Powerful Government Forces suppressing the Economic Principles of Friedrich Hayek in China and America

Posted by PITHOCRATES - November 16th, 2013

Week in Review

Large governments like to control their economies.  And their people.  Because those in power always want one thing.  More power. 

The United States became the world’s number one economic power before the federal government grew into the thing it is today.  Way too big.  Reaching way too far into the private sector economy.  Before Keynesian economics became all the rage to empower the growth of governments there was classical economics.  With simple principles.  Thrift.  People thought long-term and saved their money instead of buying everything they wanted today.  Banks collected their savings and transformed them into investment capital.  The more people saved (i.e., the thriftier they were) the more capital there was available to loan to entrepreneurs.  Thus lowering interest rates.  There was also sound money.  Backed by gold.  In various forms of the gold standard.  That held the value of money over time.  And the federal government taxed little.  Regulated little.  And spent little.  These classical economic principles stimulated strong economic growth.  (Principles similar to the Austrian school of economics championed by Friedrich Hayek.)  And it is these principles that we have moved away from as we turned to Keynesian economics.  And a form of state-capitalism that we have today.

During the Nineties China turned to classical economic principles.  As they slowly allowed people some economic liberty.  But just a taste of it.  For the ruling Chinese communists did not want what happened during the collapse of the Soviet Union to happen in China.  The Chinese Communist Party would not collapse like it did in the former Soviet Union.  While there were free thinkers that embraced the principles of Friedrich Hayek the state kept them on a short leash.  A leash that appears to be even shorter these days (see A Lonely Passion: China’s Followers of Friedrich A. Hayek by DIDI KIRSTEN TATLOW published 10/30/2013 on The New York Times).

Hayek believed that economic planning by the state leads to a loss of individual liberty, and that a private economy run by people whose rights are protected and enlarged by good laws delivers the best life.

‘‘There is some distance between Hayek and the current realities’’ in China, Gao Quanxi, a prominent Chinese Hayekian and law professor at Beihang University in Beijing, said in an interview this week.

Mr. Gao was probably choosing his words carefully. The gap is enormous, as he explained last Friday in a talk at the Unirule Institute of Economics, a think tank in Beijing…

In his talk, titled ‘‘Reconsidering Hayek’s Theoretical Legacy,’’ Mr. Gao did not mince words: China is less free now than 10 years ago, at the end of the Jiang Zemin era. There is no ‘‘free market of ideas’’ in universities. Publishing on topics the authorities disapprove of has become more difficult. The state is on the march…

Capitalism, several participants said, functions in China according to the unwritten rules created by the power holders, not by good laws, as Hayek urged.

‘‘Communism has failed. Socialism has failed. What we have here is statism. And Hayek really opposed that. So how should we understand Hayek in the context of today’s China?’’ asked Mr. Gao…

Many economists, scholars and politicians believe that China is facing deep challenges to its economic model, that it needs to shift from a fixed investment-fueled economy, where the hand of the state is heavy, to one with more private enterprise and market forces.

President Obama and the Chinese communists share something in common.  They both are trying to move their economies in the same direction.  Only the Chinese communists don’t publicly bash capitalism as much as President Obama and his fellow Democrats do.

When China was enjoying double digit GDP growth the liberals in the United States wanted to do what the Chinese were doing.  To manage the economy more.  As they thought they were even more brilliant than communist state planners in China.  And could even outperform the Chinese economy.  If they could only control it.  Decide what we make.  Like solar panels.  And electric cars.  Of course, most of China’s economic growth produced exports.  And they sold well because of China’s low wages.  Which is pretty much all they had going for them.  Their middle class did not grow.  And with the worldwide decline in economic activity thanks to Keynesian economic policies by state planners everywhere who think they are smarter than the market their export market cooled.  As it cooled so did their GDP growth.

China is suffering a little economic malaise now because they don’t have a thriving middle class of entrepreneurs starting small businesses.  All they have are large state-run factories.  That produce exports.  Because they don’t have a thriving middle class to buy these products.  Which is what happens when you don’t have individual liberty.  Friedrich Hayek understood this.  Pity the Chinese communists don’t.  Or President Obama and his fellow Democrats.  Then again, perhaps they do.  But they know the price of individual liberty is less government power.  And that’s just something anathema to communists.  President Obama.  And Democrats.

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Keynesian Economics

Posted by PITHOCRATES - October 14th, 2013

Economics 101

(Originally published February 20th, 2012)

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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The Greatest Threat to an Oppressive Dictatorship is Free Market Capitalism

Posted by PITHOCRATES - September 22nd, 2013

Week in Review

When people enter economic exchanges voluntarily everybody wins.  For example, let’s say one person has a hundred dollars of spare cash.  And another person owns a mountain bicycle that sells for $350 new.  The one with the money wants to buy a mountain bicycle.  The one with the mountain bicycle needs cash and wants to sell the bike. These two people meet.  And exchange the $100 for the bicycle.  And both walk away with something they valued more.  The person originally with the $100 valued the bicycle more than the $100.  And the person originally with the bicycle valued the $100 more than the bicycle.  Each person wins in this voluntary economic exchange.

Now contrast that to a managed economy.  Where a few decide for everyone else.  Such as in socialism.  Or communism.  Say, in the former Soviet Union.  Where the economic planners decide to make more tractor parts and less toilet paper and laundry detergent.  Resulting in shelves full of tractor parts no one wanted to buy.  And empty shelves where there was once toilet paper and laundry detergent.  As you can see, when you have forced economic exchanges no one wins.

Countries with economic systems based on free market capitalism where people enter economic exchanges voluntarily have historically had the highest standards of living.  Whereas countries with managed economic systems have had the lowest standards of living.  Liberty and prosperity are synonymous with the United Kingdom, the United States, Canada, Australia and Hong Kong.  Which were once all part of the British Empire.  Which ruled the world and kept the peace for a hundred years or so.  The Pax Britannica.  She was able to do this because of her wealth.  Generated from free market capitalism.  The rule of law.  Representative government.  Sound money.  And free trade.  Things that today give these nations immigration problems.  Because everyone wants to go to these nations for a better life.

In capitalist nations people live better because there is a profit incentive.  Whereas the countries these immigrants left typically put people before profits.  Where instead of letting market forces set prices and allocate limited resources that have alternative uses the government decides.  Like they did in the former Soviet Union.  And the more government interferes with these market forces the more these economic decisions become political.  Where friends of the ruling power get those limited resources first and at favorable prices.  Allowing them and the ruling powers to profit handsomely from this political favoritism.  At the expense of the people who have to do with less.

The profit incentive puts people first.  Because in free market capitalism market forces are the people.  Hundreds of millions of people coming together to make voluntary economic exchanges.  Where each individual person looks out for his or her best interests.  But when a ‘caring’ government manages the economy to put the people first that government interferes with those market forces.  And goes against the will of the people.  Making the people worse off.  Which is why immigration is always from a country where there is less free market capitalism to a country where there is more free market capitalism.  Because the quality of life increases with increasing amounts of capitalism.  So we should be careful what we ask for when we ask to put people first.  Even when the Pope joins the ‘put the people first’ choir (see Pope condemns idolatry of cash in capitalism by Lizzy Davies posted 9/22/2013 on theguardian).

Pope Francis has called for a global economic system that puts people and not “an idol called money” at its heart, drawing on the hardship of his immigrant family as he sympathised with unemployed workers in a part of Italy that has suffered greatly from the recession…

“Where there is no work, there is no dignity,” he said, in ad-libbed remarks after listening to three locals, including an unemployed worker who spoke of how joblessness “weakens the spirit”. But the problem went far beyond the Italian island, said Francis, who has called for wholesale reform of the financial system…

Sardinia, one of Italy’s autonomous regions with a population of 1.6 million, has suffered particularly badly during the economic crisis, with an unemployment rate of 20%, eight points higher than the national average, and youth unemployment of 51%.

Last summer the island’s hardship became national news when Stefano Meletti, a 49-year-old miner, slashed his wrists on television during a protest aimed at keeping the Carbosulcis coal mine open.

There was one other thing these nations born of the British Empire shared.  Judeo-Christian values.  They lived by the Ten Commandments.  And the Golden Rule.  The good Christians of the British Empire followed the teachings of Christ.  “Do unto others as you would have them do unto you.”  These Judeo-Christian values went hand-in-hand with free market capitalism.  It’s what made us choose to live by the rule of law.  To honor the contracts we made with one another.  To voluntarily enter economic exchanges instead of just stealing and pillaging our neighbors.

Money doesn’t have value.  It’s a temporary storage of value.  It is our human capital that has value.  Our ability to create things that have value.  Things that other people will voluntarily enter into economic exchanges to trade for with things of value they created.  Whether it be a physical good.  Or money from a paycheck they earned creating value for an employer who uses it to produce a service or good.

Capitalists don’t worship money.  For money only makes those economic exchanges more efficient.  By eliminating the search costs of the barter system.  It’s human capital that capitalists are interested in.  This is what they worship.  People.  Unlocking the latent talent in all of us.  To bring incredible things into existence.  Sanitation.  Waste water treatment plants.  New farming advancements.  Coal-fired power plants.  Things that allowed greater groups of people to live together in growing cities.  Where we have food, clean water and shelter.  Things we take for granted in capitalists nations.  Things that are luxuries in North Korea.  An anti-capitalist country that puts people before profits.  Where people worship the ruling dictator (primarily to avoid imprisonment, torture and death).  And the only people that do well are those close to the ruling power.

We don’t need a new financial system.  We just need to return to what it was before governments intervened into the free market economy to put people first.  Before we completely forget the Ten Commandments.  And the Golden Rule.  For once we use the power of government to nullify contracts to help their crony friends we no longer have a nation of laws.  But one of political favors.  Where the friends of power do well.  While those with no power live at the mercy of those in power.

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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - September 17th, 2013

History 101

(Originally published June 11th, 2013)

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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Say’s Law

Posted by PITHOCRATES - September 2nd, 2013

Economics 101

(originally published August 6, 2012)

Keynesians believe if you Build Demand Economic Activity will Follow

People hate catching a common cold.  And have long wanted a cure for the common cold.  For a long time.  For hundreds of years.  But no one had ever filled this incredible demand.  All this time doctors and scientists still haven’t been able to figure that one out.  Despite knowing with that incredible demand, and our patent rights, whoever does figure that one out will become richer than Bill Gates.  Which is quite the incentive for figuring out the ingredients to make one little pill.  So why hasn’t anyone found the cure for the common cold?

There are many reasons.  But let’s just ignore them.  Like a Keynesian economist ignores a lot of things in their economic formulas.  In fact, let’s try and enter the head of some Keynesian economists.  And have them answer the question why there isn’t a cure for the common cold.  Based on their economic analysis you might hear them say that we have a cure for the common cold.  Because a high demand makes anything happen.  Or you might hear them say we don’t have a cure because enough people haven’t caught a cold yet.  And that we need to get more people to catch colds so we increase the demand for a cure.

Keynesians believe if you build demand economic activity will follow.  Like in that movie where they build a baseball diamond in a cornfield and those dead baseball players come back to play on it.  So Keynesians believe in government spending.  And love stimulus spending.  As well as taxing people to give their money to other people to spend.  Because having money to spend stimulates demand.  Consumers will consume things.  And increase consumption.  So suppliers will bring more things to market.  And create more jobs to meet that consumption demand.  Unless people save that money.  Which is something Keynesians hate.  Because saving reduces consumption.   Which is about the worst thing you could do in the universe of Keynesian economics.  Save money.  For in that universe spending trumps saving.  In fact, spending trumps everything.  No matter how you create that spending.  Keynesians actually believe taxing people so they can pay other people to dig a ditch and then fill that ditch back in stimulates economic activity.  Because these ditch diggers/fillers will take their paycheck and spend it.

Today People wait Anxiously for the next Apple Release to Learn what the Next Thing is that they Must Have

Of course there is a problem with this economic theory.  When you take money away from others they haven’t created new economic activity.  They just transferred that spending to someone else.  The people who earned that money spend less while the people who didn’t earn it spend more.  It’s a wash.  Some spending goes down.  While some spending goes up.  Actually there is a net loss in economic activity.  Because that money has to pass through government hands.  Where some of it sticks.  Because bureaucrats have to eat, too.  So the people receiving this money don’t receive as much as what was taxed away.  So Keynesian stimulus doesn’t really stimulate.  It actually reduces economic activity from what it might have been.  Because of the government’s cut.

And it gets worse.  Because this consumption demand doesn’t really create jobs.  We get nothing new out of it.  What do people demand?  Things they see.  Things they know about.  For it is hard to demand something that doesn’t exist.  You see a commercial for another incredible Apple product and you want it.  Thanks to some great advertising that explained why you must have it.  In other words, when you give money to people all they will do is buy things they’ve always wanted.  Things that already exist.  Old stuff.  It’s sort of the chicken and the egg thing.  Which came first?  Wanting something?  Or the thing that people want?

Raising taxes on Apple to create a more egalitarian society by redistributing their wealth will let people buy more of the old stuff.  But it won’t help Apple create more new things to bring to market.  Things we don’t even know about yet.  If we tax them so much that it leaves little left for them to invest in research and development how are they going to develop new things?  Things we don’t even know about yet?  Things that we will learn that we must have?  Once upon a time no one was asking for portable cassette players.  Then Sony came out with the Walkman.  And everyone had to have one.  Once upon a time there were no MP3 players.  No smartphones.  No tablet computers.  Now people must have these things.  After their manufacturers told us why we must have them.  Today people wait anxiously for the next Apple release to learn what the next thing is that they must have.

Say’s Law states that Supply Creates Demand

Supply leads demand.  We can’t ask for the unknown.  We can only ask for what the market has shown us.  Which is why Keynesian economics doesn’t work.  Because focusing on demand doesn’t work.  Giving people money to spend doesn’t stimulate creativity in the market place.  Because that money was taxed out of the market place.   Reducing profits.  Leaving less for businesses to invest into research and development.  And reducing their incentive to take big risks to bring the next big thing to market.  Like a phone you can talk to and ask questions.  Again something no one was demanding.  But now it’s something everyone wants.

Jean-Baptiste Say (1767–1832) was a French economist.  Another brilliant French mind that contributed to the Enlightenment.  And helped advance Western Civilization.  He observed how supply led demand.  Understood production was key in the economy.  He knew to create economic activity you had to focus on the producers.  Not the consumers.  Because if we encourage brilliant minds to bring brilliant things to market the demand will follow.  As history has shown.  And continues to show.  Every time a high-tech company brings something new to market that they have to explain to us before we realize we must have it.  Or said in another way, supply creates demand.  A little law of economics that we call Say’s law.

If Keynesian economics worked no one would have to have a job.  The government could print money for everyone.  And the people could take their government dollars and consume whatever was in the market place.  Which, of course, would be pretty sparse if no one worked.  If there were no Steve Jobs out there thinking of brilliant things to bring to market.  Because supply creates demand.  Demand doesn’t create supply.  For fists full of money won’t stimulate any economic activity if there is nothing to buy.  So using Keynesian stimulus as a cure for a recession is about as effective as someone’s homemade cure for the common cold.  You take the homemade concoction and in a week or two it cures you.  Of course, the cold just ran its course.  Which is how recessions end.  After they run their course.  Which can be a short course if there isn’t too much Keynesian intervention.

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North Korea Manufactures and Sells Meth to Chinese addicts to bring Hard Currency into the Country

Posted by PITHOCRATES - August 25th, 2013

Week in Review

Keynesian economists, and those on the left, think there is nothing wrong with printing money.  Because they don’t understand money.  What it truly is.  So what is money?  It’s a temporary storage of wealth.  It is not wealth.  Doctors make a lot of money because they have learned great skills.  Skills few people have.  And doctors are willing to exchange these skills for money.  The wealth is a doctor’s skills.  The money temporarily holds this wealth until the doctor finds something to trade that money for.  From someone else that has wealth.  Who created something of value the doctor is willing to trade for.

All money did was make this trading of valuable things easier.  So we could trade with anyone even if they don’t want anything we can make or do.  A doctor doesn’t have to find someone who wants their gallbladder removed who has a television set if the doctor wants a television set.  The doctor can just go to a store and buy one.  Because of money.  Making the exchange of goods and services far easier than in a barter system.

Those who think money is wealth and that we should just print it and hand it out to the people are missing one very important point.  If you did this no one would have to work.  Those on the left would applaud that.  But if no one worked there would be no valuable things to trade.  And if there are no valuable things to trade then your money is worthless.  For if there is nothing to buy what good is having money?

North Korea has a lot of money.  But their money is worthless.  Because they just print it.  While their economy contains no valuable things to trade.  Not a big problem in a closed economy.  And you make your people slaves.  But it’s a problem if you want to trade with the outside world for the luxury items the lucky few in the ruling elite enjoy.  For if you have no valuable things in your economy then you must trade for valuable things with hard currency.  Money that isn’t worthless paper.  So North Korea came up with a way to get hard currency (see How North Korea got itself hooked on meth by Max Fisher published 8/21/2013 on The Washington Post).

A new study published in the journal North Korea Review says that parts of North Korea are experiencing a crystal meth “epidemic,” with an “upsurge” of recreational meth use and accompanying addiction in the country’s northern provinces…

So how do people in North Korea, a country where markets are so tightly regulated that even video CDs can be considered dangerous contraband and where social controls are often beyond Orwellian, manage to get hold of meth..?

The problem actually goes back to the 1990s, when North Korea experienced a famine so devastating that virtually the entire world believed the country would collapse at any moment. But it didn’t, in part because Pyongyang finally decided to open up the world’s most closed economy just a small crack, by allowing a degree of black market trade across North Korea’s border with China. The idea was that the black market would bring in food, which it did, preventing North Korea’s implosion.

The black market trade into China has remained that little bit open ever since, either because Pyongyang authorities can’t close it now or because they see some trade as beneficial, probably both. Some provinces along the border have seen their economies liberalize a tiny, tiny bit — most notably North Hamgyung, which is named in the North Korea Review report as particularly blighted by meth addiction.

In the years after the border with China opened that little crack, two other things have happened that led to the current meth crisis. First, medicine ran out and the once-not-terrible health system collapsed — more on this later. Second, North Korea started manufacturing meth in big state-run labs. The country badly needs hard currency and has almost no legitimate international trade. But it was able to exploit the black market trade across the Chinese border by sending state-made meth into China and bringing back the money of Chinese addicts.

This is where things started to spin out of control for North Korea. The state-run meth factories and the cross-border black market trade started to mingle. And some of that meth ended up migrating back across the border and into North Korea, through the black market trade that brings in Chinese rice and DVDs and the like.

This is where the collapse of the North Korean health system becomes relevant. As Isaac Stone Fish reported in a great 2011 Newsweek story, many regular North Koreans started using meth to treat health problems. Real medicine is extremely scarce in the country. But meth is much more common, which means that the prices of medical drugs are artificially inflated, while the price of meth is artificially low. In a culture without much health education and lots of emphasis on traditional remedies, people were ready to believe that meth would do the trick for their medical problems, and many got addicted.

Poor Chinese.  First the British got them addicted to opium.  Then North Korea got them addicted to meth.  It appears the Chinese people are nothing but pawns in the game of international trade.

Back in the days of mercantile Britain trade was all about who collected the most hard currency.  Basically gold and silver in those days.  The British loved Chinese tea.  And were filling ships full of the stuff to bring it back to Britain.  The problem was that the Chinese didn’t want anything the British were selling.  So Chinese goods were flowing to Britain.  But no British goods were flowing to China.  And without having exports to offset imports Britain was forced to trade the only thing they had that China wanted.  Their hard currency.  Their silver.  So Chinese goods flowed out of china.  And Britain’s hard currency flowed out of Britain.  So China was accumulating piles of hard currency while Britain saw their piles diminish.  Which was the exact opposite mercantile Britain wanted.  So they did something about it.  Thanks to India.

India was part of the British Empire.  And she grew opium poppies.  Something some Chinese did want.  So the British used this opium demand to stop the flow of hard currency out of the empire.  And traded Indian opium for Chinese tea.  This solved the trade deficit problem.  But it created a lot of addicts in China.  The addiction problem got so bad that it spawned two wars.  The Opium Wars.  Which did not end well for China.  And things did not get better in the century or so that followed.  And now here is North Korea.  Turning Chinese into addicts to get hard currency out of China (and into North Korea).  Just like the British did.  Of course, North Korea is nothing like the mighty British Empire.  So one would believe that China is allowing this addiction problem to happen.  As it is probably a smaller price to pay than the refugee problem should North Korea collapse.  And they may like that North Korean buffer between them and South Korea.  Japan.  And the United States.

North Korea is everything the left would like to have in the United States.  Tightly regulated markets.  National health care.  No rich people accumulating private property.  Where they frown on profits.  The even put people before profits.  Just like liberals want to do.  There’s no talk radio.  No Rush Limbaugh.  No Fox News.  No free trade.  No low-cost imports to undermine union manufacturing.  No obesity.  Because there is no junk food.  And no 32 ounce sugary beverages.  And a government that can do what is right for the people without having to worry about a Tea Party challenger in the next primary election.  North Korea is liberal nirvana.  Yet life there is horrible and wretched.  Because it’s everything liberals want.  But nothing the people want.

Liberals want to keep expanding government.  To have more government intervention into the free market.  But where does it end?  How far do they want to take things towards North Korea before they say they have enough?  And why anyone should worry about this is because as horrible and wretched life is in North Korea, those in the ruling elite have it pretty darn good.  Because the people in charge of these regimes never suffer like the people outside of the ruling elite.  So the farther they move towards North Korea the less they have to worry about an election taking away their comfy life.  This is why we should worry about a government growing larger.  For throughout world history life like that in North Korea has been the norm.  While life like that in the United States has been the exception.  And the United States has only been around for 225 years (counting from the ratification of the U.S. Constitution).  A crazy new fad the entitled ruling elite (i.e., liberals) would like to do away with.  So they can rule like they did in the good old days.  Much like they do today in North Korea.  Where the supreme ruler, Kim Jong-un, has an obesity problem.  One of the few in North Korea that isn’t gripped with a gnawing hunger every minute of every day.  This is life in a country where the ruling elite hates capitalism.  And puts people before profits.  This liberal nirvana.  Those in power live well.  While everyone else suffers.

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Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 12th, 2013

Economics 101

(Originally published August 27th, 2012)

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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Roman Denarius, New World Gold and Silver, American Continental and German Mark

Posted by PITHOCRATES - June 25th, 2013

History 101

Money that is not Scarce is a Poor Temporary Storage of Wealth

They say money doesn’t grow on trees.  And it’s a good thing it doesn’t.  For money is a temporary storage of wealth.  It temporarily stores value.  And one if its attributes is that it has to be scarce.  For example, let’s say you are a highly skilled tomato grower.  And you work in your garden 12 hours each day weeding, fertilizing, watering, tying, pruning, etc., your many fields of tomato plants.  Producing beautiful tomatoes that everyone just loves.  You love your tomatoes so much that you actually gave up your day job to grow them full time.  And support your family with the proceeds from selling your tomatoes.  Which you will exchange with others for money.  Provided that money is scarce.  And will hold the value of your tomatoes.  Until you can exchange that money for something you want.

Now let’s assume money grows on trees.  Anyone can plant one in their backyard.  And it grows like a weed.  That is, you don’t have to fertilize it or water it or do anything else for it.  And anytime you want something you just walk to your money tree and pick the bills you need.  We would never have to work again if we all had money trees in our backyard.  Wouldn’t that be great?  Or would it?  What would happen if everyone quit working because they, too, had a money tree in their backyard?  If no one worked then there would be nothing to buy with the money from your money tree.

But there is another problem.  If everyone had a money tree there would be such much money in circulation that it would no longer be scarce.  And if it’s not scarce it isn’t money.  It isn’t a temporary storage of wealth.  It won’t temporarily store value.  Because someone that has something of value, say delicious tomatoes, won’t want to trade them for something that he or she can just pick off of his own money tree.  Instead, he or she would rather trade those tomatoes for something that does have value.  Like, say, mozzarella cheese.  So a skilled cheese-maker and the skilled tomato-grower can meet to trade things of value with each other.  Tomatoes and mozzarella cheese.  And then each can make a delicious Caprese salad.  Which also has value.  Unlike money that grows on trees that anybody can pick whenever they want to.  Filling the world with people with lots of money but nothing to buy.  Because no one works to grow or make anything.

When Spain brought back New World Gold and Silver it unleashed Inflation in the Old World

For anything to be money it must be scarce.  Just think of the laws of supply and demand.  If there are droughts all summer long farmers have smaller harvests.  Which raises the price of what they bring to market.  Because demand is greater than the supply.  If there was a great growing season they have bumper crops.  Which lowers the price of what they bring to market.  Because supply is greater than demand.  So the scarcer something is the more valuable it is.  And so it is with money.

The main Roman coin was the silver denarius.  As the Roman Empire reached its zenith her borders stopped moving out.  The Roman legions stopped conquering new lands.  And without new conquest there were no spoils to send back to Rome.  So the Romans had to raise taxes to pay for the cost of empire.  The administration of it.  The protection of it.  And a growing welfare state to keep the people content.  To help with these great expenditures they began to debase the denarius.  Mixing more and more lead into the coin.  Reducing the silver content.  So they could make more coins with the available silver.  Thus making these coins less scarce.  And less valuable.  Unleashing an inflation so bad that it devalued the denarius so much that no amount of them could buy anything.   Eventually even the Roman government would refuse to accept it in payment of taxes.  Demanding gold instead.  Or payment in kind.

When Spain arrived in the New World they found a lot of gold and silver.  Which Europeans used as money in the Old World.  The Spanish brought so much gold and silver back to the Old World that it greatly expanded the money supply.  Making gold and silver less scarce.  And less valuable.  Requiring more of it to buy the things it once bought.  So prices rose.  Because of the inflation of the money supply.

The War Reparations the Versailles Treaty imposed on Germany led to their Hyperinflation

During the American Revolution there was little specie (i.e., gold and silver coin) in the colonies.  As wars are expensive this made it difficult to finance the war.  The Continental Congress asked for contributions from the states.  And could only hope the states would give them some money.  For they had no taxing powers.  But they never were able to raise enough money.  So they borrowed what they could.  And then started printing paper money.  The continental.  But they printed so many of them that they were far from scarce.  The massive inflation devalued the continental so much that it created the expression “not worth a continental.”  Which meant something was absolutely worthless.  The people would refuse to accept them as legal tender from the Continental Army because they were worthless pieces of paper.  So the army took what they needed from the people.  And gave them IOUs that Congress would settle at some later date.

The Germans paid for World War I by borrowing money.  The increased debt of the nation during the war devalued the currency.  The German mark.  It took more and more of them to exchange for stronger currencies.  Like the U.S. dollar.  The Versailles Treaty that ended the war saddled Germany with the responsibility for the war.  And made them pay enormous amounts of war reparations.  In gold.  Or foreign currency.  So the Germans turned up the printing presses.  And printed marks like there was no tomorrow.  Making them less scarce.  And worth less.  It took more and more of them to exchange for foreign currency to make their reparation payments.  But they didn’t care what the exchange rate was.  For whatever amount of devalued marks they needed to exchange they just turned to their printing presses.  And printed whatever they needed.  This rapid inflation devalued the mark more.  Requiring them to print more.  Which just fed into the inflation.  Eventually bringing on a hyperinflation where it took enormous amounts of marks to buy anything.  For example, it was cheaper and easier to burn marks than it was to buy firewood to burn.

Anytime you make money less scarce you make it worth less.  The inflation of the money supply devalues the currency.  Which raises prices.  Because it takes more of the devalued currency to buy what it once did before the inflation.  So expanding the money supply leads to price inflation.  Good if you’re a rich investor.  But if you’re someone just trying to buy firewood to keep from freezing to death during the winter?  Not so good.  The Romans, the Europeans, the Americans and the Germans all suffered from bad inflation.  Some worse than others.  If the inflation is so bad, such as in the case of hyperinflation, people may lose all confidence in the currency.  And simply stop using it.  Going to a barter system instead.  Like when a tomato-grower trades his tomatoes for a cheese-maker’s mozzarella cheese.

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Currencies, Exchange Rates and the Gold Standard

Posted by PITHOCRATES - June 17th, 2013

Economics 101

Money is a Temporary Storage of Value that has no Intrinsic Value

Giant container ships ply the world’s oceans bringing us a lot of neat stuff.  Big televisions.  Smartphones.  Laptop computers.  Tablet computers.  The hardware for our cable and satellite TVs.  Toasters.  Toaster ovens.  Mixers and blenders.  And everything else we have in our homes and in our lives.  Things that make our lives better.  And make it more enjoyable.  These things have value.  We give them value.  Some have more value to one than another.  But these are things that have value to us.  And because they have value to us they have value to the people that made them.  Who used their human capital to create things that other people wanted.  And would trade for them.

When we first started trading we bartered with others.  Trading things for other things.  But as the economy grew more complex it took a lot of time to find someone who had what you wanted AND you had what they wanted.  So we developed money.  A temporary storage of value.  So we could trade the valuable things we created for money.  That money held the value of what we created temporarily while we looked for something that we wanted.  Then we exchanged the money we got earlier for something someone had.  It was just like trading our thing for someone else’s thing.  Only instead of spending weeks, months even years meeting hundreds of thousands of people trying to find that perfect match we only needed to meet two people.  One that exchanges money for the thing we have that they want.  And another who has what we want that they will exchange for our money.  Then that person would do the same with the money they got from us.  As did everyone else who brought things to market.  And those who came to market with money to buy what others brought.

Money is a temporary storage of value.  Money itself doesn’t have any intrinsic value.  Consider that container ship full of those wonderful items.  Now, which would you rather have as permanent fixtures in your house?  Those wonderful things?  Or boxes of money that just sit in your house?  You’d want the wonderful things.  And if you had a box of money you would exchange it (i.e., go out shopping) for those wonderful things.  Because boxes of money aren’t any fun.  It’s what you can exchange that money for that can be a lot of fun.

Devaluing your Currency boosts Exports by making those Goods less Expensive to the Outside World

So there is a lot of value on one of those container ships.  Let’s take all of that value out of the ship and place it on a balancing scale.  Figuratively, of course.  Now the owner of that stuff wants to trade it for other stuff.  But how much value does this stuff really have?  Well, let’s assume the owner is willing to exchange it all for one metric ton of gold.  Because gold is pretty valuable, too.  People will trade other things for gold.  So if we put 1 metric ton of gold on the other side of the balancing scale (figuratively, of course) the scale will balance.  Because to the owner all of that stuff and one metric ton has the same value.  Of course moving a metric ton of gold is not easy.  And it’s very risky.  So, instead of gold what else can we put on that scale?  Well, we can move dollars electronically via computer networks.  That would be a lot easier than moving gold.  So let’s put dollars on the other side of that scale.  Figuratively, of course.  How many will we need?  Well, today gold is worth approximately $1,380/troy ounce.  So after some dimensional analysis we can convert that metric ton into 32,150 troy ounces.  And at $1,380/troy ounce that metric ton of gold comes to approximately $44.4 million.  So that container ship full of wonderful stuff will balance on a scale with $44.4 million on the other side.  Or 1 metric ton of gold.  In the eyes of the owner they all have the same value.

Moving money electronically is the easiest and quickest manner of exchanging money for ships full of goods.  These ships go to many countries.  And not all of them use American dollars.  But we can calculate what amounts of foreign currency will balance the value of that ship.  Or one metric ton of gold.  By using foreign exchange rates.  Which tell us the value of one currency in another currency.  Something that comes in pretty handy.  For when, say, an American manufacturer sells their goods they want American dollars.  Not British pounds.  Danish kroner.  Or Russian rubles.  For American manufacturers are in the United States of America.  They buy their materials in American dollars.  They pay their employees in American dollars.  Who pay their bills in American dollars.  Go shopping with American dollars.  Etc.  For everyday American transactions the British pound, for example, would be un-useable.  What these American manufacturers want, then, are American dollars.  So before a foreigner can buy these American exports they must first exchange their foreign currencies for American dollars.  We can get an idea of this by considering that container ship full of valuable stuff.  By showing what it would cost other nations.  The following table shows a sampling of foreign exchange rates and the exchanged foreign currency for that $44.4 million.

foreign currencies and exchange rates

If we take the US dollars and the Exchanged Currency for each row and place them on either side of a balancing scale the scale will balance.  Figuratively, of course.  Meaning these currencies have the same value.  And we can exchange either side of that scale for that container ship full of valuable stuff.  Or for that metric ton of gold.  Why are there such large differences in some of these exchange rates?  Primarily because of a nation’s monetary policy.  Many nations manipulate their currency for various reasons.  Some nations give their people a lot of government benefits they pay for by printing money.  Which devalues their currency.  Some nations purposely devalue their currency to boost their export sector.  As the more currency you get in exchange for your currency the more of these exports you can buy.  Most of China’s great economic growth came from their export sector.  Which they helped along by devaluing their currency.  This boosted exports by making those goods less expensive to the outside world.  But the weakened yuan made domestic goods more expensive.  Because it took more of them to buy the same things they once did.  Raising the cost of living for the ordinary Chinese.

The Gold Standard made Free Trade Fair Trade

Some economists, Keynesians, approve of printing a lot of money to lower interest rates.  And for the government to spend.  They think this will increase economic activity.  Well, keeping interest rates artificially low will encourage more people to buy homes.  But because they are devaluing the currency to keep those interest rates artificially low housing prices rise.  Because when you devalue your currency you cause price inflation.  But it’s just not house prices that rise.  Prices throughout the economy rise.  The greater the inflation rate (i.e., the rate at which you increase the money supply) the higher prices rise.  And the less your money will buy.  While the currencies at the top of this table will have exchange rates that don’t vary much those at the bottom of the table may.  Especially countries that like to print money.  Like Argentina.  Where the inflation is so bad at times that Argentineans try to exchange their currency for foreign currencies that hold their value longer.  Or try to spend their Argentine pesos as quickly as possible.  Buying things that will hold their value longer than the Argentine peso.

Because printing fiat money is easy a lot of nations print it.  A lot of it.  People living in these countries are stuck with a rapidly depreciating currency.  But international traders aren’t.  If a country prints so much money that their exchange rate changes every few minutes international traders aren’t going to want their currency.  Because a country can’t do much with a foreign currency other than buy exports with it from that country.  A sum of highly depreciated foreign currency won’t buy as much this hour as it did last hour.  Which forces an international trader to quickly spend this money before it loses too much of its value.  (Some nations will basically barter.  They will exchange their exports for another country’s exports based on the current exchange rate.  So that they don’t hold onto the devalued foreign currency at all.)  But if the currency is just too volatile they may demand another currency instead.  Like the British pound, the euro or the American dollar.  Because these stronger currencies will hold their value longer.  So they’ll buy this hour what they bought last hour.  Or yesterday.  Or last week.  There is less risk holding on to these stronger currencies because Britain, the European Central Bank and the United States aren’t printing as much of their money as these nations with highly devalued currencies are printing of theirs.

This is the advantage of gold.  Countries can’t print gold.  It takes an enormous expense to bring new gold to the world’s gold supply.  It’s not easy.  So the value of the gold is very stable.  While some nations may devalue their currencies they can’t devalue gold.  A nation printing too much money may suffer from hyperinflation.  Reducing their exchange rate close to zero.  And when you divide by a number approaching zero the resulting amount of currency required for the exchange approaches infinity.  Weimar Germany suffered hyperinflation.  It was so bad that it took so much money to buy firewood that it was easier and less expensive to burn the currency instead.  This is the danger of a government having the ability to print money at will.  But if that same country can come up with a metric ton of gold that person with the container ship full of wonderful stuff would gladly trade it for that gold.  Even though that person will not trade it for that country’s currency.  This was the basis of the gold standard in international trade.  When nations backed their currencies with gold.  And kept them exchangeable for gold.  Forcing nations to maintain stable currencies.  By maintaining an official exchange rate between their currency and gold.  If that nation devalued its currency the market exchange rate will start to move away from the official exchange rate.  For example, say the official rate was $40/troy ounce.  But because they printed so much of their currency they devalued it to where it took $80 to buy a troy ounce on the open market.  So a nation could take $80 dollars of that devalued currency and exchange it for 2 troy ounces of gold from that nation.  The official exchange rate forcing the nation to give away 2 troy ounces of gold for $80 when the real market exchange rate would only have given them 1 troy ounce.  So devaluing your currency would cause gold to flow out of your country.  And the only way to stop it would be to decrease the size of your money supply.  Undoing the previous inflation.  To bring the market exchange rate back to the official exchange rate.  Which is why the gold standard worked so well for international trade.  Nations could not manipulate their currency to get a trade advantage over another nation.  Making free trade fair trade.  Something few say today.  Thanks to currency manipulators like China.

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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - June 11th, 2013

History 101

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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