Financial innovations and hiding the risks

This weeks Economist has a feature and an editorial on financial innovation which got my mind going.

Financial intermediation is to act as the intermediary between savers and those who would use the savings.  It allows large projects to go ahead.

It also involves risk.  One is the risk of inflation and the other is the risk that the user of the savings will make unsatisfactory decisions which result in loss.  When you allow somebody else to make decisions involving your money  in most cases their interests will come before yours.

Can we really expect regulators to protect us from our own greed as well as the greed of those who work in the financial industry?

It may be that financial innovations work to hide the risk – from the original savers and most of the people working in the industry.  So long as things are going well innovations will work to hide the risks but when something goes wrong somebody will have to take the losses and those somebodies will probably be the original savers.

Debt bondage slavery

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

Slavery was a part of life in ancient Greece.   One of the ways to become a slave is to become a debtor and not be able to repay your debts.  This is one reason one should not become a borrower.  (It is not clear to me that debt bondage was common in ancient Greece.)

When an individual goes into debt bondage he often takes with him is family and descendents.   When a ruler or government goes into debt bondage it appears they take their citizens with them.

As a lender not only might you lose all or part of the purchasing power you have transferred to another you could also become a slave master and can a slave master be true to him/her self?

There are a lot of other governments with huge debts the means for repayment of which is not clear.  I fear  debt bondage is not just a historical phenomenon.

Ignorance about how money is created

Sometimes I wonder if central bankers have a conspiracy to keep us ignorant of how money is created in our economy.

They use expressions like adding to their balance sheets, credit in the economy or quantitative easing all of which relate to increasing the money supply.

When  central banks buy government bonds on the market or from the government they create money for the purchase and add the amount to their balance sheet.  This new money injected into the economy is called high-powered money and thanks to fractional reserve banking the amount is increased by a multiplier.

For an explanation of how money is created and some of the problems associated with this process, please look at my essay LETS go to market: Dealing with the financial crisis.

The U.S. Federal Reserve Board has been  criticized for not injecting high powered money into the economy early in the crisis of the 1930s.  Once this process was started the economy started to pick up.

But things are different today.  It appears bank lending and business spending is limited not by a lack of high-powered money but rather by a lack of opportunities.

In any case, money is such an important part of our economy that it would be good if a few more people than central bankers understood how  it is created.  It may take a little thinking out but I believe most of us should be able to understand the process.  An afterthought: maybe central bankers use these terms because they don’t understand how money is created.

Right to know rather than regulations

The cover feature on this week’s The Economist about regulations in the United States.

Mostly the rationalization for economic legislation and regulations is to protect the public, but I have a theory that most of these work to restrict competition so that some producers of goods and services can make excessive profits at  the expense of consumers.

What we really need is protection from those who would restrict competition.

In the final analysis we as individuals are the ones who suffer when we do stupid things.  When governments make regulations to protect us from our own stupidity they are taking away from us the responsiblity to know what we are doing.

I figure the economic role of government should be to make sure we all have the information upon which to make decisions according to our values and the risks we are prepared to take.

Therefore, rather than lots of economic legislation and regulations governments should require producers of goods and services to make available full information about their products, their companies and their industries.  Right to know legislation should go so deep that legislators would need police protection  from all the lobby groups in the country.

Good relationships

With Valentine’s day tomorrow this would be a good time to suggest one of the fundamental rules of good relationships is that for a relationship to be satisfactory there should be a more or less equal exchange between the partners.

This rule applies to all relationships and economics is partly about relationships. Some economic relationships are close and long-term and others are with strangers and fleeting.  If the exchange is not equal it will be unsatisfactory and there will be feelings if not consequences.

It has surprised me that this rule is controversial.  On three occasions I have suggested it to women in my life.  The first two accused me of being selfish and I decided I was going to remain selfish.  The third replied “of course.”  That was 32 years ago.

One of my favorite shows is The Music Man.  The title character is an unsuccesful con man.  He sold lots of musical instruments but his cons were unsuccessful  because he gave something in return by enriching  the lives of all those he tried to con.

It is my wish that all seven billion people on this planet will have lives full of satisfactory relationships.

Economic growth and working till you drop

The Economist’s columnist Buttonwood argues in the February 11, 2011 issue that there is no need to encourage older workers to retire to provide job opportunities for younger people.

The real fallacy and myth in this column is the statement that “growth depends on having either more workers or greater productivity.”

Growth also depends upon having the resources and energy to make things and deliver services.. The columnist is right when says  when people work for a living they earn money and spend it on goods and services produced by other people.  However, when we work we also use up the planets resources and energy.

There may be lots of resources and energy left but we have used up the most readily available and the easiest to extract.

This is probably the reason for the worldwide recession which is probably going to get even worse.

So far it appears more young people are feeling the effects of the recession than are older people.  It wouldn’t hurt the give some of them a break.

Economic ups and downs

Some recent positive figures from the U.S. economy are reported in this week’s Economist.  Here’s my contribution to the discussion.

I believe the economy is fractal in its behavior and that there is an element of truth in the Elliott Wave theory.  Therefor  ups and downs are natural and should be expected.  Some turning points will be minor and others will be more substantial.

It appears our economy has been on a major down trend. Do these figures indicate a major up turn or just a little bump on the way down?

(The author of this comment has a web log on economics at https://economics102.wordpress.com/)

The war on drugs and vested interests

The Economist has an article on the war on drugs in its February 11, 2012 issue.  Here’s my comment.

The problem with the war on drugs is that there are some powerful  people with a vested interest in keeping it going – judges, lawyers and police.

I once asked a (slightly inebriated) drugs police detective how many judges and police would be out of work if the drugs problem were to be solved.  His answer was one-third.

The risks of being a lender

Here in Canada we are going into RRSP marketing season. RRSP stands for Registered Retirement Savings Plan.  If you put savings into one of these plans you don’t have to pay income tax on it.  It is taxed when withdrawn, presumably when your income is less and you pay a lower tax rate.

This might be a good time to think out what happens when you make a bank deposit or give somebody a loan.

Money is a tool, or a lubricant,  to facilitate the exchange of goods and services.  It gives one purchasing power.  When you have money you can use it to purchase goods or the labor of another person or persons.

When you hand over some of your money to another person (or institution) you are transferring that purchasing power.  When you give it to a financial intermediary, i.e. a bank, that institution passes on your purchasing power, probably along with that of other people.  This gives the final borrower a larger amount of purchasing power and the ability to undertake  larger projects than any ne person could do by himself.

All this is done in the expectation that the final borrower will make enough profit to repay the loan with interest.

The industry which promotes this process likes to promise depositors fantastic returns.  However, there are two things that can go wrong.

First the final borrower may go bankrupt or not make as much money as planned or not enough to cover principle, interest and commissions.  In this case the original owner of the purchasing power will take a “haircut”.

The second problem is inflation.  A depositor may get his/her money and interest back but if there has been inflation the purchasing power of that money will be proportionately less.

During the years of prosperity with everything going up these problems have not been serious.  As we go into recession things may be different.

What about loans to government in the form of bond purchases? The same thing applies except that governments don’t expect to make profits on their spending.  If their huge borrowings are to ever be repaid it will have to be out of taxation and user fees or reduced by inflation.

During the hyperinflation in Europe following the first world war a lot of holders of government bonds lost their savings.  It appears the current holders of Greek government bonds are going to take a substantial “haircut”.

I still think the best investment these days is a market garden.

The recession scapegoat list

The economics editor of The Guardian has published a long list of the people he claimes are responsible for the recession.  The list includes many high and mighty  including for a former British prime minister, a former U.S. president,  and a couple of central bank bosses.

I don’t  like  the idea of defending these guys, nor do I like usuing people as scapegoats.  One should remember the Indian prayer that one should not criticize another until one has walked a mile in that person’s mocassins.

Most of the names on the list are those of people who are figureheads acting on behalf of the people below them, including most of us.  These people are subjected to lots of lobbying and don’t always have the ability to do what they want.

The recession has most likely been caused by resource depletion, or at least the depletion of those resources most easily accessible and for this most of us are to blame.  Most of us have wanted a good life with lots of things such as computers, nice homes and great holidays.  And we have demanded high returns on our investments and savings.

No doubt the people on the list have made mistakes and acted in the best interests of themselves and their friends.  But the rest of us should also carry some of the blame.

Facebook, advertising and social control

This week’s issue of The Economist has an article and an editorial about facebook.

I have two concerns about this facebook thing – that it is all based on advertising and that there is potential for terrible social control.

Our well-being, or perhaps it is the well-being of the one percent, depends up advertising which depends upon people consuming a lot of goods and services whether they need them or not.

Maybe we should be looking for a post-consumer economy – one which would be less dependent upon commodities and resources and one in which most people could get their life satisfactions from artistic, religious or real social interactions.

With all that personal data in one place there will be a great potential for social control.  I understand the police are already using facebook to catch criminals and employers are using it to evaluate potential employees.

Someday we may be faced with a government that wants to legislate religion, morals, values and sexuality  Then won’t police have a field day with help of all the information on facebook and the rest of the internet.

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