10/23/13 Inflate Away!
Some suggest we can inflate our way out of debt. That is, repay loans with currency worth less than the currency borrowed. While this seems to work in theory, does it work in practice? The US saw double-digit inflation throughout the 1970s yet we were deeper in debt by decade's end. Maybe we did it wrong, or maybe the theory is wrong.
Inflation results from increasing the ratio of currency supply to production. In our fiat money, fractional reserve banking system the currency supply increases by increasing lending, which is to say increasing debt. So the theory is you can get out of debt through inflation which you get by increasing debt. Or more succinctly, you reduce debt by increasing debt. Seems to be a disconnect there.
Maybe inflating away debt doesn't work so well in theory after all. Or as Yogi Berra is supposed to have said, "In theory there's no difference between theory and practice. In practice there is."
8/28/13 Buy Now and Unsave!
Say you buy a new big screen TV for $1,000 with a credit card. What did it really cost? Add $60 sales tax (6% as per my area). So you charge $1,060 on your credit card. If you're carrying a substantial balance you might not get around to paying down this charge for a year. At 15% interest, that's $159 added. That thousand dollar TV cost you $1,219 in the end. Yep, you paid interest on the sales tax, too.
Think of how many things folks buy on credit: houses, cars, appliances, entertainment, clothes, education, and on and on. Heck, when you consider taxes only cover two-thirds of government spending and the rest is borrowed, we're even buying government on credit. It makes you wonder how much of the average person's income goes to paying interest on debt year-in year-out. Are we paying two percent? Five percent? Ten percent?
Here's a bit of back of the envelope figuring using rough figures. The average American household income is $50,000. The average household has $10,000 in credit card debt. The average credit card interest rate is 13%. That's $1,300 a year in interest. That's 2.5% of income. Or rather pre-tax income. More like 3.5% of take-home pay. Just for credit cards. Got a mortgage? How about a car loan? Maybe a student loan?
This leads to a pet theory. Who profits from this debt interest? Lenders, big banks, the rich. Which leads me to think the more consumer borrowing in the system the more money accumulates at the top. It could very well be continuously rising consumer debt funneling more and more interest payments to the financial sector is significantly behind the growing disparity of wealth. If interest takes 10% of everyone's income, is it any wonder the rich get richer?
Here's the thing, we piled on the debt willingly. As Pogo said, "We have met the enemy, and he is us."
1/10/13 Another Problem With GDP
Gross Domestic Product is supposed to measure what's produced in the country. This can't be done by counting what's made because every business makes different things, cars, cough drops, corn flakes, cartoons, and on and on. It's dramatically worse than comparing apples to oranges which proverbially can't be done.
To get a standard unit of measure all goods and services are converted to dollars, what they sell for. If you spend $20k on a new car, $20k worth of car production was done. If you get a $20 haircut, the barber did $20 worth of work. And so on. GDP is figured by totalling up the dollar amount of spending for production.
GDP = Consumption + Investment + Government + Exports - Imports
Let's just look at one part of this, consumption. If you buy a new house someone built a house. Clearly that's production. So you can add the sale to GDP as it represents the production of a house. No problem there.
Now then, if you buy a house built 50 years ago, is that production you can add to current GDP? Wasn't that production counted in GDP 50 years ago when it was first built and bought? Is the house built again when resold? How many times can the same house be produced?
Let's say we both own our homes outright, no mortgage. I sell you my house for $100k and you sell me your house for $100k. Together that's $200k in consumption spending added to GDP. Our net values are the same as before, there are no more houses than before. If GDP is supposed to count production, where's the production? Let's say the following year we sell each other our houses for $200k each. Our contribution to GDP doubles to $400k. Yet nothing has been produced. Does this make sense?
So I raise the question, does the resale of existing homes add to GDP. Which leads to another question, does the resale of any existing asset add to GDP. Are we measuring product or something else?
Let's take a sci-fi hypothetical. Imagine a race of plant people, Planties, who live off sunlight and rain. Let's say their entire economy consists of Planties buying and selling existing products to each other. There's a lot of money and goods changing hands, but not one new thing has been made for generations. No matter how fast they buy and sell, no new products are ever produced. It's all a zero sum game. What is their GDP?
I may not be an econ guru, but I suggest GDP is overstated by the total amount of resales. Meaning during the run-up in housing prices GDP was inflated by the increased prices of existing home sales which were really not adding to GDP. It was phony GDP. So I ask again, what good is GDP as currently calculated?
12/15/12 One Problem With GDP
There is a notion floating around that a natural disaster boosts gross domestic product (GDP). Just think of all that economic activity it takes to rebuild. Surely that's good for all the workers and businesses hired in the effort, right? Let's think about it.
No money was created by the disaster. Money spent replacing a destroyed building is money not available for something else. The rebuilding mostly diverts money from one thing to another. In which respect it's a wash as the money would have added to GDP in some other way. Unless you think that money would have gone forever unspent. Hardly likely.
Except it's not a wash, it's a loss. Had there been no disaster you could have had a building and built a second building, a net two buildings. With the disaster you lose one building and build one to replace it, a net one building. How is it you can invest the same amount in both cases, yet be ahead in one and behind in the other? Why is this not reflected in GDP?
GDP = Consumption + Investment + Government + Exports - Imports
Investments are things like building infrastructure, capital equipment, buildings and the like. This adds to GDP. Seems to me the reverse would also be true, destroying infrastructure, capital equipment, buildings and the like subtracts from GDP. What Hurricane Sandy destroyed should reduce GDP by that amount. It's simple math.
Therein lies one of the many flaws of GDP as a metric. They only add to investment, it's always positive. They never subtract lost investment. So if disasters were destroying infrastructure faster than you replace it, you could be increasing your GDP all the way to the poor house.
What is GDP telling us? What good is it? Mightn't it be better to calculate net domestic product? What good is increasing sales if the business operates at a loss? Is it good for an entire economy to do the same? This reminds me of the old line, "The operation was a success, but the patient died."
10/13/12 The ABCs Through J of Too Much Debt
As you may know, there's more total debt to GDP now than there's ever been. I'm talking about personal, business and government debt combined. Now then, debt has to be owed to someone, one person's debt is another's credit. You can't have one without the other, they're two sides of the same coin. To say there is too much debt must mean there is too much credit.
When a huge pile of debt is accumulated by people who can't afford it, folks with little to no credit and small incomes, then there must be gobs of credit piling up for people with comparatively little or no debt. This lopsided distribution of massive debt and credit is where we get trouble. I mean, if the debt were owed by the people with the credit it could be paid off in a trice.
For instance, say there are ten people, A through J. Each owes one person $100 and is owed $100 by a different person. Say A pays B $100, B takes that hundred bucks and pays C, C takes the c-note and pays D... and so on until J finally pays A $100. The money circulates round and round between debtors and creditors and everybody pays off everybody until no debt remains. Easy-peasy.
On the other hand, say A through I each owe $100 to J who doesn't owe anyone anything. Say A pays J $100, J takes the money and... that's it. Because the credit is concentrated in one place there is no circulation of money between debtors and creditors to pay down debt. All the while J is charging interest on all that debt. So B-I are getting deeper into the hole.
I suppose it would help get money in circulation if J starts spending like a drunken sailor. But how much of what A-I make or do can J use? If B runs a hamburger stand J can only eat so many burgers. More likely J is going to buy a Picasso from fellow rich person Z. Which doesn't do anything for A-I at all.
I suggest something like that is why economies often break down when there is a high concentration of credit, or wealth, at the top. I further suggest this is the situation today. What is the current solution employed by the powers that be? Print money and lend it to the government to buy up bad debts of Wall Street and stick taxpayers with the bill. At the same time enact a Zero Interest Rate Policy so savers lose money after inflation. In other words, increase the debt and reduce the credit of people with more debt than credit, while increasing the credit and reducing the debt of folks with more credit than debt.
My solution? Picassos for everyone! Makes no sense, you say. Does the other solution make sense?
9/14/12 Maturity Mismatch Mistake
Is there an inherent problem with fractional reserve banking of maturity mismatch? What the heck is maturity mismatch anyway? Does it have anything to do with old folks acting like children?
When you make a bank deposit the money is not stacked up or rolled up in those paper coin thingies and stuffed in a vault. The bank uses that money, lends it, and pays interest to the depositor. As paltry as that might be nowadays. While it might not seem like a loan, a bank deposit is a loan to the bank.
Maturity is the time frame of a loan, when it must be repaid in full, interest and principal. For instance, the maturity of a 30-year mortgage is 30 years, unsurprisingly enough. On the other hand, loans to the bank, deposits, can be withdrawn, paid back, on demand. There is no set time frame, or maturity. Because the money can be withdrawn at a moment's notice some say the loan term is zero days. (We'll ignore that there can't actually be a period of time equal to zero, which is no time at all.) In this case, the bank is borrowing short, zero days, and lending long, 30 years. They call this maturity mismatch.
Clearly zero doesn't match thirty. Can you borrow money and lend it out for 30 years and pay back the initial loan instantaneously? Obviously not. The maturity of the two loans are mismatched. You have made a promise that's impossible to keep. You have committed fraud. At least that's the theory of maturity mismatch.
All the same, are banks really borrowing short? I mean, how often do people deposit money in the bank for zero days? Don't most folks keep a balance in the bank for years? If you kept an average bank balance of $20,000 for 40 years, have you lent the money for zero days or for 40 years?
Depositors may withdraw their money from the bank at any time. Well, any time the bank is open. In practice they usually leave a balance in the bank for years or even decades. So the effective maturity period could be years or even decades, however long the account has money in it. Which means the term of the deposit is not zero, it is indefinite. Indefinitely may or may not match 30 years. Usually not, but you just don't know.
In which case there is no maturity mismatch in practice, only in theory, if the theory claims deposit terms are for zero days rather than indefinitely. (That's the maturity mismatch mistake referred to in the title.) However, if the theory posits the term of the deposit is indefinite you can't tell if there's a maturity mismatch or not until depositors take their money back.
Here's where it gets a little fuzzy. Banks don't loan against any particular deposit, but against the total deposits. A great number of folks are putting money in and taking money out all the time. What is the maturity of all these deposits? Is there any way to track it? Does it matter as long as the total remains for extended periods? If the money is not withdrawn the loans haven't matured. So where is the mismatch?
A bank might suffer maturity mismatch when depositors withdraw more money than the bank has reserves. The deposits mature at the moment of withdrawal, while the bank's loans are yet to be paid. This results in the classic bank run and the bank goes bust.
All this means the bank has not necessarily made a promise it can't keep. If it has over-promised on potential demand but not actual demand, is that fraud? If everyone who asks for it gets their money, where's the crime? Then again, bank runs can, and do, happen. So there is an inherent risk. But then, what loan doesn't carry risk?
There are plenty of things to criticize banks about these days. But worrying about maturity mismatch is the least of our problems. And for practical purposes not a problem at all.