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Well, it appears I was ahead of the crowd on at least some of the issues I've been discussing in this blog.

For starters, a previous blog that was critical of the research paper proposing to fix the floor in the emissions trading scheme pre-empted the current debate, which threatens to postpone any emissions reductions measures. You can read about the political debacle it created here.

Another point getting more publicity is the proposal that governments make no new policies in response to the GFC (that's Global Financial Crisis for those out of the loop). My stimulating paradox blog came to the same conclusion as Dan Denning. But hey, who trusts what they read on the internet.

A final update regards the announced (finally) Queensland elections. Given the GFC, the basic lack of innovation over the past decade, the threat to the Great Barrier Reef from climate change, the massive social disruptions likely to be caused from mining operations closing down, I am surprised there is even an opposition wishing to get elected! My bet is that whoever has the catchiest slogan will win - yes, it is a fickle business. But really,there may be plenty of fodder for bloggers in the next month.

Sorry for the cop-out blog, but there will be some detailed analysis next time.

Homogenous Humanity

I want to take a bit of a break from the financial crisis to talk about humanity, and more specifically, racial identity. The growing number of interracial and relationships I have witnessed, including my own, has led me along a line of enquiry that has some interesting implications.

To summarise, the question bugging me is whether the increased interracial breeding, especially in Australia, and probably much more so around the world, will cause distinct racial identities fade away? More importantly, will we end up with a ‘standardised’ race of humans? Or, will other environmental factors contribute to changing the nature of humans? Could we develop new races?

Overall, what will this impact have on our society?

The issue has bugged me since I learnt that there are in fact different races. At primary school I was completely ignorant of race. I had friends back then who I only now realise are Aboriginal, Indian, and Chinese. Further confusion was raised when I discovered that there are many policies that specifically determine outcomes based on race – with various Aboriginal assistance programs. There is an obvious justification for singling out the Aboriginal people for assistance given Australia’s history, but what about the half Aboriginal guy? Should he get half the assistance? Should half of him assist the other half of him? Why does he identify as Aboriginal and not Irish anyway? What about the quarter Aboriginal Chinese Indian African guy? Or is he something else altogether?

This brings me to the important social implications of such racial change. With which groups will the mixed race generations identify. Am I Indian or Chinese? And what if India was at war with China (heaven forbid); with which powerhouse will I side? My point is that the destruction of racial identity might have a beneficial effect of decreasing animosity amongst nations. In Australia especially it would be difficult to conjure domestic support for wars with nations whose racial heritage runs through the blood of many of our citizens.

Will religiousness fade away as racial ties fade? What religion would the son of a Buddhist and a Catholic be?

Would we try and preserve ‘pure’ races? Will some become extinct through breeding alone?

Maybe I should have at least proposed some hypothetical answers to these questions before I started writing. Please, I am interested to know your thoughts. Having a half Anglo-Saxon (what am I anyway?), half Chinese son myself I expect that many more questions will be raised. Will this generation of interracial children have trouble fitting in at school, being neither in the Chinese nor Aussie crowd? Who knows.

Challenging the time value of money

Why is it that we expect our savings to ‘grow’ all by themselves? What would happen if our savings diminished over time instead?

Let’s first have a look at the historical coincidences that led to the absolute acceptance that the future should be discounted. Before any banking system existed, to save you must store your valuables, whether it be precious metals, grains or other food, somewhere where they can be preserved. To save them for the future, you must invest MORE in the present, in the form of preserving food, building defensible stores, and if there was enough gold in there, possibly paying for protection, to have LESS in the future. Thus prior to banking , the future was valued MORE than the present.

The logic behind this is simple. The future is risky, and to maintain your wealth for future times of uncertainty, you must invest in the present to protect it.

So where did the idea of earning a return on savings originate?

It must have been some time ago when the idea of lending money with interest first came into being – it even gets a mention in religious texts. I imagine that the ancient Greeks and Romans were the first to consider the problem I am considering today.

I guess there were two interrelated issues that led to money lending at interest – the advent of central banking in the form of paying goldsmiths to store and protect your gold, and the advent of international ‘trade’. I use the term trade loosely because much of the trade was involuntary in ancient times – by that I mean that that trade was achieved by waging war. But the point is that through trade increased wealth could be achieved easily, which could then be used to pay interest.

To get back to the questions I raised at the beginning of the blog, I would suggest that the reason we expect our savings to grow is because that is how it has been for a long time. Most of the time we can generate a small positive return on savings if there is a little growth in production.

But what if we have reached some resource limits, and growth is now a little more difficult to achieve. How can we lend money with interest in an environment of negative growth? On a national scale, how can we generate the wealth necessary to pay the interest? In short, we can't.

Maybe some readers have already noticed a major problem with negative interest rates (or a deteriorating money supply, or a reversal of the principle of the time value of money). Those who hold wealth will have a much more difficult time preserving its value. Challenging this one basic principle raises questions of the validity of land ownership and rents, and how it may be possible to own any income producing asset, let alone value it? Imagine capitalising an asset at 0.00001% - any income producing asset would be almost infinitely valuable. Where would be the motivation to invest in any capital equipment?

Where does this leave us? To be honest, the more I think about it, the more I see the importance of maintaining economic growth. A sustained period of negative growth would destroy the system – the money supply, capital values, rents – but what would it be replaced with? I am yet to think of a reasonable alternative, but I am sure there must be one.

Stimulating paradox

I read an intriguing article yesterday about the fundamental paradox that underlies the global phenomenon that is currently known as an ‘economic stimulus package’. The basic gist is that to justify spending billions of dollars the government has to scare the crap out of everyone to justify it. In doing so, they radically increase the chances that people will want to save instead of spend. They could have alternatively just said everything was fine, downplayed the situation as a media beat-up, and done nothing. At the moment, doing nothing is exactly what I think is the best thing for governments.

But let’s take a moment to look at the theoretical arguments surrounding the stimulus. I am going to raise quite a few economic theories that have been subject to debate a long time, so please do a little research if anything interests you.

Keynesian theory suggests that recession is caused by a wave of pessimism that flows through society, impacting on business decisions. It has some merit. One business sees another buckling down for tough times ahead, so they do the same, and so on until everyone has reduced production, but no one knows why. Real herd mentality in action. The economists’ prescription for getting out of a Keynesian style recession (Yes that there are different types of recession that require different policy responses. For example one caused by a ‘supply shock’ to a key resource.) is for government to intervene in markets to maintain demand and employment, in addition to ‘talking up’ the economy to raise business confidence. It seems that the current policy response forgot to mention that things will be fine, and went for the big spend – the exact problem raised in the paradox article.

But there is more. The opposition raised a very interesting point about the merit of giving people cash to spend, when the principle economic theories of consumption suggest that only a very small proportion will be spent. Milton Friedman’s Permanent Income Hypothesis (PIH) explains how people choose how much to spend based on their long-term expectations of income. Thus it would be expected that a one off payment will be diluted amongst household spending over a long period.

The opposition has a few more economic theories up their sleeve as well. One of the main maco-economic models, the IS LM BP model, that links together interest rates and output of the economy taking into account international trade and foreign exchange, makes clear that in a country with a floating exchange rate, fiscal policy (government spending) will be rendered completely ineffective.

Further, the Barro-Ricardian equivalence hypothesis (which doesn’t gain much acceptance anymore, but makes a very good point) also suggests that fiscal stimulus will be ineffective, whether financed through debt or taxes. Since any money the government has is raised through taxes, and any debt they incur must be paid by future taxes along with interest, people will realise that this round of debt funded spending is actually equivalent to RAISING TAXES. And what kind of stimulus would that be.

My final point is about the continual decline in interest rate, and the possibility of a liquidity trap. In short, a liquidity trap occurs when lowering interest rates does not increase the supply of money. Banks are already reluctant to lend, and since their real returns are minimal once the nominal interest rate approaches the inflation rate, they fail to approve more loans even though the interest rate is lower. I would suggest that there may be a little of this occurring, especially if the current interest rates drops are perceived as temporary measures.

In any case, we will never know if the fiscal (and the Reserve Bank's monetary) stimulus did anyone any good, because we have no basis from which to measure the success of failure of the policy. Maybe we could have given the money to just half the states and done a bit of a real life experiment. The political claims will be obvious - Rudd Bank will claim success no matter what the outcome, because 'it saved us from the worst of it', while the opposition will blame the stimulus for any further deterioration of economic output. Neither of them are right. We are subject to the whims of international markets, and no policy of ours have a noticeable impact.

Before I go I just want to let you know that I am more of a subsriber to the theory of creative destruction. This theory suggests that recessions are a necessary part of development. A recession is simply a process of 'destroying' outdated and outmoded production systems to enable the 'creation' of production chains for new goods and services. Followers of this theory would see a recession as a sign of development, and not something to be avoided.

Unfortunately governments have a hard time persuading people that some short term pain is worth the long term gain.

That’s all for now folks.

A monetary system for a sustainable society – the BIG question.

I spent a couple of hours this evening watching Chris Martenson’s Crash Course. For those interested in financial or environmental matters, and believe there is any connection between the recent ‘financial crisis’ and the peak of oil production it is very interesting. For others, it is probably still quite interesting.

I won’t give it all away, but the lecture series gives a thorough overview of money supply, speculative bubbles (a must see section), debt, growth and all things financial. It concludes that we are in for some tough times due to the coincidence of peak oil, retiring baby-boomers, and the collapse of a speculative bubble in housing.

These intriguing lectures got me thinking about another issue. Why is it that concerned individuals spend so much time looking at the problem, and telling others about the problem, but are rarely discussing potential solutions. And I mean real solutions – the mechanics of it all – not just ‘be nicer’, ‘do your part’. What is nice anyway? And what is the part I should do, and will it work? These are the questions that need answers if change is to happen.

I know I may have fallen into this trap a little in some of my blogs. But I’m in good company. Al Gore’s Inconvenient Truth spent hours on environmental problems, but only flashed up a few dot points on what we as individuals could do, and given my recent research, most of them are a waste of time.

All of this must be leading somewhere. It is. Given the intrinsic relationship between economic growth and environmental decay, and consumption of natural resources, we must reject growth as a long-term proposition. However, if we accept that society will be forced to exist within limits, and that any growth period will be counteracted with periods of degrowth or ungrowth, how will the financial system operate?

By the time you have watched the Crash Course, you will know that for money to stay in existence growth is an absolute necessity. So how can we have a currency that performs the basic functions of money – a store of value, a medium of exchange, and a unit of account – when the quantity of goods produced in the economy may fall for long periods of time? How can interest be charged on loans if there is no extra increase in production with which to pay the interest?

This question has perplexed me for a long time. We need a monetary system that has the flexibility to adjust the quantity of money when the quantity of goods produced changes, but one that will not be prone to periodic episodes of high or negative inflation. If we have a fixed amount of currency, maybe used gold for example, when output increases prices would decline, and then rise again when output decreases. How can money act as a store of value in this case? If you lent money in period of price deflation, no one would be able pay the interest, as the loan would be continuously getting larger in real terms. This is one of the main concerns about the current financial crisis. If deflation sets in, it will become self-reinforcing, and lending will cease altogether, stifling investment of all forms.

Anyway, for now I hope this has raised your interest in the matter of money, and I will endeavour to examine some options in the next blog.