Where's the value?

I would like to discuss the idea of value in an economy. The nature of an economy is to abstract value; the most direct abstraction is:

I give you 10 units each for your 10 turnips, you then give the shoemaker 100 units to repair your shoes, she turns around and spends 20 units for a dozen eggs, where a unit might be a penny, for instance. This is the way a simple village economy used to work a couple of hundred years ago. The money in these transactions is just a placeholder for value, whether the value of some produce or some skilled labor. Without this placeholder we would need to come to some sort of barter agreement for every such exchange, which may not be that bad an idea either, but the use of money seems to make these exchanges easier.

You could complicate the picture by adding in a credit element: the bank loans a ship captain 10,000 units to sail to another land and bring back spices. The ship captain must repay the 10,000 plus an additional 1500 units upon return or else forfeit his ship. The captain expects to be able to sell his cargo for 15,000 units, which leaves him with 3500 units profit after paying back the loan.

This still makes good sense, after all the captain has to hire a crew and buy items to trade for the spices. He does not have money on hand for this but does have the expertise to accomplish the trip. The bank has the money, but does not have the expertise.

Where we start getting into trouble is when it turns out that the bank has made 20 loans like this for a total of 200,000 units, and it only has 50,000 units in its vaults. Since it did not have the currency to pay out these loans, it issued notes that were deemed to be good for the face amount, these notes were honored by the vendors and people of the community as if they were cash. This is what we call "fractional reserve banking"; it is how our banking system works today.

Now why did it make sense for the bank to loan more money than it had? Because the odds of the bank getting paid back were judged to be very good.

I'm starting to get a sidetracked here, back to our subject. In the whole scenario above, you can see value being added by each of the participants, including the bank.

I believe our problem today is that we have taken the abstraction of money to an extreme, so that we abstract the sort of situation described above by placing bets on the bank, or on the captain. Then we abstract this by placing bets on the companies placing the first bets, and so on.

Most of the jobs in the developed world involve working for one of the companies placing many-times-removed bets, or providing a service to these companies. Is there any value added by placing bets on other economic activity? If not, then there is no value added by providing services to those placing the bets.

As they say, I believe, but cannot prove, that at some point pretty early in the cycle of betting, value is no longer added and that we are many orders of magnitude beyond that point today.

This is why I was glad to hear Robert Reich say that he doesn't think we will have either a quick or slow economic recovery, because the real question is what sort of economy will we transition to, since the economy we have known for the past 30 years or so is unsustainable?

I thought it was very telling when "This American Life" discussed a lawsuit brought by shareholders against Citigroup and mentioned that the shareholders' biggest complaint was why didn't Citi unload their worthless collateral debt obligations on some other hapless fool. If they had, everything would have been okay, both for the shareholders and even the world economy. Of course this ignores the fact that the counterparty in this trade is also part of the world economy. So ultimately the only way this sort of system can continue is for a "Deus ex machina" to throw money into the system from somewhere outside. We should say "value" here instead of "money", since we are quite capable of printing our own worthless money.

This is where we currently stand with our banks. They have not sold off their bad mortgages but instead are hoping house prices will come back up and make those mortgages worth something again. If only people would start buying houses, then everything would be okay! As Dmitry Orlov slyly puts it, we will be rescued by extra-terrestrials!

Are Alternative Energy Sources Realistic?

Jeff Vail talks about Energy Return On Energy Invested (EROEI) in a detailed post

http://www.jeffvail.net/

The basic idea is to account for the energy used to produce wind turbines, for instance, and determine if the energy they generate is more than the energy required to implement them (build, transport to location, and install). Obviously if it's equal or less than you shouldn't even be doing it. In fact, if it's not significantly more (by say a factor of 10) then maybe you'd be better off not doing it.

Vail points out that this calculation is very dependent on how wide you define the scope of implementing the technology. For instance, do you also need to add in the fuel needed to raise the rice to feed the worker that built the turbine blade? How about the infrastructure to educate and pay the engineer that designed it? He concludes that it is impossible to accurately account for this, and suggests a different approach, based on price of the technology in the market. He intends to evaluate Wind and Solar power using this methodology in upcoming posts.

The point to take home here is that if the energy alternatives we're considering do not have much of an EROEI ratio then we should not be wasting our time on them. If there is no alternative with a good EROEI then we should start figuring out how to get by on less energy. I think there are reasons why we should greatly lower our energy use even if a good alternative energy source exists; this is a topic for a different post.

Self Deception

If what we are doing is so good, how come we have to pretend it's something else?

This question could be asked about so many things: from stressless bank "stress tests", to collaboration with the health care industry for universal health coverage rather than a single payer (government) system, to spending 50 billion helping GM through bankruptcy and not wanting to talk about whether tax payers will ever get this money back.

Is it because you just can't say out loud that the decision was made for expediency in order to balance the interests of strong lobbying groups? (You could maybe apply this to several of the above).

Is it because the best long term strategy requires the taxpayers to take a hit, but we don't dare tell them?

Bill Moyers discussed the benefits of a single-payer health care system on a recent show and concluded that this was the only way to achieve large gains in efficiency and savings. But when people asked politicians why this was not on the table, they were told, "because it will never happen", and that we would be foolish to squander the opportunity for extended health coverage on a pipe dream like this.

Unfortunately there is such a thing as the "possible" and the "politically possible".

However, it would do us a lot of good to at least say what we're really doing, instead of lying to the group and to ourselves about it.

How about this: "We're giving 50 billion to GM because we need to have some manufacturing base in this country, and they are one of our few examples. You will never see this money again. In fact, they will probably start losing money again once they come out of bankruptcy, and at that time we will have to either let them go under for real, or give them more money."

I'm not particularly irate about the GM example, it just serves as a good demonstration of what I'm talking about. I'm much more concerned about the health care solution.

Bush closer to Cheney than expected

New York times columnist and "The News Hour" analyst David Brooks made the point recently that the Obama administration has essentially taken the same policy on Iraq and terrorism as the second half of the George W. Bush administration, when Dick Cheney's views were out of favor. I would pretty much buy into this, and I felt that Cheney's recent defense of torture tactics would not be supported by Bush now. However, George W. Bush gave some defense of these in a recent speech, saying that he believed they were legal at the time and that they made us safer.

Brooks also made the point that unlike Bush, President Obama gave a clear articulation of the reasons for his policy. While the policy changed in Bush's last few years, he did not emphasize this or build a case for it; instead he continued the approach of never admitting a mistake.

How do we know what's real?

Europe2020

http://www.europe2020.org

describes an epochal shift in the world economy, taking place before our eyes. During this time, the old economic indicators are unreliable, and what's worse, they have been doctored by large-scale intervention so that they say what we want to believe. Below from their May 15 post:

"Of course, everyone is free to think that a few points’ monthly variation of a particular economic or financial indicator, itself largely affected by the multiple interventions of public authorities and banks, carries much more value on the evolution of the current crisis than those stepping out of century-old referential frameworks. Everyone is also free to believe that those who anticipated neither the crisis nor its intensity are now in a position to know the precise date when it will end.

Our team advises them to go see (or see again) the movie Matrix [5] and to think about the consequences of manipulating the sensors and indicators of one’s perception of given environment. Indeed, as we will examine in detail in our special summer 2009 GEAB (N°36), the coming months could be entitled « Crisis Reloaded » [6]"

Musings on Capablanca vs. Alekhine and the nature of the universe

Jose Raul Capablanca was World Chess Champion from 1921 to 1927. During that time he was considered unbeatable in a match and dominated tournament play. Nevertheless, Alexander Alekhine defeated him in the Buenos Aires title contest by 6 wins, 3 losses and 25 draws. Alekhine, who had never won a game against Capablanca before, prepared extensively for the match, poring over Capablanca's games looking for a weakness. To his surprise he discovered that upon closer examination the seemingly strong moves of the champion overlooked certain possibilities. The challenger also altered his attacking style to a more patient, positional style more like Capablanca's.

So was Alekhine's victory a vindication of his baroque, inventive, chaotic play, and a refutation of Capablanca's simple, logical, positional buildup? Fischer said of Capablanca that he won his games by outmaneuvering his opponents in the middle game, so that the game was over when he simplified to end game, his opponents just didn't know it yet. Of Alekhine, Fischer said that his whole approach was wrong. Interestingly enough, Bobby Fischer combined the will to win of Alekhine with the classical simplicity of Capablanca.

Was Capablanca like Newtonian physics, true as far as it went, but lacking the deeper truth of chaotic quantum mechanics? Was Alekhine the Heisenberg Uncertainty Principal over the board?

After the match Alekhine admitted that he was honestly surprised that he won, and felt that he benefitted from overconfidence on Capablanca's part. In spite of a prior agreement, Capablanca was never given a rematch, and the two were bitter enemies until Capablanca's death, at which point Alekhine praised his former opponent.

Local real estate development mostly gone

This may not be a news flash, but I think it is a good reminder about the big change our economy has gone through, and the repercussions that we have just begun to see.

The Statesman/Journal ran a front page story today on the Salem City Council's proposal to cut back it's regular meeting schedule from once a week to two days a month. The reason: lack of "residential and commercial development issues". So clear evidence here that things have changed a lot, and an unintended revelation that our city's leadership has been spending half their time on real estate development. The other issues for next week's meeting are deciding how to spend some federal stimulus money, discussing cameras at red lights, and choosing a name for a fountain.

Salem has a population of about 150,000 according to wikipedia. I believe the state of Oregon is the largest employer in the area, with Salem Hospital also employing a significant number of people. After that, not much in the way of industry or large businesses. What will become of all the people who were involved in construction, real estate, and related services, and what will be the further impact on the local economy?