Economics for eedjits

[Walsingham]

I don't want to sound like LoF here, so I'm asking so someone can set me straight.

 

Basically throughout the early noughties people enjoyed a lot of services and bought a lot of stuff on credit. Other people enjoyed the benefits of providing those services and bits of tat.

 

Now, essentially, we hit a wall in that all the imaginary money used to pay for all the healthy economic behaviour and people in jobs ...was imaginary. Which is in essence fine, because modern economics is entirely based on imaginary money.

 

Now, my point is that it occurs to me that the only people who have been shafted here are rich people. As in mega rich people. they're the ones who lended the imaginary money. But they lent too much imaginary money and no w imaginary money is worth less than they think it should be.

 

I say mega rich people because all the normal people have either enjoyed or are still enjoying the things they bought with the imaginary money.

 

Am I right so far?

[Gorth]

Am I right so far?

Not really

[Rosbjerg]

No the rich are still charging interest on their imaginary money and foreclosing houses - so I'd say the lower middleclass and poor got shafted (somewhat by themselves) because they were living beyond their means and are now trying to pay off what they couldn't and still can't afford.

[Gorth]

Gorthonomic theory: Corporate greed will go as far as it can before it gets caught.

 

The simplest possible way of describing the GFC is comparing it to the worlds biggest pyramid scam ever. Every time a middle man (a bank) manages to find somebody to put into debt, the boss gets a bonus and profits gets passed up the chain of lenders. Eventually, so many people will have been put into debts they can't pay that the entire card house comes crashing down. Bank managers don't really care, since they get dibs on available funds for their bonuses first.

 

Part of the problem is that people got money lend to them for buying real estate, expecting the value of real estate to grow permanently. There is no such thing as permanent.

 

In the end, a bunch of filthy rich people got richer and everybody else got shafted, leaving the tax payers to pick up the bill. Part of the outrage was of course (imho), because the first thing aforementioned managers did when getting bail out money was to reward themselves for a job well done (i.e. gambling everybody elses money away on risky ventures, running world economy into the ground).

 

Grossly simplified, but saves years of catching up on the reading

[Gorgon]

Everyone who doesn't own capital gets shafted. As for the credit bubble, poor oversight with subsidized housing loans.

[Darth InSidious]

So, just to be clear: Who was it who thought lending imaginary money would be a good idea?

[Raithe]

So, just to be clear: Who was it who thought lending imaginary money would be a good idea?

 

Well to put it in perspective.. Isn't there only about $500 of real, printed money per person in the USA? I seem to remember that cropped up somewhere in a documentary. And that's pretty standard throughout the world.. So when you're talking just the 1's and 0's representing all the "money" floating around in banks, it's pretty much all imaginary and always has been.

Even the gold and silver currency of ye olden days tended to be based on perception of value and the faith you had in it (considering how many governments debased the coinage of the time) rather then the real value of the cash in hand.

[Nepenthe]

I don't want to sound like LoF here, so I'm asking so someone can set me straight.

 

Basically throughout the early noughties people enjoyed a lot of services and bought a lot of stuff on credit. Other people enjoyed the benefits of providing those services and bits of tat.

 

Now, essentially, we hit a wall in that all the imaginary money used to pay for all the healthy economic behaviour and people in jobs ...was imaginary. Which is in essence fine, because modern economics is entirely based on imaginary money.

 

Now, my point is that it occurs to me that the only people who have been shafted here are rich people. As in mega rich people. they're the ones who lended the imaginary money. But they lent too much imaginary money and no w imaginary money is worth less than they think it should be.

 

I say mega rich people because all the normal people have either enjoyed or are still enjoying the things they bought with the imaginary money.

 

Am I right so far?

'cept that AFAIK, U.S. banks at least can operate a money multiplier, where they can lend money that is even more imaginary than normal, ie. they have to be able to cover only a fraction of the money they lend out. (when I did high school economics, I was told that only central banks can do this, but obviously my textbooks must have sucked).

 

Problem is, letting said imaginary money presses go bankrupt is generally considered a bad idea (not least because they have a good lobby, they can afford to), their losses tend to get recouped from taxpayer money (they were in Finland in the early 90s, they are in the US etc. now). Who pays the biggest relative chunk of their income as taxes? Hint, it's not the uber rich, it's the middle class.

 

That was the short version, without the michael moore hyperbole.

[Wrath of Dagon]

Depends who you consider to be the middle class, in US the top 10% pay the greatest share of taxes. Also the stuff you said about banks is wrong. They have to keep a certain amount of money in reserve, but they still can only lend money that's been deposited. The Federal Reserve on the other hand really can create money out of thin air. Whether they actually print it as cash or transfer it electronically isn't really relevant, it's all imaginary.

[Darth InSidious]

So, just to be clear: Who was it who thought lending imaginary money would be a good idea?

 

Well to put it in perspective.. Isn't there only about $500 of real, printed money per person in the USA?

I have absolutely no idea, because I'm not American.

 

But the point is not so much about real, printed money so much as the amount of money going around vs. the value of assets in a nation.

Edited July 26, 2011 by Darth InSidious

[WDeranged]

Banks actually can and do lend more money than has been deposited, it's called fractional reserve banking.

[Nepenthe]

Depends who you consider to be the middle class, in US the top 10% pay the greatest share of taxes.

Source? Or, are we talking about the fact that since the top 5 % make more than the remaining 95 %, even with a regressive (in practice) tax rate, they still wind up paying more. Also, I can only speak about what the situation is here, in the old welfare state Europe, not in the U.S. *shrug*

 

Also the stuff you said about banks is wrong. They have to keep a certain amount of money in reserve, but they still can only lend money that's been deposited. The Federal Reserve on the other hand really can create money out of thin air. Whether they actually print it as cash or transfer it electronically isn't really relevant, it's all imaginary.

I really should have cut back on the daily dose of conspiracy theories before summarising fractional-reserve banking, but yes.

[Hurlshort]

I have a friend who was paying pretty insane tax rates once his very profitable business took off, basically 35% which came out to around $200,000 a year. Still, he was buying Ferrari's and stuff, so it was hard to really sympathize.

[Meshugger]

A dumb question: Why is fractional reserve banking better than the government issuing money itself entirely? Why do we need a bank to print money(=our currency)?

Edited July 26, 2011 by Meshugger

[Enoch]

A dumb question: Why is fractional reserve banking better than the government issuing money itself entirely? Why do we need a bank to print money(=our currency)?

It solves the initial allocation question-- i.e., how do you decide to whom to issue that money?

 

The role of a financial or banking sector in an economy is pretty simple: It is the job of the financial sector to decide where a society's aggregated assets should be invested. In order to maximize the long-term competitiveness of a society, the banking sector should be making those decisions based on what endeavors offer the highest likely real rate of return. And if you allow the mechanisms of the money supply to flow through private businesses competing for market share and returns to capital, you tend to get decision-makers who have the correct incentives governing that decision. One of the key lessons of the 20th Century is that, when prudently regulated, a capitalist banking sector tends to make more efficient decisions than does a system run with more political control (which, from a technical political-theory point of view, would probably be called fascist, but is more closely associated in the modern mindset with the communist regimes that previously lurked on the unfashionable side of the Iron Curtain).

 

That said, the "prudently regulated" bit is quite important. Because a banking sector has an enormous power over the overall functioning of an economy, there have to be some checks to ensure that it is in fact worthy of the trust that the rest of the society gives it. The incentives that private parties have in free market democracies all create tendencies towards monopoly, oligopoly, and the exercise of political influence for private gain, so the state must police its industries (particularly finance) to minimize the efficiency-sapping impact of those kinds of exercise of market power.

 

 

And that's largely at the root of what has happened. Under this view, the portion of GDP generated by the financial sector can be seen as something of a tax-- the part of our overall productivity that is rendered to the people who are making our investment allocation decisions for us. For most of the post-WW2 period in the U.S., this portion held pretty steady around 4%. It started rising above that level in the 1980s, as the de-regulation cogs started to turn and as the workplace culture changed inside the big Wall Street investment banks. (Most importantly, they started transitioning from small private partnerships to publicly traded corporations, and there's a big difference between what kind of risks a person is willing to take with their bosses' money and what kind of risks they are willing to take with money provided by millions of anonymous shareholders.) In short, when deciding which endeavors to fund with the assets of the society, the answer "Other Bankers like Me" started turning up more and more often. (Sidenote: also a factor was the frequency with which the question was answered with "Southeast Asia" or some other foreign nation instead of somewhere closer to home.) By the time the wave crested, the financial sector in the U.S. was around 8% of GDP.

 

Essentially, with the "hands off" regulatory attitude, there just got to be too much lending. Which means too much debt and too much risk. Leverage is a magical thing. Say that you find an investment opportunity that you're pretty sure will return 10% in a year. If you fund the whole thing out of pocket, you make a 10% return. But if you get get 10-1 leverage, borrowing $9 for every $1 you put up, your return on the initial investment is 100% (minus your borrowing costs). The problem, of course, is that if you're wrong, it only takes a 10% decline in the investment to wipe out 100% of your investment. By late 2008, some of the huge investment banks were at 30-1 overall leverage, and their regulators were fine with this because it was assumed that these companies were being run by the most sophisticated managers that money could buy and that no regulator could protect their investors better than those managers could. In that environment, any kind of shock could be enough to precipitate a catastrophe. It turned out to be the overvaluing of sub-prime real estate that provided the match, but had that not happened, it would've been something else instead. Too many piles of oil-soaked rags lying around for it not to catch fire sooner or later.

 

 

And Wals is incorrect in saying that only rich people suffered. The global recession is mostly a de-leveraging event. Companies, governments, and individuals have responded to this crisis largely by attempting to reduce their debt levels. Lots of big businesses are still getting over the shell-shock that happened when the commercial paper market essentially shut down in late 2008, so they're keeping oodles of cash on hand instead of investing it in hiring, expansion, or other things that keep the economy moving. In the aggregate, we've basically got lots of people either defaulting on debt or putting more of today's earnings into paying for yesterday's expenditures. That means less present consumption and fewer present jobs.

Edited July 27, 2011 by Enoch

[Nepenthe]

I have a friend who was paying pretty insane tax rates once his very profitable business took off, basically 35% which came out to around $200,000 a year. Still, he was buying Ferrari's and stuff, so it was hard to really sympathize.

HAHAHHAHAHAH.

 

(spontaneus reaction at considering 35 % tax rate "insane", especially with the arcane us tax deduction system).

[Walsingham]

35% top tax rate seems pretty fair. As you say, once you're buying ferraris then you've got enough cash to be enjoying yourself. And a good start would be sunshine and floozies, IMO. Not Italian engi-wank.

[Nepenthe]

35% top tax rate seems pretty fair. As you say, once you're buying ferraris then you've got enough cash to be enjoying yourself. And a good start would be sunshine and floozies, IMO. Not Italian engi-wank.

I've never understood the appeal of ferraris. I mean, they're nice looking, but they sound like ****. Give me a porsche any day of the week, the audio pron to go with the motor-wankery.

 

Also, I agree with your priorities.

[Raithe]

Eh, one of my friends had a dream of getting a Lotus.

But he wasn't going to save for a Lotus until he could get a garage to put it in.

So he got out of university and he drove the same crappy car he learnt to drive in, tended to get his shoes resoled rather then buy new ones..

I mean, he made a lot of money..but hardly spent any of it, really saving the pennies....

 

Then after about 8 years.. he went out ..and paid cash for a house (no mortgage) and then two months later visited the Lotus factory and ordered up his Lotus Elise (again, paying cash)...

[Nepenthe]

Eh, one of my friends had a dream of getting a Lotus.

But he wasn't going to save for a Lotus until he could get a garage to put it in.

So he got out of university and he drove the same crappy car he learnt to drive in, tended to get his shoes resoled rather then buy new ones..

I mean, he made a lot of money..but hardly spent any of it, really saving the pennies....

 

Then after about 8 years.. he went out ..and paid cash for a house (no mortgage) and then two months later visited the Lotus factory and ordered up his Lotus Elise (again, paying cash)...

That's admirable, but when a one-bedroom flat costs roughly what lawyer's entire net income for 7-8 years represents, a lot harder to achieve.

[Raithe]

That's admirable, but when a one-bedroom flat costs roughly what lawyer's entire net income for 7-8 years represents, a lot harder to achieve.

 

Yeah, he was doing software engineering. Made himself indispensible as the key programmer for some software they developed.. then "left" the company to become a consultant.. whereupon they basically brought him right back doing exactly the same job but about double the pay scale because no-one else they had really understood or could troubleshoot it like him.

 

I both admire the chutzpah for setting it up, but also kind of worry about the principles and ethics of the maneuver.

[Nightshape]

That's admirable, but when a one-bedroom flat costs roughly what lawyer's entire net income for 7-8 years represents, a lot harder to achieve.

 

Yeah, he was doing software engineering. Made himself indispensible as the key programmer for some software they developed.. then "left" the company to become a consultant.. whereupon they basically brought him right back doing exactly the same job but about double the pay scale because no-one else they had really understood or could troubleshoot it like him.

 

I both admire the chutzpah for setting it up, but also kind of worry about the principles and ethics of the maneuver.

 

Business ethics, fark them before they fark you. And they will... FACT!

[Nightshape]

Banks actually can and do lend more money than has been deposited, it's called fractional reserve banking.

 

Its also a stupid idea, like what most banks do.

 

I do so love the imagined concept of money, every time I look at my debts I just go... Oh they're only imagined fark 'em, and go to the pub.

[Wrath of Dagon]

Banks actually can and do lend more money than has been deposited, it's called fractional reserve banking.

Wikipedia agrees with me : http://en.wikipedia.org/wiki/Fractional_reserve_banking

[Meshugger]

A dumb question: Why is fractional reserve banking better than the government issuing money itself entirely? Why do we need a bank to print money(=our currency)?

It solves the initial allocation question-- i.e., how do you decide to whom to issue that money?

 

The role of a financial or banking sector in an economy is pretty simple: It is the job of the financial sector to decide where a society's aggregated assets should be invested. In order to maximize the long-term competitiveness of a society, the banking sector should be making those decisions based on what endeavors offer the highest likely real rate of return. And if you allow the mechanisms of the money supply to flow through private businesses competing for market share and returns to capital, you tend to get decision-makers who have the correct incentives governing that decision. One of the key lessons of the 20th Century is that, when prudently regulated, a capitalist banking sector tends to make more efficient decisions than does a system run with more political control (which, from a technical political-theory point of view, would probably be called fascist, but is more closely associated in the modern mindset with the communist regimes that previously lurked on the unfashionable side of the Iron Curtain).

 

That said, the "prudently regulated" bit is quite important. Because a banking sector has an enormous power over the overall functioning of an economy, there have to be some checks to ensure that it is in fact worthy of the trust that the rest of the society gives it. The incentives that private parties have in free market democracies all create tendencies towards monopoly, oligopoly, and the exercise of political influence for private gain, so the state must police its industries (particularly finance) to minimize the efficiency-sapping impact of those kinds of exercise of market power.

 

 

And that's largely at the root of what has happened. Under this view, the portion of GDP generated by the financial sector can be seen as something of a tax-- the part of our overall productivity that is rendered to the people who are making our investment allocation decisions for us. For most of the post-WW2 period in the U.S., this portion held pretty steady around 4%. It started rising above that level in the 1980s, as the de-regulation cogs started to turn and as the workplace culture changed inside the big Wall Street investment banks. (Most importantly, they started transitioning from small private partnerships to publicly traded corporations, and there's a big difference between what kind of risks a person is willing to take with their bosses' money and what kind of risks they are willing to take with money provided by millions of anonymous shareholders.) In short, when deciding which endeavors to fund with the assets of the society, the answer "Other Bankers like Me" started turning up more and more often. (Sidenote: also a factor was the frequency with which the question was answered with "Southeast Asia" or some other foreign nation instead of somewhere closer to home.) By the time the wave crested, the financial sector in the U.S. was around 8% of GDP.

 

Essentially, with the "hands off" regulatory attitude, there just got to be too much lending. Which means too much debt and too much risk. Leverage is a magical thing. Say that you find an investment opportunity that you're pretty sure will return 10% in a year. If you fund the whole thing out of pocket, you make a 10% return. But if you get get 10-1 leverage, borrowing $9 for every $1 you put up, your return on the initial investment is 100% (minus your borrowing costs). The problem, of course, is that if you're wrong, it only takes a 10% decline in the investment to wipe out 100% of your investment. By late 2008, some of the huge investment banks were at 30-1 overall leverage, and their regulators were fine with this because it was assumed that these companies were being run by the most sophisticated managers that money could buy and that no regulator could protect their investors better than those managers could. In that environment, any kind of shock could be enough to precipitate a catastrophe. It turned out to be the overvaluing of sub-prime real estate that provided the match, but had that not happened, it would've been something else instead. Too many piles of oil-soaked rags lying around for it not to catch fire sooner or later.

 

 

And Wals is incorrect in saying that only rich people suffered. The global recession is mostly a de-leveraging event. Companies, governments, and individuals have responded to this crisis largely by attempting to reduce their debt levels. Lots of big businesses are still getting over the shell-shock that happened when the commercial paper market essentially shut down in late 2008, so they're keeping oodles of cash on hand instead of investing it in hiring, expansion, or other things that keep the economy moving. In the aggregate, we've basically got lots of people either defaulting on debt or putting more of today's earnings into paying for yesterday's expenditures. That means less present consumption and fewer present jobs.

 

Thank you

 

I knew the rest, but i wanted an argument on why fractional reserve banking is the langua franca among economists.