Archive for November, 2008

Biggest myth?  That it is the best in the world.

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Not all “stuff” is created equal….or is even useful at all.

I’m not talking about diamond studded toothbrushes for your toy poodle.  That’s fine with me.  If you want to waste money on your dog’s oral hygiene, so be it.

I’m talking about entire industries/sectors of the economy that don’t provide anything useful or are unduly bloated.  Their existence is a distortion; a fluke of a particular set of conditions at the marcro level (govt, laws, etc).

Here is an example often given:  Income inequality creates crime because the really poor want what the really rich have….so some portion of them steal it.  If there are more poor and more rich (the income distribution widens)….there is more theft.  To combat this situation the really rich simply move into gated communities, install security systems, etc. 

Some portion of the home/personal security market is a distortion due to income inequality.  In my opinion, although it adds to GDP, it should subtract from it.  It is a negative value service/product.

Though the US has a 12 trillion dollar GDP….I think much of it is a fantasy.  I don’t know what percentage might fall into this “useless” or “distortion” category…but it does make me wonder how “rich” our country really is.  What is rich?  Is it having enough money to buy stuff that will insulate you from the poor?

Anyway, these arguments have been made before, but the reason I’m bringing it up again is that there is another sector of the economy much larger than personal security that I think is of debatable usefulness…and whose size is certainly a distortion:  FINANCE.

Finance will of course always exist (as will Accounting, Financial Advisors, Insurance, Lawyers, etc); however, there are so many laws and obscurity in finance, that sometimes I wonder if much of the industry is a fiction….just pushing around numbers on balance sheets, or “trading” assets that aren’t backed by anything REAL. 

I’ll give two examples:

1)  Hedging:  In managing hedges, if someone makes a negative bet on company A, in theory it allows someone else to make a positive bet on company A and maintain the overall hedge.  In my example it is easy to see that there is no real value created, just two opposing bets in a zero sum game. 

But if you manage thousands or millions of those bets, and roll them up into a balance sheet and play some accounting tricks….it may look like you have real assets, which of course someone else could then potentially hedge against.  The fact remains it is a zero sum game, an accounting fiction adding no real value….just pushing paper. 

2)  Derivatives:  If hedging seems complicated, derivatives are even more mind blowing.  Let’s take the “assets” created in the previous example, and decide that we don’t want to invest/hedge on Company A anymore…..we want to invest in part of company A and part of company B.  Of course that entity doesn’t actually exist, but through derivatives you can create it on paper. 

Do you have a new asset?  If you combine a bunch of things based on a bunch of other things in a cascade of derivatives, you eventually get so far from reality that you don’t understand the assets backing the paper.  Are there any?  Is your derivative simply backed by another package of derivatives that folds back on itself or ends in a dead end?

It is easy to see that if enough people play the game outlined above, you’ve created something from nothing.  Its a distortion too complex to get your head around, so you assume its real because really smart people are using big formulas at the top of tall buildings to work it all out.

In the end, I think much of the “cloud” of finance exists as a distortion.  In a world where people eat, sleep, talk, and move on things that EXIST in the real world……if all those fancy financial instruments didn’t exist would we be any worse off?

I don’t think so.  At least not materially (since of course there isn’t much material about finance).

What about all those jobs?  Legions of very, very smart people are employing their time in industries (Accounting, Finance, etc) that shouldn’t be as large as they are….which means they are NOT doing something else, which could be more useful:  Medicine, Science, Construction, Engineering, Teaching, etc.

Imagine how much better off we’d be if the brainpower of finance were focused on advancing clean energy technology?

Some may say, “Finance is enabling clean energy technology…by allowing money to flow into it.”

I say, “Yes.  Finance can be useful, parts of it are useful.  However, the bloat and complexity of the current system is not.  It is just dangerous paper pushing….created by distortions, enabling further distortions…..creating assets that don’t really exist and diverting brainpower from other industries where it could be better employed.”

I remember when Enron went bust I said, “Through fancy accounting tricks, one day a company is going to make a profit selling to itself.”  Well….its already happened.  The entire industry of Finance is making a profit selling to itself….forever pushing pieces of paper back and forth amongst itself….thinking that somehow it is creating value.


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about the fall of Wall Street.  Worth reading.

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Banks are not using the Fed bailout money to ease the tight credit market.  They are using it to shore up their balance sheets and consider acquisitions of weaker banks who were perhaps not able to get as much bailout money.  It is simply making the concept of “too big to fail” even worse since in this scenario the big will get bigger.
To the matter of “easing the tight credit market”….I have a comment:  How can more of the disease be the cure? If overly lax lending and inability to accurately assess the risk of debt led to the crisis, how can more debt and “easing the credit market” (aka more lending) fix it?  Its just doing more of the same thing….you can package it as a rescue if you like…it doesn’t change the fact that you can’t lend your way out of a crisis that was created by lending.
This is how capitalism works:  Bad investments fail, the capital is liquidated, and re-allocated to more fit industries and companies.  It is so two-faced to talk about the virtues of the free market with one breath while preventing it from working with another.
Why can’t banks fail?  Because banks issue money.  In a fractional banking system when banks lend, they create money.  It goes back to a crisis of faith in our fiat money.  If the issuers of the money fail….then the money itself might fail.  If the money fails, the government fails.  That’s why its tricky to let banks fail.  It is a matter of national self-interest (besides the army of lobbyist I’m sure the banking industry has).
What about General Motors?  Is the government going to let them fail?  They’ve been hemorrhaging money for years and keep asking for bailouts. The answer is NO.  The government may allow some small part of the auto industry to fail, but in general, they will not allow the inefficient US automakers to fold.  It is a matter of national self-interest.  The government wants cars manufactured in the US because in case of a war the auto industry might need to be conscripted to make weapons (as was done in WWI and WWII) or ramped up to fill a void in the absence of car imports if we’re at war with say China (where presumably Japanese cars could no longer be imported).  It is why the government continues to subsidize the farm industry in the US (when it clearly can’t compete with cheap imports from 3rd world countries).  If we are a war, we need to be able to produce our own food in the absence of imports.
I also want to comment on the red and blue states and the election results.  A map of the states that voted Republican also fairly closely matches a map of states with the worst poverty and most income inequality…exactly the issues the Democrats try to deal with.  Why is it that those who stand to gain most from the Democrats being in office vote against them?  It doesn’t make sense.  The Republican states are also generally less educated, with less health care coverage, and lose more jobs to free-trade agreements.  The Democrats also try to deal with those issues.  I truly don’t understand.  Is gay marriage, handguns, and abortion policy really THAT important to the poor?
Finally, I want to re-comment on Economics, the dismal science.  It has been shown even more dismal than imagined over the past few months.  Why is it, with all the economists in the world, that so few predicted the current crisis?  If economics is a science, it should’ve done better.  If it is a science then it should have something more prescriptive to say in terms of actions to take to remedy the crisis.  Instead Bernake and Paulson were able to blank check the banking industry…allowing them to do whatever they want with essentially as much money as they want….and call it the “best” plan of action to avert the crisis.  “Best” based on what?  Economics.  Now that is dismal.

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I went home for the weekend and saw some old friends.  Jason had a party at his new house.  I hadn’t seen most of those people since college or a little after.  Everyone is always the same mostly, except a little heavier, a little more wrinkled, a little less willing to get piss drunk (myself included).  I talked a lot about people’s kids and their marriage.  I liked it for the most part.

I wore a Halloween costume I last wore in graduate school in 2001 I think.  Its a pimp outfit with leather pants, a white fedora, and a really tight shiny shirt.  Its ridiculous but fun.  I was still able to get into the pants, but I couldn’t button the shirt anymore…not even close.  In fact, I wonder how I ever got into it.

Jason seemed good.  Its strange that so many of my friends are divorced now.  Actually, I guess its just two of them that are…but hey, how many close friends can someone have?  Two is actually a large percentage.

The next night I went to see Josh after shopping all day with my mom.  I bought this really cool piece of furniture that I don’t really need.

I’m going to use it as a TV stand because I can’t figure out any other place to put it.

Anyway, Josh was good.  His kids are super cute.  He was really drunk by the time I got there at 7 having watched the Clemson game.  You know he’s drunk when he starts talking about how good we were at basketball.  I admit its a fun conversation, since we were pretty good…but let’s face it:  I couldn’t throw a basketball in the ocean now…and if I could I’d probably hurt my back doing it.

I used to swear up and down I’d never have the “used to be” conversation, but now that I’m older I see why people have it.  Its like a fish story…it gets better every time you tell it.  You can forget the defeats and remember the victories…embellish here and there.  No one remembers the score anyway, right?  I did dunk on someone in a game one time though.  That’s true: Wes Jackson, I remember.  (Ok, the goal was about 2 inches short of 10 feet, but that’s just a detail to forget next time I tell the story).

Anyway, its weird to go home sometimes and think about all that stuff.  Honestly it seems like it all happened to another person.  Traveling sort of cut my life in half, and the first half is pretty distant sometimes….especially 10 beers in.

I guess I’m thinking about all this today because I went home for the weekend and got a message from some folks on Facebook today that made me think about some things I haven’t thought about in years.

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