Economic Crisis Demystified
author: Ersun Warncke
 e-mail: warncke@comcast.net
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A layman's primer on market theory as it relates to the current "economic crisis" and $700 Billion Bailout. I borrow many ideas from many famous (and otherwise) people, so take this as a summary of knowledge in the field rather than an original work.
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The economy is complex. Economic principles are difficult to understand. This is not an accident.
The key to understanding economics is that all of the indecipherable arcane gibberish is not what is important. What is important is what that facade conceals.
Lex Parsimoniae
Famously known as "Occam's Razor," it is a truism that: "all things being equal, the simplest explanation is best." Employing this rule in the analysis of information is essential.
One of the most basic tricks of argument is to expand the scope to such an extent that the facts become hopelessly muddled, making it impossible to reach any conclusions at all. This trick is a standby for pushing false and weak arguments. If an argument is false, then the last thing a person will want to do is debate it on its merits. The best way to avoid a debate on the merits of an argument is to hopelessly confuse the issue by introducing irrelevant extraneous information.
Whenever an argument is supported by overly complex logic, or large amounts of unverifiable information, this should create a presumption that it is weak or false.
The Casino
There is an old adage that "in a casino you can spot the cheaters, because they're the ones who are winning."
It is a mathematical certainty that in an "even-odds" game, such as flipping a coin, the only way to beat the odds consistently over time is to cheat.
Markets, for stock, bonds, or anything else, are inherently "even-odds" games. Prices are determined by external forces beyond the control of market participants, and nobody can predict the future. If you want to win, you have to cheat.
Cheating in a market, like cheating at a game of poker, can be approached in two different ways. One way of cheating at poker is to try and gain advantage within the game itself: teaming up with another cheater against your opponents, finding a way to see your opponents cards, rigging the deck, etc. The other way to cheat at poker is to come through the door with some armed thugs, and take the whole game.
Markets
Markets produce nothing. They are mechanisms of exchange, nothing more. The only way to profit from exchange is to trade less valuable things for more valuable things - "buy low, sell high."
Price fluctuations in markets create the potential for profit. Ordinary price fluctuations, like all future events, are unpredictable. The profits from ordinary price fluctuations will, over time, be distributed randomly amongst market participants.
"Extraordinary" price fluctuations must be created if traders are to profit from market exchange.
One form of extraordinary price fluctuation is the classic "boom-bust" cycle. A boom is created by the lending of excessive amounts of money, which drives up the prices of assets. As asset prices increase, people borrow against the increased value of their assets, further fueling the boom.
Extra money in the economy increases prices, because the amount of assets (land) and goods (food, gas, cars, etc.) is either fixed or at least relatively inflexible in the short term. In a market where goods are exchanged for money, if the amount of money increases while the amount of goods stays the same, the price of the goods must increase. This is inflation.
Increased lending and increased prices shift the allocation of goods and assets within the economy. As credit increases in relation to wages, those who borrow gain a greater share of the total goods and assets within the economy. If wages are fixed, those who do not borrow must either reduce their consumption, spend their savings, or sell their assets in order to afford the higher cost of living. Retired individuals have no wages, so they get squeezed no matter what.
In aggregate, debt increases, and ownership of assets is shifted to those who borrow, while those who do not borrow are forced by higher prices to sell. The debts of those who borrow are secured by the assets they own, so ownership of assets does not ultimately rest with the borrowers, but with their creditors.
That is the boom. The bust happens when credit is pulled, which results in a precipitous fall in prices.
Both the rise and fall in prices in a boom-bust cycle present opportunities for profit. Unlike ordinary price fluctuations, which are caused by forces beyond the control of market participants, a boom-bust cycle results from the actions of market participants. As a result, the cycle is predictable, and so the bulk of the profits from it are likely to go to those who are in the best position to predict it.
Additionally, the general increase in debt that takes place during a boom-bust cycle results in a transfer of wealth, potentially on a massive scale, from debtors to creditors.
The Current Economic Crisis
Boom-bust cycles are nothing new. They have been happening for centuries. The current one is probably not spectacular in any particular way.
If anything has changed, it is that money, for the most part, is no longer minted, or even printed. It is now purely fictitious, existing only as digital records of credit balances. In principal, this is a good thing.
Money, whether it be paper, gold, silver, or otherwise has never had more than nominal value. Its purpose is to facilitate the exchange of things with real value, like food, shelter, clothing, fuel, transportation, etc.
Unlike the Great Depression, when physical currency (money, gold, silver) was essential for facilitating exchange, today the vast bulk of exchange is not dependent on physical currency at all. Whether it is a consumer paying for their goods with a credit or debit card, or huge corporations exchanging massive amounts of raw materials, the mechanism of exchange is purely digital. While an exchange may be denominated in a currency base (such as dollars), the exchange itself requires and involves no physical currency.
Because the only purpose and the only value of money is in the facilitation of exchange, and that function of money has been largely superseded, money no longer plays as crucial a role in the economy. Consequently, the productive economy is not threatened by financial crises in the same way that it was in the past.
A credit freeze by major banks would have a short term negative effect, but nothing permanent. The transaction systems that banks operate are not especially advanced or complex, and many alternatives already exist and are in use. If banks refused, by cutting off access to credit, to allow businesses and consumers to use their transactions systems, people would move to alternatives, and new alternatives would be created. Alternately, the government could do what it should have done a long time ago, and either nationalize or properly regulate the banking industry.
None of this stops people from making extortionate threats about the dire consequences to the economy if they are not paid off. The "$700 Billion Bailout," and the crisis surrounding it, appear to be the last desperate attempt of those being kicked out of the White House to steal as much as possible, and rig the system to prevent recovery, on their way out. In case you are wondering, this would be the poker equivalent of knocking over the game with a group of armed thugs.
Bush & Co. still have the trappings of the Executive Office, so they can make the same moves with or without congressional action. The only question is whether or not they will be given legislative immunity, which is crucial to preventing future recovery, not to mention future criminal charges.
A final round of preemptive pardons is, of course, not out of the question. If he is worried, Bush could always pardon Cheney, then resign on his last day, so Cheney can do him before he leaves office. :) In any case, I am sure that the dignity of the American political process will hit at least a few more all time lows before this is all over.
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