Some Ramblings About the Economy:

January 31, 2008

As the credit orgy ends, and the excess leverage of the past years unwinds, few people have experienced any real pain. Big banks such as Citigroup have lost tens of billions, but who cares? There were rich Asian and Middle Eastern investors flush with cash who were happy to infuse it into Citi for a big chunk of equity. The only people hurt by this were existing Citi shareholders.

What happens to all of that “money” we thought we had when houses were priced higher? Individuals felt rich for two reasons: first, their personal balance sheets looked great because their houses were worth a fortune. Second, people extracted all the equity they could from their houses to consume. Ok, that’s all over now, so what happened to all that money people thought they had? Did it just evaporate? The velocity-of-money effects that pushed everything higher should now be working in reverse.

But the good thing about having a central bank and a paper currency is that you can literally create more money out of thin air. By lowering interest rates, issuing repos with junk as collateral, deficit spending, accepting a bunch of Asian money, the broad monetary base is being replenished.

If the Fed can pull us out of this mess without any real pain I will be shocked. It just doesn’t seem possible that you could unwind from a massive debt bubble without a recession. There just has to be some pain.

Middle class people in this country are hurting. They work night and day and yet their incomes, in real terms, are declining. Worse, they are consuming themselves into incredible amounts of debt and saving nothing. If we acknowledge that much of this consumption was financed with debt and was unsustainable, how can we possibly get out of it with a quick fix? It seems obvious to me that people need to stop spending so much — they need to downsize.

If people actually started to do this though, a long recession would be almost unavoidable. There are very powerful interests all over the world that will fight this with all their money-printing might. Because of the demographic issue facing the rich world, everyone is terrified of what happens if the US consumer has a change in outlook and starts to save instead of consume.

Ok…. None of this is news. What do we do with our money now?

Here are two important themes that shape my views. They could be completely wrong, by the way, so feel free to trash them in the comments (or to me in person) if you disagree.

1) As anybody who reads this blog knows, I think we will have lots of inflation in the coming years. Inflation of 3-4% may not seem like a lot, but if it is sustained over a multi-year period the cumulative effects will be huge. My prediction is that gold will resume its standing as a currency and will continue to gain value against paper currencies all over the world. Or, you could look at it this way: paper currencies will lose purchasing power while gold maintains its value.

2) Because of #1, US Treasuries look massively overvalued to me. They are priced as if we are going to experience deflation, something which the Fed will do absolutely anything (including trashing the value of the currency) to prevent.

3) “Emerging” economies all over the world have realized that the way to improve their standards of living is through markets. Capitalism, in one form or another, is on a tear across the world. You can’t have free markets without strong private property rights. These laws are being strengthened all over the world… especially in the BRIC countries (well, maybe not Russia).

What this means is that stocks will be a great way to make money! US Multinationals will probably do well, but we are seeing the emergence of new multinationals coming from what we use to call “the third world.” Personally, I think the Indian stock market will be a fabulous way to make money in the coming decades. As with the United States during its industrialization (18th & 19th Centuries), the path to prosperity was anything if not volatile. Same thing will happen in India and China – there will be huge booms and busts. The key is to be liquid and prepared to buy after the next crash.

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Cost of Thanksgiving Rises 7-11%

November 23, 2007

From the Washington Post:

Merrill Lynch … calculated a Thanksgiving cost-of-giving index using the prices of traditional holiday meal items such as turkey, cranberries, sweet potatoes and pumpkin pie — as well as the cost of flowers, gifts ranging from toys to clothing and electronics, plus gasoline, hotels, air fare, and greeting cards.

The index has risen 7.9 percent year-over-year in the approach to the festive season — a huge swing from a drop of 4.4 percent a year ago. In fact, this is more than double the historical trend for this time of year and the second highest since 1999

If you look only at food, the increase is more along the lines of 11% according to the American Farm Bureau Foundation.


This is scary for a number of reasons. From the perspective of the Fed, it’s getting a lot harder to convince people that we have low inflation. Bernanke has argued that inflation expectations are anchored at a low level. In other words, it’s ok to focus on core inflation because people attribute price rises in energy and food to volatility, and not to structural/permanent price increases.

The other reason this is scary – and this is true of all inflationary periods – is that poor people feel the impact of inflation much more severely than rich people. If prices for food and energy keep rising, we can expect an increase in social problems/tensions in this country.

Can printing money create "real" wealth?

July 18, 2007

There is an interesting op-ed by Bob McTeere in today’s WSJ (subscription required): Don’t Dismiss Our Dismal Savings Rate. Excerpt:

The main fallacy in monetary theory and policy is the confusion of money and wealth. Money is wealth from the individual perspective since individuals can usually exchange it for goods and services. Money — and financial assets easily converted to money — may not be wealth for society as a whole if the production of goods and services has not kept pace with claims on it. Early spenders may have some success, but inflation will dilute the buying power of others. The bottom line is that real wealth has to be produced; it can’t be printed.

The paradox of thrift says that attempts to save more in the aggregate reduce consumption spending, which, if not offset by increases in other spending, will reduce total spending and income. The paradox comes in when attempts to save more results in reduced saving out of lower incomes. The irony is that policy makers advise more saving but those who take the advice will benefit only if most of us ignore it, and policy makers are implicitly counting on that outcome.

A parallel is the farmer who hopes for a good crop year. But, if all or most farmers have a good crop year, the decline in prices may more than offset higher yields. What our farmer really needs is a good cop in a bad crop year. Then he could look for a popular restaurant that isn’t crowded.

A penny saved may be a penny earned, but it matters whether it was earned by producing more or by a rise in price of existing financial assets. A stock or housing market boom creates apparent wealth in the form of capital gains, but trying to convert it to real wealth en masse can make it disappear.

Alan Greenspan has been one of the few economists to explain these matters correctly and understandably, usually in the context of entitlement reforms. He frequently pointed out that any solution to the problem had to include real economic growth. With claims on output growing rapidly, output has to grow equally rapidly or the claims are bogus. Any solution — to entitlements or the savings rate — must include a bigger, more productive economy in the future…

The problem goes beyond government entitlement programs. Consider the baby boomers whose IRAs, 401(k)’s and personal investments helped drive the stock market to record highs. What happens when cash-in time comes? There will be a mountain of paper claims on output, but will there be an equally tall mountain of output?

This simple thesis helps to explain a lot of what confuses me about all of this new “money creation” we hear about constantly. For years now global money supply has been increasing much faster than the rate of global growth. Of course, defining “money” has become so much more difficult because of the velocity effects of increased global trade, not to mention derivatives. This is partly why the Fed has stopped publishing the M3 measure of money supply – it’s just too hard to quantify the broad monetary base.

Nevertheless, most of this new money has sloshed into assets, pushing up their prices. I have commented before that rising asset prices are not good for most people. For lower and middle class people who don’t own a lot of assets, they have not benefited much at all. Many of these people are actually worse off because they borrowed a ton of money against an overvalued asset.