A bailout has the opposite effect!

Bailouts disintegrate the economy. Companies took on too much debt and did not perform good enough to be profitable. A company would not perform because of an outdated business model, inferior products, bad cost control, etc. In any case they are doing something wrong which makes it uninteresting to let them continue operations. Instead, other companies are performing better, making those companies the ones that attract talent and investments. This is a logical economic process like in nature: “survival of the fittest”. With bankruptcies you would rid yourself of the bad performing companies, which would benefit the economy in the long run. Specializations in which other companies operate are more profitable so there is a shift in activities benefiting the economy. Giving companies bailout money would mean giving them money for being an inferior organization that is not suited for the current economy. Giving a company more money does not mean the company will suddenly be fit for the economic environment. It is nothing but a short-term fix, without addressing underlying problems.

A government is meant to govern a country, and not meant to play for an investor that will see negative returns. Any logical investor would refuse the idea to invest in a company that is about to go bankrupt. Besides, it is your taxes they invest with. I could simply refer to the failed Chrysler bail out in the 80s. No bailout can benefit the economy over the long-run. Unfortunately, politicians still don’t get that.

Economic freedom: working where you please

Recently news is reporting on the refusal of the United States government to give work visas to foreigners. I believe people should get more freedom on where they would like to work. This is because of shortages in human resources in many countries and to promote economic efficiency.

In the United States only, there are more than 3 million job vacancies that are unlikely to be filled in anytime soon. Other countries are facing the same problem, a problem that could be overcome by bringing in foreign talent. If there are job vacancies that can’t be filled, economic growth will have a limitation.

Some jobs could better be filled by foreigners. For example in The Netherlands, who would like to do cleaning work nowadays? Or paint your house? And if there are people that do it, they charge way too much for it. This forces people to “do-it-themselves” and being limited in the time they spent on other things (including work). Bring in a foreigner and he or she will do a good job for a decent price, saving the locals money and/or time. The foreigner that did the work would also be better off then when doing the same work in his or her home country. The economy will benefit because the local people will have more time for highly-skilled work and the foreigner is contributing by being part of the work force and spending part or all his money in The Netherlands.

Now it won’t be a good idea to be giving work visas to everyone that enters a country. But step by step a country could let more people in to fill vacancies, which will lead to an overall higher level of economic prosperity.

Pig Flu in China

Just for the record: the pig flu has already been in Mainland China for a while. Doctors and hospitals here know about it, but it is still kept secret by the authorities.

How the Central Bank can fight a recession

In this post I would like to show you how a countries’ Central Bank can fight a recession.

Many believe a fiscal stimulus would be the thing to go for, but as I have shown in my first article about the US stimulus this has proven not to be the right answer to a recession. It was the Chicago School of Business economist Milton Friedman that proved the Central Bank is the one and only mechanism to fight a recession. Even though he won the Nobel Prize in the 1960s, governments tend to neglect his findings.

The Central Bank could use the following tools to get an economy back on its feet:

• Lower interest rates
• Decrease in banks’ reserve ratio
• Increase money supply

Lower interest rates

The economy can benefit from an increase in peoples’ consumption. Lower interest rates will both discourage saving and encourage borrowing. It would discourage saving because the returns on those savings would be very low, and it would encourage borrowing because the interest rate on borrowing is very low. Both would in their turn trigger spending.

Interest rates should not be below zero. This is because such a rate would make money worth more when someone is not saving it, effectively making spending a stupidity.

Decrease in banks’ reserve ratio

The Central Bank could decrease the banks’ reserve ratio regulation. When banks can keep lower reserves, they have more money available to lend. Companies in their turn would have more chance of landing the loans needed for their development.

Too low reserve ratios would be risky though, since they would not protect the bank from market fluctuations. When there is a “run” on the bank or many people take out their deposits the bank would not have enough liquidity to give back its deposits. Banks would then go bust, calling Lehman Brothers as an example.

In China banks have the benefit of having a shitload in deposits. Even though many loans are non-performing, there are enough deposits to cover them. Still, instead of their American counterparts these banks see their problems shifted towards the future.

Increase of money supply

When increasing the supply of money the Central Bank simply “creates” (supplies) more money that is brought into the market in the form of cheap loans to financial institutions.

A Central Bank should not “create” (supply) too much more money. When too much money gets into the market serious inflation could dispose of the money’s value. Decreasing the real value of money would then be the opposite of the effect that the Central Bank is aiming for.

Conclusion

I hope you now get an idea on how a government can best fight a recession. Hence, no taxpayers’ money would be spent to build sandcastles. ;-)

The Fake Recovery of the Chinese Economy

The expected recovery of the Chinese economy is a “fake one” and this text will proof it. First I will let you know why figures would show a revival of the Chinese economy. Then, I will show you how this will negatively impact the economic long-term future of China. Last but not least I will explain the politics that lead to this destructive short-term thinking.

The Chinese economy is expected to grow up to 8% in 2009

While many Western economies are expected to contract with 2-3%, the Chinese economy is expected to grow with 8%. Well, most of this growth, as I read recently in some economic magazine, comes from a direct and indirect government spending. Estimates are that in case the government did not carry out the stimulus expected growth would be 3%, five percentage points lower. Then the next question would be: how is this stimulus composed? How can its effect be so big?

The effect of the stimulus is big because it is both direct and indirect. Direct by making sure the government spends more by hiring more people, providing more subsidies, spending more on healthcare and education, etc. Indirect spending is more interesting to mention. The Chinese government has forced its own state-owned banks to lend money like crazy. The banks have certain quotas on how much they should lend to companies! Currently banks are knocking on companies’ doors asking them to borrow some. The requirements for getting these loans are so few that the chances of getting the loans paid back are really small. Besides, most companies borrowing the money are state-owned, companies that have previously proven to default on their loans.

Let the next generation deal with it

The next generation will have to deal with two matters. First, it will face the government debt over which interest will need to be paid and which one will need to pay back. Secondly, they will have their money in banks that will not be able to pay them back their deposits. This is simply because the companies that are now borrowing will not be able to pay their loans back. Even if the banks will be bailed out (which has been done before in China), this will only lead to a limit on government spending in areas where it should be used (safety, clean environment) or this will increase government debt. In other words, we will not face the interest rates and government spending limits today, but they will definitely be faced in the future – say 20 years from now.

The political motive behind the huge increase in government spending

The goal of politicians in China is not to think about the long-term growth of their country, but to think about keeping people quiet. With keeping people quiet I mean making sure they do not start protests or go against the Party. This is the whole idea behind keeping this one-party dictatorship alive you see – as long as people are happy they will not bother the government. As long as the Chinese are focused on making money they would not be bothering the government. The Chinese government is keeping the economy going to keep the people happy, but with such short-term thinking a few years down the road problems will only be bigger, with the Communist Party directing its own failure.

President Obama and his Genius Stimulus BILL and the 'Sand Castle Building' Theory

(The first part is taken from the internet and slightly modified. The second part is written by myself.)

Let's run a mindboggling defecit that guarantees failure for my children's children and use that money for the illusion of wealth creation. GDP will certainly has the potential to rise next year, probably beginning in Q3 but it's a fake rise. The idea that building things that cost enormous amounts of money that you don't have making things better is even crazier than having a guy run the economy who can't figure out his own tax liability. The Obama stimulus plan can be basically summed up as follows: "if I give my 21 month son a 'job' working in the family sandbox and he makes a massive sand castle are we better off? Additionally I pay him off of one of my credit cards." Technically his business is bringing in money and thus conributing to GDP, but the money isn't real. It has to be paid back eventually! This means that money cannot be used for wealth creation in the future and instead of going into new goods it's going into NONSENSE. The economic stimulus package works exactly the same way. Robbing Peter's grandchildren to pay Paul is no way to practice macroeconomics. What are they teaching at the previously esteemed Harvard (or any university) these days?

Additionally all this 'job creation' is total and utter crap. The government doesn't create wealth it spends it. THE GOVERNMENT IS A COST CENTER. Creating 3,000,000 new jobs at let's say 40,000.00 per year just means that eventually American taxpayers will have an additional $120,000,000,000.00 in annual bills, not even thinking about including pensions and other benefits because then the number will get really scary. That's right he has proposed 120 billion dollars of perpetual new spending into what is really a depression. Where will this come from? Well, since businesses employ people and both people and businesses pay taxes it's likely that businesses will have less money to employ people as they will be paying for guys to stand at a construction site smoking a cigarette while leaning on a shovel. This can only mean less income for the government and higher taxes to make up the gap until total failure becomes evident; something which I predict grandchildren to witness.

This stimulus plan is stupid and will only bring long term harm to the economy. No matter how you look at it 'running a defecit' (wasting the taxpayers' money) with a national debt that basically equals GDP means: higher taxes, decreased business profitability and additional costs for future generations.

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Instead let's start making the economy effective and start to spend money in ways that make sense and promote the economy to become more healthy. Actuallywe learn in middle school that spending now means that you can spend less in the future. Therefore what in fact would be good is to just stop spending for a change. People refer to spending tax money to grow the economy while we should actually stop spending tax money to grow the economy. 'Borrowing money costs money (try explaining that to Obama).'

Get rid of all these taxes and what is left is companies that have more money to hire people instead of paying that money in taxes to the government that in turn hires more useless bureaucrats. Additionally, people who work more or better will get the equivelant seen in their pay. Useless people will be just accepted for how they are (useless) and will not be pushing the economy down with their low productivity so productivity will go up and we will have an unprecedented era of prosperity. Plus, our children will not be paying for current and future 'sand castle building' costs in a stimulus which has never proven to be economically beneficial. See, the less we spend now the more we can spend in the future, plus we won't be building sand castles in the hope to stimulate the economy. Let's start treating the roots of the problem instead of the symptoms.

Welcome to Johan's Economics Blog

Over the past few months I have been updating my friends on economics related topics. I figured it might be a good idea to create a blog in order to have a clear view on what I have written on economics so far.

Most economic news is inadequate or outright false. This blog aims to help you understand economics in simple wordings.

Please enjoy reading it. ;-)

Johan