Private Cos profiting from stimulus

I am sort of wandering into another thought in this blog about stimulus rather than discussing the middle ground that I was going to talk about. The govt has extended unemployment benefits now for 99 weeks. The private companies are benefiting heavily from this govt spending on deficit. The private cos are able to layoff the workers but the workers are getting money from the govt to spend on consumer products that these cos are selling. The private cos revenues are being sustained by the govt while they are able to shift the employee cost to the govt, giving them greater margins. The govt is taking on the debts thru deficit spending and those debts are shifting to the private cos balance sheet as cash. The govt's debts are ultimately the citizen's responsibility - it will have to get paid thru higher taxes or higher inflation. The deficit spending may be a stealth way of moving wealth to the coffers of the private cos - controlled by a small group of shareholders. Which is why the govt should increase taxes to spend on unemployment benefits rather than use deficit spending. Why shouldn't private cos and employed citizens not pay for the unemployment benefits. A society needs to create jobs for everybody and if it can't, then it must support the unemployed to become employed. I suspect the deficit spending is unfairly shifting wealth to the rich and may not be right just because of that.

More stimulus or not?

There are two camps out there in the economic world on ideas of how to get out of this recession. Krugman says that we have to keep spending more stimulus, throw the kitchen at it until the economy rebounds. The other camp talks about allowing deflation to occur, get all the excesses out of it, let it bleed until it reaches its new equilibrium and then the economy can have a fresh start to growing again. Both the camps focus on the fiscal and monetary policies of the economy without actually talking aboout the fundamentals of economic activity. As I have said before, money is just a proxy for economic activity and it can't be used to explain or correct everything about the economy. The economy is hinged on exchange of goods and services and an economy grows if this is exchange happens at a faster pace due to productivity increases.

By providing more stimulus, you could temporarily goose up the economy. Govt spending is never targeted at value-adding work but rather based on politically motivated allocations. no NPV valuation is done on govt spending and so it is unlikely that govt spending will give a sustainable boost to the economy - mostly it will be short-term boost. The other argument about letting the economy fall is not a good option either. Modern economy runs on optimism and entrepreneurship and you don't want to kill that spirit by going into serious deflation. The good option is somewhere in the middle of both Krugman and the deflationists. I will discuss the options out there more in my next blog.

Interest rate in Credit

A drop in an interest rate is like giving free money to a person who has borrowed in the past. It is somewhat of taking excess resource from the savers and giving it to the spenders. The savers and spenders must be in balance to utilize all the resource in an economy efficiently. but I can only charge interest if there is competition to get at my excess resource.

Going back to the farmer - machine model, I am going to borrow 5 bushels of wheat/year for 2 years if only I can sell the machine to the farmers for atleast 10 bushels - the machine takes 2 years to build and costs 10 bushels to build. If I need to pay interest on the borrowing, I need to sell it higher than 10 bushels. The 10 farmers are going to pay 10 bushels or higher only if the machine can increase their production by 5 bushels/year or more, assuming a 2-year machine life. This circle will keep going at higher interest rate as long as the machines are being improved to increase productivity. Once the productivity stops, the interest rate would go down to zero. At zero interest rates, things could break down as there would become a deadlock between farmers and machinists, leading to a downward trend in productivity.

How does population increase feature in this - say economy adds 1 extra worker per year. There is need to feed the extra worker but the extra worker can also work. GDP will be measured by how many bushels are being exchanged every year. Does the extra worker's increase in goods exchange translate to better living conditions than in the past - could lead to downward standard of living or upward depending on the skill base the person brings. the economy will benefit if the extra person is helpful in increasing the productivity.

What is Credit?

What is credit in the fundamental sense? I want to build a house and to do that, I have to pay now for the resources used to build the house but I will earn enough only in say 20 or 30 years. There is a farmer with excess wheat production. He could lend it to you now for paying later in instalments. You borrow the wheat and give it to the people who will build your house. Everybody benefits in this game as the farmer would have thrown away his excess wheat without somebody borrowing it and giving it to the people needing the wheat. Instead of one farmer, this could be a bunch of farmers pooling their excess production to lend it. They would rather lend it than just give it away for free to some needy poor people. By my borrowing, I employ the needy poor people to build a house for me and earn the wheat that way. This borrowing has now created new assets in the economy compared to the option of just giving away the wheat for free to the poor. This borrowing doesn't create inflation in the economy as there is enough supply to satisfy the demand. and good assets are being built with excess savings.

If there are excess resources in the economy, you want to grand credit to people to use those resources. credit tries to soak up the excess resources to build new assets for the economy. granting credit is not easy - have to avoid the moral hazard. If credit is not given with strings attached, it won't be used to build assets. asset building is very essential to an economy to raise the standard of living. If I get a $ for free,, I could just use it to pay somebody to massage my body. I don't have the pressure to use the $ to build something that will increase my earnings power. This is where collateral comes to play in credit granting.

What are assets doing to us - making life easier for us. With an asset called a house, we don't have to keep looking for a cave every night to sleep in or be afraid to sleep the night in fear of dangerous animals hurting us. Same thing goes for roads - helps us get from X to Y faster and comfortably.

Asset price increase?

How does an asset increase in price? If the needed resources will cost more to build the asset, its price will increase. Consider a 10-year life asset. In one year, only 10% of the existing assets will be built but all of the 100% assets will increase in price in anticipation of the future cost of replacing the assets. This is fine except that an asset could be sold today to raise cash from the increasing asset value. In cases of immovable assets like land, its price will increase if the economic activity supported by the land increases in value. If I can sell 10 times more items from a specific location than I did 10 years back, the value of the land will also increase to reflect the increased economic activity. In my next blog post, I will try to analyse credit from a fundamental point of view - let's see how much traction I will get on it. Asset price increase is closely related to credit availaibility as well and is worth analysing it.

Assets in an economy

It has been more than a month since I posted anything on my blog. have to try to keep up the momentum in July. want to discuss assets in general as asset prices get talked a lot in economic viewpoints. Assets support an economic activity, have a longer life, gets consumed over a period of years. machine, building etc - maintenance cost, depreciation a meassure of its annual consumption. Land doesn't get consumed in the same way. improvements to land do have similar characteristics as a machine consumption. Land is limited, land supports other economic activities on it and so value of land is connected to the economic activity supported on it.

What's an asset worth? There are 15 people in the economy - all are currently farmers but we can shift some farmers to become workers to build a machine. Say it takes 2 years to build a new machine using 5 workers and the machine will last for 2 years. say every person normally consumes 1 bushel of wheat/year, and without the machine, they can produce 1 bushel/year. with machine, they can produce 2 bushel/year. They can either use bumper crops or underconsume for 2 years to support the 5 workers for two years to build the machine. Once machine is built, production of wheat doubles, back to normal consumption. What is the value of the machine - 10 bushels as they have to provide 10 bushels in 2 years to get a new machine. Clearly the asset price represents the resources it takes to build the asset currently. The machine build is a win for the economy. Previously with 15 people working the farms, they produced 15 bushels of wheat/year but now with 10 people working the farms with the machine, they can produce 20 bushels of wheat/year.