Not-So-Quick Thoughts On The Economy

Topic(s): government,politics
2011-08-08 22:24:28 US/Pacific

First I want to comment on the S&P downgrade of US bonds. My comment is it does not matter one bit. The rating scale is an arbitrary measure. It doesn't matter if US bonds are rated AAA or CCC. What matters is the quantity of entities that want to buy US bonds. To wit, the real true rating is a function of supply and demand.

What irks me about the downgrading is our politicians wasting their breath arguing about which party is to blame over the downgrading. Firstly, on a long time scale they're both equally to blame for the current craptastic economy. Secondly, the downgrading doesn't matter.

OK, so now on to quantitative easing. We've done it twice recently. At the time they were both described as the economy's panacea. Clearly they were not. But here we go again, it appears that a third round of quantitative easing may be on its way in. Terrible, this idea.

Quantitative easing is a mechanism by which the government may legally steal your wealth. Over a span of many months or years, it results in inflation. Which means that e.g. groceries cost more at the grocery store. Which means that if you convert your savings (be it in the bank, in your 401k, wherever) to goods, you have less wealth. If you have $100 today, you can convert it in to 20 gallons of milk. But next year that same $100 will buy you maybe 18 gallons of milk.

So why does the government even consider quantitative easing? A couple reasons. The most obvious is that it makes debt appear smaller. If you owe $100 on your credit card today, in a few years your salary will adjust for inflation and that $100 will seem like $90. It holds at the national level as well. We sell $100 in bonds to China and guarantee them a 10% return after 3 years... well if inflation is 15% over three years then really we've given them a -5% (negative five percent) return. Which is great for us but bad for China.

(And that's another reason why quantitative easing is bad. It makes your investors unhappy. Eventually investors stop buying bonds. This is what's happening in Greece, Portugal, Italy, et al. these days. In fact, after the second round of quantitative easing China demanded a meeting with President Obama to express their dissatisfaction.)

The second reason why the government likes quantitative easing is because it adds liquidity in to the economy. "Liquidity" is jargon for cash. Which is great. Except the liquidity is given to private banks (all of it!). Not to you. Not to me. To banks. Banks then choose how to distribute the cash. Some of it finds its way to you and me through e.g. home loans. But much of it finds its way to those with connections to the banks, those that can guarantee assistance to banks in their times of need (bailouts).

If the liquidity was directly distributed to the populace, then quantitative easing would be much easier for me to accept. But it's not.

So in short, if all you've got is debt, quantitative easing is great. But if you've been responsible and you've spent only what you must and you've saved the rest, quantitative easing is terrible.

A third point I want to make, and this is very important, is that a falling market can be good for you and me. You have to understand that wealth is relative. If everybody's stock portfolio climbs 10%, well then you haven't really accumulated any new wealth. When you go to buy a house, you'll be competing against people whose portfolios have also climbed 10%, and the cost of the house will accordingly climb by 10%. The only way you can accumulate wealth is when your wealth climbs relative to other people's wealth. If your portfolio declines by 5%, and most other people's portfolios decline 10%, well then your wealth has increased by 5%.

Do not fear a falling stock market. Embrace it. Perfectly healthy economies have, at times, rapidly declining stock markets. It is a necessary function. Big companies, at times, need to crash and burn (stock price go to zero). Small companies will rise from the rubble. The time in the interim period between those two points is worrisome, no doubt. The key is to not prolong the interim period, which unfortunately is what our government has done since 2008.

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