Why I'm Draining My Savings/AKA How Reserve Banking Works

[jennypenny]

Please tell me this piece is tongue-in-cheek ...

http://finance.yahoo.com/blogs/the-exch ... 19961.html

I'm hoping it is and I'm just being too sensitive or the author too subtle (or both). I was accused of being "un-American" recently for "hoarding" my money, and told the economy would be fine if people like me would just spend money. I was very unkind to my accusers, but maybe their feelings are more common than I realized??

[secretwealth]

The only way to hoard money is to stuff it under a mattress. Money that is put in a bank account is in turn used to invest in other businesses through loans. If the bank isn't lending your money, then they're failing to fulfill their part of the social contract. Still not your fault.

Additionally, none of what he says in this article seems like he's draining his savings to stimulate the economy--rather, it sounds like he's investing in real estate on a bet that house prices will recover. Since this has already begun in Manhattan and some other key points of the region, and at least anecdotal evidence suggests there's a lack of supply on the housing market in the tristate area, it sounds like he's a savvy investor indeed.

More cynically, I wonder if he's writing an article about all of this so that he can write all of it off as a business expense.

[crosshairs]

secretwealth, can you say more about banks and how they have to lend money to fulfill their part of the social contract? I don't think I've heard that opinion before.

My reaction to the article is, all money is used for transactions at some point, whether now or in the future. A healthy economy (personal, household, and community) has some money spent now, and some saved to spend later. This is the consumption model most commonly seen in nature's colony structures.

[jacob]

Better him than me.

I'll just assume it's not a joke (although most economic theory is). The paradox of thrift is a key foundation of Keynesian economics which is widely taught in US colleges. I'll therefore assume that a lot of people operate under that world-view.

The POT idea is that money is a claim on other people's production. Other people will produce goods insofar claims are being presented to them otherwise it is assumed that they won't. Then it follows that if everybody saves, nobody will produce. Hence the outstanding potential claims (money) will be worth less because there will be less production to claim. In other words, the value of savings decrease.

I guess now we can have a long and boring discussion tearing this apart---it ignores self-reliance, spontaneous production (entrepreneurialism), taxes, and price changes---but this has been done ad nauseum already though. What's important [to me] is that a large portion of the college-educated middle-class thinks like that. It fits in well with the job-mentality.

The social contract would be in you and by extension everybody producing to uphold the value of everybody's savings. I would presume to go so far as to say that not only does the Keynes aim for a world where everybody could have a job. The aim is that everybody should have a job.

Similarly, banks, in return for certain very valuable legal favors, namely lending money they don't have, something which would constitute embezzlement for individuals, could be said to have a social contract to extend leverage to people with good/productive ideas making them able to produce despite not having the money to make them more competitive against people with bad/unproductive ideas who happens to have lots of money. As thus banks act to steer a system towards an outcome that would be natural/automatic under capitalism, but faster. Of course bad stuff happens when banks extend leverage to bad ideas.

[jennypenny]

I guess now we can have a long and boring discussion tearing this apart---it ignores self-reliance, spontaneous production (entrepreneurialism), taxes, and price changes---but this has been done ad nauseum already though.

Sorry, I wasn't trying to go down that road again. I know we've talked about the reasons people jump on the consumerism bandwagon before, but this is the second time in two weeks I've seen it explained as some sort of civic duty. Is consumerism the new Victory Garden??

[C40]

NO!!!!



Sadly, you're correct...

When I went house hunting in St Louis I saw probably 150 back yards (the houses I was looking at and surrounding yards). I saw one real garden. ONE


In public opinion, gardening isn't nearly as sexy as it used to be...

[jennypenny]

Haha, those images are funny. That's exactly what I mean. We had a big harvest this week, so I'm spending most of today cooking and putting food up. Apparently, the more patriotic thing for me to do today would be to go to the mall. I'm surprised they haven't released comics showing Batman and Superman shopping for new wardrobes at Abercrombie.

--------
C40 had an image up of Batman and Superman tending their Victory Garden but must have deleted it. I just felt the need to explain my comments about them shopping

[workathome]

We are living the reality of the machine-man. Consume for the sake of preserving the economic machine, of which we are mere cogs. Man has tossed aside the "ignorance" of religion and replaced it with an empty, goal-less worship of economy.

[secretwealth]

secretwealth, can you say more about banks and how they have to lend money to fulfill their part of the social contract? I don't think I've heard that opinion before.

My reaction to the article is, all money is used for transactions at some point, whether now or in the future. A healthy economy (personal, household, and community) has some money spent now, and some saved to spend later. This is the consumption model most commonly seen in nature's colony structures.

Jacob pretty much explained it best. That social contract isn't necessarily an ethical obligation that banks have--rather, that's their function, their raison d'etre. When they fail to fulfill that function (as in Burma--a very good podcast on Planet Money explored this), then a money-based society collapses.

Now, onto the economic theory issues...

@Jacob, your disdain of Keyensian theory is interesting. What do you think about its recent accuracy in predicting just about everything that's happened post 2008? Also, on this:

"The social contract would be in you and by extension everybody producing to uphold the value of everybody's savings. I would presume to go so far as to say that not only does the Keynes aim for a world where everybody could have a job. The aim is that everybody should have a job."

Can you show me one Keynesian who has made this argument? As far as I understand it, Keynesianism is an attempt to study monetary and economic systems as they are, not to make an ethical assertion about how they should work. I don't see how the economic theory wouldn't allow for passive income any more than Austrian economics.

Just for the record, I am worried at the "we're better than the lemmings" attitude that all too often pops up on this forum. IMO, live and let live--or, in this case, grow and let consume.

[jacob]

@secretwealth -

If the paradox of thrift holds in the form stated, the job implication follows logically. If you don't have a job producing goods (that job would be gone due to someone not spending money), then you're devaluing the savings of everybody else. By job I mean the kind of work that has a known predictable demand. Hence, the way I combine this logically ... if the paradox of thrift is a problem, which Keynes seems to think it is, then you're obligated to have a job to prop of the value of other people's savings. If the paradox is not a problem, then you're not obligated. Do you think my logic fails?

Moving on ...

Economic theory is a misnomer. I completely disagree that economic theories stick to being descriptive. Most of them try to explain "how things work". I can tell by the way they use '=' signs
in their theories! By leaving out some aspects of "how things work", they generally reveal the underlying unspoken assumptions of the particular theorist. As far as I know, there are no sui generis models. All of them leave something out. Keynesiasm has the perspective of a top-down industrialized mass-society. Keynes himself wrote that his theories would work best in a fascist society, which IS a top-down mass-society.

"The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced." --- from the foreword of the German edition of the General Theory (1936)

"Economic narrative" is better. Economics generally serve to explain after the fact. This is why various economic theories become fashionable during certain economic macrobehaviors. This is no different than why certain investment strategies become popular right near the end of periods where they've worked well.

For example, Keynes is popular during early recessions---enthusiasm later fades (see 1970s and 2010-forward).

https://en.wikipedia.org/wiki/2008%E2%8 ... resurgence

Neoclassical theories are popular during boom times, especially ones with new technology development and lots of entrepreneurial activity. They fade when lots of people go broke following their dumb investments. Governments are cool as long as you're the one getting them.

It's pretty evident why people who believe in the government tend to like Keynes and people who don't don't. This reason Keynes can be used to justify why the government should take certain actions. Similarly, people who believe otherwise would use some other theory to justify why those government actions should not be taken.

Economically, people tend to stand where and WHEN they sit.

This is why practically all economic theory is also political theory. And why economic discussions also turn into political discussions.

Furthermore ...

Economic theory is very bad at predicting.

For example, Keynes said that economic stimulus should reduce unemployment and therefore it was used massively in 2008 and 2009. However, so far in 2013, unemployment is still high. Reality no longer fits the narrative.

Our prime directors of the money system have actually been extraordinarily bad at predicting the economy. In 2006 Bernanke rejected that there was a housing crisis. In 2007 he rejected the subprime issue as the problem. In 2008 he said there wasn't an upcoming recession. In 2009 he said they wouldn't monetize the debt. In 2010 he started doing just that with QE2.

Then in 2012, Bernanke said this:
"As the Committee embarked on this path, we were guided by some general principles and some insightful academic work but--with the important exception of the Japanese case--limited historical experience. As a result, central bankers in the United States, and those in other advanced economies facing similar problems, have been in the process of learning by doing."
http://www.federalreserve.gov/newsevent ... 20831a.htm

In 2013 the feds came out saying that they wanted to taper the QE. They quickly "learned" that the market didn't like that, so they came out and said we're not going to be "doing" that anyway.

Fun stuff, eh... so yeah, I wouldn't exactly say that they have a theory that has been predicting the economy very well. The way I read it is that essentially: They're clueless. And if the smartest economists are clueless, what does that say for the rest of them?

[Triangle]

Austrian economics anyone? Anyone? Ludwig? Anyone?

Here's my thinking why Economics cannot be unpolitical.

Imagine a physicist. The physicist says "If you drop a stone, it will fall down". You can drop a stone on somebody's head and hurt them, or you can drop a stone and crack a coconut and feed them. It's very easy to see that the physicist is not telling you what to do, just what's going to happen if you drop the stone.

Imagine a Keynesian economist. He says: "If you print money, the recession will end, and everybody will eat and have shelter. If you don't print money, people will starve and freeze to death". (Imagine the opposite for a free-market economist). There's no way this can be viewed neutrally or without an implication on what is "good". Unless you hate all people and want them to die, you MUST do what the economist thinks is going to feed them and put roofs over their heads.

It is therefore extremely hard for an economist not to jump into ethics and politics. The study of people isn't as disconnected from people as the study of stones.

It's similar to medicine. "If we inject him with mercury, he will die". This isn't neutral, unless you're a psychopath, there's a clear implication of what you must do. Not inject him with mercury.

[DutchGirl]

That's some weird logic, triangle. By your own logic, physics would be political too, because of course you shouldn't drop the stone on someone's head and kill him.

[secretwealth]

Economic theory is a misnomer. I completely disagree that economic theories stick to being descriptive. Most of them try to explain "how things work". I can tell by the way they use '=' signs
in their theories! By leaving out some aspects of "how things work", they generally reveal the underlying unspoken assumptions of the particular theorist. As far as I know, there are no sui generis models. All of them leave something out. Keynesiasm has the perspective of a top-down industrialized mass-society. Keynes himself wrote that his theories would work best in a fascist society, which IS a top-down mass-society.

"The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced." --- from the foreword of the German edition of the General Theory (1936)

"Economic narrative" is better. Economics generally serve to explain after the fact. This is why various economic theories become fashionable during certain economic macrobehaviors. This is no different than why certain investment strategies become popular right near the end of periods where they've worked well.

Agreed--I like "economic narrative" much better. I also agree that economics and its "models" massively fail to address the underlying assumptions, and working on these in a more abstract and less empirical way would be more beneficial.

I think economics has, since the 1960s or so, desperately tried to redress itself up as a science to align itself with the winning side of the two cultures. However, it is much more powerful, interesting, and probably accurate, as a humanities field. On that topic, narratives can have predictive powers too, and I think the Keynesian economic narrative has done a good job of predicting how the 2008 crisis has played out. More on that below...

For example, Keynes is popular during early recessions---enthusiasm later fades (see 1970s and 2010-forward).

https://en.wikipedia.org/wiki/2008%E2%8 ... resurgence

Neoclassical theories are popular during boom times, especially ones with new technology development and lots of entrepreneurial activity. They fade when lots of people go broke following their dumb investments. Governments are cool as long as you're the one getting them.

Totally--people like to believe whatever seems to be both most effective and most profitable at the time. In recessions, Keynesianism saves economies from the bottom. In boom times, laissez faire allows (some) people to get richer faster. This seems to say more about the failures of humanity than of Keynesianism, though.

Economic theory is very bad at predicting.

For example, Keynes said that economic stimulus should reduce unemployment and therefore it was used massively in 2008 and 2009. However, so far in 2013, unemployment is still high. Reality no longer fits the narrative.

Here's where we begin to disagree a lot. I'd say this statement belies your own prejudices and assumptions (we all have them--I do too). A fairer statement would be that we don't know how high unemployment would have been without the various QE and stimulus measures of the post-2008 world. It's possible that Keynesian stimulus did reduce unemployment--and the parallel experiences in Europe, where austerity has been aggressively pushed (and where countries like Spain have double digit unemployment) seem to suggest just that.

Our prime directors of the money system have actually been extraordinarily bad at predicting the economy. In 2006 Bernanke rejected that there was a housing crisis. In 2007 he rejected the subprime issue as the problem. In 2008 he said there wasn't an upcoming recession. In 2009 he said they wouldn't monetize the debt. In 2010 he started doing just that with QE2.

Yes, sure--but Bernanke isn't Keynes!

Then in 2012, Bernanke said this:
"As the Committee embarked on this path, we were guided by some general principles and some insightful academic work but--with the important exception of the Japanese case--limited historical experience. As a result, central bankers in the United States, and those in other advanced economies facing similar problems, have been in the process of learning by doing."
http://www.federalreserve.gov/newsevent ... 20831a.htm

In 2013 the feds came out saying that they wanted to taper the QE. They quickly "learned" that the market didn't like that, so they came out and said we're not going to be "doing" that anyway.

We don't know exactly why he said this, and I think it has a lot to do with worries about his legacy and political pressure. In fact, subsequent statements from the Fed, both from Bernanke and others, suggests that the tapering talk was premature, an attempt to get the market to shoulder some risk, and most likely not going to be fulfilled as suggested initially. (I have put my money where my mouth is on this, too.)

Fun stuff, eh... so yeah, I wouldn't exactly say that they have a theory that has been predicting the economy very well. The way I read it is that essentially: They're clueless. And if the smartest economists are clueless, what does that say for the rest of them?

Agreed, but I'd say that they've gotten it more right than the competition. Austerity has failed badly in Europe, and the predictions of the libertarian side of the debate have been woefully wrong (inflation lol).

BTW, In 2008 when I first really got interested in economics, I felt the choice before me was Austrian and Keynes. Since then, I've been looking closely at their most ardent, highest conviction predictions and judging them accordingly. I think the inflation/liquidity trap debate is really where the two have differentiated each other. And, for years now, the Keynesians have proven to be very right on this point while the Austrians are very wrong. Hence I like it as a narrative theory (if not a scientific one). For now.

Now that the econ stuff is out of the way, let me address this because I think this is where we differ the most...

@secretwealth -

If the paradox of thrift holds in the form stated, the job implication follows logically. If you don't have a job producing goods (that job would be gone due to someone not spending money), then you're devaluing the savings of everybody else. By job I mean the kind of work that has a known predictable demand. Hence, the way I combine this logically ... if the paradox of thrift is a problem, which Keynes seems to think it is, then you're obligated to have a job to prop of the value of other people's savings. If the paradox is not a problem, then you're not obligated. Do you think my logic fails?

I see your logic, but I think we're just seeing things a little differently. I see Keynesian theory as a tool to understand growth economies--whereas you seem to be saying that Keynesian theory promotes growth economies.

From my perspective, Keynesianism is just the best tool to understand how this (admittedly fucked up, especially from an environmental standpoint) capitalist system works. I spent my 20s studying philosophies that promoted better alternatives; now I'm spending my 30s just trying to understand what we're stuck with.

[workathome]

Yikes! Keynesianism, as it is currently practiced, is like a heart-attack-prone McDonalds-addict using a defibrillator to jump start is heart every few months vs getting healthier. It may seem like it feels better, but long-run results are disastrous.

[workathome]

Official broad unemployment is hovering around 15%

[secretwealth]

WAH: Yes, and U6 in Spain is at 28%. So, that 15% number again supports the likelihood of Keynesianism being a better theory for the reasons I outlined above. Also, we'd need to see a parallel universe with no QE and no bank bailouts and what unemployment would be at. Keynesianism suggests it'd be over 15%, and I see no reason not to believe that.

[dragoncar]

Our prime directors of the money system have actually been extraordinarily bad at predicting the economy. In 2006 Bernanke rejected that there was a housing crisis. In 2007 he rejected the subprime issue as the problem. In 2008 he said there wasn't an upcoming recession. In 2009 he said they wouldn't monetize the debt. In 2010 he started doing just that with QE2.

Just because a poker player tells you be has four aces doesn't mean he believes it.

[tylerrr]

@secretwealth,

Keynesian stimulus has not decreased unemployment like you said....You sound like Jay Carney reading Obama's talking points.

This lie about our "recovery" is just that.....a lie. More people than ever are working "part time" even though they're searching everywhere for good full time jobs. I've worked in IT the last 20 years and I can tell you I've never seen so many over qualified candidates with PHds and Master Degrees who simply cannot find good jobs. It's never been this bad in the job market since I've been following this stuff the last 20 years.

Printing more and more money under this Keynesian model will just devalue the currency over time and it's creating a house of cards that cannot sustain itself. I really think Ron Paul explains this pretty well and he's been preaching against this insanity for years.

I forgot to add that black unemployment has gone UP in the past few years; not down....I know you are so passionate about the American black community so I don't understand how you can support a Keynesian model that has made things WORSE for that community in the past few years?

[Spartan_Warrior]

@secretwealth: "(inflation lol)"

Hm, I just went grocery shopping the other day and paid $90 for what I'm sure was $80 of groceries last year and $70 the year before that. My health insurance premiums have increased 33% year over year since I started working. Car insurance, home insurance, electric rates, water/sewer, property taxes, and phone/internet services have also all increased far faster than "official" inflation, although of course politicians are eager to point out that laptops and LCD TVs are less expensive, and food costs haven't increased too much as long as you keep changing the formula to substitute the price of beef for the price of chicken... then chicken for hot dogs... then hot dogs for cat food. Inflation, lol? For some reason, I'm not laughing...

Which brings me to...

@dragoncar: "Just because a poker player tells you be has four aces doesn't mean he believes it."

Very well said.

[secretwealth]

@tylerr I think attempts to transform debates about econometrics into polarized political debates using talking points from pop media should be kept to an absolute minimum on this forum. I'll just say two things in response to your post:

1. Bernanke and Obama are bad Keynesians (the stimulus programs done over the past few years are too little too late and poorly administered and executed).

2. As I have already said in this thread, the bad unemployment situation we're in doesn't prove the stimulus programs ineffectual, since we don't know what unemployment would be like without them.


@S_W: Everything you cite has been rising in price since before the stimulus, so is a separate issue. My point isn't that there has been no inflation, but that the stimulus programs have not caused inflation. Each of your examples actually proves my point. The radically increasing cost of groceries began in the mid-2000s. Here's how an economist at the USDA explained it to me: Since 2006, food has gotten more expensive relative to a climb in prices overall. I'd say China has played something of a role--we've been exporting a tremendous number of commodities to China. So the rise in the demand curve without a consequent rise in the supply curve is causing higher prices--and has been doing so since before 2008. (BTW, on the topic of food, you should really avoid making up absurd examples about hot dogs and cat food--it just makes you look emotional and doesn't really help the discussion at all.)

Insurance has also been going up since well before 2008, again proving my point.

Energy? That's been going down: http://www.cnbc.com/id/100675120.

Property tax rates have been going up a lot--of course. Municipalities have seen their revenues drop due to lower home prices, foreclosures, etc. This is a result of the housing crash, not the bouts of QE.

Phone and internet services? I don't really know enough about that, but I doubt there's been a particular price spike since 2008 as a result of the QE programs. If you can demonstrate this I'd love to hear it.

So, in summation: of course some things have been going up in price, and some higher than the rate of inflation. But none of these can be traced back to the explosive growth of the monetary base which, after 5 years, has caused 0 inflation on its own. I hope you now see how a rise in inflation from other factors actually proves this point, and that it's important to determine the cause of inflation in the discussion.