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

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