1/10/13 Another Problem With GDP
Gross Domestic Product is supposed to measure what's produced in the country. This can't be done by counting what's made because every business makes different things, cars, cough drops, corn flakes, cartoons, and on and on. It's dramatically worse than comparing apples to oranges which proverbially can't be done.
To get a standard unit of measure all goods and services are converted to dollars, what they sell for. If you spend $20k on a new car, $20k worth of car production was done. If you get a $20 haircut, the barber did $20 worth of work. And so on. GDP is figured by totalling up the dollar amount of spending for production.
GDP = Consumption + Investment + Government + Exports - Imports
Let's just look at one part of this, consumption. If you buy a new house someone built a house. Clearly that's production. So you can add the sale to GDP as it represents the production of a house. No problem there.
Now then, if you buy a house built 50 years ago, is that production you can add to current GDP? Wasn't that production counted in GDP 50 years ago when it was first built and bought? Is the house built again when resold? How many times can the same house be produced?
Let's say we both own our homes outright, no mortgage. I sell you my house for $100k and you sell me your house for $100k. Together that's $200k in consumption spending added to GDP. Our net values are the same as before, there are no more houses than before. If GDP is supposed to count production, where's the production? Let's say the following year we sell each other our houses for $200k each. Our contribution to GDP doubles to $400k. Yet nothing has been produced. Does this make sense?
So I raise the question, does the resale of existing homes add to GDP. Which leads to another question, does the resale of any existing asset add to GDP. Are we measuring product or something else?
Let's take a sci-fi hypothetical. Imagine a race of plant people, Planties, who live off sunlight and rain. Let's say their entire economy consists of Planties buying and selling existing products to each other. There's a lot of money and goods changing hands, but not one new thing has been made for generations. No matter how fast they buy and sell, no new products are ever produced. It's all a zero sum game. What is their GDP?
I may not be an econ guru, but I suggest GDP is overstated by the total amount of resales. Meaning during the run-up in housing prices GDP was inflated by the increased prices of existing home sales which were really not adding to GDP. It was phony GDP. So I ask again, what good is GDP as currently calculated?
12/15/12 One Problem With GDP
There is a notion floating around that a natural disaster boosts gross domestic product (GDP). Just think of all that economic activity it takes to rebuild. Surely that's good for all the workers and businesses hired in the effort, right? Let's think about it.
No money was created by the disaster. Money spent replacing a destroyed building is money not available for something else. The rebuilding mostly diverts money from one thing to another. In which respect it's a wash as the money would have added to GDP in some other way. Unless you think that money would have gone forever unspent. Hardly likely.
Except it's not a wash, it's a loss. Had there been no disaster you could have had a building and built a second building, a net two buildings. With the disaster you lose one building and build one to replace it, a net one building. How is it you can invest the same amount in both cases, yet be ahead in one and behind in the other? Why is this not reflected in GDP?
GDP = Consumption + Investment + Government + Exports - Imports
Investments are things like building infrastructure, capital equipment, buildings and the like. This adds to GDP. Seems to me the reverse would also be true, destroying infrastructure, capital equipment, buildings and the like subtracts from GDP. What Hurricane Sandy destroyed should reduce GDP by that amount. It's simple math.
Therein lies one of the many flaws of GDP as a metric. They only add to investment, it's always positive. They never subtract lost investment. So if disasters were destroying infrastructure faster than you replace it, you could be increasing your GDP all the way to the poor house.
What is GDP telling us? What good is it? Mightn't it be better to calculate net domestic product? What good is increasing sales if the business operates at a loss? Is it good for an entire economy to do the same? This reminds me of the old line, "The operation was a success, but the patient died."
10/13/12 The ABCs Through J of Too Much Debt
As you may know, there's more total debt to GDP now than there's ever been. I'm talking about personal, business and government debt combined. Now then, debt has to be owed to someone, one person's debt is another's credit. You can't have one without the other, they're two sides of the same coin. To say there is too much debt must mean there is too much credit.
When a huge pile of debt is accumulated by people who can't afford it, folks with little to no credit and small incomes, then there must be gobs of credit piling up for people with comparatively little or no debt. This lopsided distribution of massive debt and credit is where we get trouble. I mean, if the debt were owed by the people with the credit it could be paid off in a trice.
For instance, say there are ten people, A through J. Each owes one person $100 and is owed $100 by a different person. Say A pays B $100, B takes that hundred bucks and pays C, C takes the c-note and pays D... and so on until J finally pays A $100. The money circulates round and round between debtors and creditors and everybody pays off everybody until no debt remains. Easy-peasy.
On the other hand, say A through I each owe $100 to J who doesn't owe anyone anything. Say A pays J $100, J takes the money and... that's it. Because the credit is concentrated in one place there is no circulation of money between debtors and creditors to pay down debt. All the while J is charging interest on all that debt. So B-I are getting deeper into the hole.
I suppose it would help get money in circulation if J starts spending like a drunken sailor. But how much of what A-I make or do can J use? If B runs a hamburger stand J can only eat so many burgers. More likely J is going to buy a Picasso from fellow rich person Z. Which doesn't do anything for A-I at all.
I suggest something like that is why economies often break down when there is a high concentration of credit, or wealth, at the top. I further suggest this is the situation today. What is the current solution employed by the powers that be? Print money and lend it to the government to buy up bad debts of Wall Street and stick taxpayers with the bill. At the same time enact a Zero Interest Rate Policy so savers lose money after inflation. In other words, increase the debt and reduce the credit of people with more debt than credit, while increasing the credit and reducing the debt of folks with more credit than debt.
My solution? Picassos for everyone! Makes no sense, you say. Does the other solution make sense?
9/14/12 Maturity Mismatch Mistake
Is there an inherent problem with fractional reserve banking of maturity mismatch? What the heck is maturity mismatch anyway? Does it have anything to do with old folks acting like children?
When you make a bank deposit the money is not stacked up or rolled up in those paper coin thingies and stuffed in a vault. The bank uses that money, lends it, and pays interest to the depositor. As paltry as that might be nowadays. While it might not seem like a loan, a bank deposit is a loan to the bank.
Maturity is the time frame of a loan, when it must be repaid in full, interest and principal. For instance, the maturity of a 30-year mortgage is 30 years, unsurprisingly enough. On the other hand, loans to the bank, deposits, can be withdrawn, paid back, on demand. There is no set time frame, or maturity. Because the money can be withdrawn at a moment's notice some say the loan term is zero days. (We'll ignore that there can't actually be a period of time equal to zero, which is no time at all.) In this case, the bank is borrowing short, zero days, and lending long, 30 years. They call this maturity mismatch.
Clearly zero doesn't match thirty. Can you borrow money and lend it out for 30 years and pay back the initial loan instantaneously? Obviously not. The maturity of the two loans are mismatched. You have made a promise that's impossible to keep. You have committed fraud. At least that's the theory of maturity mismatch.
All the same, are banks really borrowing short? I mean, how often do people deposit money in the bank for zero days? Don't most folks keep a balance in the bank for years? If you kept an average bank balance of $20,000 for 40 years, have you lent the money for zero days or for 40 years?
Depositors may withdraw their money from the bank at any time. Well, any time the bank is open. In practice they usually leave a balance in the bank for years or even decades. So the effective maturity period could be years or even decades, however long the account has money in it. Which means the term of the deposit is not zero, it is indefinite. Indefinitely may or may not match 30 years. Usually not, but you just don't know.
In which case there is no maturity mismatch in practice, only in theory, if the theory claims deposit terms are for zero days rather than indefinitely. (That's the maturity mismatch mistake referred to in the title.) However, if the theory posits the term of the deposit is indefinite you can't tell if there's a maturity mismatch or not until depositors take their money back.
Here's where it gets a little fuzzy. Banks don't loan against any particular deposit, but against the total deposits. A great number of folks are putting money in and taking money out all the time. What is the maturity of all these deposits? Is there any way to track it? Does it matter as long as the total remains for extended periods? If the money is not withdrawn the loans haven't matured. So where is the mismatch?
A bank might suffer maturity mismatch when depositors withdraw more money than the bank has reserves. The deposits mature at the moment of withdrawal, while the bank's loans are yet to be paid. This results in the classic bank run and the bank goes bust.
All this means the bank has not necessarily made a promise it can't keep. If it has over-promised on potential demand but not actual demand, is that fraud? If everyone who asks for it gets their money, where's the crime? Then again, bank runs can, and do, happen. So there is an inherent risk. But then, what loan doesn't carry risk?
There are plenty of things to criticize banks about these days. But worrying about maturity mismatch is the least of our problems. And for practical purposes not a problem at all.
8/21/12 The Magic of Compound Interest (and Compound Inflation)
Save your money and watch it grow with the wonders of compound interest. For instance, at 10 percent interest 100 dollars will become $285 in ten years. That $100 grows to $740 in twenty years. In thirty years it will be $1,967. Zowie, that's quite a return. Or it would be if inflation were zero. If inflation were 10% that whole time what cost $100 then costs $1,967 now. Which means, you basically broke even.
These days savings interest is next to nothing. But let's take a hypothetical where you earn 1% and inflation is 5%. In such a scenario, how much value has your money lost in ten years? In ten years at 1%, $100 in savings becomes $111. At 5% inflation what cost $100 costs $162 ten years later. Your $111 is about 2/3 of $162. In 10 years you lose 1/3 of your money.
In effect, because of inflation you were underpaid $67 for $100 worth of savings. Only after the fact when you spend the money. It would seem somebody owes you $33, but who? Just as you'll never get that money back, you'll never trace who took it.
You could blame inflation. But inflation doesn't just happen of its own accord. Inflation means the money supply grows faster than production. The way things work nowadays money is credit/debt. This excess money is created by banks through over-lending against reserves. The banks lend first and get the reserves afterwards. Which they get from the central bank which creates the reserves, partly by buying government bonds. The government pays off the bonds with taxes.
In a strange way you pay taxes so the government can help the banks create inflation to steal your savings. It's the magic of modern monetary practice.
3/12/12 Thoughts on Bail-outs. Take Greece. Please.
They "saved" Greece. Again. They loaned more money to a country that can't pay its debts. What the result will be I couldn't say. All the same, Greece's desire to remain in the EU at all costs reminds me of a joke.
"What's your job at the EU Circus, Mr. Popolous?"
Anyway, it has me thinking of bail-outs and subsidies. It seems many abide subsidies, but dislike bail-outs. Aren't they both essentially the same thing, money for something that would otherwise fail? The difference is in the timing of when the money is provided. The bail-out is money after the failure, the subsidy is front money before the failure.
To me, subsidies are worse. Subsidies are ongoing, like a bail-out year after year after year. For something known ahead of time that doesn't work on its own. Make sense to you?
2/17/12 Dime Stores are Here
Officially there's no such thing as a penny in American currency. According to the U.S. Treasury that small copper coin is a one-cent piece. Calling it a penny started way back when because it resembled the English and Colonial penny people were familiar with. We've been calling it a penny ever since. Everyone but the U.S. Treasury, anyway. I'll not buck the trend and call it a penny, too.
There's talk these days of changing the penny and the nickel because they cost more to make than they're worth. A penny costs 2.4 cents and a nickel 11.2 cents. This is a money-losing proposition, though money-losing propositions are what governments are good at. Only 1.1 cents of a penny is for it's metal content. Which means even if it were made of something much cheaper it'd still cost more than it's worth.
Some people have suggested we do away with pennies altogether. Others think we might as well lose the nickel to boot. Everything would be rounded to the nearest ten cents. Which would mean they'd have to eliminate the quarter. After all, if you bought a ten-cent item with a quarter you couldn't get 15 cents in change without pennies or nickels.
So they'd have to go with only dimes and fifty-cent pieces. Which leaves two unused coin compartments in the standard cash register. Meaning they might as well have dollar and five-dollar coins. This opens up two money tray slots for paper money, fifties and hundreds. Then cashiers wouldn't have to slip them under the tray any more. Or maybe they could use one slot for checks. Whatever.
Axing pennies and nickles would effectively "re-decimalize" American money. Since the smallest amount of currency is ten cents, a dime becomes like a penny and a dollar becomes like a dime. Price signs would no longer need the second decimal. Something for two dollars and fifty cents, $2.50, would be written as $2.5 instead. Dollar stores would be like dime stores. Which they already are if you remember what dime stores were.
This re-decimalization would pretty much agree with how prices have inflated since I was a boy. We used to get an order of fries from the local burger joint for ten cents, now it costs a buck. A can of Coke was ten cents, now it's a dollar. A burger could be had for twelve cents, now they're a dollar. It doesn't work for everything, but it's fairly close.
Which only goes to show, a little inflation year after year adds up to a lot over time. That's because it compounds, like savings interest. From ten cents to a dollar, that's 1,000% inflation. And in those 45 years or so inflation was never over 20%. A quarter ain't worth a dime anymore.
1/7/12 More Than Numbers
They tell me replacing my old windows with more efficient units will save me 20% on my heating bill. I did a little back of the envelope calculation. My gas bill runs about $600 a year. Besides the furnace, my dryer, water heater and stove also use gas. Let's knock off $100 for those. So heating is $500 a year, 20% of that means new windows will save me $100 a year. Sounds OK.
Though to get the savings I first have to spend some money, get the new windows. Estimates from window companies say it would cost around $3,500 to upgrade my windows. Making back the $3,500 up-front expense with savings of $100 a year would take 35 years. Hm-m-m, not so OK.
Thing is, if I don't get new windows the money doesn't vanish. I have $3,500 to spend on something else. Let's say instead of buying windows I invested that $3,500 at a 1% annual return, that's $35 a year. Which means replacing the windows saves $100 a year but costs a possible $35 a year in lost earnings. Under this scenario my net saving is $65 a year so it would take just over 53 years to pay off the windows. A 3% return would be $105 a year so new windows would never pay off.
What I'm getting at is this, we don't buy anything and everything we want because we know our funds are limited. When we spend money on one thing we don't have that money to spend on something else. They call this opportunity costs. Buying windows means I lose the opportunity to invest the money.
Of course, people who decide not to buy something don't necessarily invest the money instead. Nor do they leave it in the bank to collect interest or in a shoe box to collect dust. (About the same thing nowadays.) Usually they spend it on something else.
Then the question is not would I be better off with new windows or not, but would I be better off spending the money on new windows or something else. Like a motorcycle. Since I can only spend the money once, how do I compare what I get out of a motorcycle to what I get out of new windows? There's no math for that.
Still, there's a bit of uncertainty in the calculations. Will I be in the house in 35 years? Will the price of gas go up? Will my investment make or lose money? Will I sell the house, and will new windows make the house more valuable or easier to sell? If I wait a few years, can I buy a jetpack? There's no math that can foretell the future, either.
11/28/11 Upside Down and Underwater
Some people say you're upside down, others say you're underwater. Either way it means you owe more on your mortgage than the house is worth. As bad as that is, it gets worse.
When people buy a house with a mortgage they might think they've paid the selling price of the house. What they've really paid is the selling price of the money that pays for the house, the mortgage. Depending on the interest rate, a 30 year mortgage on a $200k house might cost $200k in interest over the time it takes to pay off the loan. Which means the buyer will spend $400k in total for the house.
When the housing bubble burst prices dropped considerably, in some places by half. So, a house sold for $100k, rose to $200k during the bubble, and went back to $100k after the bubble burst. If not for the bubble, the house would have sold for $100k all along, and a 30-year mortgage would have cost $200k. The bubble cost mortgage house buyers an extra $100k in principle and an extra $100k in interest, or $200k total.
When the value of the house went down by half, so did the value of the mortgage. The bubble inflated $400k mortgage is paying for what a post-bubble $200k mortgage buys, which is a $100k house. So they are paying $400k for a mortgage worth $200k. In effect, they're underwater on both principle and interest.
8/3/11 The Non-Excess Value of Labor
A business makes a product. The capital costs provided by the owner are $10. The labor costs provided by the workers are $10. The product sells for $30. Where does the extra $10 of value come from?
According to some, the additional $10 of value came from the labor which transformed the less valuable raw material (capital) into the more valuable finished product. The idea being the capital is only worth $10 until labor increases the value by $20 to the $30 sale price. So the conclusion arrived at, as the owner only paid the worker $10 the $10 profit is excess value stolen from the worker.
But did you notice anything missing? Only capital and labor adds or creates value in this formula. Let's go back to the original premise, notice it says "the product sells for $30". Well, if the product sells there must be a buyer, a customer. But what of the customer? Did the customer add any value? If not, then we don't need the customer to asses value. What happens to the formula when there is no customer?
A business makes a product. The capital costs provided by the owner are $10. The labor costs provided by the workers are $10. Nobody buys the product and the owner loses $20. Where did the $20 of value go?
The entire exercise falls apart without a customer. If the product never sells its value is not the $30 sale price, nor the $20 it cost to make, it is $0. The formula identifies the source of value incorrectly which is neither from capital nor labor. The entire $30 of value came from the customer. If there is no buyer the product has no value no matter what it cost to make.
The value is not what you put into it, but what you get out of it.
This is easy to show. It might take the same amount of paint, canvas and labor for me and Picasso to each paint a picture. Yet the Picasso sells for a million dollars and I'd be lucky to get a hundred. If the value came from materials and labor they'd be worth the same. But the value is what is produced, not the labor it took. Picasso produced Picassos, I produce Colons.
The dollar value of products are determined at the point of sale and not the point of production. In the original premise, the capital is worth $10 because the supplier sold it for $10. The labor is worth $10 because the worker sold it for $10. The finished product is worth $30 because that's what the customer paid for it. And a Picasso is worth a lot more than a Colon because art collectors will pay a lot for a Picasso and very little for a Colon.
In altogether ignoring the customer, the excess value of labor theory has a gaping hole. Once the hole is filled the excess vanishes.
11/24/10 Economics in Four Pictures
I don't know that any additional verbiage will help or hurt the pics. They are what they are. You're amused or you're not. That's the bottom line.
8/14/10 Pseudo Paradox
Below is an old story that makes the rounds from time to time. It's a tale supposedly relating some kind of debt paradox or something. Though no-one seems to actually explain the absurdity as it's supposed to be self-evident, or something. Here's the short version.
Butcher, Baker, Tailor, and Candlestick Maker
A candlestick maker has a hundred bucks and goes to the butcher shop where we pays off $100 he owes the butcher. The butcher takes the money next door and pays off a $100 outstanding debt to the baker. The baker runs next door and makes right a hundred dollar debt to the tailor. The tailor stops the candlestick maker walking past his shop and gives him the hundred bucks he owes him, with the same money the candlestick maker used to pay off the butcher.