Credit expansion and cyclical economies

[JJChicken]

Over the past few days I've come across three articles that have delved into our credit expansionist policies and why they cause our economies to be cyclical and have lent some reason for the chaos of 2008. I thought it would be useful to share with the rest of the P&N crew. By no means am I an expert in economics so I hope that those with a better understanding can chime in with some useful commentary.

Paulson's interview with FT.com
Cliffs

• Rising emerging markets (particularly China and oil exporters) are production-oriented, and have higher levels of savings (budget surpluses) while the majority of the Western world is consumption-oriented and have budget deficits funded by credit. This has created global economic imbalances.

• High levels of savings by emerging countries fund our budget deficits (China is holds vast amounts of US treasury notes) but have put downward pressure on interest rates and consequently risk spreads (the former is easily seen, the latter likely results because lower interest rates make risky investments more attractive (the intuition I'm thinking would be that with a constant 2% risk premium, at interest rates of 2%, the risky asset offers double the return over the risk-free, and is much more attractive than at interest rates of 10%, where the 12% return on the risky asset is only 20% more than the risk-free) and drive down their equilibrium risk premia

• These imbalances thus created the credit bubble that burst recently (September?)

Soros's opinion on the financial crisis
Cliffs

• The U.S. economy has been cyclical since the second world war, with cycles ranging from 4 to 10 years. Soros believes the current crisis is not only the end of the latest cycle but the end of a 'super-boom' era where the previous booms and busts were but fluctuations about an upward trend line.

• The previous financial crisis were overcome, particularly since the 1980s, by liquidity/credit injections and economy stimulations by the Fed.

• Free market ideology provided sound (or apparently sound) reasoning for such intervention: in words well put by soros, "common interest is best served by allowing participants to pursue their self-interest".

• Globalisation, where production was shifted outside US at places where it could be undertaken more cheaply, pushed the US to a consumption-oriented economy and accordingly led to budget deficits (US current account deficit in 2006 was 6.2% of GNP) that must inevitably funded by credit that is sourced from the savings of production-oriented economies like China.

• The key problem now is inflation (due to the Fed flooding the money supply to pay for TARP and current and future stimulus packages) and a depreciation in the dollar. A devaluation of the dollar will devalue US treasuries and cause yields to increase. This will go against the Fed's goal to keep yields low in order to stimulate the economy. This will prevent a credit expansionist policy to pull the US out of this recession. In layman's words, we can't afford it and we need to tighten our belts (reduce consumption and increase production through a recession "we had to have").

• Soros's finishes poignantly and touches upon the very points Paulson makes in his interview:
  

  Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other developing countries.
  
  The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

The jigsaw piece that provides a backdrop for these two articles:

http://www.economicsjunkie.com/credit-expansion-policy/

Objectives of Credit Expansion

Credit expansion is the activity where the authority or the business producing money (be it by mining gold or by printing paper money and making it legal tender by force) channels additional currency into the market by purchasing merchant bills, government bills or bonds or other credit instruments. In a monetary system based on gold there exist strict limits for money producers when it comes to credit expansion, due to the natural scarcity of the precious metal. In a system based on paper money (fiat money) there are no natural limits on the amount of additional curreny printed and used to purchase credit instruments.

The effect of credit expansion is that the interest rate charged for additional credit instruments drops.

Credit expansion is the policy that central banks pursue. It is broadly accepted as a measure to make society prosperous.

When the Federal Reserve Bank lowers the discount rate it really begins purchases of bills and bonds on the market, until the interbank interest rate is at its desired level. The lowering of the discount rate by itself has no effect because banks hardly ever draw upon this source of money.

It is its declared objective to make credit abundant. New credit channeled into the system is said to spur business activity, capital becomes inexpensive, entrepreneurs can borrow more money for investments, commerce flourishes and soon all of society is permeated by the magical boon that the additional credit boom bestows upon it. Everyone is supposed to enjoy all the products and services they have been longing for under the stingy policy of tight credit.

This idea is based on the substantially flawed assumption that capital can be created out of nothing. Capital can only exist if factors of production are available for use. Every investment necessitates the use of factors of production that turn out more or more valuable products after a roundabout process rather than consuming fewer or less valuable products immediately. Factors of production can only exist if people have generated savings. Savings are generated if one forgoes immediate consumption for the prospect of future consumption. Foregoing present consumption can only be feasible if a person considers the future remuneration he gets in return more valuable than the immediate consumption he sets aside. This is what is called time preference. Time preferences are expressed on the market in the form of interest rates. (Terms explained: capital, factors of production, interest, value, money)

This causality ensures that market interest rates always provide an indication of the availability of factors of production and individuals' time preferences. While prices give entrepreneurs an indication as to what products are desired or needed, interest rates provide a measure as to when they are desired or needed. It creates an environment where entrepreneurs have an incentive to fulfill demands based on value judgments and time preferences at any given point in time.

The Effects of Credit Expansion

It is now necessary to examine what the process of credit expansion entails. The central bank that creates money does not own any capital, it does not create factors of production. The only thing it channels into the market is pure fiat money, money that is enforced via legal tender laws.

Before examining the purchase of credit instruments it makes sense to take an intermediary step and look at the simple purchase of consumption goods. For example, if it were to purchase bread with the newly printed money, its governing board could decide to supply the bread to all its officials. They will be able to enjoy the bread while its price rises and bread will not be available to other would-be buyers who would have purchased it at a lower price that would have represented their value preferences. While on the market people can only buy things if producing things in return, and while all transactions are based on voluntary exchange and value judgments, the central bank does not act under these constraints. It skews the natural price of bread that would usually be based on voluntary value preferences and supply and demand. The result of this will be that entrepreneurs' judgment of value preferences will be skewed. Because it suddenly appears more profitable than before they will begin producing bread instead of another commodity that is located higher on the actual value scale of the actors in the market. The outcome is precisely that consumers on the market are not supplied with products as their voluntary value preferences mandate. What happens instead is that the supply of surplus bread is triggered by an arbitrary action on the part of a few central bank officials.

(As a side note: It is commonly understood that this inflationary purchase of present goods by printing money would be an unacceptable procedure of government arbitrariness. It was the method used by kings and emperors to subtly tax the populace and enriching themselves.)

The equivalent, however, occurs in the sphere of time preference if the central bank purchases bills or other credit instruments on the market. Providing a loan to someone is nothing but the obtainment of future goods. People demanding capital on the open market issue credit instruments such as merchant bills, governments issue government bonds and bills. The credit instruments purchased by the central bank will go up in price after each additional purchase, interest rates drop. Other providers of capital on the market whose time preferences were matched by the credit instruments offered will abstain from obtaining the corresponding credit instrument. Now the central bank has withdrawn future products from the market that would have gone to those who were outbid by it in the process of purchasing the loan contracts. They were not able to enter into a transaction that would have represented their time preferences. On top of that, the interest rates for the loan contracts purchased drop below the market rate that represents actual time preferences. This entails that the entrepreneurs' assessment of time preferences is skewed. They think that present goods against future goods are valued less than actual voluntary time preferences warrant. Those roundabout projects, that were not being embarked upon, because interest rates indicated time preferences in favor of less roundabout projects (whose goods would be consumable earlier) now appear to be feasible. Entrepreneurs begin embarking upon more roundabout projects that yield a produce in the farther future. At the same time they set aside those less roundabout projects which the market interest rates would have induced them to begin, had the credit expansion not taken place. The result is now precisely that consumers are again not supplied with products as desired as per their time preference.

The Credit Boom

Since no additional capital has been created via real savings, prices for factors of production used for the longer term will rise. The stock market, it being the main market for factors of production, will see a price increase, primarily in those stocks for companies whose projects yield a later produce. In particular, a lot of companies incorporate, that are currently not producing anything yet, nor plan to produce immediately, but are rather aiming to turn out goods a few years down the road, after spending time on roundabout research and production processes. As a tendency, the labour force of society becomes employed in roundabout long-term projects.

The Credit Crunch

The labour force, however, at the same time represents the bulk of the consumers whom those products are intended to be produced for. But their time preferences have not changed in reality. While being employed in very roundabout projects and processes, they still desire present goods over future goods more strongly than the entrepreneurs expected based on their assessment of interest rates. After the credit expansion is completed, consumer spending and saving habits will not be in line with those expectations. They demand more present products than are available and hence bid up their prices. Due to their shortage, an overall tendency towards rising prices for present consumption goods, such as food and gasoline, ensues. Market interest rates will now readjust in accordance with real time preferences again, based on savings generated. They will move up to the market level again. Incorporation of companies with overly roundabout projects will decline. Some entrepreneurs, who are in the middle of overly roundabout projects will not immediately realize this. They will keep employing resources in these projects. However, when they announce their new earnings expectations they will have to take the true time preferences into consideration. The products that were expected to be turned out in the farther future are not demanded by the consumers as expected. They will have to let the owners of the factors of production, the capitalists, know that their capital will not yield the return expected. This will cause a downward pressure on the prices of those factors of production used for overly roundabout processes. Correspondingly the prices for shares in such companies decline. They will be sold at prices that reflect true time preferences again. However, the time that resources have been employed in overly roundabout projects has been wasted. The true yield of their produce did not match the capitalists' expectations. The capitalists have suffered a loss.

Some of the factors of production can be easily channeled into new lines of production, in particular the factor labour. Others however, those which are fixed and specific to one particular project and are merely half finished may be forever lost, in particular this will be the case for huge construction or manufacturing projects that involve the erection of factories, machinery, etc. which have turned out to be useless.

Depending on the amount of surplus credit channeled into the market and depending on the duration of the credit expansion, the repercussions can be anything between mild and disastrous.

If this process of readjustment is not hampered with, the problems caused by the credit expansion will be within limits. The market will quickly recover, albeit, at a level that is less desirable than where it could have been at without credit expansion.

Conclusion

The objective of credit expansion, namely to ensure that more capital is generated in order for the market to provide more of what consumers demand, fails. In fact, it has the opposite effect. It skews the entrepreneurs' judgment and makes them align resources to produce products that consumers are not demanding and makes them use factors of production for processes that turn out products later than consumers are demanding them while withdrawing them form those production processes that would have been in compliance with consumers' time preferences.

Historical Relevance

The policy of credit expansion has been pursued by governments time and time again. It has become prevalent in the United States under President Woodrow Wilson after the inauguration of the Federal Reserve Act during the Christmas Holiday of December 1913. Since then, it has caused major credit booms and crunches in the form of stock market and real estate booms and subsequent crashes and economic booms and subsequent recessions. In particular this has been the case in the years of 1929, 1987, and 2001. It has always precipitated precisely the effects outlined above. Its workings and effects have been fully explained by this theory of the business cycles. No one has ever refuted the correctness of this theory.

Yet, to date economists and politicians appear completely riddled as to what causes booms and crashes. It is claimed to still be a matter of discussion amongst experts. It has been attempted to impute it on humans' greedy nature and natural exuberance. Whenever a crisis emerges the greatest supposed experts, central bank representatives, and politicians call in meetings and try and regulate the market to stave off the impending crunch. They forget or don't have the intellectual capacity to understand that it has been their own policy that has caused the crisis in the first place. As long as the central banks keep pursuing this policy, there is no need to be surprised when the next credit crunch occurs.

Cliffs (+commentary)

• Interest rates, the price of credit, factor into two important decisions, the capital expenditure decision by producers (when interest rates are high producers will prefer to invest in projects that offer cash flows in the shorter term and conversely will be more open to long-term investments when interest rates are low. This flows on from basic DCF analysis) and the consumption decision by consumers (when interest rates are high consumers will prefer to delay consumption and will be more inclined to save whereas when interest rates are low consumers will prefer to consume now than save).

• When the currency is fiat based, increases in the money supply through credit expansionist policies are not accompanied with real increases in the economies net worth: when the Fed prints money, the productive capacity of our economy is unchanged. In gold (or other resource) backed monetary systems this nominal increase in the money supply is limited.

• Wealth is not created by credit expansionist policies. The debate is whether government intervention in credit markets is value maximising. The argument against (and the point of the whole article) is that artificial non-market control over the interest rates (e.g. low interest rates in the Greenspan era) skews the aforementioned decisions made by producers and consumers towards investment in long-term projects and present consumption respectively. These two decisions are asynchrous with each other because, in the absence of global markets, a gap is created between the higher demand for current consumption and the lack of investment in productive capacity to satisfy current and near-term consumption (since producers shift capital to long roundabout projects). The divergence is also corrected by 'credit crunches' where producers investing in long-term projects realise the demand for these projects is not as envisioned because consumers are focused on present consumption and will suffer losses on these investments and scale back production. Interest rates rise because the risk premiums associated with production return to their true levels. Consumers will bid up prices of present goods and will also scale back consumption and will save more due to higher (and more attractive interest rates). Upto now globalisation has prevented this divergence from being too significant as emerging countries like China and India fulfill our current consumption needs. However, this creates economic imbalance (as discussed by Paulson above) as wealth flows out from our consumption-oriented economies to production-oriented economies.
  
  The counterargument to this is that the US is investing in the long-term future and its present consumption will be funded by the wealth to be created in the future. In itself, this argument is perfectably acceptable. However, the reason for the financial crisis lies in that artifical control over interest rates in sub-optimal from a total economy standpoint, producers are being skewed to investments that they would otherwise not make and consumers are skewed to consumption that they would not otherwise make (the wasteful consumption we see today). This goes precisely agaisnt the free market ideology espoused by our government. The sub-optimality will cause us to overpay for present consumption when we buy from emerging markets (live beyond our means) that will not be able to funded by our long-term projects because their true returns will be lower than expected. This falls in line with Soros's 'superboom' logic - we finally cannot afford to live beyond our means and our credit expanisionist policies will no longer work (or work as effectively as desired).

Whew such a long post...I'll edit it later. Hope it was useful.

 

[idiotekniQues]

marked for later

 

[bamacre]

I think Obama is saying that Paul was right.

 

[JJChicken]

Originally posted by: bamacre
I think Obama is saying that Paul was right.

I'm not too sure on what RP's stance on this is, but the article i quoted fully had links to Ron Paul on it. It actually made me skeptical of the article's merits , but there doesn't seem to be any obvious flaws in its logic.

 

[bamacre]

Originally posted by: Barack Obama

Originally posted by: bamacre
I think Obama is saying that Paul was right.

I'm not too sure on what RP's stance on this is, but the article i quoted fully had links to Ron Paul on it. It actually made me skeptical of the article's merits , but there doesn't seem to be any obvious flaws in its logic.

I'm sure our resident Fed-loving "experts" will come in here and say the OP is full of shit, the Fed and its artificially low interest rates do not cause bubbles and busts, economic cycles happen naturally, just like the weather, and the devaluing of the dollar is a good thing. If you question their assertions, you must provide copies of your resume including all education levels and employment positions.

 

[fskimospy]

Originally posted by: bamacre

I'm sure our resident Fed-loving "experts" will come in here and say the OP is full of shit, the Fed and its artificially low interest rates do not cause bubbles and busts, economic cycles happen naturally, just like the weather, and the devaluing of the dollar is a good thing. If you question their assertions, you must provide copies of your resume including all education levels and employment positions.

It's almost like economics is a field that you need to know something about before you can speak intelligently on the subject. It's the same way those snooty theoretical physics snobs keep insisting that I know something about theoretical physics before I declare all their theories crap. I think they're just apologists.

READRANDREADRANDREADRANDREADRANDREADRAND.

 

[bamacre]

Originally posted by: eskimospy

Originally posted by: bamacre

I'm sure our resident Fed-loving "experts" will come in here and say the OP is full of shit, the Fed and its artificially low interest rates do not cause bubbles and busts, economic cycles happen naturally, just like the weather, and the devaluing of the dollar is a good thing. If you question their assertions, you must provide copies of your resume including all education levels and employment positions.

It's almost like economics is a field that you need to know something about before you can speak intelligently on the subject. It's the same way those snooty theoretical physics snobs keep insisting that I know something about theoretical physics before I declare all their theories crap. I think they're just apologists.

READRANDREADRANDREADRANDREADRANDREADRAND.

I know enough to see and smell the shit we're standing in.

 

[bamacre]

For a good laugh...

http://www.federalreserve.gov/aboutthefed/mission.htm

 

[BoberFett]

Originally posted by: eskimospy

Originally posted by: bamacre

I'm sure our resident Fed-loving "experts" will come in here and say the OP is full of shit, the Fed and its artificially low interest rates do not cause bubbles and busts, economic cycles happen naturally, just like the weather, and the devaluing of the dollar is a good thing. If you question their assertions, you must provide copies of your resume including all education levels and employment positions.

It's almost like economics is a field that you need to know something about before you can speak intelligently on the subject. It's the same way those snooty theoretical physics snobs keep insisting that I know something about theoretical physics before I declare all their theories crap. I think they're just apologists.

READRANDREADRANDREADRANDREADRANDREADRAND.

Yeah, that damn Soros. Doesn't know shit.

Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so.

 

[JJChicken]

Bump!

 

[BoberFett]

Sorry Barack, if the headline doesn't say BUSH'S FAULT nobody around here wants to read it.

 

[piasabird]

If lowering the Interest Rate really helped we would see home loans 1-2 percent over prime. However, we dont see this, so only banks are getting these sweet deals.

Basically the little guy is getting ripped off.

 

[LegendKiller]

Originally posted by: piasabird
If lowering the Interest Rate really helped we would see home loans 1-2 percent over prime. However, we dont see this, so only banks are getting these sweet deals.

Basically the little guy is getting ripped off.

not a very astute observer are you?

http://www.bloomberg.com/markets/rates/keyrates.html

I have seen 30yr fixed mortgages go out under 5%. 15 years under 4.5%.

 

[JJChicken]

Originally posted by: BoberFett
Sorry Barack, if the headline doesn't say BUSH'S FAULT nobody around here wants to read it.

Sadly I guess non-politics threads don't get much headaway around these parts

I spent two hours typing this up, yet get 10x replies in any other thread I create. Go Figure.

 

[JJChicken]

Bumping this thread like MJ bumps you before fading away and shooting hoops

 

[JJChicken]

:ninja bump;

 

[soccerballtux]

I bookmarked this a while ago and have finally gotten around to reading; I'm up to the "jigsaw" piece.

"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other developing countries. "
This in particular, is just flat wrong. China is going through a recession of far greater magnitude than we are, seeing as their ENTIRE country is one giant export based industry, much less diverse than ours. Oil producing countries are in a world of hurt-- their budgets depended on a $150 barrel of oil...and it's currently 1/4th that price.

Continuing to read, will post more.
At this point my opinion is the best way out of our situation would be some planned inflation-- but only after consumers have felt enough hurt from their debt that they've learned the lesson and are interested in paying it off and beginning to save some. This is the least brutal, most politically friendly option. In this environment the savers lose, and the debters benefit. I think our middle class is enough of a debter class that this would perhaps be the right option to take.
Leave the government out of it, none of this socialist "redistribution of wealth" that Obama has been touting; simply do it through inflation-- don't write anybody check-- this way only those that are working and pulling an income realize the benefit (and it provides positive pressure to those not working to try harder to find a job).

Let me say one thing to the liberals (who tend to frown upon our defense spending) if you want to continue spending like madmen like the Republicans have, and want to continue to fund social security, medicare, welfare, and other entitlements; then it is in your best interest to ensure we have the most powerful military/army/airforce/etc. Eventually our debt will be greater than our ability to pay the principle, and at that point you'd better hope we can keep our economy propped up by force-- as in, not paying out those treasuries that China owns and being ready to defend ourselves if necessary. It's much easier to play catch-up when the tech already exists, than to invent the next great thing. For this reason the defense sector is the last thing we should cut funding for; we must stay ahead of China. (Japan is not an issue because our military is theirs).

 

[bamacre]

Originally posted by: soccerballtux
"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other developing countries. "
This in particular, is just flat wrong. China is going through a recession of far greater magnitude than we are, seeing as their ENTIRE country is one giant export based industry, much less diverse than ours. Oil producing countries are in a world of hurt-- their budgets depended on a $150 barrel of oil...and it's currently 1/4th that price.

I would think that the statement to which you are responding is in regards to the long run, not current nor short term. While China is hurting now, they aren't up to their elbows in debt like we are.

Let me say one thing to the liberals (who tend to frown upon our defense spending) if you want to continue spending like madmen like the Republicans have, and want to continue to fund social security, medicare, welfare, and other entitlements; then it is in your best interest to ensure we have the most powerful military/army/airforce/etc. Eventually our debt will be greater than our ability to pay the principle, and at that point you'd better hope we can keep our economy propped up by force-- as in, not paying out those treasuries that China owns and being ready to defend ourselves if necessary. It's much easier to play catch-up when the tech already exists, than to invent the next great thing. For this reason the defense sector is the last thing we should cut funding for; we must stay ahead of China. (Japan is not an issue because our military is theirs).

That's a fairly mad thing to say, IMO. That we can depend on our ability to make war and commit murder across the globe to make up for our own financial recklessness?

 

[gingermeggs]

me thinks your income is tied to military spending-
to pay a small amount off your principle would be a smarter way to avoid conflict, why not use the technology you have in manufacturing at home, reduce your import reliance and become "great" again?
You got the biggest arsenal of nukes in the world, who's gunna try shit! and not get turned into cinders.
For me the answer is to create sustainable existences for the middle class, with clear and secure life paths to follow, so luxury excesses should be priced higher and basics lower, accentuate the positive- eliminate the negative.

 

[JJChicken]

Originally posted by: bamacre

Originally posted by: soccerballtux
"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other developing countries. "
This in particular, is just flat wrong. China is going through a recession of far greater magnitude than we are, seeing as their ENTIRE country is one giant export based industry, much less diverse than ours. Oil producing countries are in a world of hurt-- their budgets depended on a $150 barrel of oil...and it's currently 1/4th that price.

I would think that the statement to which you are responding is in regards to the long run, not current nor short term. While China is hurting now, they aren't up to their elbows in debt like we are.

Let me say one thing to the liberals (who tend to frown upon our defense spending) if you want to continue spending like madmen like the Republicans have, and want to continue to fund social security, medicare, welfare, and other entitlements; then it is in your best interest to ensure we have the most powerful military/army/airforce/etc. Eventually our debt will be greater than our ability to pay the principle, and at that point you'd better hope we can keep our economy propped up by force-- as in, not paying out those treasuries that China owns and being ready to defend ourselves if necessary. It's much easier to play catch-up when the tech already exists, than to invent the next great thing. For this reason the defense sector is the last thing we should cut funding for; we must stay ahead of China. (Japan is not an issue because our military is theirs).

That's a fairly mad thing to say, IMO. That we can depend on our ability to make war and commit murder across the globe to make up for our own financial recklessness?

mad maybe, but true (as bad as it sounds for the human race, the past 2000+ years have taught us this)

 

[bamacre]

Originally posted by: Barack Obama
mad maybe, but true (as bad as it sounds for the human race, the past 2000+ years have taught us this)

And here I thought you were all about change.

 

[soccerballtux]

"Those roundabout projects, that were not being embarked upon, because interest rates indicated time preferences in favor of less roundabout projects (whose goods would be consumable earlier) now appear to be feasible. Entrepreneurs begin embarking upon more roundabout projects that yield a produce in the farther future. At the same time they set aside those less roundabout projects which the market interest rates would have induced them to begin, had the credit expansion not taken place. The result is now precisely that consumers are again not supplied with products as desired as per their time preference."

I believe he's wrong on this point-- the investors never go for the more risky, more-roundabout projects, in favor of the less-roundabout options. In credit expansion, the roundabout options are saturated, then the less-roundabout, more risky investments pursued.

"Since no additional capital has been created via real savings, prices for factors of production used for the longer term will rise. The stock market, it being the main market for factors of production, will see a price increase, primarily in those stocks for companies whose projects yield a later produce. In particular, a lot of companies incorporate, that are currently not producing anything yet, nor plan to produce immediately, but are rather aiming to turn out goods a few years down the road, after spending time on roundabout research and production processes. As a tendency, the labour force of society becomes employed in roundabout long-term projects. "

Again, I think not-- labor and captial become employed at an equal risk-level rate. By this I mean the price on the immediately profitable investments rises until it makes more sense to invest in the long term profit options, and take the increased chance that the long term yields won't deliver.

"The objective of credit expansion, namely to ensure that more capital is generated in order for the market to provide more of what consumers demand, fails. In fact, it has the opposite effect. It skews the entrepreneurs' judgment and makes them align resources to produce products that consumers are not demanding and makes them use factors of production for processes that turn out products later than consumers are demanding them while withdrawing them form those production processes that would have been in compliance with consumers' time preferences."

As I spoke of before, I fail to see how any time preferences are destroyed-- the simple fact is that with more credit the long-term-projects (risky) become more economically feasible.

You are right to say the role of credit expansion does nothing to create actual wealth-- that can only come with legitimate enterprise and new inventions. However, and as I mentioned this in my first post in this thread, credit expansion can be useful as a means of clearing debt-- make it easier to pay back your credit cards, make it easier to pay off your student and house loans, etc-- and this is something I think we may need in the not _too_ distant future.

I think the 2nd to last article guy has a good understanding of the effects of free credit, but it's nothing that an economics 101 class won't teach you. However, I believe he is wrong to say (and someone please correct me with an example because I fail to see) how cheaper credit DIVERTS resources from immediately-profitable projects. Good credit ensures immediately-profitable projects get funding (where this line is nobody knows and this is why economic policy is still debated among even the most educated of PhDs); cheaper credit makes more risky, long term profit projects more attractive to an investor. But I do not see how the cheaper credit somehow takes money away from the immediately profitable projects.

"The counterargument to this is that the US is investing in the long-term future and its present consumption will be funded by the wealth to be created in the future. In itself, this argument is perfectably acceptable. However, the reason for the financial crisis lies in that artifical control over interest rates in sub-optimal from a total economy standpoint, producers are being skewed to investments that they would otherwise not make and consumers are skewed to consumption that they would not otherwise make (the wasteful consumption we see today). This goes precisely agaisnt the free market ideology espoused by our government. The sub-optimality will cause us to overpay for present consumption when we buy from emerging markets (live beyond our means) that will not be able to funded by our long-term projects because their true returns will be lower than expected. This falls in line with Soros's 'superboom' logic - we finally cannot afford to live beyond our means and our credit expanisionist policies will no longer work (or work as effectively as desired)."

You're completely right; but it's not all bad: the good that we pay for when we make a decision like this is that in the mean time (before we hit rock bottom), the system/process is sustainable and usually very reliable. It enables us to live low-stress lives. This is a worthwhile gamble in my opinion; the gamble being "how much longer can we keep it going" (inevitably there must be a correction, but for the last 25 or so year's we've out-innovated it).

One last thing-- "Upto now globalisation has prevented this divergence from being too significant as emerging countries like China and India fulfill our current consumption needs. However, this creates economic imbalance (as discussed by Paulson above) as wealth flows out from our consumption-oriented economies to production-oriented economies."

That would be true if the wealth were leaving, but the fact is it isn't and hasn't-- any trade deficit we hold with China is give right back to us when they buy T-bonds from us. This is in both our interest for now-- it keeps us able to consume, and it gives their people something to work on. The problem comes when our debt becomes so great and their economy self-sustaining enough that they no longer need us to consume their products-- and this is when we need to be afraid, for it is no longer mutually assured to destruction to cash in all your T-bonds at once, and could be used were their a reason to (IE we pissed them off). And this is why defense spending and having the best tech to defend your country with is such a great thing-- because this way, we always hold the upper hand; while China holds the greater risk. Meanwhile we grow and build and invent and live more successful lives.

 

[soccerballtux]

Originally posted by: bamacre

Originally posted by: soccerballtux
"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other developing countries. "
This in particular, is just flat wrong. China is going through a recession of far greater magnitude than we are, seeing as their ENTIRE country is one giant export based industry, much less diverse than ours. Oil producing countries are in a world of hurt-- their budgets depended on a $150 barrel of oil...and it's currently 1/4th that price.

I would think that the statement to which you are responding is in regards to the long run, not current nor short term. While China is hurting now, they aren't up to their elbows in debt like we are.

Let me say one thing to the liberals (who tend to frown upon our defense spending) if you want to continue spending like madmen like the Republicans have, and want to continue to fund social security, medicare, welfare, and other entitlements; then it is in your best interest to ensure we have the most powerful military/army/airforce/etc. Eventually our debt will be greater than our ability to pay the principle, and at that point you'd better hope we can keep our economy propped up by force-- as in, not paying out those treasuries that China owns and being ready to defend ourselves if necessary. It's much easier to play catch-up when the tech already exists, than to invent the next great thing. For this reason the defense sector is the last thing we should cut funding for; we must stay ahead of China. (Japan is not an issue because our military is theirs).

That's a fairly mad thing to say, IMO. That we can depend on our ability to make war and commit murder across the globe to make up for our own financial recklessness?

It's not our ability to _make war_ as it is our ability to defend against China should they become unhappy with our choices. And nobody has to die in the end if we have a big enough air force/army/military, because they'd realize it's just pointless. You see in the end it's not a big deal though, because lets say worse comes to worst and we default on our T-bonds, 3 things could happen. Either China decides to forgive our debt because it's really just a number and doesn't mean anything; or they let us refinance to a certain point but no further and then we have to live with a perpetual tax on our economy (this would be the worst result); or finally they both don't let us refinance (and stop making us new loans), nor doe they forgive our debt; they demand it to be paid in full and proceed to cash in all the Treasury notes they hold. The last would be considered an act of war and probably would not happen.
I guess a 4th option would be we simply choose to stop paying it.

Like I said the end of the day I don't think any of it matters what we do as long as people don't die; I think in China's eyes us paying off the Treasuries in entirety is unlikely, dare I say not expected; they are in it for what they are gaining from us and through us now-- they have a market to sell to, and have been able to build their country to something it never would have reached without both our consumption, which was used to pay for, their development of their country (using our knowledge of bridges, environmental recovery technologies, improving healthcare using our tech, etc. At the end of the day the debt is a number, the real benefit to them is vastly improving the standard of living across the country; the benefit to us is we get anything that can be manufactured there, for super cheap.

I think this is why Congress is not concerned with our spending; for all we know our government could have a standing word from the top Chinese officials that none of this matters; they are happy with what they are getting and if we can't pay our debt to them no big deal. This is unlikely, however, because otherwise we wouldn't be spending so much on defense.

 

[soccerballtux]

Originally posted by: gingermeggs
me thinks your income is tied to military spending-
to pay a small amount off your principle would be a smarter way to avoid conflict, why not use the technology you have in manufacturing at home, reduce your import reliance and become "great" again?
You got the biggest arsenal of nukes in the world, who's gunna try shit! and not get turned into cinders.
For me the answer is to create sustainable existences for the middle class, with clear and secure life paths to follow, so luxury excesses should be priced higher and basics lower, accentuate the positive- eliminate the negative.

Well to a point bringing manufacturing (unskilled labors) back here gets in the way of the end you are seeking-- to create a sustainable existence for the middle class. When the money that would be spent paying workers in the US to manufacture, can realize a greater return by being invested in a more skilled job (employing a college graduate or a masters student doing R&D), then it makes sense to let someone else do what is less profitable to free funds for more profitable expenditures over here (like any work that requires an education to carry out).

Also, no; no military/defense stuff; I'm simply looking at this from "what makes the most sense for how to run the country given the current situation and trends". The trends being lots of spending.

Our military is at least part of the reason why the dollar is doing so well right now-- in the absence of any sure investments, go with what is safe (government bonds), and of all the governments most likely to still be around and kicking in 20 years, ours is at the top of the list. Of those, choose which one has the most ability to exert its will on other nations.
Also, the US Treasury has never defaulted on any bonds, so...we look great on paper.

 

[soccerballtux]

Also bamacre, you are right China is not up to their necks in debt (neither are we yet); but they have a hundred far more pressing problems at hand to deal with, problems that make our debt a non-issue. Specifically, how to maintain the 10% growth they need that will pacify the lower class and enable them (the Chinese officials) to maintain power. But even with that growth, the communist regime is full of inefficiency and abuse of power-- corrupt officials confiscating land from peasants by force, paying them practically nothing for it, and then turning around and selling it to multinational corporations for millions, and taking home a hefty bribe along with it. How are you supposed to control something like that, or even stop it, in a totalitarian system where the bureaucracy and politics between a 25th and 26th in command override those from the dictators at the top? What I mean is all the officials cover for each other so nobody can prove who's doing what, abusing what, misusing what; in a way that is reliable enough such that, should justice be administered, it will have any effect. The criminal wouldn't stop the crimes if he could always push it onto a scapegoat.

So you could lobby or campaign or picket over "those poor peasants in China who get their land stolen from them for pennies on the dollar", but if we just let this continue, they will dig their own grave. This way it would be the people enacting the change, and we could be there to facilitate their move to democracy; instead of us trying to push it onto them when they just don't care and haven't seen enough evil to be willing to do something about it (which is how it worked in Iraq). This sort of policy may be painful in the short run but if we look at history, for the new government to be successful, the desire for change has to have come from within. So by continuing to by from China, we pad our lives with cheap luxuries, we help them build their country and emerge from extreme poverty, AND we are handing the Communist Party officials a shiny golden shovel that they can't resist accepting and can't help but dig their own graves with.

The food for thought is how much faster, more effective, and especially how much greater the magnitude of scale on which this can all be done. Pulling them out of poverty this way as opposed to doing it with charitable giving and 3-minute commercials of cute, but starving, Asians kids. The percent of the world's population living in what is classified as "extreme poverty" (by whoever it is that defines that) has decreased from 40% to 20% in the last 20 years...