Bitcoin and Venezuela

Instapundit already linked to this, but I found the article very interesting as it finds the intersection of two very, very different topics - a country (Venezuela) destroyed by inept government and the cryptocurrency Bitcoin where the currency is possibly making lives better for at least some people in Venezuela because it can be traded and kept securely at very low cost.

Bitcoin's (legitimate) use has been limited so far because the U.S. dollar is a reasonably stable currency to use even in unstable regimes. But as the U.S. (slowly) follows Venezuela's footsteps into banana republicdom (I had a banana for breakfast again!), there may not be a stable unit of account supported by any country. In which case Bitcoin might save us all by enabling efficient trade in the chaos since it doesn't rely on any government or other bureaucracy and can provide a very stable unit of account.

I hope you enjoy the article!

The Great Experiment

Since early last fall, it's been my strong opinion that the real (and only) solution to the financial situation was to have the Fed pump huge amounts of liquidity into the system. Instead, we got TARP's and bailouts and stimulus packages and all kinds of stuff. The stock market continuously tanked in response to all those packages and the financial system continued to be mired in fear, uncertainty and doubt.

Finally, in early March, the Fed did just what I hoped they would:

"...the Bernanke Fed launched another shock-and-awe stimulus plan that will expand the Fed’s balance sheet another $1.2 trillion through the purchase of $300 billion in long-dated Treasuries, $750 billion in mortgage-backed securities (Fan/Fred), and another $100 billion in U.S. agency debt."

Sure enough, the stock market had its biggest rally in many months in response. Banks are looking healthier, the financial system is starting to look a bit more stable, and some economic indicators are starting to point to a recovery.

I'm really happy the Fed finally did this. Beyond the fact that I thought it would help, it's also a very interesting experiment. The second half of the experiment will take place in the future. The Fed created a huge amount of liquidity. Eventually, as the credit markets thaw completely and money velocity returns to normal levels, the Fed will need to mop up all that excess liquidity or the economy will drown in all that extra money. I'm hoping they have the resolve to do the right thing. I think they can, but not everybody agrees with me. If I'm wrong, we'll see quite an uptick in inflation, probably starting in the next several months.

But my curiosity will be sated either way.

The Paradox of Thrift

Are you feeling a bit poorer right now? Did your portfolio get a haircut lately (or a massive defoliation from head to toe)? Does the future suddenly not look as rosy to you? Are you thinking of saving more in the coming months and years (and centuries) to try and make up for recent losses?

Yeah, me too. Join the crowd.

Unfortunately, savings is inherently selfish. It's only good for the saver, not for the economy as a whole. Even worse, in a recession due to weak demand, the more we try to save in aggregate, the less we'll all end up saving. This is known as the Paradox of Thrift (or Paradox of Saving):

[It] is a paradox of economics propounded by John Maynard Keynes. The paradox states that if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population. One can argue that if everyone saves, then there is a decrease in consumption which leads to a fall in aggregate demand and thus leads to a fall in economic growth.

The extreme case is easy to see. If we all decide to buy and consume absolutely nothing at all (i.e., save everything we make), then there would be no reason to produce anything, therefore no reason for employers to employ and pay anybody, and therefore no one would have a job or any money to save. We'd all ending up starving in the dirt.

Applying The Paradox of Thrift to the current situation, Bob McTeer, who was the President of the Federal Reserve Bank of Dallas, writes:

The problem for the economy is this: consumption makes up about 70 percent of total spending, and consumption has been supporting the economy for years even though the personal saving rate is close to zero. The reason is that individual consumers who have experienced capital gains in their homes and in their stock or mutual fund portfolios (including those in their pension funds, 401Ks, IRAs, and the like) have thought of those capital gains as saving and thus have been willing to consume virtually all of their current income. (This is legit for individuals, but not for the nation as a whole since resources aren't being made available by capital gains.)

His conclusion (which I agree with), isn't a happy one:

I've recently heard economists say that, if saving increases, it will reduce consumption; but they imply that the result will be just a reduced growth rate. Perhaps. However, if saving increases on a broad scale, as it should, based on individual circumstances, the outcome could be a severe recession. [...]

I hope I'm wrong, but this is not just a curiosity. Consumer spending is key to a recovery from the recession. A sharp decline in consumer spending would only make the recession worse even though-individually-it is the right thing to do. We are in a pickle.

Apparently, he doesn't like pickles.

So if you really want to help the country, don't save! Instead, consume till you drop!

High Finance

The financial problems continue to be of great interest to me so I'm continuing to investigate it in my slow and plodding manner (hey, it's mostly just a hobby for me these days so it gets a low priority). Someday, I may be able to actually draw some solid conclusions about it with some confidence. I'll be sure to report back when and if that happens.

In the meantime, I grow more and more convinced that the government should have just let the financial institutions fail and then compensated by having the Fed pump liquidity into the system at a much higher rate. Don Luskin's recent National Review article identifies problems so far with the bailout which illustrates just how fiendishly difficult it is for a central agency to plan and execute such things:

When the Fed sets the precedent that it will, on a weekend when normal market processes aren’t available, hand over a troubled bank to a competitor at a price well below its market value—below even its value in bankruptcy—there’s no incentive to remain a shareholder at all. Long-term shareholders, who ought to be incentivized to stick with banks that run into difficulty, instead receive the message that they should flee at the first sign of trouble lest they be wiped out by the “rescue.” Stronger banks, sovereign-wealth funds, and other private investors that might profitably help a troubled bank by investing in it learn instead to wait for trouble to boil over into crisis, at which time the Fed will practically give the bank away on a Sunday night.

What’s worse, speculators get the message that they can push banks over the brink by shorting their stocks and spreading rumors, driving share prices so low that it becomes prohibitively costly to raise new capital—assuming anyone would dare invest new capital—and the Fed or some other regulator then has no choice but to step in and put them out of their misery. Such speculative attacks work on any bank the government deems “systemically important”—the new way of saying “too big to fail.”

The other thing I've noticed while investigating the subject, is that the ratio of profits in the financial industry versus all other industries has been steadily rising. Forty years ago (1967), about $1 in $7 of total profits in the United States was made by a firm in the financial industry. Twenty years ago (1987) it was about $1 in $4. Last year (2007), it was almost $1 in $3.

Both the trend (which is pretty smooth) and the direction are worrying to me. The financial industry is an enabler of production, but doesn't actually produce anything of value itself, so to absorb that much of the entire economy's profit incentive seems like a distortion. There may be perfectly good reasons for the trend. For example, the total profit relative to the global economy has probably not increased as much, and the United States does have an oversized share of the global finance business. But still, bailing out the most profitable sector is a bit tough to swallow.