowed the poor to drift into an imagined affluence and the affluent to drift into actual poverty. Stagflation, once seen as rather rare and precarious, can be seen as the norm in contrast to which economic growth and inflation are exceptions. If mortgages are the first thing people can’t afford, then their credit card and student loans may be tied for second with their gas tanks. To stress the point: being able to buy more by access to consumer credit only artificially stimulates the economy and in actuality make consumers poorer precisely because they have more. What Karl Marx called false class consciousness has become a false class conscience.
The proposed newest round of “economic stimulus” packages may be fueling, rather than extinguishing, the financial fires burning up retirement and college savings, home equity, and physical and mental wellbeing. As the Associated Press reported:
The Fed program for consumer debt will lend up to $200 billion to the holders of securities backed by various types of consumer loans such as credit cards, auto and student loans. The goal is to provide greater demand for these securities as a way of lowering interest rates consumers are paying and to make these loans more available.
“Rich in debt” sounds like a paradox because it is one, but it accurately describes the basis upon which more and more people, corporations and governments make their daily and momentous decisions, which a passing thought about posterity would prohibit.
Combined with the checks by which the government is effectively giving out the taxes our children’s children will pay, such stimuli, although welcome on individual levels, accentuate rather than abate the social incongruities of poverty and affluence in two ways. First by giving some poorer people an artificial, short-term spending spree or debt reduction which allows them to continue buying patterns they may not have been able to afford to begin with. Second: by enabling some richer people to sustain their real or imagined wealth a little longer and/or to increase it in the long-run by purchasing discounted securities and property. The point is that the very pitfalls people are waking up to find themselves in today, corporations and governments are rushing into as if the practice of usury was a step towards paradise.
Antony Adolf, author of *Peace: A World History*, is an independent scholar and creative writer. His blog, “One World, Many Peaces,” is at http://oneworldmanypeaces.typepad.com/.
By Dan McLaughlin, on February 9th, 2009
Health care has gotten to be one of the top issues of our time. Many people believe that the present system in America is broken. It is too expensive and excludes too many people. The political solution is to move from a highly centrally planned system to one that is even more centrally planned. Government is to be the savior and magically solve all of the problems and make everyone healthy, but that can only happen when it gets big enough, and interferes with the markets on a grand enough scale.
The problem with central planning in health care is the same as the problem for central planning in any other area of our lives. It assumes that the planning body is able to make decisions for hundreds of millions of people and optimize the results. The justification for government provision of health care is wrapped up in morality and rhetorical turns of phrase, as it must be to get around the obvious contradictions and logical incoherence.
Discussions of health economics, even by many PhD economists, often seem to neatly and conveniently avoid any mention of the relationship of prices, supply and demand, the essentials in any economic discussion. In every respect, the provision of health care is an economic issue, similar to the provision of food, shelter, clothing, transportation, and every other need of humanity. There is absolutely nothing special about a doctor doing brain surgery. It is a service that he or she provides, and the market for brain surgery operates according to the same economic laws as the markets for plumbing, catering or transportation services.
Not all discussions of health economics avoid economic principles, however. A growing number of participants acknowledge the tradeoff in the triangle of access, affordability and quality. In a health care system, you can successfully manipulate one or maybe even two of the three, but you can’t manipulate all three at once. You can artificially make health care accessible to everyone and even control prices to make it more affordable. In that case, the quality will inevitably suffer. You can have the highest quality and make it accessible to all, but the society will go bankrupt trying to pay for it. In order to make a high quality health care system with a low overall cost to society, you must necessarily exclude people with expensive problems. The three factors are opposing. You can’t have them all together.
The iron triangle of access, affordability and quality is really just a nod to the relationship of demand, price and supply. In any market, whether for health care or automobiles, manipulation of prices, demand or supply inevitably leads to negative unintended consequences. Health care would benefit a great deal if only people would take economic law into account.
Central planning, in all of its various forms, must, by its very nature, ignore economic law. It must manipulate prices, demand or supply. There are no other tools for central planners to use. Taxes, regulations and other legislative vehicles are merely the methods they choose to impose controls on supply, demand or prices.
If one assumes that all politicians and bureaucrats are actually benevolent and really care about the needs of the citizens, one might believe that the laws and regulations they enact will be beneficial to all of the people. That belief fails on at least two points. The first, most glaring fault is that politicians and bureaucrats are generally not benevolent and don’t care for the rest of us. Their career advancement depends on accumulation of power. Their benevolence falls toward those special interests that give them the highest bang for the buck they take from taxpayers.
The second failing is vastly more important, though much more subtle. Planning by government assumes that individuals don’t plan, or more to the point, that individual’s plans are wrong and don’t count. In reality, only the plans of people count. All that government planning can do is restrict the options for consumers and entrepreneurs and distort the economic environment under which they make their decisions.
The crisis in health care has only been an issue since politicians decided they know better than consumers do. The real solution to the health care crisis is to remove the cause, the severe interference that has distorted the markets for decades. Quality health care will be affordable only when individuals are accountable for their own costs and providers are free to compete on their own terms. Everything else is political whitewash.
By Vipin Veetil, on February 6th, 2009
The eventful happenings of last year or so have not only unleashed a crisis on the world economy, but also unveiled what is probably an even greater problem – a crisis within economics itself! In the two decades or so before 2007, the primary proponent of anti-Keynesianism within the mainstream tradition was the Rational Expectations School (RES). Lucas, Prescott, Sargent et al, were the “best” macroeconomists, and their work is the staple diet of masters and PhD programs.
The basic idea behind RES is that “perfectly rational individuals” with “complete information” will react to government policies by adjusting their own behaviour, thus nullifying its impact. So for instance, if government increases its expenditure (fiscal stimulus), people will figure that taxes will go up in future since government is incurring a deficit which will have to be reduced later, so the net effect is 0.
There are of course various ways to contest the broad idea. But at the moment, policy makers have ignored the rational expectations guys on the simple grounds that their assumptions are entirely “unrealistic”. And this brings us to the bigger issue of what was the point of spending so much time and energy in deriving the results of RES, of teaching it around the world, if it is of no use when the we get an economic crisis. A compass is useful because it points to the north! Check out what RES has to say now here.
The Austrians have of course been doing much better. Within the Austrian Business Cycle Theory the present crisis originates from the low interest rate policy followed by Fed in the post dot com bust scenario. Natural rate of interest is the rate at which two individual will voluntarily be willing to lend and borrow from each other.
There is no such thing as “the” natural rate of interest, but many such rates. But let us for analytical ease assume there is one such rate, and its 5%. When a central bank (RBI did this too) fixes the rate at say 3%, we get two problems.
1. How to produce?
Entrepreneurs begin to investment in more long term production facilities, since the same quantity of monetary resources can now fund longer term projects. So I can begin building a factory which will take 10 years to complete and 10,000 tons of steel at 3% interest, but would have had to build a factory which takes 6 years to complete and uses 70,000 tons of steel at 5% interest. In other words, the time structure of production is artificially skewed.
2. What to produce?
Many goods which would have been unprofitable to produce at 5% interest, become profitable at 3%. In the very short term, low interest lowers cost of production but prices of final output remain the same. So we get goods which would not have been produced under natural conditions. At 3% households are saving less than at 5%, entrepreneurs are borrowing and investing more than at 5%. Less savings mean more consumption. More consumption and more investments pull the economy in opposing directions, we get inflation, central bankers panic, interest rates are hiked (remember the last months of the Y V Reddy regime), many projects become unfeasible because of rising cost, recession!
Note that since the cause of the crisis is misallocation of resources, we would like economy wide churning. Firms must readjust production processes, some firms will have to reduce employee count, these people will then be employed elsewhere (the time lag between the two registers a high rate of unemployment), some firms will have to shut down, other firms will have to produce new products (less luxury villas, more apartments for instance), and so on. And soon enough we will be back to a rather normal state of affairs.
Not understanding this process is the root cause of many dangerous proposals floating around in the press. Take A. K. Arun’s Economic Times article for instance, he says,“What is rational for individual enterprises could spell gross irrationality at the level of the economy. Job cuts at a large number of companies in the wake of the slowdown, is a good example of this phenomenon. As individual companies try to cut costs and reduce the impact on their bottom lines by laying off workers, the cumulative result is to depress demand for what all companies produce in the aggregate. This accelerates the slowdown, and releases further pressure to cut costs. There must be intervention at the macro level to stop this vicious cycle.”
Any government intervention will only further delay the process of economy wide churning which is the only way to recover with or without a fiscal stimulus. Arun proposes “a tax break for companies that do not lay off staff”, and says the tax break itself maybe a certain percentage of a firms “wage bill”. So we have an economy where there is been gross misallocation of resources, plenty of capital is been destroyed (10 year factories will have to be torn down, 6 year ones build), and instead of encouraging firms to become more efficient, employ least cost methods of producing goods so that there are more resources available for economy wide reconstruction, we encourage firm to increase wage bill, i.e. increase cost!
In fact what we really need is more savings, and it’s a good thing that household reduce consumption and increase savings during recessions, we need more resources to restructure production. But its not just Arun’s article really, the problem is with the whole of Keynesianism which is pretty much just the 20th century name for mercantilism!
By J.D. Seagraves, on February 5th, 2009
“How is the Fed’s performance in the present economy,” asks The Citizen Economists’ Poll. “They’re doing excellent,” say a sarcastic and/or deranged 5 percent of respondents. Twenty-one percent say they’re “doing okay,” and another 12 percent say “pretty good.” But the most popular answer is “horrible,” which leads polling with 30 percent, and the second-place answer is more radical yet: 25 percent of respondents say, “We should get rid of them.”
Support for abolishing the Federal Reserve System is mounting every day. Hundreds of anti-Fed protesters convened on the Federal Reserve Bank of Detroit, where they joined former Governor Jesse Ventura, The Creature of Jeckyll Island author G. Edward Griffin, and Libertarian Scotty Boman in calling for a return to the gold standard. Eleven thousand people broke into several impromptu chants of “End the Fed!” at Ron Paul’s Minneapolis counter-convention this past September, and Google searches for “Austrian Economics”—the school of economic thought most vociferous against fiat money and central banking—are have spiked dramatically in the past year. This all begs the question: Why are so many people suddenly interested in what has for years been considered a “boring” subject? Well, it wasn’t always viewed that way.
Monetary Policy: Once a Burning Issue
The presidential elections of 1896 and 1900 were almost entirely about monetary policy. The “conservatives,” for lack of a better term, were the “hard money” camp—they supported a strong gold standard. The “radicals” wanted a government-managed fiat-money system much like we have today—only they were naïve enough to believe it would be to the benefit of the working man, rather than a vehicle to serve the interests of the elite. And finally, there were the “moderates”—those who favored a middle-of-the-road position in which silver would be coined in addition to gold, thereby causing inflation which, believe it or not, the moderates and the radicals thought was a good thing.
All three of these constituencies existed primarily within the Democratic Party. The “conservatives” were in fact the classical-liberal wing, led by staunch gold man Grover Cleveland. The “radicals” were Midwestern farmers who had broken with the Dems in the previous election and formed the Populist Party, winning 5 percent of the electoral vote in 1892 and nearly costing Grover Cleveland the election. Stepping in to “unify” the party was William Jennings Bryan, a staunchly anti-gold populist but loyal Democrat who did not go as far as the Populist Party. Instead, he was a “silver fusionist.” Bryan won the Democratic nomination in 1896 and 1900, losing in the general election both times to William McKinely (who was nominally pro-gold), and changing the Democratic Party forever, for the worse.
Now think about how much has changed since the turn of the 20th century: disputes over monetary policy were the basis of a third-party presidential campaign that grabbed 8 percent of the vote and won five states, led to a civil war within the Democratic Party and the realignment of the two-party system, and were the major issue discussed in at least two consecutive presidential elections. The American people were engaged and educated, and didn’t fall for bogus platitudes about “change,” “mavericks,” “yes, we can,” and “country first,” etc.—they understood the real issues that affected their daily lives, and nothing could possibly be more critical than the money question.
Why The Monetary System is So Important
And why is that? Well, when the government has control of the monetary system, it can manipulate it for the benefit of some and to the detriment of others. Ultimately, this government manipulation is always to its own benefit and at the expense of the people.
For example, under a hard-money gold standard, paper dollars can only be created if there were real gold coins to back them. Thus, unless there is new gold, there can be no new money. Inflation—which is correctly defined as the expansion of the money supply—did occur under the gold standard as new gold was mined, but only very slowly. As a result, there was no “price inflation” whatsoever. That’s because the advances in technology and accumulated capital more than offset the rate of monetary expansion, and thus, consumer prices went down a little year after year.
But when the government claims for itself the right to print paper money out of thin air—notes that aren’t backed by gold—and uses its military might to force people to accept those notes, there is a recipe for exploitation.
Inflation = Theft
Think of it this way: Imagine there is $1 trillion in total world currency. Paper money itself, of course, is worthless—it’s what you can exchange the money for that’s important. So if the total money supply was $1 trillion, then all of the world’s wealth—all the factories, the natural resources, the finished goods, etc.—would be worth $1 trillion. Now what happens when the government creates $0.1 trillion new dollars? It doesn’t expand the supply of factories, resources, and goods—only the money that the values of those items are denominated in. All existing wealth would now be worth $1.1 trillion, since the total wealth would still be equal to the total money supply. Only now, the $1 bill in your pocket would be worth $1/$1.1 trillion instead of $1/$1 trillion—you’d have just been robbed of 10 percent of your purchasing power.
And that purchasing power doesn’t just disintegrate—it’s redistributed. First, it goes from you to the government, just like a (hidden) tax. And then it goes from the government to its favored industries. This is why corporations spend so much time and money lobbying Congress instead of developing more competitive products: it’s easier to bribe the government to give them your money than it is to convince you to part with it willingly in exchange for better products and services.
Clearly, the intelligence of the average American has fallen precipitously since the elections of 1896 and 1900. But the fact that people are beginning to wake up to the problems caused by the Federal Reserve System is a hopeful sign. The only question is: is it too late? Can the dollar be saved by the political action of the president and the Congress, or must we wait for the entire global financial system to completely melt down so we can start over? If you’re an optimist you can hope for the former, but as a realist, I think the latter is the better bet.
By G.L.C., on February 3rd, 2009
Short sellers have been vulnerable to attack on the claim that they’re spreading rumors or are out to destroy a company. Companies have mounted public-relations campaigns against them. In a short sale, investors borrow shares and immediately sell them, hoping to profit by replacing them later at a lower price – a sell-high, buy-low strategy.
There have been concerns that short sales are behind the big price slides. Short sellers seek to profit from a stock’s decline by selling borrowed shares and replacing them at a lower price. Short sellers have been blamed for the declines in stocks including Fannie Mae and Freddie Mac which were taken over by the Federal government last month.
Concerned about the possible unnecessary or artificial price movements based on unfounded rumors regarding the stability of financial institutions and other issuers exacerbated by short selling, the U.S. Securities and Exchange Commission (SEC) has come out with a new set of rules. The SEC also banned the short selling of nearly 1000 stocks until three days after the $700 billion rescue package is enacted into law.
The new rules require money managers with at least $100 million under management to report short selling if it exceeds a certain percentage of the shares outstanding and is greater than $1 million in value. Short sellers who haven’t added to their positions since the rule went into effect won’t have to report. Mutual funds and exchange-traded funds that short stocks also are subject to the disclosure rules. The disclosures would be made public by the SEC with a two-week delay – due to start in mid-October.
The new rules bring an end to secrecy which short sellers have long held to be one of their dearest tools. Short sellers will have to report which stocks they are short and how their exposure to those stocks changes during the day. The new rules have been welcomed by some who feels that since investors who own 5% of a company’s outstanding shares have to report their stakes, there is no reason for short sellers not to.
The new set of rules has been criticized by many. Forcing such public disclosure would be like asking Coca-Cola to reveal the super-secret formula for its popular fizzy beverage. It could lead to variety of consequences, some of them unintended. Short sellers are already plotting changes in strategy. Short sellers represent a supply of shares when the market is rising and demand for shares when markets are falling. It could affect the liquidity of some stocks if short sellers retreat fearing companies will cut off information flow, investment firms will lock them out of investor conferences and competitors will see who has built what positions. Stocks exposed as targets of well-known shorts could suffer if other investors piggyback on the same companies.
The SEC subsequently modified the disclosure requirement stating that the disclosure will not be made public. This came as a relief to short sellers and other hedge-fund managers worried that public disclosure of their bearish bets might expose them to pressure from the companies they target.
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