economics - where to begin?

who gets to trust the banks?

or not trust them

other banks

Lex's thought processes must be much like those of a cartoon character when it realises it's run off the edge of the cliff and is standing on thin air.

Or alternatively a bit like everything we've gone through in three years except all hitting home at once.

who gets to trust the banks? or not trust them?

These are the questions that governments are wrestling with the world over.

i watched the first 10 minutes of the video tracer video and it's like an actual horror film when the main protagonist keeps going off by themselves to explore empty rooms down darkened corridors and not bothering to turn on the light

the history of modern banking seems to be

- banker does something greedy and stupid
- people find out and are briefly annoyed
- and then go "oh it's ok, never mind"

the history of modern banking seems to be

- banker does something greedy and stupid
- people find out and are briefly annoyed
- and then go "oh it's ok, never mind"

― lex pretend, Thursday, August 18, 2011

This kind of seems to have happened again quite recently!

when you all first learned about this, did you at any point have the same "THIS IS COMPLETELY MAD" reaction that i'm having, and if not why not?

I did!

the entire edifice seems optimistic to the point of stupidity

when i've finished writing this piece i am actually going to email my libertarian friend in arizona and ask her about silver

tbh it's got us pretty far. well aside from all the inequality, poverty, hunger, and death in the world.

... probably had the last three before capitalism came along

don't think it's had a monopoly on inequality either

when you all first learned about this, did you at any point have the same "THIS IS COMPLETELY MAD" reaction that i'm having, and if not why not?

You also have to think about what would happen if they suddenly stopped, which would be even worse.

what would happen if they stopped?

Businesses big and small would be unable to operate properly, the government would abruptly be unable to continue to fund a health service, police force, army, school system, whatever, a shitload of people would be made unemployed and homeless. Crime and social disorder would escalate. This explains why governments would rather get themselves into enormous debt and run up massive deficits than risk the banking sector collapsing in 2008.

There's interesting stuff about Abraham Lincoln and the funding of the US civil war here that I'd like to know more about.

http://en.wikipedia.org/wiki/Demand_Note

Like - as I understand it, for a (pretty brief) period of time the US govt issued currency directly and not via banks (because European banks wanted levels of interest Lincoln didn't want to pay?). Could do with a better explanation of what actually happened here though!

i have some questions that i thought of as i was absent-mindedly picking the nuts out of the muesli box instead of doing my work.

so the financial crisis was caused by the markets losing confidence in people's ability to pay back the money that they'd been lent. kind of like dominoes if everyone was lending to each other? (who is at the top of this pyramid, by the way?)

but...none of it is real, i learned from this thread the other day. if everyone demanded what they were owed, people wouldn't be able to pay it back ANYWAY. and that is what drives the economy? so, why is it suddenly an issue? why don't the bankers reassure themselves with this whole "none of it is real anyway" maxim that seems to underpin the whole system, and carry on as before?

i still don't understand this notion of "confidence" either - do the "markets" have some sort of monolithic hivemind on this? why can't they just snap out of it (by...governments?) if they lose confidence? what if some banks lose confidence and some don't? this whole reliance on "confidence" makes it seem like the entire system is dependent on bankers' whims and caprices.

actually what ARE the "markets"?

also what the hell is going on in this article

http://www.guardian.co.uk/politics/2011/aug/21/so-what-do-we-do-now-chancellor

what does it actually mean when it says markets plunge? why does that matter? the markets don't seem very reliable, why are we subject to their whims and moods?

There are different types of markets. Equity markets, which that article is largely referring to, are thousands of people or institutions buying and selling stakes in businesses of all kinds. If a business is "quoted" on the stock market then anyone can buy and sell a stake whenever they want.

There are long-term and short-term investors - long terms ones will buy a stake in a company hoping to realise its value (both in terms of profit share aka dividends and in being able to sell that stake off for a profit later). Long-term investors are more likely to be willing to ride out the value of their stake rising and falling according to its market value. There are also short-term investors, who buy stakes in companies hoping that stake will rapidly increase in value and they can sell it off quickly for a profit. Those people are more likely to sell quickly.

If a lot of people are buying shares, the value of a company goes up. If lots of people are selling (or pulling their money out) then the value of the company goes down, there is literally less money in it. That has consequences for the businesses ability to expand or invest. Generally speaking if markets are plunging it means that investors are (rightly or wrongly) panicked about the state of the economy and what that will mean for the companies in which they invest. Or they're short-termist and are selling that stake before it can go down in value and leave them at a loss.

If the stock market plunges, then the cumulative value of all the companies quoted on it goes down, so a lot of investors are concerned. It's not necessarily a terrible disaster, as what goes down can later come back up again, but it's a sign of declining confidence in the UK economy.

if everyone demanded what they were owed, people wouldn't be able to pay it back ANYWAY. and that is what drives the economy? so, why is it suddenly an issue?

The underlying thing here is - they don't want you to pay it all back. If i lend you £10k plus interest - i don't want you to just give me the £10k straight back, what would be the point? i want you to continue paying the interest on it each month - and you still owe ME the £10k as well. The less you pay off of that £10k the more in interest you continue to pay, so I'd rather you didn't give me back much of the actual £10k

The problem comes if you start to struggle to pay back the interest, then for me there is no point in you continuing to have that £10k anymore i might as well ask for it back and go do something else with it. Except if you're struggling with the interest, there's no way you can give me the £10k:(

But as long as you are giving me interest on the £10k I'm fine with it (and if you were ONLY paying interest, then eventually, one day you would have paid me more than 10k - and STILL owe me the 10k). Say i'm charging you 10% interest - I'm getting £1000 a year off you and my £10k is still there should i ever want it back. I'm willing to overlook the fact you don't actually have it as long as that interest continues to roll in

re: the markets - it seems totally at the mercy of people's panic and whims and herd behaviour (i assume the shareholders, if they sell, do so because they see lots of others are?). why aren't there fixed minimum terms for holding shares to prevent that panicky short-termism leading to instability?

i assume herd behaviour is the default, too - is that what people mean when they say "confidence"?

is there a point at which a business gets big enough that it's immune to the panicky stuff?

also isn't every business different...if the "markets" as a whole are plunging, does this mean the majority of businesses are suddenly going shit? surely at any given time there are always some thriving businesses.

if so many of these tenets - they don't want you to pay the loan back, they don't want full employment - are so patently bullshit, why don't people call the banks/politicians out on it?

and why did they not teach me any of this when i was studying economics at the best university in the country, lol.

in fact i've long been scandalised that politics isn't compulsory in schools, and that languages aren't compulsory from a much earlier age, and now i'm scandalised that these economic basics aren't compulsory. i believe there was an option to do economics a-level, and it was very much a niche subject like drama or design & technology, and i went to a decent school. but nothing compulsory. what is wrong with our national curriculum? why did i have to spend so much goddamn time doing biology/chemistry/physics (completely irrelevant to my adult life) while the educational system failed to give me the basics of this shit that underpins everything we do?

And underlying the debt thing is that is that you borrow the £10k because it's worth it regardless of the future interest payments - as an individual you get your nice house now and know you can afford £1k a year in future, especially with wage rises (inflation erodes debt, so collectively we'll get out of this eventually); as a company you can trade with it and make more than £1k a year in profit; as a government you can continue to provide services to maintain your tax base and bring in more than £1k that way; etc.

And underlying that is stability, it gives everyone an interest in an orderly, prosperous future. If kept in check, obviously, but I'm thinking Weimar Republic here, not credit crunch.

http://epetitions.direct.gov.uk/petitions/8903

as an individual you get your nice house now and know you can afford £1k a year in future

oh fuck, freelancers never ever get to own a house, do they

i mean even apart from the basic "not paid enough" thing

'The markets' are the people with the money, ultimately - governments, companies, etc need to borrow from/buy from/sell to them, all the stuff that goes on day-to-day is setting the price at which those things happen.

Herd behaviour is totally the thing, but it's a very complex herd. Yes, that's basically 'confidence'.

The markets plunging means the price of shares is cheaper - or the flipside, money is more expensive. If you have cash, it's a great time to buy; the difficulty is knowing whether it's an irrational plunge, in which case wahey the sales are on, or a rational one because the businesses are turning to shit. Like you say, every business is different, so it might be both.

also isn't every business different...if the "markets" as a whole are plunging, does this mean the majority of businesses are suddenly going shit? surely at any given time there are always some thriving businesses.

I work for company A (who everyone suddenly realizes are totally shit) and my wife works for company B (who are about to go bust). We've both been investing in company C (a very healthy and good company) and have both advised all our colleagues to do the same thing

Everyone starts selling off their shares in company A and B once they realize whats going on, and both my wife and I lose our jobs along with many of our colleagues. We need money now to pay our rent/mortgage/food,/debt. We don't really have much in the way of ready cash - but we do have a lot of shares in company C. Unfortunately we're going to have to sell them even though we'd rather not. our colleagues do the same...suddenly, "why is everyone selling shares in company C? I thought they were good, shit i better dump mine too"

And also - huge badly run factory in small town has a really great noodle place just opposite, well run and great food. Rumor is the big factory is about to go bust....knock on effect for the noodle place might not be so good, I'm kind of jittery about it, might dump my shares now before anyone else starts to think the same thing

And then you get - A, B, C and Noodles Inc are all falling, I'd better sell D, E and F and check in in a week or so to pick up some bargains.

ok, i think i get it, but it doesn't seem like a very sound foundation for an economy. so:

why aren't there fixed minimum terms for holding shares to prevent that panicky short-termism leading to instability?

I guess because then you'd lose the ability to react instantly to events - this would make it less attractive to own shares, which would make it more difficult to issue them, which is how companies raise capital. You have to put up with the instability to keep the price-setting mechanism functioning - it's like the line about democracy being the worst form of government, apart from all the others.

That last bit looks like a non sequitur. The parallel I meant is about getting a better type of order from chaos, but you can't expect the type of order you'd get from more logical planning.

why aren't there fixed minimum terms for holding shares to prevent that panicky short-termism leading to instability?

well because both in theory and to some extent in practice the more liquid (or responsive) a 'market' is the better it works i.e. in posts example once company C's stock price falls but you realize that its a pretty healthy company and decide to buy shares since the price is falling and its cheap now. other investors should (and will) come to the same conclusion and thus company C's price will start to rise again as you buy the shares. but if post and his/her partner are stuck holding shares they cant sell than they are worse off (since they need the money) and you're worse off since you miss out on a good investment opportunity.

Lex, its not particularly concrete, but obviously it works for enough businesses, because being on the Stock Market gets them cash, that the benefits outweigh the risks. But of course there are loads of non-quoted businesses that are less subject to the whims of the market.

Theoretically, if a well run business sees its share price fall hugely because of market panic, at some point it becomes a bargain, because it's still a fundamentally good business that you can suddenly buy into cheaply, and as more people realise that and do the same and start buying then the price goes up again. That hasn't always happened over the last couple of years because the herd has been behaving in a very jittery way.

Hah, what Lamp said...

Something like Lloyds has been creamed (again) in the current panic. If it goes on to be a successful business then its shares are sanely cheap just now; if it goes on to fail, then obviously they are not. They are low right now because noone knows which it's going to be; because the effect on Lloyds from the European debt problems is unknown but feared to be huge; (but also because buying Lloyds is right out of fashion). If those things were known, the price would already have risen or fallen to the 'right' level to take account of that.

I get the feeling the modern world economy is a bit like musical chairs -- there's all this hypothetical capital/debt/money floating around out there and the economy runs as though the numbers are a certain way, but then the music stops and you realize the numbers aren't what you thought they were -- more debt and less capital, and some people don't get a chair.

I'm entirely unable to discern whether that makes sense right now.

it's more like three of the players own the chairs and just keep sitting in them whether the music is playing or not.

That makes a lot of sense. Concentrating wealth = taking away chairs. xp

BTW, in re stocks, it's less about what businesses are like now than what people think they will be in the future. A stock's price bears some theoretical relation to a company's FUTURE earnings prospects, so if information suddenly changes about the company's future earnings potential, people may try to sell the stock to get out. I mean there's nothing entirely rational about any of it -- a stock price is ultimately just a function of supply versus demand for the stock, like any other product, and the reasons people buy and sell the stocks aren't always entirely rational.

With a big insurance or finance company it's frighteningly easy for things to get misstated or fudged about future earnings, as opposed to a company that just sells food, where all you're really concerned with are the costs of making and supplying the food and the level of demand for the food. AIG, for example, had all kinds of crazy shit on its balance sheets that was kind of hard to value because you're talking about, like, insurance policies on securities that are bundles of other securities that are bundles of mortgages. It's much easier for a company like that to one day make it seem like everything is rosy and then the next day reveal that no, actually the company is completely and utterly fucked.

Also, I don't think a drop in share price has a direct negative impact on a company unless the company needs to raise capital, i.e. it effects what price the company can issue/sell shares at to raise capital. Otherwise the company being "worth" less on the market should not matter. The stock price is usually more an effect than a cause of a company's problems.

That makes a lot of sense. Concentrating wealth = taking away chairs. xp

― L.P. Hovercraft (WmC), Sunday, August 21, 2011 5:01 PM Bookmark

Not exactly what I meant although actually yes that's true. In the mortgage bubble, e.g., there was all this paper wealth being "created" that didn't actually exist, and when the music stopped a lot of it disappeared, but a few lucky parties had managed to create real wealth from the paper wealth in the meantime.

can i point out, incongrously and hopefully without being jumped upon, that hayek had an intersting set of insights into the way complex systems (ie economies but also etc) operate and that his work isn't even really incompatible with our friend keynes so much as the crazies pushing the awful 'road to serfdom' would have you believe?

^^^^^this

Hayak had much to say about the conditions of artificially low interest rates that lead to credit bubbles, malinvestment, and subsequent financial crises, but offered little advice on how to extricate the economy from the lingering aftereffects. Keynes had much to say about how to escape a deflationary spiral, but offered little advice on how to prevent one in the first place. Arguably they're complementary viewpoints, which when taken in concert would suggest running fiscal surpluses and eschewing any monetary stimulus during mild growth (the road not taken 2000-2008), which might obviate the need for both when a business cycle turns.

The economist who has come out smelling of roses from the current debacle is the post-KeynesianHyman Misky, whose financial instability hypothesis describes the last decade well. The Dodd-Frank financial reform bill would have a lot more teeth if lawmakers paid attentin to Minsky.

the difficulty is knowing whether it's an irrational plunge, in which case wahey the sales are on, or a rational one because the businesses are turning to shit.

Keynes major insight was that, so far from these being merely difficult to separate, in actual practise they are inseparable. When money stops circulating, whether or not it is instigated by irrational fear, then the only rational response is to avoid debt, and not spend or invest, until conditions improve. But this very prudence inhibits conditions from improving.

Keynes understood that the antidote for this vicious cycle is for someone to fly in the face of prudence, by borrowing and investing. Since too few individuals would be willing to take that risk to make any aggregate difference, the only actor able to respond in this way is the government, because the risk of borrowing and spending will be shared equably by the entire society.

This was the exact opposite of what governments were doing when Keynes first wrote his theory. Revenues were down, so governments were retrenching and shrinking their budgets to keep them balanced. This only aggravated the slowdown, of course.

What's going on now in the USA is that the tea partiers are rejecting Keynes's antidote, on the grounds that the risk of debt is too great for society to bear, except almost all of them appear ignorant of Keynes's basic argument or his research, and unappreciative of the risks that are being run by cutting government spending.

Bernanke is doing everything he can from the monetary easing side of the equation, but the risk is that he will only fuel another bubble, while businesses sit on their cash, unemployment stays high, spending slows further and the vicious cycle gains momentum. Good times.

In my mind one of Hayek's best contributions was on the theory of the firm, particularly outlining the limits of Weber's bureaucracy, but that is stepping somewhat beyond the field of economics.

Is the tea party being called on this? For an ideology-free society, you do seem prone to utterly counterproductive bouts of ideology sometimes.

I'll put it this way, harping on the idea that tea partiers don't understand Keynes would do them zero damage politically, because a good 95% of US voters would just shrug, because they, too, know nothing about Keynes and anyway all anyone needs is just some "common sense".