The Economy, Lounge Style

[Borodog]

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Borodog. I am very interested in this subject.

Did you know that Greenspan was a student of Ayn Rand?

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Yes, I did. He was also a huge supporter of the gold standard, until they gave him the keys to the printing presses. [img]/images/graemlins/wink.gif[/img]

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I am also under the impression that credit is weakening the dollar. I calculated that the dollar is only about 1/10th of it's actual value because there is way more credit than actual money. Am I correct in my assertion. How do you think this is effecting the dollar, and is this why the interest rates change?

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This is not quite right. The "credit" you speak of is "real money", in every sense of the word. After all, you can buy stuff with it. The actual proprtion of the money supply that is physical paper and coins doesn't really matter much; it is determined by people's preference for holding cash versus using other methods of payments like check, debit, credit card.

But it definitely is "credit expansion" that weakens the dollar's purchasing power in the long run. By "credit expansion" we mean an increase in the money supply that is injected into the loan market. By increasing the number of dollars vs. the amount of goods and services in the economy, prices are bid up, and the purchasing power of the dollar falls. This is reflected in both price inflation and the weakening of the dollar internationally relative to other currencies. Of course the dollar weakens relative to those other currencies, which are also inflationary, over the long term because the dollar supply is being expanded faster than them. There are of course lots of short term things that can also affect the value of one currency relative to another that don't have much to do with expansion of the money supply per se.

[Borodog]

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1. Have there always been sub-prime lenders or is this a relatively new phenomenon?

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I believe subprime lending first started in the 90s, but I'm not sure. Because interest rates are artificially very low, meaning there is an overabundance of funds competing for borrowers, the competitive pressures to sign borrowers are artificially enhanced, meaning lenders will take more risks trying to make a loan. Especially since they could then turn around and immediately offload that risk by selling that loan off. It got to the point where the demand for the MBSs was so high that the mortgage brokers would literaally almost do anything just to create a mortgage to sell.

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2. You say that these risky loans looked justifiable...but to whom? The sub-prime lender, the MBS's, or the customer? Did the sub-prime companies know this would happen and is this why they turned around and sold the mortgages quickly?

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Shrug. It looked justifiable to everyone, otherwise they wouldn't have done it. The sub-prime lenders turned around and sold the mortgages quickly because the market was demanding them.

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3. What kind of financial institution would think this was a good idea? It seems like this kind of outcome could be predicted.

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It was predicted, as long as 5 years ago. Banks generally think this sort of thing, creating money to lend out at interest, is a great idea, as you can imagine. It's just that this particular go round the first asset bubble to go happened to be in real estate and these mortage backed securities. In the last one it was tech stocks. In other bubbles it has been other things. The 1920s saw a huge stock and real estate bubble that led to the 1929 crash.

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Overall, what company suffered the most from the housing bubble bust? The large banks?

4. I wonder if any of my mutual funds were invested in these MSB's.

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The banks never really suffer too much, in my opinion. After all, they do get to create money out of nothing and then loan it out at interest. As for who got smacked the worst, it was the people who bought the MBSs and were left holding the bag when it was revealled that they were vastly overvalued.

[Borodog]

Oh, and what he said about the mutual funds.

[Borodog]

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So what we are set for is staglation; we are entering a recession at the same time we will see significant price inflation. The last time this happened was the 1970s, and that occured for largely the same reasons it is happening now.

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Borodog can you expand on this? As far as I am aware, oil prices are leading to inflation but growth is still rather strong. I checked the latest economic data from the Fed and there was 3.9% growth in the last quarter, and very little spillover from housing into other sectors. But I'm writing a paper right now and cannot do further research [img]/images/graemlins/frown.gif[/img]

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In the long run, only monetary expansion can drive inflation. And I believe that it is probably inflationary expectations that are driving up the price of oil, just as with gold.

The problem with the Fed's growth data is that GDP is entirely driven by the expansion of the money supply. When more money is created, loaned out and spent, GDP goes up. People are hired and the unemployment rate goes down. People bid of the prices of inputs, so corporate profits go up in the capital goods industries. Wages are bid up. Workers spent their new money on consumer goods, driving up profits there as well. So these kinds of macroeconomic aggregate indicators can all look "good", but what is really happening is that you are weakening the economy even more, by yet more misallocations of scarce resources. You can delay the recession by papering it over with new money, but you cannot do that indefinitely. Eventually all of this malinvestment and increased consumption must be paid for.

[tw0please]

Didn't mean to steal your thunder or anything BD, just helping out with the questions I feel qualified to answer.

[tw0please]

Err as far as measurement of GDP goes that 3.9% is an estimate of real growth. So it shouldn't have anything to do with changes in the money supply.

Edit: so what I'm saying is that we're not in a recession now nor appear to be on the brink of one. This is independent of your expectation of a recession because of u.s. fiscal policy in general.

[Borodog]

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Didn't mean to steal your thunder or anything BD, just helping out with the questions I feel qualified to answer.

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No problem at all. Be my guest.

[Borodog]

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Err as far as measurement of GDP goes that 3.9% is an estimate of real growth. So it shouldn't have anything to do with changes in the money supply.

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"The GDP of a country is defined as the total market value of all final goods and services produced within a country in a given period of time." - wiki

The point being, that when the money supply is expanded via credit expansion, that money is used to actually buy things, which bids up the prices of those things, which drives up GDP. GDP is not really a measure of the "size" of the economy at all. An increase of 3.9% in GDP does not necessarily measure any actual "growth" of the economy in any meaningful sense (which would be a real increase in the quantity of goods and services being produced in the economy, which cannot even be aggregated, because you cannot add apples to oranges to cars to TVs to shoes to movies tickets, and not the total price tag thereof).

By the way, I know this is not the orthodoxy.

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Edit: so what I'm saying is that we're not in a recession now nor appear to be on the brink of one.

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I disagree strongly.

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This is independent of your expectation of a recession because of u.s. fiscal policy in general.

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[tw0please]

Growth of an economy can't just be measured in quantity. Quality changes also influence growth of an economy.

And if you don't believe that the value of an apple cannot be added to the value of a car I have no idea where to go! Not believing in prices would make me so confused. How do you make decisions on whether to buy things or not? If you are deciding whether to buy a vacation package that includes hotel and travel are you not adding two unlike things together?

[Borodog]

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Growth of an economy can't just be measured in quantity. Quality changes also influence growth of an economy.

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I know that. The point is that the GDP is not a real measure of growth. Growth is folded in there, but so are a lot of other factors.

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And if you don't believe that the value of an apple cannot be added to the value of a car I have no idea where to go!

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That isn't what I said. I edited and chenged the ordering of the clauses to make it more clear. I said you can't add apples to cars to TVs, not that you couldn't add the market values of apples and cars and TVs. You can. But doing that doesn't magically give you a number that represents the "size" of the economy in any real way, and in particular the first derivative of this quantity, i.e. what is labeled as "growth", can be completely dominated by effects other than growth in the real production of goods and services.