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.

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.

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.