Wednesday, 25 March 2009

So when exactly will the dollar collapse?

It seems that many economists are predicting the collapse of the US dollar. The argument goes something like this: The U.S. government is in huge debt. It maintains its borrowings by selling bonds. These bonds have to compete on the open market with other types of investments, so they have to offer a competitive balance of interest rate, security (against default) and protection against inflation. At the moment, the US is clinging on to the edge of the cliff for some rather temporary reasons...
  1. People are still holding on to the (perhaps irrational) belief that the U.S. government could never conceivably default on its bonds and so the "risk premium" the US needs to offer on the bonds is negligible.
  2. The rest of the world is in such a dire state that they don't know where else to put their money.
  3. There is not much (obvious) inflation in the US.
Now many of the people who believe in the Armageddon scenario are being ridiculed by others who point to the relative strength of the dollar compared to so many other countries. But these three conditions can not remain favorable forever. I have been thinking about when exactly the dollar bubble will burst and it just occurred to me that there will be an upper limit - and that is when the first few countries start to pull out of this recession. As soon as that happens then there will be a new place for investors to put their money. The result of this is that US bonds will now have a serious competitor and the only way that the US can compete would be to raise the interest on their bonds... now this would quickly become very painful for the US and all their options would be horrid... they would fall off the cliff.

This is of course just an upper limit... the dollar collapse could be triggered before then at almost any time... including tomorrow.

Friday, 20 March 2009

The Pensions Casino - an alternative.

Until recently, I had very little idea of how pensions worked, but when I looked into it carefully, I realized it was enforced gambling! And the more I thought about it the more I realized how incredibly unfair and stupid the entire pensions system was. The reason it is so bad is that there are so many ways your pension could be dramatically bigger or dramatically smaller than you planned for, in ways that you can not reasonably control. To illustrate this consider two people born 5 years apart. Lets call them Mr Lucky (the older man) and Mr Unlucky. Let us imagine that they are both equally conscientious, equally hard working, equally intelligent (averagely intelligent), equally everything.

Now Mr Lucky starts his working life and starts saving towards his pension. Just by chance, this is at a time which is the end of a recession when stock prices are low. He's already off to a good start because his early pensions investments are likely to rise nicely.

5 years later Mr Unlucky starts his working life. He does a similar job, and saves the same fraction of his income toward his pension. Unfortunately now is the beginning of a stock bubble. His early pensions investments will turn out to be a disaster.

For several decades to come both men have investments in the stock market at the same time. Unfortunately Mr Unlucky's fund manager was not as financially savvy as Mr Lucky's. This was not really his fault - neither men are financial experts. How can anyone possibly expect your average man in the street to determine the different skill levels of two different fund managers? They can't. Mr Unlucky's fund gradually drifts even further behind Mr Lucky's... but it doesn't stop there...

The fund managers make their choices based on their knowledge of the markets and the fundamentals. However, a sizable component of the variability of stock prices are things that no fund manager could be expected to prepare for. Things like earthquakes, floods, political assassinations, industrial accidents etc... and you've guessed it - the floods and earthquakes just happened to be to the benefit of Mr Lucky's stocks and Mr Unlucky's fund manager's stock selections get badly hit, so his pension fund falls even further behind... and it doesn't stop there...

Now we come to retirement time... and would you believe it, Mr Lucky retires at the peak of another bubble... and oh dear, Mr Unlucky retires at the depths of a recession.

So there you have it - two similar guys doing similar jobs, saving similar fractions of their wages towards their retirements and yet their retirement incomes could be hugely different, based entirely on luck... is that fair? Is that how we want the system to work? Personally I find it extremely stressful worrying about my pension - am I going to be lucky or unlucky? What should I do? Should I just save way more than I really need just in case I'm unlucky? Or should I scrimp on my pension hoping I get lucky, then simply carry on working longer if I get unlucky?

Note that there two types of random variability between pensioners. One type is between pensioners of the same age. Lets call this stock selection variability. Another type is concerned with the start and end times of pensioners saving period. Call this bubble timing variability. Now bubble timing variability will affect entire age groups of pensioners, some of them having miserable retirements others having good ones.

Now of course the people who really pay (or rather, "pay back") for old people in their retirement are working people. These wild fluctuations in pensions are inefficient for us workers. We feel sorry for Mr Unlucky when we see him on the TV in some documentary about old people not being able to afford their heating bills. While at the same time cursing that we have to work so hard to support Mr Lucky who seems to have superfluous wealth. Just imagine if you applied the same pensions system in your own home... imagine you have your old grandma and grandpa living with you. They've both worked hard all their lives... now at dinner time you serve grandma a feast of the finest foods and champagne, while you give your grandpa a slice of bread and a glass of water. They say "what did we do to deserve this?" and you have to remind them that grandma thought Ebay was a great idea and grandpa liked Betamax. Now you may say that this is simply how life is - if you get lucky then you do better in life if you're unlucky then you do worse. But that's not true in all aspects of life, and people can usually select the degree of risk they want to take. If you want to be a professional stock broker then you may get rich or you may go bust -it goes with the territory. People choose to be stockbrokers. Nobody who loses on the stock market ever says "gee, nobody told me there was any risk involved". But we can choose to take a less risky career. Say you become employed as a plumber. there's not much risk in that. If business gets bed then, you can always retrain as something else. There's no chance of ever suddenly being wiped out as a plumber. So you see there are some choices in our working lives which are inherently risky and some inherently safe. Now when it come to designing a pensions system, is it so obvious that we should select a mechanism so full of risk? I think not. I think its possible to design an inherently safe mechanism.

Now the first characteristic I wanted for my system is that people who save more in their working lives should get more - and roughly speaking if you save twice as much as the average guy in your working life then you should get twice as much in your retirement.

The second characteristic of the system is that people must be forced to save for at least a minimum standard of living in retirement. Now some people may say "how dare you take away our freedom! Its up to us to individually decide what we save for retirement". To which I would say, "but not saving throughout your life puts a blatantly unfair burden on the rest of society when you retire. We can't just stand by and watch you become homeless and starve. We'll be forced to give you a certain minimum standard of living for free". I would also add that the amount we are forced to save for retirement will be very small. Just enough so that you could have a bare minimum quality of life.

My system to achieve all these things is the following:

The government invent a new type of tax (but of course we don't want to call it a tax!), call this compulsory elderly-support. Say its X%. This is the minimum. People can optionally also put whatever extra they want in to the elderly-support system. The continuous flow of elderly-support money that comes in from workers is used to pay money to the retired. Note that this is all happening at one instant - there is no pretense that some investment is being put in storage for future use. Its plain and simply workers-now-support-retired-people-now. So the next question is how to apportion the money - this is where we need to do a little mathematical jiggery pokery. The money is not distributed evenly amongst retired people, instead it is (roughly speaking) distributed in proportion to the amount of money those retired people fed in to the elderly-support system during their working lives. The maths required to achieve this is not trivial, but it is certainly doable.

So what are the advantages of this system?
  • Nobody is being forced to predict the stock market. People who save similar amounts will be similarly comfortable in their retirements.
  • If a country develops well and has a boom, then the retired population will automatically benefit from the boom.
  • If the country has a recession then retired people will take their share of the burden, rather than requiring an unbearably large fraction of the now-poorer nations GDP.
  • The whole system will be far more predictable for pensioners, workers and government.

Thursday, 19 March 2009

My predictions...

OK, just for fun I am going to make a set of predictions so that in a few years time you can all look back and laugh at how wrong I was.

I predict the the price of Gold, as measured in Chinese Yuan, will rise dramatically then fall again over the next few years and end up lower than it is now. I say measured in Chinese Yuan because I think that will be the worlds most stable currency over the coming years.

I predict that the dollar will lose at least 30% of its value against the Chinese Yuan over the next few years, but the change in rates will be very uneven, there will be a sudden drop over a very short period.

I predict that the average U.S. and Chinese hourly incomes will move dramatically closer together. I think the gap will halve.

I think that the GDP of China will overtake that of the US within 5 years.

I think the tax rates in both the US and UK for the better off will be forced to rise significantly.

I think that the interest rates offered by the US for their government bonds will, at some point, at least double from where they are today.

I predict that the average PE ratio of the companies in the Dow Jones index will fall to about 7ish.

I predict the price of oil will be three times as high in five years time as it is now even when adjusted for inflation.

I predict unemployment in the US and UK will rise to 15%.

I Predict that the contribution to the GDP of the UK of the banking sector will be reduced to less than 20% - even after the recession.

Ditch the dollar.

The pressure is building. I think the dollar bubble is going to burst. The U.N. Commission of Experts on International Financial Reform are about to recommend that governments worldwide ditch the dollar as their reserve currency.

P.S. The original title of this blog entry was "Ditch the dollar?"... but on reflection I think the question mark is inappropriate!

Wednesday, 18 March 2009

Global Warming - a recent development.

Global warming, and the degree to which it is man-made will have and is already having a huge impact on the course of the world economy....

First off, I should say that for most of the past 20 years I have been a firm believer in man made global warming. Not because I was any great authority on the science of it, but more because, as a scientist myself, I am included to go along with the consensus opinion of scientists unless there is very good evidence presented to the contrary. All the arguments about the financial motivations of the scientists (for or against man-made global warming) did not influence me. Also the opinions of non-scientists, journalists and politicians held no sway whatsoever. Then when I saw the "great global warming swindle" my beliefs were shaken. I was no instant convert to the other side, but it alerted me that perhaps I should look in to this.... which I duly did. After some research I gradually realized that most of what the "swindle" program was saying was either misleading or downright wrong. My faith in the mainstream view was restored... but then, when I was looking in to the subject in even more detail I came across this lecture (on video: part1, part2) by Dr Roy Spencer given in March 2008. This lecture blew me away. It seems that the climate modelers have entirely omitted a very important phenomena which I don't think they have corrected to this day. Dr Spencer believes that if these factors are added to the climate models then the effects of our added carbon dioxide are dramatically reduced. By the way Dr Spencer does not believe that global warming is not happening, he simply believes that the man-made component of it is much smaller than previously thought. Two extra aspects of this have made me more inclined to believe his views. 1. His work is relatively recent. If it was much older then I would be inclined to dismiss it because the IPCC et al would have already considered it in detail and if it was found to be correct then they would already have changed their opinions. and 2. I can not find anything anywhere giving reasons his data or his arguments are wrong. When I saw his lecture, the very first thing I did was to do a Google search on him, confidently expecting to see him described as some kind of nutcase and to find articles describing the flaws in his logic - but was amazed to find no such thing. What I find equally amazing is how few people have watched the video - only 2400 at the time of writing.

So in summary, global warming is happening and will cause mankind huge problems... but we may not have to feel so guilty about it!

Friday, 13 March 2009

Wen Jiabao, "a little bit worried" about U.S. defaulting.

China's Premier Wen Jiabao has just been speaking at a news conference. I wrote down some of his words...

"Of course we are concerned about the safety of our assets. To be honest I'm a little bit worried, and I would like to, through you, call on the United states to honor its word and stay a credible nation and ensure the safety of Chinese assets".

Obviously the Premier was nervous because he had read my earlier blog entry.

Now the reason I think it is so significant the Wen Jiabao has publicly stated that he is worried about ability of the U.S. to pay its debts is because of something called the "risk premium". Everyone knows that when banks lend to high risk (usually poor) people that stand a higher than normal risk of not paying back then what they do is to charge a higher rate of interest. The "extra" part of the interest being to cover the risk of not getting the money back. Now currently the U.S. borrows money (to finance its great debts) from abroad, by issuing bonds. The bonds are really a statement saying "Give me your $X now, and I'll pay you back $X+bonus% later". Now the bonus% has to be high enough to A) be competitive with interest available elsewhere through other investments AND B) has to be high enough to compensate potential customers for their perceived risk of not getting their money back. So of course the higher the perceived risk the higher the effective interest rate the U.S. has to pay on its borrowings.

Now look again at the table at the bottom of my earlier blog entry... Scared? You should be!

Thursday, 12 March 2009

Exactly why does the bursting of an asset bubble cause a recession?

I think it is well known that after a big asset bubble bursts, there often follows a recession. But why should that be? One could argue that, the bubble bursts - a bunch of people lose some money - after a few tears, its back to work and we all continue as before. Why doesn't that happen? This is what I think...

In this earlier post I explain how the price P people are willing to pay for goods G is a function of how "painful" it is to have our monetary wealth reduced by P. Now at the peak of a bubble, there will be a lot of people who (incorrectly) think that their current monetary wealth (e.g. their cash + their perceived sale value of their assets) is very high. So, correspondingly, the perceived pain in having their wealth reduced by P is low. Therefor they will merrily pay P for that G. Or to put it another way, why bother thinking long and hard about buying that new car because I'm rich as I'm the owner of a valuable house that I can use to fund my retirement... "Heck - I barely ever need to save ever again!".... Now comes that bubble bursting - the house never was that valuable - it was all a charade - the houses were only "valuable" because people thought that their price was going to continue to rise forever - the fundamental, true, value was way lower. Now let's reconsider that price P. Again we have to consider how much "pain" is caused by the loss of wealth, P. Now its all different - the same P is looking like a far bigger fraction of your existing wealth. The size of that financial buffer between where you are now, and poverty, is going to have shrunk dramatically. Therefor the size P that you are willing to pay for G has correspondingly shrunk dramatically. Or in other words it has become more painful to depart with your money... or... you are going to try and spend less if at all possible. Now this is not much of a problem globally if it was only a relatively small group of people that were duped by the bubble. The overall reluctance to spend will be small. The real trouble comes if A) a large number of people got duped and B) the size of the bubble was large, i.e. the peak price of the asset was way bigger then the logical price. If many people got stung badly by the bubble-burst then the global reluctance to spend can trigger a self fulfilling cycle or recession (as described here). This is what is happening right now - a huge number of people in many countries were tied up in this bubble, so there is correspondingly, a widespread reluctance to spend... and through self fulfilling feedback, the "widespread" reluctance has grown to an almost universal reluctance.

Give us free trade!

George Bush, and capitalists everywhere... say "we want free trade - remove the barriers!"
They chant it like a mantra.

Give us free trade... remove the barriers!
Give us free trade... remove the barriers!
Give us free trade... remove the barriers!
Give us free trade... remove the barriers!
Give us free trade... remove the barriers!

OK... lets give them what they want (in several steps) and see how they like it.

Lets say we are God and we can arrange all the following things...

Step 1. all china's legal barriers to trade are removed.

Happier now?

Step 2. all the U.S. trade barriers are correspondingly removed.

Happier now?

Step 3. God re-arranges the continents and slides China over the earths surface so that its touching America.

Happier now?

Step 4. God rearranges the shapes of both countries like two interlocking combs so that all parts of America are within easy commuting or transportation distance from China.

Happier now?

Step 5. Legal barriers are lowered so that workers from each country can cross the borders in to the other and work in each others factories.

That's just about the freest trade you can get.

They must be ecstatic!

Now tell me what's going to happen to your average wages compared to the Chinese?

....still ecstatic?

Wednesday, 11 March 2009

How NOT to think of a trillion.

I've seen a lot of people jumping up and down about how big some of these numbers are in this crisis. I've seen people say that if you stacked up the bills they'd reach the moon or circle the globe and all that. See here for an example. But actually this irritates me because it serves no purpose in making the numbers more understandable. The thing is that there are already some massive numbers that could be reported from an economy that are not indicative of anything abnormal. I dare say that the number of cups of coffee drunk by Americans each year is a massive number that most people would not be able to visualize very well. So what should we do when faced with these "massive" numbers. Well a better thing to do is divide them by the number of people in the country to get perhaps the debt per person. But I think its possible to do one step better than that. What we should really do is divide by the number of workers in a country. After all, retired people aren't going to be paying back any of this debt. And neither are children. Now you may say "aha, but children will grow up to be workers, so the debt will fall on them"... this is true, but as children become workers, workers become retired people (approximately). So the burden of debt is always on the workers.

So lets do the math for American government debt. I'm guessing that about half the population are workers at any one time. Assuming 11 trillion debt and 300 million population (=150 million workers) then the debt per worker is 11,000,000,000,000/150,000,000 = $73,333.

Now lets have a look at how much would need to be paid in interest alone on
$73,333.... of course the interest rates could change at any time, so I'll make a table...

So, if the interest rate on the money is the figure on the left then each worker in the U.S. will be paying the figure on the right just to pay the interest.... that's before even paying pack one cent of the actual debt itself. And of course this is totally separate from the tax you have to pay the government for its "ordinary" expenditure.

So to start properly paying this money back - the government will have to raise enough taxes to pay for all their (non-debt related) expenditure. Then add the figure on the right. Then add another chunk to start reducing the debt (how about $2000 per year?).... Is Obama brave enough to do that?... or will the U.S. just decide to default? It's got to be one or the other eventually.

A great article

I just came across an article that gives such a clear overview of the current crisis that I'm just going to put a link here and encourage people to read it: More debt wont rescue the great American ponzi. Oh, and for anyone who doesn't know the word "Ponzi" yet, take a look at the Wikipedia entry here.

Tuesday, 10 March 2009

A blog "un-entry"

Just a note to say that I deleted my blog entry "List of countries by current account balance?" because someone posted a reply which revealed my ignorance on a certain matter. And presumably nobody wants to read about stuff that's clearly wrong (or do they?). Anyway, having my misconceptions corrected is half of what this blog is for - so I'm happy.

100% mortgages? Not a problem!

Over and over again I hear people claiming that a big part of the current crisis was that banks were giving people 100% mortgages... but I think they are missing the point. I think it should have been no problem at all to have given people 120% mortgages - if their income was high and the house was cheap. The vastly more important thing to measure is the income multiplier! Having a high income multiplier is dangerous because that's what really tells you the chances of default in the long term. Having a high income multiplier for your mortgage is like living on the edge of a cliff - the slightest rise in interest rates and suddenly you're in trouble.

Now had people all been talking about income multipliers instead of the erroneous "100% mortgages", then they may have noticed that in the long term the income multiplier has historically been around 3 to 3.5. And it only rises above that in bubbles.

According to the Halifax, the typical income multiplier for houses sold recently in the UK is 4.42, so if anyone asks me how much more the UK house prices will go down, I would say down in the ratio 4.42 to 3.25-ish... so that's about 25% more to go from where it is today.

Finally - I just had a quick look at the Halifax historical data and saw that the multiplier reached 5.84 in July 2007. How on earth did any economist or banker not know that this was a massive speculative bubble?

Below is a chart showing what percentage of your income would be required just to pay the interest on your loan, given a 5.84 income multiplier, should the mortgage rates become the values in the left hand column.

Sunday, 8 March 2009

Return to the gold standard?

I have been hearing two things about gold a lot recently...
  1. Gold keeps its value in the long term.
  2. Therefor gold should be used as a peg for currencies - "the gold standard".
Now I do absolutely agree with point 1. In the long term gold has kept its value very well. This is in large part because it the quantity of it in existence is very restricted. However I would not agree with statement 2 at all. The problem is that whilst golds long term value has been very constant, its short or medium term value has varied all over the place. The reason for this is that it is a popular target for speculation, in fact it's value is largely dominated by speculation. Its price can become temporarily very high purely because of the belief that it will go even higher - this is a self feeding phenomena leading to great booms followed by busts... mark my words - just watch what happens to the price of gold when (or shortly before) this recession finally comes to an end (which may be some time) - it's price will come crashing down.

So one may ask, how can we keep the value of a currency stable? I think the answer is obvious - ditch the ridiculous, unstable, out of control, fractional reserve currency system and instead arrange to have a fixed quantity of money in an economy. This way a currency will only vary with the productivity of the nation. There is no need to peg it to anything in order for it to be stable. Instigating this plan could be achieved in a variety of ways, the only real obstacle being the political will to do it.

Some people, when faced with the thought of a fixed quantity of money in an economy seem to think that it would somehow "stunt growth" because "you need more money if you're ever going to pay for the ever increasing output of an economy" - but this argument is entirely fallacious. Money continuously adjusts its own value.

How will the current crisis come to an end? and how bad will it get?

If person X thinks that their future financial state is probably going to be worse than it is now then there is only one course of action they can take. They will try to avoid spending on stuff they don't really need. And the more worried they are the harder they will try. The effect of this is that a person Y who makes the goods, that X is now avoiding buying, will be out of a job. The effect of Y losing his job will be to prevent him from being able to buy all sorts of things that he used to buy, and to an even greater degree than someone who has a job but is simply "worried". Not only that, but the fact of Y losing his job will scare people in to thinking its more likely they will lose their jobs... and so on and so on.

Notice that the jobs that are lost are the ones producing stuff that people easily cut back on. If your job is to grow basic food stuffs then you are safe. As long as there are social security systems in place then nobody will be cutting back on food. The people I feel most sorry for are poor people who's job it is to make frivolous stuff that people don't really need at all. They will be the first ones out of a job.

Now one may ask how does it ever come to an end? And the answer lies in the bold text in the very first sentence in this blog entry. People have to be worried that its going to be worse in the future. Now when everyone who manufactures stuff that people don't really need has lost their jobs then the news reports are going to change from "the economy is a disaster and thousands more people lost their jobs" to "the economy is a disaster but not many more more people lost their jobs". When people hear this, then although they may be in a poor financial state, they will at least start to assume that the future is not going to be significantly worse than the present. Then they will be able to make more normalized decisions about spending their money. There will no longer need to be any cutbacks "just in case". This will be the turning point and things will start getting better from there on in. The bad news is that one hell of a lot of people will have lost their jobs. In the past, the proportion of goods that were made, that could be considered luxuries-people-will-readily-cut-back-on, was much smaller that it is today. Nowadays this fraction is so large that the loss of the jobs making those things will be huge. I predict that we will see unemployment rates of 20% or more in great swathes of the world before things get any better.

Please tell me I'm wrong.

"Supply and demand" - we can do better than that.

My pet interest in macroeconomics is the value of money. Now it seems that economists everywhere are queuing up to give lectures about how various phenomena will change the value of money. But if one dares ask the question "yes, but what is the money worth in the first place?" then you will be greeted by a stunned silence... or perhaps a feeble recourse to "well its all supply and demand innit". Well I'm not satisfied by this answer - it doesn't tell me very much, and I don't believe we need be so vague. I will suggest an improvement...

Supply and demand is an expression used to determine what price someone will pay for some product. Now when someone makes this choice, lets consider what they are gaining and losing. They are gaining the product which presumably they desire (otherwise they wouldn't even be thinking about buying it!) and they are losing some money. Now lets consider this win and loss a bit more mathematically... say we have a function W_gt(G,t) which expresses our feelings of wellbeing due to being the owner of a collection of goods G at time t. We can also have a similar function W_mt(M,t) which expresses our feelings of wellbeing due to being the owner of an amount of money M at time t. Then when we are faced with a purchasing decision to buy X at cost C at time t, when we already own goods G and we start with money M, the equation we use is:

Buy if: W_gt(G+X,t)+W_mt(M-C,t) > W_gt(G,t)+W_mt(M,t)

Now this is getting more interesting... these functions can be modeled using artificial intelligence and built in to a simulated "population". The simulation would then finally give us an answer to my original question and actually tell use what assorted goods will cost in terms of whatever money there is in the model economy.

A potential glitch... you may realize that actually W_mt() is in itself a function of the value of money. You see that if you have 10,000 shekels then your level of wellbeing will be dependent on what 10,000 shekels will buy. Now you may think that - all I've done is produced a circular argument which can never be resolved, but this is not the case. Its simply a dynamical systems problem that will need multiple iterations (i.e. a long simulated time to pass) in order for prices to reach an equilibrium. The simulation will have to start out with some random prices and then watch how they later converge towards a stable value.

Now it just so happens that my "day job" is that of an artificial intelligence programmer and I'm on the case!

P.S. please note that the change in well being due to the ownership of a new item X at time t is [W_gt(G+X,t) - W_gt(G,t)] and not simply something like W(X). The additional terms G and t in the function are to allow for effects like the fact that probably the greatest determinant of how much happier you will be made by gaining product X is whether or not you own one already!... If you already have a fridge why buy another, even if its a bargain? Then the "t" may come in to play for many different reasons, for example the desirability of some products may vary with the seasons.

P.P.S. Once you have a better grasp of the starting value of money, you would of course have a much better grasp of exactly how various phenomena would change the value of money. So perhaps you could make more accurate predictions than the "queue of economists" who attempt to make such predictions without even knowing what money is worth in the first place.

Update 12 Sept 2009: After a couple of false starts I have finally got down to some programming and have a small model economy up and running on my PC. There are an awful lot of factors that need to be got right before the system behaves in an orderly manner and I am not happy with the results yet. But watch this space.

Update 23 Oct 2009: Simulations going better. For the first time I have managed to get a model economy in which the value of money stabilizes.

Mick's law of savings - a thought experiment

Following on from my earlier post "Savings" - what they are and what they're not I'd like to propose Mick's law of savings and illustrate how it can not be broken, with a thought experiment.

Mick's law of savings - "Savings are a zero sum game, you can't have everyone save at the same time".

Now, an immediate counter argument to this law would be the following - "surely there is nothing to stop everyone is a society keeping a pile of spare cash under the mattress - therefore everyone is saving therefore Mick's law is FALSE - QED". Now my answer to this would be that it is an imagined or artificial form of saving that will not work. And to illustrate why I have developed the following thought experiment:

Imagine that it has been arranged that 10,000 sterile people that are all 20 years old are placed on an island that is separated from the rest of the world. Each one is given a sum of money to trade with. When they get to the island each person specializes making whatever it is that they have the skills to make and they all trade with each other using the money that they were given. Now imagine a particular islander, lets call him Tom. Say he is a carpenter and makes stuff out of wood to trade with other people for food and whatever else he needs to live. One day he has a thought, he realizes that when he becomes elderly, he's going to be weaker and slow down. He won't be able to make so much stuff that he can trade for food etc. So he decides to save a certain fraction of his money earnings under the mattress for his old age. Let us also imagine that Tom is the only person that had this realization and he didn't tell anyone else. Now fast forward a few decades... Tom is now 80 years old (as are all the other islanders). Tom is now in a much better state than the rest of the population. He can use his saved money to buy extra stuff to make sure he can keep his standard of living just as high as it was when he was younger. This state of affairs is all fine and Mick's law of savings has not been broken because only one person on the island was saving.

Now lets try and break Mick's law...

In this scenario Tom has the same realization about his old age, but this time he tells everyone else. This time everyone on the island decides to save for their old age. They're all worried that when they slow down they won't be able to keep up their standard of living unless they save.... now you can imagine what's coming... fast forward a few decades... now everyone is 80 years old. everyone has slowed down and is producing less stuff per day. Its easy to see that on average everyone's standard of living has gone down in old age. Everyone thought they were saving to prop-up their future lifestyles - but they were deluding themselves. They were trying to break Mick's law... but failed.

Who can get the world economy moving again.. and who can't.

First of all lets consider who can't get the economy moving again... and the answer to this is most western nations! The reason is that broadly speaking western nations are in the following state:

  • They already have plenty of good quality stuff (roads, cars, trains, fridges, washing machines, Hoovers, TV's etc.)
  • They owe other countries a stack of money.
  • They are worried that if they spend unnecessarily then they will get in to even more debt and may struggle to pay it back (especially because of interest payments).
Now if you approach people in that state and say "pleeease go and buy some more stuff" (which is exactly what western governments are all doing) then you will obviously get an extremely negative response. There is fundamentally going to be a lot of resistance to the idea - and for good reason.

Now lets consider who can get the economy moving again... and the answer to this is China! The reason is that broadly speaking China is in the following state:

  • They don't already have plenty of good quality stuff (roads, cars, trains, fridges, washing machines, Hoovers, TV's etc.)
  • They don't owe other countries a stack of money - quite the opposite - they are sitting on a mountain of I.O.U.'s (of various kinds) from other countries.
  • They are not worried that if they spend unnecessarily then they will get in to even more debt and may struggle to pay it back.
Now if you approach people in that state and say "please go and buy some more stuff" then its not so clear they should resist. Sure they may prefer to have a nice big pile of I.O.U.'s from the rest of the world... but they're not going to come to that much harm at all if they use some of it up... even a big chunk of it. If I were Barak Obama or Gordon Brown, I'd be straight on the phone to Wen Jiabao begging him, saying "pleeease buy some of our western goods!!". This is a great opportunity for the huge masses of poor Chinese people to raise their standard of living while simultaniously helping the world economy.

Why don't I see this idea being discussed in the media? have I got something wrong?

Saturday, 7 March 2009

My favorite sources of information about macroeconomics

Max Keiser - at first glance he seems like a comedian... but don't let that fool you - he knows his stuff and has absolutely top class guests on his regular shows.

Peter Schiff talks a lot of sense.

Marketplacevideos is an excellent source for information about those very technical things like credit default swaps.

Paj Holden... maybe not as slick as my other sources, but if you'd like some free lectures on erm... "conventional" economics then this is a good place to look.

Hyperinflation - why hasn't it started yet?

Right now, most people seem to be worrying about deflation while others (Notably, Peter Schiff) are worrying about hyperinflation. The arguments go like this:

Deflation: People have so little "confidence" in the future right now that they are unwilling to spend their money. This causes retailers to lower their prices to tempt the reluctant customers to buy their stuff.

Hyperinflation: The central banks are being forced to print so much money (for a variety of reasons) that the purchasing power of each of the dollars or pounds can only reduce.

So far, in reality, what we seem to be observing is neither (neither remarkably high nor low)... but how can that be if the central banks are printing so much money? The answer is tied to the money creation mechanism, so called "fractional reserve banking". If you don't know exactly what this term means, then please watch this brilliant cartoon right now. Once you understand this mechanism you should be able to see that, if the overall flow of money(with respect to banks) is predominantly a process of the banks customers paying back money the had borrowed earlier (as opposed to taking out new loans), then there will be a large amount of money disappearing out of existence.... by the way, if at this point you think that the idea of money disappearing out of existence is crazy, then either you didn't watch the cartoon, or you never fully understood fractional reserve banking.

At the moment, the forced reduction of prices due to lack of confidence combined with the disappearing out of existence of money, seems to be a larger effect than the (otherwise inflationary) process of printing money.

Its not obvious to me what's going to happen in the long run. But I'm writing this blog entry because I haven't seen reports elsewhere discussing the disappearing out of existence of money when people are paying back more than they are taking on new borrowings. Did Peter Schiff miss it... or did I miss something? Please comment on this and tell me!

"Savings" - what they are and what they're not.

I believe that most people have a shorthand model of "savings" in their minds which goes, very crudely, something like this:

I work in a factory producing "stuff".... if I want to "save" then instead of consuming my "stuff" right now, I will put it aside in a huge warehouse where it will be stored, so that when a rainy day comes in the future I can go to the warehouse where I will find my "stuff" has been preserved in pristine condition ready for me to consume at some point in the future.

Now we all know that it doesn't work exactly like this... but many people feel its a good approximation to work with. The problem with this mental picture is that it leads to some important false conclusions....

False conclusion 1. Everyone can save.
False conclusion 2. Savings are safe.

Now to explain why both conclusions are false we have to consider what savings really are:

I work in a factory producing "stuff"... if I want to "save" I have to find a second person to make an agreement with. The agreement is that I give him some of the "stuff" I have just made for him to consume immediately. In return for this he promises that at some point in the future (when a rainy day comes) he will then make some new "stuff" in his factory and give it to me to consume.

From this truer model of savings it should be obvious that not everyone can save at the same time! Savings are in fact a zero sum game! It should also be obvious that if the person you made the savings agreement with has lost his job or his factory burnt down, then your "savings" will have vanished.