Monday, October 06, 2008

Blood on the market floor

Today the US stock market set a new record for one day fall, in points (not in percentage, I'd think). Here's a comment from Farmann. (And a video article.) (Hans also points to this site,, which seems interesting.)

I never understood economic crashes. We still have the same people, knowledge, machinery, houses, and factories we did a year ago, so how can the economy suddenly be a lot worse?

I guess the crux is credit. But it still does not make sense to me.

I also guess that if economic crashes don't make sense, then economic booms don't make sense either. Like I wrote in the updated money article, in the wider picture you can't expect any growth larger than 5%. And it'd be less if not for inflation. And in the smaller picture you can get higher growth, but it depends upon luck.
And it's simply because you can only build factories and educate people so fast. Faster growth is based on credit and optimism, and those always crash sooner or later when they have stretched too far from reality, like right now.

Here's an interesting article.
"For many years, the money supply in the form of banknotes and deposits (M3) has grown at an average rate of over ten percent per year (which means that every six or seven years the total volume of money circulating in the world has doubled)."

Wow!!! This explains a lot to me! Anybody with common sense can see that this is just like having water gun fights with gasoline and then having a nice relaxed cigarette after. And then the government is blaming the crisis on "the greed of investors"...

"Economic theory teaches us that, unfortunately, artificial credit expansion and the (fiduciary) inflation of media of exchange offer no shortcut to stable and sustained economic development, no way of avoiding the necessary sacrifice and discipline behind all voluntary saving. (In fact, particularly in the United States, voluntary saving has not only failed to increase, but in some years has even fallen to a negative rate.)"

On The West Wing there was an astute observation: the president's aide asked the president: "but don't you want people to save up?" The president said: "Yes, but we want them to do it while the other guy is president."
Because spending booms the economy in the short term, and saving helps it in the long term. And how can we get re-elected if we think in the long term?

"Indeed, the artificial expansion of credit and money is never more than a short-term solution, and often not even that."

In the SF novel Battlefield Earth (which was a hundred times better than the movie based on it, trust me) near the end they have to save the economy of the entire universe (!). The way they do it is to extend new credit to everybody, secured by new planets being discovered. And it is projected that it will become a big problem when they run out of new planets far in the future. ... And yet it's not even speculated that you could have a healthy economy which is not based on credit! That's insane, it's like saying you can't have a good personal economy if you don't have any debt! (And some people even do say that, I remember my former brother-in-law who is a high-ranking insurance executive say to my mother that it was nuts having so little debt in her house.)


Anonymous said...

"I guess the crux is credit. But it still does not make sense to me."

I think that maybe those who should have known better were all telling themselves that everything was going to get better and better, and so they were extending credit to people who really had no hope of paying it off in a timely fashion.
Many years ago, between jobs in my regular career ( in power stations) I worked for a couple of years in the consumer finance racket, collecting bad loans, and lending out more money - sometimes even to those guys who hadn't paid off on time with a previous loan.... and the cardinal rule governing all that was (and is) never lend out what you can't collect. Our American cousins seem to have forgotten that number one rule. So everybody's up to their asses in debts and bad credit, and all that. And it was just because the guys who should have been paying attention to all that weren't keeping their eye on the ball (and the payments!) The famous "fly now - pay later" plan doesn't work without the "pay later" part, obviously.


Anonymous said...

Part of the problem is that people have not been encouraged to save money, but to spend it. The interest rates on savings accounts are so low(less that 1 percent in many banks), there is no logic in saving when inflation is at least 3-4% and now approaching 6%. If interest rates on savings do not increase, it will be a long, severe financial problem.

Eolake Stobblehouse said...

I'm sure you're right.

At least Europe has been wiser in this area. For the last several years, savings rates have been something like 5%.

Anonymous said...

You were closest to the truth of what is really going on when you mentioned What is going on is the complete revelation that Keynesian economics - the predominant Western economic theory for the past 60 years - is horribly, horribly wrong. A good site to follow and learn about this is at Guy seems to know his stuff. He doesn't post frequently though.

Anonymous said...

The entire monetary system is based on debt. In short, no debt=no money. The only thing that makes US currency valuable is the promise that it's valuable.

Also, because of the way the money is created, the demand for goods and services has to increase in proportion with the money supply, otherwise it becomes diluted. This dooms us to a crash because the demand for services can't keep increasing when our resources are limited.

The only people who really benefit from this system are the corporations that put it in place. Greed takes precedence over any long-term impact their policies have. What's worse is that corporations basically own the US government, meaning that nobody (barring a few individuals like Ron Paul and Ralph Nader) is looking out for the interests of the people.

Anonymous said...

The way I see it, when you loan money to people that in reality cannot pay you back, (and in many cases the government forced you to promote a false sense of equality) and then you go ahead and sell investments that are backed up by the loans, eventually there's a point where the investors come calling, and everyone realizes the money you loaned out is not coming back. It's a Ponzi scheme. It's a game of dominoes when word gets out, and the fear of failure accelerates and feeds on itself to the point of panic. It's like the bookie that can't cover all his bets when the odds go against him. When you are highly leveraged and things move against you, and there's no way to cover it, the game is over. So today, there is no money to loan, no credit to fuel economic engines, not only because of the losses, but also because people refuse to let go of what they have left.

The people are catching on, and it's only a matter of time before they figure out that there isn't enough money to even cover the $10.3 trillion US debt. Then comes the real socio-economic breakdown, and all the things that the so-called crazies have been predicting start to become real. But wait, storm clouds are gathering in the Middle east. Israel will not risk losing a whole nation this time. There are 4 US carrier groups in position, Russian ships in Syrian ports, and China is building its navy in unprecendented numbers (they depend on Iranian oil). The party is just beginning.


Anonymous said...

Dear Eolake,

Australian University Professor Steve Keen predicted this economic meltdown and explains very clearly in simplest terms why the whole system must collapse providing true facts and figures to support what he says.He also states Govts in this crisis are worried by Inflation and wont print money when thats exactly what the must do right now. China is the only unknown equation if it rerates its currency inflating total moneycount worldwide. The link is

BlankPhotog said...

Money started out as a way to keep track of "apples and oranges" in a unified system. Then it became a way to track "value." That is, as we later came to believe, how much something was wanted, or how marketable something was. Enter Feudalism. Enter Capitalism, then, once we decided that the appearance of value was good enough, that the promise that something was valuable had value in itself. Now, of course, tons of economic theory has rationalized this belief system, with corporate Ponzi schemes, government collusion, and stockholder fraud to spice things up. In the end, we might have to go all the way back to the beginning, and call an apple an apple, and a fraudulent system a fraudulent system.

Even if this ruins everything.

Anonymous said...

China until recently had a predominantly no-credit economy, at least on the person to person level. You couldn't buy anything on credit, everyone paid cash. They all saved until they had enough cash, then they purchased. The government didn't behave this way, but individuals did.

Unknown said...

I can honestly say that I don't understand this credit based economy, and I live in it. I am considered a bad credit risk because I have no credit cards, and owe no money. I am unable to get a bank to loan me money for a mortgage on a home for my family, because I have always felt that, if I could not afford something, and didn't have the cash on hand, I would not get it. If I was a bank, this is the person I would trust with my investments primarily because of this attitude. Would I rather loan money to someone who owes money, or to someone who doesn't. Seems like a no brainer to me.

kurumi said...

Who's blood?

Just adding my two cents.
I really lake Eolakes approach to looking at the real economy and the existing extended capital base, factories, commerce relations, tecnical expertise, measures of efficiency etc and seeing that it changes slowly and certainly does not drop and rise in leeps and bounds like the price of financial assets but slowly. This simple truth makes investing an economic discipline and has made a few long term investors very wealthy, look at Stephen Graham, Warren Buffet and many others. Warren Buffet says I buy companies not shares or stock. So, true wealth can only be created slowly and constantly. This slow and constant is there when you look at financial assets over say 10 year periods or more.
So truly there is no crisis in the real economy and investment based on the real economy is a sure winner over time, investing in the real economy long term is like being the owner of the casino. You "bet" and never lose. A true crisis in the real economy would be if you went to the gas station and there was no gas, to the supermarket and there was no food. A crisis in the offering of goods. Or say if you produced something and could not get it to buyers. This has happened very rarely in capitalist industrialized economies (oil shocks) but empty shelves in some socialist societies of a while ago show it can happen. So the problem then is not difficulties in offering/demanding goods but something more subtle but also simple. The true question behind all boom and busts is who gets what piece of the GDP pie. How much each one of us gets to "eat" of the GDP. Booms and crises transfer morsels of the GDP between us, subtracts from some and adds to others...
The financial market and financial instruments in general are mechanisms for the transfer of wealth. So are taxes.
If it where possible to measure truly how much of the GDP I produced in a given year and looked at how much income I had, how much I got paid for doing what I do, they would not be equal. (Sorry if that statement is not correct for economists but it is a simple truth). Some people produce more than what they have as income and some produce less. And if you look strictly at how much income each person has and how they spend it you would see: Some people are frugal and spend less than their income and save and some people for some good or bad reason need to spend more or want to spend more. Some people pay more taxes than others relative to their income. In third world countries these tax differences can be very acute and are a very unjust transfer of wealth. The same goes for companies, some companies need more wealth than they produce, they may be growing or adapting, implementing changes, and their current income may be insufficient. Some companies may be producing more wealth than they need, companies in mature, or contracting or stable markets. So in the end of a period, say a year, for a fair or unfair reason some people/companies have surplus income and some people/companies need surplus income. And the really interesting thing to me in all of this is that
at the end of the same period, everything that was produced was utilised somehow. If a society produces and does not utilise (consume in a non technical sense) then inventories must grow (how many years can you hold in inventory last years model of car or yesterdays bread or a package of beef?). So when you save it is only possible to save if somebody else borrows from you. So if you for some reason do not utilize all your income, then it is necessary for somebody else to utilize what you did not. The person who borrowed from you will need in the future to take from her income the same quantity you lent her and a little more for your trouble. If you want to save and do not find somebody to borrow now and in a later period deduct from her income then it is impossible to save.
I like to use the word "work" instead of income. It is easier to understand. When we save income we are truly saving our (surplus) work. When somebody borrows from us they are truly borrowing our work. It is as if you worked a day or two in your neighbors crop fields to help them out and they promise to work next year a day or two in your field to pay you back (that may be hard to do if they move or die or for some natural disaster both of you are ruined). Things we produced and did not use must he utilised by somebody else.
Hopefully this person who borrowed from you will use wisely the resources you provided (from your work and frugality) and be able to pay you back. So lets say you saved in the course of some time the value of a car. Would it be wise to lend this for somebody else to buy luxury items? Or would it be prudent to lend these resources for somebody who wants to buy machinery and produce some new goods or lend this money (read income or work) as a student loan so the borrower can increase his future income. How can the person who bought luxury items pay you back? So this is credit. Good credit is lending to people who have a better chance of paying you back. The future is not known so when you save you can only be prudent, lend wisely and hope everything works out. Now, if you notice that the great majority of savers DOES NOT INVOLVE ITSELF IN TO WHOM THERE MONEY (or work or income) is LENT it is easy to understand said crisis. They delegate this vital decision to so called "financial experts". It seems that spending (oops I meant investing) somebody else's savings in a responsible manner is very hard. It is so tempting to spend somebody else's money poorly when they are looking the other way. Why is it that financial experts are so overpaid? Are they smarter than everybody else? Better educated? NO! It seems that all those MBA and PHDs and other three letter titles..such as CFA...did not help them invest wisely the resources given to their care. Why so many titles then? As a group they invested very poorly the monies they where trusted to care.
And they were able to do all of this simply because they convinced others that they are smarter and that you should let them hold in their pockets your wallet.
And what makes it all very funny is that this happens in cycles of say every 7-12 years and then it starts over and happens again.
And what makes it all very sad is that governments usually step in and makes every taxpayer pay for the mistakes of savers and financial experts.
And they do this based or coerced by the end of the world hype that is present in every boom/bust cycle. And sadder still is that this hype is created by the same financial experts who invested poorly in the first place.
And until savers understand that if they delegate to so called financial experts credit, lending, and other decisions relative to their savings the boom and bust cycle will continue.

The bottom line in booms and busts is that money or work is being taken from some and given to others.

To understand a given cycle you must find out who lost money and in who's pocket these monies ended up.

Eolake Stobblehouse said...

Thanks to all so far, good contributions.

Author said...

Hi Eolake,
Thanks for the links.
Traffic from your site shows up in our stats.
Stay out of the market.

Hans Lysglimt

Anonymous said...


The reason that you have been *deemed* a "bad credit risk" is because...although you have excellent money-management skills, the lender is not able to SEE that in your financial activities.

With credit, they are able to SEE: if you are consistent in your payments of bills; are they paid in a timely manner; have you already been deemed a credit risk by, say, a credit card company. They have access to all your credit activity and...a fairly accurate record of your past history.

Similar to someone going to apply for a job (you're applying for money, when you're asking for money to *buy* a home and...ALOT of it, at that! It is a HUGE risk to them to lend the money.), your credit history is much like a resume. Of course, much like an employer is hoping that you haven't fudged your work history on your resume (it happens all the time), a lender is asking you to disclose as much pertinent DATA to assure them that you are not a high/"bad" credit risk.

You have a credit score that can be adversely affected by untimely monthly debt repayments; how many credit cards you have open; what the balances are on them; and...the worst: a bankruptcy. Bankrupcties stay on your credit history for 7 years so that is an especially painful option to costs!

Anyhow...yes...the lender IS trying to rule out the possibility that you might be a high risk to them...of not being able to repay them; hence...they need DATA (ie: credit track record) to prove this point. Trust me; they WANT to lend you the money. They, however, are obligated to show a track record of financial stability.

An *empty slate* would NOT be a wise candidate to lend money to...because the lender doesn't know a THING about you.

Hope that helps.

Anonymous said...

You imply you don't understand the 'business cycle' of booms and busts. It's simple enough to understand. Think of booms and busts as waves, up and down, around a central trend.

Now, if you're an engineer and you see continual waves of this kind, you look for a driving force that's driving the oscillation. Here's a sample of how it works.

Imagine that we have a starting point where interest rates are low. This could happen because people have been risk averse and steady savers and so there's a lot of capital available, but it doesn't really matter how we got there.

Now, some entrepreneurs say to themselves 'the cost of money is low, so I can borrow some and use it to fund a high-return but risky venture'. Others are willing to invest a portion of their money to get the higher returns. Invested by sane entrepreneurs, the returns are risk-rated acceptable.

Now, others see the returns being made, and they borrow money too. Over time this demand for money bids up the interest rates. Note that this makes newer investments more costly.

The driving force now becomes greed and me-too-ism, which is a constant in human affairs. People see the good returns being made and jump on the ship. This drives the cycle past the central point and into over-developed. This is one side of what drives the oscillation.

Eventually the enterprises being founded do not justify the risk being taken and the cost of money. Some start to collapse at the margins. People start to lose their money. Fear of loss, another part of the human condition, drives selling, which drives the market down; this is the other side of the oscillator.

Eventually people are so scared that they're willing to accept low cash rates rather than share investments, and interest rates bottom out as share market prices drop.

So the driving forces that continue the oscillation are greed or desire for high returns on the upside, and fear of loss on the downside. This is why the business cycle will always be with us, because the drivers are part of human nature, and even to some extent rational.

The current cycle is particularly volatile, and this has been cause by a number of things, including government keeping interest rates too low for too long, which forced the 'upside' push to be far too strong, and also various de-regulations of lenders which limited the size of previous up-cycles, and mis-pricing of risk in il-liquid debt instruments.

Because we swung too far on the upside, the downside swing will be too violent too, as many actually unprofitable ventures now crash to earth.

This is all simplified, but I've tried to put it into a physical driving-force context to show why we have ups and downs and why there will never be a simple flat trend line.


Eolake Stobblehouse said...

Yes, funny: I applied for a credit card and was rejected, despite me having a big savings account in the same bank! (Much bigger than the monthly limit on the card.)

I called them up, and it was just an automatic rejection by computer, and it was corrected.