Credit <=> crisis

[ddstory.livejournal.com]

We often hear the assertion that economic crises occur as a result of personal incompetence, greed and bad credits. Never mind the structural inconsistencies in a society. Now, two economists (Michael Kumhof and Romain Ranciere) are proposing a different approach in explaining these phenomena. They've explored an aspect of the US market which is often overlooked, but which is closely related to bankruptcy. And that is the relative level of financial disparity between the various layers of society.

They investigated the economic data around the two biggest financial crises in modern history (1929 and 2008). In both cases they concluded that the crisis happened when the "scissor" between the rich and poor was opened too widely, until at some point it turned out that the top-5% layer was in possession of 34% of the wealth. That was coupled with a simultaneous increase of the share of private credits - in fact it doubled.

They argue that the logic is very simple. In order to sustain the tempo of consumption, people with weaker financial capabilities were compelled to take credits, which eventually they were unable to pay back. Meanwhile, the wealth of the rich (I'm sorry, did someone say "job creators"?) was increased to such an extent that they would invest significant amounts into presumably highly profitable (but also very volatile) credit deals. When the credits stopped being served by a significant number of debtors, the whole system would collapse.

The authors are also proposing some solution to the situation. They argue that workers and employees should be paid such a level of salaries as to allow them a minimum level of living standard without taking credits. Now, the objection is that with increasing their income their needs would automatically increase as well, and this does make sense, but only to some limited extent. The data shows that the usual consumption levels of the wealthy would rise at a slower rate compared to their income, and the remaining extra money they'd rather invest into speculative deals and luxurious items, as opposed to actually fueling the engine of the economy.

Sources:
http://www.smarterearth.org/content/inequality-leverage-and-crises

Comments

[il-mio-gufo.livejournal.com]

i say who needs a damned credit deal from a frackin' bank when one can rent to own and/or barter. get creative people! WE DON'T NEED THE BANKS!!!!!!!!!!!!!!!!!!!!!!!

[ddstory.livejournal.com]

This sounds a little extreme. But oh well... :)

[a-new-machine.livejournal.com]

Rent-to-own is a far bigger scam than any bank. You *could* take a loan out for that car/patio set/whatever and pay maybe 5-8% interest, OR you could rent-to-own it and pay 11-25%. Great idea!

[majortom-thecat.livejournal.com]

I'm with you, except for renting to own. Bartering and sharing is great though! I use a local alternative currency (http://fourthcornerexchange.com/) that works pretty well.

Why own?

[sophia-sadek.livejournal.com]

Ownership is over-rated.

[a-new-machine.livejournal.com]

They argue that workers and employees should be paid such a level of salaries as to allow them a minimum level of living standard without taking credits. Now, the objection is that with increasing their income their needs would automatically increase as well, and this does make sense, but only to some limited extent.

There are other relevant objections. Where are you getting this money to pay them more? Cut the pay of the super-rich? OK, let's do that. Wal-mart, for instance, apparently has 2.1 million workers worldwide. Wal-mart CEO Michael Duke makes $35 million a year. So divide that out so that Duke gets $0, and his employees split his pay, and you're giving each and every employee... $16.67. Hardly enough to break the need for credit...

[fizzyland.livejournal.com]

Hint: corporate profits encompass more than just the salary of the CEO.

[ddstory.livejournal.com]

You want to leave Mr Duke without pay?

...Evil kitteh approvz. Nyah-ha-haaa.

[il-mio-gufo.livejournal.com]

Where are you getting this money to pay them more?

Yeah - plus, why pay more? why not adjust the cost of living? what ever happened to that proposed change in the tax system where the only time you have to pay a tax is on the goodies you purchase?!

[korean-guy-01.livejournal.com]

They argue that workers and employees should be paid such a level of salaries as to allow them a minimum level of living standard without taking credits

I subscribe to the theory that poor money habits exist, no matter if one is poor or suddenly attains wealth (i.e. the lottery). How does one attain a house under this system? A car? Those two seems to be American rights these days.

What about the person that overspends? Did we just not take enough profit from the big bad corporations in the first place (an analogous situation to US social programs) and further redistribution needs to occur?

[yahvah.livejournal.com]

The minimum level of living standard still requires job stability to justify buying a house. Today it's more sensible to rent.

Socialist thinking is fundamentally a reversal of cause and effect

[montecristo.livejournal.com]

Leave it to the witch doctors of socialist thinking to see the disease and yet attribute it to "evil spirits." More accurately, they see the germs and presume that the germs are the effect of the disease not the cause.

The fiat money system transfers wealth. When you print up currency or set the interest rate or availability of credit by political fiat, you allow the people to whom they are given to buy stuff with it. The people who get the new dollars first bid up the prices of goods and services. The people who get the dollars last find that their purchasing power is diluted because prices have risen — there are more dollars chasing the same quantity of actual goods and services. Who gets the new fiat currency first? The banks and financials (Wall Street) get the new dollars first, followed by their large customers. Do the math.

Of course, the new dollars or credit or both distort the market, making longer range projects look more profitable than they actually would otherwise be if the credit market and interest rates reflected the true average time preferences of people acting in the market. On top of this, the increased money supply induces people to consume instead of saving, lowering peoples' apparent time preferences. Eventually, the disparity is revealed when the prices of labor and resources are bid up by those investing in higher order production structures. The higher prices reveal that many of the projects are not actually profitable and the bubble pops and there is an unwinding.

So yes, what the article claims on the surface is true. Nevertheless, when it comes to cause and effect, Kumhof and Ranciere are reversing cause and effect. This is precisely the fundamental erroneous premise at work in socialist thinking — the idea that consumption precedes and causes production.

The idea put forward in the cited "Inequality Leverage" article is not new, and it has been refuted, over and over. See: Say's Law and the Austrian Theory of the Business Cycle. (http://mises.org/journals/qjae/pdf/qjae12_2_4.pdf) [PDF, 13 pages]

Re: Socialist thinking is fundamentally a reversal of cause and effect

[ddstory.livejournal.com]

http://talk-politics.livejournal.com/1117122.html?thread=89196482#t89196482

Re: Socialist thinking is fundamentally a reversal of cause and effect

[luvdovz.livejournal.com]

You used too many words to say that socialism is here to kill us all.

Re: Socialist thinking is fundamentally a reversal of cause and effect

[underlankers.livejournal.com]

The Gold Standard would revert humankind to a way of existence that would make Planet of the Apes look like a utopia.

Re: Socialist thinking is fundamentally a reversal of cause and effect

[mrbogey.livejournal.com]

'More accurately, they see the germs and presume that the germs are the effect of the disease not the cause.'

That's one way to put it.

The stratification and difference in pay isn't what's causing the problem but another symptom of the problem. Treating the symptoms doesn't stop the disease and if anything just lets it fester more.

[lai-choi-san.livejournal.com]

Obviousness itself, it was before our eyes since... since... I don't remember anymore.

By the way, Romain Rancière is a member of "the Appalled Economists" whose manifesto has been an enormous success in France in 2010. If you're interested, you can read the translation here (http://www.paecon.net/PAEReview/issue54/Manifesto54.pdf). Being an incurable optimist, I really hope that their propositions will be applied some day or inspire governments.

To what the original post boils down:

[montecristo.livejournal.com]

The article linked would have us believe that the housing bubble happened because Jane had to borrow to buy her house and then couldn't afford to pay back the loan. If "society" (meaning government) had merely redistributed enough money to Jane in the first place, she wouldn't have had to borrow to buy the house at all and could have bought it outright and therefore all of those unsold houses wouldn't have happened and everything would have been right with the world.

Of course, this neglects what really happened in the first place. Jane had to borrow because the expansion of money and credit fueled an unsustainable investment bubble in housing in the first place, driving the prices up as people invested in flipping properties and building subdivisions that weren't needed as much as production in other goods and services would have been needed. Of course now the government won't let the market clear by allowing prices to fall and are instead destroying wealth by bulldozing the houses rather than allowing them to be purchased at a lower price which just maybe Jane could actually afford! (http://www.lewrockwell.com/blog/lewrw/archives/92340.html) Reversal of cause and effect. This is essentially the result of political thinking: the childish demand to eat one's cake and have it too, and using force to hide the fact that this was only accomplished by stealing the neighbor's cake.

The problem is NOT too little consumption but rather that meddling in the market to redirect capital flows in the first place causes distortions and malinvestment (http://wiki.mises.org/wiki/Malinvestment). It's not that consumption has "slowed too much" but that production has been misallocated, producing goods and services in proportions which are not actually the proportions demanded by consumers.

Re: To what the original post boils down:

[zebra24.livejournal.com]

Fact statement "Jane had to borrow" is a lie.
It was her choice to go into this bubble and become a homeowner or be a renter.

[harry-beast.livejournal.com]

Giving more money to those who use reckless borrowing to over consume seems like a very bad idea. It's bad enough when the government does this; we shouldn't encourage it in private households.
There are two main problems that need to be addressed: too much borrowing and too much consumption. The first problem can be addressed by increasing the costs of borrowing through higher interest rates and various fees and surcharges. The second problem can be addressed by increasing the cost of consumption, e.g. with a sales tax or maybe a carbon tax, which would result in higher energy costs being passed to consumers. Luxury goods or those that are non-essential, frivolous or socially undesirable could be taxed at higher rates. The tax money collected can be used to reduce income taxes, resulting in higher take home pay for workers and increased incentives for job creation.
With these measures in place, people would divert their money away from bad loans and excessive consumption, and toward investment in productive assets, which can generate a better return.

that's just a big lie.

[zebra24.livejournal.com]

"workers and employees should be paid such a level of salaries as to allow them a minimum level of living standard without taking credits"

In fact it is always true.
Even with worst payroll in USA "minimum level of living standard" are available.

The thing is that credits in 99,99% of the time aren't for "minimal level of living standard", but for fun and increase of living standard above "minimal".

[rasilio.livejournal.com]

I think they are losing sight of the forest and only seeing the trees.

I think a deeper analysis would show that the cause of the disparity in wealth AND the over reliance of credit in both cases was a shift in economic importance from production to equities and other financial markets.

The problem is not directly salaries being too low but rather "modern" financial markets comprising too much of the economic activities of the nation.

This is why their solution would be nothing but a band aid. Raising salaries across the board without increasing production correspondingly would just lead to inflation.

The real solution is of course laws and rules which make an over reliance on financial markets impossible, of course such laws would probably make stock markets in their current form impossible because it would mean a complete elimination of absentee ownership and require stock owners to have an active role in managing their business.

[ddstory.livejournal.com]

The real solution is of course laws and rules which
and require

Who are you and what have you done to the real Rasilio!

[underlankers.livejournal.com]

1929 and 2008 are too different to be comparable. The Great Depression was due to WWI having really been unaffordable as it was fought and the inability of the Great Powers to square the circle. Attempts to pay reparations turned into a giant Ponzi scheme that brought the USA, the only Great Power of WWI to get out of it better than it went into it to the same levels as everybody else.

2008 was the result of attempting to negate all the business regulations since the Sherman Antitrust Act and is more akin to the Long Depression of the 1870s-1890s in terms of causes and irresolvable equally in nature. The idea that sustained economic growth happens and is inevitable is not born out by history, and if the last Long Depression is any guide to go by this would be the start of a decades-long slump.

[sealwhiskers.livejournal.com]

People outside the US don't in general know how big a part credit plays in the US society, not only for luxuries but to tie people over in all kinds of situations. Basically the whole US society is fueled by credit and loans in a much bigger sense (on both small and large scales) than a lot of other societies, from the smallest grassroot person in a mobile home to billionaires.

People *in* the US don't in general know that there are whole societies that work differently out there, yet still look pretty similar to their own. That there are countries where for the vast majority of citizens it is pretty foreign to use credit at all, and yes, in some of these places the people don't have nearly as much need to carry themselves over with nonexistent money.

This is what I see when I read most of these answers.

[jerseycajun.livejournal.com]

Question: Why was it necessary to maintain the level of consumption beyond the point where it became clear that it was no longer healthy?

"They argue that the logic is very simple."

Things are always simple when human beings force complex mechanisms into appealing, simple constructs. I'm thinking of sandwichwarrior's post on the god complex a few weeks ago, specifically.

[underlankers.livejournal.com]

From a 19th Century monetarist (i.e. Rand and Ron Paul) POV, the entirety of 20th Century economic growth should never have happened. Instead countries grew far greater when they abandoned segregation and the gold standard.....

I love heresies.

[sophia-sadek.livejournal.com]

This is clearly one of those heresies that I can appreciate. The "pro-growth" crowd are a group of dead-enders who are either trying to become independently wealthy or are pandering to those who are trying. One of the distortions of the current tax structure can be seen in the shuttering of businesses that catered to middle class customers in favor of new business that pamper the affluent.