Thursday, July 03, 2008

Questions for Economists

Let's take a hypothetical Joe Blow. He is married and has a teen-age son. Like many Americans, Joe likes to live big: a big suburban mansion, a gigantic SUV, and, pièce de résistance, a sportfishing boat with not two but three 325-hoursepower Yamaha outboards on the back! Joe sells vacation/investment properties: condo units in partially completed new neighborhoods overlooking scenic brackish swamps in a hurricane zone. I have some questions about the effects of macroeconomic shifts on the financial outlook of the Blow family.

1. Joe's savings and retirement funds are tapped out, and he doesn't seem to be able to get any more loans. Nobody wants accept his prized possessions as collateral. What effect will rising interest rates have on Joe's ability to borrow?

2. The condos that Joe is trying to move are dropping in value. He hasn't been able to move a single one in many months. What effect will continuing asset depreciation have on his ability to earn commissions?

3. Joe's wife's credit cards are maxed out, and she doesn't seem to be able to get any more. What effect will inflation in China have on her ability to continue buying those stylish Chinese-made outfits she likes to surprise Joe with?

4. Joe's wife has planted some potatoes and squash in the back yard. What effect will rising food prices have on the cost of the produce she is growing?

5. To keep warm in the wintertime, the Blow family plans on burning their furniture. What effect will the rising heating oil and natural gas prices have their family budget?

6. Joe's son hasn't been able to get the student loans he needed to go on to college, so his Plan B is to develop a heroin habit and spend his days sitting in his room nodding out to music. He plans to pay for his habit by dressing up in some of his mom's sexier outfits and turning tricks. What effect will the economic policies of the two presidential candidates have on his business plan?

I am guessing that, in tackling these questions, an economist would most likely want to discuss whether what we have should properly be called inflation or deflation. Joe's assets are decreasing in value, and that is deflationary. There is also a great deal of volatility in food and energy prices, which might look like inflation, but then Joe's wages aren't rising to keep up, so there is no wage inflation. So perhaps it's a wash. What then is the optimum interest rate? There will certainly be some short-term pain, but it will make the economy more efficient in the long run. What was the question again?

It seems to me that a perfectly reasonable answer to all these questions is "none at all," but then I am not an economist. I am an engineer by training. And so here's a question I should be able to answer. Joe's stereo system is on fire. It kept blowing fuses, so he wrapped the fuse in tin foil, and then rats chewed through the speaker wires and shorted them out. What effect will graphic equalizer settings have on the sound quality of his stereo system?

None at all.

11 comments :

weelebob said...

How about inverting these questions.

1. Joe can no longer burrow money and is defaulting on his current loans. *KNOCK*KNOCK* Mr. Repo is at Joe's door. How will this effect interest rates?

2. Joe is no longer generating income from his current job. Maybe it is time for a career switch from condo sales to condo dismantling. Condo's as real estate will depreciate, condo's as raw materials may appreciate. So, how will a boom of salvaged lumber and metals effect the above raw materials value?

3. Joe's wife will no longer be able to support the textile industry of China. Perhaps she could use some of her spare time to create new fashions using her current wardrobe as fabric. What effect will homemade couture have on the international fashion world?

4. Joe's wife is in the initial stages of becoming a backyard farmer. Will this create 'demand destruction' on the global food market thus lowering food prices?

5. This will relieve some strain on their budget (assuming they used heating fuel in the past). What effect will less demand for petrol based home heating fuel have on rising prices?

6. Will joe's son be able to acquire a good produced primarily on another continent? Will there be a market for prostitute transvestite young men in his area? Will potential customers have anything for compensation? Is he willing to relocate to China in order for this business plan to succeed? The economic policies of the two potential president's may make it very difficult to practice this profession and even more difficult to move to greener pastures abroad.

NOTE: I have been out weeding and baking in the sun for the past few hours. This post probably jumps about and leaves gaps.

The point is: what effect will the bottom have on the top?

zhu said...

I'm surprised Joe, Jr., is not joining the Army! Iraq or Afghanistan are probably a good places to feed a heroin habit, and gay sex is part of the local culture. It's true that he might have to fight, but there's a chance he won't end up in the infantry.

Of course, he could always go Navy, which is what I did in the Viet Nam era. Patthaya Beach is at least as much fun as Subic Bay was in the past.

Zhu Bajie

Degringolade said...

I know that I am in the fringes here, but I have a tendency of feeling sorry for Joe.

You have to remember where Joe came from. He grew up in a high school where education was secondary, only "self-fulfillment" and "self-esteem" were required courses. Being the captain of the football team, he and his future wife (the head cheerleader of course), were repeatedly informed that the world was their oyster.

Having achieved the lofty high school diploma by the daunting task of performing nearly four hours of homework, he moved onto college.

College was amazing, the fraternities were filled with happy times, mom and dad paid the bill (Dad worked at a Ford factory), and the coursework in business school was easy once he figured out that short-term gain was the only valid criteria for any analysis.

Once married, Joe moved into a job selling the condos and houses that his old frat buddies had built. Since they were all frat buddies, he knew that the skids were greased and things were going up fast. Why brother Boone and Brother Otter were in charge of the banks and Brother Bluto had even managed to get elected to the Senate.

Joe is living in a strange world now. One where the second law of thermodynamics seems to rule, and dammit, no one taught him a thing about physics.

Can't we just pity poor Joe? Maybe a coffee can set up at the Safeway near you can help

Hari Seldon said...

1. Joe's ability to borrow will diminish in time.

2. In the short term, the asset will continue to depreciate and he will not be able to earn comission. In the longer term, however, as the economy improves he will be able to move the condos again, particularly since the drop in financing will also drop production of new units, and eventually demand will catch up with supply. His earnings will arrive in the future. However, due to the high interest rates, his earnings will be NPV discounted.

3. In anticipation to the US cutting down on spending, China will reduce production. In the not too long term, China's inflation will stabilize and so will US prices. Joe's wife will be able to continue surprising Joe, albeit, less frequently, provided that the credit cards are continued to be paid on time.

4. The rising food prices should not affect the cost of produce she grows, as long as she is growing it in a sustainable manner (i.e., enough of the produce is replanted so that the mini-farm continues to produce potatoes and squash at a similar rate).

5. Blow's plan on burning their furniture will have no effect on their budget, except that selling the furniture to buy materials for heating may be more profitable (and less wasteful) than burning the furniture. As long as Joe invests in alternative heating for his home (like solar power), his budget should improve in the long run. If Joe decides to continue to rely on oil and natural gas (or electric utilities that rely in these commodities), the continuing rise in prices will affect him in the short term. In the long term, prices will stabilize and eventually drop, which should compensate for the short term inconvenience.

6. If McCain wins, he will "secure the border", which means that he will make it easier for drug dealers to charge more money for drugs, even though corruption in the border patrol system does not really increase their transportation costs. If McCain wins, Joe's son's plans will become more expensive as time goes by. Obama's plans include stopping the war, which should reduce the deficit, and if he also raises taxes to pre-Bush levels, then he'll balance the budget (again) or earn a surplus, easing pressure on the financial markets and making money more accessible to the middle class again, even though the upper class will have a little less cash available for extravagant spending.

7. The circumstances faced by the American economy are caused by extreme debt without enough savings. Eventually, this catches up with society and people guilty of living on credit without having the savings or assets to back up the credit will pay the price. The reason why the effect that the circumstance is having on the economy is neutral in the long term is because the market is simply adjusting itself. Production capacity and inventories will not be destroyed because of a financial recession (this will only stop the ability to increase the economy, but not to maintain it). When consumers and debtors return to sanity (and one of the biggest debtor is the US government, which should return to sanity by returning to a budget suplus and paying back its debt), then the economy will have the opportunity to grow again.

It is important to note that the economy grows through increased productivity. Investing in speculative assets instead of assets that produce and grow the economy will be counterproductive in the long run. A prime example is condos and real estate in general....

Joe's troubles arise from the fact that his work was not productive to the economy, it was redistributive (he took money from those who had it offering things that did not increased wealth, when the market couldn't afford this luxury any more, Joe's business plan collapsed). Joe also is guilty of living on debt, with his maxed out credit cards and spending in depreciating assets (instead of investment in productive assets). No wonder his teenage kid needs a loan to go to school. Joe has no savings! Somehow, someone else is at fault for these poor financial decisions? Come on!

zhu said...

" Somehow, someone else is at fault for these poor financial decisions? Come on!"

Yes, I look for a lot of scapegoating, pf Arabs, of China, maybe of Israel, for not rebuilding the Temple in Jerusalem, and thus preventing Jesus from Rapturing the Blows, etc., away from their problems.

Zhu Bajie

M. Pyre said...

degringolade,

That was a very witty and insightful comment. Thanks for sharing it.

Anonymous said...

Well, scapegoating of the Chinese government would be justified, since that government (along with the Japanese, EU, and some other) has been acquiring massive amounts of US currency rather than buy US exports.

Of course, US policymakers also deserve a lot of blame for that, as they would rather serve US capital that wants to invest in China (and sell out the US population) rather than use tariffs and quotas to ensure balanced trade.

But, Orlov's major point is also important- economists have served as the major justifiers of most of the stupidest US policies of the last 15 years: unilateral free trade with mercantilist nations (like China), an unwillingness to focus on energy conservation, and a blind worship of free markets when US success has always come with reciprocal trade (enforced by government) and government regulation (with the New Deal).

zhubajie12 said...

So what does the US export? Anything that Chinese people would want? China imports lots of soybeans, but mostly from Brazil. New Orleans used to be a major place for exporting US farm products, but now? I don't know.

zhu said...

Economics is the modern day equivalent of astrology or extispicy. They are great at explaining things AFTER they happen, but not good at predicting.

Anonymous said...

That's a level of Deep Snark-- on many levels-- that only a Russian could provide.

Beautiful.

It drives me nuts when economists get all ivory tower and go on about "self-correcting markets" and other dross... people are suffering, people are screwed, their lives are ruined, and the economists just keep nattering on about abstractions.

Anonymous said...

Dear Mr. Orlov,

I am a college student whose parents have a large house with a large back yard on a somewhat densely-populated island off the coast of Seattle. There is a lot of forest and no shortage of deer. We have an orchard, a garden, and even a store of canned food. However, the parents aren't listening to my advice to sell off their stock and pay the mortgage off while they still can, claiming the economy might get better.

Should I be more persistent in my attempts to make them understand, or should I simply start repairing that Cal sailboat I got recently and expect to live off fish and clams?

Thank you for your time.