The meeting of finance ministers from the top 20 nations had a split between two different policy proposals. The United States argued for more stimulus spending. Germany and France preferred a focus on stronger regulations. Because neither one of these proposals is aimed towards resolving the underlying problems that caused the financial crisis, neither proposal will actually make much progress in abating the financial crisis.
While the lack of regulation may have driven the actual form of the crisis, the underlying problems were more long term. Simply fixing the regulations will not result in a short term improvement or prevent another crisis in the future that will probably manifest in a different way.
Similarly, stimulus spending alone will not fix the problems with the economy and will just give short term relief while leaving the country worse off when the relief ends. The world economies are suffering from two main problems: the over-accumulation of wealth by the rich and the large current account deficits of first world countries. Stimulus spending by countries like China may help to resolve the current account problem. However, the United States and European nations still need to change their economies so that they produce products that can be sold to countries like China. Additionally, the rich, who have been hoarding wealth and thereby reducing consumer spending and demand, must either spend money or be taxed. Any stimulus package that does not address these changes can grant short term relief at best.
Tuesday, March 17, 2009
Sunday, November 30, 2008
The Consumer Problem
The first part of the problem comes from the situation of consumers. Consumers get the majority of their money from wages, government entitlements, and credit and spend most of their money buying goods and services, paying taxes, or repaying credit.
Simply looking at the numbers tells the story. For the poorest 80% of Americans real wages have remained almost stagnant since the 70's. For the economy to continue to grow, consumers have needed to spend more money each year. With taxes and wages remaining the same, that extra spending has had to come from the richest 20% (who have seen rises in income) and credit.
Credit has grown significantly over the past 20 years. Credit cards have become almost ubiquitous among the American population. Other kinds of loans have seen tremendous growth as well including pay day loans, title loans, car purchase loans, and home mortgages. The explosion of home mortgages in the past few years has allowed consumers to pay off credit card debt, so that they can spend more on their credit cards and take money out of their home so that they could spend it.
The big problem with all these loans is that consumers had to repay them with interest. This was okay initially, but the amount of payments that consumers had to make back to credit providers has grown larger and larger. Eventually, consumers could not continue increasing the amount of spending on goods and services as well as make payments back to credit providers. As a result, consumers began defaulting on their mortgages and credit cards. At the same time, consumers also began to cut back on spending.
Facing the prospect of a recession due to falling consumer spending and rising defaults, investors stopped making as many loans to consumers and businesses. This meant less consumer spending as fewer consumers could get loans and less corporate investment as fewer businesses got loans. This also caused more consumers to default when they could not refinance their homes or take out more debt to make debt payments.
Finally, to make matters worse, consumers began getting laid off from their jobs. This meant that consumers had less wages and would spend less and default more. Meanwhile, the wealthiest 20% of consumers lost money from stock market declines, loan defaults, and layoffs as well. They have also reduced their spending. As a result, US GDP has declined over the second half of 2008.
The process is very similar to what happened in the great depression according to Franklin Roosevelt's Federal Reserve Chairman. Wikipedia has a quote here. Among other things, he says:
"We sustained high levels of employment in that period [the 1920's] with the aid of an exceptional expansion of debt . . . . The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption . . . . Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle."
Simply looking at the numbers tells the story. For the poorest 80% of Americans real wages have remained almost stagnant since the 70's. For the economy to continue to grow, consumers have needed to spend more money each year. With taxes and wages remaining the same, that extra spending has had to come from the richest 20% (who have seen rises in income) and credit.
Credit has grown significantly over the past 20 years. Credit cards have become almost ubiquitous among the American population. Other kinds of loans have seen tremendous growth as well including pay day loans, title loans, car purchase loans, and home mortgages. The explosion of home mortgages in the past few years has allowed consumers to pay off credit card debt, so that they can spend more on their credit cards and take money out of their home so that they could spend it.
The big problem with all these loans is that consumers had to repay them with interest. This was okay initially, but the amount of payments that consumers had to make back to credit providers has grown larger and larger. Eventually, consumers could not continue increasing the amount of spending on goods and services as well as make payments back to credit providers. As a result, consumers began defaulting on their mortgages and credit cards. At the same time, consumers also began to cut back on spending.
Facing the prospect of a recession due to falling consumer spending and rising defaults, investors stopped making as many loans to consumers and businesses. This meant less consumer spending as fewer consumers could get loans and less corporate investment as fewer businesses got loans. This also caused more consumers to default when they could not refinance their homes or take out more debt to make debt payments.
Finally, to make matters worse, consumers began getting laid off from their jobs. This meant that consumers had less wages and would spend less and default more. Meanwhile, the wealthiest 20% of consumers lost money from stock market declines, loan defaults, and layoffs as well. They have also reduced their spending. As a result, US GDP has declined over the second half of 2008.
The process is very similar to what happened in the great depression according to Franklin Roosevelt's Federal Reserve Chairman. Wikipedia has a quote here. Among other things, he says:
"We sustained high levels of employment in that period [the 1920's] with the aid of an exceptional expansion of debt . . . . The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption . . . . Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle."
Saturday, November 29, 2008
A Cash Model of Our Economy
The above picture shows how money moves about the economy. (The government is missing from the picture because of how complicated it would be draw it. Among other things the government takes taxes from consumers, corporations, and investors; gives the money back to consumers in the form of entitlements and wages and gives the money back to corporations through government spending; and also borrows money from investors.)
The blue arrows indicate spending that is included in GDP. This is money that is given to a corporation to create something. The red arrow for imports is subtracted from GDP, because GDP only counts things made in this country not others. The green arrows indicate transactions that are not directly counted in GDP.
Although some people are both consumers and investors, investors tend to invest significantly more than they consume and consumers tend to consume significantly more than they invest. The model is not completely accurate, but should be good enough to teach us some things.
Finally, please note that Foreign Entities also act as investors and make loans to consumers, corporations, and our government. I left it out of the drawing to make the drawing less complicated, but this will become important later.
Friday, November 28, 2008
Background
Before I actually begin, I first want to define a few of the measurements / terms that economists use to indicate the health of the economy. Hopefully this will allow people who have never taken an economics course to better understand the story that I am telling.
GDP (Gross Domestic Product):
The main way that economists measure the health of the economy is to see if our country made more things this year than it did last year. Generally, we are hoping that we create about 3% more stuff each year. If there is a decline in the amount of stuff made for six months (2 quarters), then we say the economy is in a recession. By stuff I am referring to goods (such as food, cars, or houses) and services (such as hair cuts, day care, or internet service).
Economist measure the GDP by measuring how much money four different groups spend on US products:
Consumer - About 70% of the stuff made in the US is bought by US consumers. This makes sense considering there are a lot of people in the US and they spend a lot of money covering every day needs.
Industrial - Corporations play their role by buying computers, manufacturing equipment, and various items to keep their company running.
Government - The government spends money on computers and other office equipment like corporations, but it also spends large amounts on tanks and defense equipment. This is all counted toward GDP.
Exports - Some goods are made in the US and then sold to buyers (Consumers, Industry, or Government) from foreign countries. This is included in US GDP as well.
Current Account Deficit:
It turns out that Americans spend a lot more on products made in foreign countries than foreigners spend on American products. The term current account deficit refers to this imbalance that results in more money flowing out of the country than in. If more money was flowing into the country than out, we would have a current account surplus.
Inflation:
You can probably picture a grandparent or someone else complaining that things cost more now than they used to cost (e.g. When I was kid, movies cost a nickel). Inflation is the term that economists use to describe rising prices.
GDP is measured by looking at the amount of money (US dollars) spent. This can cause problems if the cost of things is rising. For example, imagine a person spent $3 on milk one week and spent $6 on milk the next week. If the price of milk rose from $3 a gallon to $6 a gallon, then that person bought the same amount of milk, but spent twice as much money. When something has been corrected for this problem it is called real (like real GDP) and when it has not been corrected for this problem it is called nominal (like nominal GDP). I almost always be talking about things in real terms because it is more useful.
Unemployment:
The last term is pretty straight forward. The unemployment rate measures the number of people who are looking for jobs, but cannot get them. I may also discuss people who have given up looking for jobs and those who are employed part time but want full time work. These people aren't counted in the unemployment number, but show that there are problems in the economy.
GDP (Gross Domestic Product):
The main way that economists measure the health of the economy is to see if our country made more things this year than it did last year. Generally, we are hoping that we create about 3% more stuff each year. If there is a decline in the amount of stuff made for six months (2 quarters), then we say the economy is in a recession. By stuff I am referring to goods (such as food, cars, or houses) and services (such as hair cuts, day care, or internet service).
Economist measure the GDP by measuring how much money four different groups spend on US products:
Consumer - About 70% of the stuff made in the US is bought by US consumers. This makes sense considering there are a lot of people in the US and they spend a lot of money covering every day needs.
Industrial - Corporations play their role by buying computers, manufacturing equipment, and various items to keep their company running.
Government - The government spends money on computers and other office equipment like corporations, but it also spends large amounts on tanks and defense equipment. This is all counted toward GDP.
Exports - Some goods are made in the US and then sold to buyers (Consumers, Industry, or Government) from foreign countries. This is included in US GDP as well.
Current Account Deficit:
It turns out that Americans spend a lot more on products made in foreign countries than foreigners spend on American products. The term current account deficit refers to this imbalance that results in more money flowing out of the country than in. If more money was flowing into the country than out, we would have a current account surplus.
Inflation:
You can probably picture a grandparent or someone else complaining that things cost more now than they used to cost (e.g. When I was kid, movies cost a nickel). Inflation is the term that economists use to describe rising prices.
GDP is measured by looking at the amount of money (US dollars) spent. This can cause problems if the cost of things is rising. For example, imagine a person spent $3 on milk one week and spent $6 on milk the next week. If the price of milk rose from $3 a gallon to $6 a gallon, then that person bought the same amount of milk, but spent twice as much money. When something has been corrected for this problem it is called real (like real GDP) and when it has not been corrected for this problem it is called nominal (like nominal GDP). I almost always be talking about things in real terms because it is more useful.
Unemployment:
The last term is pretty straight forward. The unemployment rate measures the number of people who are looking for jobs, but cannot get them. I may also discuss people who have given up looking for jobs and those who are employed part time but want full time work. These people aren't counted in the unemployment number, but show that there are problems in the economy.
Thursday, November 27, 2008
Introduction
The ideas I'm planning to lay out in this blog have been floating around in my head for a while, but I haven't yet been able to put them down into print. The goal of the blog is to paint a more complete picture of our economic situation and how we got here. Many of the ideas I'll present I have seen discussed and published before and are not my own original ideas (Keynes, for example, was very influential on my thinking), but this blog will attempt to put them all together in an easy to understand narrative.
That is not to say that I will be explaining in detail credit default swaps or the housing crisis. Rather, it will be easier and more illuminating to try and look at in general terms what purpose these transactions served and what impact they had on the economy. The true problems are long term structural problems that cannot be solved easily. As a result, this blog will try to show that tough long term solutions are needed. I felt this was all the more imperative as George W. Bush and Barack Obama continue to suggest short term solutions that may actually be exacerbating the situation rather than improving it.
Initially, this blog will look more like a book and each post will serve as a chapter in that book explaining a piece of what is going on in the economy or how it should be solved. Once the book portion is finished, this blog will function more like a traditional blog where I may comment on news articles or things on the internet.
I am not a professional economist (although professional economists got us here in the first place), so I welcome feedback and will adjust my ideas if I see fit. I believe economics is the study of human behavior, so any theory should attempt to describe that behavior rather than starting with false assumptions (e.g. people are rational, people have perfect information, and markets are competitive) or previously decided ideology (laissez-faire economic policies). As humans, your feedback about human behavior should be helpful in trying to describe that behavior.
I hope you enjoy!
That is not to say that I will be explaining in detail credit default swaps or the housing crisis. Rather, it will be easier and more illuminating to try and look at in general terms what purpose these transactions served and what impact they had on the economy. The true problems are long term structural problems that cannot be solved easily. As a result, this blog will try to show that tough long term solutions are needed. I felt this was all the more imperative as George W. Bush and Barack Obama continue to suggest short term solutions that may actually be exacerbating the situation rather than improving it.
Initially, this blog will look more like a book and each post will serve as a chapter in that book explaining a piece of what is going on in the economy or how it should be solved. Once the book portion is finished, this blog will function more like a traditional blog where I may comment on news articles or things on the internet.
I am not a professional economist (although professional economists got us here in the first place), so I welcome feedback and will adjust my ideas if I see fit. I believe economics is the study of human behavior, so any theory should attempt to describe that behavior rather than starting with false assumptions (e.g. people are rational, people have perfect information, and markets are competitive) or previously decided ideology (laissez-faire economic policies). As humans, your feedback about human behavior should be helpful in trying to describe that behavior.
I hope you enjoy!
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