We are governed by incompetents. They are so incompetent they do not even know what competency looks like.
Suppose the economy grows at 3%. Then just by controlling where that 3% is spent, the government can control the direction of the growth of the economy.
Of course, that is just the first approximation. The economy also undergoes change, which does not show up as growth, but investment compensating for depreciation and other asset consumption. This percentage must also be controlled. Further, what is destroyed must also be controlled. It can tax what it wants to destroy, and it can then spend the money to direct investment. This will cause the money to be spent in the direction the government deems desirable. The economy will then grow in the direction the government desires.
And it does this already. A government which is 20% GDP can’t help but direct the economy. That it does so inefficiently, and without much direction, merely means both it doesn’t understand what it is doing, and that some, or a lot, of the ‘growth’ is directed to waste.
What we are talking about is Gross private domestic investment, nonresidential. (Although the government could control the residential as well. It can tax larger mortgages, a graduated mortgage tax. It can tax the building of some houses, and subsidize the building of others.) Nonresidential gross private investment works out to be just under 10 percent of GDP. So by directing that 10 percent of the economy, the government can make it grow any way it desired, and provide any services desired. Well, any way desired that was sustainable. It could do this simply by subsidizing desired services, and taxing the crap out of any other investment.
Of course, it wouldn’t have to be so crude. It could be more measured, taxing according to degree of undesirability, subsidizing according to degree of desirability. If they wanted more health care, they would subsidize its production. Pay for more doctors, more nurses, more hospitals. If they wanted less concentration of wealth, they could tax it. More windmills, subsidize; fewer automobiles, tax. Less financial, tax. More manufacturing, subsudize.
Think this is heavy handed? Look at the ham handed government we have now. Look at the effects of its policy. It is 20% of the GDP, controls more, and what direction do we get from it? Instead of planning, we have special interests, pulling government investment this way and that. Financial has increased to 6%, with more profits than manufacturing. Manufacturing gets little support, and has been in decline for decades. Just 1% of our GDP goes to industrial equipment. That’s the stuff that goes into factories. In agriculture, unsustainable factory farms are subsidized, while family farmers are not. Health care has increased to 17% GDP. (This is not in contradiction to what was said above. This is demand (subsidized) driven inflation as a result of inadequate supply (taxed). The government should do the opposite. Subsidize production, and tax demand.) Infrastructure deteriorates, at the same time demand for it is subsidized. Unemployment is subsidized, employment is taxed.
All this and more is the result of government policy, of its spending, taxation and subsidy, Either that, or the government, spending 20% of GDP, and controlling more, has no effect on the economy. That is, it is essentially impotent. Of course, the government can still be essentially impotent, spending 20% of GDP, if it is locked into its commitments, the captive of special interests, and cannot change the way it spends its money. Like the government we have now.
Thursday, September 30, 2010
Wednesday, July 21, 2010
A Brief Keynesian Digression
This will help with the next posting. Its not necessary, but if you don’t understand it you will have to take some things on faith.
Over the long run, Consumption and Income (or production) are equal, for economies of all sizes. Everything that is consumed must first be produced. Everything that is produced is pretty quickly consumed. Yes, there are inventories, but they are seldom for more than a few months, and they usually stay more or less stay the same. (Every economy, especially modern ones, is at most, only a few months from disaster) Let’s draw a picture, Diagram 1, with Consumption on the vertical axis and Income on the horizontal axis. Then the line where they are equal, for economies of all sizes, is the 45 degree diagonal. If we draw a point above this 45 degree diagonal, the economy it represents will have Consumption greater than Income. Below this line, Income is greater than Consumption.
So any economy we talk about, is in the long run, going to be a point on this 45 degree diagonal. If we talk about a 100 billion economy a, it will lie on this line, where its Income and its Consumption are equal. The same for a 200 billion economy b, or a 500 billion economy c.
Now think about Consumption. If our economy is really little, we are going to want to consume more than we produce. If our economy is bigger, we are going to produce more than we want to consume. (Then we are also going to want to save, or more properly accumulate.) We represent what we want to consume by a line C. Diagram 2. This line is called a curve, by economists, lest they forget, as they sometimes do, that it really doesn’t have to be straight. The distance between this line, and the bottom of the graph, is how much we want to consume, at each level of income y. It slopes upward because the greater people’s income (y), the more they want to
Consume. Now this line C, this curve, crosses our 45 degree diagonal, at point e. Below, to the left of this at point e’’ for instance, our economy is little, and people are going to want to consume more than they produce. (In this simple model they can’t, of course. They have to starve) So the Consumption line is above the 45 degree diagonal, more desire to consume than income. To the right of e, at e’ say, our economy is larger, and people are going to have leftovers from what they want to consume, which they will want to save. As our economy grows bigger, and moves further to the right of e, people will want to save more and more. This is shown by the vertical distance between the 45 degree line, and the Consumption line C. Note they are also consuming more and more.
Now this Consumption line is sort of a matter of attitude. (And other things. In fact, this whole argument, is a matter of attitude. As is the diagram, except for the fact that the economy is on the 45 degree diagonal. Notice we’re also ignoring little things like taxes and government and exports and imports.) If people feel like consuming a greater proportion of their income, for a given size of their income, the Consumption line would be higher. This is shown by curve C’ in Diagram 3. At the size of income marked by y, though people are neither saving or dissaving at C, at C’ they want to consume so much they would be dissaving.
Back to the C curve, and Diagram 4. At income y, C is below the 45 degree diagonal, and the difference is how much the people in the economy want to save. (Want to consume + want to save = what is produced.) Now, where can this savings go? It has to go somewhere, because in the long run, economies cannot accumulate stuff. Economies do not save. (This is particularly true of market economies. A company that ‘saves’ too much of its product ends up going under. Well, maybe except for banks. But saving money is not saving stuff.) Nobody is going to make 50 million dishwashers, or 50 million cars, so that 5 or 10 years down the road, they will have them to sell. (Inventories that are accumulated are for at most a few months, and we’re talking about longer than that. Also, note that services cannot be saved.) No. They’re going to want to build a factory to make these things. They’re going to want to invest in a factory. That’s where all the savings goes, investment, and so savings is equal to Investment. (Remember, we’re talking about real savings. Right now, people are money savings like crazy, or trying to. But it is not being invested. So really, they are not saving anything. THey are redistributing demand, both in the present, and the future.)
Now Investment uses resources and is therefore like Consumption. Desired Investment also depends on the Income of the economy, so it can also be represented by a curve, and if we take this curve for desired Investment and add it to the (desired) Consumption curve, we end up with a total, the sum of Consumption and Investment, which economists call Aggregate Expenditures, or AE curve. Actually, what we have here is Aggregate desired Expenditures. Now where wishes, that is the AE curve, meet with reality, that is with income, or production,(y) on the 45 degree line, at e, we have the size of the real economy. This is also where desired savings is equal to desired investment.
(We cheated and used a different argument, that real investment and real savings really have to be the same. The Keynesian argument with desired savings and desired investment is more complicated: Suppose the economy produced more than at e, at e’ say. Then the economy would be really producing more than people wanted to expend (at the AE curve.) So with all this extra production, inventories will expand, producers will want to cut back, they will invest less, and the economy will fall back to e. Suppose instead, the economy produced less than at e, at e’’, say. Then the economy will really be producing less than what people want to expend. Inventories will shrink, producers will see this and want to produce more, so they will invest more, and the economy will grow, back to e.)
Now this diagram doesn’t explain very well how economies grow, and move up the 45 degree line as both income, that is production, and consumption grow. Apparently, the AE curve has to keep shifting upward, which means either desire to Consume, or desire to Investment, or both must also keep shifting upward.
In the diagram, though, the economy is kind of stuck at e, because we can’t save more than we invest, and we can’t invest more than we save.
From this diagram, we can draw a simpler diagram of just the relationship between desired Savings and desired Investment. We do this by simply subtracting the Consumption curve in the diagram. If we subtract the C curve, that is shift the C curve down to the horizontal axis (down the orange arrow) and keep the other lines in the same relationship to each other, we have a diagram of the relation between desired savings and desired investment. Diagram 5.
As in Diagram 4, the economy we are talking about is really where the lines cross, at e, where desired Savings equals desired Investment. This is the diagram we will be discussing in the next posting.
Over the long run, Consumption and Income (or production) are equal, for economies of all sizes. Everything that is consumed must first be produced. Everything that is produced is pretty quickly consumed. Yes, there are inventories, but they are seldom for more than a few months, and they usually stay more or less stay the same. (Every economy, especially modern ones, is at most, only a few months from disaster) Let’s draw a picture, Diagram 1, with Consumption on the vertical axis and Income on the horizontal axis. Then the line where they are equal, for economies of all sizes, is the 45 degree diagonal. If we draw a point above this 45 degree diagonal, the economy it represents will have Consumption greater than Income. Below this line, Income is greater than Consumption.
So any economy we talk about, is in the long run, going to be a point on this 45 degree diagonal. If we talk about a 100 billion economy a, it will lie on this line, where its Income and its Consumption are equal. The same for a 200 billion economy b, or a 500 billion economy c.Now think about Consumption. If our economy is really little, we are going to want to consume more than we produce. If our economy is bigger, we are going to produce more than we want to consume. (Then we are also going to want to save, or more properly accumulate.) We represent what we want to consume by a line C. Diagram 2. This line is called a curve, by economists, lest they forget, as they sometimes do, that it really doesn’t have to be straight. The distance between this line, and the bottom of the graph, is how much we want to consume, at each level of income y. It slopes upward because the greater people’s income (y), the more they want to
Consume. Now this line C, this curve, crosses our 45 degree diagonal, at point e. Below, to the left of this at point e’’ for instance, our economy is little, and people are going to want to consume more than they produce. (In this simple model they can’t, of course. They have to starve) So the Consumption line is above the 45 degree diagonal, more desire to consume than income. To the right of e, at e’ say, our economy is larger, and people are going to have leftovers from what they want to consume, which they will want to save. As our economy grows bigger, and moves further to the right of e, people will want to save more and more. This is shown by the vertical distance between the 45 degree line, and the Consumption line C. Note they are also consuming more and more.
Now this Consumption line is sort of a matter of attitude. (And other things. In fact, this whole argument, is a matter of attitude. As is the diagram, except for the fact that the economy is on the 45 degree diagonal. Notice we’re also ignoring little things like taxes and government and exports and imports.) If people feel like consuming a greater proportion of their income, for a given size of their income, the Consumption line would be higher. This is shown by curve C’ in Diagram 3. At the size of income marked by y, though people are neither saving or dissaving at C, at C’ they want to consume so much they would be dissaving.
Back to the C curve, and Diagram 4. At income y, C is below the 45 degree diagonal, and the difference is how much the people in the economy want to save. (Want to consume + want to save = what is produced.) Now, where can this savings go? It has to go somewhere, because in the long run, economies cannot accumulate stuff. Economies do not save. (This is particularly true of market economies. A company that ‘saves’ too much of its product ends up going under. Well, maybe except for banks. But saving money is not saving stuff.) Nobody is going to make 50 million dishwashers, or 50 million cars, so that 5 or 10 years down the road, they will have them to sell. (Inventories that are accumulated are for at most a few months, and we’re talking about longer than that. Also, note that services cannot be saved.) No. They’re going to want to build a factory to make these things. They’re going to want to invest in a factory. That’s where all the savings goes, investment, and so savings is equal to Investment. (Remember, we’re talking about real savings. Right now, people are money savings like crazy, or trying to. But it is not being invested. So really, they are not saving anything. THey are redistributing demand, both in the present, and the future.)
Now Investment uses resources and is therefore like Consumption. Desired Investment also depends on the Income of the economy, so it can also be represented by a curve, and if we take this curve for desired Investment and add it to the (desired) Consumption curve, we end up with a total, the sum of Consumption and Investment, which economists call Aggregate Expenditures, or AE curve. Actually, what we have here is Aggregate desired Expenditures. Now where wishes, that is the AE curve, meet with reality, that is with income, or production,(y) on the 45 degree line, at e, we have the size of the real economy. This is also where desired savings is equal to desired investment.
(We cheated and used a different argument, that real investment and real savings really have to be the same. The Keynesian argument with desired savings and desired investment is more complicated: Suppose the economy produced more than at e, at e’ say. Then the economy would be really producing more than people wanted to expend (at the AE curve.) So with all this extra production, inventories will expand, producers will want to cut back, they will invest less, and the economy will fall back to e. Suppose instead, the economy produced less than at e, at e’’, say. Then the economy will really be producing less than what people want to expend. Inventories will shrink, producers will see this and want to produce more, so they will invest more, and the economy will grow, back to e.)Now this diagram doesn’t explain very well how economies grow, and move up the 45 degree line as both income, that is production, and consumption grow. Apparently, the AE curve has to keep shifting upward, which means either desire to Consume, or desire to Investment, or both must also keep shifting upward.
In the diagram, though, the economy is kind of stuck at e, because we can’t save more than we invest, and we can’t invest more than we save.
From this diagram, we can draw a simpler diagram of just the relationship between desired Savings and desired Investment. We do this by simply subtracting the Consumption curve in the diagram. If we subtract the C curve, that is shift the C curve down to the horizontal axis (down the orange arrow) and keep the other lines in the same relationship to each other, we have a diagram of the relation between desired savings and desired investment. Diagram 5.
As in Diagram 4, the economy we are talking about is really where the lines cross, at e, where desired Savings equals desired Investment. This is the diagram we will be discussing in the next posting.
Wednesday, July 14, 2010
Who do you owe - An answer.
Well, look what we came across:
http://www.oftwominds.com/blogjuly10/con-of-decade07-10.html
Not easy to navigate to Part II: Go to bottom of page, click on 'blog,'
then down that page to the list of entries for July.
http://www.oftwominds.com/blogjuly10/con-of-decade07-10.html
Not easy to navigate to Part II: Go to bottom of page, click on 'blog,'
then down that page to the list of entries for July.
Saturday, July 3, 2010
The Producer-Consumer Problem, Again
In a earlier post we talked about how a net-producer (Germany) ended up with all the money, and the net consumer (Greece) ended up with lots of debt. Apparently the same thing is happening in the US. US corporations seem to have an extra $1.84 Trillion in cash lying around. And consumers…well.
You will remember the producer-consumer problem: No matter how much cash the consumer starts with, the consumer has to keep spending it, and eventually the producer ends up with all the money. Then the system crashes. The problem is more general, since any difference in relative gains results in one party ending up with all the money. For instance, if we imagine a system of company and labor in balance, and then, say, labor is given a slight cut in pay, eventually the company is going to end up with all the money. And then it’s the company store. 16 tons. That’s because the equilibrium between company and labor is an unstable one: The slightest disturbance and it heads, one way or another, for a crash. (It could head the other way, labor ending up with all the money, the company in bankruptcy. But it hasn’t.)
Now an enlightened government, (we don’t have one,) would either take steps before things got out of hand, (like say around 1990,) or arrange things so that the equilibrium between company and labor was, locally, a stable one. Graduated asset, or property taxes might by one way. Graduated income taxes, one for the corporation, one for labor, though trickier, would be more efficient.
The idea is actually tax and subsidy: Suppose the system of company and labor in balance. Then there would be no net transfer of money, and no taxation or subsidy by the government.. Suppose the company got a little ahead. Then there would be a slightly greater tax on its earnings than this increase, which would, directly or indirectly, go to labor, to bring it back down to equilibrium. If labor got ahead, there would be a tax on labor, which would go to subsidize the company, to bring the system back to equilibrium.
This oversimplifies things. Of course, you want the system to grow. That means business has to make a profit. It has to have the extra money to invest in itself. But this profit would have to be shared, since you want labor, (demand) to grow apace. One way to do this would be to induce inflation. Suppose with a 3% inflation rate, the company has a nominal 6% profit. The government spends the extra, inflation inducing deficit on labor, effectively sharing the profits. Hmm. Interesting. Another motive for moderate inflation. In fact, the whole thing could be managed through the rate of inflation: Set inflation to over half the nominal profit rate of business to transfer resources to labor, so demand would grow faster, or to under half, to transfer resources from labor to business, so supply would grow faster.
Another Hmm. We’ve been at very low inflation for along time now. We should not be surprised, then, that corporations have a lot of extra cash. There’s been a lot of transference of money from labor to business in recent years. So not only do we have grounds for policy, but we have an explanation, in part, anyway, for what is now happening.
As grounds for policy, though, it has problems, most noticeably the delay between the time the money is actually pumped into the system and the inflationary effect. Perhaps business profits could be anticipated…
But what is to be done with the current corporate cash glut. Well things are way ($6000 per capita) out of balance. The problem, of course, is that the corporations have no motive to spend the money on increased production: Consumers (labor) don’t have any money to spend! So corporations have to be induced to give it up, or it has to be taken from them, or government can print more money to give to labor, to compensate.
So we have a financial asset tax on corporations. And a tax holiday for labor.
But, our government has neither the guts, nor the sense. And, of course, there’s all those bonds.
By the way, if corporations have been taking money out of the system in equal amounts over the last 10 years, about $184 Billion per year, then that contributes about 1.3% per year deflationary pressure, that is inflation would be 1.3% more without their hoarding all that money.
You will remember the producer-consumer problem: No matter how much cash the consumer starts with, the consumer has to keep spending it, and eventually the producer ends up with all the money. Then the system crashes. The problem is more general, since any difference in relative gains results in one party ending up with all the money. For instance, if we imagine a system of company and labor in balance, and then, say, labor is given a slight cut in pay, eventually the company is going to end up with all the money. And then it’s the company store. 16 tons. That’s because the equilibrium between company and labor is an unstable one: The slightest disturbance and it heads, one way or another, for a crash. (It could head the other way, labor ending up with all the money, the company in bankruptcy. But it hasn’t.)
Now an enlightened government, (we don’t have one,) would either take steps before things got out of hand, (like say around 1990,) or arrange things so that the equilibrium between company and labor was, locally, a stable one. Graduated asset, or property taxes might by one way. Graduated income taxes, one for the corporation, one for labor, though trickier, would be more efficient.
The idea is actually tax and subsidy: Suppose the system of company and labor in balance. Then there would be no net transfer of money, and no taxation or subsidy by the government.. Suppose the company got a little ahead. Then there would be a slightly greater tax on its earnings than this increase, which would, directly or indirectly, go to labor, to bring it back down to equilibrium. If labor got ahead, there would be a tax on labor, which would go to subsidize the company, to bring the system back to equilibrium.
This oversimplifies things. Of course, you want the system to grow. That means business has to make a profit. It has to have the extra money to invest in itself. But this profit would have to be shared, since you want labor, (demand) to grow apace. One way to do this would be to induce inflation. Suppose with a 3% inflation rate, the company has a nominal 6% profit. The government spends the extra, inflation inducing deficit on labor, effectively sharing the profits. Hmm. Interesting. Another motive for moderate inflation. In fact, the whole thing could be managed through the rate of inflation: Set inflation to over half the nominal profit rate of business to transfer resources to labor, so demand would grow faster, or to under half, to transfer resources from labor to business, so supply would grow faster.
Another Hmm. We’ve been at very low inflation for along time now. We should not be surprised, then, that corporations have a lot of extra cash. There’s been a lot of transference of money from labor to business in recent years. So not only do we have grounds for policy, but we have an explanation, in part, anyway, for what is now happening.
As grounds for policy, though, it has problems, most noticeably the delay between the time the money is actually pumped into the system and the inflationary effect. Perhaps business profits could be anticipated…
But what is to be done with the current corporate cash glut. Well things are way ($6000 per capita) out of balance. The problem, of course, is that the corporations have no motive to spend the money on increased production: Consumers (labor) don’t have any money to spend! So corporations have to be induced to give it up, or it has to be taken from them, or government can print more money to give to labor, to compensate.
So we have a financial asset tax on corporations. And a tax holiday for labor.
But, our government has neither the guts, nor the sense. And, of course, there’s all those bonds.
By the way, if corporations have been taking money out of the system in equal amounts over the last 10 years, about $184 Billion per year, then that contributes about 1.3% per year deflationary pressure, that is inflation would be 1.3% more without their hoarding all that money.
Wednesday, June 30, 2010
Savings and Investment
There is some illusion about people saving, for retirement, for example. People do not save for retirement. They may think they do. But the reality is society invests to support its people, of whom the retired are (will be) a part.
What do we mean? We mean that it is only in the present that society supports its members. It doesn’t ‘save up’ present production to support them in the future. It doesn’t take past production to support them in the present. In terms of what is being produced, it only has what is currently being produced, to support its economy. Yes it has inventories, but usually these are at most a few months. Society doesn’t accumulate (save) a 20 year supply of dishwashers, so it will have them when they are needed ‘down the road.’ Society doesn’t do this with anything.
The closest society does to this is invest in its productive structure. Roads, structures and machinery last a fair length of time. It builds these things in the present, so it will have their productive capacity in the future. It has built these things in the past, so that we have them now. This is physical capital. A society builds capital in the present, so it will have the productive facilities to support its people in the future. In order to do this, it takes away some of its current production from direct consumption, and invests it.
Now the more society builds these things in the present, the more productive capacity we will have in the future. The more productive capacity we will have in the future, the better off, materially, we will be. Assuming, of course, we have the energy to power it. And the labor to direct it.
In particular, the greater comfort we will be able to support our retirees, and the rest of the idle class. And of course, everyone else. And everything else. Because production must also be supported.
Now the way we decide how to divvy up this production is with money. Those who spend the most money get the most goods and services. Those who spend the most, in the long run, are those who have the most. So if you save money in the present, in the future you will have more money to spend.
Now the theory is that the banks will take this money and loan it to someone who will invest it. That is, take current production, and use it to build more productive capacity, so there will be more goods and services to divvy up in the future. This isn’t the only money that does this. Corporations make profits, which they may spend to increase their productive capacity. Some of government spending may go to increase productive capacity, as with some of the ’stimulus.‘
So what happens instead when the banks take your money and squirrel it away?
Well, you’re still saving, but society is not investing in its future. Its capital is not expanding. So the pie is not growing any bigger. So down the road, when you retire and spend your savings, you may have a bigger share of the pie. But since the pie will not be any bigger, everyone else will, on the average, have a smaller share. This includes other retirees, say those on social security, and those who still work, who are supporting you with their labor. It also includes those other things, the productive facilities which must be supported to maintain present production and expand production in the future. So your individual savings, when you spend it in the future, takes away from everything else, including supporting the production on which it depends.
Now, if this were just you, this would not be very significant. But if there is a substantial share of savers, and the banks are not investing the money, (or investing it badly, say in housing or commercial real estate) then all the other people will have a significantly smaller share. And so will production.
What does this mean? Well, under these circumstances, savings is deflationary in the present, and inflationary in the future. In the present, money is being taken out of the economy, and since it is not being invested, (spent on capital) and put back in the economy, there is continually less money, chasing a constant supply of goods. And since the money was not invested, but merely saved, productive capacity is not expanded, so the quantity of goods will not increase.
So when in the future the money is taken out of savings and spent, along with the money that was there before, we will have inflation. Over time, these two effects could be expected to cancel out. What won’t cancel out is a big increase in money supply caused by deficit spending. If this is invested to expand the pie, well and good. If squandered, so the pie still does not expand, much the worse for inflation. What also won’t cancel out is the contraction caused by the deflation, which is that the decreasing amount of money chases a quantity of goods which is also decreasing., though not as fast., which does tend to mitigate the deflation, at the expense of the destruction of productive capacity. The pie actually shrinks.
So this is what is caused by the financial industry doing its retrenchment thing. Now we have already pointed out that the financial ‘industry’ is much too big, so its hoarding of money (rather than investing it in real industry) can be expected to go on for a while. To the detriment of the rest of the economy, since it means that the money supply in the rest of the economy can be expected to decrease, thus robbing productive industries of their nominal profits. Since these industries are losing money, they are not investing, they are cutting back. Still. (Add to this the contraction brought about by the trade imbalance! See: April 2010 The Effects of Unbalanced Trade)
The problem, of course, is that as long as these banks are in business, they’re going to be sucking the money out of the economy, so destroying the economy on which they depend. The government with its stimulus tried to counteract this action. It didn’t, much. It can’t. The banks are sucking too much, too fast.
So. In Economics, savings and investment are equal. At equilibrium. But not in the economy we are experiencing, where savings and investment are not equal.
Just by the way, elementary Keynesian theory predicts a reduction in a nation’s income with an increase in its ‘thrift.’ It assumes savings increases with income, but investment is relatively independent of income, or flat. How to explain the Chinese, though, eh? Next time.
What do we mean? We mean that it is only in the present that society supports its members. It doesn’t ‘save up’ present production to support them in the future. It doesn’t take past production to support them in the present. In terms of what is being produced, it only has what is currently being produced, to support its economy. Yes it has inventories, but usually these are at most a few months. Society doesn’t accumulate (save) a 20 year supply of dishwashers, so it will have them when they are needed ‘down the road.’ Society doesn’t do this with anything.
The closest society does to this is invest in its productive structure. Roads, structures and machinery last a fair length of time. It builds these things in the present, so it will have their productive capacity in the future. It has built these things in the past, so that we have them now. This is physical capital. A society builds capital in the present, so it will have the productive facilities to support its people in the future. In order to do this, it takes away some of its current production from direct consumption, and invests it.
Now the more society builds these things in the present, the more productive capacity we will have in the future. The more productive capacity we will have in the future, the better off, materially, we will be. Assuming, of course, we have the energy to power it. And the labor to direct it.
In particular, the greater comfort we will be able to support our retirees, and the rest of the idle class. And of course, everyone else. And everything else. Because production must also be supported.
Now the way we decide how to divvy up this production is with money. Those who spend the most money get the most goods and services. Those who spend the most, in the long run, are those who have the most. So if you save money in the present, in the future you will have more money to spend.
Now the theory is that the banks will take this money and loan it to someone who will invest it. That is, take current production, and use it to build more productive capacity, so there will be more goods and services to divvy up in the future. This isn’t the only money that does this. Corporations make profits, which they may spend to increase their productive capacity. Some of government spending may go to increase productive capacity, as with some of the ’stimulus.‘
So what happens instead when the banks take your money and squirrel it away?
Well, you’re still saving, but society is not investing in its future. Its capital is not expanding. So the pie is not growing any bigger. So down the road, when you retire and spend your savings, you may have a bigger share of the pie. But since the pie will not be any bigger, everyone else will, on the average, have a smaller share. This includes other retirees, say those on social security, and those who still work, who are supporting you with their labor. It also includes those other things, the productive facilities which must be supported to maintain present production and expand production in the future. So your individual savings, when you spend it in the future, takes away from everything else, including supporting the production on which it depends.
Now, if this were just you, this would not be very significant. But if there is a substantial share of savers, and the banks are not investing the money, (or investing it badly, say in housing or commercial real estate) then all the other people will have a significantly smaller share. And so will production.
What does this mean? Well, under these circumstances, savings is deflationary in the present, and inflationary in the future. In the present, money is being taken out of the economy, and since it is not being invested, (spent on capital) and put back in the economy, there is continually less money, chasing a constant supply of goods. And since the money was not invested, but merely saved, productive capacity is not expanded, so the quantity of goods will not increase.
So when in the future the money is taken out of savings and spent, along with the money that was there before, we will have inflation. Over time, these two effects could be expected to cancel out. What won’t cancel out is a big increase in money supply caused by deficit spending. If this is invested to expand the pie, well and good. If squandered, so the pie still does not expand, much the worse for inflation. What also won’t cancel out is the contraction caused by the deflation, which is that the decreasing amount of money chases a quantity of goods which is also decreasing., though not as fast., which does tend to mitigate the deflation, at the expense of the destruction of productive capacity. The pie actually shrinks.
So this is what is caused by the financial industry doing its retrenchment thing. Now we have already pointed out that the financial ‘industry’ is much too big, so its hoarding of money (rather than investing it in real industry) can be expected to go on for a while. To the detriment of the rest of the economy, since it means that the money supply in the rest of the economy can be expected to decrease, thus robbing productive industries of their nominal profits. Since these industries are losing money, they are not investing, they are cutting back. Still. (Add to this the contraction brought about by the trade imbalance! See: April 2010 The Effects of Unbalanced Trade)
The problem, of course, is that as long as these banks are in business, they’re going to be sucking the money out of the economy, so destroying the economy on which they depend. The government with its stimulus tried to counteract this action. It didn’t, much. It can’t. The banks are sucking too much, too fast.
So. In Economics, savings and investment are equal. At equilibrium. But not in the economy we are experiencing, where savings and investment are not equal.
Just by the way, elementary Keynesian theory predicts a reduction in a nation’s income with an increase in its ‘thrift.’ It assumes savings increases with income, but investment is relatively independent of income, or flat. How to explain the Chinese, though, eh? Next time.
Thursday, June 24, 2010
What is valuable?
What is valuable? There seems to be some confusion here. This is because what is valuable to an individual need not be valuable to a society. For instance, money is wealth to an individual, but to a society, it is…. well, nothing. To an individual, it is demand over the production of an economy. For a society, its only use is as a means of allocating… real wealth.
How does it do this? Well, it does it in a most peculiar way: Money values most what is least valuable to an economy. And this is necessarily so.
Consider, for instance, which is more valuable, a dollar’s worth of gasoline, or a dollar’s worth of greeting cards. Well, as far as money, or the market, goes, they are the same value. But from the economy’s point of view, the dollar’s worth of gasoline is more valuable, because you can do more with it. For instance, you can have a modern economy without greeting cards, but you cannot have one with out gasoline. We’ll call this a real valuation, as opposed to the monetary one. The monetary valuation undervalues the real value of the gasoline, and overvalues the real value of the greeting cards.
Consider the resources that go into a car: the energy, the materials, the labor. In money terms, these things together add up to less than the price of the car. That is why we build the car. Because the maker of the car sells the car for more than the price of the resources .that go into the car. But in real terms the combined value of the energy, the materials, the labor, is greater than the car.
In particular, energy is, in monetary terms, undervalued. Its less now, but it used to be that 10 times the amount of energy came out of a gallon of oil than went into producing it. It is this real profit, this 10 to 1 ratio, that allows us, drives us, to use (burn) the oil. Suppose instead, there were no real profit: That the ratio was 1 to 1, that as much energy went in to producing the oil as was gotten out of it. Then, from an economic point of view there would be no point in producing the oil in the first place. (In particular, if we used the energy from the oil to produce the oil, nothing would be produced. Except waste.) Nothing is gained. (Of course, with subsidy, an uneconomic process may still go forward. Witness ethanol production from corn)
Allowing for profit, and neglecting things like taxes, that means that the monetary value of the oil was about 1/10 its real value. Suppose instead that it sold at its real value. Suppose your gallon of deisel sold at $30, or 10 times its current valuation. Then there would be no point for you to buy it, because you couldn’t make money off it. (at least using it for energy.) Its real cost to you, monetarily valued at $30, would be equal to the benefit you expected from it. (We’re not allowing for the induced inflation. With the price of oil going up, the real price, the price of everything will go up. More on that in a later post.)
Similarly, commodities are undervalued. Undervalued energy went into making and extracting them. But it is this monetary undervaluing that makes them more valuable in reality. Because they are undervalued, they can go into making things. For instance, you wouldn’t use gold to wire a house. Monetarily, it’s too valuable. You would use copper. Copper is more valuable here than gold, because if you used gold, you couldn’t sell the house for a profit. In fact, the less valuable it is, the more useful it is. If the price of copper were to double, you might still use it to wire the house, but you might not use it for the plumbing.. If the real price of copper were to halve, you would not only use it for the wiring and the plumbing, you might use it for the roof as well. So the lower its monetary valuation, the greater its real valuation.
Suppose now that copper was as rare as gold. Those who owned copper would be much richer, but society would be much poorer. They wouldn’t be able to use copper to wire houses. Indeed, the uses of copper would be few. It would have little real value. Just like gold. It would be too precious to be useful.*
Now if some things are undervalued, other things must be overvalued. That is the monetary value is more than the real value. Or, these things are worth less to society than they are to the individual. So what is overvalued? That is what is overpriced?
If we look at production, at each step, resources are destroyed. Energy and labor are destroyed at all steps. Now the irony is, that the more resources are destroyed in making something, the more (monetarily) valuable it becomes. (This is in a well functioning economy. Under subsidy, resources can go into making something that is less monetarily valuable. For instance, the subsidy of corn production makes possible the production of hamburgers at less than would be their monetary cost.) But as those resources are destroyed, the real cost of the thing goes up. So its real value goes down. The more resources are destroyed making a thing, the less valuable it is. To society. Suppose 10 times the resources as now go into making an automobile are used. Automobiles would cost 10 times as much. There would be many fewer of them. They would be less useful to society. Conversely, if automobiles cost one tenth the resources to make, there might not be more of them, but the resources freed up which would otherwise go to their production could be destroyed to other use. In that sense, they would still have a greater value to society.
But, at each step in the destruction of resources, that is, the destruction of real value, “value is added.” Monetarily. The thing becomes monetarily more valuable, and can be sold at a profit. So in general, resources, which are undervalued, are converted to finished goods, which are overvalued, and it is this twist in valuation which drives economic process. (We can even go a little further, and say that those goods which are most overvalued will be preferentially produced. They will have the highest profit margins in the conversion process. Goods under subsidy will be preferentially produced, for instance.)
Now the economy does need finished goods. Indeed, that is the whole point of an economy: To create goods and services to the benefit of the individual. But economically speaking, most finished goods are useless to an economy. A dishwasher, for instance is economically useless. (It may benefit the individual. It does free up leisure. Depending on how much one valued that, one can calculate the benefits one would get from buying a dishwasher.) The end result of economic process, the conversion of resources, in particular the destruction of energy, is a finished good or service. (Actually, since energy can neither be created of destroyed, we really mean the conversion of energy from useful forms to useless forms. So for instance, one could say the dishwasher was worse than economically useless, since the power it consumes when operating increases the conversion of energy to useless forms.)
So where does money fit into this? Well, in real terms it is worthless, so we can say it is most overvalued. If government printed up a room full of money, society would be no better off. More on this later. Energy, which drives the modern economy, is most undervalued. Some labor is also undervalued. (Some is overvalued.) Some has to be exploited, for the manufacturer to make his profit. This is not a bad thing. But because labor is also the ultimate market, (all economic processes are ultimately for the benefit of individuals,) it does create a problem. So does overvalued labor. For a later post.
So what is valuable? To a society, the resources, and the means to convert those resources to goods and services desired by individuals. To an individual, these desired goods and services. It is the difference between these two valuations that drives an economy.
__________________________________________
*There is an ironic phrase which refers to extraction of minerals: ‘The riches of the earth.’ However, it is the poverty of the earth, the scarcity of what is extracted, which makes it monetarily valuable, and reduces the real value to society. But, it is this relative scarcity that makes extracting the minerals profitable to the individual in the first place.
How does it do this? Well, it does it in a most peculiar way: Money values most what is least valuable to an economy. And this is necessarily so.
Consider, for instance, which is more valuable, a dollar’s worth of gasoline, or a dollar’s worth of greeting cards. Well, as far as money, or the market, goes, they are the same value. But from the economy’s point of view, the dollar’s worth of gasoline is more valuable, because you can do more with it. For instance, you can have a modern economy without greeting cards, but you cannot have one with out gasoline. We’ll call this a real valuation, as opposed to the monetary one. The monetary valuation undervalues the real value of the gasoline, and overvalues the real value of the greeting cards.
Consider the resources that go into a car: the energy, the materials, the labor. In money terms, these things together add up to less than the price of the car. That is why we build the car. Because the maker of the car sells the car for more than the price of the resources .that go into the car. But in real terms the combined value of the energy, the materials, the labor, is greater than the car.
In particular, energy is, in monetary terms, undervalued. Its less now, but it used to be that 10 times the amount of energy came out of a gallon of oil than went into producing it. It is this real profit, this 10 to 1 ratio, that allows us, drives us, to use (burn) the oil. Suppose instead, there were no real profit: That the ratio was 1 to 1, that as much energy went in to producing the oil as was gotten out of it. Then, from an economic point of view there would be no point in producing the oil in the first place. (In particular, if we used the energy from the oil to produce the oil, nothing would be produced. Except waste.) Nothing is gained. (Of course, with subsidy, an uneconomic process may still go forward. Witness ethanol production from corn)
Allowing for profit, and neglecting things like taxes, that means that the monetary value of the oil was about 1/10 its real value. Suppose instead that it sold at its real value. Suppose your gallon of deisel sold at $30, or 10 times its current valuation. Then there would be no point for you to buy it, because you couldn’t make money off it. (at least using it for energy.) Its real cost to you, monetarily valued at $30, would be equal to the benefit you expected from it. (We’re not allowing for the induced inflation. With the price of oil going up, the real price, the price of everything will go up. More on that in a later post.)
Similarly, commodities are undervalued. Undervalued energy went into making and extracting them. But it is this monetary undervaluing that makes them more valuable in reality. Because they are undervalued, they can go into making things. For instance, you wouldn’t use gold to wire a house. Monetarily, it’s too valuable. You would use copper. Copper is more valuable here than gold, because if you used gold, you couldn’t sell the house for a profit. In fact, the less valuable it is, the more useful it is. If the price of copper were to double, you might still use it to wire the house, but you might not use it for the plumbing.. If the real price of copper were to halve, you would not only use it for the wiring and the plumbing, you might use it for the roof as well. So the lower its monetary valuation, the greater its real valuation.
Suppose now that copper was as rare as gold. Those who owned copper would be much richer, but society would be much poorer. They wouldn’t be able to use copper to wire houses. Indeed, the uses of copper would be few. It would have little real value. Just like gold. It would be too precious to be useful.*
Now if some things are undervalued, other things must be overvalued. That is the monetary value is more than the real value. Or, these things are worth less to society than they are to the individual. So what is overvalued? That is what is overpriced?
If we look at production, at each step, resources are destroyed. Energy and labor are destroyed at all steps. Now the irony is, that the more resources are destroyed in making something, the more (monetarily) valuable it becomes. (This is in a well functioning economy. Under subsidy, resources can go into making something that is less monetarily valuable. For instance, the subsidy of corn production makes possible the production of hamburgers at less than would be their monetary cost.) But as those resources are destroyed, the real cost of the thing goes up. So its real value goes down. The more resources are destroyed making a thing, the less valuable it is. To society. Suppose 10 times the resources as now go into making an automobile are used. Automobiles would cost 10 times as much. There would be many fewer of them. They would be less useful to society. Conversely, if automobiles cost one tenth the resources to make, there might not be more of them, but the resources freed up which would otherwise go to their production could be destroyed to other use. In that sense, they would still have a greater value to society.
But, at each step in the destruction of resources, that is, the destruction of real value, “value is added.” Monetarily. The thing becomes monetarily more valuable, and can be sold at a profit. So in general, resources, which are undervalued, are converted to finished goods, which are overvalued, and it is this twist in valuation which drives economic process. (We can even go a little further, and say that those goods which are most overvalued will be preferentially produced. They will have the highest profit margins in the conversion process. Goods under subsidy will be preferentially produced, for instance.)
Now the economy does need finished goods. Indeed, that is the whole point of an economy: To create goods and services to the benefit of the individual. But economically speaking, most finished goods are useless to an economy. A dishwasher, for instance is economically useless. (It may benefit the individual. It does free up leisure. Depending on how much one valued that, one can calculate the benefits one would get from buying a dishwasher.) The end result of economic process, the conversion of resources, in particular the destruction of energy, is a finished good or service. (Actually, since energy can neither be created of destroyed, we really mean the conversion of energy from useful forms to useless forms. So for instance, one could say the dishwasher was worse than economically useless, since the power it consumes when operating increases the conversion of energy to useless forms.)
So where does money fit into this? Well, in real terms it is worthless, so we can say it is most overvalued. If government printed up a room full of money, society would be no better off. More on this later. Energy, which drives the modern economy, is most undervalued. Some labor is also undervalued. (Some is overvalued.) Some has to be exploited, for the manufacturer to make his profit. This is not a bad thing. But because labor is also the ultimate market, (all economic processes are ultimately for the benefit of individuals,) it does create a problem. So does overvalued labor. For a later post.
So what is valuable? To a society, the resources, and the means to convert those resources to goods and services desired by individuals. To an individual, these desired goods and services. It is the difference between these two valuations that drives an economy.
__________________________________________
*There is an ironic phrase which refers to extraction of minerals: ‘The riches of the earth.’ However, it is the poverty of the earth, the scarcity of what is extracted, which makes it monetarily valuable, and reduces the real value to society. But, it is this relative scarcity that makes extracting the minerals profitable to the individual in the first place.
Sunday, June 13, 2010
That Bloated Financial Sector
Suppose the auto industry was twice the size it was now. That means it would have to sell twice as many cars, AT THE SAME PRICE, to stay in business. Naturally, it couldn’t do this by itself. It would either be forced to contract, or it would require government support to stay in business. It would have to do sneaky and unethical things, like sell fraudulent products. Its companies would have to collude, to hold prices high. It would have to hold its customers hostage, one way or another, to stay in business. And the fact is, we should expect this. It would merely be doing what it had to do to survive, in the bloated and destructive form, it had become.
Consider now the financial sector. Historically, even during times of prosperity, it had ‘produced’ under 3% of GDP. But as of 2006, it has ‘produced’ 8% GDP. I put ‘produced’ in quotes, because the financial sector produces nothing. It is merely there to allocate resources. It does not make things. It is overhead to the economy. It rearranges money. And instead of arranging money to encourage productive industries, it seems to be allocating much of these resources to itself: Its profits, in recent years, have been over 40% of the total profits of all US businesses, despite the fact that it ‘produces’ only 8% of the GDP.
How does it do this? How does it ‘sell’ almost 3 times as much ‘services’ as in the past, and make more money than ever doing it? After all, we would expect that if it had more services to sell, their price, and their profits,would go down.
Well, it has government support. It has its bailouts, and the government has gone through agonizing contortions to see that the banks' mortgage income and value are maintained. The Fed also supports the industry with low interest loans. And the government throws business its way by selling bonds at a higher interest rate.
It does sneaky and unethical things: It sells fraudulent products, CDO’s and CDS’s and dubious mortgages with teaser rates that balloon into unpayable amounts after a few years. The whole real estate bubble was an effort by the banks to generate profit, in fees and interest, sufficient to keep themselves in business. Now the bubble is gone, and the only way the banks can support themselves is to eat into the real economy, It withholds credit from the real economy until its bloated balance sheets will be 'repaired,' inflicting deflation on the economy. And where is the next bubble going to be? Perhaps we are looking at it: the debt bubble.
It colludes, with the combination of algorithmic trading and ‘front running,’ to effectively defraud legitimate traders of their just profits. In these it is explicitly self-serving, and not to the benefit of the rest of the economy.
It holds its customers hostage. With too big to fail banks that the government thinks it is obligated to maintain and foster. With fees and usurious interest rates on credit cards and payday loans.
Meanwhile, the financial sector uses its power to deflect the efforts of government to effectively regulate it. In fact, should the regulation the government is considering prove effective, it would cut into the financial sector’s profits, would tend to its ruin, and force the government, as it now conceives its duty, into even greater efforts to rescue and maintain it.
It siphons off from legitimate industry, and corrupts, some of the best minds of society with its disproportionate remuneration, and contributes to the country’s increasingly inequitable distribution of wealth and income.
And we should expect this. We should expect it to act, not to be benefit of society, but to its harm. It is merely doing what it has to do to survive, in its bloated and destructive form.
That this should lead to the destruction of the economy which supports it, it does not care. The people involved are either indifferent or oblivious to the damage they inflict.
I have painted all banks with the same brush. I'm mainly aiming at Wall Street, though many other banks were a party to the real estate bubble. To those that don’t deserve such a paint job, I apologize. I’m sure there are good banks out there. I hope mine, that is the bank I use, is one. But these banks are at a competitive disadvantage to the bad banks. And the absence of effective regulation reinforces this.
Yet I don’t hear the officers of good banks decrying the malfeasances of the officers of the bad banks. Is it because I just don’t hear, of is it because they do not. Perhaps they feel more a sense of community with those who work at the destruction of their society, than those of the communities they ostensibly serve.
Consider now the financial sector. Historically, even during times of prosperity, it had ‘produced’ under 3% of GDP. But as of 2006, it has ‘produced’ 8% GDP. I put ‘produced’ in quotes, because the financial sector produces nothing. It is merely there to allocate resources. It does not make things. It is overhead to the economy. It rearranges money. And instead of arranging money to encourage productive industries, it seems to be allocating much of these resources to itself: Its profits, in recent years, have been over 40% of the total profits of all US businesses, despite the fact that it ‘produces’ only 8% of the GDP.
How does it do this? How does it ‘sell’ almost 3 times as much ‘services’ as in the past, and make more money than ever doing it? After all, we would expect that if it had more services to sell, their price, and their profits,would go down.
Well, it has government support. It has its bailouts, and the government has gone through agonizing contortions to see that the banks' mortgage income and value are maintained. The Fed also supports the industry with low interest loans. And the government throws business its way by selling bonds at a higher interest rate.
It does sneaky and unethical things: It sells fraudulent products, CDO’s and CDS’s and dubious mortgages with teaser rates that balloon into unpayable amounts after a few years. The whole real estate bubble was an effort by the banks to generate profit, in fees and interest, sufficient to keep themselves in business. Now the bubble is gone, and the only way the banks can support themselves is to eat into the real economy, It withholds credit from the real economy until its bloated balance sheets will be 'repaired,' inflicting deflation on the economy. And where is the next bubble going to be? Perhaps we are looking at it: the debt bubble.
It colludes, with the combination of algorithmic trading and ‘front running,’ to effectively defraud legitimate traders of their just profits. In these it is explicitly self-serving, and not to the benefit of the rest of the economy.
It holds its customers hostage. With too big to fail banks that the government thinks it is obligated to maintain and foster. With fees and usurious interest rates on credit cards and payday loans.
Meanwhile, the financial sector uses its power to deflect the efforts of government to effectively regulate it. In fact, should the regulation the government is considering prove effective, it would cut into the financial sector’s profits, would tend to its ruin, and force the government, as it now conceives its duty, into even greater efforts to rescue and maintain it.
It siphons off from legitimate industry, and corrupts, some of the best minds of society with its disproportionate remuneration, and contributes to the country’s increasingly inequitable distribution of wealth and income.
And we should expect this. We should expect it to act, not to be benefit of society, but to its harm. It is merely doing what it has to do to survive, in its bloated and destructive form.
That this should lead to the destruction of the economy which supports it, it does not care. The people involved are either indifferent or oblivious to the damage they inflict.
I have painted all banks with the same brush. I'm mainly aiming at Wall Street, though many other banks were a party to the real estate bubble. To those that don’t deserve such a paint job, I apologize. I’m sure there are good banks out there. I hope mine, that is the bank I use, is one. But these banks are at a competitive disadvantage to the bad banks. And the absence of effective regulation reinforces this.
Yet I don’t hear the officers of good banks decrying the malfeasances of the officers of the bad banks. Is it because I just don’t hear, of is it because they do not. Perhaps they feel more a sense of community with those who work at the destruction of their society, than those of the communities they ostensibly serve.
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