Crisis! (Part 1 of 2)

The past few years have been turbulent for the global economy, especially in Europe and America.  With the rise of the Asian economies like China, and recovery of others like Japan, the West has sometimes had an increasingly difficult time keeping up.  Industries like manufacturing have, to some extent, moved overseas where the costs of production are cheaper.  In response, the developed world has had growing pains as its populace has been forced to shift away from low-skill labor to high-skill labor. In the financial industry, there have been shockwaves from change as well, though in a different form.  Over-speculation has been a major cause of much banking turmoil in the past couple decades.  Additionally, much of the financial problems that have arisen can be attributed to poor expectations for the economy, which has the potential to become a self-fulfilling prophesy.  To combat these national hardships, central banks intercede for the people in the hopes of healing the economy and staving off further damage.

            Where do central banks come from, and what are their purposes?  A working knowledge of a central bank’s functionality is crucial in understanding its actions in the economy and what effects it has brought about as a result.  For this paper, the Bank of England and the Federal Reserve, England’s and America’s central banks respectively, will be considered in particular. Before that however, it is helpful to look at the political context and country from which each of those banks arose.  Both America and England are fairly similar in that the foundation of their systems was the Magna Carta.  This 1215 charter of freedom gave citizens the right to be free from oppression by their rulers. It was a short leap to a government “of the people, by the people, and for the people”.  Fast forward to modern times and the world looks a lot different.  People have been enjoying their rights and have bettered all of society.  Markets and industries grew up and developed.  Much of this flourishing can be attributed to a banking system that evolved into the complex organism that it is today.  The ability to store value (money as purchasing power) and facilitate loans for investments has been a great boon to civilization.

            This is where the central bank comes in.  Each country, at some stage in development has required the service of a single bank that oversees the national monetary policy: setting interest rates, making sure that enough money is in circulation, being a lender of last resort, and setting reserve ratios.  Interest rates are “the price of money”.  More specifically: it states how much it costs a borrower to have access to money now that an individual, or firm, would not have had until later, had the money been saved up.  Interest rates also give people with excess money an incentive to loan their money to other institutions, whether it takes the form of a bank account, stocks, bonds, etc.  The ability to borrow money for investment purposes is what allows people to buy capital and hire workers when initially starting businesses.  This is the only way to begin unless the entrepreneur is already wealthy or has a beneficiary who is.  Conversely, the ability to gain interest by saving money in one of the ways mentioned above can teach people from a very young age the value of saving and being frugal.

            Zoom out to the national level where instead of individuals lending and borrowing, banks are lending and borrowing.  Who fills the need of lending and borrowing to banks?  In America, it is the Federal Reserve (a “bankers’ bank” as it is sometimes called); in the United Kingdom it is the Bank of England.  When banks need money for large investments, they can get that from the Reserve, which can both expand and contract the economy’s money supply.  Not only that, but the Federal Reserve sets the “reserve ratio” which stipulates the percentage of money that a bank must have on hand for each dollar of a loan they grant.  At the present time, American loans less than $11.5 million require zero percent to be on hand.  Loans between $11.5 million and $71 million require three percent of the amount to be in deposits.  For loans exceeding $71 million, 10 percent of the liabilities must be available¹.  Finally, central banks like the Federal Reserve and the Bank of England have the ability to act as a “lender of last resort”.  This means that if a banking institution is at risk of going out of business, it can get an emergency loan for as much as it needs to stay afloat.  The power to grant large amounts of money became a point of tension in both the American and British economies during the pecuniary turmoil of the past few years.  While the particulars of operations and rates are different in the United Kingdom, the purposes and powers of the Bank of England are essentially the same as the Federal Reserve’s.  “The Bank’s job is to work with others to help ensure that problems at one financial institution don’t disrupt the way the [financial] system as a whole operates.”²

            The most recent English recession and subsequent financial crisis started in early 2008, though the gavel did not sound until the beginning of 2009 when the Office for National Statistics declared that the economy had shrunk for the past two quarters.  The closures of several major retail chains such as Waterford Wedgwood and Woolworths in the glassware and clothing industries respectively were major contributors to the downturn at this time.  In response to this and the trend of general decreasing GDP, the Bank of England reduced interest rates in March of that year to .5 percent.  While such action is generally used to incent spending and borrowing by the populace, this did not have the desired effect and the economy continued to shrink.  Over the course of the year, the economy contracted significantly more.  Unemployment also increased to around 2.5 million by September of 2009³.

            The single most important instance that sparked the powder keg of England’s recession actually happened a couple years prior with the collapse and subsequent bailout of one of the country’s largest financial institutions: a bank called Northern Rock.  In September 2007, executives from Northern Rock called on the Bank of England, as the national lender of last resort, for an emergency liquidity funding.  The Chancellor of the Exchequer approved the bailout citing, “the difficulties that [Northern Rock] has had in accessing longer term funding and the mortgage securitization market, on which Northern Rock is particularly relevant.”⁴ The main trouble Northern Rock had was not in small-time savings, but rather in the mortgage industry.  An identical situation had been unfolding during this time and the years preceding in America’s real estate and banking industries.

Sources

Board of Governors of the Federal Reserve. Reserve Requirements. October 2011. Web. 14 April 2012. Web. <http://www.federalreserve.gov/monetarypolicy/reservereq.htm>

Bank of England. Your Money-What the Bank Does. Web. 14 April 2012. <http://www.bankofengland.co.uk/publications/Pages/other/whatthebankdoes/default.aspx>

Wearden, Graeme. Timeline: “UK Recession.” BBC News [London] 23 October 2009 Web. <http://www.guardian.co.uk/business/2009/oct/23/uk-recession-timeline>

Bank of England. Liquidity Support Facility for Northern Rock plc. London: 17 September 2007.  Web. <http://www.bankofengland.co.uk/publications/Pages/news/2007/090.aspx> 

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The Nature of Self-Interest

The Following is a short essay that I wrote for an economics assignment based on two articles.  The first, is written by Johnathan Leightner and entitled "Utility versus Self-Sacrificing Love".  The second is called "The Neoclassical Model in a Post-Modern World" by John Lunn and Robin Klay.  With a 350-word limit, I was unable to go into thorough detail, but that may make this essay more digestible for readers who don't have a large chunk of time to read.  We were asked to respond to this prompt: what the main point in Leightner's article.  How would Lunn and Klay respond based on their article? 

Leightner states that our economic paradigm is to think that the ultimate aim of human beings is to achieve the most utility that can be had given our available resources. He goes on to say that this is an unchristian attitude towards life since God calls us to be not concerned for ourselves (Matthew 6:34) but rather to invest our time and energy in others (John 13:34-35).  Furthermore, he says that calling a person’s acts of self-sacrifice for others “utility maximization”, does a disservice to the nature of love, which in its purest form has no orientation towards itself.  As is often the case, when refuting the doctrine of utility maximization, Leightner cites the life of Mother Teresa: someone who lived as righteous of a life as any.  How could we say that she was acting only in her self-interest to maximize her utility in life while feeding orphans and treating deadly diseases?

            Klay and Lunn would respond to this indictment by saying that utility maximization is not the single driving force behind every single action in a human being’s life.  Rather, they say, economists think on the margin: making decisions based on circumstances influencing an individual at a particular moment: will it rain? How can I treat my headache?  Now given the fact that it may or may not rain, do I bring an umbrella or not?  Given the fact that I have a headache, do I treat it with one medicine or the other?  All the situations faced by a person in a day, or in a lifetime, have a multitude of possible responses.  In light of that, a person must be able to choose what actions are best for him.  The heart of utility maximization it is not about being selfish, but rather about being smart.  This utility model does not take into account every aspect of a human being’s lifestyle, nor should it since it is only a model.  (Think of a model airplane, which can tell you a lot about an airplane, but cannot itself carry passengers across the world.)  Rather, it simply explains how a rational individual will make decisions as circumstances present themselves. 

For anyone keeping track, that was just over 350 words.  But I added a sentence here for clarity that was not necessary in the essay I'll be submitting, which is under 350. 

 

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An Important Virtue To Remember

Adam Smith, who as you may or may not already know, was the father of modern economics.  In particular, he invented the free market/capitalism systems.  This, in summary, was the idea that people could specialize in producing the things they are good at producing and exchange with others for the things that they were not good at producing.  I would have much more to say about that at some other time, but that is not today’s topic.  I would like discuss him as a person, besides just a great theorist.  He was an incredibly humble individual, as shown in this story I once read in an econ textbook. 

Smith was a professor of theology at the University of Edinburgh and one semester he was unable to finish the materials he outlined in the syllabus.  Feeling rather disappointed in himself, he offered the class a refund of their tuition.  All of the students turned the offer down stating that they had already learned so much from him.  Smith immediately began to weep upon hearing his students’ response.

There is so much in that story that tells of Smith’s character.  But instead of rehashing my opinion about it, I would like you to consider what his various actions tell about his character.  I am, however, very proud to say that the science of economics was founded by a great man, and not just a great mind.

Fast forward 150 years or so and economics has evolved into a full-fledged social science.  Many well-educated experts were giving more specific ideas about how the world should be run, what role the government should play in the market and in the lives of the populace, etc.  In fact, people had gotten so smart with their theories and models that they had started treating economics as if it were like a physical science.  Most notably was a man named John Maynard Keynes.  His contribution to the study of economics should not be underestimated and even his fiercest critics saw validity in some of his work.  However, he held the opinion that the government should intervene more in the lives of its citizens, particularly in times of crisis. He had the belief that if the government, or some governing body, could know enough about the needs and desires of a population that it could make decisions about the use of resources to produce things that best serve that population. It is an interesting idea and has been implemented in such great nations as the former Soviet Union and North Korea.

Of those two countries, one failed entirely and the other is tragically impoverished.  The problem is that there is no way that some people can be smarter and have universal knowledge of what’s best for people, or know absolutely what everyone in a population desires.  There is just no way that a ruling coalition can say that they know the preferences of hundreds of millions of human beings and that they will produce and distribute those things.

This is the crux of where economics diverges from the natural sciences.  In the case of the physical sciences, we can know the nature of things with certainty, such as the molecular composition of water, or the equation of force in relation to mass and gravity.  In physical sciences, we can be comfortable applying our knowledge to things in different circumstances because of the nature of things we have studied doesn’t change.  In economics, what we study are human beings: humans on an individual level, on a social level, on a corporate level, on a country level, and beyond.  It is important to realize that humans can’t be studied in the same way that physical things can.  People are too dynamic and complex.  To say we can know them like we know electricity or photosynthesis is not only arrogant, but potentially dangerous to the people who are affected by our actions.

F.A. Hayek, Keynes main ideological opponent during their lifetimes, won the Nobel Prize for economics in 1974 and gave a speech entitled “The Pretense of Knowledge”.  I recently (between now and the time I started writing this post a few weeks ago) read Socrates’ Apology, which is where the phrase comes from.  Socrates, in this monologue, talked about his interactions with other philosophers and found that most of those who were considered “wise” by their own standards and the standards of society were really rather foolish.  This was because those individuals lacked the capacity to see the limit of their own knowledge, and therefore that there was infinitely more to be known that was entirely foreign to them.  In other words, by thinking that they knew so much, they were blinded to all that they did not know.   

Hayek, in his speech, warned of the danger of believing that we know too much.  Throughout his career, he pointed to the importance of decentralization of information: that the collective knowledge of society serves us better than the limited knowledge of a few powerful elite.  Imagine that one of the preeminent economists of his time used the occasion of a Nobel Prize speech, which might usually be a time for self-promotion, to remind us to stay humble.  We as individuals know very little and are best served to remember that through times of forging personal beliefs as well as policy decisions that affect millions. 

F.A. Hayek

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The One Percent

            I was just reading this interesting article in the New York Times about how there is a big disparity between data consumption of high data users and low data users.  For those who didn’t read the article, the main fact from the article is that the top one percent of cell data users account for half of the total use.  The top 3 percent use 70 percent.  Now having read this, and as a smart phone user myself, there are a few ways I could respond.  First, I could say “that’s interesting” and move on with my life.  That wouldn’t be worth a blog post though. 

Second, I could get jealous of those one percent people and demand more for myself.  I could try to get #OCCUPY THE ELECRTOMAGNETIC SPECTRUM trending on Twitter. (See what I did there?  If you protest banks by occupying where they operate, you protest cell data by occupying where it operates.)  Maybe I could get people all worked up and have them demand that the government enact regulations that limit how much data can be used by individuals in the one percent.  I could demonize those that take up the bandwidth that clearly I deserve as a living breathing human being.  Inequality is unfair because we’re all equally human beings.  

But there’s another option.  I could be thankful for my allotment of 200 megabytes per month.  It isn’t a lot, and I don’t enjoy AT&T’s overage charges or the fact that my dad gets angry at me.  But who am I to complain?  I have an iPhone for goodness sake.  Most people in the world don’t even have cell phones.  I didn’t even have a cell phone before going college.

Last semester, I learned the difference between absolute and relative gains.  As the names imply, absolute gains pertain to a measure made in relation to some fixed starting point while relative gains pertain to ones measured in relation to a relative standard.  If you compare yourself to those who have more than you (a relative measure), then obviously you’ll feel shorted.  It would be better to find some absolute standard and measure your progress since then.  I find time to be a good absolute standard since you can look back at the past, which won’t change, and measure relative to that.  (It would be an absolute measure.)  As mentioned before, I didn’t even have a cell phone before going to college.  I would note that and be content that I have a phone.

This is a parable.  I’m not really talking about cell data.  I’m going to go on a limb and guess that my readers are not in the top one percent of income earners.  So since we’re all part of “the 99%” here, I’d like to suggest that rather than complaining that there are some super rich people out there, we should instead be thankful for what we have and to show what we have to be thankful for, we’ll measure ourselves relative to the past, which is absolute. 

We in the modern age enjoy quite a lovely life.  Lots of things have become cheaper (adjusting for inflation) than before due to advances in technology.  I’ll make this brief and write a whole post dedicated to how standard of living has changed over the course of time if anyone is interested in hearing more but I’ll hit some highlights here.  Think of food, for starters.  A pineapple used to cost the equivalent of 4626 dollars in medieval England.  Now it costs…well I couldn’t find it in our grocery store’s flyer, but it isn’t all that much.  This is because of the invention of refrigeration and modern shipping.  Up until recent times, if you wanted to hear music, you had to go to a performer or have him come to you.  Now we can carry thousands of songs in our pockets and listen to them any time we want to.  A couple hundred years ago, most people never traveled more than 20 miles away from their homes but because of the invention of planes and cars, we can go thousands of miles in a day!  Most homes have air conditioning, or can buy a portable unit.  This is a luxury that Andrew Carnegie didn’t enjoy despite being one of the richest men of his era.  This brings me to my final point.  If, instead of using a relative measure, you look at the absolute past, you’ll realize that just about all of us in modern America are living longer, healthier, and more enjoyable lives with more leisure time than ever before in the past.  As I said before, I could write more but this post is already getting long so I’ll only expound more if someone requests it.  I would also recommend watching Matt Ridley’s TED talk on this subject.  He communicates a lot better than me. 

At Occupy London, an encampment that understands relative differences, but doesn't understand absolute gains.

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All The Small Things That Make Me Thankful

           I recently got back from spending Christmas in England!  It was a blast and as I was flying back across the Atlantic, I was struck with inspiration for my post about emergent order.   Now I want to share the particular moment from the flight where the thought hit me.  I was just relaxing and watching The Big Bang Theory, which is a series that came highly recommended to me from my old college RA.   Then all the sudden, it hit me (I must have implicitly remembered this video) that I was sitting in a chair 30,000 feet in the air, moving along at 550 miles per hour, and just watching a TV show (while eating a Twix bar).  When I stopped being awestruck by that fact, I took a minute to unpack everything that went into crafting this wonderful moment. I do not hesitate to submit to you that the work of millions of people allowed me to have this experience.  Let me show you how.  For the flight, we have the captain and his co-pilot to thank for the flying itself.  We have the flight attendants to thank for making sure that everything else was running smoothly (and making sure I got a Twix).  We should probably also thank the actors who make Big Bang Theory so that I could be entertained on that long flight.  So that’s a couple dozen people who made a contribution to my flying-high-and-watching-TV moment.  It’s a far cry from millions.  But if we stop here, we’ll be missing a lot of others who made crucial contributions.  In television and in flying, the main players that you see are accompanied by support staff that you don’t see.  There are ground control workers, baggage workers, air traffic controllers, airline chefs, mechanics and engineers who make repairs, etc.  In television is the same thing: gaffers, cameramen, directors, prop managers, makeup artists, editors, producers, promoters, the people who made licensing agreements with the airline that allowed BBT to be shown on my flight, and others who in absence, the show would not go on.  In light of that, it makes us want to respect the ground crew or the prop man more.  Though less visible, their impact would be felt if they were gone. 

Perhaps you are saying, “Well, this is a lot, but surely not millions.”  But wait, there’s more!  Think of the plane itself.  A Boeing 777 is not just two wings attached to a fuselage.  It’s a pretty complex machine.  It had to be designed by engineers and built by other workers who specialize in making planes.  I have one friend who actually presses airplane turbine engines for a living.  That’s pretty impressive!  So there’s a lot more people who design and assemble the plane.  But there’s still more!  Airplane parts don’t grow on trees, they have to be made from raw materials that are made by other companies, who themselves employ even more workers.  Think of the cameras, computers, microphones, and all other equipment used in the production of a TV show.  They had to be designed and made by still more people.  Think of the fuel that powered the plane.  It got from the ground to the tank because of the labor of more people.  Think of my Twix bar, it was made somewhere else by some other people.  Do you believe me now when I say that millions of people made my soaring over the ocean possible? 

When you think of flying like this, you realize it’s a miracle that such a thing could exist.   After all, there was no central planner that dictated some people work for some company or another.  There was no aviation czar telling the president we need to have x number more planes this year and allocate these resources for it.  No, the economy does not have a central planner and yet we see incredible collaboration by the whole workforce, millions upon millions of individuals.  Everyone plays a part to support everyone else, producing this or that so that everyone else can focus on producing something else.  It is because of this collaboration that we make each others’ lives better.  I got to travel across an ocean in comfort because of our economy.  This is something that was impossible a thousand years ago and impractical for most until the rise of commercial aviation in the last century. 

This all comes from one moment that I lived in the modern world.  Apply this train of thought to anything from your cup of coffee, to your car, to a university, and you’ll see that our world that could be chaotic is actually incredibly orderly.  All the things great and small work together to allow us to enjoy the life we do.  That’s why I’m thankful.

Tune in next time to learn about the force that causes everyone to work together.

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Pennies!!

Here's an interesting video about pennies. I must admit they do have sentimental value, but probably not enough that they'd be worth keeping. That's just my two cents worth.

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