Money disappearing in to thin air

Last month I wrote an article about how money disappears in to thin air when there is a preponderance of people paying back loans. In it I expressed surprise at how it seemed that almost nobody was discussing this effect, I felt like I was the only person to have noticed it! Now at last I have found some support from a section of the book "The Origin of Financial Crises" by George Cooper. Please read the following section:

I suspect that anyone who is not fully aware of this phenomenon can not conceivably understand what is going on in this financial crisis... at that includes almost everyone!

Banking is not like other industries

Consider this...

Imagine that someone was walking through a national park and accidentally stepped in a puddle of oil oozing out of the ground. After some further investigation it was realized that this was a, previously undiscovered, massive reserve of easily extractable oil... billions of barrels of the stuff equivalent to 10% of the nations GDP. Now lets say that the government gets to hear of this. What should it do? Lets consider a couple of options.

A) Let any old "group of guys with a big pump" extract it out of the ground and keep 100% of all the proceeds (Obviously this group will shortly become the richest guys in the country and consume 10% of the nations GDP between them).

B) Consider the oil to be a national asset. Design some special mechanism for remunerating the guys with the pump but make sure that the government (or the people) get the bulk of the profit. This could be done an myriad ways, but two simple options may be either tax them at a rate much higher than other industries or simply nationalize the pumping business.

Obviously any sane government would select some version of option B.

Now here is the problem. I would contend that the privilege of being a bank within our current fractional reserve/central banking system is rather analogous to being the "guys with the pump". Its just too easy to make money from banking with very little effort. The banking industry is absolutely not like any other (see here). The idea of just letting them get on with whatever they want to do and allowing them to pay normal taxes is a disaster for any nation.

My solution - option B.

So when exactly will the dollar collapse?

It seems that many economists are predicting the collapse of the US dollar. The argument goes something like this: The U.S. government is in huge debt. It maintains its borrowings by selling bonds. These bonds have to compete on the open market with other types of investments, so they have to offer a competitive balance of interest rate, security (against default) and protection against inflation. At the moment, the US is clinging on to the edge of the cliff for some rather temporary reasons...

1. People are still holding on to the (perhaps irrational) belief that the U.S. government could never conceivably default on its bonds and so the "risk premium" the US needs to offer on the bonds is negligible.
2. The rest of the world is in such a dire state that they don't know where else to put their money.
3. There is not much (obvious) inflation in the US.

Now many of the people who believe in the Armageddon scenario are being ridiculed by others who point to the relative strength of the dollar compared to so many other countries. But these three conditions can not remain favorable forever. I have been thinking about when exactly the dollar bubble will burst and it just occurred to me that there will be an upper limit - and that is when the first few countries start to pull out of this recession. As soon as that happens then there will be a new place for investors to put their money. The result of this is that US bonds will now have a serious competitor and the only way that the US can compete would be to raise the interest on their bonds... now this would quickly become very painful for the US and all their options would be horrid... they would fall off the cliff.

This is of course just an upper limit... the dollar collapse could be triggered before then at almost any time... including tomorrow.

The Pensions Casino - an alternative.

Until recently, I had very little idea of how pensions worked, but when I looked into it carefully, I realized it was enforced gambling! And the more I thought about it the more I realized how incredibly unfair and stupid the entire pensions system was. The reason it is so bad is that there are so many ways your pension could be dramatically bigger or dramatically smaller than you planned for, in ways that you can not reasonably control. To illustrate this consider two people born 5 years apart. Lets call them Mr Lucky (the older man) and Mr Unlucky. Let us imagine that they are both equally conscientious, equally hard working, equally intelligent (averagely intelligent), equally everything.

Now Mr Lucky starts his working life and starts saving towards his pension. Just by chance, this is at a time which is the end of a recession when stock prices are low. He's already off to a good start because his early pensions investments are likely to rise nicely.

5 years later Mr Unlucky starts his working life. He does a similar job, and saves the same fraction of his income toward his pension. Unfortunately now is the beginning of a stock bubble. His early pensions investments will turn out to be a disaster.

For several decades to come both men have investments in the stock market at the same time. Unfortunately Mr Unlucky's fund manager was not as financially savvy as Mr Lucky's. This was not really his fault - neither men are financial experts. How can anyone possibly expect your average man in the street to determine the different skill levels of two different fund managers? They can't. Mr Unlucky's fund gradually drifts even further behind Mr Lucky's... but it doesn't stop there...

The fund managers make their choices based on their knowledge of the markets and the fundamentals. However, a sizable component of the variability of stock prices are things that no fund manager could be expected to prepare for. Things like earthquakes, floods, political assassinations, industrial accidents etc... and you've guessed it - the floods and earthquakes just happened to be to the benefit of Mr Lucky's stocks and Mr Unlucky's fund manager's stock selections get badly hit, so his pension fund falls even further behind... and it doesn't stop there...

Now we come to retirement time... and would you believe it, Mr Lucky retires at the peak of another bubble... and oh dear, Mr Unlucky retires at the depths of a recession.

So there you have it - two similar guys doing similar jobs, saving similar fractions of their wages towards their retirements and yet their retirement incomes could be hugely different, based entirely on luck... is that fair? Is that how we want the system to work? Personally I find it extremely stressful worrying about my pension - am I going to be lucky or unlucky? What should I do? Should I just save way more than I really need just in case I'm unlucky? Or should I scrimp on my pension hoping I get lucky, then simply carry on working longer if I get unlucky?

Note that there two types of random variability between pensioners. One type is between pensioners of the same age. Lets call this stock selection variability. Another type is concerned with the start and end times of pensioners saving period. Call this bubble timing variability. Now bubble timing variability will affect entire age groups of pensioners, some of them having miserable retirements others having good ones.

Now of course the people who really pay (or rather, "pay back") for old people in their retirement are working people. These wild fluctuations in pensions are inefficient for us workers. We feel sorry for Mr Unlucky when we see him on the TV in some documentary about old people not being able to afford their heating bills. While at the same time cursing that we have to work so hard to support Mr Lucky who seems to have superfluous wealth. Just imagine if you applied the same pensions system in your own home... imagine you have your old grandma and grandpa living with you. They've both worked hard all their lives... now at dinner time you serve grandma a feast of the finest foods and champagne, while you give your grandpa a slice of bread and a glass of water. They say "what did we do to deserve this?" and you have to remind them that grandma thought Ebay was a great idea and grandpa liked Betamax. Now you may say that this is simply how life is - if you get lucky then you do better in life if you're unlucky then you do worse. But that's not true in all aspects of life, and people can usually select the degree of risk they want to take. If you want to be a professional stock broker then you may get rich or you may go bust -it goes with the territory. People choose to be stockbrokers. Nobody who loses on the stock market ever says "gee, nobody told me there was any risk involved". But we can choose to take a less risky career. Say you become employed as a plumber. there's not much risk in that. If business gets bed then, you can always retrain as something else. There's no chance of ever suddenly being wiped out as a plumber. So you see there are some choices in our working lives which are inherently risky and some inherently safe. Now when it come to designing a pensions system, is it so obvious that we should select a mechanism so full of risk? I think not. I think its possible to design an inherently safe mechanism.

Now the first characteristic I wanted for my system is that people who save more in their working lives should get more - and roughly speaking if you save twice as much as the average guy in your working life then you should get twice as much in your retirement.

The second characteristic of the system is that people must be forced to save for at least a minimum standard of living in retirement. Now some people may say "how dare you take away our freedom! Its up to us to individually decide what we save for retirement". To which I would say, "but not saving throughout your life puts a blatantly unfair burden on the rest of society when you retire. We can't just stand by and watch you become homeless and starve. We'll be forced to give you a certain minimum standard of living for free". I would also add that the amount we are forced to save for retirement will be very small. Just enough so that you could have a bare minimum quality of life.

My system to achieve all these things is the following:

The government invent a new type of tax (but of course we don't want to call it a tax!), call this compulsory elderly-support. Say its X%. This is the minimum. People can optionally also put whatever extra they want in to the elderly-support system. The continuous flow of elderly-support money that comes in from workers is used to pay money to the retired. Note that this is all happening at one instant - there is no pretense that some investment is being put in storage for future use. Its plain and simply workers-now-support-retired-people-now. So the next question is how to apportion the money - this is where we need to do a little mathematical jiggery pokery. The money is not distributed evenly amongst retired people, instead it is (roughly speaking) distributed in proportion to the amount of money those retired people fed in to the elderly-support system during their working lives. The maths required to achieve this is not trivial, but it is certainly doable.

So what are the advantages of this system?

• Nobody is being forced to predict the stock market. People who save similar amounts will be similarly comfortable in their retirements.
• If a country develops well and has a boom, then the retired population will automatically benefit from the boom.
• If the country has a recession then retired people will take their share of the burden, rather than requiring an unbearably large fraction of the now-poorer nations GDP.
• The whole system will be far more predictable for pensioners, workers and government.

My predictions...

OK, just for fun I am going to make a set of predictions so that in a few years time you can all look back and laugh at how wrong I was.

I predict the the price of Gold, as measured in Chinese Yuan, will rise dramatically then fall again over the next few years and end up lower than it is now. I say measured in Chinese Yuan because I think that will be the worlds most stable currency over the coming years.

I predict that the dollar will lose at least 30% of its value against the Chinese Yuan over the next few years, but the change in rates will be very uneven, there will be a sudden drop over a very short period.

I predict that the average U.S. and Chinese hourly incomes will move dramatically closer together. I think the gap will halve.

I think that the GDP of China will overtake that of the US within 5 years.

I think the tax rates in both the US and UK for the better off will be forced to rise significantly.

I think that the interest rates offered by the US for their government bonds will, at some point, at least double from where they are today.

I predict that the average PE ratio of the companies in the Dow Jones index will fall to about 7ish.

I predict the price of oil will be three times as high in five years time as it is now even when adjusted for inflation.

I predict unemployment in the US and UK will rise to 15%.

I Predict that the contribution to the GDP of the UK of the banking sector will be reduced to less than 20% - even after the recession.

Ditch the dollar.

The pressure is building. I think the dollar bubble is going to burst. The U.N. Commission of Experts on International Financial Reform are about to recommend that governments worldwide ditch the dollar as their reserve currency.

P.S. The original title of this blog entry was "Ditch the dollar?"... but on reflection I think the question mark is inappropriate!

Global Warming - a recent development.

Global warming, and the degree to which it is man-made will have and is already having a huge impact on the course of the world economy....

First off, I should say that for most of the past 20 years I have been a firm believer in man made global warming. Not because I was any great authority on the science of it, but more because, as a scientist myself, I am included to go along with the consensus opinion of scientists unless there is very good evidence presented to the contrary. All the arguments about the financial motivations of the scientists (for or against man-made global warming) did not influence me. Also the opinions of non-scientists, journalists and politicians held no sway whatsoever. Then when I saw the "great global warming swindle" my beliefs were shaken. I was no instant convert to the other side, but it alerted me that perhaps I should look in to this.... which I duly did. After some research I gradually realized that most of what the "swindle" program was saying was either misleading or downright wrong. My faith in the mainstream view was restored... but then, when I was looking in to the subject in even more detail I came across this lecture (on video: part1, part2) by Dr Roy Spencer given in March 2008. This lecture blew me away. It seems that the climate modelers have entirely omitted a very important phenomena which I don't think they have corrected to this day. Dr Spencer believes that if these factors are added to the climate models then the effects of our added carbon dioxide are dramatically reduced. By the way Dr Spencer does not believe that global warming is not happening, he simply believes that the man-made component of it is much smaller than previously thought. Two extra aspects of this have made me more inclined to believe his views. 1. His work is relatively recent. If it was much older then I would be inclined to dismiss it because the IPCC et al would have already considered it in detail and if it was found to be correct then they would already have changed their opinions. and 2. I can not find anything anywhere giving reasons his data or his arguments are wrong. When I saw his lecture, the very first thing I did was to do a Google search on him, confidently expecting to see him described as some kind of nutcase and to find articles describing the flaws in his logic - but was amazed to find no such thing. What I find equally amazing is how few people have watched the video - only 2400 at the time of writing.

So in summary, global warming is happening and will cause mankind huge problems... but we may not have to feel so guilty about it!