Saturday, June 19, 2010

On Intergenerational Transfers

Finance is simple at sight, whether the question is what a dollar will be worth sometime in the future, what a dollar sometime in the future is worth now, or what the net present value is of an income stream extending far into the future. There are assumptions and unknowns, of course, most of which we can estimate from past experience, if only roughly, and if only assuming some similarity between past and future, but these are the kind of assumptions we must make whenever we approach the future. The predictions we make can be informed and weighed and even reasonably accurate where we are concerned. Without some semblance of predictability, no actions can be planned and no expectations can be formed.

It is easy to believe that adding up everyone's expectations is sufficient to extend this to society and assume the same, but it would be wrong. The assumptions and unknowns that individuals face within a society are of an entirely different order than the assumptions and unknowns a society must face. Each of us is a small enough part of the whole that our actions and expectations do not much effect that of the whole, but the whole of us is broadly affected by the whole of our actions and expectations. As individuals we can estimate savings rates, inflation rates, interest rates, discount rates, return rates, and tax rates, but a society cannot because their actions and expectations are not independent of one another.

Finance is much more complex at heart, and a dollar in time is as illusory as our ability to predict the distant future. A society cannot assume a rate of return, they must produce it. A dollar in time will be worth whatever society will make it worth. Assets require considerable reinvestment over time to maintain their usefulness. Few have lives even approaching that of individuals, and changes in circumstance and technology can make them obsolete even before then. We inherit the natural environment, our knowledge and technology, our institutions and society, and the state of world as it exists, but remarkably little else over a lifetime. We have done well if we leave it improved.

We can acquire assets in other societies, but this is dependent on someone having the means and desire to acquire them in the future and not every society can have a positive net balance with every other society so these may be a poor store of value, but everything may be a poor store of value.

Money and time are considerations for work, debt, savings, transfers, and retirement. For an individual, societal rank is often more important than absolute level as it will determine their call on societal resources, and this is what their savings provides. For societies, absolute level is usually more important since others are more distant and this will determine their call on world resources and their standard of living. Most of what we consume must be produced shortly before, from perishable food, worn clothing, household maintenance, depreciating autos and equipment, and deteriorating shelter. Shelter and furnishings are among our longest lived personal assets and both require regular maintenance and upkeep. Little can be stockpiled and stored in any sizable amount for any considerable time. Our main choice, if it is a choice, is whether or when we transition from work to retirement. Even that is transfer in part since remaining in the workforce will lower the real wages of other workers. Dependents always live on the efforts of the independent. How well they live is largely dependent on the productivity and numbers of those providing for them. Debt, savings, and transfers are largely how we divide this output and all are burdens on producers, but production limits what can be divided. The lower the transfers the higher debt and savings and asset prices, and the higher the transfers the lower the debt and savings and asset prices. People retire on the economy they create and live off its product. Society may prosper or suffer and this is the greatest threat to work and retirement, not some numerical return that results.

Sunday, June 13, 2010

On Demand Curves

Normal demand curves are downward sloping. Lower prices will increase the quantity demanded and higher prices will decrease them. How do monetary conditions affect this? Deflation tells us prices will be lower in the future and falling prices tell us to seek liquidity and delay our purchases, inducing them to fall further. Inflation tells us prices will be higher in the future and rising prices tell us to flee liquidity advance our purchases, inducing them to rise further. Significant monetary conditions can invert normal demand curves and negate normal elasticities. Falling prices can lead to falling demand and output. Rising prices can lead to rising demand and output. They just can't do so predictably indefinitely because our expectations will adapt, but they can do so on the cusp of reversing.

Monetary conditions can be altered and are a necessary condition to a reversal, but are not sufficient in themselves. Expectations must also be changed. It is not enough to change the present if most do not believe you have the power or will to change the future. It is not enough to change the present if expectations are it will all be abandoned and reversed in the future. Demonstrations of power and will, of dedication and persistence, are not purchased cheaply. That can be difficult if you have built your reputation on fighting the opposite problem and don't want to lose it. You can't forget to seek stability, but you have to remember that involves fighting instability of both ends and persisting in this as the job is never done.

Tuesday, June 1, 2010

A Balancing Act

Economic growth has been very slow and risks returning to retrograde. The appropriate solution depends on the diagnosis of the problem.

If one views the recession as one of demand, a financial one, the problem is nominal and the solution is to provide more money. This could be the monetary authority purchasing other assets increasing their prices and introducing more money to the system, the fiscal authority running larger deficits whether spending more or purchasing other assets similarly. If the fiscal authority fears larger deficits or the monetary authority's willingness to absorb them, there is no reason they can't subsume some of the monetary authority's powers, suspend borrowing and merely credit their accounts with any amounts they deem necessary. We have no reason to fear deflation other than our own unwillingness to do what is necessary.

If one views the recession as one of supply, a resource one, specifically oil, the problem is real and the solution much more difficult. Oil is fairly unique in this regard. No other resource is as abundant in use and as difficult to substitute with substitutes generally being much more expensive. Its price seeps throughout the economy into everything. While inflation is low and unemployment is high, oil is still high at 2005 levels. Inflation could increase growth but even moderate growth could cause us to hit the supply wall and cause oil prices to increase faster than the economy can grow. They doubled over 2006-2008 and will do so again. The economy can adjust to moderate price increases, but prices can always increase by more than this. They must, since that is the only way for the market to balance demand and supply since supply is lagging. So unemployment may be the cost of keeping demand in check. Now inflation is low and somewhat higher inflation could be tolerated, but it could also shorten the time until we next hit that supply wall. The solution in this case is to accelerate development of alternatives though it is difficult to accelerate what is already urgent.

Let me say that I do not believe oil caused this recession. I do believe it could cause one though. I believe it lowered the growth rate to near zero and that we are growing now because it has fallen and if we grow much faster it will double again causing growth to collapse again and that we won't be able to grow solidly again without oil collapsing or competitive alternatives.

So does one increase inflation and growth now at the risk of a recession sooner or try to buy time for alternatives and supply to increase before one hits at the risk of incurring one now? It a balancing act.