Money keeps the world going round, is the root or all evil and the ultimate way of keeping score. One would think that everyone knew where it comes from and where it goes, but alas, like the wind of old , its left up to the gods.
The U.S. government issues new money by printing off as much as it likes and issuing an I.O.U.
The banks issue fresh new money for loans and mortgages essentially the same way within certain limits. Thats how the banks give money away they don't have. But they are the primary creators of new money. If they don't increase their outstanding loans every year the money supply stays constant.
When you add it all up, almost all money in the economy is backed by debt somewhere. Increasing the supply of money (and debt) every year is the main cause of long term inflation, and its by design. Since money in itself is only a fraction of all assets (stocks, real estate and so on) it may not be as scary as it sounds.
But here is the frightening part. If you collected every single dollar in the U.S. and used it to pay off all public and private debt at once, there would not be enough. This is because debt charges interest and since all money adds up to just the debt portion, how will the interest be covered?
In the real world, debt doesn't have to be paid off at once. It is paid back in installments there are two factors at work:
(1) By the time the last installment is paid, the money supply will have increased significantly since more money will have been created via more I.O.Us. You will be forgiven for seeing this as the ultimate Ponzi scheme.
(2) The gross profit on the montly loan installment will become either profits or expenses to the bank and end up filtering back into the economy where it used by someone else to pay off another debt. If the banks kept their profits under the mattress we would all be in trouble.
The amount of money in the economy is shrinking as people pay off old loans and the bank don't start enough new ones. The machine is broken. If new money is not created, the ponzi scheme will ultimately fall apart. The amount of money in the economy is starting to shrink. The machine can't be broken for long without the whole lending industry getting destroyed since the only thing that can relieve the pressure of this scenario are failed loans and massive bank losses. There will not be enough money in the economy to pay off loans and interest. Although mathematically, if everyone's money was spared for loan installments it would take many years, in reality it would take less than that since people also need money to survive.
Normally consumer debt increasing every year would save the day but when your shopaholic cousin pays off her credit card instead of buying that handbag, she reduces the amount of money in the economy.
The Fed is meant to come to the rescue using its tools to create more money in the markets but the Feds actions are not changing peoples or banks behaviour enough, at least not yet. The Obama administration has to print off more money (against IOUs) to make up for your cousin's frugality. People talk about stimulus package efficiency and Keynesian economics, all of which play a part but simple math on your fingers could tell you that if the money supply shrinks the whole pyramid scheme falls apart. There is a good chance that he will not be able to print off enough.
So whatever you do, for the sake of your country, buy those manolo blahniks on credit or we're all finished.
Wednesday, August 26, 2009
Thursday, August 20, 2009
World Stock Market - What return should I expect?
I remember a textbook in College saying that a company that says that its going to grow indefinitely it will eventually become worth more than the whole planet. A simple statement but one that also could be applied to the stock market. If the value of shares in the stock market is expected to grow by 10% a year it won't take long before the stock market is worth more than all the assets in the world.
Long term company growth will have to eventually be the same as the growth of the economy unless we want the company to outgrow the planet. The S&P 500 companies are expanding overseas. The Chinese will probably eventually converge to the standard of living of the Europeans or Americans (if the planet can take it) and will need a lot of stuff to do it. But when these countries have converged and the markets become saturated then it becomes a zero sum game. You grow at the expense of your competitors and net growth will be zero unless the economy grows. Increases in productivity can make an economy grow but who wants to invest in something that just tracks the economic growth. An anemic 2 to 5 percent (after inflation).
So what will the long term world stock market return be?
The value of all world publicly traded stocks cannot grow faster than the value of the stuff these companies produce, since their profits are usually a fixed percentage of their sales, and all stock valuations are ultimately based on future profits. Hence the value of all stocks will trend guesses of future world production. The value of world stocks will rise faster than this rate only if they:
(a) Displace private competitors. For example, McDonalds driving mom and pop restaurants out of business and taking their customers. Production hasn't gone up, it has just been gobbled up by a company with public shares instead of a private "mom and pop" business. In this way, the value of McDonalds, and the price of the whole stock market will go up.
(b) Increase profit margins. For example, Boeing buys Airbus and with less competition can jack up the price of planes. This can increase stock prices without any real increase in the value produced.
The previous two examples is how the stock market can increase in value without an increase in world economic production. Most other scenarios, e.g. a country getting more productive or wealthier, are captured in the world production growth number.
So, here is my premise. World stocks should track predicted world production and have a net real price increase of about 2% to 5%. You can add this to a dividend rate of say 3% to give you a return of about 5% to 8% annually, ignoring taxes. So if you don't know any more than the next guy and you invest in world stocks, be happy to get share price growth of 4% and dividends of 3% and your investment should be relatively inflation protected.
So what about growth stocks where the dividend rate is 0% and the return is expected only from share price increases? Growth stocks are always confusing since its more art than science to determine when a growth company will reach maturity and start behaving like everyone else and pay dividends but the stock actually has no value without future dividends. Hence the argument will still hold, the share price will represent the value of the stocks future dividends albeit further into the future. Additionally, although the market isn't efficient, it is not completely innefficient either, so the long term return on growth stocks will trend the return on established stocks.
Eventually, even world production will have to stop growing since consumption can't increase forever without consuming the entire planet, but no one has told that to the captains of industry yet.
Long term company growth will have to eventually be the same as the growth of the economy unless we want the company to outgrow the planet. The S&P 500 companies are expanding overseas. The Chinese will probably eventually converge to the standard of living of the Europeans or Americans (if the planet can take it) and will need a lot of stuff to do it. But when these countries have converged and the markets become saturated then it becomes a zero sum game. You grow at the expense of your competitors and net growth will be zero unless the economy grows. Increases in productivity can make an economy grow but who wants to invest in something that just tracks the economic growth. An anemic 2 to 5 percent (after inflation).
So what will the long term world stock market return be?
The value of all world publicly traded stocks cannot grow faster than the value of the stuff these companies produce, since their profits are usually a fixed percentage of their sales, and all stock valuations are ultimately based on future profits. Hence the value of all stocks will trend guesses of future world production. The value of world stocks will rise faster than this rate only if they:
(a) Displace private competitors. For example, McDonalds driving mom and pop restaurants out of business and taking their customers. Production hasn't gone up, it has just been gobbled up by a company with public shares instead of a private "mom and pop" business. In this way, the value of McDonalds, and the price of the whole stock market will go up.
(b) Increase profit margins. For example, Boeing buys Airbus and with less competition can jack up the price of planes. This can increase stock prices without any real increase in the value produced.
The previous two examples is how the stock market can increase in value without an increase in world economic production. Most other scenarios, e.g. a country getting more productive or wealthier, are captured in the world production growth number.
So, here is my premise. World stocks should track predicted world production and have a net real price increase of about 2% to 5%. You can add this to a dividend rate of say 3% to give you a return of about 5% to 8% annually, ignoring taxes. So if you don't know any more than the next guy and you invest in world stocks, be happy to get share price growth of 4% and dividends of 3% and your investment should be relatively inflation protected.
So what about growth stocks where the dividend rate is 0% and the return is expected only from share price increases? Growth stocks are always confusing since its more art than science to determine when a growth company will reach maturity and start behaving like everyone else and pay dividends but the stock actually has no value without future dividends. Hence the argument will still hold, the share price will represent the value of the stocks future dividends albeit further into the future. Additionally, although the market isn't efficient, it is not completely innefficient either, so the long term return on growth stocks will trend the return on established stocks.
Eventually, even world production will have to stop growing since consumption can't increase forever without consuming the entire planet, but no one has told that to the captains of industry yet.
Tuesday, August 18, 2009
The richest 0.1% - Are they really rich?
So what about those richest 0.1% that seem to be spoiling it for everyone else?
There seems to be many articles right now about seemingly impoverished teachers or farmers that leave millions to charities or Universities. The core of the stories are often something like, "Gee, why would someone with so much money live like a pauper until they died". Often they don't live in squalor but just regular working class or lower middle class comfort. Many of us watching have a sneaky suspicion that we know why. We remember our own indoctrination from our mothers or fathers. A penny saved is a penny earned, waste not want not and essentially wasting money unnecessarily is the work of the devil, and saving it will somehow help us get into heaven although we are not sure why. (I call this potato famine insecurity). Many of us can solve modern day mysteries in this way. One example is: why does someone like Warren Buffet live in the same house he bought 3 decades ago for $31,500 when he could buy out his own street for a whisper of his fortune?
But here is an interesting question. If you have the legal right to spend millions, or billions but don't, have you ever really been rich, other than in your own head? It may seem like a silly question but a man that has the right to spend billions but leaves it all with money managers until the day he dies hasn't really left any mark that he has owned the money at all. His money could have been owned by anyone else in the world and, so long as they didn't withdraw the money, the effect would have been the same. His main contribution to the economy was choosing which money manager to use. This is not a trivial decision since one money manager could have a bias towards real estate and distort prices there, while another may have a bias towards hi-tech stocks and create a different distortion in the economy.
What is in essence happening is that the "rich man" is giving his money into investments and hence letting it ride in the economy. That money, if invested directly in a company goes to salaries, capital expenditures etc. The money, if invested very well in established securities correctly could help towards market efficiency (buying the right stocks/assets low and selling high) but all the gains remain in the hands of the market. In essence, the investor is putting his money to work to help the economy as an investor in a way that will usually increase the wealth of the economy although not himself until he starts spending his money directly on himself.
So here is my premise. It is not your income every year that matters to the economy. It is the amount you spend directly on yourself that actually changes the economy and hence the only thing that really matters. A person is not rich until he has taken a chunk of Production for himself. The Pharaohs of Egypt were rich because they took a huge chunk of labour out of the market every year to build great big near-useless pyramids (in the days before tourists from Nebraska). That same labour could have been planting fields or building houses. When Warren Buffet lets his massive gains every year ride on his investments, it is almost the same as his not owning it at all, nevertheless his hand is seen more indirectly by having some control in the investments although a theoretical efficient market would suggest that someone else would make similar investments if he weren't there (Efficient markets are always a sticky point for Warren).
Making a huge assumption that all passive investments are relatively efficient (one money manager for you money isn't that much different than another) then the only thing that should matter to the economy is not how much a person earns, but how much they consume, ignoring the taxman for a minute. That Bill Gates being rich doesn't really take any bread from the mouths of the needy in the world until he starts buying up all the bread. Ironically, it is only now that he is spending his money on world charity that one can argue that he is redirecting production away from others.
So lets get back to the "wealth charts" and consider how much more there would be for everyone if it wasn't for the richest 0.1% families that earn much more than they can spend. I would guess, there wouldn't be that much more, until the crazy grandson decides to blow it all on a party in Las Vegas.
There seems to be many articles right now about seemingly impoverished teachers or farmers that leave millions to charities or Universities. The core of the stories are often something like, "Gee, why would someone with so much money live like a pauper until they died". Often they don't live in squalor but just regular working class or lower middle class comfort. Many of us watching have a sneaky suspicion that we know why. We remember our own indoctrination from our mothers or fathers. A penny saved is a penny earned, waste not want not and essentially wasting money unnecessarily is the work of the devil, and saving it will somehow help us get into heaven although we are not sure why. (I call this potato famine insecurity). Many of us can solve modern day mysteries in this way. One example is: why does someone like Warren Buffet live in the same house he bought 3 decades ago for $31,500 when he could buy out his own street for a whisper of his fortune?
But here is an interesting question. If you have the legal right to spend millions, or billions but don't, have you ever really been rich, other than in your own head? It may seem like a silly question but a man that has the right to spend billions but leaves it all with money managers until the day he dies hasn't really left any mark that he has owned the money at all. His money could have been owned by anyone else in the world and, so long as they didn't withdraw the money, the effect would have been the same. His main contribution to the economy was choosing which money manager to use. This is not a trivial decision since one money manager could have a bias towards real estate and distort prices there, while another may have a bias towards hi-tech stocks and create a different distortion in the economy.
What is in essence happening is that the "rich man" is giving his money into investments and hence letting it ride in the economy. That money, if invested directly in a company goes to salaries, capital expenditures etc. The money, if invested very well in established securities correctly could help towards market efficiency (buying the right stocks/assets low and selling high) but all the gains remain in the hands of the market. In essence, the investor is putting his money to work to help the economy as an investor in a way that will usually increase the wealth of the economy although not himself until he starts spending his money directly on himself.
So here is my premise. It is not your income every year that matters to the economy. It is the amount you spend directly on yourself that actually changes the economy and hence the only thing that really matters. A person is not rich until he has taken a chunk of Production for himself. The Pharaohs of Egypt were rich because they took a huge chunk of labour out of the market every year to build great big near-useless pyramids (in the days before tourists from Nebraska). That same labour could have been planting fields or building houses. When Warren Buffet lets his massive gains every year ride on his investments, it is almost the same as his not owning it at all, nevertheless his hand is seen more indirectly by having some control in the investments although a theoretical efficient market would suggest that someone else would make similar investments if he weren't there (Efficient markets are always a sticky point for Warren).
Making a huge assumption that all passive investments are relatively efficient (one money manager for you money isn't that much different than another) then the only thing that should matter to the economy is not how much a person earns, but how much they consume, ignoring the taxman for a minute. That Bill Gates being rich doesn't really take any bread from the mouths of the needy in the world until he starts buying up all the bread. Ironically, it is only now that he is spending his money on world charity that one can argue that he is redirecting production away from others.
So lets get back to the "wealth charts" and consider how much more there would be for everyone if it wasn't for the richest 0.1% families that earn much more than they can spend. I would guess, there wouldn't be that much more, until the crazy grandson decides to blow it all on a party in Las Vegas.
Monday, August 17, 2009
Safe as Houses - What return should you expect from houses?
While at Business School I took classes from Real Estate "experts" which can be summarized by:
(a) There are some really cool ways to avoid taxes with real estate
(b) Don't invest in any properties overseas, unless its with your cousin who lives there, ideally with mafia ties (cause you'll end up paying tourist prices, and management would be a nightmare)
We used clever charts calculating returns. As usual, we used historical prices to calculate future prices which is nature's way of creating bubbles. I'm not going to revisit the tired topic of the mortgage mess in the country but here is a simple question. What investment return should you really expect from real estate investments every year? 15%? 5% ? 1%?
Efficient market theory suggests that all investments converge to the same return over time, since money will flow to the higher yielding investment until this is true. REIT (Real Estate Investment Trusts) out-performed the stock market since their recent inception, present debacle excepted. So how has real estate performed over the long haul.
Robert Shiller is perhaps one of the most widely read experts in this field, but his conclusions pretty much match up with common sense. The simple rule of thumb is that people cannot spend more than they have on housing, at least not for long. Their monthly income vs. monthly housing costs is a ratio that has been quite constant over time.
This is true for all countries, all centuries. Monthly housing payments (be they mortgages or rent) will typically vary from quarter to half of someones salary. In Huston they will be closer to quater and in San Francisco they will be closer to half, the higher rate is often blamed on artificial control of supply through zoning laws and local city ordinances. Perhaps I am stating the obvious but there are just a few factors involved in the average U.S. house price:
(1) The average income of an house buying family, closely related to GDP per family
(2) The mortgage interest rate.
(3) The "extras" in a monthly house cost such as local taxes and monthly apartment dues.
So, if none of these three factors have changed, and the price of houses go up, surely you are in a housing bubble. If the mortgage interest rate is temporarily low and is the only factor that has changed, then the price increase will only last as long as the mortgage rate is low. If suddenly mothers start going back into the workforce and taking up more professional work, then the median family income goes up, and hence house prices will go up. It seems as this bird has flown already, since the percentage of women in the workforce is not growing significantly anymore in most urban areas.
Shiller has deduced that over the last 100 years, median house prices have risen just slightly more than inflation each year. I would expect it tracks median family income.
My guess is that the only places that have had genuine long term increases in house prices that beat the average are places that have seen a demographic shift, e.g. from lower middle class incomes to upper middle class such as the upper west side in Manhattan over the last three decades. In other words, you can get genuinely rich in real estate investments, bubbles aside, when you can predict when a neighborhood is going to dump a chunk of its current residents and bring in richer ones.
I almost feel that this is too obvious but perhaps people are getting too wrapped up with supply and demand.
No matter how scarce the supply, people can only pay from what they earn. Even if you choke supply artificially buyers will not be able to pay much more than half of their income on housing and still have a life. So utimately, the average house price in the U.S. is married to the average family income in the U.S. Additionally, the average rent paid is also married to the average family income.
Stating what must be common knowlege by now, the recent bubble was magnified by the banks giving loans to people who historically wouldn't qualify. They did this because of the new process of mortgage securitization, which means that mortgages were broken up into shares and sold to many customers leaving the banks to take a nice commission and have little or no stake in the success of the mortgage. The customers were typically not informed that the quality of loans were going drastically down year on year so they kept buying them. With so many generous new mortgages, house prices were able to lose touch with income, but obviously not for long.
When the dust settles how much return should you expect if you buy an investment property for cash?
If you assume house prices are fairly valued right now, (a big assumption) mortgage rates can't go much lower, so the average house price will trend the average family income. This is unlikely to exceed 3%-4% (so in real terms with inflation at 3% the actual gain is 0% to 1%). Rent minus expenses will possibly give you another 3% to 5% annually, although the taxman may take at least a third of this. So an all cash purchase of an "average" investment property to rent out should give you something like 6% to 9% annually before taxes.
If you borrow the money to buy the house your return is about 2% above the mortgage rate which you could consider your risk premium.
(a) There are some really cool ways to avoid taxes with real estate
(b) Don't invest in any properties overseas, unless its with your cousin who lives there, ideally with mafia ties (cause you'll end up paying tourist prices, and management would be a nightmare)
We used clever charts calculating returns. As usual, we used historical prices to calculate future prices which is nature's way of creating bubbles. I'm not going to revisit the tired topic of the mortgage mess in the country but here is a simple question. What investment return should you really expect from real estate investments every year? 15%? 5% ? 1%?
Efficient market theory suggests that all investments converge to the same return over time, since money will flow to the higher yielding investment until this is true. REIT (Real Estate Investment Trusts) out-performed the stock market since their recent inception, present debacle excepted. So how has real estate performed over the long haul.
Robert Shiller is perhaps one of the most widely read experts in this field, but his conclusions pretty much match up with common sense. The simple rule of thumb is that people cannot spend more than they have on housing, at least not for long. Their monthly income vs. monthly housing costs is a ratio that has been quite constant over time.
This is true for all countries, all centuries. Monthly housing payments (be they mortgages or rent) will typically vary from quarter to half of someones salary. In Huston they will be closer to quater and in San Francisco they will be closer to half, the higher rate is often blamed on artificial control of supply through zoning laws and local city ordinances. Perhaps I am stating the obvious but there are just a few factors involved in the average U.S. house price:
(1) The average income of an house buying family, closely related to GDP per family
(2) The mortgage interest rate.
(3) The "extras" in a monthly house cost such as local taxes and monthly apartment dues.
So, if none of these three factors have changed, and the price of houses go up, surely you are in a housing bubble. If the mortgage interest rate is temporarily low and is the only factor that has changed, then the price increase will only last as long as the mortgage rate is low. If suddenly mothers start going back into the workforce and taking up more professional work, then the median family income goes up, and hence house prices will go up. It seems as this bird has flown already, since the percentage of women in the workforce is not growing significantly anymore in most urban areas.
Shiller has deduced that over the last 100 years, median house prices have risen just slightly more than inflation each year. I would expect it tracks median family income.
My guess is that the only places that have had genuine long term increases in house prices that beat the average are places that have seen a demographic shift, e.g. from lower middle class incomes to upper middle class such as the upper west side in Manhattan over the last three decades. In other words, you can get genuinely rich in real estate investments, bubbles aside, when you can predict when a neighborhood is going to dump a chunk of its current residents and bring in richer ones.
I almost feel that this is too obvious but perhaps people are getting too wrapped up with supply and demand.
No matter how scarce the supply, people can only pay from what they earn. Even if you choke supply artificially buyers will not be able to pay much more than half of their income on housing and still have a life. So utimately, the average house price in the U.S. is married to the average family income in the U.S. Additionally, the average rent paid is also married to the average family income.
Stating what must be common knowlege by now, the recent bubble was magnified by the banks giving loans to people who historically wouldn't qualify. They did this because of the new process of mortgage securitization, which means that mortgages were broken up into shares and sold to many customers leaving the banks to take a nice commission and have little or no stake in the success of the mortgage. The customers were typically not informed that the quality of loans were going drastically down year on year so they kept buying them. With so many generous new mortgages, house prices were able to lose touch with income, but obviously not for long.
When the dust settles how much return should you expect if you buy an investment property for cash?
If you assume house prices are fairly valued right now, (a big assumption) mortgage rates can't go much lower, so the average house price will trend the average family income. This is unlikely to exceed 3%-4% (so in real terms with inflation at 3% the actual gain is 0% to 1%). Rent minus expenses will possibly give you another 3% to 5% annually, although the taxman may take at least a third of this. So an all cash purchase of an "average" investment property to rent out should give you something like 6% to 9% annually before taxes.
If you borrow the money to buy the house your return is about 2% above the mortgage rate which you could consider your risk premium.
Wednesday, August 12, 2009
Gold - The oldest Pyramid scheme
All the gold in the world would only make a cube with a side length of about 60 feet.
Even though there isn't very much of it, almost the last thing a gold speculator would want would be to have the gold delivered to her. Besides the odd jewelry maker or old fashioned dentist, there really isn't that much need for gold in the world, so why the hell are billions of dollars spent on it every year.
Gold being used as money always seemed a bit odd to me. Didn't anyone think it was fishy that you could wake up some day and find lumps of your currency buried in your back yard, where it had been for 5 billion years.
Initially gold was pretty so people liked make pretty things out of it and people would barter turkeys for it. Then gold was used as money because there was a limited supply of it and it didn't corrode, but both reasons are fallacies.
Firstly, the corrosion argument doesn't hold much water as so many materials today don't corrode. Even gold colored plastic would cover this angle.
Secondly, there is not a limited supply of gold, demonstrated with the Spanish flooding Europe with gold after the discovery of the "New World" and in more modern times, there are discoveries of new mines, the largest in the world being in Papau New Guinea discovered only two decades ago. Additionally, physicists tell us that there is mountains of gold at the center of the earth (http://www.abc.net.au/news/newsitems/200606/s1664312.htm) It falls to the core because its heavier than the other elements. Its just lying there for some future digging traveller to dredge up (albeit hundreds of years from now). So, given that some day in the future, gold will probably be worthless, why does everyone want to buy it.
Perhaps everyone buying gold is hoping that someone later will buy it for more. It is the oldest Pyramid system since the Pyramids. People talk about hedging against the stock market or not trusting currencies but gold is the ultimate useless commodity, unlike something like copper that you can do stuff with. Most of it remains locked up as the pieces of paper representing it are passed from hand to hand. Like any Pyramid scheme, it depends on people later buying it for more. People don't talk about anything production related when they talk about gold prices, they talk about human confidence and sentiment. Its a share that will never pay a dividend (like some high tech stocks) so technically can have no value as an investment.
This doesn't mean that you can't get rich buying gold. Lots of people get rich in Pyramid schemes.
Even though there isn't very much of it, almost the last thing a gold speculator would want would be to have the gold delivered to her. Besides the odd jewelry maker or old fashioned dentist, there really isn't that much need for gold in the world, so why the hell are billions of dollars spent on it every year.
Gold being used as money always seemed a bit odd to me. Didn't anyone think it was fishy that you could wake up some day and find lumps of your currency buried in your back yard, where it had been for 5 billion years.
Initially gold was pretty so people liked make pretty things out of it and people would barter turkeys for it. Then gold was used as money because there was a limited supply of it and it didn't corrode, but both reasons are fallacies.
Firstly, the corrosion argument doesn't hold much water as so many materials today don't corrode. Even gold colored plastic would cover this angle.
Secondly, there is not a limited supply of gold, demonstrated with the Spanish flooding Europe with gold after the discovery of the "New World" and in more modern times, there are discoveries of new mines, the largest in the world being in Papau New Guinea discovered only two decades ago. Additionally, physicists tell us that there is mountains of gold at the center of the earth (http://www.abc.net.au/news/newsitems/200606/s1664312.htm) It falls to the core because its heavier than the other elements. Its just lying there for some future digging traveller to dredge up (albeit hundreds of years from now). So, given that some day in the future, gold will probably be worthless, why does everyone want to buy it.
Perhaps everyone buying gold is hoping that someone later will buy it for more. It is the oldest Pyramid system since the Pyramids. People talk about hedging against the stock market or not trusting currencies but gold is the ultimate useless commodity, unlike something like copper that you can do stuff with. Most of it remains locked up as the pieces of paper representing it are passed from hand to hand. Like any Pyramid scheme, it depends on people later buying it for more. People don't talk about anything production related when they talk about gold prices, they talk about human confidence and sentiment. Its a share that will never pay a dividend (like some high tech stocks) so technically can have no value as an investment.
This doesn't mean that you can't get rich buying gold. Lots of people get rich in Pyramid schemes.
Tuesday, August 4, 2009
Obama's Dollar - Worth 50 Cents
Bob was really clever when he started the Bank. He put in $100 and they allow him to loan out $900. He gets to do this by "borrowing" from some nebulous government entity which creates $900 out of thin air on his behalf, so long as it (and Bob) doesn't exceed certain loan/deposit ratios. But if this $900, that has just been created from nothing, is dumped on the economy, you have just diluted the economy by $900 and hence devalued everyone's dollar. The only way to prevent this, is if this $900 is backed by production or assets of some kind. Hence, when farmer Joe borrows $900 and works his plough for two months to pay it back, the $900 is essentially given its value by the fact that farmer Joe has exchanged his labor for it, hence $900 of production has been added to the economy for the $900 of hard currency.
When Obama borrows a trillion and puts it into production and/or assets that will fetch only a fraction of that in a fair market system, he has devalued the dollar. More dollars will circulate in the economy with "government production" behind it rather than fair market production. This is not Obama's fault. The government in any country, as a giant monopoly, would be structurally inefficient. People talk about secondary effects of this dollar (getting re-spent) where each government dollar adds two to the economy, but this is disingenuous. This re-spending effect is analogous to giving everyone free dollars which just causes inflation without production when they "re-spend" it.
So if Obama's "public works" projects end up worth every penny put into them in a "theoretical" fair market, there may be no inflation and they will ultimately pay for themselves, which is an argument made for the freeway system in America, but if it ends up being soviet style government production where no one would pay a penny for the fruits of this labor, then it is just free handouts to the lucky companies that get the work, and inflation will be rampant. My guess is that an Obama dollar will be worth about half a regular dollar, based on historical government efficacy, diluting the dollars in cirulation. If 15 trillion dollars is spent on production in the U.S. every year and the government spends 1 extra trillion on production worth half a trillion in real terms to the economy, the devaluation of the dollar (and hence inflation) would be about 3% more than without the spending spree. In other words, if inflation is going to be 2% without goverment action, this spending will bring it up to 5%. Not earth shattering, but food for thought.
When Obama borrows a trillion and puts it into production and/or assets that will fetch only a fraction of that in a fair market system, he has devalued the dollar. More dollars will circulate in the economy with "government production" behind it rather than fair market production. This is not Obama's fault. The government in any country, as a giant monopoly, would be structurally inefficient. People talk about secondary effects of this dollar (getting re-spent) where each government dollar adds two to the economy, but this is disingenuous. This re-spending effect is analogous to giving everyone free dollars which just causes inflation without production when they "re-spend" it.
So if Obama's "public works" projects end up worth every penny put into them in a "theoretical" fair market, there may be no inflation and they will ultimately pay for themselves, which is an argument made for the freeway system in America, but if it ends up being soviet style government production where no one would pay a penny for the fruits of this labor, then it is just free handouts to the lucky companies that get the work, and inflation will be rampant. My guess is that an Obama dollar will be worth about half a regular dollar, based on historical government efficacy, diluting the dollars in cirulation. If 15 trillion dollars is spent on production in the U.S. every year and the government spends 1 extra trillion on production worth half a trillion in real terms to the economy, the devaluation of the dollar (and hence inflation) would be about 3% more than without the spending spree. In other words, if inflation is going to be 2% without goverment action, this spending will bring it up to 5%. Not earth shattering, but food for thought.
Monday, August 3, 2009
Americans - Greedy Capitalists or Naive Victims
The old argument goes something like this: Americas buy more than they sell because they can't make decent cars, toasters or bread to put in it. Also because Americans are greedy and/or lazy hence they will forever spend more than they earn.
In contrast to this, economists such as Bruce Greenwald at Columbia University put forward this argument:
America wants to be the international transaction (reserve) currency (oil and other inter-country transactions), hence everyone wants dollars since everyone will accept dollars. Since everyone wants dollars, not just to buy stuff, but to hold as reserves, the demand for dollars is artificially high and hence the dollar is overvalued. This, he explains, happened to Sterling in the 20s and 30s leading to high unemployment in the U.K. since their overvalued currency made them uncompetitive. To make it more personal, lets assume that China has made the executive decision to sell more to America than it buys (which it has) and will constantly devalue its currency until this happens (which they do). Hence, no matter how clever the American engineers are, or how hard the people work, currencies will be manipulated until the U.S. buys more than it sells.
Now here is the odd thing. Normally, the dollar flowing unilaterally to China would mean that China would be filling up with Dollars, devaluing the Dollar against the Yuan. This would normally right itself eventually when the dollar devalues enough to fix the trade deficit (as U.S. goods get cheaper) and dollars are sent back to the U.S. to buy stuff. But instead of the dollar being used to buying U.S. goods and services, its flowing back to the U.S. to buy government debt and other securities. The dollar ends back on U.S. soil but the "goods" China bought was a claim against future U.S. production. China gets stiffed if it doesn't take up its claim on U.S. production some day. When it does come time to take up its claim, there is a really good chance the dollar will be devalued, so China will get stiffed anyway.
This is a fascinating argument that says that the U.S. currency cannot naturally adjust in a way to allow exports to match imports over the long term. So even if the U.S. tightens its belt, spends less, works harder and smarter for less, suddenly the Chinese imports will get even cheaper so that more money still goes to China that comes from China. China will take steps to that the currency will be just low enough to out-cheap the U.S. In this way, China suffers in that it cannot pass the true value of its production onto its people, instead leaves their own people significantly worse off and diverts the difference into U.S. investments to prevent the Yuan from appreciating.
This wasn't such a big deal when China (and other Asian countries) were dwarfs compared to the U.S. but now, they have turned in to 800 pound gorillas and this makes the practice unsustainable. As America's employment and production fall the currency cannot adjust and devalue and instead continues to appreciate on the global market, things can only spiral worse, especially as everyone else scrambles to devalue.
China now holds roughly half a trillion of U.S. debt. They have a great weapon over the U.S. head. They can (temporarily) tank the U.S. currency by dumping them on the global market, only that tanking the U.S. currency could hurt them and their investment more than it hurts the U.S.
China is also getting annoyed with the wildly fluctuating and weakening U.S. dollar and now is making noises about making the basket of currencies called "Special Drawing Rights"(SDR) securities by the IMF the international reserve currency. Nobody else really wants to be "it" in terms of the reserve currency so even on the "SDR" wikipedia page, there is a section on "why not to use SDRs as the reserve currency".
So China is a in a conundrum. It can pretend that its strategic devaluing of its own currency is not damaging the U.S. and continue to take steps that and completely unsustainable, or they can, heaven forbid, stop manipulating their currency and allow the Chinese people take the dollars they are earning and spend them on the world market for themselves on stuff and not promissory notes from the U.S. government. But, alas, could China live with spending as much as it earns
In contrast to this, economists such as Bruce Greenwald at Columbia University put forward this argument:
America wants to be the international transaction (reserve) currency (oil and other inter-country transactions), hence everyone wants dollars since everyone will accept dollars. Since everyone wants dollars, not just to buy stuff, but to hold as reserves, the demand for dollars is artificially high and hence the dollar is overvalued. This, he explains, happened to Sterling in the 20s and 30s leading to high unemployment in the U.K. since their overvalued currency made them uncompetitive. To make it more personal, lets assume that China has made the executive decision to sell more to America than it buys (which it has) and will constantly devalue its currency until this happens (which they do). Hence, no matter how clever the American engineers are, or how hard the people work, currencies will be manipulated until the U.S. buys more than it sells.
Now here is the odd thing. Normally, the dollar flowing unilaterally to China would mean that China would be filling up with Dollars, devaluing the Dollar against the Yuan. This would normally right itself eventually when the dollar devalues enough to fix the trade deficit (as U.S. goods get cheaper) and dollars are sent back to the U.S. to buy stuff. But instead of the dollar being used to buying U.S. goods and services, its flowing back to the U.S. to buy government debt and other securities. The dollar ends back on U.S. soil but the "goods" China bought was a claim against future U.S. production. China gets stiffed if it doesn't take up its claim on U.S. production some day. When it does come time to take up its claim, there is a really good chance the dollar will be devalued, so China will get stiffed anyway.
This is a fascinating argument that says that the U.S. currency cannot naturally adjust in a way to allow exports to match imports over the long term. So even if the U.S. tightens its belt, spends less, works harder and smarter for less, suddenly the Chinese imports will get even cheaper so that more money still goes to China that comes from China. China will take steps to that the currency will be just low enough to out-cheap the U.S. In this way, China suffers in that it cannot pass the true value of its production onto its people, instead leaves their own people significantly worse off and diverts the difference into U.S. investments to prevent the Yuan from appreciating.
This wasn't such a big deal when China (and other Asian countries) were dwarfs compared to the U.S. but now, they have turned in to 800 pound gorillas and this makes the practice unsustainable. As America's employment and production fall the currency cannot adjust and devalue and instead continues to appreciate on the global market, things can only spiral worse, especially as everyone else scrambles to devalue.
China now holds roughly half a trillion of U.S. debt. They have a great weapon over the U.S. head. They can (temporarily) tank the U.S. currency by dumping them on the global market, only that tanking the U.S. currency could hurt them and their investment more than it hurts the U.S.
China is also getting annoyed with the wildly fluctuating and weakening U.S. dollar and now is making noises about making the basket of currencies called "Special Drawing Rights"(SDR) securities by the IMF the international reserve currency. Nobody else really wants to be "it" in terms of the reserve currency so even on the "SDR" wikipedia page, there is a section on "why not to use SDRs as the reserve currency".
So China is a in a conundrum. It can pretend that its strategic devaluing of its own currency is not damaging the U.S. and continue to take steps that and completely unsustainable, or they can, heaven forbid, stop manipulating their currency and allow the Chinese people take the dollars they are earning and spend them on the world market for themselves on stuff and not promissory notes from the U.S. government. But, alas, could China live with spending as much as it earns
Saturday, August 1, 2009
Money - Spare a $trillion?
Recently two world famous economists saw the economy in dire straits, for opposite reasons. Allan Meltzer sees crippling inflation and Paul Krugman sees the potential depression era deflation.
So the government is going to borrow (and essentially print) a trillion dollars on our behalf. What does this mean?
Since most new money comes from loans, add up all the money in America and it will not cover all the debt (because of interest). The banks essentially create money when they lend money for construction or other projects, so long as they don't max out their deposits/loans ratios. When they stop lending to their historical rate, they are taking trillions out of the economy, which left to its own devices will result in massive deflation. Defaltion (the dollar increasing in value and prices going down) like this, is not in itself a bad thing once the process is finished since all prices will be proportionately less, but getting there is hell. Everyone will have to take paycuts and pricecuts since there will not be enough cash in the economy to pay everyone at the old rate. There will be strikes and lawsuits everywhere. Debts in place before the deflation period will be too big to pay back since money will get scarser. Everyone will start conserving cash since they will expect the dollar will be worth more in the future.
So the government creates a trillion dollars out of thin air (using an IOU) and spends it on government programs. So there are two possible outcomes:
(1) The goverment doesn't cover the hole left by the reduction in loans by the banks and the amount of money in the economy shrinks, hence scary deflation.
(2) The government is going to overshoot the amount of money the banks are taking out of the economy(by reduced lending) and set the country awash in dollars. This will cause serious inflation.
What the government is doing is risky. By, in effect, printing money (or borrowing it on our behalf) they are subtly reducing the value of everyone's dollars unless its put into production or assets that are exactly worth the money borrowed, but if they match exactly the shortfall coming from the banks, we should be back in the same place as an economy although different people will end up with the money. The main difference is that the banks historically would target people that would show a direct "return" for this investment and try to direct loans to production or productive people, whereas the government will redistribute wealth to favored senators, lobbyists and some civil-service-bureaucracy-determined needy project. This will result in assets and production that will absorb a trillion but only fetch a fraction of that in a "theoretical" open free market. In this way, they will have devalued the dollar directly and caused inflation, as if they had a giant basket of money and given half of it or more to favored sons of the government. The wealth redistribution will be clumsy, inefficient and perhaps a little corrupt, but if the government doesn't do it no one else will and as a result I reluctantly support it. We will take the surgeon with the bent fork instead of a scalpel because there are no other surgeons around. We all allow this because we believe that desperate times call for desperate measures. However, bureaucrats spending trillions of dollars can be addictive, and a lot of people will become powerful that were not powerful before. There will be no taking back the largess without a fight. So, the trillion dollar question is, will they be able to dial it back completely before the tail wags the dog? History says probably not.
So the government is going to borrow (and essentially print) a trillion dollars on our behalf. What does this mean?
Since most new money comes from loans, add up all the money in America and it will not cover all the debt (because of interest). The banks essentially create money when they lend money for construction or other projects, so long as they don't max out their deposits/loans ratios. When they stop lending to their historical rate, they are taking trillions out of the economy, which left to its own devices will result in massive deflation. Defaltion (the dollar increasing in value and prices going down) like this, is not in itself a bad thing once the process is finished since all prices will be proportionately less, but getting there is hell. Everyone will have to take paycuts and pricecuts since there will not be enough cash in the economy to pay everyone at the old rate. There will be strikes and lawsuits everywhere. Debts in place before the deflation period will be too big to pay back since money will get scarser. Everyone will start conserving cash since they will expect the dollar will be worth more in the future.
So the government creates a trillion dollars out of thin air (using an IOU) and spends it on government programs. So there are two possible outcomes:
(1) The goverment doesn't cover the hole left by the reduction in loans by the banks and the amount of money in the economy shrinks, hence scary deflation.
(2) The government is going to overshoot the amount of money the banks are taking out of the economy(by reduced lending) and set the country awash in dollars. This will cause serious inflation.
What the government is doing is risky. By, in effect, printing money (or borrowing it on our behalf) they are subtly reducing the value of everyone's dollars unless its put into production or assets that are exactly worth the money borrowed, but if they match exactly the shortfall coming from the banks, we should be back in the same place as an economy although different people will end up with the money. The main difference is that the banks historically would target people that would show a direct "return" for this investment and try to direct loans to production or productive people, whereas the government will redistribute wealth to favored senators, lobbyists and some civil-service-bureaucracy-determined needy project. This will result in assets and production that will absorb a trillion but only fetch a fraction of that in a "theoretical" open free market. In this way, they will have devalued the dollar directly and caused inflation, as if they had a giant basket of money and given half of it or more to favored sons of the government. The wealth redistribution will be clumsy, inefficient and perhaps a little corrupt, but if the government doesn't do it no one else will and as a result I reluctantly support it. We will take the surgeon with the bent fork instead of a scalpel because there are no other surgeons around. We all allow this because we believe that desperate times call for desperate measures. However, bureaucrats spending trillions of dollars can be addictive, and a lot of people will become powerful that were not powerful before. There will be no taking back the largess without a fight. So, the trillion dollar question is, will they be able to dial it back completely before the tail wags the dog? History says probably not.
Subscribe to:
Comments (Atom)