Chingo De Dinero

I am not sure about others, but the majority of this financial crisis, I have seen on TV, and not in real life.  Is there a slow down?  I don’t doubt, but if you look at the facts there are three reasons why it does not have such a strong affect:

1.  The GDP has just begun to dip and the dip is not so large, so really this year’s consumption is not so different than last year’s.

2.  The cut back that we do have is on discretionary funds.  The point I am trying to make here is that in the past a larger portion of our income went to things we really needed, food, shelter, etc.  Now, we have to buy the 25 KUSD instead of the 35 KUSD…this is much different than having to skip meals due to a lack of food.

3.  Unemployment is still low.  It is true that we are not at full employment, but we are not much over it.  If you need a job, you can get one.  It may be at a grocery store, or flipping burgers, but something is out there.  If you are worried about finding work to feed your family, no need to worry, those jobs are there.  The unemployment now, keeps us from getting our dream jobs, but not from putting food on the table.

Here are a few reasons why I do not think the “crisis” is so bad.  It may get worse, but I think we have a ways to go before people really feel pain.  In my opinion, I do not think this will happen, the economy should turn early in 2009, and we will be back on the upward path.  Lets hope I am right!!!

If you have followed the Yen lately, you might have heard the reason for its appreciation is the unwinding of the carry trade.  The main idea for the carry trade on currencies is to borrow in one currency, transfer to another, invest, then in the future, transfer the funds back to pay off the loan, and you will have some left over.  The reason for the leftover is the higher interest rates in the currency you invest in over the one you borrow in.  This was popular with the Yen and Dollar because the Yen rates were so low, and the risk of default for the Dollar are so low.  This works, and is very profitable as long as the currency you borrow in does not appreciate vs the one you invest.  Since Japan wanted to keep their currency weak to help exporters, investors could get a big paycheck.

This has since changed a little since the Yen has appreciated greatly vs the Dollar.  This means that investors started to lose money, which resulted into them closing their position…ie sell Dollars to buy Yen, which resulted in more appreciation.  In the end, a plan that seemed safe and highly profitable turns into a big money loser.

The key to a good carry trade is to find a safe currency which should keep its strength and pays a good rate, and a currency which has a government who wishes to keep it from appreciating, and has a very low interest rate for borrowers.

What came first, the chicken or the egg?  The difference between Keynes and Say is about what same, what drive the economy supply or demand.  If you do not know these two guys, I recommend looking them up real quick, it will shed some light on what the government is trying to do now.

For the last few decades the Keynes argument has been followed, increase money supplier, increase demand, speed up the economy.  Or do the opposite to slow down the economy.  This is what the government does when it lowers or raises the interest rates (a certain interest rate).  It is also the goal of the increase in infustructure speeding which is being talked about now.  In the past this has worked pretty well to control changes in the business cycle.  Hopefully since it is clear that this is what the government will use now, lets hope it works in the future too.

The other way of thinking is from Say, which thinks that supply is the more important factor.  When the economy slows down, it is not due to a lack of demand, but a shift in what is supplied.  In other words, the wrong items are being supplied, and a shift is taking place to stop producing the current items, and produce the other items.  If this is true, we are pretty much at full employeement at all times, only have structural unemployement which involves moving to different jobs, with different skill sets.  It this correct, could be, there are lots of places hiring for the people with the right skills, even as unemployement grows.  You will end up getting in the descussion what is full-employement.  We all know it should not be 0%, there will always be some unemployeement, but I think it is agreed that it is not 10%.  Also, I would say the number is moving, at some times, the shift in production is low, at others, it is high, I think between 3 and 8 is a reasonable range.  If this is true, the government is doing the wrong thing, instead of working to increase demand in certain areas, let production shift naturally, and move towards equalibrium.  Shift production artificially will only result in additional production of goods where they market does not think they should be produced, which is really the will of the people in a free market.  This will result in a decrease in long-term prosperity, with prosperity being people having the maximum amount of utility.

Not to get to deep, it is important to know these two ways of thinking to better understand what the government is trying to do currently.  We many never know for sure if demand drives supply or if supply drives demand, but it is something good to think about so we can try to limit our impact on long-term productivity as much as possible.  By the way, I would also speculate that sometimes demand drives, and other times supply drives…it is a social science.