the economy

[gusl]

It's hard for me to understand how the economy can bust so badly when the fundamentals haven't changed. Is it because our economy has become so virtual, so disconnected from reality? Have our past selves essentially borrowed from our future selves until they hit the credit limit?

Why does the economic behavior of the masses seem so shorted sighted, as in: why does it appear to have such a high subjective discount rate?

Comments

[altamira16.livejournal.com]

There are certain aspects of a society that are considered part of its critical infrastructure. The lines between parts of the critical infrastructure have gotten very fuzzy over time so bringing down one part of the infrastructure can bring down other parts of it. For example, if you took down electricity in New York, you would take down the computers that make a lot of the financial markets work if they do not have generators or backups.

Another problem with infrastructure is that as society grows, it has to expand to serve society, but people try to cut corners and put things off until later so things like road and bridge repair in major cities have not been done well for a long time and fixing these problems will be very costly.

[the-locster.livejournal.com]

http://www.youtube.com/view_play_list?p=79184D14F872B80D

[the-locster.livejournal.com]

But the fundamentals have changed. Everyone (or a large majority anyway) thought that the world's capital and assets were worth more than they were. Here's one example. Consider a machine that produces widgets at a profit of X per year. The value (V) of the machine to the operator/owner is a function of X and the interest rate over time.

The market value/price (P) of the same machine is replacement cost. If P is less than V then people will tend to borrow money to buy machines until increased supply of widgets brings the price X down such that V reverts to P. There's some oscillation of prices and values around means causing some operators to go bust sometimes and others to make a lot of money at times. This is all part of a 'normal' market.

Now pull the rug from under everyone's feet by telling them that the demand for widgets was artificially inflated for the last 10-20 years making all of their investment calculations invalid. Not only is the price of widgets falling now but the expected long term value is much less than everyone thought. Widget manufactures can no longer service their debt and the widget industry is decimated. Factor in the effects on the widget industry supply chain and you've got a depression.

Now consider someone making investment decisions now - what is a good estimation of long term widget demand and interest rates? Answer) no-one has the slightest clue, hence investors take the cautious approach of assumign widget demand will be low and interets rates high.

I liken the rate of economic activity to that of flow rate through a pipe. As the rate increases you start to get turbulance on the pipe surfaces and at some point turbulance disrupts flow significantly. The only way to eliminate the turbulance and get the flow rate back to 'normal' is to reduce pressure/rate (perhaps by quite a lot) back to a normal rate.

[the-locster.livejournal.com]

"expected long term value"

I did of course mean long term demand. Demand is no longer being artificially increased by unsustainable debt growth.

[selfishgene.livejournal.com]

Good points. I want to emphasize that the SEC and Federal Reserve think that any method of pumping up the economy is OK. They are not restrained by law or reason or caution. They bear the main guilt for this debacle.
Other government agencies like Freddie Mac share that guilt for their lending. A first year accounting student could tell that many people were never going to be able to pay back.

[the-locster.livejournal.com]

My current thinking is that artificially low interest rates where the root cause. All of the other problems were significant in their own right but probably would have resulted in a recession/downturn rather than the financial system being stressed to near breaking point and a probable worldwide depression. Those other problems were being fed/expanded by low interest rates - the most significant of those other problems being:

Overleverage in banks due to flawed risk models, poor accountancy, failure to meet existing accountancy standards, inappropriate relaxing of accountancy standards, the backward relationship between bond sellers and the rating agencies. There was a mix of stupidity and fraud/corruption feeding all of this, much of which persists so far.

[selfishgene.livejournal.com]

Re the banks : Moral hazard.

[gwillen.livejournal.com]

Have you ever met someone who didn't have a high discount rate? Welcome to America.

[easwaran.livejournal.com]

Hey, not just America! This is natural human behavior. One might even try to given an evo-psych explanation for it in terms of the fact that modern adult lifespans are several times longer than adult lifespans in "evolutionary time".

[wjl.livejournal.com]

there's an argument that collapse is inevitable, since our monetary system is based on interest-bearing debt, and paying it off in the long-term requires exponential growth. see google: "money as debt"

[trufflesniffer.livejournal.com]

Money as Debt was probably the most eye-opening thing I saw last year.

[wjl.livejournal.com]

it's got a little bit of a rough "conspiracy theory" edge to it, but it is indeed quite informative if you can get past that :)

[trufflesniffer.livejournal.com]

I don't necessarily mind 'conspiracy theories', so long as the 'theorists' don't really believe that the 'conspiracies' being advocated are pre-designed and pre-intentioned, rather than just 'causal narratives' that attempt to present simplified coherent accounts of sequences of events.

I think Money as Debt fit broadly into the Adam Curtis school of 'conspiracy theory', whereby quotes by and stories about influential individuals are used to humanise and epitomise moods, ideas, concepts, habits, trends and practices that, collectively, act as historical forces, but that neither originate within or are designed by a single mind (or 'cabal' of historical puppetmasters).

If that sounds like it's stretching the definition of 'conspiracy theory' a bit far then I guess I just don't like conspiracy theories, but also don't consider Money as Debt to be one.

[peamasii.livejournal.com]

$6 trillion lost on bad house loans
$6 trillion lost on stock market correction

all of it was virtual money.

[trufflesniffer.livejournal.com]

I have a theory that real economic development is sigmoid (undeveloped, developing, developed: and more often undeveloped, undeveloped, undeveloped), but governments and economic institutions across the world have gotten it into their heads that it must be exponential, and so are just concerned with % growth rates, with little or no recognition that this % figure isn't as meaningful for developed nations as it is for developing nations.
The only way to maintain the illusion of growth therefore becomes to attempt to whisk the speculative 'froth' that sits atop the real economy (where real value + speculative modifier = nominal value, and nominal value is what goes into national accounting figures).
This speculative froth is now starting to deflate, but as you say the underlying real economy is pretty much unchanged.

[the-locster.livejournal.com]

It's axiomatic that exponential growth within a finite medium is unsustainable.

Also I probably should have agreed previously that the fundamentals have indeed not changed - it's just that they were deeply flawed before but most people didn't realise it yet.

[trufflesniffer.livejournal.com]

It's only axiomatic if you accept the basic axioms of physics (second law of thermodynamics etc). I have some doubts that macroeconomics qua economists believe in the axioms of physics, however, and just consider the axioms of economics (where people are utility-maximising sociopathic robots and resources are potentially infinite).

[the-locster.livejournal.com]

heh :)

"In this house we obey the laws of thermodynamics!" - Marge Simpson