Brexit: the unilateral free trade option

 

As the British and the Europeans renegotiate the European Union following a British referendum a number of options are being considered.  What will not be considered is the option which would in the long term give the best standard of living – unilateral free trade.

For a long time this blogger has believed the best way to do free trade is for a country to do it on its own by removing all barriers to imports.  “Free trade” agreements are not free trade, they are negotiated trade.  To get the full benefits of the law of comparative advantage there must be no barriers to imports. There should be no import duties, no quotas and health and safety restrictions should be genuine rather than to restrict imports.

Unilateral free trade could easily be done by any country as each country has the right to control its imports.  This will leave them open to “dumping” or subsidies by trading partners.  If another country wants to subsidize our standard of living, then we should say, “Thank you very much”.

The case for free trade is based on the law of comparative advantage which says that two countries will be better off if they specialize in their most efficient production and trade even if one of the countries is more efficient in all trading items.  With our background we generally think of better off as meaning more economic growth but it could also mean more leisure time.  The law still applies.

There are two major problems with unilateral free traded – our  commitment to economic growth and the difficulty in making employment changes.

This blogger believes there will be little if any future economic growth because we have used up the easily accessible energy and mineral resources.  There are lots left on the surface of this planet but they are so difficult to extract they are mostly useless.  I also believe many people are aware of this economic uncertainty even if they do not understand what is happening.  This is probably behind the British vote for Brexit, the United States election of Donald Trump,  the increasing popularity of extreme left and right wing politicians and the rise of dictatorships around the world and a lot of other unpleasant developments.

The fear of losing one’s job is highly emotional and this is the second big problem with free trade.  Free trade means changes in production and this means some people will lose their jobs and have to find new employment.  The other side of this problem is that economic changes are a fact of life and will happen regardless of free trade.  We try to deal with changing market conditions with subsidies, import quotas, health and safety restrictions on imports and other trade restrictions. In the long term market forces usually win.

Under current economic conditions a lot of people are likely to lose their employment and a lot of people are going to suffer.  The challenge should be to facilitate the changes and reduce the suffering.  Most people are going to have to accept a lower standard of living.  This blogger believes the best way to adjust is to introduce a basic income plan.  For more discussion of this please see the rest of this weblog and my book Funny Money: Adapting to a Down Economy.

This guy believes the British and the Europeans would benefit if the British were to use the referendum as an opportunity for unilateral free trade.  I also would not want to be a part of the negotiating team as there is unlikely to be a consensus as to what degree of trade to negotiate.  There is so much fear, so many emotions and so many conflicting interests that it will be difficult to come up with something most people will be able to accept.  There is likely to be a lot of turmoil.

 

 

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Pensions: Promises and reality

It is difficult for this blogger to get excited about pensions because he grew up to Doris Day singing “Whatever will be, will be“.  I heard that song so many times I still believe it.

There are two things that make pensions difficult.  They are part of a big business and they involve promises to be redeemed  in an unknown future.

This post was inspired by this article in The Economist about pension problems in Taiwan but the ideas here apply anywhere around the world where people rely upon pensions for their future.

Pensions are a problem because we evaluate economic problems in monetary terms and assume there will be no inflation or deflation.  We would get a more accurate evaluation if we did it in physical terms.  The reality is that our future standards of living depend upon the ratio of population to the quantity of goods and services we will be capable of producing. Monetary savings will probably be irrelevant thanks to inflation or bankruptcy.

We know, or we should know, from experience that the economic growth is fractal in nature rather than linear as we learned in university economics.  Being fractal means there are a series of ups and downs and sometimes major changes in direction.  There is some evidence that we are experiencing a major turning down.  This blogger  believes current economic problems are because we have used up the most easily accessible energy and mineral resources.  Yes, there are lots left but they require so much energy to extract they are mostly useless.  Regardless of what financial people say there may  be some grim prospects. If this analysis is correct the best career and investment is a market garden.

Pensions and other forms of savings are a big business in which sales people earn  commissions and profits on current sales.  They are selling promises for a future they probably will not have to keep.  The reality is that there may not be enough resources to keep them.

To believe in pensions one must have a lot of faith that the world is going to continue as it is for the rest of one’s life.  We can sometimes see into the near future but the further out we look the more blurred is our vision.

Back to Doris Day.

 

Compassionate austerity to deal with the economic crisis

To cope with the economic crisis we need austerity with compassion.  Stimulus as a policy will likely make things worse more quickly and austerity as currently practiced is mean and hurting victims.  Those people voting for politicians urging austerity may regret their votes when they too get caught in the crisis.

Compassionate austerity would recognize we are dealing with events beyond our control and would therefore not blame the victims.  It would include some sort of income support for people caught in the crisis

How one wants to deal with the economic crisis depends upon how strongly one believes in economic growth.  If one believes this is just a temporary setback, then one probably wants either stimulus to keep things going or some austerity until the economy corrects itself and growth returns.  This blogger figures the crisis results from problems in the resource base and it is unlikely we will again see the golden  years of prosperity which we have experienced in recent decades.

If this is the case, then austerity is something which will be forced upon us and we should try to cope with it with as little human suffering as possible.

I figure the basic economic problem is that while we have lots of energy and mineral resources left in and on the surface of the planet we have used up the most easily accessible.  Those that are left take so much energy to extract it is becoming less feasible to do so.  Suppose that during the age of prosperity we were able to build an automobile with 1,000 units of energy and labour and suppose it now takes 2,000 units to build the same car.  Not only is this going to double the real cost of building a car it will probably limit the number of cars that can be built.  It will certainly limit the number of people who will be able to afford them.

If this is a correct analysis of the problem, then clearly we need to make some revolutionary changes in the way in which we organize ourselves to produce and exchange goods and services.  I predict there is little likelihood of the revolution starting until the economic crisis hits pensioners.  For the time being it is mostly young people who are hurting.

There is a need to rethink our commitment to economic growth and rearrange our economy so we take advantage of modern technology so that most of us can live comfortably without having a job.

What disturbs me about austerity is that the people who promote it have so little compassion and understanding for those who have been caught by the crisis.  Many of those who vote for politicians pushing austerity need to rethink their votes as it could be only a matter of time before they too will find their comfortable lifestyle being challenged,

Austerity with compassion should include some sort of income support.  This blogger would like to see  a guaranteed annual income scheme combined with changes in the way in which we create money.  However, the need is so great I will say we need anything that will provide everyone with a more or less equal share of the goods and services we are capable of producing.

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Why we have financial crises

I believe the root cause of financial crises is in the fractional reserve system of creating money.  Therefore the way to avoid future crises is to change how we create money.

Dear Reader,  This post requires you to understand how money is created by the banks.  I’m feeling too lazy to write that up now so if you don’t already know I encourage you to figure it out.  Google “fractional reserve money”  or look at my essay “LETS go to market: Dealing with the financial crisis” or these other posts on this weblog.  It may appear complicated and overwhelming but if you think it out it should be easy to understand.  I think very few people understand this process which is unfortunate because we can not reform something people don’t understand.  There is a lot of emotion when dealing with money.

There are two aspects to the economy – the physical and the financial.  It’s a distinction which is easily forgotten because we measure the physical side in financial terms.    Both of these can cause economic crises and solutions probably require knowing where the problem originates.  A complication is that a physical problem can and usually does trigger a financial problem.  I believe our current economic problems are largely physical in that we have used up the most easily accessible energy and mineral resources.  There are lots of resources left but they are becoming more and more difficult to extract.

The big problem with fractional reserve money is that  interest is charged on the money created by the banks.  But the process does not create money to cover the interest.  So long as the economy and the money supply continues to grow there is no problem.  However, when growth ceases and the money supply contracts there just isn’t enough money in the economy to repay all the loans with interest.  It’s sort of like a Ponzi scheme.

Fractional reserve banking is about increasing the money supply but to the best of my knowledge not much thought has been given to when the process unfolds.  Just as money can be created out of thin air it can just as easily disappear into thin air.  This is a problem because money is essential in our economy for the exchange of goods and services.  Even a small reduction in our money supply can cause severe economic hardship because losses on bank loans come out of the reserves.  Thus losses are high powered money or leverage in reverse.  A run on the bank would also be a loss of reserves if the money is put under some mattresses.  If the money is transferred to another bank then there would be no loss of money supply to the economy although it would take some time for the adjustments to work through the system.

During the crisis of 2008 I figure the losses to the banks reduced the money supply forcing a slowdown in the physical side of the economy.  During the crisis people talked about a shortage of credit and the need for banks to start lending.  As our money supply is based on loans this is the same as saying we didn’t have enough money to facilitate the exchange of goods and services.

The U.S. officials dealing with the crisis were aware of the danger to the economy. They were also aware that a large part of the economy was sound and that the banks had to be saved so as to not have a complete collapse.  They were in a bind because saving the banks appeared to be saving people who did not deserve to be saved.  To have let the banks fail would have hurt all of us.  That is the power of the banks.  They are too important to fail.

The financial intermediation industry is focused on the double  R – risk and rewards.  The great  profits and bonuses of the industry are based on maximizing the rewards and passing the risk on to others.  As a general rule the higher the risks the greater the rewards.  In an ideal world the rewards would go to the people taking the risks but bankers have ways of grabbing the rewards while leaving the risks with the depositors.

The first thing they do is that their  marketing focuses on expected returns.  The risks involved are seldom mentioned so that customers don’t demand the rewards to go with the risk they are taking.  Governments try to protect savers with deposit insurance schemes although the real reason is to prevent runs on the bank.

The second trick is leverage.  If you did your homework you know that banks are required to keep a fraction of deposits on reserve for people who want to withdraw their deposits.  The smaller this reserve requirement the greater the leverage and the more money they can create and the larger the profits.  Regulated banks are told how much they must keep on reserve.  Unregulated financial institutions can get away with greater leverage – until things go wrong and they cannot repay their depositors.

The third profit-making stunt is to finance long-term loans with short-term deposits.  As short-term interest rates are generally lower than long-term interest rates this increases the spread/margin for the banks.  Some people claim this conversion of short-term deposits into long-term loans is a great accomplished of the financial system.  In fact it is a very dangerous practice and through the centuries many bankers have lost their businesses, if not their shirts. (But the profits were great while they lasted.) This is because when there is a crisis people will refuse to roll over their short-term deposits.  With no way to call in their loans the banks become bankrupt even though most of their outstanding loans are good.

If banks were to match the terms of their deposits with the terms of their loans their business would be financial intermediation rather than speculation and the risk would go to depositors  who are carrying the risk in any case.

I hope you can see from these notes that there are serious problems within the financial industry and the fractional reserve way of creating money.  Money is such an emotional issue and the interests of the financial industry are so strong that I believe it will be impossible to make reforms.  

 

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What will be left for our grandchildren?

Should we feel sorry for our grandchildren who will have to repay the massive debts we have been building up?  Probably not but we should feel sorry for our grandchildren who will have to survive on mineral and energy resources which are difficult to extract.

Debts can suffer fatalities from three causes: bankruptcy, inflation or government haircuts.  Considering current economic conditions  there is some possibility the current debt load will be written off before our grandchildren even understand the word.  If and when this happens there will be considerable  economic turmoil.

I believe economies should be analysed first and mostly in physical terms rather than money terms.  This way we can see some underlying trends and problems which can easily be hidden behind financial terms.

Currently we are probably dealing with problems in both sides of the economy.  We have used up the most easily accessible energy and mineral resources and the marginal cost of accessing what is left is going up.  At the same time the fraction reserve way of creating money in which interest is charged on the money supply is a Ponzi scheme which frequently breaks down.  Financial crises have long been a  feature of our economy.

If one analyses the economy only in phyiscal terms we are not living beyond our means as we produce everything we consume.  In this respect there can be no borrowing from the future.  What we are doing is using resources which won’t be available to our grandchildren at a reasonable cost.

A major financial collapse will have a devastating effect on our exchange of goods and services.  It is quite likely our grandchildren will have to pick up the pieces from a financial collapse.  What is more certain is that they will have to cope with our having used up the most easily accessibe energy and mineral resources.  There will be lots left for them but these resources will require a lot of energy to extract.  That will be enough of a burden to impose upon them.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

Why stimulus is not working

At least since Keynes conventional economic wisdom has been that the cure for an economic depression is government stimulus spending – even if it means increasing the government debt.  Recently, some people, especially  those who will lose their savings from inflation or if debt has to be written off, have been fighting plans for stimulus spending.

There are other reasons to be leery of stimulus spending.  It isn’t working and it could bring forward an even more serious economic collapse.

To explain this we have to go to the blackboard of an economics classroom where the professor draws an x-shaped graph.  One line represents the financial side of the economy and the other line represents the physical aspect.  The problem is that we measure the physical side in financial terms and tend to forget this distinction as soon as we get away from the blackboard.

polettix_stone_age_wheel_1For stimulus to work there has to be adequate energy and mineral resources to support the increased economic activity.  When Roosevelt implemented the New Deal and when we undertook the Second World War there were still loads of resources.  Now we have used up the most easily accessible energy and minerals.   What’s left requires a lot more work and energy to extract.  Putting more energy into extracting resources is taking away from the standard of living most of us want.

The other problem with stimulus spending is that it will use up even more of the existing resources and make the economic crisis even worse.

If stimulus is going to make things worse, what do we do?  After all people are suffering from the crisis. I think the answer is to drop our commitment to economic growth and the consumer society.  The economic task should be to see that everyone has adequate food, shelter. clothing,  hobbies and entertainment.  It is important to be able to communicate but I’m not certain it is necessary for everyone to have a micro cell phone.

What is really happening in the economy?

With all the headlines about the fiscal cliff and quantitative easing there is a danger that too many people will think economics is just about money.,

When my economics professors stood in front of the black board they often drew an X-shaped graph.  One side of the x represented the real or physical side of the economy and the other represented the financial.

This is an important distinction to make especially as we generally use monetary terms to measure the physical side.

The financial side of the economy has lots of potential to wreck our lives and has done so, but if we really want to know what is happening we need to look at the physical side of things.  We should not assume there is an unlimited supply of energy and mineral resources and that economic growth can continue forever.

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

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