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General

How Economies Work


photo credit: unforth

When Adam Smith wrote The Wealth of Nations he was not writing about how economies and markets should work, he was writing about how they do work. Anyone who wants to know how they do work must read that book. Be prepared – it’s long and very detailed and you must be committed to doing a good deal of intellectual work if you are going to really understand it. The copy I have been reading is over 400 pages of small print and it is completely lacking in filler material.

I could not even pretend to give a summary of the book (as Wikipedia does) but I would like to point out one crucial detail that few people seem to realize and which shreds virtually every economic move our government makes. Money is a representation of value. Value is a representation of work and the only accurate determiner of price. Price controls and subsidies cannot alter the actual value of goods and services – all they can do is distort the representation of value and confuse the consumer by manipulating the data. Anytime there is a manipulative force in an economy the economy will respond, it will conform to the manipulation, but it still operates on the same universal laws.

I can easily understand how people today would be confused about the laws of economics because we have pundits, professionals, and even many economists who talk about the forces of economics as if they were under the control of men. The fact is that men can operate in accordance with those laws or they can try to manipulate them, but regardless of what we may observe the laws of economics will be obeyed and we will receive the consequences of our actions even if we are not sophisticated enough or have long enough lives to recognize those consequences. No matter how hard or how high we throw a ball – even into (or out of) orbit, it still must obey the laws of gravity.

The laws of economics are exactly as universal as the laws of physics. You can stand around all day arguing with a physicist about how gravity operates but at the end of the argument gravity will be unchanged. In your argument you can propose many great new ideas about how gravity should work, but gravity will be unchanged. If you have a misunderstanding of how gravity does work and operate based on that misunderstanding it will not preclude the possibility that you could design an airplane that flies, but designing an airplane that has not crashed yet does not prove that your understanding of gravity is correct and odds are pretty good that if your understanding is flawed the plane will have a flaw in its design that will either cause a crash or make the plane less functional than a plane designed by someone who understands the laws of physics.

What we have today in Washington – among both political parties – are a bunch of people most of whom grossly misunderstand the laws of economics and who believe that the laws of economics are no less subject to revision than the speed limit on an interstate highway. They mistake the reference to an invisible hand and believe that it refers to sleight of hand. The do not recognize the fact that there is nothing tricky or supernatural about the laws that Smith explained centuries ago. He did not make them up, he simply wrote them down after decades of study and observation – like any good scientist. In fact, the name of the book is “An Inquiry into the Nature and Causes of the Wealth of Nations.”

Categories
National

Money Down the Drain

A little statement from an article titled “Cash For Clunkers”: Did It Work? got me wondering about the fate of three hundred million dollars.

When the $3 billion is exhausted, roughly 600,000 vehicles will have been swapped for more fuel-efficient models, based on statistics released from the government so far.

Do the math there and we find that if every single “Cash for Clinkers” deal returned the maximum $4500 to the person trading their car in there was still another $500 paid by the government for the deal. For 600,000 cars that makes $300,000,000 that went into someones pocket. (This does not count any other hidden costs of the system which may never be revealed in losses to other businesses or interest paid by people who already had a working vehicle that they owned outright.) I’d like to know how much of it went to dealers, how much went to paying for the destruction of the “clunkers” and how much was government setting up a website and processing paperwork.

One thing is for sure, we have a huge double standard operating when insurance companies are considered greedy when 2% of their gross income is profit while government is considered efficient when only 10% of their cost goes directly to program overhead.

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culture National

The Economic Bill of Rights

During his final State of the Union address Franklin Delano Roosevelt spoke about what he said could be considered a second bill of rights which may be referred to as The Economic Bill of Rights. In his address he said some important things that ring true such as:

We cannot be content, no matter how high that general standard of living may be, if some fraction of our people — whether it be one-third or one-fifth or one-tenth — is ill-fed, ill-clothed, ill-housed, and insecure.

He described the original Bill of Rights as proving itself inadequate:

This Republic had its beginning, and grew to its present strength, under the protection of certain inalienable political rights — among them the right of free speech, free press, free worship, trial by jury, freedom from unreasonable searches and seizures. They were our rights to life and liberty.

As our nation has grown in size and stature, however — as our industrial economy expanded — these political rights proved inadequate to assure us equality in the pursuit of happiness.

This is very likely the first and most blatant blurring of the nature of rights ever promoted by a president. It has set the tone for our widespread misunderstanding of what rights are as a majority (or at least a vast minority) have come to view the following as rights equal to the rights described and protected in the Bill of Rights.

  • The right to a useful and remunerative job in the industries or shops or farms or mines of the nation;
  • The right to earn enough to provide adequate food and clothing and recreation;
  • The right of every farmer to raise and sell his products at a return which will give him and his family a decent living;
  • The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;
  • The right of every family to a decent home;
  • The right to adequate medical care and the opportunity to achieve and enjoy good health;
  • The right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;
  • The right to a good education.

As someone else has said – these are all goods, but only one of them is a “right.” The only real right is the right to trade goods and skills in an atmosphere free from unfair competition. The rest of this list are only protected as far as that one right extends – that every person has the right to not have others undercut their efforts as they labor to acquire a useful and remunerative job, enough money to provide adequate food, clothing, and recreation, a decent home, adequate medical care, protection from economic fears, and a good education.

Along with the first example I cited of things that ring true in his words is this:

People who are hungry and out of a job are the stuff of which dictatorships are made.

Both of those truisms however are incomplete. To the first I would add that no matter how low our standard of living we cannot afford to give up on true principles in exchange for popular sentiment. To the second I would alter it to say that people who are dependent on a central political authority for food and work are the true stuff of which dictatorships are made – being hungry and out of a job only make them ripe for recruitment.

It is interesting to note that as we have pursued policies to provide government funded education, economic security, and now health care in order to eliminate sickness and the economic distress of unemployment and underemployment the result is more widespread economic fears. Because of the ubiquitous belief in these so called rights many people wish to turn to government for security even where the government is the cause of the insecurity in our nation.

Categories
National

The Paradox of Government

Paradox of Thrift
Paradox of Thrift

Today I read Paul Krugman writing about the paradox of thrift. As is often the case, I found it interesting to read and to notice the assumptions that Krugman bases his positions on. While anyone can go read what he wrote I’ll give a quick overview of the paradox of thrift – increases in personal savings can have an adverse effect on the economy causing a net decrease in actual savings overall.

The first assumption made by Krugman is that savings come in the form of currency with an assigned value but with no real intrinsic value – paper money. If savings come in the form of debt reduction or in acquiring real goods for future use then a bad economy increases the value of the savings rather than decreasing that value.

The second assumption made by Krugman is that government should be a significant force and substantial contributor to the economy. This is a man who argued that the government was doing the wrong thing and not enough of it when Obama got his stimulus bill passed (ARRA). While I often disagree with his assumptions I absolutely trust Krugman to be able to read the numbers and do his math so I won’t attempt to do my own numbers. I will link to the source of his numbers and then play with his graph to show how things look under new assumptions.

Categories
National

Economic Recovery

I was listening this morning to a story on NPR about rising unemployment when an interesting thought struck me. The story was talking about the negative feedback loop of rising unemployment leading to lower housing prices and more economic uncertainty. These factors then dampen consumer spending and keep unemployment high and even encourage more unemployment.

I know it’s a very perverse perspective, but my reaction to that news was that maybe there is an outside chance that our economy will actually undergo the correction that it obviously requires despite the best efforts of Bernanke and Geithner to prevent the necessary correction. If the economy continues to defy the stimulus efforts it may yet reach a solid foundation – but I won’t hold my breath on that.

Categories
General

Economic Contradiction

Paul Krugman and I agree on little politically (I have at times agreed with him when he was arguing that TARP was a bad idea – although we disagreed on the reasons why) and despite the fact that my assumptions about the nature of sound economics differ from his most of the time I recognize that he has a lot of expertise in the field that I can learn from. For example, I have not known enough about economics to be aware of the Setser point that he is looking at. For those like me who are new to the term, the idea is this:

high government borrowing is more than offset by net negative borrowing from the private sector

As far as I can tell, Krugman is among those who believe that the flow of money defines the health of the economy – the more the money moves (borrowing, spending, and creating) the healthier the economy. Krugman and those who believe like him will doubtless argue that when the private sector borrowing declines governments must borrow more to keep the economy healthy. In other words, lower private sector borrowing causes (or rather necessitates) higher government borrowing. Unfortunately for them the numbers appear to paint a different story. If the cause and effect relationship is not simply the reverse of that assertion then the relationship is at least symbiotic with governments trying to manage or compensate for the actions of the private sector causing an opposite, but more than equal, reaction as the private sector tries to outguess the government.

On the other hand, I believe that people in the aggregate (meaning many individuals over a sustained period of time) make economically beneficial decisions (not always the best decisions necessarily, but better than rolling government loaded dice).

What the Setser point tells me is that government borrowing drags the economy down because of the opposite but more than equal principle noted by Sester and Krugman and it prolongs the agony when those in the private sector – for whatever reason – determine that we need to slow the borrowing to set the economy back on a fundamentally sound foundation.

Categories
National

GM Surprise (or not)

Back at the end of March David Brooks made a prediction for GM in the New York Times that came due today. I have been waiting to check in on that. He started with this background of the situation as it stood that day:

The Bush advisers decided in December that bankruptcy without preparation would be a disaster. They decided what all administrations decide — that the best time for a bankruptcy filing is a few months from now, and it always will be. In the meantime, restructuring would continue, federally subsidized.

Today, G.M. and Chrysler have once again come up with restructuring plans. By an amazing coincidence, the plans are again insufficient. In an extremely precedented move, the Obama administration has decided that the best time for possible bankruptcy is — a few months from now. The restructuring will continue.

But this, President Obama declares, is G.M.’s last chance. Honestly. Really.

No kidding.

With that background, Mr. Brooks’ reactions was this:

The most likely outcome, sad to say, is some semiserious restructuring plan, with or without court involvement, to be followed by long-term government intervention and backdoor subsidies forever.

Looking at the relevant news today (also from the New York Times) we find that the result is a restructuring plan with court involvement and long-term government intervention including continuing subsidies – initially at least the subsidies are anything but backdoor.

American taxpayers will invest an additional $30 billion in the company, atop $20 billion already spent just to keep it solvent as the company bled cash as quickly as Washington could inject it.

The imagery is all too apropos – like Fannie, Freddie, AIG, and the economy in general GM is and has been addicted to shooting up with public money to feel like a real free-market enterprise. Conveniently too many of our elected leaders are equally addicted to intervening in the markets in order to feel like they are performing a real job for the American tax payer.

Mr. Brooks called the President the “Car Dealer in Chief” in his predictive essay, and now that is more true than before:

Mr. Obama is taking several risks under the plan. None may be bigger than the decision that the United States government will take a 60 percent share of the stock in a new G.M., leaving taxpayers vulnerable if the overhaul is not successful. (Canada, for its part, is taking a 12 percent stake.)

“We don’t think that after this next $30 billion, they will need more money,” one senior administration official said. “But the fact is there are things you don’t know — like when the car market will come back, and how much Toyota and Honda and Volkswagen will benefit from the chaos.”

This is G.M.’s last chance. Honestly. Really. We hope.

Categories
General life

A Currency All My Own

I really enjoyed Scott’s introduction to different currency types.  It’s a great introduction to the differences between fiat currency, commodity currency, and representative currency. Coincidentally we have implemented a new representative currency in our household in an effort to teach our children about money and work. Personally I think that the commodity backing our currency is the safest commodity around except for it’s non-transferable nature and often short shelf-life. Our currency is backed by goodwill – although there is an exchange rate from U.S. dollars.

As for real world crisis scenarios, my personal philosophy is to do my best to maximize my production ability, build up my stores, minimize my vulnerability, and do what I can to maximize social stability by building up a strong and prepared community around me.

Categories
State

Public Transportation

I have just changed my commuting from riding the bus to driving. This was not due to my own choice – my office moved and I was unwilling to take an extra 2 to 3 hours per day to get to and from this highly underserviced area. Coincidentally I had to buy gas on my way to work on my first driving day. It threw some real perspective on the price of riding the bus

At my old building the bus took 30 to 45 minutes each way while driving took 20 to 30. At my new location the bus would take at least 90 minutes each way but more likely 2 hours while driving takes 25 – 35 minutes. Of course the bus has never been portrayed as the fastest method of commuting so lets look at cost. The bus cost me about $6 a month because my employer paid the other $70 for my pass. I no longer have that option so a bus pass costs me almost as much as my gas ($60) plus my insurance while taking 3 or  4 times as long to make the trip. Imagine if I were paying on a per trip basis for my bus riding – that would be $99 a month to ride the bus – not counting the taxpayer money that supports UTA. Notice that all the prices I am quoting for the bus are not the express passes or the trains, just the regular bus system.

As I started to put all that together I realized that despite the fact that I believe that good public transportation is a good idea, it is notanywhere near economically competitive with private vehicle ownership. Whatever money we spend as a society to prop up our public transit system we need to realize that we are not making any significant economic benefit to those who use the system – they come out a little bit ahead of simply hiring a taxi every time they need to go somewhere.

I still favor the idea of public transportation in theory, but in practice I’m not sure that our taxes should be used simply to hide the fact that the system is not economically competitive. If we are unwilling to pay enough to make it beneficial then our tax support is wasted.

Categories
National

Senators Seeing the Future (Clearly)

There are obviously a few things that I don’t understand about the Senate. Yesterday I reported that according to Senator Bennett the most important (he said it was most important, it was not simply the first thing on his list) part of the job of a senator is to try to see the future clearly. Little did I know that later in the day I would find an example of that prescience in action. Becky Edwards shares from the State Legislature:

There was discussion and explanation of the federal stimulus package and how it will affect Utah. We will receive $1,536,834,051 of stimulus funds. This is one time money only. Of that $86M is to be used at the Governor’s discretion. Much of this money is targeted, cannot be moved around, has strings attached (we’re still waiting to find out what they are), some cannot be spent for 1 or 2 years . . .

(emphasis added)

Apparently our representatives at the federal level (Not Utah’s delegation specifically) can already see the future clearly enough to know that the economy will need continued stimulus next year and the year after that. And here I thought that the stimulus bill was intended to get the economy back on its own two feet sooner rather than later. If I wanted it to take 3 years (it’s already been more than 1) we could have achieved that by sitting back and watching. Now we run the risk of nursing it along for years to come.