Monday, November 15, 2010

Economics: Bubbles pt 1 - Housing Bubble

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We know that inflation is merely the creation of new money, which results in higher prices (duh, because now the money outnumbers the goods/services and is therefore worth less than before). We know that deflation is the decrease in the money supply, which leads to a stronger dollar/currency, and lower prices. We know that money is merely a representation of a product or service, a placeholder for a future trade. Let us tackle the "boom and bust" cycle, or financial "bubbles" as they are often called.

A bubble is when something like a house is trading for more than it's actual value. This bubble bursts when no one is willing to trade at the higher value, therefore causing the value to decrease to a number that suits would-be buyers. It's a bit like "hot potato" in this fashion, as whoever is holding it when the bubble bursts is the loser.

The real question is "Where does the bubble come from?", and I intend to make this plain.

(Entire books are written on such things, so I will try to get the juiciest and most relevant bits. However, Mises.org is a fantastic site with loads of audio, video and articles discussing a wide range of economic and philosophic matter.)

Let us focus on the most recent bubble, the housing market that burst a couple years ago that sent ripples throughout the globe. The opinions on who to blame spans far and wide, some blame speculators for driving up prices, some blame the home-owners for wanting nice housing they couldn't afford, some blame banks for making the loans so easy to get through Subprime mortgages (prime=deserves the credit, SUBprime=does not meet ordinary standards for a loan), some blame Wall Street for selling off these debts through Credit Default Swaps (basically an insurance policy to hedge their bets and free up capital).

While there's a certain amount of culpability for all of those mentioned, the actual secret demon is none other than the Federal Reserve (the Central Bank for the United States). At first glance you may think this to be absurd, I mean they only make money right? They don't tell us how to spend it, right? Eh, not so fast.

Yes, the Fed creates money (through many mechanisms, but for simplicity's sake and not to jump into Fractional Reserve banking practices yet we'll just say "create money" for now), but what happens when they put this money into circulation? Can they indeed influence how it is spent? Yes, they can, obviously first they get to decide where the money goes.

Imagine you're in a house with low water pressure, like say a slow trickle at every faucet. What if you found out one faucet was suddenly flowing? Well, you'd form a line at that faucet, get while the getting is good. Same difference! The Fed decided it would create money at low interest rates and let Fannie Mae and Freddie Mac lend it out. Fannie & Freddie are GSEs, Government-Sponsored Enterprises, who basically compete on the open market, but kind of like the US Post Office they get to offer the market certain things that are beyond competition.

So, the Fed in coordination with the government (through policy and Fannie & Freddie) turned on the spigot for capital to be poured into real estate. The money is pumping, that of course attracts speculators, who attract homeowners, who go to banks that already know that the money is there to lend out, thanks to the Fed! The banks want to keep the capital flowing so they sell off these risky mortgages to someone else. Before you know it there's so much money flowing, that due to this inflation (of the currency) the value of the product (real estate) has risen to accommodate all the new capital flooding in, whereas without the inflation these would never have been reasonable prices that would've attracted any sane person. What happens when the faucet gets closed? Crash.

Now perhaps I grammatically messed something up in there, but that IS the gist. You can blame irresponsible buyers who walked away from their upside-down mortgages (owing more than their real estate is worth), you can scream at greedy banks or write the President (Bush, thanks again buddy) about ill-advised housing policy, but NONE of those things matter as much as the Fed, because without the ability to create all of that money (from NOWHERE) none of those people are able to make their dumb decisions.

I hate dead horses, so allow me to keep beating on them: this is only one example, one area of where the Fed has hurt the economy. This isn't to say that many people didn't come out ahead, I'm sure a lot of speculators are quite happy, a lot of traders on Wall Street probably did okay as well. The real, true, heartless irony is that the people this was supposed to help, the poorer families, are actually the people who are worse off. They're the ones who can no longer afford their house, they're the ones whose money is worth less thanks to all of the inflating done by the Federal Reserve. So, if you want a face to blame for bubbles, I'll give you two: Alan Greenspan and Ben Bernanke.

Next week I'll go into a little more detail about the philosophy of why pure credit expansion is the cause of all boom/busts.
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A View of Economics
Week 1: The Coming Disaster
Week 2: What is currency?
Week 3: Inflation
Week 4: Hyperinflation
Week 5: Deflation
Week 6: Money Represents Production
Week 7: Bubbles pt 1 - Housing Bubble
Week 8: Bubbles pt 2 - Pure Credit Expansion
Week 9: Bubbles pt 3 - The Bust is a Good Thing
Week 10: Productive vs Destructive

Monday, November 8, 2010

An Open Letter to My Congressman

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Mr. McCaul,

I've voted for you twice the past two elections and can see others joined me as well. This letter will address my expectations for you as my representative. While I know we completely differ on what qualifies as national security (you can find my analysis of foreign policy on my blog http://www.dawnoftheweak.com/2010/08/us-foreign-policy-part-11-conclusion.html), I would like to primarily address economics & liberty in this open letter.

I am quite in line with Austrian Economists views on monetary policy and I'm hoping you are an open minded individual, as this philosophic approach to monetary matters will seep into the philosophy of small government and equality for all individuals.

I think we'll both agree that it is quite hypocritical for the Federal government to demand individuals and states to balance their checkbooks while not demanding the same of their own household. This is simply unacceptable, and any deficit spending of the government only goes towards creating more oppression and the destruction of more American wealth. Allow me to elaborate.

First: Tyranny. Anytime government oversteps its core reason for being it is immediately en route to tyranny. So, what is the core reason for having law? It is simply to protect life, liberty and property. Frederic Bastiat said it succinctly, "Life, liberty and property do not exist because men have made laws. On the contrary, it was the fact that life, liberty, and property existed beforehand that caused men to make laws in the first place." To attempt anything further than protecting every person's property equally, means that the law has immediately become unjust, for what lies beyond equality but inequality?

The government has nothing, so it must first take from someone so that it may give to someone else. Perhaps you demand every child be given a free education. Who should teach them if no one volunteers? Who should pay the teachers, with whose money? Who should fund the facilities? I'm greatly in favor of an education, but what is an education if not someone's perspective on life? Accurate math should always provide the same answer, yet who gets to decide which formulas and equations are best and most relevant to learn? History has only happened once, yet who gets to decide which side of the single truth is told? Why is it that science and creationism cannot coexist on purely academic terms? If the government is to be involved in an area, then it must show no biased to or against any people group.

From a federal standpoint, I expect you to fight against the Department of Education and allow our communities who balance their own budgets to decide these matters. That excess money is no longer federally needed to be extracted from the public. Not only education, but the same can be said for same-sex marriage, drugs and prostitution. These are personal choices, and though I am heterosexual, do not do drugs or participate in prostitution I feel that the lowest form of expressing my morals is by using force through legislation.

If the government protects property rights then I say it protects everything it is there to protect: I'm vindicated in acts of violence against my person since that is a violation of my property; it prosecutes against theft and the breaking of contracts; and when it's limited to protecting my property then it does not encroach on my individuality by legislating how I choose to live my life. Anything further begins the process of picking a side. How much money can be saved by allowing cops to enforce meaningful laws? Imagine how the courts would be expedited without the logjam in the judiciary system, and what of the money saved in prisons and jails! If someone desires to harm their bodies with pot, heroin or alcohol it is their own business as long as they do not violate my property, because we are not legalizing violence and theft. The law should protect my property rather than plunder it, or else what good is law?

Secondly: the government's destruction of wealth. Government is not a business which produces anything of worth. It is not a productive entity. On the contrary, it only consumes from those who DO produce and uses it in a destructive manner.

For instance, some say that the IRS creates jobs. However, I say that it destroys jobs and potential jobs in the private market through the consumption of resources. These resources lay in many areas, the direct taxation that the IRS agents are expected to collect is an obvious resource that the private sector loses right off the top, but what of the human resource that is lost? Yes, the IRS agent himself is a lost resource! On the open market perhaps this man would be an entrepreneur, or a financial analyst or bookkeeper, helping a business that produces something of value on the open market. Perhaps the business' own accountant could be better utilized as a forecaster instead of wasting time and filing space figuring out the chaotic tax code! To think of the man-hours wasted on taxes that could be spent on productivity! What of the physical land that is consumed? Perhaps this land would be a factory or a warehouse for shipments! What of the resources that are used in the building itself? What of the men who spent their time building that building? The government thinks that these are jobs created, but I say that it is a resource wasted on something that is merely a destructive end. For what good is produced out of the use of these resources?

Consider for example a farmer who grows wheat, he consumes half his crop to live and sells the other half on the open market. He then uses the proceeds to start his next crop and double his land producing even more! Let us inject a soldier who eats only half of what the farmer requires, yet, what has the soldier produced of value? Nothing! He merely has destroyed 1/4 of the crop and created nothing of value himself. Perhaps if we turned that soldier into another farmer they could work twice as much land and be that much more productive. Thus we can see the possibility of how government destroys what the free market could more efficiently utilize.

Surely providing protection of life, liberty and property has not always been so expensive! The day of our founding fathers could not have been a day of such a fiscally oppressive budget. Therefore I expect you to fight against the income tax, and as many taxes as you can fight against. Trim the fat until we can see the six-pack abs of Lady Liberty!

This is not to even mention the destruction of our dollar through inflation, helmed by Ben Bernanke and the Federal Reserve, an evil devourer of wealth if ever there was one. What else can we call an entity that is designed to steal the value of the money I earn? Therefore, I expect you to fight to end the inflationary policies of the Federal Reserve and the Fed all together, instead let us Americans decide what we desire to trade with, we are smarter than your colleagues deem us to be. All that the constitution requires is that we pay our debts to the state in gold or silver, so let it be so and let us trade amongst ourselves however we please. Let us opt out of the destruction of our wealth (through the erosion of the dollar) and repeal legal tender laws!

I voted for you, and though I'm technically a registered Republican, I am no loyal slave to a party. I voted for Bush, and I voted for Obama, though I have great disappointment in their Presidencies. This mid-term I've voted for Democrats, Republicans and Libertarians. I am no partisan slave. No, I think it's a vile thing indeed and would repeal every law respecting party lines if given the chance. Martin Luther King Jr desired that men would be judged on their character, not on their color. Similarly, I believe that politicians should be judged on their philosophy and not on their party. How egregious the thought that you can know someone's ideals without first asking. This is a bipartisan dictatorship, and the core "values" that each party claims to have, they violate daily. Republicans claim a stance of small government, yet how long since a Republican President has decreased the budget or said what program they'd cut if given the chance? Republicans cry foul over the "socialist" Obama, who looks to redistribute wealth, where was this philosophy when Bush was taking oil from Iraqis to give to tycoons, when he taxed us directly and indirectly (through inflation) to give to Halliburton and other war profiteers? Republicans cry as though they're Pro-Lifers yet kill citizens with warmongering, both foreign and domestic, guilty and innocent alike. Not to mention the foul stench of our inhumane torture, and to people who have been given no trial! Liberty-minded party indeed! Democrats claim to be for individuality and personal choice, yet Clinton enacted "Don't Ask, Don't Tell", the government deems itself as the bestow-er of marriage and yet discriminates against homosexuals. Fighting for the oppressed, there's an unenviable amount of oppression. Therefore, I expect you to stand for a philosophy of individual liberty, and find like-minded individuals regardless of their affiliation. I expect you to fight for my right to be left alone. I expect you to be willing to learn from anyone, wisdom favors the humble. No grandstanding, no rhetoric, no excuses.

Some may ask what all this "injustice" and "tyranny" is that I speak of, because we do indeed still have a country to be marveled about. So, let me clarify that I find the income tax a modernized form of thievery and servitude. My money is something I spent my time earning, if I pay $200 in taxes while earning $5/hour then the government has made me work for them for 40 hours! If I don't pay then I face jail, and even if I am deemed as a "late" payer of the income tax then I face fines. I am to pay late fees on thievery! What do I get in return of this taxation? The Patriot Act? A subversive CIA that entangles us in foreign affairs? 700 bases in 130 countries? How does intruding on other countries make us any safer? This is like saying waving a gun around in public and shooting bystanders is the only way to ensure no one attacks me! How does intruding on my life increase my freedom? No, transparency should be limited to the government! Should we expect that the few in power will look out for the many? No, it's more reasonable to say that the many with equal power will keep each other in check. Give the power back, let us choose how we live without fear of big brother's disapproval and incrimination.

I'm no tea-partyer, though I admire their spirit. I'm no anarchist, I love our Republic. I'm only a 29 year old white male from a small conservative town (transplanted to Austin), but I know enough to see injustice and inconsistent ideologies, and I know when change is promised I'm expecting a change of direction, not a change of shoes. I make myself available to you for any exchange of ideas, in person, by phone or email. I have no qualms with listening to your views or hearing my philosophy corrected, an open-minded and honest conversation is the only way to change the hearts and minds of an individual, and this country is only made up of individuals. I expect you to see them that way, and protect their American right to live as such. I wish you well Congressman.

Sincerest Regards,
Wes

Monday, November 1, 2010

Economics: Money Represents Production

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I think this is where it starts to get very interesting. We've covered that currency is just a medium of exchange, so the rules of supply and demand work the same way. Inflating the currency results in higher prices (through the currency's loss of value), and similarly deflating it results in lower prices (through the currency's gain in value). Inflating it too much too quickly will result in hyperinflation and possibly result in its destruction altogether.

Now we'll begin to set the stage for understanding what a "bubble" is (aka "boom and bust"), where it comes from, and how some can spot it but others do not (or at least they refuse to acknowledge it).

Money represents real productivity. For example, if I work at Wal-Mart for 40 hours and get paid $5/hr then I'll get paid $200. That $200 represents a service rendered, real productivity. A more illustrative example would be a baker who bakes a loaf of bread and sells it for $2. That $2 represents one loaf of bread made, and when that baker goes and buys a carton of milk for $2, then we've essentially said that the $2 was merely a place-holder for the exchange of a carton of milk for a loaf of bread.

Very important to understand the concept that money is a physical representation of a good or service. Money in and of itself is a mere placeholder for some rendered good or service, for something of value that's been produced. This is why counterfeiting is illegal, because you suddenly have the power to purchase a good or service but you never created anything of value yourself, you simply created out of thin air the medium of exchange that represents rendered productivity.

Let's show this in a real example. I want a pair of shoes, I go to the shoemaker and he says that he'll make me a pair of shoes for one loaf of bread. I bake the bread, give it to the shoemaker, one week later he brings me a pair of shoes. Society evolves and we're now using a bill of credit to represent my loaf of bread. I go to the bank and hand them my bread, they hand me my bill of credit which is redeemable for 1 loaf of bread. I go to the shoemaker and hand him a credit note saying that he has access to one loaf of bread. He makes the shoes and goes to the bank to redeem his bill of credit for his bread. Society expands, there's now 2 bakers. I bake my regular loaf of bread, take it to the bank and put it on deposit for my bill of credit. The other baker does not make his bread, but instead gets a loan from the bank for a bill of credit and hands it to the shoemaker.

Business is booming for the shoemaker!

He makes 2 pairs of shoes, takes his bills of credit in for redemption but the bank only actually has 1 loaf of bread in reserve. He's been robbed. He's wasted his time and resources making a product that he cannot immediately sell, if he handed it over already then he has nothing in return for it. Yet, on the outset it seemed as though business was picking up! In reality, the bank sent a false signal to the market to ramp up production when in fact there had been no real increase in productivity. It was not immediately apparent, because it takes time for the real resources to be called upon, in our case it took a week for the shoemaker to find out that there weren't 2 loaves of bread. He had a very short boom and bust cycle. (This example tweaked from Thomas Woods' version in his book "Meltdown", I highly recommend it.)

This is why the Federal Reserve, the US central bank, is the root of all the market volatility for the past 100 years (including the Great Depression). As the controller and sole creator of US Dollars, they have the ability (and exercise it quite often) to create as much new money as they desire, however they merely create it out of thin air, that newly created money represents no new productivity from the market place. Thus, upon the new creation of money it sends the signal to the market to ramp up production which ultimately results in a large collapse once the resources are ultimately found to not exist.

After the 2001 Dot-Com bust, the Fed in conjunction with politicians started up the next bubble, the housing market (more on that later) in order to get the economy going again. Now that the housing bubble has popped, the Fed is trying to start its next Boom, but the market may be too taxed. Time will tell, but this Wednesday may be a landmark day, the Fed will officially announce its next batch of inflationary policies, how much, how often, and for how long. The keyword will be "Quantitative Easing", don't let the lingo fool you, it just means inflation, aka "creating money that nobody earned", or as I like to call it, "stealing".
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A View of Economics
Week 1: The Coming Disaster
Week 2: What is currency?
Week 3: Inflation
Week 4: Hyperinflation
Week 5: Deflation
Week 6: Money Represents Production
Week 7: Bubbles pt 1 - Housing Bubble
Week 8: Bubbles pt 2 - Pure Credit Expansion
Week 9: Bubbles pt 3 - The Bust is a Good Thing
Week 10: Productive vs Destructive