Thursday, February 16, 2012

Fool's Gold Redux

Came across Warren Buffet's comment on gold and would like share it with everyone here.

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil  will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.”

I have made a similar view on gold last year and you can read it here

Tuesday, February 14, 2012

Paperless Education

At last! We are now inching closer to a paperless education system. A pilot project is currently underway. Learn more - http://www.bt.com.bn/news-national/2012/02/14/rimba-ii-secondary-school-selected

Hope that we do not have to wait long for the whole system to be converted. Well done for my country. 

For those who are curious as to my excitement on the matter, please refer to my previous postings.

Friday, February 10, 2012

Let's Starve The Goose That Lays The Golden Eggs

Today, I came across an interesting article published in the Brunei Times about paying corporate taxes. Full story can be read on the following.


I honestly applaud the minister initiative on introducing a new guidelines in giving local companies a fair chance of participation in the oil and gas industries. However, I do not quite agree on his views about corporate taxes and its relationship to our government incomes.

First let me asked you this question, where did you get your money? Unless you inherited it, you obtained your money by working for a business. It either was your business or someone else’s business. If you inherited your money, your parents or other benefactor worked for a business to obtain their money.

Whichever scenario is appropriate to your situation, the money you received came from a business, and that money is part of what was left over after the business paid its bills — including its taxes.

As with so many arguments about economics, the corporate tax discussion devolves to a discussion of Monetary Sovereign. If you understand Monetary Sovereignty, you know that corporate taxes take money out of your pocket and slow the economy. 

To me, we simply should eliminate the corporate tax and allow the Brunei dollars to go into the economy rather than to disappear as tax payments. Our government does not need or use tax money, so why do we want corporations to undergo that added expense? 

In short, business is the goose from which we all receive our golden eggs. Taxing business is like stealing the goose’s grain, then cooking the goose.

Friday, February 3, 2012

Money..Money..It's...a...

It was reported that our government is making a saving of B$20 million on the revised electric tariff. Those savings are purportedly being channeled to other areas such as education, health and etc. Full details can be found on the following.


For those who had been following my ramblings shall undoubtedly understood that B$20 million saving by the government meant that the people shall be B$20 million poorer. But the biggest question remain is to why do a monetarily sovereign nation needs to save her own money?

Money is a human technology. It is a tool created and managed by human beings to organize the tasks of assigning prices and values to goods and services, and to organizing the production, exchange and distribution of those goods and services. A sovereign government like our country is not the mere user of a form of currency for whose existence it is dependent on someone else. Our country can always produce and issue the additional monetary resources and financial instruments it needs, in whatever quantities it needs, and it can do so at negligible cost. 

In the world of modern money, a sovereign currency issuer can create money simply by using computers to mark up the government accounts it administers. It is always possible that such a country cannot achieve some desired end because of a shortage or real, non-monetary resources. But it can never be the case that the government of such a country is incapable of organizing some needed effort of production and exchange because it has “run out” of the money over which that government itself exercises sovereign monopoly control. That’s like saying that we can’t have any more people in the world because we have run out of names.

Once again then, why do our government needs to save up her own money?

Thursday, February 2, 2012

Money Printing Myth

It is conventional wisdom that printing more money causes inflation. The only problem is, it is not true. That is not how inflation works. And so, let me start with the “money growth ==> inflation” view. This is based on the equation of exchange:

MV = Py     where,

M - is equal to the supply of money,
V - the velocity of money (or the average number of times each dollar note is spent),
P - the average price of goods and services, and
y - the total quantity of all goods and services sold during the time period in question.

Thus, if there were 100 goods and services that sold for B$10 each (on average), then that means a total of B$1000 - worth of transactions took place. Were there 200 one-dollar notes in this economy, then it must be that each was used 5 times (hence the “velocity” of money, or how fast they were spent again).

MV = Py

200 x 5 = 10 x 100

It is important to note here that the above is not the least bit controversial. No economist disagrees with the basic equation MV=Py. The arguments arise when additional assumptions are made regarding the nature of the individual variables. For example, this is what is assumed in the “money growth==>inflation” view:

M - That which is money is easily defined and identified and only the central bank can affect its supply, which it can do with autonomy and precision.

V - The velocity of money is related to people’s habits and the structure of the financial system. It is, therefore, relatively constant.

P - The economy is so competitive that neither firms nor workers are free to change what they charge for their goods and services without there having been a change in the underlying forces driving supply and demand in their market.

y - The economy automatically tends towards full employment and thus y (the existing volume of goods and services) is as large as it can be at any given moment (although it grows over time).

Now let’s go through an example, recalling the mathematical example from above:

MV = Py

200 x 5 = 10 x 100

Consider the assumptions made regarding each of the variables. P can not change on its own, y is already as large as it can possibly be given current technology and resources, and V is constant. Only M can change in the short run and it must therefore logically be the starting point of any fluctuation we introduce. Furthermore, according to our assumptions, the central bank or in our case our AMBD has the power to (for example) double the money supply at will.

In Milton Friedman’s example from “The Optimum Quantity of Money,” a helicopter is used to accomplish this. Now what happens?

MV = Py

400 x 5 > 10 x 100

There is clearly a problem here which could be solved in one of three ways (assuming we don’t just lower M back to 200):

1. y could rise to 200, but of course it can’t because it’s already at its maximum; or

2. V could fall to 2.5, but it is constant (something Friedman takes pains to emphasize in the original article); or

3. P could rise to 20. It is of course the third that proponents of the “money growth==>inflation” view say will occur.

MV = Py

400 x 5 = 20 x 100

Equality again!

Let me reemphasize why this is the only logical outcome. We have assumed that y and V are constant. Friedman says that y is constant at the level associated with the natural rate of unemployment, while V is indirectly related to agents’ demand for cash. When people want to hold more cash, V, the rate at which they spend cash, naturally falls, and vice versa. But, Friedman further specifies that V is relatively constant and so, therefore, is the demand for cash. Thus, when the AMBD raised the supply of cash from 200 to 400, this meant that people were holding more cash than they wished to have in their portfolios. The Government had created a situation in which the supply of money (newly raised) exceeded the demand (still at the original level). The result was that people, in the language of the “money growth==>inflation” view, rid themselves of excess money balances by spending that cash. They hoped to buy more goods and services but since, in aggregate, more did not exist, they only bid up their prices: money growth led to inflation.

This is this standard view. It makes for a great lecture in an intro or even intermediate macro class. But the problem is that after the lecture is over, people only remember this:

increase M ==> increase P

What they do not recollect are all the assumptions we made to get there! And not only are some questionable, they are downright inconsistent with other lectures we make in the very same class.

Take for example y. One need only look out the window to see that it is not currently at the full-employment and therefore maximum level (Note: currently unemployment rate in Brunei is 3.7 percent). Hence, given this scenario:

MV = Py

400 x 5 > 10 x 100

There is no reason that this could not lead to the rise in y shown below as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand:

MV = Py

400 x 5 = 10 x 200

This is, of course, the goal of the government deficit spending that so many economically - ignorant people are trying to stop right now.

In addition, there is a great deal of evidence that the velocity of money IS NOT constant. As one would expect, it tends to decline in recessions when people do, in fact, want to hold more cash. Hence, if we assume that the AMBD undertakes the above policy during such a period (as we see today in some countries), the final result might be this:

MV = Py

400 x 2.5 = 10 x 100

Or it could be some combination of a rise in y and a fall in V – this would make perfect economic sense. Notice how the process of making the initial assumptions of this approach more realistic is making it far from certain that a rise in M leads to a rise in P, particularly during an economic downturn.

But that is not the worst of it. There is actually a much more fundamental problem with the “money growth==>inflation” approach. Recall the original assumptions for M:

M - That which is money is easily defined and identified and only the central bank can affect it’s supply, which it can do with autonomy and precision. What is “money” in a modern, credit-based financial system? Is it that stuff you carry in your pocket, the 1′s and 0′s of the electronic entries in your bank account, the available balance on your credit card, your current account, your savings account? In practice, this question is so difficult to answer that economists actually offer several possible definitions, just in case! Suffice it to say that for present purposes, the idea that we can precisely identify the current “supply of money” in our economy is suspect. This by itself causes problems for operationalizing the above equation.

To make matters worse, the financial sector can create and destroy money without direct action by the AMBD. Every time a loan is made, the supply of money increases. The bank is creating money out of thin air, with only a fraction of the total necessary to have already been in the vault as reserves. And when loans are repaid or there are defaults, the supply of money contracts. Hence, the private sector has a great deal of control over M.

But perhaps the real nail in the coffin of the “money growth==>inflation” view is this – the phenomenon that Milton Friedman identifies as key to the whole process, i.e., the excess of the money supply over money demand, cannot happen in real life. The irony here is that something else we already cover in the intro macro class makes this evident. How is it that the Government increases the money supply? Remember that Friedman used a helicopter – indeed, he had to, for there was no other way to make the example work. This was not just a simplifying device, it was critical, for it allowed the AMBD to raise the money supply despite the wishes of the public.

However, that can not happen in the real world because the actual mechanisms available are AMBD purchases of government debt such as sukuk from the public, AMBD loans to banks through the discount window, or AMBD adjustment of reserve requirements so that the banks can make more loans from the same volume of deposits. All of these can raise M, but, not a single solitary one of them can occur without the conscious and voluntary cooperation of a private sector agent. You cannot force anyone to sell a sukuk in exchange for new cash; you cannot force a private bank to accept a loan from the AMBD; and private banks cannot force their customers to accept loans. Supplying money is like supplying haircuts: you can not do it unless a corresponding demand exists.

The bottom line is that the “money growth==>inflation” view makes perfect sense in some alternate universe where all those assumptions regarding the variables DO hold, but not here, not today, not in the this world in 2011. That is not how it works.

There is no reason to throw the baby out with the bath water, so let’s retain the equation. However, we need new assumptions with respect to M, V, P, and y:

M - A precise definition and identification of money is elusive in a modern, credit-money economy, and its volume can change either with or without direct central bank intervention. In addition, the monetary authority cannot raise the supply of money without the cooperation of the private sector. Because central banks (in some countries) almost always target interest rates (the price of holding cash) rather than the quantity of money, they tend to simply accommodate demands from banks. When private banks communicate that they need more reserves for loans and offer government debt to the central bank or AMBD, the central bank buys it. It is the private sector that is in the driver’s seat in this respect, not the central bank or AMBD. The central bank’s impact is indirect and heavily dependent on what the rest of the economy is willing to do (which is, incidentally, why all the QE and QE II money done in the USA is just sitting in bank vaults and that is why the US economy is still in the doldrums’).

V - The velocity of money is, indeed, related to people’s behavior and the structure of the financial system, but there are discernable patterns. It is not constant even over the short run.

P – While it is true that factors like production bottlenecks can be a source of price movements, the economy is not so competitive that there are not firms or workers who find themselves able to manipulate the prices and wages they charge. The most important inflationary episode in recent history was the direct result of a cartel, i.e., OPEC, flexing its muscle. Asset price bubbles can also cause price increases (as they are now). The key here, however, is that P CAN be the initiating factor – in fact, it has to be, since M can’t.

y - The economy can and does come to rest at less-than-full employment. Hence, while it is possible for y to be at its maximum, it most certainly does not have to be.

A number of scenarios can be described based on this more realistic alternative and it would be nice to go through each. Unfortunately, as I suggested above, the big problem with this topic is that it takes to long just to reject the popular view!