Credit expansion and cyclical economies

[soccerballtux]

condensed this post to an above post.

 

[soccerballtux]

well darn seems I wrote all this for naught :/

 

[smokeyjoe]

I hate economics and I am definitely no expert on it. In fact, I hate money and economics so much that I gave account access to my friend so he could help me. When I need to pay a bill I just call him up and he loans me the money I need. He charges me interest on it, but it's better than having to deal with all the headache of just doing it myself.

 

[soccerballtux]

You must know him/trust him well. That's cool. Do keep in mind that saving is important.

 

[smokeyjoe]

Everyone once in a while, we make plans to meet at a restaurant so we can talk about how he has handled my money.. the last couple times, he canceled at the last minute, saying he had to go to some meeting with a few of his banker buddies.. I'm beginning to worry that maybe he is not using my money in my best interest.

 

[EXman]

Originally posted by: 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%.

No he is... There is more to credit than mortgages.

What have you seen the credit card market? Credit cards all over are going straight up. It takes a couple weeks to bail out big business but it will take if we are lucky 1.5 years to cap preditory banks screwing the little guy with arbitrary hikes in rates?

 

[soccerballtux]

Originally posted by: EXman

Originally posted by: 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%.

No he is... There is more to credit than mortgages.

What have you seen the credit card market? Credit cards all over are going straight up. It takes a couple weeks to bail out big business but it will take if we are lucky 1.5 years to cap preditory banks screwing the little guy with arbitrary hikes in rates?

Haha if the little guy would read the letters from his credit company then he would know he could call in by a certain date and tell them he wanted to opt out of the rate increase. The company has to abide by their side of the contract as well and if he won't let them increase the rate then they're not allowed to.

Gogo democrats, screw personal responsibility.

 

[soccerballtux]

Originally posted by: smokeyjoe
Everyone once in a while, we make plans to meet at a restaurant so we can talk about how he has handled my money.. the last couple times, he canceled at the last minute, saying he had to go to some meeting with a few of his banker buddies.. I'm beginning to worry that maybe he is not using my money in my best interest.

It would be wise of you to learn how to handle these numbers things. It's just math.

It sounds like he's throwing you for the loop. I'd get out now before it gets worse.

 

[smokeyjoe]

Originally posted by: soccerballtux

Originally posted by: smokeyjoe
Everyone once in a while, we make plans to meet at a restaurant so we can talk about how he has handled my money.. the last couple times, he canceled at the last minute, saying he had to go to some meeting with a few of his banker buddies.. I'm beginning to worry that maybe he is not using my money in my best interest.

It would be wise of you to learn how to handle these numbers things. It's just math.

It sounds like he's throwing you for the loop. I'd get out now before it gets worse.

Very sound advice.. of course, I don't really let my friend do this, I was just making a not so obvious analogy I guess. I thought someone would catch on, but who reads a thread with a title such as this one? hehe

 

[soccerballtux]

Ha, you sure fooled me!

 

[JJChicken]

Originally posted by: soccerballtux
well darn seems I wrote all this for naught :/

Read through, and am formulating a reply

 

[soccerballtux]

Originally posted by: Barack Obama

Originally posted by: soccerballtux
well darn seems I wrote all this for naught :/

Read through, and am formulating a reply

 

[JJChicken]

Originally posted by: 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.

China is very export based, but it also has alot of infrastructure development within its borders and this can keep up industrial activity for a period of time. Maybe if the recession is prolonged, then China will face the brunt of a significant period of lower exports, but in the short-term it could focus more of its economic activity in infrastruture development. Completely agree with your assessment of oil-producing countries.

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).

This is an interesting concept, certainly counterintuitive to many economists who have sought to keep inflation in check for so many years. Naturally, the arguments against high inflation must be kept in mind if we were to follow your approach, e.g. menu costs, inefficiencies from distorted product markets (muddier price signals), etc. The problem the US faces is two-pronged: we already have too much debt on our hands, but, at the same time, our economy thrives on consumer spending, credit-driven consumer spending, and if we were to start borrowing less and saving more, our economy will invariably suffer, which will cause a loss of jobs. Thus, by itself, I personally don't think a planned inflation approach would be the most successful because althought it would definately help us reduce our debt, and make us more of a saving country, it would also lead to lower consumer spending since people are going to hurt from the high interest rates on the credit card bills. That said, I can certainly seeing the logic in reducing our focus on inflation, such that inflation may occur and the benefits you outlined be realised, and focusing more on strengthening the systemic base of our economic system. Bailouts, government packages, etc would thus be used and their effects on inflation can be less scrutinised/less worried about on.

On the notion of redistribution of wealth, politically speaking its an unwise option that will not go down well with republican supporters and swing voters given our nations belief in working hard to make your own wealth and not be handgiven wealth by the government. Conceptually, I agree, its a disgusting idea to redistribute wealth from those who worked hard to those who do nothing. But these are difficult times. The focus of the new administration must be to kickstrat the economy in the most efficient manner. If writing down the debt of mortgages on homes about to be foreclosed will provide a floor the property sector, then it may be a viable alternative. If providing a check to certain parts of the population who need money to meet their bills will help maintian consumer demand, then it may be a viable alternative. These are because when the government "redistributes the wealth" it stimulates the economy by maintaining consumer demand. The ethics of such practices are obviously unclear - who should be given a check? why should honest hardworking taxpayers pay for somebody elses mistakes? I think the best approach is not to give a blank check but provide a loan that will be paid back.

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).

Agreed, its unfortunately the path America must take (maintain defence-spending). It would have been alot more ideal for us to play catch-up since its so cheap to copy/steal/backward engineer technology, but I safety of mind (that we won't be attacked) and some slight economic benefits that we can extract from our position of power (pressuring countries to sign certain economic treaties etc) make up for it slightly. That said, alot of great technologies been derived from our defence spending and if we can efficiently channel our defence spending into providing new technologies for consumers, on top of improving our defence, then that would be great. We should also cut alot of the wastage in our government, e.g. overpaying contractors/costs of bureaucracy, (not that this inherently means having a small government, but having an efficient one).

 

[JJChicken]

am editing my posts as well, will provide a consolidated version once done

 

[JJChicken]

Originally posted by: 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.

I agree with you on this, investors should always go for less-roundabout options. I think the author is definately reaching very far with the economic model he is presenting.

"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.

This depends, I am not sure if the author's logic is right, but there is some truth to his conclusion. In bull markets, what tends to happen, is companies with strong profit potential (growth options) have their share prices rise alot (think tech boom). I think, and I quite likely may be wrong, managers of companies will focus on immediate bottomline and will prefer projects that can produce profits quickly (unless there is a disparaging NPV difference between the short-term and long-term project and they are mutually exclusive) but investors can "profit" from price appreciation of shares, i.e. paper profit, and, I think, are more likely to skew towards companies with long term potential in times of bull markets (which typically coincide with credit expansion cycles).

"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.

I think time preferences get slightly moved, but definately no where near to the extent the article suggests. Its funny how I initially took alot of faith in this article, but now see, like you do, its very theoretical models and how it "reaches" too far with some of its ideas.

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.

As per above, I now come to agree with your line of reasoning here.

"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.

It will be interesting to see what happens when China starts cashing in on their T-Bonds. I think the US is now going to move to a more producer focused economy and financial armageddon won't occur, we cannot continue to consume at the current levels we consume AND maintain our wealth at the same time. By force, maybe we can; but not by market forces. We are still a very very very prosperous nation, so our standard of living, relative to other nations, won't drop too much, but it will have to drop a bit so that we can sustain ourselves. So imports relative to exports should drop a bit to improve the balance in our economy.

 

[JJChicken]

Originally posted by: 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.

This is spot on. I think refinancing will be the most likely outcome, but its early days to predict anything

 

[economicsjunkie]

I posted a more clearly structured article explaining the business cycle caused by credit expansion here:
http://www.economicsjunkie.com/the-business-cycle/

I also posted an article that outlines the effects of credit expansion on global economic balances here:
http://www.economicsjunkie.com...rrent-account-deficit/

Obama is spot on. Credit expansion precipitates a mismatch between consumption behavior and entrepreneurial expectations. It withdraws resources from employment in the consumer goods industries and places them in the capital goods industries. At the same time consumers consume more consumer goods and save less capital which is needed to produce capital goods.

I examine the exact workings behind savings and investment here:
http://www.economicsjunkie.com/savings-and-investment/

 

[economicsjunkie]

soccerballtux needs to read up on inflation. His statement that the government should not interfere but at the same time we need inflation is wrong. What we do in fact need is deflation. Deflation is the only possible path to pursue with a non-government-intervention policy. Inflation is the epitome of government intervention.

 

[soccerballtux]

Originally posted by: economicsjunkie
soccerballtux needs to read up on inflation. His statement that the government should not interfere but at the same time we need inflation is wrong. What we do in fact need is deflation. Deflation is the only possible path to pursue with a non-government-intervention policy. Inflation is the epitome of government intervention.

I'll have to admit I'm sitting on both sides of the fence with this one. I'm starting to see you're right; that there is too much credit/cash sloshing around and we need some deflation.

However, I would qualify that by saying I do not know if the deflation would be good or bad for the middle class. Inflation is a tax on those with money; deflation is a tax on those with debt. Many took on debt in ignorance. Many also believed that the tech explosion was not a bubble but rather a permanent positive shock to wealth.

I am taking the debt on for an engineering education, others were taking it on because they thought buying a house would be wise, why look at the rise in property values over the last 15 years, it must be the thing to do! I'm not talking about the people that took $200k loans on $20k salaries, but the people that did so on $40k salaries perhaps.

Particularly with education debt I must say I am biased; education cost has been exploding and if we go through deflation now I'm going to be ticked-- I had basically no choice but to take the debt at the current market price; but that market price accounted for the extra cash sloshing around (inflation). Now if we go through deflation, I'll be paying back that inflated cost of my education, plus interest, plus the "real interest" from the deflation. Oh and about the time I get that paid off, the taxes will start coming due for the baby boomers' Social Security and Medicare. Which means it's going to be near impossible for me to be fiscally responsible and get married + start a family + save for the kid's education + save for retirement. I'm not the only one that is facing such a future. I see your point that more inflation is not going to get us out (it'll just push the burden onto future people taking on education debt); but I don't see deflation as quite the answer to our woes either, not unless it entails a serious deflation in education costs.

 

[soccerballtux]

Originally posted by: economicsjunkie
I posted a more clearly structured article explaining the business cycle caused by credit expansion here:
http://www.economicsjunkie.com/the-business-cycle/

I also posted an article that outlines the effects of credit expansion on global economic balances here:
http://www.economicsjunkie.com...rrent-account-deficit/

Obama is spot on. Credit expansion precipitates a mismatch between consumption behavior and entrepreneurial expectations. It withdraws resources from employment in the consumer goods industries and places them in the capital goods industries. At the same time consumers consume more consumer goods and save less capital which is needed to produce capital goods.

I examine the exact workings behind savings and investment here:
http://www.economicsjunkie.com/savings-and-investment/

EJ I find your links interesting and will read your posts sometime in the future.

 

[economicsjunkie]

soccerballtux, your last sentence in your post from 02/16/2009 01:08 AM actually raises the best point:

"not unless it entails a serious deflation in education costs."

Of course this will be the case in a deflation scenario. We will see education cost come down significantly. Falling prices in themselves are actually not deflation, they are rather the remedy to deflation, they are the answer of the market participants to the new circumstances. (Good article on that: http://mises.org/story/3296)

It is important to point out that deflation is not a matter of choice, like we could choose between deflation and inflation. Deflation is here and now and it has been for a while, despite all attempts to reflate prices. All the government can do is slow down the course of the deflation and prolong it.

 

[economicsjunkie]

soccerballtux, thanks for reading my blog. Leave some comments there if you like and we can continue our talk.

 

[Zebo]

Soros saying what idiots like me, bober, skoorby and others been saying for awhile - notice a couple dreamers are missing from this thread.

Bottom line we are deadbeats. Will pay though the nose our debt off and have to start producing again or we face banana republic as rest of the world passes us by..

 

[rchiu]

Originally posted by: economicsjunkie
soccerballtux needs to read up on inflation. His statement that the government should not interfere but at the same time we need inflation is wrong. What we do in fact need is deflation. Deflation is the only possible path to pursue with a non-government-intervention policy. Inflation is the epitome of government intervention.

I disagree inflation is the epitome of government intervention. There are plenty of other governments that intervented but the priority is to stablize price and reduce inflation. Many Asian countries are good example.

You people need to stop pointing finger at governments for this crisis. Government isn't the one borrowing what you cannot afford. Government isn't the one lending without checking thoroughly. Government isn't the one leveraging all the money without proper risk management. So far, all the banks and companies that failed are private companies ran by CEO appointed by the board, not government.

 

[StageLeft]

Originally posted by: rchiu

Originally posted by: economicsjunkie
soccerballtux needs to read up on inflation. His statement that the government should not interfere but at the same time we need inflation is wrong. What we do in fact need is deflation. Deflation is the only possible path to pursue with a non-government-intervention policy. Inflation is the epitome of government intervention.

I disagree inflation is the epitome of government intervention. There are plenty of other governments that intervented but the priority is to stablize price and reduce inflation. Many Asian countries are good example.

You people need to stop pointing finger at governments for this crisis. Government isn't the one borrowing what you cannot afford. Government isn't the one lending without checking thoroughly. Government isn't the one leveraging all the money without proper risk management. So far, all the banks and companies that failed are private companies ran by CEO appointed by the board, not government.

But they all play by the rules the government sets. Or doesn't set. Lest we forget, a great majority of this crisis is caused by legal activity. Somebody did not setup the playing field properly, whether it's tolerance of risky assets being leveraged endlessly across the economy or setting the lending rate so low that money is too easy to come by, the government has an influence on all of this.

CEOs and financial people were doing what they do best, which is screw as much money out of a system without going to prison, and they did a great job, but nobody looks to them for moral guidance or justice as it is not their job; it is, however, the government's job to keep people in line and ensure that the "screw as much money without going to prison" does leave everybody else holding the bill.