Tuesday, February 24, 2009

Old Growth Forest

Fire, Man's Reliable Solution!  

Fire is a natural part of a forest's life.  However, we used to believe that fires always need to be put out.  This led to old growth forests that were even more prone to fires because they had dead wood strewn throughout.  Nowadays, we realize that fires should occasionally even be set in order to reduce the severity of natural forest fires and to permit better growth of the forests.

This anecdote fits our current monetary policy perfectly.  When the economy begins to dip into recession, interest rates are cut.  This has the effect of cheapening money.  Anyone that has a credit card knows that lower interest rates mean charge it!  After the terrorist attacks of September 11th, the interest rate dropped so low that it helped to cause the housing bubble.  The economy exploded on this cheap money, fueled in part by the same reasoning that has us reaching into our pockets for the credit card with the lowest interest rate.  

Now let's engage in a thought experiment.  (Thought experiments are better because you can have have explosions in them that don't create any damage, and there will be an explosion in the following thought experiment!)

Imagine that you've been on a speeding spree, due in no small part to your low interest credit card.  And after charging and charging, you've started to accumulate too much debt.  The mail is delivered one day with the bad news.  The low, low rate has now been raised by a couple of percentage points!!!  Oh, expletive deleted!  Ka-boom, you explode and set fire to everything in the house (Thank God, it's a thought experiment).  After you settle back down what happens?  Do you go out and keep on spending with the same cavalier attitude?  Heck no!  You may even start budgeting.  

But what does old growth forest have to do with anything?  It has everything to do with how our central bankers only put out fires.  If anything slowed down the economy, they would cut interest rates.  The economy would heat up and catch a bubble (dotcom bubble, housing bubble).  But the central bank would not do anything to reduce the impact of the next fire.

No small controlled fires were set to prevent catastrophe.  Greenspan would simply utter terms like "irrational exuberance," or "froth", and then go back to impressing Andrea Mitchell, probably.  He didn't raise rates to calm things down.   The credit card example above illustrated how to stop people from spending before they were too deep in debt.  Greenspan waited with firm belief in a policy doctrine that enjoyed widespread support: there can be no bubbles in stock prices because the market reflects all relevant information and are therefore efficient.  

More on this in: Santa, the Easter Bunny, and the Efficient Market Hypothesis. 

This crisis ends now

I'm mad as hell, and I'm not going to take it anymore.  

Aside from blatant and rampant plagiarism, this blog will give you straight dope on what is going on in the economic world.  Because it deals with what is going on, there is no other option besides rampant and blatant plagiarism.  Life doesn't just happen, it happens repeatedly. Life leaves little room for anything other than plagiarism, especially in the fields of economics, history and politics because the SAME DAMN thing keeps happening again and again.   E.g. Napoleon invades Russia and fails, Hitler invades Russia and fails. 

So one question is just begging to be asked.  Why does the same damn thing happen again and again, down through the ages, despite whatever solution is concocted to solve the problem?  Because solutions come from people that are concerned with their own power rather than truth.  If the truth of the matter was at the forefront of every issue, elections would be duller than egg salad made with only eggs and mayonnaise. 

I couldn't give a flurking hoot about the aspects of finance, economics or politics that obscure the truth of the matter.  Power and profits have led to a manipulation of the truth in these areas.  And while it's darling that people are misleading people for their own advancement, it's a damn shame that life is so time consuming that 99.5% of all people have no clue about what is going on in the powers impacting their lives.  

This blog shall not be a vanity mirror to highlight my beautiful little face; I'm not that self centered.  Everything in here is for you, the reader!  It will be about why some economies die, why politicians lie, and how to correctly tie a tie.  Be happy to know, the preceding sentence is the first, and last rhyme of this blog.  

For us to understand why the price of stocks just fell off of a cliff, the first thing people need to know is this: credit contraction ALWAYS follows periods of credit expansion.  Think about it.  What happens when you max out your credit cards? (Tune into this blog for the explanation of how and why credit cards came to be.)  You either declare bankruptcy, basically default on those loans, or you tighten your belt and begin paying them off.  What happens to your credit score when you go on a spending bender with your credit cards?  It goes down.  What about your interest rates?  They skyrocket.  The whole system is rigged like a rocket powered see-saw.  You go big, so big that soon you have to go home, and then some repo guy shows up and takes your home.  If you're lost at that, fine.  The core tenant was a) credit expands at its maximum rate, until b) it contracts at its maximum rate.    

The first post on this subject will be done next time.  It will deal with 3 BIG time credit expansions followed by contractions.  Here's a preview: 1) installment purchase plans 2) fiat money 3) CDOs.

Stay optimistic