Sunday, November 04, 2007

Money From Nowhere Going Somewhere

Private industry and government both contribute to the economy. An economist uses a rule of thumb that private investment has a 5 to 1 multiplier effect on the economy; whereas government expenditures contribute at a 2 to 1 ratio. So, to stimulate the economy, private investment is the most cost effective and transfer payments the least.

Here is where I get shot for simplification again. Divide the government into five areas of financial involvement; administration, infrastructure, defense, education and retirement.

Administrative tasks produce nothing and could be considered transfer payments. It comes from our taxes and goes into a paycheck (government, police, fire etc).

Infrastructure and defense purchases by government create jobs where something is produced for the economy. Congress spends billions dollars on the Iraq war. The money is not shipped off to Iraq. Private companies build new war machinery. This mirrors private investment returns at a somewhat lower scale.

Education is kind of a necessary lubricant for the whole system. It has returns that benefit the economy; they are not as visible. When a sales clerk can’t make change for a $20 bill, the need for education becomes very apparent.

Retirement and government health care are also transfer payments. Our tax dollars go into a retiree's bank account. This stimulates consumption but no new product was added to the economy. I know someone will say, “Hey that Social Security money is mine, I paid into the system.” How about if we cut your benefits off when you exceed what you contributed? The fact is some guy, who died after 35 years on social security, probably consumed all of your contributions and ten other people’s as well.

So let’s go one step further. Home equity loan withdrawals are another form of transfer payments. Notice, the money extracted from mortgage equity withdrawals (MEW) was not earned by building something new for the economy. Housing just doubled in price; it’s free money (this is the way the government does it). Of course, the homeowner is supposed to pay it back. It looks as if that concept has a “few” holes in it.

Step back and look at the big picture. Government can issue checks for retirement and health care costs by increasing the national debt. This is what the homeowner was doing with a MEW. The American consumer has been on a buying binge with US monopoly money. Where did all of this stuff that we didn’t make but we needed to purchase come from? Here's a clue “lead paint.”

Looks like this Thanksgiving, we are giving China the bird. Just maybe they will give us a goose for Christmas (triple pun intended).


Anonymous said...

Jim, when you say that China may give us the "goose" for Christmas, are you talking about them getting out of the dollar?
Would they be cutting their own throats by getting out of our dollar?
Any opinion on this would be appreciated, thanks.

Jim in San Marcos said...

Our gift to the Chinese was to devalue the dollar. So instead of devaluing their currency, they're going to raise prices.

Since China and Japan own about 1/4th of our debt, refusing to renew these instruments, results in our interest rates going up. In essence, they have the power to raise our rates to a level where they feel comfortable with the rate of return. This would "cook our goose." It kind of reminds me of the book titled "Antlers in the Tree" by WhoGoosed TheMoose.

Unknown said...


Think of it this way, in every market, you have a breaking point. This is the point were, regardless of extra losses that will occur, the need to liquidate overrides short-term profitability.

Housing is a perfect example. Condo's in New York are currently being sold at 1/2 of their "value" 6 months ago. The need to liquidate is greater than the need for short-term profits.

China is close to facing the same situation. They are artificially inflating their currency to keep dollar parity, however this is having severe negative domestic implications for them. If they reach the "breaking point" were it becomes unfeasible for them to continue their current policy, and their need for liquid wealth becomes overriding, they will dump the dollar.

Anonymous said...

Thank you, both Jim and ltrand.

Anon 5:44

Anonymous said...

Generally speaking, if oil prices plummeted, would that help the stock market or signal bad things?

Anonymous said...

Jim, this is Anon 5:44.
Could you explain in a simple way what the "Yen carry trade" is about?
I seen where it was in the 110`s today, I have seen it in the 118`s mainly. What does this mean? I see it kicked around the web a lot(usually with some doomsday scenario attached), but it`s hard to get my brain around it(please keep in mind that I`m a newbie to this financial stuff). Do you feel like this Yen carry trade thing is a big deal?

Jim in San Marcos said...

Japan in 1990 had a stock market crash and bank collapse. The bank of Japan ever since then has been paying almost zero interest on money deposited in the banks. So the average investor can take his Yen and buy T-bills that pay 3-5 percent. As long as the currencies stay at par to each other, you have a winning strategy. This is refered to as the Japan carry trade

So your return on your investment today depends on what rate you got when you converted yen to dollars and the rate you got back when you converted your dollars back to yen.

So on June 24th you would have gotten a dollar for 124 yen today that dollar will convert to 110 yen. That's about an 11% loss on principle in 5 months.

The other thing you can do is to buy a forward option on the currency you want to convert back to cover the possibility of a loss. It hasn't been the most profitable investment lately.

In the past the dollar was appreciating in relation to the Yen so the carry trade gave you interest and appreciation at the same time.

This trade can be profitable in the future if the dollar appreciates in relation to the Yen

Anonymous said...

Thank you Jim, finally this is starting to make a little sense.
I can`t tell you how much I appreciate your website.
Thanks! Anon 5:44

Anonymous said...

"Here is where I get shot for simplification again." Actually, no, I for one, am not an accountant or economist or at all connected to the world of high finance, but I am trying to understand what the heck is going on out there and I really appreciate your explanations, so as far as I am concerned, your simple and witty posts are much appreciated!

Sackerson said...

Hi Jim: no posts for a week - on holiday?

Jim in San Marcos said...

Hi Sack

No Holiday, just writers block.

I just published one. I spent about 6 hours getting it right.

Some people can write forever. I'm just not one of them.

I should have dropped in a reprint.

Take care

Anonymous said...

HSBC bank IS NEXT TO JOIN THE BANKERS GRAVEYARD,,,Some damaging information on HSBC is due out shortly,,shitloads of subprime on the books,,,wow wow wo wo woshhhhhhhhh