rationalist's Comments

International Cooperation? It's Payback Time

Sat, 28 Mar 2009 10:07:15 -0400

blah blah blah - Easter Europe is a mess. Imagine that I actually live in Eastern Europe and I don't see any of the crisis proclaimed to be here by people, who never actually have been here and know nothing of the place...

International Cooperation? It's Payback Time

Sat, 28 Mar 2009 06:33:00 -0400

I'm writting from Poland.
Yes - I do admire Amercans' ability to reinvent themsleves. But this time around there are big uncertainties. And the budget deficit and reckless money printing are really a "way to hell", as Mr Topolanek put it (please excuse his not-so-diplomatic langauge - bear in mind that this is his _second_ language. Before you ridicule anyone for speaking bad english, ask yourself if you can speak his mother tounge equally well, as he does ;)

I observe from some time that Americans of all kinds (maybe except Peter Schiff) are trying to tell themsleves and others that yes - the US is in a bad shape, but others are in an even worse shape. Yes - some others are. Iceland is, Estonia is, Ukraine is, maybe even Ireland or the UK are in a worse shape than the US. But when you look at Europe as a whole, you have to understand one thing - is is far more complex than the US. Each contry has it's own history and experiences. Germany has the experiance of hyper inflation in the 1920' and following this the fall of Weimar Republic and the raise of Nazis. Did you know for example that during the war Hitler hired the best printers and printed huge amount of Pounds? He wanted to destroy the UK currency. There were also plans to print dollars, but the war ended sooner. Germans actually believe that you can destroy the economy by printing money! And they are right. But look at it in perspective - now the US and the UK are doing it by themsleves. Hitler is probably rejoicing in his grave...

Another example of different European experiences - Poland. In the 1970' the newly-appointed secretary general of the communist country Edward Gierek started borrowing money from the west to bring more of consumer prosperity to the impoverished people. First decent quality radios were assembled. I remember a Grundig casette player and a Nivea lotion that were ubiquitious in Poland all the way to the breakdown of communism. The important thing is that these were made for borrowed money. Poland ended up with huge government debt. After the '70 borrowing binge a crisis came (as if a crisis could still come to a permanent crisis of communism). The lenders got so concerned that they got assosiated in two clubs: the london club (government lenders) and the paris club (private lenders). In the early '90 before the First Gulf War the polish secret service helped to rescue Americans from Iraq. As a reward, the london club cancelled much of the debt owed to it by Poland. But still a huge debt burden remained and is there to this day. Of course the country could default on these debts, but due to its size and stage of development that would mean creating an even worse economic hardship and killing economic reforms. The debts are being paid. Contrast this with the current situation of the US. $11 trillion debt today, $2 trillion owed to the much poorer Chinese. In 1.5 year from now, it will grow to $15 trillion. This cannot be possibly repaid. There is not enough money in the world. Total amount of M0 money (all currencies) is estimated equivalent at $4 trillion. The default of the US is inevitable. We know that this will happen through printing, which means inflation. Now - the US will get away with this, but how other people in the world, most of whom are much les prosperous than Amricans and most of whom pay their debts - how are they supposed to be sympathetic to the Americans???

One last thing about who is in a deeper shit. Of course everybody is in a shit today. However - most parts of the world outside the US, maybe except oil-exporting countries, have viable economies, with more or less balanced or positive trade accounts. Even those with deficits are in a relatively good position, since most deficits are due to investment inflows, not consumption. This means that most contries have either balanced economies or are exporters, who (at least theoretically) could switch their industris to work for their domestic economies. this is of course not easy, but is achievable with a lesser pain than switching from a debt-burened, consumption-addicted economy to a viable balanced conomy. Of course - many uncertainties are involved. Great Depression and the Japanese crisis of last 20 years have shown than even a successfull exporter nations can get badly hit by a crisis due to bad policies. But imagine what would be the picture if equally ineffective policies were applied to an economy that has no sound foundation...

Lastly - for those that still like the inflation vs deflation topic, i invite you to read my article on this issue here:

www.liberalizm.pl/inde...

Economics of Depression

Tue, 03 Mar 2009 03:38:39 -0500

I thought that consumption was more than 2/3 of US GDP. Is that too little, according to Krugman?

The example is misleading, because the couples that earn cupons cannot do anything else with them than consume. In reality - we also have investment market, where the savings are invested.

The more people save and invest, the better. If everybody was just consuming, we would go back to caves, as nobody would be investing in houses, infrastructure, research, etc.

Krugman is a pure Keynsian, who was proven time and again to be wrong about how economy works...

Gold: The Only Remaining Bubble?

Thu, 19 Feb 2009 15:51:39 -0500

Is gold a _hard currency_?
I dont think so.

Is it a commodity?
I dont think it is a commodity like all other commodities either (even silver).

Gold can have two uses - either as currency (which it currently does not anywhere in the world) or as commddity - mostly in form of jewelery.

The value of gold depends crucially on the first use of it. If gold was becoming currency, it's value will shoot up to the moon, because there is so much less gold than the paper money flowing around the world. If gold merly stays as a fancy, odl-fashioned welath and inflation protection tool, then it's value will go up for some time to come, but then it will crash down again. This would not be bad in itself, but of course the timing would be impossible to guess - just like with all other speculations.

Now - the question is "will gold become a currency"? Will it take on its traditional role of money?

I dont know the answer, but I think that it has a much greater chance of doing so than ever since the 1971, when it's last use as money was abandoned by Nixon. Whyere is this chance coming from? Well - countries are realizing that keeping their hard-earned reserves in paper is perhaps not the best idea. Russia announced recently it will start buying gold; China said some time ago it will start diversyfying reserves. This will mean also gold purchases.

Even more importantly - people start realizing that government has too much freedom with the printing press and that in the past it has abused it. People like investors are also realizing that gold while it may be old-fashioned is a much surer thing than any paper - be it in form of treasuries or notes. It is absolutely sure that if the market was allowed to decide what they want as a currency, they would chose gold. Gold was the money of choice for the market suring thousands of years of modern economy - it would be the money of choice now as too, had the government not interfered. There is even infrastructure being built for this purpose - go to e.g. goldmoney.com.

Of course governments will never do such legislation but I dont think such legislation is necessary. What is necessary is the freedom of market participants to choose what they want to use as money. I don't think the critical mass has developed yet to start getting back to gold-based money, but as the crisis develops and people suffer from unpredictable currency exchange rates and from dilution of savings by the printed money, this idea will gain traction and later on the pressure to have this possibility will grow.

One last word about inflatin vs deflation - we may not perceive price decreases now, even huge amounts of money are printed. But people who have saved, especially those who have saved in assets thwt would not disappear had the banks gone bust, have witnessed already a huge dilution of their savings. In a situation of uncertaing brought by recession the demand for liquitidy is huge. People want to get back to the most liquid asset until the dust settles and they are able to discover the real value. With the pumping of money by the Fed, the dust does not settle, the real value is not discovered and noone knows what will happen in the future. This increases uncertainty and the huge, unnormal demand for liquidity remains. This keeps the prices down despite the monetary inflation. Of course - I also agree that debt deflation is happening. The availability of loans has plummeted, because the banking system is broke and they dont want any more risk. But monetary inflation is going on, just that it doesnt show up because the demand is outpacing it. As soon as the dust settles the demand for liquidity will change into demand for returns. This will release all the inflation that is happening now into the price increases. This will be the time when gold will rais big time.

Emerging Markets Watch: Upcoming Eastern European Economic Cataclysm

Wed, 11 Feb 2009 19:08:03 -0500

this is another shallow "analysis" of East Europe. First - it puts all the countries into one bucket, although there are substantial differences between them.

Second - while some countries like the baltics have clearly overheated economies by too lax domestic monetary policies, others have had quite prudent domestic monetary policy (E.g. Romania), but have been impacted by the easy money flowing from Euro-zone.

The second type of overheating is less damaging to the economy (it is less pervasive), although it creates large FX exposure.

FX now is the largest problem, because it can cause defaults and some cleaning in the economy. However - those that have been sticking to the domestic currency are nt impacted directly.

This is balanced by the fundamentally good position of most countries in the region (comparing to the US). These countries have competitive advantages in form of cheaper labor markets and in the same time are located in close proximity to large potential clients in western Europe. The workforce is educated and becoming more mobile. The drag could be bad government policies, but actually in the last couple of years these countries have become the lowest-taxed in Europe (e.g. Slovakia 19% flat tax, Romania 16% flat tax) - so the policy trend is positive. Those contries that are in the EU are additionally facing an increased scrutiny on their economic policies by other member-states. Budget deficits are largely under control (copare that to the US!).

So - while there are panics in Ukraine and Russia, which can be explained in large part by recent experiances of these populations with bad government policies, most countries in the region are fairly safe. My Polish friends are actually joking that there is a crisis, but no one has seen it yet. Some industries are impacted - notable financial industry - but this is due to precautionary actions and often an order from western-based owner, rather than a worsening of potfolio quality. As long as currency panic will be avoided (which seems likely except for Ukraine and Russia), the slowdown will be rather mild comparing to what will be happening in the US, UK, Spain, Ireland, etc.

Thank Goodness the Banks Aren't Lending!

Mon, 19 Jan 2009 11:57:29 -0500

your article is showing exactly how much confusion there is about economy. consumption, credit, growth - they are all over the place with no order or logical structure.

let's try to get it right:
1. total spending = consumption + investment. The more you consume, the less you invest and vice versa. By definition - consumption is figuratively and literally the act of eating the wealth. This is the ultimate economic goal of every human being. investment is the opposite - it is creating the wealth, that later can be eaten.
From this follows - the more you consume now, the less you invest. The less you invest now, the less there will be to consume in the future. This is true for individual, for the whole country and for the whole world.

In my opinion this simple truth invalidates all Keynesian arguments that consumption should be increased at all cost. On the contrary - investment should be increased! This is how all rich countries got there - they were saving and letting the free market invest the funds profitably. Why then not invest by... printing money? That's why:

2. money <> wealth. think of wealth as time. Everyone has 24 hours / day. you may decide to spend 16 hours consuming and 8 hours investing. or just 12 hour consuming and 12 hours investing. you cannot consume for 16 hours and invest for 12 hours - there is simply not enough time to do it. You can "save" some time if you come up with a way to do the same thing but more effectively - i.e. wealth is growing mainly by techological innovation (this includes the use of natural resources).

Or - actually you can work for 12 hours and have fun for 16 hours. The way to do it is to make day have 28 hours. Does it mean that you will have more wealth? No! All it does is to reduce the wealth that can be created (or consumed) in one hour. The day will last the same amount of time as before. Hence - inflating time (increasing the total amount of time) is not a wealth generating activity.

This simple illustration rendres all inflationary policies ivalid.

3. You should be careful with inflationary policies, however, because if they get into the system in the form of credit expansion, they will cause more damage than just higher prices (=lower value of one hour). Imagine that suddenly you are told that day is 28 hours long, but noone gives you the new watch (this is inflation coming from one source). This will mean that you will work for 12 hours thinking that you still have 16 hours to sleep and have fun. Of course - you have fun for the usual 8 hours and then go to sleep. However - you wake up after 4 hours completetly tired (not only you worked more, but you also slept less) and you are told you have to go to work again. The additional 4 hours that you worked was the economic boom. The fact that you are tired due to not enough sleep is the economic bust. the only way to fix this is by sleeping at least the missing 4 hours (if not more) in the following day to come back to equilibrium. This is the recession.

4. Actually Keynes considered the relation between consumption and investment/saving and he concluded that there is no relation between how much people save and how much is invested. In fact - there can be an increase of saving that is not invested (he called it "the paradox of thrift"), this however is the case only in times of big economic reshuffling, when people are seeing revaluations of all investment opportunities. It is normal, natural and economically healthy for people to wait in this time with their investment decisions (actually Keynes called it "animal spirits" of the business people - no doubt he didn't like entrepreneurs).

In this sense the behavior of banks (and all other businesses) is normal and desired - wait to see what will come out of this mess once the dust settles.

What Can We Learn from the 1930s?

Mon, 19 Jan 2009 10:02:43 -0500

the above critique of fractional reserve banking is causing one to ask this follow-up question: "what else than fractional reserve banking? Where would all the money come from?"

to make sure - bank runs are not a necessary part of banking business. Not if the on-demand deposits are really on demand. In fractional reserve banking on-demand depostis are only in x% of the cases on demand (where x is the reserve ratio). Hence - the banks are inherently bankrupt.

For the economy it means that there is more money to be lent. This implies that the lending rate is lower than it would have otherwise been. And this is the key (not the bank runs) to the understanding of the boom-bust cycle.
The fractional reserve makes it seem to workers and business people like if there was more money in the economy than there really is. If i have say $10.000 on my current account, but the bank takes $9.000 out of that and lends it to some business, I fell like having $10.000 and the business feels like having $9.000 - the impression is that there is $19.000, while there is only $10.000.

This false impression makes it possible that wrong investments are done. After all - money is much cheaper than it would have been, if I was honestly asked / offered by the bank to transfer $9.000 of my money from my on-demand account to a long-term investment account (from which i would not be allowed to withdraw the money until the investment is completed). Cheap money makes profitable a large number of projects that previously would have been thrown into a dustbin.

So - a significant amount of resources is transferred into in fact (if the cost of money was the real one) unprofitable projects (currently - real estate bubble, but also stockmarket bubble, commodities bubble, etc). In the same time this creates an illusion of growth. These projects attract workforce, who get higher salaries than otherwise would have been the case. People spend the money on consumer goods creating inflation. At some point in time the economy runs out of resources. There are still projects to be completed but no money to complete them. The real interest rates go up. Seems like not the case today? Wrong. While the official rates are low today, try to go to a bank and borrow money for your business and you will find out that is is almost impossible. Today if you want to borrow you will be either turned down, or you will be charged interest that is preposterously high. This is because all capital has been depleted on unprofitable projects.

The above is as simple as it gets. The fact that people are continously confused about this is beyond my undertsanding. Please go to mises.org or to auburn.edu/~garriro/ppsus.htm to learn more about this.

Now - coming back to the question - if there was no fractional reserve banking, where owuld all the money for loans come from?
1) First - there would be much higher interest rates, reflecting the real balance between consumption and saving/investment.
2) Second - nobody would be earning interest on their current deposits. In fact - people would be charged a lot for keeping their money on on-demand deposits (i know this is the fact in many coutries also today, but this rather reflects the inefficiency of banking sector. If the on-demand deposits were really on-demand, the cost of keeping money on them would be even higher). In this way people would be forced to keep on demand only the money they really need on demand. After all - this would be idle money, and money itslef does not bear any fruit.
3) Third - people would be flooded with investment opportunities and they would be much more handsomely paid for this (again: rising cost of money = greater returns to investors).

All of the above would on the one hand decrease the growth (that would depend on the savings rate of a particular economy) and in the same time there would be no more recessions. The only big events that would affect economies would be wars and technological disruptions.

I don't know when this will happen, but I'm telling you that once it will happen, people will be learning at school how their primitive great-grand fathers belived that earth was flat and everything revolved around it ;)

Buffett's Import Certificates Plan Could Pilot the Economy to a Safe Landing

Mon, 19 Jan 2009 08:07:03 -0500

Thanks for pointing to that article from 2003 (!).

to summarize Buffet's idea for those that don't have time to read it:
- every exporter would get certificates from the US government for the dollar amount of good that they export
- these certificates would be tradable
- every importer of good to the US would have to have the required number of certificates (for the same dollar amount of imports)
- the market would set the certificate price, but since there is much less imports than there is exports, their price would be definitely positive

The way I see this plan is the following:
- this is a kind of dollar devaluation, but without devaluation. On the one hand this would automatically increase the price of imported goods (making americans poorer, with smaller purchasing power); on the other hand all the foreign holdings of american assets would still be worth the same
- this would introduce a huge distortion into the already distorted international trade
- there is a much easier way for US government to solve the problem - make a real devaluation by printing more dollars. On the one hand this is what Buffet calls "a hidden theft", on the other hand it is easier to do and more generally accepted.

About the economy - Buffet got it right. The most important thing about economy is to see the important dynamics and not get lost in the petty details.

The only way for the US to get out of this mess is to restore it's international competitivness. With 1 bn chinese and another 1 bn indians that came on the labor market in the last 2 decades, the american (and european) worker (even though enahanced by all the education, machinery, etc) became much less competitive. There is and will be a shifting as these differences tend to equalize. As a result americans who live only off their manual labor on average will become poorer. In the same time if the market is allowed to work (which is not the case) this decrease of purchasing power will quckly reverse, while the rest of the world will grow rich and be able to absorb more and more of american exports. If China did not keep it's currency artificially low, chinese exports would become more expensive and american imports to china would become cheaper. The chinese conumer would be richer and would consume more. China would not depend that much on american consumption to fuel its growth and would develop a more varied, more resilent economy. Chinese would not be stuc with billions of US paper assets, that are being stolen from them now by Ben Bernanke printing money. It is simple to say it now ;)

If the above was the only dynamic in international trade, we would see now only continuing improvement. In my opinion the critical point of global labor markets inequalities has been reached. China is becoming more and more consumer oriented economy and soon would drive a large part of its growth (and america's growth) by itself.

The problem is that this change has been mixed with another set of inequalities - the bubbles created specifically by "some of the most competent people in the world" working for the US. To be sure - no country has been blessed by the right leadership. Communist China, fractional India, megalomaniac and divided Europe... but the US leadership in the last 20 years has been just catastrophic... it looked more like a bunch of kids playing with fire, than a leadership of a serious country...

Now the youngest and most inexperienced of these kids is coming to play too... Have fun!

Watch for Yourself: 60 Minutes Oil Story Was Spot On

Wed, 14 Jan 2009 04:33:53 -0500

Can anyone explain me how these markets really work? I was doing some quick research on the internet but I couldnt find any confirmation of what I've heard:

1. roughly 10% of all global oil trade (i mean the physical stuff) is conducted on commodity markets; the remaining 90% is traded in the form of long-term oil contracts... however - most of these contracts do not have a fixed price, but a price that is indexed to the commodity market price. This is certainly true for example with Gazprom natural gas contracts with its european customers. Is it true with Oil???

2. As I understand the no-delivery futures contracts - these are pure bets, gambling. For example - I can buy oil, while I don't receive any physical stuff. I can also sell oil, while i don't need to actually send the physical stuff to anyone. What happens is a cash settlement at the end of the contract (unless I sell it sooner, which in fact is also a cash settlement). Of course this is obvious that this can be useful for those really holding oil and oil related contractual obligations. However - this also opens wide the gates to speculation - i.e. to gambling on the price. It is amazing to me that a substantial part of today's financial system became one large casino. All those quants in hedge funds and investment banks are equivalent to crazy math students, who go to Casion to "trick the system".

3. take point 1 and 2 together, add easy money and no credit standrads (i.e. huge leverage) and you get a bubble-ready environment. A small market (10% or x% of phisical deliveries), with cash-settlement tools (no need to actually bother with the real stuff) and easy money. The guys that have easy money go and start gambling. Some say - oil will go down, other that it will go up - and they place bets on their predictions. If it went up, the losers pay the winners in cash. Now - since there is more that say it will go up, it really goes up. The greater the difference between those that buy (say "go up") and sell (say "go down") the faster it actually goes up... Why demend and suyppy cannot correct it? Why oil doesn;t flood the market? Because the supply needs years of development (research, drilling, etc), because existing oil fields are being depleted, and finally - because the producers are benefiting from the high price. If there was no OPEC and the oil production was a highly fragmanted industry, there would be a relatively fast increase in production in response to higher price. This would be like sliver. But it is not - OPEC does not care that much about keeping price down - on the contrary - it was set up precisely to keep the price at a high level. That's for supply. What about demand? Well - demand is very inelastic in this case. The whole world is addicted to oil and there is no serious alternative to it now. People cannot say - i will not drive to work today, because oil is high. Of course - some adjustments are taking place, but very slowly.

What about the remaining 90% of deliveries that take place off-market? Well - as long as the prices are fixed or at least semi-fixed, they will be lowering the price at the pump. However, since (as I suspect) many of them have an indexed price to the price on the exchange, they berly passively follow the market. If there was a true bidding market for all physical oil (and no funny cash-settled instruments), we would then be able to discover the real price. Of course the way in wich those long-term contracts are structured is in some way informative about buyers' and sellers' preferences. I am sure that for those contracts that were signed 15 years ago, some negotiation has been taking place (Especially if the price was fixed then). However - the most important that it tells is that people are ready to accept a wide range of prices (as set by our gambling boys) because the supply and demand are both so inelastic.

Now - the bubble may form or may not. All depends on psychology and easy money. Once it starts it will grow to some extent. Nobody can say how much and how long. Tulips in Holland were the same as oil now. Back then there was a genuine demend for tulips and people were ready to pay quite a high price for them. This was however a basis for the bubble. From psychological perspective bubbles form because people have a tendency to ascribe value to assets, while the real value is only with utility that the end user perceives. From financial perspective bubbles form, because there is easy money (thank you, Mr Greenspan).

What If the Economic Model Is Wrong?

Mon, 12 Jan 2009 05:09:16 -0500

This is exactly the right question!
Unfortunately the answers above are not so right...

the problem is that people (governments, inverstors, etc) are using the wrong economic model. Both Keynes and monetarists are not correct with regard to how they describe economy.

The school that is most close to the trith is the Austrian School (it is called so because it's founding fathers come from Austria; i would rather call it the "capitalist school", since a central piece of it is the theory of the structure of capital).

Anyway - on this site there is a very good, simple and illustrative powerpoint. Take 15 minutes to look at it and you will gain a basic understanding what this school is talking about:

www.auburn.edu/~garriro/ppsus.htm

Also check out
mises.org
for a wealth of literature, critique, commentary on current events, etc.

So - the answer to the question above is - yes we have been using a wrong model; but the right model is not some new, undiscovered yet idea of the type we have been served over and over again by management gurus. The correct model was created 100 years ago. It is just that what it prescribed would call for dismantling of our ill-conceived banking system and in this way - for a serious limitation of government power.

What Is Going On With Gold?

Thu, 08 Jan 2009 10:08:41 -0500

This was funny - the US still AAA rated. The US was actually the best of the lot after WW2. This was the lucky time for America. While I dont doubt the entrepreneurial spirit of Americans, come on - everybody on this planet has to be entrepreneurial in some way to survive. Have you ever seen kids washing windcreens on traffic lights in Latin America or Eastern Europe? You think they are not entrepreneurial? What about the fact that it is Germany and Japan that file most patents?

The fact is that America was lucky (and Europe and Asia stupid) with WW2. Of course that was long time ago and times have changed. Now the US has blew it. Have fun holding $ while it lasts. My guess is that in 5-10 years from now the $ will no longer be reserve currency. If I were China I would declare war on the US for all that printing, while the Chinese earned their $200 billion the hard way. This is a rip-off!

About your triple-A rated country - it has defaults already in 1971, if you dont remember.

God save America ;)