Breaking the Monotony

I know it’s been a while since I’ve posted anything here, so let’s just get something up to let the world know that yes, I do still exist.  Here’s a rather handy video that explains our current credit crisis.

The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

Why Medicaid and Social Security Were Always Doomed

Pretend for a second that all retirement pensions were perfectly funded.  Pretend for a second that politicians didn’t raid Social Security and Medicaid funds for pet projects, or that business owners didn’t pretend that their employee’s group pensions were always going to generate 10%+ a year and fund accordingly.  Let’s pretend for a second that we put all of this money away, nice and thriftily, so that every single retired person on the planet had a fully funded pension with a fully funded social medical entitlement.  What would that look like?

The answer?  Much, much worse than it looks now.

In order to understand why, it’s important to understand what money is.  Money, by itself, no matter what form it takes, has almost no intrinsic value.  It doesn’t matter if it’s gold, silver, wampum, or “fiat” money.  By themselves, each of these monetary objects are about as useless.  Can you grow food on a gold coin?  No.  Can you build a house on a gold coin?  Not unless it’s freakishly huge.  Can you build a house out of gold coins?  Probably not - it’s rather malleable, so it’ll probably collapse under its own weight.  To be honest, gold excels at being an electrical conductor and, frankly, not much else.  The same could be said for silver, though it’s actually hard enough to make easily tarnishable utensils out of; its worth as a weapon against the undead is, at present, somewhat limited.  Wampum… well, you can make belts out of it, I guess.  Paper money can be used for most of the same things that every other kind of paper can be used for, though, in my experience, it’s not particularly absorbent, so that limits its usefulness somewhat.  The reason any of this stuff has value in the first place is because it’s common enough where everybody can get some, scarce enough where everybody can’t get a truckload whenever they want, it’s useless enough where we don’t want to use it for something else, and money is a heck of a lot more convenient than bartering.

Unfortunately, it’s that last bit that kills entitlements.  See, we’re still bartering - we’re just bartering with something that we all want, instead of trying to barter with various disparate goods of varying worth.  In order to barter, though, there has to be something to barter.  If you don’t have land and I don’t have land, it doesn’t matter how much money or cows or whatever either of us have - we can’t trade for land with each other.  If you don’t have wood and I don’t have wood, it doesn’t matter what either of us have - neither of us can trade for a log cabin.  Similarly, if we suddenly have a bunch of people needing medical care and fewer people able to provide it, it doesn’t matter how much money we have set aside or how responsible we were forty years ago - there’s only so much medical care to barter for in the here and now and there is nothing we can do to change that.  Worse yet, if we suddenly have a bunch of people that aren’t working and aren’t providing anything but money to trade, it doesn’t matter how much money they have - there’s less stuff to barter for, so either they’re not going to be able to buy as much stuff or we’re not going to be able to buy as much stuff.  The amount of stuff is finite.  No amount of money ever changes that.

This brings us to why fully funded pensions, Social Security, and Medicaid would be diastrous to everyone under the age of, say, 55.  If our politicians were prudent, the elderly would have enough money to purchase a disproportionate share of every single good that we consume and would be able to do so from when they were 55 until they were dead, on average, about twenty years later, all without having to add a single thing to barter with other than money.  The result would effectively be “stagflation” - a steadily increasing money supply released by every retiree burning through their pensions while the labor pool and the economy shrinks.  This would erode the value of the pensions while simultaneously pricing the producers out of the economy.  If you think going to the doctor is expensive now, imagine how expensive it would be if the biggest consumers of medical care could pay twice as much.

Fortunately, in a “blind squirrel finds a nut” fashion, our politicians and corporate leaders have lucked out.  Thanks to nearly criminal mismanagement of pensions and a ridiculously expansionist monetary policy, it’s much more difficult for the elderly to hoard enough money to disproportionately consume the products of our economy without providing anything in return.  By inflating the money supply, we ensure that those that produce get their fair share - after all, they’re the ones receiving new money, not the pensioners.  Meanwhile, by kneecapping elderly pensions, we ensure they don’t hoard enough money to jack the price of medical care, leisure, and housing any higher than they already have.  Best of all, by the combination of these effects, we encourage the elderly to continue producing and adding to the economy long after they would like to; instead of retiring at 55 or even 65 like they thought, they’re instead going to have to contribute well into their 70s to make ends meet, in much the same way that their grandparents had to work nearly to their grave.

So, if you’re under the age of 55 and can afford anything, thank a spineless politician or a greedy capitalist!  Without them, your grandparents would have priced you out of existence a long time ago.

The Chicago Cubs and Mark To Market

(Via Instapundit) Andy Kessler at Forbes.com wrote an interesting piece about the Mark Cuban’s failed purchase of the Chicago Cubs.  There was one particular excerpt that stood out for me:

So here we sit in early 2009. Banks aren’t lending much, so assets are being quickly revalued back to some rational cash-flow multiple. A house is increasingly worth what your income cash flow can afford to carry mortgage payments, not what the next sucker will pay to take it off your hands. Same for stocks. Earnings were and are king. Low-debt or debt-free companies with earnings potential once the economy bottoms out will be the next wave of winners. Debt-ridden companies have a long workout ahead.

This got me thinking - the entire point of mark to market accounting is that the value of something is determined only by what the next sucker will pay to take it off your hands.  Consequently, is it really that surprising that, once it became the method proscribed by law to determine the value of securities and bank assets, financial institutions treated these assets the same way that many people treated real estate?  Is it also particularly surprising that, sooner or later, securities values would crash down the exact same way that real estate values crash?

This is where a purely libertarian understanding of the bailout can become somewhat troublesome.  When it’s federal regulations that effectively orders businesses to make excessively risky decisions, does the federal government have a responsibility to bail out those businesses when the risks sour?

On Gold Bugs & Central Banks

One of the fun aspects of being a big-L Libertarian again is listening to people discuss whether or not we should have a central bank such as the Federal Reserve, along with what powers such an entity should enjoy if it should be allowed to exist.  Of course, such arguments are largely moot; the United States Federal Reserve has existed for nearly 100 years and there is, at least at present, very little political or voter interest in doing anything about it.  Even so, a decent summation of the arguments against central banking can be found at the Campaign for Liberty:

We believe with Ludwig von Mises, Henry Hazlitt, and F.A. Hayek that central banking distorts economic decisionmaking and misleads entrepreneurs into making unsound investments.  Hayek won the Nobel Prize for showing how central banks’ interference with interest rates sets the stage for economic downturns.  And the central bank’s ability to create money out of thin air transfers wealth from the most vulnerable to those with political pull, since it is the latter who receive the new money before the price increases it brings in its wake have yet occurred.  For economic and moral reasons, therefore, we join the great twentieth-century economists in opposing the Federal Reserve System, which has reduced the value of the dollar by 95 percent since it began in 1913.

Now, it’s fairly obvious to anybody that’s paid attention that, though a single dollar doesn’t buy as much as it did in 1913, we not only have more dollars collectively than we used to (Ford’s infamous $5 per day in 1914 doesn’t even come close to sniffing minimum wage now, nominally speaking), our buying power is far better than it was in 1913.  For example, in 1929, the average American spent nearly 1/4 of their income on food.  Nowadays, it’s less than 10%.  Of course, many of the price changes are due to better technology and increased production across the board, but it doesn’t change the fact that, in terms that matter (i.e. “How much can I buy with the money I have?”), people are far better off now than they ever were in 1913.  None of this is new - in fact, it’s elementary Econ 101.  However, take a look at what is supposed to be the root cause of all of this…

…for showing how central banks’ interference with interest rates sets the stage for economic downturns.

It’s a monetarist argument - They’re manipulating our money and distorting our markets! However, what if the monetarist policies of central banks matter less than either side thinks?

From The Big Picture:  SO AGAIN - HOW DID IT HAPPEN?

But Cooper describes another type of inflation that is derived from what he calls “private sector credit creation.” Unlike public sector central bank money creation which creates high powered money out of thin air and does not produce additional debt, private sector money creation involves the simultaneous creation of offsetting debt. People borrow for new projects and for new consumption. Positive feedback loops and natural human tendencies toward herd behavior keep the process going until a point of excess is reached and the debt becomes a major problem. Once that point of excess is reached there is very little the central banks can do. Deleveraging and asset price deflation become unstoppable.

[...]

Cooper’s work is based upon the work of the late Hyman Minsky who developed the Financial Instability Hypothesis. Minsky thought financial markets were inherently unstable, given to credit-driven booms and busts. Until recently, Minsky has been generally ignored by the economics profession.

In other words, when credit dries up and everybody has to pay their bills, the economy grinds to a halt for a while until people get their debts paid off.  This causes deflation due to money leaving the system (the money supply is contracting faster than the supply of stuff to purchase - people are still making stuff at about the same rate, but they’re spending much less - so the remaining money pool becomes worth more), which, naturally, makes it harder to pay down loans.  This makes sense - any time a bunch of people decide to do something, the cost of doing that thing is almost invariably going to go up.  In this particular instance, the cost of paying back a loan increases; the dollar you’re giving back to the bank now can buy more than it could a few months back, so it’s worth more to you now, so your cost increases.  Eventually, you reach a point where you’re not in quite so much of a rush to pay back the bank and choose to buy something for yourself instead; at the same time, the banks have used your money to pay back their loans, so they can loan more money again, and thus the cycle continues.  At each point, there’s little for the central bank to do, monetarily speaking - they can make it a little harder to loan money when times are good by increasing interest rates, and they can make it a little easier to loan money when times are bad by decreasing interest rates, but it still doesn’t change the fact that the cycle is still coming and that the central banks really have little control over the direction or intensity of that cycle.

Interesting stuff.

Moments In Blunderbustery

Okay, this post really has nothing to do with blunderbusses; I just wanted to highlight a couple of brilliant government-sponsored blunders.  Both examples are from the SF Gate:

Signs to warn Hwy. 99 drivers of fog:

(11-12) 04:00 PST Fresno — California authorities plan to unveil a highway safety program to alert motorists when heavy fog makes driving hazardous in the San Joaquin Valley.

[...]

Officials with the California Department of Transportation and the California Highway Patrol say the new changeable message signs will update automatically when visibility sensors detect poor driving conditions.

That’s right - the same state that’s good for a $28 billion deficit and wants a federal bailout has set up a system to let people know that there’s fog… y’know, on the off chance that not being able to see was an insufficient warning.  Apparently, some people can’t seem to grasp that, if it seems like they’re driving through the middle of a grey pea-soup filled cloud, they might be… um… driving through a grey pea-soup filled cloud. Of course, any questions asking how one expects to see a sign letting you know that you’re driving through a nearly impenetrable gassy wall of water vapor when your vision is impaired due to driving through a nearly impenetrable gassy wall of water vapor were quickly refracted and ignored.

Meanwhile, if you guessed that those banks we’ve been throwing money at aren’t using the money to increase the credit supply but instead to increase executive compensation and fund bank buy-outs, well, good news…

Banks promise they won’t use bailout money for pay:

Members of Congress complained Thursday that banks haven’t used $163 billion infusion of capital, already received or promised by the government, to open credit lines for more lending.

[...]

Treasury has so far has devoted $250 billion of the bailout money to buying equity in banks and another $40 billion to insurance giant American International Group Inc. The hope was that the infusion of news capital would enable them to increase lending, but so far that hasn’t happened, lawmakers said at a hearing by the Senate Finance Committee Thursday.

Instead, some of the recipients of the money have continued to pay dividends to stockholders, provide pay raises and bonuses to executives and other employees and level takeover bids at other companies. Lawmakers said they want to impose restrictions on all those activities for companies getting bailout money.

That’s right - our crack team of legislators gave the banking industry $750 billion dollars to increase liquidity but failed to require that banks spend that money on actually increasing liquidity. So, instead, they’re treating the money like college kids routinely treat financial aid checks and spending it all on their friends.  Of course, legislators are also the same people that think that, when you’re driving in fog, what you need is a sign letting you know you’re driving through fog, so I guess this shouldn’t come as a huge shock.

Re-Establishing Normalcy

Welcome back, everyone.  I know I’ve been gone for a while - between the new job and my dad visiting, things have been rather busy around here.  Now that normalcy is beginning to return, however, I should be able to maintain a somewhat more or less regular pace.

Since just about everyone and their mother is weighing in on the bailout, I suppose I can join the fray.  Before I begin, I’d like to make a note about my qualifications:  I took three semesters of Economics.  I got in A in Micro, either a B or a C in Macro (don’t remember), and a D in the third one, which I was a little too distracted to focus on.  This means that, as far as economics go, I’m probably in “So, I stayed at a Holiday Inn Express last night” territory.  With that in mind, I will state that, in principle, I agree with those that say that there should be no bailout and those who made poor investments should just learn to accept the consequences.  There’s quite a few of them out there, to be honest, on both sides of the political spectrum, and it’s understandable - why should I have to pay for the mistakes of a bunch of people far richer than I ever will be?  I mean, personally, I don’t really care why they failed.  I don’t care if it’s because Congress decided to order banks to lend to uncreditworthy people to increase minority home ownership, or if it’s because people decided to use financial instruments that nobody understands, or whatever.  It’s really not important.  What’s important is that a bunch of rich people are about to stay rich because our tax money is going to keep them that way.  F— that!

Then I remember where my money is and who’s in trouble.

I’m not going to pretend I know what caused this mess, though I do have some ideas; one of those ideas is that there’s no single thing that anybody did (Congress, the banks, whatever) that caused this to occur.  Part of it could be Congress trying to increase home ownership.  Part of it could be overregulation causing financial institutions to seek profits via more unconventional means.  Part of it could have something to do with the ginormous mess that is Fannie and Freddie.  Whatever the reason, it’s clear that, if we just let the financial sector melt itself down into slag, we’re all going to lose a lot more than $700 billion.  We’re already beginning to see some proof of this.  Want to buy a Honda?  Expect to see interest rates that are at least 4% higher than they were last month.  Planning to do any building?  Expect to see the interest rates for equipment purchases to go up at least 1.5%.  Imagine what would happen if it wasn’t just increasingly expensive to get a loan - imagine if it was damn near impossible.

Fortunately, I don’t have to - Megan McArdle did a halfway decent job of doing that for me.

Long story short, thanks to the joys of fractional reserve banking, if the banks decide they can’t loan money anymore, either because they’re broke or just plain scared, we’d be looking at a severe loss of money supply.  The last time we lost a huge chunk of the money supply, it took World War 2 to get us out of it.  I’d rather not see a reprise of that, and, if that means we pay off some people I’d rather not see paid off, well… things could be worse.

Think about it this way:  Let’s say you’re a farmer in a farming community.  You’re a good farmer - you tend regularly to your crops, you make sure they’re well watered and fertilized, and you make sure you only till as much land as your labor can support.  You make a decent living doing this, as do most of your neighbors.  There’s one neighbor, however, that isn’t quite as good of a farmer as everyone else.  Perhaps he was greedy and planted more seed than he could keep up with.  Perhaps he was lazy and didn’t tend to his fields as regularly as he should have.  Whatever the reason, his crops are failing and weeds are beginning to take over - noxious, virulent weeds that strike fear into the hearts of every other farmer in the community.

At this point, you and your fellow responsible farmers have one of two choices:

1. Let the bad farmer get what’s coming to him.  Let his crop fail, let the weeds wipe him out, and let someone who knows what they’re doing take over that farm.
2. Get the community together, bail the bad farmer out, and have everyone pull the weeds out of the farm before the weeds spread to every other farm in the community and wipe out everybody’s crops.

With most business failures, you can get away with pulling option 1 - yeah, you might get a few weeds on your farm, but it’s nothing you can’t handle.  In this particular case, though, the failing companies are really big farms and their “weeds” spread really fast.  Consequently, for better or worse, we’re going with option 2.  Option 2 has drawbacks, too.  For starters, you have to ignore your farm while taking care of your bad neighbor’s farm.  Worse yet, the bad farmer can continue to do business and sell the few crops that are successfully growing on his farm.  If you don’t let him do that, after all, he won’t let the community get on to his farm and pull the weeds.  But, it’s either that or we watch the weeds take over the community and bring everybody down.

That’s my take - I don’t like it, but, given a choice between spending $700 billion that we don’t have and watching a few trillion dollars in equity just disappear, well… I know that “trillion” is a bigger number than “billion”, so let’s just go with the smaller number, m’kay?  M’kay!

Why Metal Standards Don’t Work (Part 2)

I would’ve finished this post last night, but two things got in the way:

1. I had somewhere I had to be in short order.
2. The post was getting too long, so splitting it wasn’t a bad idea.

That said, if you haven’t read the first post, you can do so here.

Continuing on…

I’ll start by pointing out that, even with our current currency system, it’s quite possible for hostile countries to affect the value of our money. In fact, China has been buying T-Bills for years, which has caught some people’s attention. What I was getting at, however, was that, in a commodity-based or metal-based currency model, there’s no good way to get control of your currency when someone acquires enough of what your currency is based on. In fact, it was due to China indirectly buying a large amount of silver from Britain (what the Pound was based on at the time) that led to the Opium War. Coincidentally, this helps show that China has a long history of getting large trade balances on its side and picking up the wrath of the prevailing powers of the time in the process.

With that out of the way, it’s now time to explain what our current currency is based on - us! Simply put, our currency is based on the economic production of our country. If our economic production and our money supply increase at the same rate, our currency will retain value. However, pulling that off is rather tricky - there are numerous variables at play. So, what the federal government usually does is shoot for mild inflation - they do this by loaning money to banks at very favorable rates, which encourages banks to loan more money. If the government was unable to loan money due to a shortage of gold, banks wouldn’t be able to loan as much money, which would stunt growth since businesses wouldn’t be able to borrow money to increase capital.

So, why am I touching this? Because, though I’m libertarian-minded, I don’t agree with the entirety of the Libertarian Party platform. Take the following from the LP’s Family Budget section:

During those same years, the government has increased the money supply — producing inflation. Whether the inflation rate is 12% or 3%, the result is the same: groceries cost more; clothing costs more; your car costs more. You work harder every year for less purchasing power.

The solution, from the LP’s perspective, is to eliminate inflation. However, doing so would cause the millions of Americans on credit cards extreme hardship - banks, to maintain profits, would increase interest rates, causing undue hardship on American people. One way that some in the LP would like to fix inflation is by bringing back the gold standard. Unfortunately, bringing back the gold standard would cause extreme deflation (gold is currently selling for $668.90/ounce, so basing the dollar on gold would require fewer dollars on the market), which, as the article notes, would cause severe hardship - since the price of everything would go down, profits would go down, people would lose jobs, and anyone that’s borrowing money would be in dire straights.

I have other issues with the Libertarian Party’s platform as well… stay tuned.

Why Metal Standards Don’t Work

This post is inspired by the following article on TCS Daily titled “What Roosevelt Didn’t Know”. The crux of the article is about how policy makers and economists reacted to the Great Depression in the early 1930s and how, if they had the same access to economic indicators that we have today, they would have behaved very differently. One section, however, that really caught my attention was the following:

The Meaning and Effects of Deflation

Inflation is a general decline in the purchasing power of money. Deflation is a general increase in the purchasing power of money.

It is easy to confuse general inflation or deflation with a change in the relative prices of goods. Thus, a spike in gasoline prices might be mis-labeled as inflation, while a drop in the price of wheat might be mis-labeled as deflation. A genuine inflation involves rising prices in most goods and services.

Inflations tend to be good for borrowers and bad for lenders — at least at first. In the early 1970’s, mortgage rates of 8 percent looked pretty steep to homebuyers. However, inflation accelerated later in the decade, and mortgage borrowers did really well, paying back their loans in much-cheaper dollars. Lenders, on the other hand, were crushed, with many going out of business between 1978 and 1982.

Conversely, deflations tend to be bad for borrowers. The farmer who borrows today to plant a crop for harvesting in six months cannot repay the loan if prices fall during the meantime.

Lenders can protect themselves from inflation, but borrowers cannot protect themselves from deflation. When lenders see inflation taking place, they can charge higher interest rates, and they can make loans for shorter periods of time. When borrowers see deflation taking place, they do not have the ability to demand appropriately low interest rates, because the appropriate interest rate might be less than zero. Lenders will hold onto money rather than lend it at negative interest rates.

Irving Fisher understood this. Even today, among economists, the relationship between inflation and interest rates is known as the Fisher effect.

So, what does this have to do with metal standards and why do I feel compelled to touch on this issue? Before I answer that question, let’s clear up something:

What is a metal standard?

Some of you may already know this - a metal standard is when you base your currency on metals, usually gold or silver. Back in the day, this meant that you could take a dollar (or pound, franc, mark, whatever) and get a predefined measure of gold or silver from a bank; the British Pound got its name because 1 British Pound used to be worth precisely 1 pound of silver. There are some benefits to a metallic standard:

- Conversions between metallic standard currencies is relatively easy; simply convert between currency A to the mineral it’s backed on, then convert from that metal to the equivalent worth of currency B, which is also based on the same metal.
- A government cannot simply print more money, thus preventing extreme inflation. Since the currency is based on a particular tangible product, the government can only print enough currency to buy the amount of that tangible product that the government has.
- It’s easy for people to understand and relate to. People trust gold a lot more than they trust the government, and they understand that gold has value because it’s gold. Why is a dollar worth something? It’s just a colorful piece of paper, right?

However, there are some big problems with metallic standards. The big two are:

1. A currency based on a metallic standard is basing its worth not on the value of the economy in which it’s used, but instead on the value of a metal which may or may not be produced in that economy.
2. A government cannot simply print more money.

To fully understand these two issues, let’s pretend the United States decided, for whatever reason, to base the dollar on oil. Oil has a tangible value - there’s a finite amount of it, it has economic worth (we use it for fuel), it’s portable (I wouldn’t want any in my pocket, mind you), and everyone understands oil. However, as everyone knows, the value of oil can go up or down, often at the whim of countries quite hostile to the United States. Consequently, if the United States decided to enact an oil standard, the dollar would be at the whim of regimes with hostile intent that could inflate or devalue the dollar (by increasing or decreasing the supply of oil, respectively), which could severely disrupt the economy, and there would be nothing the United States government could do about it. If a hostile country started buying all of our currency to increase the value of the dollar, thus making our exports cost more overseas, could we print more money to counteract that, thus stabilizing prices? No - the amount of dollars we produce would be fixed to the amount of oil those dollars are worth. The only way we could print more dollars would be if we produced more oil, which would not be economically feasible if the cost of producing that unit of oil on which the dollar was based was greater than $1.

More on this tomorrow.