Tuesday, February 8, 2011

quantitative easing and you

I guess pretty much everyone knows this, but for those who don't, the federal government has been talking about trying to drive up inflation and drive down the value of the dollar compared to other currencies through something called quantitative easing. This is a technical euphemism for printing more money.

There are a lot of objections to quantitative easing mostly, though not exclusively, from the political right. As is often the case, these objections can be broken down into two general groups -- the objections of people who don't have any money and interpret the world through a sort of crackerjack protestant code of moral absolutes, and the objections of people who do have money and who interpret the world through a code of getting more money or -- and this is really the rub -- making sure the money they have stays valuable.

The moral objection basically says that it's not cool for the United States to devalue its foreign debts by devaluing the dollars those debts are to be paid in. There's also a line of thinking that it's not cool to penalize people who saved money and were frugal while giving a reward to those who piled up a lot of debt. I guess it's the second issue I find compelling, speaking as someone who has something like $60k in education debt, plus a mortgage. But it matters in a more general sense as well.

The old argument on inflation is that it's regressive -- that the burden for inflation falls harder on poor people than on rich people, because rich people only lose savings, but that poor people get caught in the margin between rising prices and relatively static minimum wages. And that was basically true, even 40 years ago. But over the last 40 years, credit has become much more common, and credit cards in particular have become much more common. Pretty much everyone -- even really poor people -- have tons of consumer debt. The old equation, about rising prices running ahead of minimum wages will continue to be true. But it will be offset in the medium term by a reduction in the value of debt.

The longer term is more interesting. Or at least I find it more interesting.

And I guess I'm just going to take a minute here to riff about real estate values.

In 1984, a large house I know of in a desirable West Coast city sold for $60k. Four years later, in 1989, that same property sold for $90k. In January 2007, the value of that home peaked at $676k. It's now estimated to be worth $490k. Now, let's take a minute to compare those prices to inflation.

1984: House = $60k, compared to $60k in 1984 dollars; minimum wage = $2.30
1989: House = $90k, compared to $72k in 1989 dollars; minimum wage = $3.85
2007: House = $676k, compared to $118k in 2007 dollars; minimum wage = $7.93
2011: House = $490k, compared to $126k in 2011 dollars; minimum wage = $8.76

First, I guess it's worth noting that the inflation rate in the United States is pegged to the Consumer Price Index, and that the CPI is calculated by the federal government's Bureau of Labor Statistics, and that it's bullshit. It's a bullshit number. The government has all kinds of incentives to keep that number as low as possible and, even if they didn't, it just so happens that a lot of the industries that determine the value of the CPI are heavily subsidized to keep the price of their products down. So one way of describing the CPI is to describe it as "a basket of goods and services." A lot of the goods in that basket are groceries, and groceries in the United States are much cheaper than they should be because of farm subsidies. So. Inflation. Bullshit number. But it's one benchmark so, moving right along.

Second, it's also worth noting that the price of real estate isn't just the price of real estate -- it also tends to be very closely related to the price of rent. There are some places where this is only partly true, and some places where it's not true at all. I heard recently that mortgage payments in Brooklyn are going to be something like three times the cost of rent for some people. But, generally, mortgage payments and rent will be sort of in the same neighborhood of each other and, when real estate prices double, rents will generally double too because the people who own the home you're renting have to cover their mortgage, and they're going to pass that on to you.

Third, the price of residential real estate has coincided, in a very correlative and non-specific way, with a similar increase in the price of commercial real estate. This probably has less to do with a general increase in the price of real estate than it has to do with the growth of credit that I mentioned earlier. This credit bubble has fueled changes in consumption patterns, including a sort of terrifying increase in the number of restaurants and bars, as well as retail stores that sell semi-durable consumer goods like kitschy African art and t-shirts that say, "I know you are but what am I?" Basically, it has become possible to make a lot more money on retail than it used to be, because there has been a lot more consumer credit available. Zoning laws in most major cities create an artificial scarcity of commercial retail space that basically pegs the value of commercially zoned real estate to the value of the businesses that can occupy it, rather than the value of the land as it would be determined by the real estate market at large.

Points two and three relate to a couple of issues that I think are pretty important. One of those issues is land use, which relates to sprawl, which relates to air pollution, water quality, and workers' rights.

It goes something like this: once upon a time, factories were in cities because cities had the largest concentrated pool of semi-skilled labor to work in factories. Take a look around any decent-sized city, you'll see huge old buildings that used to be factories for companies you've probably even heard of -- Ford Motor Company, General Electric, Western Electric, Wonder Bread and so on. People lived near those factories, and tended to live so densely that they could take public transit to get to them. Then (at least) three things happened. One of them has to do with international trade, and we don't need to get into it here. The other two were the increasing mechanization of manufacturing, which made it possible to replace semi-skilled workers with a smaller number of unskilled workers, and the increase in the price of real estate in the city. So, basically, if you want to open a factory, and you only need five people with an IQ of 80 or above to run the thing, where are you going to put it? In Manhattan, where real estate goes for something like $100,000 per square foot, or in rural Indiana, where real estate goes for something like $10 a square foot AND the state will give you tax breaks to come there? Easy question.

But here's the thing about that. When the person who makes the t-shirts that say "I know you are but what am I?" opens a factory in rural Indiana, he or she typically builds a one-story building with a torch-down roof and a large asphalt parking lot. It costs more to heat and cool, but the state's giving them a break on utilities, so what the fuck. Then workers are expected to commute in from all over the place, and the population density out there is so low that there's no point in even trying to have public transit. So what you get is, you get people driving 30 miles, pumping out air pollution and dribbling motor oil all over the place, paying for their own cars and their own gas out of their wages, on their way to a square mile of blacktop that soaks up heat, increases the temperature of the rainwater that falls on it, decreases the oxygen content of the water, kills fish, causes algae blooms and, also channels the rainwater, rather than allowing it to soak into the ground, which increases the flow rate and leads to more flooding and erosion. And let's not forget that by scorching a square mile of earth into a hardened tar-like shell, the factory and its parking lot have also wiped out a bunch of grass and trees and shit that would otherwise be helping to mitigate all this pollution.

And don't even get me started about how the high price of land in cities makes it harder to build ecologically or aesthetically sound buildings. You know those ugly, ugly new condos you keep seeing? When a developer pays $2 million for a 1,000 square foot lot, they couldn't build an attractive building on that lot if they wanted to.

Anyway, I could go on about this all day, and I'll probably come back to it at least a few times, but the point here is that the high price of real estate, and the disproportionately high price of real estate in cities, fucks everyone up.

But here's the problem -- all that over-valued real estate is financed with loans and mortgages. The people who own those houses and business literally cannot afford to sell them for what they should be worth, if we wanted cities to be anything other than giant money pits.

So, what's this got to do with quantitative easing?

Simple -- there are two ways to bring the price of real estate more in line with inflation and wage growth over the past 30 years. You can bring the price of real estate WAY down, which would basically mean wiping out millions of homeowners and defaulting on trillions of dollars in mortgages. OR you can devalue the currency the mortgages are written in, putting upward pressure on wages, and making it easier for American companies to export at the same time you make it easier for American factories to move in closer to major population centers.

And those are some of my thoughts on quantitative easing.

Saturday, January 29, 2011

price signal. central planning.

Price signal is the mechanism through which cost accounting affects the interaction of supply and demand. So if I want to build cars, and the total cost of me building a car is $1000 per unit, and people want to buy cars but the maximum price they're willing to pay is $999 per unit, I receive a price signal that says, "Don't build any cars." There is significant demand for cars, and there's a supply of the stuff used to make cars, but the price signal says, "STOP!" Then if something changes to either lower my costs or increase the maximum price consumers are willing to pay, the price signal will say, "GO!"

Central planning is when supply, and sometimes demand, are controlled by a central bureaucracy for policy reasons that may or may not have to do with price signal. So if I were running the department of cars in a central planning system, and I determined that the reduced transit time and the commensurate increase in production time had greater value than the net social cost of car manufacturing, I might order the car factory to start pumping out cars whether there was sufficient demand for them or not. Then I might issue car ration coupons to people and have them go get them. I might cover my costs by cutting back on the steel used in rowboats. So now rowboats are made of fiberglass, everyone has a car, everyone spends an hour a day less commuting and puts in an hour-longer day at the factory. Meanwhile perhaps you will win victory over yourself. You will love Big Brother.

These are both gross oversimplifications, but they'll do for our purposes.

Once upon a time, there was a lot of debate about which of these two methods was "best". The argument went something like -- "Yes, we love the flexibility and individuality of a price signal system, but central planning uses resources more efficiently by reducing transaction costs and opportunity costs." And there were sort of archetypal examples of the successes of these systems. There was the Ford Motor Company, and there was Sputnik. But then the Soviet Union collapsed and computers went a long way toward lowering transaction costs and streamlining opportunity costs, and the general consensus, even among communists, came to be that price signal won.

It's true as far as it goes -- price signal is the superior system for certain kinds of transactions and certain kinds of economies. Once you've made the decision, for example, that you're going to allow logging in a National Forest, price signal is the best way for logging companies to decide whether or not to work a timber lease and it's the best way for a pulp mill to decide whether or not to buy the logs and so on.

What people don't talk about so much -- or what some people don't like to talk about -- is that price signal isn't necessarily the best tool for making the initial decision: whether or not to log the National Forest in the first place. And there are various arguments for why it is a good tool for making that decision -- there are pure utilitarians who will pose questions about what cash value should be placed on a National Forest, including all subsidiary interests such as aesthetics and oxygen production and so on. But most of us can agree that these people are assholes. Nobody wants to live in a world without trees, at any price.

The reason there's even any debate about this shit is that there is a disconnect that individuals experience, where the benefit to them is immediately quantifiable and the harm is speculative or difficult to visualize. It's the reason fire departments aren't subscriber based (or have had serious legal and ethical problems when they have been), and it's the reason there are no more cod left in the Atlantic. And as far as that goes it's very strange to me that the Republicans, who bend over backwards to support the War on Drugs, seem to have such a difficult time imagining that their own decision-making, at the individual level, may be impaired by the serotonin spike they get from off-roading in their Hummer, or shooting off their ridiculously enormous guns. Or -- and this is really the issue -- they don't seem to be able to acknowledge that the profits derived from extraction industries are not tied to the effort of engaging in the industry. Finding the last salmon will probably require a lot more expensive equipment than finding the first one did, but catching it will involve pretty much exactly the same amount of work. There's no special virtue in commodifying shit that's just lying around and making a profit off it. The idea that we have a moral duty to allow people with mid-range IQs to "earn an honest living" by chopping down every tree they can find is just ridiculous. There are cheaper ways to keep people employed. Sacrificing our natural resources to create the illusion of independence is a chump's game.

I mention this, essentially, to lay the groundwork for a conversation about surplus labor, but I think the point is worth making on its own.

Thursday, January 27, 2011

thoughts on investment

One narrative that's useful when you're thinking about questions relating to the economy is the one that supposes there are two groups concerned in any governance question: the governing and the constituent. It's important to recognize that this isn't the dichotomy most people imagine when they think about this idea -- it's not rulers and ruled. It's more like executives and shareholders. The endpoint of this discussion is speculation, but first some groundwork.

First, it's useful to go back to a basic model of what investment means. Imagine for a minute that I'm a plumber. Not only that I'm a plumber, but that I have worked closely with a plumbing contractor such that I understand both the running and the execution of the business. I can braze a pipe, I can make rational assumptions about the future cost of my basic materials, and I can handle HR and other side issues. I can do it all. But I don't have enough money to start my own firm. So I get as much together as I can, and then I go look for investors. To make it as simple as possible, I get one investor who pays for 51% of my new plumbing company. We'll call him Bob.

Now, what this guy owns is 51% of the assets of the company: the stock on hand, the tools, the building where the company is, and whatever cash assets or cash debts the company has. The value of his share of the company is equivalent to 51% of the liquidation value of the firm. So if I decided to stop being a plumber and we sold the entire operation, my partner would get 51% of the total net return. Bob's incentive to invest could be one of two things. One is that I don't plan to grow the firm. I'll pay myself a salary to be the plumber and the business manager of the firm, I'll pay the firm's bills, and the rest will be pure profit. That profit will be split between me and Bob 49/51 for as long as the firm continues to operate and, if the firm is in the red, Bob will be on the hook for 51% of the debt. The other possible incentive is that I will take the profit and re-invest it in the firm, such that the value of the firm -- the liquidation value -- increases over time. We'll have more stock on hand, we'll get a delivery truck, we'll get a bigger building, and we'll hire more people. Enlarging the operation will enlarge the profit which will accelerate the growth of the operation until we meet the market ceiling -- until we've done as much with the company as we can, given the size of the market. And during this process, the value of Bob's 51% of the company will increase hugely, without him actually having to do much beyond the initial investment.

In this scenario, I'm a technocrat. I'm the guy who knows what's going on. Bob's the guy whose money is at stake. Because he owns a majority interest in the firm, Bob theoretically has control of what the firm does -- including, incidentally, the option to fire me and hire someone else to run the firm. But Bob doesn't know anything about the plumbing business, or any of the rest of it. This isn't a judgment of Bob. Presumably he has his own business that he knows all about. But if Bob tried to run our company, he'd fuck it all up. Even though he owns a majority, he's sort of just along for the ride.

This is the basic governance question that comes up, in one form or another, pretty much everywhere. Lawyers know more about the law than we do; we want them to deal with it, but we hate and mistrust them. Politicians know more about politics; we want them to deal with it, but we hate and mistrust them. CEOs know more about business than we do; we want them to deal with it but... well, you see where this is going. The question is, how do you have experts run things without giving them too much power? Where do you draw the line between ownership -- or interest -- and control? The answers to this question tend to be doctrinal, but they're sort of tangential to the issue I'm trying to get at here.

The issue I'm getting at here has to do with the third reason Bob might want to invest in my plumbing company. Specifically, Bob might want to invest in my plumbing company because he believes I'll grow the business, he believes other people will believe I'll grow the business, and he believes he can make a profit selling his initial investment interest to one of those people on the premise that, since the business will grow, they'll pay more than the current value of the interest in anticipation of future value.


So the problem that comes up here arises when Bob sells his 51% for $100. Tom buys it at $100, goes to Helen and says he'll sell it to her for $105, because it'll be worth $110 by the end of the year. She buys it and tells Ed, who pays $115 for it, because it'll be worth $120 in two years. But then a weird thing happens. Nancy buys it for $120, because she thinks someone else will buy it for $125. Someone else looks at it, sees it's gone from $100 to $120 in a week and pays $125 for it, believing it'll sell for $130. Pretty soon that 51% is trading around town for $100,000 and, around that time, I have a bad month. The company loses money. Or maybe someone just makes the mistake of looking down. The price of the thing plummets until one day Rosanne buys it for $50.

Now, Rosanne has an interesting new option that nobody else has had. She just paid $50 for something that's actually worth $100. She can take her good investment and sit on it, in the hopes that the company will be profitable and the value of it will grow. OR she can order the liquidation of the company and make $50 right now. This is, by the way, basically the plot of the first Wall Street movie.

The fact that this scenario can occur has been pissing people off for hundreds of years and speculation is one of those things, like usury, that half-smart people have been railing against since the middle ages. Because, of course, speculation -- like usury -- is one of those basic engines that power the whole economy.

That doesn't mean regulation isn't a condition precedent to keeping the whole thing from blowing up in our faces.

basic theories of economics in retrospect

[The following is reprinted from a now-defunct blog. It was originally published on the internet in 2006.]

You know what I was thinking about last time I was in London? I was standing in the Underground next to the tracks and I was thinking about the electrified rails and the speeding trains and the depth of the trench the tracks are in and I was thinking that standing next to the tracks in the Underground is as dangerous, in its way, as standing in front of a loaded gun or standing near the edge of a 100 foot tall building. I think about that sometimes with cars too, like when I'm standing on a corner waiting for the light to change cars go by doing 40 mph-- they go by within a foot or two and I don't even think about it. Life's full of that kind of shit. The trick is not to look down, or you'll freeze up-- but you don't want to ignore it altogether. That can be just as dangerous.

Here's one I've been thinking about a lot lately:

So, like, most of us live in a capitalist economy and -- I think most people know this -- capital is stuff. Specifically, capital is stuff you use to make other stuff. So, like, iron ore is capital; trucks you use to move ore from the mine to the factory are capital; machines you use to turn ore into steel are capital; steel you process into sheet metal is capital; sheet metal is capital; a hydraulic press you use to stamp sheet metal into spoons is capital; replacement parts for the press are capital. The spoons might be considered capital if they're going to be, like, put into a kitchen set prior to being released on the market; or you can think of them as capital in a home economy. Food cooked at home has market value even if it isn't ever released into the stream of commerce, because it is competitive with goods and services that do run in the stream of commerce. Basically, capital is assets.

Alright. Now, the value of any business is equal to the total value of all its capital, minus its debts. Shares in a company or firm represent a portion of the net value of the business. The interesting thing is this:

Imagine a firm owns 100 widgets and has no debt. It offers 100 shares of stock for sale. In real terms, each share of stock is worth one widget. In practical terms each share of stock is worth the market price of the widgets the company owns. So if the company's widgets sit around for a while they'll get old and they may sell for less than the price of new widgets. When that happens the cash value of the stock drops-- but each share is still worth a widget. For most intents and purposes this is six of one half dozen of the other. Most countries have laws about how a company can be liquidated that require them to give you cash rather than widgets. But it's worth keeping in mind that there's a difference between what a company is and what it's worth.
Which brings me to the thing I've been thinking about lately.

When a firm offers stock (or shares or whatever) for sale, the trading price is usually higher than the real value of the firm based on anticipated increases in the value of the company due to profits and subsequent re-investment of same. Right? So if you've got a company that uses widgets to make doohickeys and the doohickeys are selling at a good profit then the company will use its profits to buy more widgets. After a year the company has twice as many widgets as it used to; now they've got 200 widgets. But each share of stock is still worth 1/100 of the company (2 widgets), so each share has basically doubled in value. When the company offers the initial 100 shares for sale, investors will look at the company's profits and speculate that the shares will be worth more than 1 widget each in the future-- so they'll pay more for the shares in order to outbid other investors and reap the returns at a future date.

But how much do they bid up? Ten percent? Twenty? Ha! Noooo. They bid up by whole number multiples of the value of the company. Big numbers. You can get an idea (certainly not a precise idea, but some idea) of the discrepancy between value and price by looking at the price/earnings ratio, which is the current price per share divided by the earnings per share for the trailing twelve months (the last year). So, like, if Starbucks has a P/E ratio of 52.59, that means that the current price of the stock is 52.29 times the company's gross earnings (after depreciation, tax, interest and dividends paid to holders of preferred shares) for the last 12 months. That doesn't necessarily mean anything -- maybe the capital the company has on-hand returns relatively small earnings on investment and if you liquidated the whole shebang tomorrow you'd get your money back and then some. But really, you gotta figure there's some pretty fuckin' wild speculation going on when you see a P/E ratio like that.

Of course the actual value of a company like Starbucks is basically impossible to calculate for various reasons -- but if you're wondering why someone would even consider paying that much more than a company is earning (or worth or whatever) it's useful to get back to our widget company. If they make enough profit in a year to double their capital base -- and all other conditions remain constant -- it follows that the annual doubling could continue indefinitely. At that rate your initial investment of $1 is worth $64 in something like 6 years. That never actually happens in the real world (or rarely, at any rate), but it's easy to see why someone would be willing to invest well beyond the current value of a firm, and it makes the idea of a 52.59/1 P/E ratio for Starbucks seem slightly less irrational.

Now, where things start to get interesting -- and by "interesting" I of course mean possibly Very Very Bad -- is when you start figuring in money.

Because -- and here again, I'm sure most of you know this -- money isn't capital. Money is a medium for transferring debt. An IOU for one cow is money. The slip of paper is worth a cow; a cow is worth so many chickens and so many pigs and so on and you can trade the piece of paper for that many chickens or pigs or some combination thereof. It's easy to get fucked up and start thinking of the piece of paper as having intrinsic value but it's only worth what it represents. So its trade value in relation to other things is directly connected to the trade value of the capital backing the money relative to other capital. That's Thing One.

Thing Two is, IOUs have to come from someplace; the piece of paper comes from a specific person or farm or whatever. So for practical purposes, the IOU isn't just worth "a cow." It's worth a specific cow; it's worth Bessie. An IOU for Bessie is still money but if a screw falls out the ranch gate or something and Bessie gets loose and goes wandering and gets hit by a train, the value of your money relative to chickens and pigs and whatnot is drastically reduced. Likewise if Bessie gets old or steps on a nail and gets lockjaw or whatever. The holder of the IOU can try to defer those risks onto the person who issued the IOU by stipulating that the issuer has to provide a cow in good physical health and so on, but really those guarantees are a legal fiction; if the cow gets hit by a train it gets hit by a fuck'n train, and Farmer Bob isn't just going to pull a new cow out of his ass. So the value of money doesn't just change in relationship to the machinations of some invisible hand; it changes in response to specific circumstances, i.e., Farmer Bob and Bessie.

Things One and Two describe the shape of a problem that people have been having with money for centuries, which is that it's not actually a safe medium for investment. Which confuses people because it seems like it should be: if I buy a cow, the cow can be stolen or killed. I have to watch it all the time and make sure it's being taken care of. So my investment is always at risk. On the other hand, if I have a slip of paper worth a cow, I can just stick the slip of paper in my pocket and forget about it. But the thing is, someone still has to take care of the cow or the paper isn't worth shit.
(And I'll just take a moment here to note that the kind of money I talk about above is a very specific kind of commodity currency that is obviously very different from fiat, or fiduciary, currencies in many respects; however, for our purposes here today, the differences are not so great. Fiduciary currency is still tied to real-world variables, even if those variables are much more complicated than the value of the figurative cow.)
People have spent a lot of time trying to get on top of this particular problem with mixed results. And by "mixed" I mean "various kinds of bad." Because whatever Farmer Bob might promise you -- however hard he might try to keep an eye on Bessie -- the fact is that screws just fall out all the time. The world is an imperfect place. And nowhere is this more apparent than in the history of monetary and fiscal policy.

But wait -- how does all this relate to capitalism and the London Underground?

I'm glad you asked.

Back in dinosaur times, governments based the value of their currency on gold. So the IOU was for a certain amount of gold. That stabilized the value of currency relative to most commodities but it also prevented deficit spending which meant that it was possible for a government to just run out of money. After that happened a couple of times and the global economy collapsed causing untold human misery and death, most governments got rid of the gold standard and went over to what I call the Um System. The way the Um System works is that a wizened gnome in a bomb shelter somewhere controls the value of money by controlling how much of it is available. He or she does this, basically, by setting the interest rate that the government charges banks for money it lends them: low interest rates mean that banks can get more money from the government and offer it to the public in the form of credit. High interest rates mean that banks can't get as much money and they have to cut back on lending in order to meet their reserve requirements. The gnome has a lot of very complex indicators that guide his or her behavior around all this and some even more complex ways of making the money available (buying debt, etc) but all most people see of the whole business is kind of the economic equivalent of Groundhog Day. The Chair of the Federal Reserve comes out of his or her hole, sniffs the air, looks around with squinty eyes and says, "Um... today, the Federal interest rate will go..."

If the rates go down, it's party time. Otherwise you've got six more weeks of Top Ramen.

Okay, so, remember what I was saying before about the real value of a company compared to the price of its stock? The upshot of that is that the total trading value of all the stocks on, for example, the New York Stock Exchange vastly exceeds the real value of the companies that are being traded. So, like, it's possible for the value of the stock on the exchange to just drop. And it can drop for a good long while: the bottom is way the fuck down there. And one of the interesting things about that state of affairs is that it actually makes it sort of difficult or impossible to safely invest in capital that's attached to successful businesses because any successful business is publicly traded-- and therefore totally inflated. So you can either buy some iron ore and a truck to ship it in or you can buy some stock in Starbucks and hope you don't get zapped -- the road between those two points is weirdly devoid of intersections. But the fact is that a really stunning volume of money is tied up in an economy that is, for most intents and purposes, a mass hallucination.

But then you reckon into all this the fact that money isn't really worth anything either and that its value as a medium of exchange is based on, for example, foreign exchange rates that can be negatively impacted by Federal deficit spending, and -- well. You know...

Looking over the edge of a very tall building. Having a loaded gun pointed at you. That kind of thing.