Saturday, 28 November 2009


I am trying to get my head around the hundreds of trillions in derivatives that are still out there and came across the following, remarkably clear, YouTube video. I have no idea why its only had 4000 hits.

I have just discovered that this vid was in fact edited down from a 40 minute version here.

Tuesday, 24 November 2009

How does the US make this transition?

I'm repeating myself from my last post but, you hear people talking about "export based" economies as if it were a permanent condition. Presumably people who talk about export based economies assume that countries that appear to be "export based" will remain "export based" forever. Strangely you don't often hear about "import based" economies! Its obviously nonsensical! No country could be an "import based" economy forever! I will suggest a translation of these terms.
  • Export based economy = Country temporarily giving goods to other countries in return for IOU's.
  • Import based economy = Country temporarily receiving goods from other countries that they will have to fully pay back (in goods) in the long term.
So in the long term the US will have to pay China back in goods. The question is how can this happen? How can the US economy make a transition to a state where its populous are busy making stuff to give to China? Presumably the goods will gave to be better value than the ones the Chinese make for themselves otherwise why would the Chinese buy them? Presumably this can not happen until the wages paid for a certain level of production in the US is lower than the wages paid for that same level of production in China. How's that going to happen?

I see a lot of pain ahead. This crisis sure as hell isn't over.

Saturday, 21 November 2009

China doing the right thing

I've always thought it was strange when you see people say that this or that country's economy is "based on exports", as if that was just "the kind of thing they're in to", something fundamental, to do with their character. I think to myself... "hang on a second, that means that they make a load of stuff and give it to other people!". To me its just a temporary thing that a country can do for a while, building up I.O.U's from other countries to use on a rainy day. There is no way any country would or should do this indefinitely. In this crisis some people are looking at china saying "how sad, their 'export based' economy is going to be devastated because the West is not buying any more". I would say well that's rubbish. Its no problem at all. They just have to stop making stuff to give to foreigners and consume it themselves instead. Now one problem with this scenario is that if the Chinese are worried about the future they will been keen to save and reluctant to spend. But there is a cure - you see up until now China has not had much of a system of social security so the Chinese were very keen to save for their old age or if they lost their jobs. But now China is starting to build a "social safety net". This will have an enormous effect of the savings rates. After all why save so much for the future if the government will look after you if things go wrong. This is exactly the right thing to do. I can see China's economy marching ahead in the next decade or so even if America goes down the plug hole (which it might!).

Here's a nice video on the subject


Monday, 9 November 2009

Bailing out the Titanic with a thimble..

I have recently been hatching a new theory...

Steve keen has likened the process of attempting to keep up the money supply to bailing out the titanic with a thimble. This is part of his argument for massive deflation.

Well I'm not so sure about it being the titanic that needs to be bailed out. And I'll illustrate it with a thought experiment. Imagine a simple primitive society with no banking, only gold coins used for exchange. People in this society spend their money on one of two things 1. Food. 2. Diamonds. The food they eat and the diamonds they like to wear as jewellery. They can make all the food they need with relative ease and so on average, on any given day, 90% of the coins in existence change hands diamond trading and only 10% change hands trading food. Now one day, God is looking down on this land and decides to do a monetary experiment on the people. He suddenly makes all the diamonds disappear, and at the same time makes 90% of the coins disappear (he does this evenly over the entire population in proportion to how many coins each person had in the first place). God then wonders, what will happen to the price of food? I suggest that the answer just may be "noting at all". The money supply might have shrunk by a factor of ten, but then the stuff they spend their money on has correspondingly shrunk at the same time.

Now I know that this fairy tale may have all sorts of problems with it in the details, but I just wonder if this type of phenomena might be going on to some degree in the real world right now. Maybe the diamonds could correspond to some types of (that mountain of) derivatives that have gone out of fashion. If this is the case then the reduction in some countries money supply may just be "diamonds and coins" disappearing at the same time, leaving the money available for the "food" (or should I say "everything else which are not derivatives") relatively unaltered. Well at least not nearly as altered as the reduction in overall money supply would suggest.

If I'm right then you may see the price of goods in the shops rise while the money supply shrinks... Come to think of it I don't know whether that scenario would be called inflation or deflation.... maybe there's no term for it. Perhaps it just needs to be called prices-rising-while-money-supply-shrinks.

Saturday, 7 November 2009

The value of money - someone else pondering the same question.

Following on from my earlier posts about the value (purchasing power) of money here and here. I have discovered that Ludvig von Mises, one of the founders of the "Austrian" school of economics had pondered the same question. i.e. what determines the purchases power of a purely fiat (not backed by gold or any other asset) currency. To answer this question Mises proposed his "regression theory". This theory relies upon the assumption that all currencies, even fiat ones, were at some earlier time, non fiat, i.e. they were backed by some commodity. Mises suggested (a rather clumsy theory in my opinion) that you can trace the value of a fiat currency through time back to the point where it was not fiat and therefore derive the purchasing power of a fiat currency in modern times. Mises also thought that if a new pure fiat currency as suddenly hoist upon a society then its value could not be determined for the following reason: Imagine day one of the new fiat currency - you are a shop keeper selling some product, say a television set - what on earth do you charge?... Lets say that in the days of the old currency a television set usually sold for about ten times the cost of a kettle. You could see what kettles were selling for and then charge ten times as much as that, but because its day one of the new currency the people selling the kettles also have no idea what to charge. This is an apparent impasse and Mises assumed the situation was insoluble.

This situation is rather like saying if X depends on Y and Y depends on X then you can never find out what X and Y are. For example if we say:

X = 2 times Y
Y = X / 2

Then this arrangement does not find a specific X and Y. There are infinitely many X's and Y's that fit. I guess this is why Mises thought that the problem was insoluble. But this is where he missed an opportunity to make a less clumsy version of his theory because the X and Y problem is not always insoluble. Consider the statements

X = sqrt(Y)
Y = sqrt(X)

I wrote a little computer program to demonstrate what happens when you start off with some arbitrarily chosen values for X and Y.

a = 12;
b = 7;

for (i = 1;i < 10;i++)
a = sqrt(b);
b = sqrt(a);
print ("a = %f b = %f\n",a,b);

The output when you run the program is as follows:

a = 2.6458 b = 1.6266
a = 1.2754 b = 1.1293
a = 1.0627 b = 1.0309
a = 1.0153 b = 1.0076
a = 1.0038 b = 1.0019
a = 1.0010 b = 1.0005
a = 1.0002 b = 1.0001
a = 1.0001 b = 1.0000
a = 1.0000 b = 1.0000

Now x=1 and Y = 1 is the correct (and only) solution!

What this demonstrates is that even if you start out with the wrong values, the correct values can quickly emerge all by themselves. So in the case of the TV seller and the Kettle seller, as long as someone can be persuaded to have a stab at an initial selling price and as long as the selling price is viewable to all around, then this can give other people a benchmark and people can make more informed guesses as to their prices.

I need to add a bit of detail here. When the TV seller sets his price to say 1000 units of the new currency the Kettle seller can not immediately conclude that he should be selling his kettles for exactly 100 units. It may be that the TV's price is too cheap, or perhaps too expensive. What the Kettle seller should do is wait a while and see what happens. If a big crowd of people instantly form outside the TV shop scrambling to buy every TV in sight then the kettle seller can deduce that perhaps the price was too low and he may try selling his kettles for 200 units. However if the TV's went unsold for months then the kettle seller can deduce that the price was too high and he may try selling his kettles for 50 units. Obviously everyone will be carefully watching everyone else. The key thing they are trying to arrange is for their typical time-to-sale to be about right. Too short and that may indicate that your price is too low, too long (incurring storage costs) and that tells you your prices are too high.

Deriving the purchasing power of a new fiat currency is thus not impossible.