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Posts Tagged ‘Economics’

One of the largest frauds in the history of the world is happening right now. And make no mistake about it, like all other frauds this, too, will come to light. It will make the housing crisis seem insignificant. It will shake the financial markets to the core. It will likely cause the dollar to lose immense value and may even lose its reserve currency status. Simply put, this is the mother of all crises and it has yet come to pass. It’s the brainchild of Robert Rubin. And no one gets to be Treasury Secretary or Fed Chairman without understanding how and why it works. And when the shit hits the fan, your tax dollars will be used to bail out the banks that, right now, are making billions hand-over-fist by manipulating markets. Like all great frauds, this one started with a simple, moneymaking scheme that eventually became institutionalized corruption.

Back when Robert Rubin was in London overseeing Goldman Sachs’ gold trades, he figured out a very clever way to finance operations. He borrowed gold from central banks at 1% interest, virtually free money, and then sold that gold at market value, investing the revenue into US Treasuries, which during this time had interest rates between 6-12%. That may not seem like a big deal, but bear in mind that it is illegal for the Federal Reserve to sell its gold without congressional approval as its technically “our” gold. But a legal loophole allows them to swap and lease that gold, running on the assumption that the gold it leases will be returned. But therein lies the rub.

How do you sell something you have leased and must now return? Simple. As with any fungible commodity, you just buy it back. But in order to make it a profitable endeavor, it’s best if you buy it back at the same price that you sold it. So after selling the gold, Goldman Sachs hedged its bet by going long on the gold futures market, opting to repurchase the gold at a later date, at a predetermined price. This allowed Goldman to buy back the gold and return it to the central banks while making a big profit in process. All the while, the central banks never counted the gold as having left their books, as is the case with a lease. This created a “double booking” of gold, a situation where real gold was sold on the market, increasing supply, while the same amount was also being counted as if it were still in the central banks’ vaults. The illusion of more gold was created, which suppressed the price. Thus allowing the game to continue. The only problem was the limits of supply.

In order to understand what’s happening now and what the fraud really is, one must understand the Gold ETF market. Think back to a time when the dollar was still redeemable for gold. Each bank was required to keep a minimum amount of gold in reserve, a fraction of the paper money in supply. The concept worked on the assumption that not everyone will demand gold at any one time so it only needed a fraction of the wealth it claimed to possess. This allowed for banks to lend out and create out of thin air more paper money than gold it actually had. So long as confidence remained and there was no run on the banks, the system worked. Eventually, any pretense of having a commodity-backed currency was eliminated and the US switched to full fiat money. In truth, the gold-backed paper was fiat too. It just operated on the false notion that the paper could, theoretically, be redeemed for real gold and silver. But having a fractional reserve system makes that unsustainable in times of crisis, which is the only time people would want their gold. Getting off the gold standard ended the charade completely. But that’s currency. (more…)

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Oskari Juurikkala of The Acton Institute has an interesting column on whether increased regulation in financial markets increases or decreases the virtuous behavior of market participants.  I’ve reposted a good chunk of it here:

 

In his book Not Just for the Money, economist Bruno Frey sheds some light on the question. Invoking research in motivational psychology, he argues that external compensation or punishment does not always produce the desired results. Human persons are more complex actors than traditional homo economicus models suggest.
Frey writes: ”Intrinsic motivation is of great importance for all economic activities. It is inconceivable that people are motivated solely or even mainly by external incentives.” There is more: according to Frey, the use of monetary incentives and threats of punishment crowds out intrinsic motivation under identifiable and relevant conditions.
For example, giving monetary compensation to a child for doing household chores is likely to result in decreasing contributions made without compensation. Or if, at the end of having dinner at a friend’s place, you insist on paying for the dinner, you may destroy your friendship. Similarly, given that some university professors work harder than others, imposing strict working hour regulations will probably provoke those better workers to reduce their effort and dedication.
Frey talks about the hidden cost of reward or regulation. When an external intervention is perceived as controlling and not respecting the rightful autonomy and reasonableness of the person, extrinsic motivation tends to crowd out intrinsic motivation. When people feel that they are being forced to act in a certain way, their behavior becomes more extrinsically guided.
Incentives are not always harmful, of course. External interventions may enhance intrinsic motivation when they are perceived as supportive. When the father gives a present to his daughter who has been helpful in the house, he may reinforce her willingness to help, as the gift is a token of affection and gratitude rather than a payment conditional on specific performance.
When you go to a restaurant and leave a generous tip, the diner-waiter relationship is strengthened. Hard-working professors will work even harder if their dedication and effort is rewarded with, say, being elected to form an official delegation to an important conference in an attractive city.
According to Aristotle, a good ruler is much like an educator. A skilful educator does not focus on external conduct alone, but seeks to instill a sense of the good so as to encourage virtue chosen freely. Putting too much weight on external incentives – sticks and carrots – has hidden dangers that often reveal themselves later. Vice is the common fruit of the manipulator and the tyrant.
Is lighter regulation the solution to present and future economic crises? It depends. Let it first be noted that some over-the-counter financial derivatives are practically unregulated at the moment, so there is nowhere to cut regulation. It might be more appropriate to cover such clear gaps in existing rules in a principled manner so as not to lead people to the temptation of recklessness.
But a few clear and fast rules are often better than numerous rules that are hard to understand – especially if they are poorly enforced. The latter is arguably the state of the art in financial markets regulation.
When designing rules for a game, one must take into account the moral character of the players. But there needs to be adequate variation: general laws designed for crooks will not produce any saints.
Soft measures are sometimes more productive in the long term. Strict regulations imposed by law tend to damage the intrinsic motivation of better managers; in contrast, their motivation can be enhanced by explicitly acknowledging the value of those who maintain sound policies. The support principle could be applied in numerous ways in economic and regulatory policy.

In his book Not Just for the Money, economist Bruno Frey sheds some light on the question. Invoking research in motivational psychology, he argues that external compensation or punishment does not always produce the desired results. Human persons are more complex actors than traditional homo economicus models suggest.

Frey writes: ”Intrinsic motivation is of great importance for all economic activities. It is inconceivable that people are motivated solely or even mainly by external incentives.” There is more: according to Frey, the use of monetary incentives and threats of punishment crowds out intrinsic motivation under identifiable and relevant conditions.

For example, giving monetary compensation to a child for doing household chores is likely to result in decreasing contributions made without compensation. Or if, at the end of having dinner at a friend’s place, you insist on paying for the dinner, you may destroy your friendship. Similarly, given that some university professors work harder than others, imposing strict working hour regulations will probably provoke those better workers to reduce their effort and dedication.

Frey talks about the hidden cost of reward or regulation. When an external intervention is perceived as controlling and not respecting the rightful autonomy and reasonableness of the person, extrinsic motivation tends to crowd out intrinsic motivation. When people feel that they are being forced to act in a certain way, their behavior becomes more extrinsically guided.

Incentives are not always harmful, of course. External interventions may enhance intrinsic motivation when they are perceived as supportive. When the father gives a present to his daughter who has been helpful in the house, he may reinforce her willingness to help, as the gift is a token of affection and gratitude rather than a payment conditional on specific performance.

When you go to a restaurant and leave a generous tip, the diner-waiter relationship is strengthened. Hard-working professors will work even harder if their dedication and effort is rewarded with, say, being elected to form an official delegation to an important conference in an attractive city.

According to Aristotle, a good ruler is much like an educator. A skilful educator does not focus on external conduct alone, but seeks to instill a sense of the good so as to encourage virtue chosen freely. Putting too much weight on external incentives – sticks and carrots – has hidden dangers that often reveal themselves later. Vice is the common fruit of the manipulator and the tyrant.

Is lighter regulation the solution to present and future economic crises? It depends. Let it first be noted that some over-the-counter financial derivatives are practically unregulated at the moment, so there is nowhere to cut regulation. It might be more appropriate to cover such clear gaps in existing rules in a principled manner so as not to lead people to the temptation of recklessness.

But a few clear and fast rules are often better than numerous rules that are hard to understand – especially if they are poorly enforced. The latter is arguably the state of the art in financial markets regulation.

When designing rules for a game, one must take into account the moral character of the players. But there needs to be adequate variation: general laws designed for crooks will not produce any saints.

Soft measures are sometimes more productive in the long term. Strict regulations imposed by law tend to damage the intrinsic motivation of better managers; in contrast, their motivation can be enhanced by explicitly acknowledging the value of those who maintain sound policies. The support principle could be applied in numerous ways in economic and regulatory policy.

This sounds reasonable to me, but I also realize that my bias towards laissez faire economics may cause me to enjoy hearing what I want to hear.  But trying to put that aside, a reason it does sound reasonable is when I compare it to a Christian faith.  Christians talk of legalism and how setting rules or checklists to try and live a Christ-like life is most often (or always) defeating, since the spirit of the law is obviously not resonating, it is simply the letter of the law that is being followed and no transforming of the heart is taking place.  I believe it is when we get to the core of our own reasoning for making a moral decision that we will be more consistent and more likely to make that moral decision again and again.

Obviously there is the matter of the Holy Spirit and its role in our lives that cannot be applied to a financial managers decision-making.  But equally obvious is the fact that people who do not believe in the Holy Spirit or God or what have you, can and do make morally responsible decisions all day long.  And if that is true, then perhaps as Juurikkala proposes it would encourage even better decisions when less regulation is enacted. 

Is this is an appropriate comparison?

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I have tried very hard to not write too often about my continuing disagreements with president Obama, as that was something that annoyed me to death during W’s presidency when he couldn’t sneeze without people hating him for it.  So I have sat on my hands while I daily read stuff that does perk my interest, but that I don’t think deserves a report from me.

But here’s one that I think is both funny and disturbing at the same time.  It has been in the news for a few days that Obama was going to cut $100 million from his budget.  You think, “Wow, he’s really got this deficit in his cross hairs!”  But you would be wrong.  As George Will points out that:

…$100 million, which is about 13 minutes of federal spending, and 0.0029 percent — about a quarter of one-hundredth of 1 percent — of $3.5 trillion.

So now you think, “By Grabthar’s hammer…. what a savings.”  [anyone, anyone?]

How much is a zillion dollars?

How much is a zillion dollars?

Would you agree, that this is laughable and disturbing simultaneously?  It’s probably not even worth the time of the cabinet to find the $100 million to save, since it amounts to so little.  Will goes on to point out that Obama is also going to “save” $15 million by shutting down a program (which is very popular, and considered successful) in Washington, D.C. that was basically a voucher system to get black and hispanic students out of poorly performing public schools.  Will sees this as a direct pandering to teacher unions who hate vouchers, and who donated significantly to Obama’s campaign – and I agree with Will.

I feel like for some reason American’s have lost all perspective about money.  We each can struggle individually with coming up with a few thousand dollars to pay for our lives, and yet shrug off the fact that $100 million has become less than pocket change to our national government.  Isn’t that a sign that we have, 1) allowed our gov’t to grow too large, and 2) lost the sense of the value of things when money is placed in the hands of others?

MARK ADDS:  Reader Tim had a link to a post with a great image from The Heritage Foundation demonstrating the significance of cutting $100 million.

obamacuts

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The Acton PowerBlog has a few posts on this question.  One of the responses provided by Hunter Baker is from Aristotle in response to Plato’s call to socialism:

What is common to the greatest number gets the least amount of care. People pay most attention to what is their own: they care less for what is common; or, at any rate, they care for it only to the extent to which each is individually concerned. Even when there is no other cause for inattention, people are more prone to neglect their duty when they think that another attending to it . . .

“The Republic advocated that women and children also be common property. What Aristotle wrote about sons applies to other things, as well:”

[Under the plan of The Republic] each citizen will have a thousand sons; they will not be the sons of each citizen individually; any son whatever will be equally the son of any father whatever. The result will be that all will neglect all.

The problem with socialism, I believe, is the same as the “tragedy of the commons“, a theory originally applied to land use.  Common ownership of a resource, or rather lack of any private ownership, will many times cause the improper use of that resource.  In addition to the environmental application of this theory, I also think it most definitely applies to ideas like universal health coverage, social security, and even our government’s attempt at spreading wealth through the Community Reinvestment Act that is the cause of our real estate collapse.

When the reward of a certain behavior is limited to specific individuals, but the risk or damage of that same behavior is spread to society at large… then there is no impetus for those specific individuals to not engage in that act.

There are some other good posts on this subject at Acton, so I encourage you to check it out.

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American Poverty?

I was reading a post by Larry Elder this morning, which talked about poverty standards in America, a topic I have read about with much interest before.  Larry quotes from The Heritage Foundation so I went there to scope out the article he referred to.  The Heritage article compiles statistics from multiple government resources to come up with a picture of American poverty.  That picture is not quite as dire as we tend to associate with poverty.  Whenever there is talk of the poor (our country defines that as family of 4 with income of $21,203 or less), my mind reels with images of beggars at the temple gates, or 10 “Okies” and all their earthly belongings piled onto a truck like in Grapes of Wrath (which I just watched for the first time).  Check this chart out.

Click for larger image

Click for larger image

Not exactly the destitute image I had in my mind.

“Today, the expenditures per person of the lowest-income one-fifth (or quintile) of house­holds equal those of the median American household in the early 1970s, after adjusting for inflation.”

So basically the “poor” of this generation are living like the middle-class of the 70’s.  I don’t point this out to belittle poverty, but rather to say that we should find a better way to describe or list those people who are truly in need.  Whenever we hear about government policies to help the poor, or to bring them out of poverty, well this is the group they are talking about.  What are the policies?  To get them a 3rd television set?  Upgrade them from regular dvd to Blu-ray?

Wouldn’t it be more productive to actually help the 10-20% at the bottom of this spectrum?  And by help I don’t immediately mean money or food stamps.  If you read the article you will find even more information on staying out of the poverty line.  This is a major sticking point for conservatives; that is, getting people to make right decisions to help themselves.  I would say most Americans, republican or democrat, have no problem helping people that are hitting a tough patch.  But the typical republican has a problem with a welfare state for any length of time.

In good economic times or bad, the typical poor family with children is supported by only 800 hours of work during a year: That amounts to 16 hours of work per week. If work in each family were raised to 2,000 hours per year—the equiva­lent of one adult working 40 hours per week through the year—nearly 75 percent of poor chil­dren would be lifted out of official poverty.

There are even more numbers on the amount of children lifted from the poverty line if their single mothers had married the fathers.  There are very many elements to the marriage equation, but in general I would think it’s fair to say that marriage is a smart decision that can be made by the poor, but is discouraged by welfare and/or the prevailing culture.  So again, I am curious what kind of label or qualification we can create that would find the truly needy individuals versus those who are actually somewhat comfortable in their lives, or are at least comfortable in making decisions that cause their financial difficulties?

I obviously understand that poverty is not black & white (hence my desire to find better ways to classify it), and am not a completely heartless bastard.  But I do like to put things in perspective, especially in America where we have so much, but complain equally as much about what we don’t have.

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Value of High Prices

Is there any benefit to high prices?  Absolutely.  It creates incentive for efficiency, innovation, and development of new technology.  As a free-market advocate I firmly believe in the need to let supply and demand, and prices dictate the marketplace.  Only then will the “real” values of a commodity or product be known.  Many oil-rich countries subsidize the the cost of fuel for their citizens, resulting in extremely low prices that create behavior that is inefficient.  Wikipedia states:

Fuel subsidies are common in oil-rich countries. Venezuela, which has vast oil reserves, maintains a price of Bs.F 0.097 per litre (around US$0.05), and has done so since 1998.

If my math is correct that works out to around $0.20 a gallon.  And so people, such as those in Venezuela, use gasoline at will, since the costs are so low.  This can become expensive for the government to subsidize (since that is not the true cost in the market) so they will lower or cut the subsidies, which then can lead to unrest from the people since their behavior is having to be changed drastically without the benefit of gradual change and predictability that comes in a free market.

The reason I started thinking about this is Elijah’s statement in an earlier comment that he likes the Pickens Plan to break our need of foreign produced energy.  I like the plan too, if only it’s originator T. Boone Pickens is willing to pursue it without government subsidies, which I’m afraid is a significant part of the plan.  I am a fan of wind, solar, wave, and any other kind of power that we can harness.  But taxing the public to pay for it takes away the market forces necessary to decide the most efficient and reliable alternative.  Our best bet, and the one that is probably hardest to swallow, is to leave things alone state-wide and federally and let businesses and consumers fight it out in the marketplace.  If fuel prices get high enough, then it becomes profitable to pursue alternative means of energy and companies will do just that, I guarantee you.  As shown earlier, subsidies are typically only useful for creating behavior that is not indicative of what is really most efficient.  This behavior and the subsequent need for correction can many times be worse than what the original subsidy was supposed to alleviate.

For further proof of this, read about the harm America’s corn-based Ethanol subsidies have done here, here and here.

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Earlier this year when oil was at $150 dollars a barrel, and congress forced oil executives to testify about price-gouging and other nonsense, there was talk of trying to control the price (W. Bush included).  Many of my favorite economists, including Thomas Sowell, explained that supply and demand will (and should) dictate the price.  They explained that with higher prices will come change in behavior and reduced consumption which could lead to lower demand and lower prices – which has happened (though this was not a certainty since much of the demand was from China and India, and verily out of our consumers control).

Well many of us are thankful for the current $60 dollar price of a barrel.  It might be too much to hope that this lesson will be remembered by our leaders next time things get dire, but here’s hoping anyway.

MARK ADDS: Further confirmation that supply and demand are the true forces to be reckoned with.  Now that demand is down, the only way to raise or stabilize prices is to reduce supply.  Thanks OPEC.  Glad you have a near monopoly on that stuff.

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