The use of holistic aggregate systems as an excuse for government intervention

 

I actually believed that unlike the mainstream financial outlets in The States or elsewhere in Europe, my country would have a more grounded and unbiased picture of the state of the economy.

Unfortunately, I was mistaken. In a recent article in business.hr, there is an article named: “Do Croatian citizens have more purchasing power than their neighbors?”

“Gross domestic product (GDP) per capita in Serbia according to the criterion of purchasing power is 35 percent of EU average, it is evident from the data that was presented this week by the European statistical office Eurostat.

Among the countries of former Yugoslavia, according to Finance, Slovenia passed with 84 percent of EU average.

Lower standard than the Serbian, according to the criterion of purchasing power in Europe, were the only two countries - Bosnia and Herzegovina, with a GDP per capita last year reached 31 percent of the EU and Albania, whose GDP per capita was 34 percent of the EU average.

Among the countries of former Yugoslavia, Slovenia recorded the best result with 84 percent of EU average. This is followed by Croatia with 61 percent and better than Serbia, also last Montenegro and Macedonia.

The richest country in terms of purchasing power is Luxembourg. Luxembourg's GDP per capita in purchasing power of the criterion was 274 percent of the EU average. Followed by the Netherlands (131 percent), Austria (129 percent), Ireland (127 percent), Sweden (126 percent), Denmark (125 percent) and Germany (120 percent).

From countries outside the EU, Norway has reached 189 percent of average, 151 percent of Switzerland, Iceland 110 percent, which is considerably less than before the crisis.”

The first error in this analysis is comparing a meaningless holistic concept such as National Income and dividing it by the citizenry. It is impossible to grasp the concept such as subjective wealth, nor does it take in consideration of any discrepancy between the various differences between the groups of individuals who actually contribute to growth in societal welfare.

Second of all, it uses an ideologically bankrupt national accounting metric, called the GDP. In my view, any increase in GDP has to be incorrect because it accounts for the rise is nominal money supply that somehow adds to the nations productive structure. It doesn’t. Some would then argue, that the nominal number is deflated (removing inflation) to represent real growth. But again, this is wrong because as Ludwig von Mises stated nearly a century ago, it is the productive structure of the economy that matters, not the stock nor flow of money in the economy.

GDP is also a term that has the word “gross” in it. Because it counts the differences in inventory growth from quarter to quarter. But this is in no way gross, because it doesn’t include the nominal values of intermediary goods which are used up in the productive structure. This is omitted because it would amount to double counting. But, adding in this value would get a picture of the capital stock of the economy and the total “capital buffer” in case of rampant consumption.

The government likes to use these numbers because they can point at discrepancies between per capita GDP among nations and neighboring countries and rationalize intervention as a prelude to boosting nominal GDP. The tarnished GDP metric is closely used with the “Gini coefficient” to measure income inequality. Government sees that any discrepancy from a solely chosen arbitrary number is a pretext for meddling and redistribution. If that doesn’t work, they try to figure some other holistic form of gauging the wealth of nations, such as the HDI or the “happiness” index. Trying to correlate happiness by weighting certain variables in a model such as the number of vacation days in a year, number of children in the family or the marginal difference in taxation between different income groups is futile. According to the HDI, Ireland was called developed because it had a 0,959, which is excellent, until their economy crashed and it fell to 0,908. Even though it is a high number, how does a bailout of the banking system funded by taxpayer austerity amount to a high HDI?

Maybe if the government would stop deficit financing through monetary expansion and wasteful resource allocation, it would see that the market in its own virtue, distributes income to individuals who are rewarded serving the consumer.

The difference between the effects of a legitimate default on a loan issued by an inflationary banking system and a noninflationary banking system

 

When trying to differentiate the positive from the negative impacts of modern banking on todays complex economy, we have to understand the mechanics behind the process itself. And by process, I mean the way the intermediary institution of banking operates.

We shall, first of all, separate two very distinct, but in the evolutionary banking process, blurred phenomena. One is deposit banking and the other loan banking. Well shall focus only on loan banking. Deposit banking is the art of safekeeping ones possession. In this case, the possession is money. In loan banking, the accumulated funds are loaned out of the bank to an entrepreneurial endeavor.

In this second case, funds are shifted from the saver to the lender, leaving the bank for an agreed upon time. In any case, these funds that leave the bank cannot be redeemed at any time at their nominal value. The funds shall be relinquished only after the term of the saved funds at interest only if the mirror image of the savings – the loan, is to be returned to the bank. The bank is rewarded for its services as an intermediary and the saver is rewarded with additional purchasing power with which he/she can purchase additional goods and services (more than if the saved funds were consumed at the beginning).

The question we pose is: What happens when the entrepreneur defaults on his loan in an inflationary banking system, and one in an noninflationary banking system?

In the first case, diverted funds which are legitimately loaned out. What this means is that funds are diverted from legitimate savings and NOT from deposits which are redeemable on par. If for example, these funds are saved for a 3 year period and loaned out for exactly the same period, the money supply hasn’t expanded nor contracted. It remains the same, just the term structure of accumulated resources are utilized in a different manner. If the entrepreneur overestimates his future revenue stream, he is in trouble, and unable to return the loan. In this case, any capital goods that are diverted to his/her project will be lost as they do not successfully fulfill the consumer demands along the structure of production.

These capital goods, to be of any use must be firstly liquidated to have any meaningful purpose. This usually involves high conversion costs, trapped idle resources and a lower standard of living. The lower standard of living is reflected in higher nominal wages as the funds flow back to the stage of production closest to consumption. With more units of exchange a deficient amount of goods can be purchased to satisfy greater desires, as the resources are trapped (momentarily or permanently) in useless lines of production. Society does get poorer in this case, but there is NO business cycle, NO contraction in the money supply.

The second case is when the commercial banks flush with excess reserves from the central bank decide to expand demand deposits in the economy, by pyramiding on a fraction of cash deposits. This exerts an artificial impact on the economy’s structure of production. An inflationary loan adds “shadow” savings in the economy as a fake euphoria (optimism) enters the economy. Capital goods rise in price as well as the general price level, and unlike the previous example, inflation exerts its negative influence on the productive structure. A loan that defaults in this sort of environment will exert a negative cascading effect on the entire economy, because, just as easily as new loans are brought into existence through credit expansion, the elasticity of the money supply reverses and collapses in on itself leaving a POORER capital structure than before. The loan itself will default if not for an ever accelerated dose of monetary expansion than before. If it happens sooner than later, not only will their be losses on the created loan, but a depleted capital structure as capital consumption is also experienced as the malinvestments are worked through.

This is a rough exposé of what happens in different systems. To fully understand this process is to thoroughly grasp capital theory and the impact of credit expansion on intertemporal preferences among the various economic actors. I would suggest reading Jesus Huerta de Soto’s masterpiece – Money, Credit and Business Cycles and for a short treatment of this subject:  A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis by Joseph Salerno.

Two wrongs don’t make a right

 

The following excerpt is from Euro Pacific Capital’s website and is authored by Peter Schiff.

Peter is one of the few CEO’s and respected businessmen in the financial spectrum who correctly called the housing collapse and testified on a Senate subcommittee regarding additional loan guarantees provided by the FHA for multifamily housing. The following can also be found as a video clip on Youtube.

“I was invited to testify about the Federal Housing Administration's (FHA) policy in the apartment lending market. Although this was a fairly narrow issue, I told the congressmen the same thing I did last year when I was invited by a different subcommittee to testify about job creation: government programs don't solve problems, they just create new ones. While I thank the Committee for inviting me, I believe the congressmen may have gotten more than they bargained for. […]

The subcommittee was considering whether to expand the activity of the FHA to insure loans for multi-family (apartment) buildings. The mechanism to achieve this was to extend FHA guarantees to pools of collateralized mortgages backed by multi-family residential housing units.

I have absolutely no objection to the idea that a healthy rental housing market is needed. However, I believe that market forces are sufficient by themselves to create it. The average American family now only has $7,000 worth of savings, which would not be nearly enough to afford a 20% down payment on the average American house. This means that most Americans should be renters and not owners. […]

Normally, these simple facts would attract investment capital to build affordable rental properties. However, these forces have been blunted by Federal tax and housing policies that have exaggerated the economic benefits of home ownership and have drawn excessive amounts of investment capital into that sector. To correct the distortions, the Subcommittee was considering, you guessed it, more distortive regulations. It never occurred to them to simply scale back the original regulations that are the root of the problem.”

Government officials liken the idea that whenever there is a problem that cannot be serviced immediately by the free market, they have to jump in and make a utter and complete mess regarding the “apparent” problem at hand.