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Banbury Cross

a pillow for lost thoughts...

Archives for: August 2012

Myth of Job Creation

As the Marathon presidential campaign season enters its homestretch, some of the sound bites that were coyly droning under the radar so far are putting on the war colors and bursting high into the sky.

My favorite bite of wishful thinking is the notion that cutting taxes for the wealthy will somehow automatically create millions of jobs. To begin with - it is not clear why the rich would turn any additional wealth into job producing assets, when there are other - and less dicey - places where you can park your money. Commodities, currency exchanges and especially foreign markets supported by cheaper labor present lucrative opportunities every day. Why would you choose investment vehicle whose risk/reward ratio is only slightly better than planting turnips in the Yankee Stadium outfield?

But what bothers me even more is the mechanism itself. Are jobs really created when the wealthy owners of the means of production get to keep larger share of their profits? I always thought that what created jobs was organic demand. The willingness and ability of potential customers to buy your stuff. Pure and simple.

Imagine this. You have a struggling factory which makes only a modest profit because no one in the country has any money to buy your product. You, the owner, get your brand new Congress approved tax cut - and then what? - all of a sudden you start hiring more workers to produce more stuff which no one can still afford? Methinks not.

In my world, a smart businessman will ramp up the production only if there is an increased demand for his product - which usually happens when a significant segment of the society has more money to spend. Rich people - being a fairly limited group almost by definition - simply do not have the numbers to drive the consumption up by themselves. How many bars of soap, how many iPhones or loaves of French bread do the affluent really need? That is why a healthy economy starts with a strong middle class whose members - by the sheer volume of their purchases - can significantly stimulate the overall business activity. Henry Ford knew this 100 years ago. What is so difficult about it that the conservative commentators don't understand these days?

Cutting taxes will only create more income inequality, and less vibrant economic environment. It will lead to the bananization of our republic. But it will contribute very little to the job growth we need. The bottom line is very simple. If the majority of the population won't have means to buy goods and services, then this recovery will wither on the vine - no matter how deeply the upper bracket income taxes will be cut.

Czech Switzerland

My sister travels a lot, so she knows many hidden gems the tiny Czech Republic harbors in its interior. For this summer's family trip, she took us to a remote region in Northern Bohemia where the river Labe (Elbe) leaves the country and squeezes into Germany through a series of shallow river valleys meandering along a gently undulating landscape. When - more than a century ago - two Swiss travelers visited the sparsely populated hills crowned with sandstone formations and separated by colorful meadows, they were so reminded of their homeland that they chose to give the surrounding area the moniker Czech Switzerland.

As we were hiking through its flagrant gorges and across the brawny ridges, I suddenly remembered a snippet from an old history book which claimed that had it not been for the Soviet occupation, Czechoslovakia would have been an Eastern European Switzerland. Indeed, between the wars my old country sported many burgeoning industries that manufacturing cars, airplanes, chemicals, textile, construction materials, machinery and just about anything the modern world might need. It had large deposits of coal and uranium (the latter plundered by Russians in the 1950s), well maintained infrastructure and educated and hard working population to boot. But the dream was not meant to be.

In 1948, a Communist coup installed a puppet regime whose various incarnations managed to turn this Switzerland in waiting into a Balkan wasteland - all that over the course of merely 40 years. And not by an accident either. Collectivism - which was adopted as the state doctrine - may sound like a great idea on the surface, but humankind still has not figured out its proper working implementation. Unlike capitalism, socialism does not provide a natural driving force that would be compatible with the individual desire to succeed. Somehow its notion of everyone working selflessly for the common good does not rhyme well with the human nature. At least in Czechoslovakia it didn't. Small minds, pervasive envy, incompetence, petty grudges, lack of natural incentives and bloated personal ambitions eventually got the better of Lenin's lofty intellectual framework and buried it deep under the ashes of mediocrity.

We hear a lot about socialism these days. The excesses of the financial expansion showed that capitalism may have overstayed its welcome in the annals of economic history and people are desperately looking for alternatives. I hope that those who are trying to offer socialism a second chance will keep the bleak lessons of the Soviet experiment fresh in mind. However crude and cruel the current embodiment of crony capitalism is, it is still a few leagues above the self-proclaimed humanism and efficiency of the Stalin's paradise. I breathed its noxious fumes for almost 30 years, so I know what I am talking about.

There must be a third way somewhere between the Scylla of capitalist greed and the Charybdis of communist apathy. A successful amalgamation of social responsibility and free market principles. But finding it may prove trickier than discovering a Swiss restaurant in the heart of Czech Switzerland.

z3

A Call for Sane Banking

We have a somewhat conflicted variety of capitalism. Capital is supposed to be a surplus wealth for which its creators have no immediate use and so they set it aside and invest it in a worthy enterprise that will generate an additional income later on. But the machinations of the modern banking system and its never ending quest for liquidity are increasingly blurring the lines between the real and imaginary wealth and in the process make the tracking of capital rather difficult.

The mechanics of investing/loaning is not the rocket science. Here is an easy example. Joe has an extra $10,000 lying around, Carl has a great business idea that could multiply this $10,000 into $12,000 over the next 12 months, so Joe lends Carl the money for 12 months say at 5% interest and at the end of the year Joe collects his $500 in interest, Carl makes a nice overall profit of $1500 and everyone is happy. The problem is that in real life Joes with extra money do not have time to wait for Carls with brilliant ideas to waltz around and there arises the need for a middleman - the banking system. A banker is effectively a matchmaker who matches people with capital to people with ideas and takes a cut for this service.

But modern day finance has strayed far from that ideal. The funny monopoly money which central banks print at will these days gave investment banks an opportunity to turn the world's markets into giant casinos with little oversight or accountability. Trillions of dollars are swirling in the abstract monetary space without any backing and if there is collateral involved, you can bet that no one has any idea how much it is really worth. And I mean it - you can literally bet on it. The system got so far out of whack that the saver - the original creator of the capital - gets only a bit more than 0% interest for his or her effort these days. Who exactly profits from the capital flows and how much is an issue that has been successfully obscured by the gargantuan amount of global "money printing" effort which makes any real accounting virtually impossible.

I think that the original sin that brought about this perversity happened when bankers in the Middle Ages realized that they could lend out the deposited money many times over and unless the depositors conspired and demanded all of their money back at the same time, no one would really find out. Say you have some extra money and deposit it at a local bank which then lends it out to some Carl and collects interest on it. Some of that interest goes to you - the capital creator - and some stays with the bank as a payment for this service. So far so good. However, at some point the bankers realized that they could make another loan against this deposit and just pocket the interest themselves this time. In other words, they learned they could "print money" for their own private purposes.

Printing money is not a bad idea per se. In some instances injecting liquidity/credit into the larger economy may be just what the doctor ordered. The crucial question is, however, who really has the right to extend our money supply and - even more importantly - who is supposed to benefit from this operation? In a democratic society I would assume that the right to create money out of nothing belongs to the people themselves, although in practice this right would probably be transferred to some governmental institution, say the Treasury department.

The fractional reserve banking - which is the contemporary term for the system in which you loan our more money than you take in - is really a legalized form of counterfeiting, because bankers make no effort to share the interest collected from the "newly printed money" (which is what those unbacked subsequent loans are) with the depositors (the original providers of the capital) or with the Treasury (representing the people with whom the money printing rights should reside). And since the full reserve lending (where each dollar loaned out would be backed with a dollar deposited) may be economically too restrictive, we should look for a mechanism which would permit some money printing (to keep the economy well lubricated) but would do so so in a way that allowed for profit sharing with the depositors and the Treasury. The principle should be simple. The more often the bank loans out a given sum of money, the more profits it will have to share. This negative feedback loop itself should discourage excessive leverage (the multiple of the deposit that is being lent out) which nearly destroyed our current financial system.

So let us revisit the loan process and see how this scheme would work.

First, the recap of the actors.

Joe - the person who has capital
Carl - the person who has a business idea
Bank - which manages the loan
Treasury - which represents the people

In the present case Joe gets some interest on his mediated loan to Carl while the bank pockets all of the profits from subsequent loans. Let's suppose the interest rate for a loan (such as Carl's is 5%), the savings rate is 3% and the leverage is 10 (the bank lends any deposited money 10 times over). The profit sharing looks more or less like this:

1st loan (Joe gets 3%, the Bank gets 2%)
2nd-10th (Joe gets nothing, the Bank pockets all 5%)

Such division of spoils is conducive to higher and higher leverage and with it to riskier and riskier behavior. So what if we tried to tame this hazardous - almost gambling like - behavior by a distribution like this.

1st loan (Joe gets 3%, Bank 2%, Treasury gets nothing - no money was created)
2nd-3rd loan (Joe gets 2%, Bank gets 2%, Treasury gets 1%)
4th-5th loan (Joe gets 1%, Bank gets 3%, Treasury gets 2%)
6th-7th loan (Joe gets 0%, Bank gets 2%, Treasury gets 3%
8th-10th loan (Joe gets 0%, Bank gets 1%, Treasury gets 4%)

The above numbers are just made up, of course. They are whole for convenience. The actual interest rates would have to be finer and subject to expert discussion and/or some market mechanisms. But in this simple example you can actually do the math to see who ends up with what portion of the overall lending pie.

My point is that such a scheme would be fairer to both the creators of the capital and the taxpayers who get nothing under the current system although the money expansion is (or should be) their prerogative. Not to mention the fact that they implicitly guarantee the functionality of the banking system as a whole, so one would think they should be rewarded for it. Also note that the bank will think twice before going into very risky businesses because the higher its leverage, the more of its profits will have to be shared with the Treasury. At some point the bankers will have to conclude that the rewards are just not worth the risks, and stay away from leveraging their deposits to the point of near self destruction. Sure - they may lose some of their stellar profits, but over the course of time their profession may regain some of its lost respect.

And that is how it should be, in my humble opinion.

Complexity of connections

Multitude is not enough. If you put 10 billion ping pong balls in a container and shake it vigorously, you will still have only 10 billion ping pong balls. Nothing to write home about. To make something interesting happen, you need to add interactions, relationships, feed back loops between individual members. They are the ingredient that adds complexity to the mix.

Draw 10 circles on a piece of paper. Simple, right? Now think about the number of ways in which you can connect them. Soon you will realize that such exercise leads to mind boggling number of possibilities. Interconnectedness is that magical wand that can touch a mere quantity and conjure up a new quality out of it. Almost as if the connections made whole system undergo a phase change.

Carbon is not alive. Neither are protein molecules, amino acids or carbohydrates. But put enough of them together, stir the mix with a spatula of time and strange things will happen. Individual components will start exchanging signals, they'll become codependent and before you know it - life jumps from the crucible into its precarious existence. As if the complexity of interactions tripped up some invisible trigger.

Now think of living cells in your body. Neither of those cells is really you. None of them is even aware of itself. Each taken as an individual cell is just a simple living unit without any identity, feeling, mind or other human attribute. Yet add them all together, make them communicate and voila! A person arises. An entangled conglomerate of subsystems with a mind of its own.

Let's take it one step further: take several humans, place them together on a relatively warm blue planet and make them interact. A new entity arises again. Humankind. The sum of all people which can be viewed as one giant organism. In fact, there are some schools of thought which claim that this aggregate entity is in fact God. And I have to say I am not entirely opposed to that idea. The collective humankind does have a divine signature. It has a higher perspective than any individual and can make better judgements than individuals. None of us humans is God, of course. But together with all our interactions we may just as well be.

And a natural question is - what if humankind itself is but one building block of some higher form. Perhaps, one day, if we meet other civilizations and start interacting with them, a higher purpose will emerge. A pattern that we cannot comprehend on our own.

dd

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