A Millennial's View of the World

Tag: economics

On Money, Wealth and Taxes

At the time of the writing of this article, there are several major protests being held in cities throughout the world under the “Occupy Wall Street” banner. In the midst of one of the greatest economic downturns in the past hundred years, citizens are taking to the streets to protest the gross disparity in wealth between the wealthiest Americans and the large majority who are struggling to get by. This movement has brought the issue of economic disparity to the  forefront of the mainstream media. As the Obama administration proposes a special tax on annual income over a million dollars, it is pertinent to discuss what money really is, how it is accumulated, and the effects of taxation on individuals, corporations, and the economy as a whole.

Money
I remember first gaining an understanding of the existence of money as a child while shopping at a toy store. Learning that I could not have a toy that I wanted because it was too expensive was a harsh reality to take in. This was clearly a problem. There are all these amazing toys out there, but for some reason I can only have the cheap ones? Something was clearly wrong.

I thought that I had solved the problem of money not too long after my discovery of its existence. “Why doesn’t the country just give everyone a million dollars so that we can all be rich and have all the toys we want?” It seemed like a great idea.

Of course, we all know why this doesn’t work. If the country gives me a million dollars, then it must give the guy who works at the store a million dollars and the guy who makes the toy a million dollars. The worker will quit his job, and the toy maker will stop making toys. The price of the toy will have to go way up to make it worth it for the toymaker to produce the toy and the worker will demand more money to sell the toy. All of the sudden I’m paying 100,000 dollars for the toy that once cost 100 dollars, and before you know it, my million will be gone.

The principle that I learned is that the value of money is only related to the fact that there is a disparity in how it is distributed. The fact that only a select few have a lot of money gives money its value. This principle goes back to the first monetary economies.

Before money, economies were based on a system of barter. The hunter would give meat to the berry gatherer, who would provide the hunter with berries in return. Once additional products were demanded, the barter system broke down. If the hunter needs shoes, the clothier needs meat and the shoemaker needs clothes, the hunter will have to trade his meat for clothes from the clothier, then trade the clothes to the shoemaker for shoes. Every individual would have to carry a variety of goods to trade, depending on what was to be demanded by a trading partner. With the introduction of money, the hunter can sell his meat for money, and then purchase what he wants with that money.

The money that the hunter receives in exchange for his meat is the value of the hunter’s contribution to the economy. If one chicken’s worth of meat is worth one pair of shoes, then both will be worth the same amount of money. When the hunter makes a purchase with money, it is as if he is using a chicken, or a pair of shoes to make the purchase.

Even in a modern economy, this truth still holds. The value of all money is still based on the product of the individual producer at the bottom of the chain. The worker in a factory in China, the farmer on a mega farm in Nebraska, and the homebuilder in Orange County create the wealth that gets distributed up the economic chain. When I make a purchase at 7/11, it is as if I am exchanging the work that produced that money for what I am purchasing.

With modern technology, of course, it takes fewer and fewer workers to produce base goods. The worker at the bottom of the chain actually contributes a huge amount of wealth to the economy. In America, only 2% of individuals work on farms, but those individuals provide enough food for more than the entire population of the country. Fortunately, a new level of the economy arises once our basic needs are accounted for; the service economy. New products and services are demanded which go beyond the basic needs of the individual. Attorneys are required to settle disputes, doctors fix the sick and graphic designers create images. This new level of service providers takes the wealth that has been created at the bottom and redistributes it again at the next level of the economy. Individuals in the service economy only have this luxury, however, because of the money creators at the bottom of the chain.

Wealth
Going back to our primitive economy, another phenomenon exists which affects the distribution of money. With the introduction of money, the rise of a middle man will likely occur. The shopkeeper collects goods from those who produce them, and provides the producers with money that they can then exchange for other goods. The  shopkeeper will sell goods for more money than he pays for them, thus making a profit. Once the shopkeeper has paid for all of his needs, he will likely still have money, which leads to savings, and the accumulation of wealth.

On his own, the hunter is limited in the amount of wealth that he can accumulate. He is limited by the amount of food that he can produce in a given day minus his expenses for himself and his family. The hunter can only increase his wealth by becoming a middleman. He can train several other hunters to hunt, then collect their spoils, give them money, and sell their meat to the shopkeeper at a profit. The hunter now has a hunting business, and is essentially operating like the shopkeeper.

The shopkeeper’s accumulation of wealth is only limited by the number of customers purchasing goods and suppliers providing him with goods. In the modern economy, the shopkeeper’s limitation has grown to an enormous extent. The shopkeeper can sell goods to billions of customers. Bill Gates became the richest man in the world by selling billions of copies of Windows at $100 a copy. Gates produced a product that was useful. Individuals purchasing a computer with Windows purchase that product with money that they have earned. The money they have earned has a value based on the initial creation of wealth by the producers in the economy. Bill Gates was able to accumulate his billions in profits because the producers at the base of the economy pushed their wealth up the chain, with billions eventually landing in his pocket.

Wealth is created based on a pyramid. The producers at the bottom of the pyramid push wealth up the chain, and the business owners at the top are the eventual benefactors. In essence, the rich can only become rich because of the contributions of the poor. In an economy with 10 individuals, the wealthiest individual can only accumulate a fraction of the money that can be produced by the other nine individuals. In an economy of 7 billion individuals, the wealthiest individual can accumulate a fraction of the wealth that can be produced by the other 6,999,999,999 individuals. The wealthiest 1% in America could only become wealthy because of the other 99%. Anyone who is wealthy got that way because other individuals gave them money in some way shape or form.

Many wealthy individuals would say that they became wealthy because of their own hard work, ingenuity, and perseverance. This is true, and the wealthy need to be commended for what they have done. Becoming wealthy is not easy, especially in a world with so many people who want to be wealthy, and so few who actually are. Even those who have inherited their wealth only did so because someone in their family line figured out how to accumulate wealth so that his or her heirs would not have to worry about doing so. This point, however, does not detract from the fact that the wealth was created because of the contributions of the poor and middle class, and this principle must be remembered when determining how wealth should be redistributed.

Taxes
Going back to our primitive economy, there is another factor which arises that affects how money is distributed. The early shopkeeper accumulates his wealth, and stores it in his home. The jealous hunter breaks into the shopkeeper’s home, kills the shopkeeper and takes his wealth. The hard work of the shopkeeper has now been destroyed by one criminal act. Enter the King.

The King, or the Government in modern times, organizes society so as to allow individuals to keep their wealth. For the early shopkeeper, it is worth it to dedicate a portion of his wealth to the king, who will maintain order. If the hunter kills the shopkeeper, the king will punish the hunter with death. The hunter is thus detracted from committing a crime. If a neighboring village invades, the king assembles an army to fight them off. The king is the absolute protector, and is in charge of the general welfare of all in the kingdom.

Of course, the king is also responsible for wealth redistribution. If the shopkeeper loses his wealth, the king will provide him with food, so that he has the opportunity to rebuild his shop, and accumulate wealth once again. By providing for the poor, the king redistributes wealth from those who have accumulated it back to those who produced it, or will produce it in the future.

The issue then arises over how much in taxation can be appropriated by the king. If the king takes too much, the shopkeeper will lose his incentive to maintain the shop. If he can no longer accumulate wealth, then there is no purpose in continuing the process of shop keeping. He will simply resort to working. However, if the king takes too little, the shopkeeper won’t receive adequate protection, and the society will fall apart.

In modern society, the role of the government has expanded greatly. With more and more money being created by producers, citizens come to expect that more and more money will be spent by their governments on maintaining a good society. Economic downturns lead to situations in which society demands high sums from its government to maintain a decent existence. Government expenditures are needed to put money into the pockets of the producers, who will make purchases that allow the shopkeepers to accumulate more wealth. All of the workers who produced the wealth when times were good now require that the wealth be redistributed to them when times are bad.

There is no ideal rate of taxation. The rate should be high enough for the state to acquire the revenues required to provide the services that its citizens demand. Of course, there is also no ideal level of services that the state must offer to its citizens. The role of the government is to find this equilibrium. The state must redistribute money from those who have accumulated it to those who produced it in order to create more spending and producing. The government should not be afraid to raise taxes to meet the tax revenue equilibrium.

United States Taxation
A country that taxes 90% of the income of its wealthiest citizens would likely not experience a great increase in revenues by taxing 95%. At a certain point, incentives are lost, and the producers can no longer accumulate wealth because of the unnecessarily high tax burden. However, the tax burden in the United States is quite low for the extremely wealthy.

An individual earning over a million dollars a year should pay an additional tax on his or her income in order to pay for programs that will boost the economy and bring back jobs to the wealth producers. Of course no one wants to pay more taxes than they already do. The wealthiest currently pay 35% in Federal Government taxes on income above $357,701. On capital gains income, the wealthiest only pay 15%, no matter how much they make. Of course, there are also state taxes and payroll taxes that the wealthiest pay, but in the end those with high incomes take home a lot of what they make after taxes.

Total government revenues actually went up when the Bush administration lowered the tax rates that Americans pay. This phenomenon, however, coincided with a massive asset bubble in the real estate industry. Tax revenues increased because wealth was being created artificially. Rather than wealth being created based on production, it was being created based on an artificial increase in the value of real estate. Banks essentially used an increase in property values as an excuse to print money, which was then redistributed through the economy. As soon as the real estate bubble crashed, tax revenues began to fall again.

Increasing tax rates on the extremely wealthy would only lead to a decrease in tax revenues if it caused a significant slowdown in an economy. The argument goes that small business owners won’t make investments if their tax burden is too high, since they will have less disposable income to reinvest in their companies. I find this logic to be unsound.

Take an individual with a successful small business that gets $5 million in annual revenues. After expenses, the company makes a profit of $1 million. If the business owner takes out all $1 million as personal income, he or she will pay about $300,000 to the IRS and another $100,000 in state taxes. This individual now has $600,000 in disposable income. If the Federal tax rate was higher and the individual had to contribute another $50,000 to the IRS, he would now have $550,000 in disposable income.Will this 8% decrease in spending money really make any difference in whether the business owner decides to hire more workers for his company?

Now assume that the owner reinvests $500,000 in to the company to open another office and hire more workers. The owner now earns only $500,000 in pre-tax income. He takes home $300,000 at a lower tax rate or $275,000 at a higher tax rate. The 8% difference is not the factor that will guide the owner’s investment decision. Regardless of the tax rate, the investment decision is going to significantly lower his after tax income in the short run.

The owner is only going to make the investment decision if he thinks that it will lead to more revenues for his company in the future, which will give him more profits before taxes. If he anticipates $6 million in revenues in the following year due to his $500,000 investment, then he will make the investment. His after tax income will only affect the spending

decisions he makes with his personal money, not the spending decisions he makes for his company. If anything, a higher tax rate will encourage the owner to spend more on the company so that he makes more profits in future years and takes home more money after taxes.

The thing that is going to determine the business person’s investment is anticipated revenue. This revenue will be determined by the amount of customers that demand her product. The amount of customers who will demand her product will depend on the amount of people who have disposable income, and the amount of disposable income that they have. If the economy is bad and people do not have disposable income, then there will not be anyone to purchase the business owner’s products.

The government’s role in a recession is to create more purchasers of products so that businesses can expand. The government cannot create more purchasers without additional money to invest in creating those purchasers. The government cannot raise more money without taking more money in the form of taxes.

Conclusion
A minor increase on taxes for the wealthy should not be looked at as the government punishing the wealthy for accumulating wealth. Rather, it should be looked at as the government returning to the masses a small portion of the wealth that the wealthy have accumulated so that the wealthy can have more opportunities to sell their products and services to the masses and accumulate more wealth in the future. The wealthy can only become wealthy if the masses are producing money. The masses can only produce money if they have jobs and security. The masses can only have more jobs and security if the Government makes investments that give them more opportunities and gives businesses incentives to expand. The Government needs money to make these investments, and the wealthy have the money available. Increasing taxes is the right thing to do, and the government should not be afraid to do it.

Understanding the Debt Ceiling Debate

Anyone who has watched cable TV in America over the last few weeks has probably seen ads attacking the Obama administration and calling for an end to an increase in the debt ceiling. The ads point out several truths about the economy since Obama took over in 2009. The unemployment level has gone up and the federal debt level has increased by a large margin. The problem with these ads is they use true facts to lead to a false conclusion and an even worse policy prescription for America.

 

The Debt Ceiling

Regardless of who should be blamed for America’s economic woes, not raising the debt ceiling would probably be the stupidest thing that the government could do. The fact is that the United States government has not had a balanced budget since 2001. It has been running a deficit for the last decade, and with a deficit, the total amount of debt will inevitably increase.

The United States Congress has to approve of any increase in the total amount of debt that the American government takes on. This is the debt ceiling, which must be adjusted to reflect deficits. The ceiling currently sits at $14.3 trillion, but must be increased to reflect new deficits that the government needs to take on to function.

Obviously the size of America’s deficits is a problem that needs to be addressed. However, the fact is that there is currently a deficit and the debt ceiling needs to be increased to pay for the American government to run. If the debt ceiling is not increased, the government will not have the money to pay its obligations to employees, debtors and federal programs.

Imagine a guy who owns a house worth $500,000.00 and a home business. He has borrowed $200,000.00 and is making payments on the $200,000.00 debt. The bank is offering to give him another $50,000.00 in debt to finance his home business and make the payments on the debt. He refuses and decides that $200,000.00 in debt is too high, and that rather than taking the loan, he will leave the debt as is. However, his income is not enough to make the monthly payments on the loan and pay his business’s employees. So, he doesn’t make his interest payments or pay his employees. What will happen? The bank will foreclose and the employees will be out of work. The person will lose his home and business. Game over.

Rather than a home, the American Government has its economy as collateral for its debts. Investors have lots of confidence in the strength of the economy, and are therefore willing to lend money to the government. By not increasing the debt ceiling, the government is refusing to take on the debt that it needs to survive.

If the American government doesn’t increase the debt ceiling, we will see a financial crisis like the world has never seen. It will be even worse than the one that happened in 2008.  Investors and foreign countries will lose confidence in the US government. There will be a massive sell off of government bonds and treasury bills, which are normally considered the most secure instruments. Total Armageddon could ensue, especially with the world economy already in a fragile state. The Federal Reserve would likely use its reserves to delay the problem a little longer, but eventually the ceiling will have to budge for the economy to survive.

 

The Republican Strategy

Fortunately, the Republican Party is mostly filled with rational actors who are aware of the necessity of raising the debt ceiling. The Republicans, however, have used this opportunity for their own political purposes. They realize the power that they hold with respect to approving of the increase in the debt ceiling through their control the House of Representatives.

The Republicans are using the opportunity to starve the government, fire government workers, take health care away from senior citizens, and take away regulatory agencies that protect the environment and the general public. Federal government programs that help the poor and underprivileged are being cut.

The Paul Ryan plan for Medicare reform will certainly be a step in the wrong direction. This plan intends to pass off the costs of the deficit to the senior citizens of the future (i.e. people currently under 55). The Plan will take away insurance coverage for seniors and instead provide seniors with a voucher to purchase insurance from private companies. Of course, eventually the laws of economics will send prices for health coverage higher than the vouchers, and seniors will have to dig into their savings to purchase health insurance. Seniors without savings will end up with inferior healthcare plans, which will lead to deaths from treatable illnesses.

Of course, the Republicans would say that this is an opportunity to get deficits under control for the long term future of America. This comes after several studies have shown that at its current rate, the government’s deficits will keep on expanding, and eventually the country will no longer be able to afford to pay for government programs or make interest payments on government debt. This is scheduled to occur in the 2020s without any changes under the status quo. This obviously is a serious concern, which can’t be passed off to future generations.

The problem with the Republican solution to this issue is that they refuse to budge on the revenue side of the equation. With an increase in revenues, the government could afford to pay for its obligations like Medicare, Medicaid and Social Security, although these programs do need some minor reforms to save on costs.

Think about the U.S. government as a company. The company is operating at a loss. Revenues coming in are less than expenses. The company has to take on debt to pay its expenses. To balance its budget, there are two options: cut expenses or increase revenues. Of course, the company could do both and return to profitability.

 

Taxes

So, how does the U.S. Government increase its revenue? Taxes! The government should be paying its expenses with tax dollars from its Citizens, not from money that is borrowed, right? Not necessarily. Debts can be good for governments, allowing them to expand at a quicker rate and increase ownership of the country by its citizens, who buy government debt. It can help relationships with other countries, allowing countries to invest in each other and become interconnected. Of course, debts do need to be manageable to prevent a default on interest payments.

So if the Republicans are really so concerned about the deficit, why don’t they just increase taxes? The answer is that there is a pervasive dogma that has infiltrated the Republican Party. This dogma states that any increase in taxes will actually lead to a decrease in total revenue. The logic goes that lower taxes allow the economy to expand, which will actually increase total government revenues.

A company or person that pays 40% in taxes with profits or income of $100,000.00 will pay $40,000 to the federal government. A company or person that pays 25% in taxes with profits or income of $200,000.00 will pay $50,000 to the federal government. Therefore, if cutting the tax rate from 40% to 25% will allow the company to double its total profits, then the tax cut will actually lead to more government revenue!

Of course, the major caveat with this theory is that lower taxes must lead to increased profits or income to compensate for the decrease in government revenue per dollar earned. The Republican theory has basically become that any decrease in taxes will lead to an increase in total profitability that will more than compensate for the decrease.  If the theory were really valid, then taxes should just be decreased to 1%, because with taxes this low, the economy would expand exponentially.

What is to say that the company’s profits will double if its taxes are cut in half? The truth is that with any economic principle, the results are inevitably parabolic. At a certain rate, you can cut taxes, but the effect will not increase the company’s profit to account for the decrease in revenue. There is going to be a tax rate at which total revenues are maximized.

The Republicans would make the argument that this rate is lower than the current rate, and that taxes must continually be slashed until the perfect rate is found. However, this would assume that the “incredibly high” taxes that companies and individuals are currently paying are keeping them from making money. The thing is, companies are making tons of money, even after taxes. Many individuals are also making lots of money, and even after taxes, are still walking home with a lot. Yet, the economy is still stagnant.

The federal government does need to make spending cuts as part of its deficit reduction plans, but the Republicans want to turn America in to a third world country to do this. Any nation that punishes its poor, elderly and unfortunate is not going to be successful in the long run. These are long term problems, and the government needs to come up with long term solutions, which must include increasing revenue by raising taxes.

 

The U.S. Economy

The U.S. economy is not stagnating because taxes are too high. Companies are making huge after tax profits, and individuals who do have jobs have lots of disposable income after taxes. The problem is that after a decade of insane consumption and borrowing, followed by an economic meltdown, businesses and individuals are still in a state of shock. Companies are reluctant to hire new employees, and people are more likely to save than to spend. Companies have become more efficient, and can make the same revenue with fewer employees. This problem will only be solved by an increase in confidence, technological innovation, and government investment.

The compromise made at the end of 2010 shows that keeping taxes low did not have a serious stimulating effect on the economy, at least not enough to compensate for the loss in revenue associated with the cuts. The compromise prevented taxes on the rich from going up to pre-Bush levels of 39.6% (from 35%). It also changed the estate tax so that heirs to multi-million dollar fortunes would no longer have to pay taxes on the first $5,000,000 of their inheritance (or $10,000,000 for estates of couples), and would pay a tax rate of 35% on any inheritance above that amount. There may have been a small effect from this cut, but it has not had the stimulating powers that the Republicans promised.

The US economy is getting better, but it is happening very slowly. The biggest lie being spread by Republicans is that the stimulus package failed. The U.S. has had 7 consecutive quarters of positive GDP growth. Employment has been trending upwards since March, 2010, and there hasn’t been a month with net job losses since September, 2010.

The Republican Party is trying to take advantage of the short term memory that people have and blame the US economic problems on the person who has been fixing them, not on the people who caused them. The bad economy that we are experiencing is still the result of the horrible catastrophe that was caused by the Republican Party’s deregulation of the financial sector. This is still Bush’s recession, even though Obama has been trying to make it better.

Many parts of the stimulus package kept the economy from getting worse than it did. For example, the extension of unemployment benefits in the package kept money in the pockets of the millions of unemployed. They were able to use that money to buy food, rent apartments, and generally remain consumers in the economy. Each expenditure within the stimulus package can be directly related to an infiltration of dollars into the U.S. economy.

When Obama took over, the economy was in a horrible downward spiral. Hundreds of thousands of jobs were being lost every week. After the bailouts and the stimulus package, the economy stabilized and things began going in the right direction. The stimulus worked. It will take a long time to dig out of this whole, but at least we are no longer in the bottom and are on our way out. Obama did all that could possibly be done. He’s a politician, not a God.

Of course, if the debt ceiling isn’t raised, we could go right back in to the hole. Hopefully an agreement will be reached that solves some long-term problems, doesn’t punish the poor too much, and increases revenues. Until then, we can only watch the farce go on and hope for the best.

The Post-Recession World

The world has changed. Many ideologies that were previously thought to be correct by many have now been debunked. We are attaining a new level of understanding of how our society should work, and when governments should intervene in private actions. However, the greatest change is yet to come.

The Profit Incentive
Many conservatives thought that corporations should be in charge of everything, and that the private sector will always operate more efficiently than the public one. They really felt that taking away the autonomy of the health insurance companies was akin to crushing the free market and leading America down a slippery slope to socialism. After all, if the government is controlling your health insurance, what says that they can’t tell you what work you can do or what business you can operate.

The reality is that there has to be a balance in society between private enterprise and public organizations. Our society has decided that fire protection, crime prevention, justice, delivery of mail, national defense, record keeping, education of our children, and several other services are best placed in the hands of the government. Meanwhile, the private sector is in charge of distributing consumer goods, food, professional services and real property, among others. Why is this?

There are certain services for which the profit incentive is fundamentally misaligned with the good of society, whereas there are other services for which that incentive allows more goods and services to be produced, allows society to progress, and gives us the sense of freedom that drives the democratic system.

Policing is a perfect example of this misalignment. Imagine if police would only protect you if you purchased crime insurance. The poor would be subject to murder and violence without any repercussion. Vigilante justice would prevail, and total anarchy would result.

Computers, on the other hand, are best controlled by the profit incentive. Computer companies are incentivised by profits to make newer and greater computers so consumers will buy them. Some individuals may be priced out of the computer market, but that can be considered acceptable by society. Not having a computer may be a disadvantage, but it would not cause pain and suffering like not having healthcare does.

The fundamental difference is whether society decides that something should be a right or a privilege. The privilege of owning a house, getting a computer or hiring an attorney puts those items in the private category. But the right of being protected from fire or crime, or of getting decent medical treatment if sick necessitates government intervention.

The Exchange System
Although I did not get my public option, the Obama health care exchange system will serve to realign the health care system in a positive way. With the public option, the government insurer would be able to bargain with health providers to lower expenses.

The exchange system simply keeps the insurer as a middle man. However, customers are able to collectively bargain with the insurance companies by making individual choices on a grand scale (by simply purchasing the cheapest and best health insurance). The insurance companies will be forced to bargain with the healthcare providers to maintain lower costs. If an insurer does not bargain, a different insurer who does bargain will get their customers. The government will subsidize insurance costs for the middle class, and therefore will be able to dictate which plans get subsidies.

The inevitable result of this exchange will be the emergence of a select group of extremely large insurance providers, possibly just one. The government will either control this one insurer, or break it up into two that would compete. Health care costs will be lower, and insurance will be available to more individuals.

The Regulated Private Sector
There are some categories in society that do not neatly fit into the public or private sectors. Hence, the regulated private sector becomes necessary.

The illicit drug market is a great example of the consequences of a completely unregulated, lawless market. When I say lawless, I realize that there are laws banning drugs. But there are no laws governing the sale, transportation, cultivation, or delivery of drugs, which means that any disputes in the industry must be settled through vigilante justice. Hence the large crime wave that emerged along with the drug wars of the eighties and early nineties. Gangs were fighting for drug selling territory, and since there was no legitimate mechanism for settling disputes, they resorted to violence and murder to do so.

The war on drugs demonstrates that even though society may have an extreme animosity towards certain goods or services, the fact that there is a demand for those goods will inevitably create a market. It is therefore the prerogative of government to provide a mechanism by which that demand can be satisfied through legal means. Otherwise, anarchy results. The government needs to legalize, regulate, and create disincentives for the use of drugs, not simply throw every drug user or dealer into jail or prison.

The Financial Sector
The financial sector is another example of a market that needs government regulation to succeed. The recent crisis has shown us that if left to their own devises, really smart individuals will make poor decisions if their incentives are misaligned. Why would banks take such risky bets on mortgage backed securities when it should have been obvious that the system would be crushed if housing prices fell. The answer is that banks, as public corporations, are incentivised by short term profits, not long term sustainability. Mortgage backed securities provided such great returns that bankers did not think about the risks that they were taking. It is for this same reason that Enron continued its fraudulent accounting practices until it became insolvent, or that Madoff kept taking new money into his Ponzi scheme even though he knew that it would collapse if new money stopped coming in.

The government has to step in to protect investors’ money from people who are investing it unwisely for current gains. The libertarian mantra of less government is always better is now a fallacy. Sometimes, government intervention is necessary. Monopoly busting was an early form of positive government intervention. Post-depression financial reforms kept the financial system relatively stable. It was when those reforms were reversed that this crisis occurred.

The Fed
I recently had a conversation with an individual who claimed to be part of the end the fed movement. He concluded that the Federal Reserve caused the great recession by keeping interest rates too low for too long, thereby encouraging too much borrowing, which led to the mortgage meltdown.

Although keeping rates low may have been a small factor in causing certain individuals to get mortgages who should not have, low rates did really not matter that much. Many sub-prime borrowers were given mortgages regardless of whether they could afford the interest payments. Banks gave out variable rate mortgages knowing that rates would eventually go up and that the borrower would not be able to afford his or her house. It was the banks, who were not properly regulated by the federal government, that caused the recession; not the Fed.

The Federal Reserve, led by Bernanke, has had just as much of an impact, if not more, than the federal government, led by Paulson, Geithner and Obama, in ending the recession and leading to the current turnaround. While the government was managing $350 billion in bailouts to artificially prop up the economy, the Fed was managing trillions. The Fed is like the great counterbalance in our society. It is independent from the government, so as to ensure that economically sound decisions are not affected by politicians judgment. It has to be, and needs to remain independent.

Evolution
I have been thinking a lot about what this all means in the grand scheme of things. The truth is, the economy, law and politics are all insignificant when compared to the revolution that we are currently experiencing. Humanity is at the end of its 60,000 year reign as the most advanced species on earth, and is about to be the first species to be replaced by its own creation.

Humanity
Recently, a 2,000,000 year old fossil was discovered showing an intermediary species between humans and apes. Although this species may not necessarily be a direct ancestor of modern humans, it provides even greater proof of our natural origins, providing evidence of an intermediary species between early hominids and Homo Erectus, the most successful hominid in the history of the world. Homo Erectus roamed the earth from over a million years ago to the time of early humans . The new species is just one species discovered among many that have already been unearthed. We lived alongside one of our inferior relatives, the Neanderthal, for almost 10,000 years in Europe, a period ending approximately 20,000 years ago. That is a period of time longer than human civilization has existed as we know it.

Humans have been continually evolving, even though from a physiological standpoint, we are probably not very different from our ancestors who lived alongside those Neanderthals. Through civilization and technology, we have been able to maximize the productivity of our earthly forms, providing ourselves with extreme amounts of knowledge and using technology to allow us to interact with the world in a more efficient way. We have created numerous ways to express ourselves, and have made the world smaller by creating efficient methods of transportation.

The Singularity
Unfortunately, we have reached the limits of our earthly forms. Futurists predict that within the next 50 years, computers will have matched and surpassed our level of intelligence. They call this the singularity principle, as the distinction between humans and computers will no longer exist, making us one singular being.

The logical conclusion is that humans will have to become one with computers in order to compete. Those of us that survive to that period of time will have to augment ourselves, becoming cyborgs. Those who cannot afford this augmentation will become an inferior species that will likely eventually die out, as the Neanderthals and dinosaurs did.

The only thing that will prevent this from happening is literally a global catastrophe like one never seen by humanity. Technology as we know it would have to be destroyed. Even the greatest catastrophes, the great world wars or global epidemics, could only delay the progress of technology, not halt it. In many cases, those catastrophes actually increased progress. Although an earth shattering event could happen, I would give it an extremely low likelihood, since economics, technology, diplomacy and science have allowed us to progress to a point where such threats are diminished. A great technological roadblock (such as the end of Moores law, which will happen within the next 20 years) may present itself, but it will be overcome eventually, as all technological roadblocks are.

We Become God

After thousands of years of looking to the skies thinking that there were invisible creatures out there more advanced than ourselves that crafted us into being, it is time to realize that we are in fact the creator creature. We will create life forms much more advanced and complex than our naturally occurring selves, and those life forms will create even more advanced life forms. The only thing we can be certain of is that we do not travel to the past to visit our ancestors, at least not in such a way as to make our presences known.

And So It Goes
We stand at the foot of the great turning point in humanity. We are about to experience the greatest global economic and technological boom that the world has ever seen. We have braved the storm of the great recession, and now will be passengers on this great ride to the end of humanity as we know it. Hopefully, we will maintain our health and life so that we can be a part of it. Otherwise, c’est la vie.

How The Recession Happened

1. The Olden Days
Dave needed a place to live, had a job with a steady income, a good history of paying back any money he borrowed, and a little bit of money saved up. Unfortunately, he didn’t have enough money to buy a piece of property outright. So, Dave went to his bank and said “let’s make a deal. You lend me the rest of the money to buy this property, and I’ll pay you back in monthly instalments over the next 20 years, plus some extra money every month (interest). If I don’t pay you back, you can take my property and sell it, pay yourself whatever I still owe you and I’ll get the rest” The bank agreed, knowing that Dave was a good guy and would pay them back. Plus, if he didn’t, they could just take the property, sell it, and get their money back. The bank got their money from cash they were holding on to, and borrowed the rest from a bigger bank or the country’s central bank. Dave got his house, and was happy. The bank was paid back over 20 years, and made a nice profit.

Alice had no money saved up, a crappy job, and didn’t pay back money she borrowed. Alice wanted her own place too. She went to the bank, but was denied because they didn’t think she would pay them back.

2. Mortgage Backed Securities
One day, a bunch of investment bankers had a great idea. Instead of getting the money to give Dave to buy his property from money already in the bank’s hands, they would get a bunch of Investors together to put money into a pot. Dave would get his loan from the pot of investor money. Then, whenever Dave made his payments, the bank would take a chunk for themselves, and the investors would get the rest. These investments would be called “mortgage backed securities” because the investments were backed by mortgages.

This worked great for a while, except eventually the investors started to get angry because they weren’t making enough money. The bank had a great idea. They would give a loan to Alice so she could buy her property too. Because they were worried that Alice wouldn’t pay them back, they charged her a lot of extra money in interest on top of what she owed. If Alice couldn’t pay the full amount, they would just add what she couldn’t pay to the total amount she owed. If she stopped paying, they would sell the house, and hopefully it would be worth more. The bank then bundled a whole bunch of loans to people like Alice and made the bundles into an investment that investors could invest in.

The bank took their investments to a rating agency, and asked the agency to tell them how risky the investments were. The rating agency looked at the bundles of mortgages to people like Dave, and said they were not risky, and gave them a good rating. They looked at the investments to people like Alice and said they were very, very risky, and gave them a bad rating.

The banks needed more money. They decided to take a bundle of loans to people like Dave, and a bundle of loans to people like Alice, and put them together into an even bigger bundle. They then went back to the rating agency, and asked how risky these loans were. The rating agency thought that this big bundle would really spread out the risk, since there were so many little bundles in it, and gave the bundles a good rating.

The rating companies screwed up, because the risky investments were still risky, they were just in a bigger bundle. Investors flocked to these big bundles, thinking they were not risky, when they really were, and bought them in large quantities.

3. Credit Default Swaps
The investors were worried though. What if they lost money on their bundles? Insurers like AIG came along and had a great idea. The investors would pay money to AIG. In return, if the investors lost any money on their bundles, AIG would pay them back whatever they lost. This was called a credit default swap. AIG was confident that people could only lose a little bit of money on these investments, since they were all backed by hard, tangible, real estate. Historically, real estate prices had never gone down very much, and had a steady increasing price trend.

Banks all over the world bought billions of dollars of these big bundles of mortgages. They invested all of their money in them, and were so happy that they were getting so rich. Plus, if they lost money, they had insurance.

4. The Beginning of the Collapse
Dave started making more money, and decided that he was going to buy a nicer house. He sold his house and went to buy a bigger one. He found a house he really liked, and put an offer on it. But, it turned out that Alice made an offer on the same house that was $100,000 higher, and got the house. The investors gave the bank money to give to Alice so that she could buy the house.

One month later, Alice didn’t make her payment on the house, and the bank took it back. They put it up for sale again at the amount that Alice had bought it for to get their money back. But, no one would pay that amount. Dave came back in with his offer that was $100,000 lower. The bank did not get any other offers and had to give Dave the house.

Now, the bank had lost $100,000 that it owed to investors!

All of the sudden, the prices of houses everywhere started going down. Alices all over America stopped paying, and banks lost billions of investor dollars. Real estate prices started tanking. In the past prices had never gone down much because they never got too high. They never got too high because loans were always made to low-risk people like Dave. But prices got too high because anyone, including people like Alice, could get a loan for however much they wanted.

The investors asked for their money back from the banks, but the banks didn’t have it. The investors then went to AIG and said “I want my insurance money”. AIG started paying out insurance money.

By the end of 2007, this caused the American economy to stop growing. It slowly started to decline, but the problem got worse. Eventually AIG had no more money to compensate investors and banks, and the banks were losing billions of dollars.

5. Lehman Brothers
One of these banks was Lehman Brothers. Lehman had been in business for a long time, and lots of people put their money in Lehman thinking it was safe. Lehman realized that they had no more money because they had too many investors trying to get money back. Lehman owed billions of dollars to these investors, but didn’t have it . Lehman asked the government for help, but the government at the time (Republican) did not want to interfere with the free market, and decided to let Lehman fend for itself. Lehman realized that it couldn’t pay money back, and went bankrupt.

6. The Catastrophe
Banks and investors all over the world were terrified. If investments in a secure bank like Lehman were unsafe, then any investment could be unsafe. Investors decided that they wanted all their money in cash, and really safe investments, because they didn’t want to lose it. So they all started selling all their shares and bundles of mortgages. But, no one wanted to buy their investments at a regular price, so they had to sell them at a really low price.

These lower prices caused the stock market to start crashing. People started selling stocks in regular companies that had nothing to do with investments because they were worried about their money. This sent share prices crashing. People who were just regular investors saw their share prices crashing, and decided to sell before prices got too low. This sent prices even lower.

This could have spiralled into another great depression. If more banks went bankrupt, and more investors lost more and more money, then all sorts of companies would go bankrupt. Banks owed hundreds of billions of dollars and had no way to get that money. It appeared that civilization as we know it could come to an end.

7. How the world was saved
The federal government saw this problem happening and realized that something had to be done. They knew that if the banks kept making loans like they did in the olden days they would surely make money again. So, Treasury Secretary Paulson decided to loan money to all the big banks and to AIG to compensate them for all the money they lost in the crisis. Paulson convinced president Bush, and a majority of congress that this was a good idea. The media called this a bailout, but it was really necessary to prevent another great depression.

With the billions of government dollars in hand, the banks could pay their investors back, and pay for all the losses that were occurring. Countries all over the world undertook similar bailout plans to keep their banks from going out of business.

8. Why there was still a recession
Unfortunately, the damage done was already severe. The banks had lost so much money that they didn’t want to make loans to companies and lose more money. Companies were losing money, and realized that the only way they could save money would be to cut costs. They started laying off workers and shutting down operations.

People who lost their jobs stopped spending money, and lived off of unemployment insurance. People who did have jobs got paranoid, especially after losing so much of their investments when the market crashed, and started putting away any last penny they could. This meant that stores and companies were selling less stuff and making less money. Stores had to shut down and lay off more workers.

9. The Aftermath
Although the recession is/was the worst since the great depression, the new Obama government and the Federal Reserve have fought to end it. The reserve made it very easy for banks to borrow money to lend out to good customers like Dave, charging really low rates of interest to banks, and making lots of money available.

The federal government’s stimulus package was designed to give the economy a boost at the other end, by creating actual jobs, extending unemployment benefits, and spending money on government programs.

In the end, this recession will be looked at as a wakeup call in the history of modern human civilization. The free market works brilliantly when it is monitored and regulated. But, it has the capacity to spiral out of control when people make the wrong decisions. If it was not for secretary Paulson and the TARP bailout, the free market would have self destructed, and would have taken years to correct itself.

This recession has been horrible, and has negatively affected the lives of millions. However, it would have been much worse if it were not for the bold and swift actions of the responsible bodies, guided by hundreds of years of economic thought. Hopefully, we can learn from these mistakes, and try to make sure something like this never happens again.

© 2024 Millenniality

Theme by Anders NorenUp ↑