The Business Cycle Theory - Economics

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The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
RobbyG wrote: On the other hand, if mankind would finally evolve from warmongering idiots to freedom embracing nations, then we might see Libertarian thoughts develop the world to one giant economic engine with free trade, no protectionism, no war, cultural diversity, tolerance, property rights, international justice system etc.

Thats my utopia. Its a view, further enhanced with the benefits of Capitalism and Socialism, purely by motivating human contribution to society, without subsidies and central planning. Its a decentralized vision with the optimum use of scarce resources available on our planet. Near absolute efficiency.

Perhaps I'll write an essay about this one day. :wink:


He-he, Your Utopia reminds me Anarchism. Anarchia is a mother of order?


Rather limited government. Just enough to enforce limited regulations needed to protect the consumer and for defensive measures of the nation. So no big warmachine or military industrial complex.

Simply all resources aimed at improving society by eliminating big government, fraud and abuse, misallocation of capital and scarce resources. That is what I consider to be the role of government in a free market capitalist economy with a human mindset based on Libertarian thinking, like the ones of Ron Paul, as an example.

Ludwig von Mises was a great thinker in Liberty and individual freedom. Same with Friedrich Hayek and Murray Rothbard. I also like some views from Milton Friedman and Ayn Rand. http://www.mises.org.

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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
RobbyG wrote:Same with Friedrich Hayek and Murray Rothbard. I also like some views from Milton Friedman and Ayn Rand.

Wow, So well-known faces. As far as I understand, Anglo-American World has lived reading every single word of their economic theories and was rearranged according to their templates. Margaret Tatcher declared love to them.

Your Utopia has just come in reality as anti-Utopia. It's pretty common for any Utopia. :lol:


Hold there. Important point you make.

In our current capitalist system we kept hanging on the opposite figure of Friedrich Hayek. Namely, John Maynard Keynes. Hence the use Keynesianism.
Nearly every study book you read about economics in Universities accross the globe, including ivey league Harvard, Yale and Princetons, are based on the econimc thoughts in the book written by J.M. Keynes in 1936. 'The General Theory of Employment, Interest and Money'.
This theory might have worked nice after WWII, but was incomplete and nothing useful when government debt levels are too high, as is happening in the developed world today.

Friedrich Hayek was the utter opposite of Keynes, as his economic theory was based on the Austrian school of economics. Nobody listened to this guy back then. He said:
No stimulus efforts to revive an economy as this leads to misallocation of capital and resources from productive sources in the private sector to government created jobs, which costs way more to sustain. Its the boom that causes the problem, not the bust. The bust is merely the correction, a purging of malinvestment and overcapacity from the system. Milton Friedman even showed that the Great depression was prolonged because of government intervention and trade barriers during the 1930's.

This is not Utopia. Its real. The only utopia I hold is a peaceful world. The free market system is viable and mostly in place today as long as government stays out of the the market and merely focusses on fraud and abuse, defensive measures and consumer protection. Then its job is complete.

The private sector creates viable jobs and allocates efficiently. That is where economic growth comes from. Nothing else.
The role of government is to protect and serve, but in a very limited size as it takes more resources away from the private sector to function when it grows bigger. Then government becomes a drag on economic growth.
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
RobbyG wrote:The free market system is viable and mostly in place today as long as government stays out of the the market and merely focusses on fraud and abuse, defensive measures and consumer protection. Then its job is complete.

The private sector creates viable jobs and allocates efficiently. That is where economic growth comes from. Nothing else.
The role of government is to protect and serve, but in a very limited size as it takes more resources away from the private sector to function when it grows bigger. Then government becomes a drag on economic growth.


I read the books of both authors but it looks like that both approaches has proven their inefficiency in real World.


In my view, the approach of Friedrich Hayek has never been implemented in a broad measure. There is no level playing field, so we are bound to have protectionism and trade barriers, so that one nations benefits and the other loses. There has to be more free trade without government intervention on monetary policy. Interest rates need to be set by the market, not by Federal Authority like the FED. Thats the problem of booms, followed by the natural reaction, the bust.

I've explained my view about the FED involvement in the private sector here, by addressing the monetary policy of the US, from here on and downwards in the topic:
dubai-politics-talk/iran-shooting-itself-the-foot-doing-this-t40668-60.html#p329033

I recommend you read that and give your view about that, Chief. :idea:

In my view, China is the cause of last crisises in 1997/8 in SE Asia/Russia and last global one. It proves a simple idea of Karl Marx, that sustainable growth without development of real sector is not possible.


Interesting, can you explain more about that view?

With launching such a big disturbance as China, economic system became open, but all theories was developed for closed systems. The government incentives for cars in US came to the coffers of Toyota and another Japs. More globaly stimulating demand increses import (read better for China) instead of creating new jobs in homecountries.

On the other hand, Anglo-American World tried to save financial sectors but eventually understood that beeing survived the sector don't invest money to the real one.


I agree with what you are saying. The US got rid of financial regulation (deregulation) during the 90's and let the private sector have its way. Now the financial services sector in the US is 15 procent of total GDP, which is way to large for people who only shift paper rents from table to table, without manufacturing real products for export.

Now this bailout of the financial system is nothing but damaging to the real economy, because taxpayers need to pay for public debt from increased taxes. This is so non-productive policy. Doesn't make sense.
It does make sense for a bunch of crooks politicians who want to be reelected by bailing out their special interest who finance their campaign with contributions, I mean WallStreet and the Big Three automakers and its worker unions.

But this is not capitalism! This is corporate cronyism. Capitalism is based on the premise of creative destruction. Companies with good management and prudent standards need to be rewarded with increased market share, while bad managed companies need to go bankrupt. That is totally defied now by government policy. And those 'US central planners' now think they can revive the private sector by lowering interest rates to zero so to keeps banks solvent and hope to see loans flowing to the real economy, preferably the consumer /retail industry which is 70 percent of US GDP. MADNESS. Never gonna work.

Same mistake that Franklin D. Roosevelt made by continuing and expanding the Hoover stimulus programs during the Great Depression. They hope to increase spending from renewed aggregate demand, but they use borrowings from domestic or foreign lenders, who otherwise would be investing in the organic growth of the private sector. Now government redirects those funds into non-viable and expensive government projects. Again, so unproductive.

What the US does is just insane. I know the financial system had to be saved to keep the interbank lending market open, so wages could be paid when liquidity dried up in 2008. But a bailout with no serious strings attached, while totally ignoring the average citizen is just plain wrong. It shows how wrong the US system really is. Politics in the US is corrupt and the people there know it. There is no difference in the two party system, although the media appears it to be so. No words for what happened in the US.

Jobs exported to China and India, US manufacturing sector is depleted, only thing left is the technology sector and a bunch of multimillionaire paper money shifters in the financial services sector and a 12.5 Trillion dollar national debtload, approaching 90 percent of a 14 Trillion dollar economy, not even mentioning the unfunded liabilities arising from Social Security, Medicaid, Medicare totalling 65 Trillion dollars, or 500 percent of US GDP.

Just insane.
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Friedrich Hayek was the utter opposite of Keynes, as his economic theory was based on the Austrian school of economics. Nobody listened to this guy back then.


A nice jolly rap video, explaining these two opposite economists:
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Re: The Business Cycle Theory - Economics Mar 17, 2010
shafique wrote:That's a cool video!


A quick question - and I apologise for the tangent - but shouldn't true free-market liberals argue that interest rates and exchange rates be set by the market? If both are free floating, then the market will decide where to invest etc?

Cheers,
Shafique


Thats basically what I'm proposing following the thoughts of Friedrich Hayek, along with the entire Austrian school of economic thought. :wink:
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
RobbyG wrote: a bunch of crooks politicians who want to be reelected by bailing out their special interest who finance their campaign with contributions, I mean WallStreet and the Big Three automakers and its worker unions.

But this is not capitalism! This is corporate cronyism. Capitalism is based on the premise of creative destruction. Companies with good management and prudent standards need to be rewarded with increased market share, while bad managed companies need to go bankrupt. That is totally defied now by government policy. And those 'US central planners' now think they can revive the private sector by lowering interest rates to zero so to keeps banks solvent and hope to see loans flowing to the real economy, preferably the consumer /retail industry which is 70 percent of US GDP. MADNESS. Never gonna work.


He-he, after destruction of ineffective real economy by Tatcher the UK financial sector accounts for 30% of GDP, but whole service one contrubutes 76% to GDP there.

It's not about poor management but about full destruction of most industries (automative for instance) as non-competitive. If governments remove trading bars almost 100% of industry will be shifted to China in a very short period.


If governments removed the trading barriers earlier on, then the Big Three would have understood much earlier that their business model was unviable. If protectionism was absent, then GM would have been restructured already, losing some jobs more slowly and the sector would transform itself over a decade or so. But now, suddenly the real truth becomes obvious! They didn't specialize their product lines. They didn't innovate fast enough with Toyota and Nissan. Look what happened! Tens of thousands of layoffs in the automotive industry and related aftermarket suppliers, not gradually, but instant!

As an industry, the big three were simply aiming at production numbers while reneging on product innovation while oil prices remained low. Only because oil prices remained low until 2000, were they able to continue with the gazzguzzlers. In Europe we have taxes on fuel. So that companies are incentived by a thrift consumer. So the automakers like BMW, Mercedes and Opel did listen to the changing market circumstances. Same with Ford, who had a huge customer base in Europe and now shows to be the most viable Car manufacturer in the US, if we focus on the Big Three, namely: General Motors, Chrysler and Ford.

So, opening trade barriers is good, since it keeps an industry alert and innovative. GM and Chrysler have been sleeping for 2 decades and living on government bailouts. Now they have a huge problem with labor Unions who are staggering because the wages need to come down to make the business viable again. At least in Europe they have the better incentives in the market place, although alot of it is still subsidized.

The solution in the developed world is to eliminate trade barriers and minimum (sticky) wages. Wages need to be dynamic, following the market demand of labor and products. Unfortunately, the reality will one day come in the form of more and more market share being lost to the emerging markets. It requires alot of adjustments from current day social welfare systems. Those are not viable in the long run. Europe is going to get real issues with sticky wages in the future. Guaranteed that reform is needed.

Just look at the workers that are jumping to get onto the global bandwagon, from the former soviet satelites, Eastern Europe, Asia and Pacific. All willing to work for 10 times less than a high paid European and American.

You can stop this short with trade barriers, but in the end, you'll lose either way. Innovation lets you keep the edge. Denial never worked. :P
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:Well, Rob. If you wish let's emphasize on von Hayek.

I read only one book of the author "The Road to Serfdom". Of cause it's a pamphlet, but many his ideas are there. To be franck his arguments both with Marx and Keynes are not convincing.

In my view, there are some weeknesses:
1) No interest to demand. Demand=supply.

According to Marx capitalist always tries to minimize expenses, including wages, but in this case who will buy products as the main difference of this crunch from previous one that the main driver of economy is mass demand nowadays? In contrast, in XIX century and at the beginning of XX century lives of workers were pretty basic and consumption of upper classes defined economy.


I've read 'The Road to Serfdom' also, so we have something to talk about. Its a very good introduction to his views indeed.

Let me quote Hayek for you as this basically answers your question:
One argument frequently heard is that the complexity of modern civilization creates new problems with which we cannot hope to deal effectively except by central planning. This argument is based upon a complete misapprehension of the working of competition. The very complexity of modern conditions makes competition the only method by which a coordination of affairs can be adequately achieved.

There would be no difficulty about efficient control or planning were conditions so simple that a single person or board could effectively survey all the facts. But as the factors which have to be taken into account become numerous and complex, no one centre can keep track of them. The constantly changing conditions of demand and supply of different commodities can never be fully known or quickly enough disseminated by any one centre.

Under competition - and under no other economic order - the price system automatically records all the relevant data. Entrepreneurs, by watching the movement of comparatively few prices, as an engineer watching a few dials, can adjust their activities to those of their fellow entrepreneurs.


In conclusion: Solving the economic problem, by decentralization plus automatic coordination through the price system, is the best possible solution. The method of central planning/direction is incredibly clumsy, primitive and limited of scope i.e. very inefficient in allocating resources.

2) Model of Hayek assumes absolutely flexible wages or salaries of employees, but most of them are united in trade unions which signed collective agreement with employers.


Most of the time, monopolies exist only because government policy supports this. When monopolies are created, small companies have a problem with obtaining market share due to price agreements between monopolies as in cartels. This needs to be reversed.
If monopolies do exist, then profits are increasingly growing for these companies, which in turn will require labor unions to demand higher wages. So when a government allows monopolies to exist, then you must allow labor unions for workers to demand equal pay and benefits too.

Of course, this is all leading to exploitation and profiteering and the size of these companies make them sluggish and less capable to react to market demand, leaving the consumer with higher prices for less desirable products. So the solution is to erradicate and fight monopolies. Without monopolies there is no need for labour unions and prices, wages will be dynamicly set by the market.

Moreover, majority of people has loans and if their income drops drastically due to crisis they imediately go bancrupt. One author calls it "privatised Keynesism": the situation when ordinary people (instead of government) take the huge debt and then suffer the most in crisis.


Well, it is obvious that privitization requires personal responsibility, together with the added benefits of personal freedom of choice. Everything comes at a price.

So when people take huge loans and can't pay them off, the same rule of law applies for companies that behave badly, resulting in bankruptcy. Everybody is treated equal, when making equal mistakes. So you have to be informed to make good choices, be able to pay your loans and government can guide this process by some consumer protection law, which requires the lender to inform you about costs and potential pittfalls.

Not everybody makes good decisions, and that is what capitalism is build upon. Creative destruction. The people with smart decisions thrive while the people with bad decisions dive. A rule of law can acquit you from (part) of your liabilities. For that we have Western style bankruptcy codes and laws.

Not in Sharia law of course, since your individual liberty would be taken away from you in jail. The highest price one can pay.

I partly agree that it's not only weekness of theory but rather its practical realisation. The situation was defined by artificial stimulation of demand. Low interest rate was the main driver. It isn't sustainable.


The theory can be debated, but realistically we have issues with governments that are not aligned in one level playing field. Protectionism is a problem. E.g. China is centrally planned and unwilling to let its currency float to market rates, artificially lowering its Yuan (RMB) exchange rate to keep manufacturing exports higher than the market would set it. China is too much focussed on trade surplus, while not increasing the domestic consumption and purchasing power accordingly. Thats why the US wants China to revalue the Yuan (RMB), but China has a different plans. Its not a free market world economy. This invokes other governments to introduce trade barriers to protect and maximizing its own interests. So there is no laissez faire situation. Just marginally.
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Re: The Business Cycle Theory - Economics Mar 17, 2010
by shafique » 15 Mar 2010, 13:27

Just a quick aside for you RobbyG concerning the Shariah law comment - under Shariah, the principle is that leniency is shown to the borrower by default - the loan is only repayable if the borrower can afford to pay back and the risk of default lies squarely with the lender - hence it encourages responsible lending. Coupled with the fact no interest can be charged, the lender needs to make doubly sure that the loan will be repaid by only giving to worthy lenders.

This is distinct from investments instead of loans - there the returns in form of profit share/dividends does give a return, and the risk of default or loss of investment is also shared.

Thinking that Dubai's laws are Shariah compliant when they operate in an environment which isn't Shariah compliant (interest bearing loans - even the 'Islamic' ones) is a common misconception. The harsh debtors law is more a reflection of the generally lax other economic structures here.

However, - that's just an aside - please go back to Hayek etc. This is genuinely new to me and most interesting.

Cheers,
Shafique


I agree with the above, but the reality from the newspapers is clear to me. A debtor gets jailed until balance is renegotiated or repaid. Now, how on earth can you work or cover your other obligations and liabilities while in jail?

Doesn't make sense to me.
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
RobbyG wrote:In conclusion: Solving the economic problem, by decentralization plus automatic coordination through the price system, is the best possible solution. The method of central planning/direction is incredibly clumsy, primitive and limited of scope i.e. very inefficient in allocating resources.


I didn't say anything about central planning. Well... Let me drop it.


I know, but I was quoting from Hayek's 'the Road to Serfdom'. Which basically argues against central planning and favors the price system also known as the free market place.

"Automatic coordination through the price system" is rather baseless assumption. I like how Maynard Keynes argue with it in his great book. Man is not about current day, but future. Everybody tries to predict something and wait something. On the other hand it's absolutely true that nobody can take into account all factors. So "correction" requeres time (inertia) because due to boom period everybody is planning from current achivement and so "the correction" could be painful and even deadful for whole economy. The growth is gradual but downfall is sharp.

In broader view, I think, the nature of any industry, which based on credits, is constant expansion. As it's not possible infinitely, wars are required to cut capasities. WWII is a good example.


Are you serious Chief! Wars are required! Thats just crazy you imperialist! :D

I guess you are still struggling with how credit becomes available in society, which is by savings. How else did we manage under the gold standard for so long? With periods of moderate inflation and deflation, the cyclical effect of the flow of capital.

When people work and save money at the bank, they get paid interest. The bank lends those funds to a creditworthy borrower. This way loans (preferably not leveraged) will find its way into the real economy into manufacturing and other investments. Eventually the loans is paid off over time, 5 years, 10 or 30 years. And the bank earns a return on investment, together with the saver at the bank, for storing his money with the bank.

In Europe, the initial idea of credit expansion was to limit the total money supply (M3 measure) by the same increase in population, namely 3 percent a year. In hindsight, since the start of the EMU currency union, the expansion of credit was so large that the total money supply increased 9.1 percent on average per year since 1999!
Thats all bank leveraged loans and inflation. And the workers in the real economy keep fighting for a few percent a year in higher wages. So the entire problem of inflation is caused by fractional reserve banking. You see?

Well, it is obvious that privitization requires personal responsibility, together with the added benefits of personal freedom of choice. Everything comes at a price.

So when people take huge loans and can't pay them off, the same rule of law applies for companies that behave badly, resulting in bankruptcy. Everybody is treated equal, when making equal mistakes. So you have to be informed to make good choices, be able to pay your loans and government can guide this process by some consumer protection law, which requires the lender to inform you about costs and potential pittfalls.


Well... Here we go... If you take loan for a cottege for 15-25 years for instance, what do you have in mind? You cannot estimate possible 20-30% unimployment rate in the country after 10 years. Nobody is able to estimate such a "potential" risk.

Is the most reasonable behavior rejecting long loans at all?

In conclusion, I must say that you count credits as something insignificant but it's the central part of economy.


Chief, perhaps you should read how money circulates through the system. Perhaps that makes it more clear to you how the inflated boom cycle can be avoided, so that loans (credit) will never be leveraged high enough to go bad in a market correction (recession). It will be more gradual and transient without fractional reserve banking.
Below I added my response to a discussion I had with Shafique about Fed policy and interest rates.

Let me clear my view about money and interest rates with an analogy.


Lets visualize a room with a fixed (inelastic) amount of money, like in a gold standard. The room has four corners, each representing a part of the economy. So lets say that in one corner of the room, some entrepreneur discovers an oil field. Suddenly investors start investing in that booming corner, resulting in a rising asset price, called inflation.
At the same time, money has to come from other parts of the room, so in those corners where money moves out there is per definition (some) deflation.

A room based on fractional reserve banking is a room with a money printer in its center, controlled by Ben Bernanke, setting interest rates at which banks can loan money from the FED.
In an economy (room) based on fractional reserve banking, there is the possiblity of leverage. So when an entrepreneur needs a loan for his oil company investments, he borrows $100.000 from his communal bank. The bank asks for a collateral (a deposit, or a claim on his oil company assets) and determines the interest rate based on the risk it sees with the borrower.
When the entrepreneur (the investor) buys goods and services for his oil company, he electronically pays a counterparty the $100.000, thus creating a new deposit at the (same or another) bank. The banks are allowed by the regulatory body (FED) to leverage at a maximum of e.g. 12:1. Therefore, the second bank has to keep $8333 at the FED in order to be able to lend out the difference of $100.000 minus $8333 which is a loan amount of $91.666 for someone else. So each time, money is created, with little collateral at the bank.

So fractional reserve banking goes well when the investment prices keep rising (inflation) but this reverses when price levels continue to decline (deflation). This results in margin calls and bigger loan-loss facilities to keep the banks solvent (assets to liabilities ratio). The company can also go bankrupt when it defaults on its interest paying obligations (e.g. because oil revenues decline) and the investor loses his money.

With deflation, the amount of money in circulation decreases (since credit is destroyed as loans go bad) and less money in circulation chasing the same amount of goods means a stronger currency (if the room has no doors open and money doesn't flow out to other rooms as in other countries). For a creditor, who has savings at the bank, this is great as his purchasing power increases. But for a debtor, who carries a loan amount, inflation will erode his obligations away over time, but the oppossite happens when deflation occurs. After all, his nominal loan amount still has to be paid off.

So once you are locked in debt and inflation decreases (disinflation) or even turns negative, as in deflation, then you have a hard time working your way out of debt. So people and businesses, but also politicians, like inflation as it erodes debt obligations over time.

But your recommendation was to install negative interest rates. So what that means is that the FED is not charging interest to banks to obtain money, but now it needs to pay! the banks money to get their money from the FED. Also, that would mean that you and I are going to get paid interest for loaning money FROM the bank while at the same time the savers who deposit money at the bank for interest, will have to pay the bank! for storing their money at the bank! That doesn't make sense from a capitalist perspective. After all, you want your efforts aimed at improving your personal situation. And when banks can't attract savings capital to lend out, then the economy stops functioning.

So negative interest rates won't work as a solution. The problem is credit creation through fractional reserve banking. Lower gearing ratio's are needed, but if you do it at once, the system would collapse immediately as all banks would be insolvent. As a matter of fact, most banks ARE insolvent, were it not for the FED and ECB to spray money in the economy for practically zero interest rates.

The situation we have today, in the world, is that the private sector is contracting and repaying its huge debtload, while monetary authorities are printing money like madmen to counter that deflationary force of credit contraction. So in a dynamic situation as our global economy, that means huge volatility in markets. Prices go up and down and essentially this means that with near zero interest rates, the markets are incapable of determining value and pricing the assets. After all, with so much money being printed, when that money finds its way from the banking sector into loans on the ground (real economy) then you would have exploding prices, as in hyperinflation.

The only force that keeps that development at bay is the private sector, which is deleveraging by repaying debt loads and behaving rationally. The one body that causes these disturbances is the FED who sets interest rates and hereby supplies the wrong incentives to the market place.

To give an analogy of people as in the amount of money, consider the following:

You own a restaurant in your small town. Each year you get a little more customers in organic population growth, say 3 percent. Suddenly a Circus comes to town without your knowledge, and you get a huge increase of customers so you expand. You build an additional section to your restaurant with a loan from the bank to cope with the increased demand for your services. Suddenly the Circus moves out. Now you overinvested and the market returns to normal. You were given the wrong incentives to expand your business.

Wallstreet got drunk because the FED lowered the cost for obtaining the punchbowl. Same happens in the rest of the economy. Interest rates must be higher to be able for businesses to respond rationally and to determine value over the long run.

Negative interest rates are not a solution. Capitalism doesn't work that way.
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Re: The Business Cycle Theory - Economics Mar 17, 2010
RobbyG wrote:
Are you serious Chief! Wars are required! Thats just crazy you imperialist!

When people work and save money at the bank, they get paid interest. The bank lends those funds to a creditworthy borrower. This way loans (preferably not leveraged) will find its way into the real economy into manufacturing and other investments. Eventually the loans is paid off over time, 5 years, 10 or 30 years. And the bank earns a return on investment, together with the saver at the bank, for storing his money with the bank.



Chief replied:
Thank you, Rob. You opened my eyes. I was blind before and guessed that if people live in credit they don't have savings at all. Some of my former countrymen in US drive Lexus but $20K in cash is beyond their imagination. I also thought that huge profit that some companies generated (it's slightly another money than working people's savings) during boom but cannot reinvest to the own company due to finite demand is also make pressure on financial market. The money was so huge but there were no place to reinvest that some bankers desided that even beggars should have a cottege (sub-prime).

My question is: "Where did you find those average Americans?"
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:
My question is: "Where did you find those average Americans?"


There is an easy answer to that; There aren't many average saving Americans left....

The US budget for 2010 is calculated to be 3.5 Trillion dollars. Only approx. 2.3 Trillion is obtained by tax revenues etc, the rest of the government budget is borrowed from two sources, either domestic savings or foreign savings, namely China, Japan and Saudi Arabia and India (the largest US creditors). Also known as US internal debt and external debt.

So the US is the best example how you should not borrow your way into oblivion, while exporting your producing jobs overseas. As a nation, you couldn't do any worse than what George W. Bush did in the last decade. Prudence is key.

EDIT: And with a fiat currency system like the globally accepted dollar (for now) if the US fails to attract capital from domestic and/or foreign savings pools, then you have to resort to: monetization.

Its called a printing press, in modern days, its an electronic input on a simple computer at the Federal Reserve. Money creation out of thin air, costs even less than printing it on paper. Saves the forest also. No pun intended. ;)
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Red Chief wrote:Well, in this case which coutries were you writing about?

I guess that Anglo-American World is quite different from Europe. Or the difference is negligible?


Look Chief, there is an easy measure to see if a country's economy is sound. Just look at the current account balance, also known as the balance of trade. Exports minus Imports = surplus

The US runs trade deficits of around 40 billion dollars a month. Multiply by 12 and on a yearly basis they import 480 billion dollars more than they export. If you do that for a decade, you are undermining your economy. Fake economic growth is only possible by inflation and debasing the currency to erode the national debt. Didn't you notice that the dollar is in a structural bear market slide for some time now?

The entire Western developed world is loaded with debt, so reasonably said, we are f@ckd. Growth is done, so we in the West are going to monetize alot of debt and/or save (the prudent thing) away our debt over the next decade or so. Think Japan. The deflation and economic stagnation that Japan experiences for over 2 decades now is the direction we are heading too. All Keynesian errors all over again.

We need structural reform, but those academic puppets at the most important monetary body in the world, the FED, are all Keynesians. They think in academic models and figures and basically live in an ivory tower. Bernanke and Geithner haven't even worked in the private sector before. What do they know about the business cycle. They only know to find the handle of the printing press, debasing a currency to oblivion.

So get your canned food, buy some physical gold and buy a nice cottage somewhere in Siberia, where you are selfsustaining, grow your veggies and stuff, cause this world is going to be painfully nasty in the decade ahead. Following the American imperialist planners, we probably have another war in the ME coming with Iran. History has showed us many times before that a government goes to war to distract the people's attention from the issues at home.

Oh and buy some jodium pills. We might go nuclear and viral this time. :wink:
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Re: The Business Cycle Theory - Economics Mar 17, 2010
See US Debt Clock in real time >>> http://www.usdebtclock.org/

Image

The financial bomb.
RobbyG
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Re: The Business Cycle Theory - Economics Mar 17, 2010
Ok - that's my reading sorted out for tomorrow morning then! ;)

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Shafique
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Re: The Business Cycle Theory - Economics Mar 18, 2010
RobbyG wrote:Now this bailout of the financial system is nothing but damaging to the real economy, because taxpayers need to pay for public debt from increased taxes. This is so non-productive policy. Doesn't make sense.
It does make sense for a bunch of crooks politicians who want to be reelected by bailing out their special interest who finance their campaign with contributions, I mean WallStreet and the Big Three automakers and its worker unions.

But this is not capitalism! This is corporate cronyism. ...

Jobs exported to China and India, US manufacturing sector is depleted, only thing left is the technology sector and a bunch of multimillionaire paper money shifters in the financial services sector and a 12.5 Trillion dollar national debtload, approaching 90 percent of a 14 Trillion dollar economy, not even mentioning the unfunded liabilities arising from Social Security, Medicaid, Medicare totalling 65 Trillion dollars, or 500 percent of US GDP.

Just insane.



Thanks, I had a more leisurely read through the posts.

I have to say, I pretty much agree with your assessment and views here. I'd perhaps use some different labels, but would indeed be denouncing the bad aspects of 'corporate cronyism' as you put it - but then I'd argue I'd be using the labels attached to that system by society (arguably 'free market capitalism').

That aside, the logic is sound and actually accords with my views.

I've argued that:
Trade should be real, liquidity should be there to facilitate trade - but underpinned by real assets. Returns on capital should reflect the results of investments and not be divorced from the circumstances of the 'borrower'/recipient of capital.

This gets rid of speculative bubbles which are hyper-inflated by leverage and also restrains irresponsible lending (as the risk of default lies largely on the lender).

(This is my reasoning for advocating no interest rates but a tax on unused capital - which will encourage investments and profit sharing rather than mortgages/loans/bonds paying interest)

Now, in the real world - what's your view that the jurisdictions that had more stringent Government control/regulation over financial institutions (primarily banks, and investment banks in particular) came out of the crisis relatively unaffected. I'm thinking of Canada, South Africa, Lebanon - and even Spain (IIRC) - where does this type of regulation fit in with Hayek's theories?

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Shafique
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Re: The Business Cycle Theory - Economics Mar 18, 2010
shafique wrote:Thanks, I had a more leisurely read through the posts.

I have to say, I pretty much agree with your assessment and views here. I'd perhaps use some different labels, but would indeed be denouncing the bad aspects of 'corporate cronyism' as you put it - but then I'd argue I'd be using the labels attached to that system by society (arguably 'free market capitalism').


The common misconception.

That aside, the logic is sound and actually accords with my views.

I've argued that:
Trade should be real, liquidity should be there to facilitate trade - but underpinned by real assets. Returns on capital should reflect the results of investments and not be divorced from the circumstances of the 'borrower'/recipient of capital.

This gets rid of speculative bubbles which are hyper-inflated by leverage and also restrains irresponsible lending (as the risk of default lies largely on the lender).


Indeed, risk and return need to be transparant and traceable to the lender/borrower.

The securitization that happened on WallStreet by turning pools of MBS's, HEL's into of CDO's, CMO's, ABS etc were misleading. I've read a book on how those mortgage pools (e.g. 1 billion of MBS) were sliced and diced into tranches of seniority, and how lower quality mortgage tranches were fed to investment bank top lawyers so to structure them ready for the rating agencies who label them with sovereign status (AAA) or mezanine (AA). As soon as these products were sold, the risk was off the books. Its pure fraud in my opinion.

MBS = Mortgage-Backed Securities, and the universe of MBS is vast, it is however reserved by market participants to denote the pass-through mortgage bonds (agency pass-through and nonagency pass-through).

CMBS = Commercial Mortgage-Backed Securities, which are trust certificates (bonds) backed by a pool of commercial mortgage loans. The certificates are tranched on the basis of prepayment and credit.

CMO = Collateralized Mortgage-backed Obligations, which are pool of pass-through mortgage bonds tranched to reflect the degree of sensitivity to prepayment (particularly, agency CMO).

ABS = Asset Backed Securities, for example home equity loans (HEL), credit cards, etc. These are securities backed by receivables [payments] that are either secured (HEL) or unsecured (credit card), tranched on the basis of prepayment and default risks.

CDO = Collateralized Debt Obligation, for example, ABS CDO which consist of a portfolio of different ABS bonds, and the payments to the holders of these trust certificates are derived from the cash flows of the ABS bonds.

CBO = Collateralized Bond Obligation, for example high yield [emerging market] CBO which consist of a portfolio of different high yield [emerging market] bonds.

CLO = Collateralized [leveraged] Loan Obligation which consist of a portfolio of different leveraged loans.


(This is my reasoning for advocating no interest rates but a tax on unused capital - which will encourage investments and profit sharing rather than mortgages/loans/bonds paying interest)


The abundance of capital in the markets, by obligation more or less, will also lead to inflation in my opinion. Liquidity is good, but constantly encouraging investments makes risk taking go sky high, after all, everybody is trying to get into the same high-yield trade then, to get the best return and outrun inflation.

People should have a choice of keeping money where they see its fit. Either accruing interest or by other investments. Governments already steal your money by creating inflation. Lets not encourage more risk taking on a personal level with no interest on your bank deposits. If you want to encourage the capital to work, go put your money into Goldman Sachs and let them find you a higher return, over the back of someone else. :!:

Now, in the real world - what's your view that the jurisdictions that had more stringent Government control/regulation over financial institutions (primarily banks, and investment banks in particular) came out of the crisis relatively unaffected. I'm thinking of Canada, South Africa, Lebanon - and even Spain (IIRC) - where does this type of regulation fit in with Hayek's theories?

Cheers,
Shafique


This is the real world Shaffy! You think I'm daydreaming here? :D

I don't agree with your premise. Problem we have at major financial centers is the absence of good regulation. The less regulation a country implements, the higher the returns can be, so (investment) banks have an interest to move out to low regulatory locations.

Since the 1990's, during the Clinton adminstration, under willingness of Treasury chief Robert Rubin, Larry Summers and FED chief Alan Greenspan, you had the laissez faire mentality based on the thoughts of Milton Friedman and Ayn Rand. This resulted in deregulation of financial markets. They thought that markets would always behave rationally and calculate in the best interest of the business in coordination with the markets. So they eliminated the Glass-Steagall act (intro 1933) in 1999 to facilitate the merger of Citibank and CitiCorp into CitiGroup, if I recall the merger name correctly. This proved to be a major mistake.

By repealing this law they dumped the law that had lessons from the Great Depression, namely that bank deposits should be separated from Investment banking activities. By eliminating this divide, this barrier, banks were able to speculate on the markets with depositors money, engaging into proprietary trading, merger and aquisitions etc.

The problem here is, that if one regulatory system allows banks to grow to enormous size, the other regulatory system has incentives to do the same, so not to lose your financial institutions to the competitor nation location, i.e. London/New York. So its a self reinforcing spiral of deregulations that causes Too Big To Fail institutions (TBTF). If your bank doesn't grow in size, you would be overtaken by a competitor and be out of business as a business leader. This is what happened during the last 15 years. Bigger was better because then we survive the merger and acquisition war that was going on. This even meant that banks were trying to get deposits in other countries, like the banks in Iceland did. Slighty higher rate of interest, but that meant a higher risk of losing your deposit.

Anyway, banking was totally out of control. This proves once again that Hayek has a good standpoint, since his views are not against effective regulation. He isn't promoting the laissez faire situation for the sake of it. Friedrich Hayek is advocating efficient markets with the right barriers so that business remains prudent and productive.

Greenspan even admitted that his laissez faire attitude was a mistake, in hindsight.

http://www.cbsnews.com/stories/2008/10/ ... 0592.shtml

Hope that clarifies a bit.
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Re: The Business Cycle Theory - Economics Mar 18, 2010
(This is my reasoning for advocating no interest rates but a tax on unused capital - which will encourage investments and profit sharing rather than mortgages/loans/bonds paying interest)

The abundance of capital in the markets, by obligation more or less, will also lead to inflation in my opinion.

How could abundance of capital lead to inflation if there are no interest rates and securities available in the economy?

Liquidity is good, but constantly encouraging investments makes risk taking go sky high, after all, everybody is trying to get into the same high-yield trade then, to get the best return and outrun inflation.

If risk taking is sky high how could the investor constantly be encouraged?
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Re: The Business Cycle Theory - Economics Mar 18, 2010
Berrin wrote:
(This is my reasoning for advocating no interest rates but a tax on unused capital - which will encourage investments and profit sharing rather than mortgages/loans/bonds paying interest)

The abundance of capital in the markets, by obligation more or less, will also lead to inflation in my opinion.

How could abundance of capital lead to inflation if there are no interest rates and securities available in the economy?


Take the current situation for instance. Interest rates are near zero in the US. Thats equal to interest rates being absent, so banks get to obtain money free of charge at the FED. Because of overcapacity and malinvestments during the last 10 years, we now have a great recession. A purging of bad debts and overinvestment. The banks don't loan out that capital because there is no creditworthy borrower available, because the private sector, also households, are in debt. So they accrue interest by investing in government bonds. They borrow money for 0.25 (say zero) percent interest, and invest in gov. bonds for say 3 percent. The spread is the profit, namely 2.75 percent.

So what happens if interest can't be earned because of some new system. Then you would need to invest that money to earn a return on capital. So what happens, the FED will open the spigot gates and banks lend huge amounts of money for free, while loaning it out to private sector companies, households etc, going into debt even more. All this money will search for a return on investment, which leads to pure asset inflation. Because if you don't use the capital, it sits still and doesn't accrue interest, or a small ROI.

Investors will invest in everything that looks likely to giving a return (ROI) and will attract more speculators into asset bubbles, like for instance Dubai property.

So instead of the possibility of having interest rate returns, every investor and bank would be chasing asset price inflation for a return. This is bubble prone. Nothing but instability and rising asset prices (commodities, gold, housing, etc). The markets would go wild coodinating value with social benefit.

Liquidity is good, but constantly encouraging investments makes risk taking go sky high, after all, everybody is trying to get into the same high-yield trade then, to get the best return and outrun inflation.

If risk taking is sky high how could the investor constantly be encouraged?


Again, without interest rates in an economy, you would need to seek a return on nominal capital. That means pure price inflation. If one asset rises, more investors want to participate in that trade for the major returns. The higher the prices go, the higher inflation. Especially when every person, company and bank can obtain money free of charge (zero interest rates).
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Re: The Business Cycle Theory - Economics Mar 19, 2010
RobbyG wrote:
Take the current situation for instance. Interest rates are near zero in the US. Thats equal to interest rates being absent, so banks get to obtain money free of charge at the FED.


But Rob - in the 'Islamic system' the same rules will apply to the FED - why would they lend money to banks at no interest rate rather than invest directly (provide venture capital).

I think the logical conclusion of zero interest rates is that Banks business model which relies on interest rates becomes unviable and they morph into investment vehicles/managers and do something real in the economy.

Interestingly, the recommendation of the 'documentary' 'Money as Debt' is that banking should be a service provided by the Government - i.e. it provides the liquidity/capital directly to the markets.

I couldn't think of a compelling argument why the state shouldn't nationalise banks. I mean, that's what the system relies upon right now - the whole capitalist system would have disintegrated if the Government hadn't spent your and my money saving banks - right?

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Shafique
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Re: The Business Cycle Theory - Economics Mar 19, 2010
shafique wrote:
RobbyG wrote:
Take the current situation for instance. Interest rates are near zero in the US. Thats equal to interest rates being absent, so banks get to obtain money free of charge at the FED.


But Rob - in the 'Islamic system' the same rules will apply to the FED - why would they lend money to banks at no interest rate rather than invest directly (provide venture capital).


So you are basically suggesting for a full government takeover of banking? You want to eradicate the private sector and allocate capital inefficiently? I don't get that logic. Explain your idea in full please.

I think the logical conclusion of zero interest rates is that Banks business model which relies on interest rates becomes unviable and they morph into investment vehicles/managers and do something real in the economy.


What about my dividend? Do I just need to jump of a cliff and forfeit my (only) income stream for the sake of asset inflation? What about stable prices?

Interestingly, the recommendation of the 'documentary' 'Money as Debt' is that banking should be a service provided by the Government - i.e. it provides the liquidity/capital directly to the markets.


Banking a service from the government.... Sorry Shaf, but I sense you want a communist system, state controlled, no interest income, only asset inflated returns and no price stability.

If you think I'm wrong, explain to me in a deductive manner how your policy would influence the business cycle in your view.

I couldn't think of a compelling argument why the state shouldn't nationalise banks. I mean, that's what the system relies upon right now - the whole capitalist system would have disintegrated if the Government hadn't spent your and my money saving banks - right?

Cheers,
Shafique


Horrible, just horrible when you say you can't think of a compelling argument why the state shouldn't nationalize banks. You communist. Socialist and/or Shariaist :lol: :wink: :mrgreen:

First of all, banks that failed should go bankrupt in our capitalistic system. Then debt-restructuring (good bank/bad bank) takes place, bad bank assets liquidated and a new owner buys up the good part of the business and proceeds with banking. Problem would be solved by the booklet.

Second, but we didn't let banks fail, because governments bailed them out. Why did they bail them out you ask? Because there's $500+ Trillion of OTC derivatives counterparty risk on the books (black pools, no regulation) that would collapse the entire system, in part because of fraudulent accounting practises that represent the old 'bucket shop' from the 1900's. If your interested, view this humble warning by Charlie Munger. Not much info, but he and Buffet know how the system works.


Third, The problem we now face is so big and inrreversible, because we kept bailing out banks, regulation for OTC derivatives is absent. The incentive structure for accounting firms is wrong and accounting gimmicks are common in the industry. The real issue in my opinion is business ethics that were not addressed after the Enron debacle. Now we introduced moral hazard, as government will eventually bail out the private sector if all goes wrong. That is risk prone, nobody at the big banks on WallStreet cares anymore about minimizing risk, when you can load off the risk to the government, in essence the taxpayer.

From my perspective, government is the biggest culprit in creating moral hazard, absence of efficient regulation and laws and failure to learn lessons from the past.

Sigh...government takeover. Horrible Shafique, you invoked my worst nightmare. :wink:
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Re: The Business Cycle Theory - Economics Mar 19, 2010
RobbyG wrote:So you are basically suggesting for a full government takeover of banking? You want to eradicate the private sector and allocate capital inefficiently? I don't get that logic. Explain your idea in full please.


Well, that is the conclusion of the guy who made 'Money as Debt'.

I would still keep banks and banking, but just have them lend at zero interest or invest and share in the profits. They can make their money by providing a service - charging fees etc.

The market will then sort out the capital allocation - not much will actually change, those with capital will still need to invest, it's just that banks won't be able to create money from nothing and lend it out at fixed interest rates. Banks can have a role as conduits for those with capital to invest and they can pass through the returns. Everyone is happy.

RobbyG wrote:What about my dividend? Do I just need to jump of a cliff and forfeit my (only) income stream for the sake of asset inflation? What about stable prices?


Dividends are what you're going to enjoy - it is just fixed interest rates which are forbidden, and in practice dividends are higher than interest rates (by design, otherwise banks don't make money).

So, society actually gets higher levels of income under my proposals, not lower.

RobbyG wrote:
Interestingly, the recommendation of the 'documentary' 'Money as Debt' is that banking should be a service provided by the Government - i.e. it provides the liquidity/capital directly to the markets.


Banking a service from the government.... Sorry Shaf, but I sense you want a communist system, state controlled, no interest income, only asset inflated returns and no price stability.


Nope - a meritocratic state where the producers of wealth get to keep the wealth they create. Far from a communist state. My proposals are designed to stimulate investments and ensure that economies grow in real terms and not by inflation caused by money supply issues. Prices should fall as more is produced by the economies and the benefits filter to all the workers.

RobbyG wrote:If you think I'm wrong, explain to me in a deductive manner how your policy would influence the business cycle in your view.


Sure, so let's look at the business cycle then. Overnight you can't earn or borrow at fixed interest rates. So those with Capital now have to decide on where they are going to invest. In practice, very few rely on fixed interest stocks - they give lower returns than 'equity' and lower than direct investments/venture capital. The risk averse can still invest in unitised pools - unit trusts etc.

Finance hasn't dried up - the money is still in the system. There is an adjustment though, in that imaginary money just disappears (but it wasn't there to begin with - was it?) - and banks find that their major source of income has gone - but it wasn't productive anyway, was it?

So, as long as the capital flows to the businesses that need it and produce things that give income/utility - the only ones crying are the banks.

Suddenly mortgages are gone, so rents come down to meet incomes. Some of the capital allocated for mortgages can go to buy houses to rent - and given that there isn't that great a demand for houses to be bought on borrowed money, the prices will come down. The rental returns will be better than the interest on the mortgages - so the lenders are better off. Those selling may feel aggrieved, but the rise in price was artificial anyway.

Rents will be lower than the mortgages on the inflated (pre-correction) market - so people will have more spare money and be able to spend more in the economy. So renters are better off, the economy is better off, the lenders are getting higher returns... all are happy.

As for your worst nightmare - it could be worse. Perhaps the tide will go out when Governments run out of our money to save the system and then where will we be?

:)

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Shafique
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Re: The Business Cycle Theory - Economics Mar 19, 2010
Now I understand what you want! :idea:

What you propose is exactly what Friedrich Hayek and the Austrian school of economics wants. Which is going back to the gold standard. A fixed (inelastic) amount of money in circulation, where productivity gains are visible in lower prices, increasing your purchasing power subsequently.

The only thing that differs from you and my view, is the role of government in society. Which should be to protect and serve. Not guide monetary policy like they do now. Thats something for the market place. Government creates moral hazard by influence of the FED and therefore the solution to your interest rate problem is to abolish the FED. We don't need it!

Are you familiar with the Austrian Economic philosophy?

Try the views of Ron Paul and sound money policy on YouTube. He's advocating the solution we all need!
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Re: The Business Cycle Theory - Economics Mar 19, 2010
:idea: Indeed.

No, seriously - I am not familiar with the Austrian school at all.

I studied economics - but we covered only Keynesian and Monetarist theories - and not to a great deal of depth. I remember the authors of the text book we used ' borne fischer and dornbusch' but don't recall the name of the book though (it had 'Economics' in the title though).

But I guess you're right - money being tangible and inelastic would not compromise my model, but I wouldn't have defined it that way. I'd still let the Gov print the money - this will have a direct effect on inflation 'ceteris paribus' - and this can be the lever they use. But then real prices will remain unchanged - so there's no incentive to print money.

Hmm.

I guess I'll have to go and listen to Mr Paul then.. but not tonight.

Cheers,
Shafique
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Re: The Business Cycle Theory - Economics Mar 19, 2010
Try this video for a start, skip to 2:00 onwards and how the Austrian perspective correctly led Ron Paul to warn about the hazards in the system.

Just for starters:
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Re: The Business Cycle Theory - Economics Mar 19, 2010
Lets strip this down to the bare basics:

This is not real money, this is speculation on a vast scale by governments and international institutions and is a theoretical pack of cards. Its all smoke and mirrors. The recent economic crash seemed to catch these prestidigitators unawares and they all ended up blubbering in their beards. You can model economics until the cows come home, but unless you make a product, offer a service or provide a benefit as a government entity, that people really need or want, then you are standing in an empty shop.

Money comes with pictures on it and can be exchanged for beer.

If you don't have any, don't try to conjure it up from nowhere.

Get a real job and make something worthwhile and beneficial to humanity.
:shock: :shock: :shock:


Cynical Knight
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Re: The Business Cycle Theory - Economics Mar 19, 2010
Hallelujah Knighty fella.

Those paper money shifters have a limited use and there are way to many of them around. PhD Quants may have talent, but all they really do is leverage capital and inflate assets like oil etc. Society could use them better in the technology sector.

Liquidity is good, but too much of it is merely inflationary. Very unproductive.
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Re: The Business Cycle Theory - Economics Mar 20, 2010
Well, looks like at least 3 of us agree. Keep it real.

It goes to show though - those 'anti-globalisation' protestors that were so demonised in the press, haven't they been proved right?

Cheers,
Shafique
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Re: The Business Cycle Theory - Economics Mar 20, 2010
I'm very skeptical about globalization, since the word may sound very nice in terms of free market philosophy, but when you consider that other politicians talk about it in a New World Order, like in a World government or UN type body, then I get wary. Who's going to decide for me?!

I think nations should decide individually and on its own terms what to do in the international context. Freedom of choice for the individual aswell as for a nation, no matter what its size is.

For Shafique: Watch the hero of Liberty, champion of the Constitution, Ron Paul, talk about the Constitution and Individual rights with CNN's John King: http://www.youtube.com/watch?v=GVrFfO-X-XQ&feature=sub

This is what gets young people moving for the cause of Liberty. Unfortunately, the establishment war machine and its affilliates aren't exactly happy with a voice of reason that gets people and campaign money, moving to his direction.

Ron Paul boycot in primaries: http://www.youtube.com/watch?v=J4unznqe ... re=related
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Re: The Business Cycle Theory - Economics Mar 20, 2010
Liquidity is good, but too much of it is merely inflationary. Very unproductive.


All the countries of the world have got to do is abolish interest rates and usuary from world economics.
Only then liquidity will find its way for investments and become productive rather than lying around idle on interests. Once profits(income) starts to come from investments/trade than there is no reason why there should be inflation or world poverty either.

Read chapters 5-6-7-8 at least.
http://www.islamreligion.com/articles/538/viewall/
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Re: The Business Cycle Theory - Economics Mar 20, 2010
Berrin wrote:
Liquidity is good, but too much of it is merely inflationary. Very unproductive.


All the countries of the world have got to do is abolish interest rates and usuary from world economics.
Only then liquidity will find its way for investments and become productive rather than lying around idle on interests. Once profits(income) starts to come from investments/trade than there is no reason why there should be inflation or world poverty either.

Read chapters 5-6-7-8 at least.
http://www.islamreligion.com/articles/538/viewall/


Lets start with chapter 6:

First, interest leads to an inequitable distribution of income. This can be seen by taking an example of three people. Suppose there are three people who consume of all of their income in a given year yet one of them starts with $1,000 in savings, a second with $100 and a third with zero. At 10% interest per annum, by the end of the year, the first person will have $1,100, the second $110 and the third person zero in their accounts. If the same scenario follows in the next year, the first person will have $1,210, the second $121 and the third will have zero. Already, one can see how the distribution between them grows every year, even between the one who has some savings of his own.


Three people who consume, while two of them save money. The third one either earns less (less educated or capable) in order to save as much as the other two, or simply consumes too much! If he limits his expenditure, he would also be able to save a portion of his disposable income and would be able to save aswell. The ability to save is one that comes from personal sacrifice on consumption and is rewarded with future consumption and a reward for storing your money at the bank.

Furthermore, when one saves money at the bank for interest, the bank managers will use their specific capability and expertise to use those loanable funds for the benefit of productive society. The money stored at the bank can be used for investments by entrepreneurs who have to expertise to make a product work.

A single person cannot do this all at once. Therefore, he is merely rewarded with interest to store his money at the bank, so that the bank is able to make the money useful in society. After all, without interest rates on bank deposits, the saver doesn't have an incentive to store his money with the bank and can just as well keep in under the mattress. In this case, the funds are useless for society. At the bank, it is put to work immediately.

The added benefit, is that the bank earns money on its project, losses are for the bank while your money is safe until a specific amount, guaranteed by government. So your savings are guarded by the bank and the government.

If the thrift consumer would have invested the money himself in a start up company, he could lose his entire savings all at ones and can start over once again. If only he had the expertise that the bank had. Not everybody is capable of doing that next to his daytime job.

Interest keeps the distribution of money possible. Without interest payments, the velocity of money would decline and money will be hoarded for retirement or used for consumption, without functional use in society. After all, consumption is to increase your standard of living, but too much consumption is a sign of decadence and materialism, which is not something that Islam would reward as well.

Agreed?

This scenario will be made even worse if the richest person will also to be able to add savings. Suppose he adds one thousand at the end of each year. He will have 1,100 at the end of the first year, he adds $1,000 and continues with his 10% interest and he will have $2,310 at the end of the second year, and so on. Now it is one thing if this money paid was actually due to some positive factor of production but in reality one cannot make that argument in this case. The money that the people are making via interest may have been squandered, lost or even stolen by the people who borrowed it, but one still has to be pay the interest. It may have been invested in a completely losing project and therefore it actually did not produce anything. But all of that does not matter, it has to be paid regardless of whether that “factor of production” produces anything or not. This is simply one of the unique aspects of money and payments to money. No one can argue that this is just and therefore its results are an inequitable distribution of money.


Rich people have just as equal a right to save as any other. Only because the family earned alot of money in the past, doesn't mean they aren't allowed to save and spend accordingly. If they spend alot, this creates upportunity for producers, and if they save, the bank is able to fund major projects that need lots of capital, like infrastructure works. The little saver can't supply all of these funds, perhaps in aggregate, and so here the rich come in, who carries additional risk since his deposits are not fully insured if the bank goes bankrupt.

Sounds equal to me and beneficial to society. Without the savings of (past) hard working families and earners, the development of society would grind to a halt. Therefore you should encourage savings and live life frugal. Excess consumption occurs everywhere and is the result of poor judgement or overspending. Loans should not be made available to people who are not creditworthy since bank losses are a drag on a prosperous society. Fraud should be eliminated, and bad judgement needs education. If you make it rich from savings or investments, then you succeeded in your part of contributing to society and you are able to enjoy ALL the fruits of your labour.
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