Peter Yastrow's Blog

MULTIPLIER EFFECTS

The concept behind any stimulus plan, or easing campaign is quite simple. By assisting or jump-starting a sector or segment of an economy, we can then expect that other sectors of the economy will also benefit. In economics, the concept of a multiplier effect, with regard to bank lending, is considered an absolute. There is no doubt among FED officials and economists world wide, that we can expect a domino effect with regard to lending. For example, lending money to a bread maker will mean that the farmer sells more wheat, eggs, and butter. The farmer’s increased business causes him to buy more chicken feed, and milking machines. The cycle continues on, as the people who provide for the farmer see their sales rise. This ripple effect through the economy causes the positive benefits of the original bank loan to be multiplied.

    When we created mortgages, we also had multiplier effects.  When a mortgage banker secured a loan for a homebuyer; there was an enormous ripple effect.

The homebuyer needed movers, and curtains, and paint, and cable, and dishes, and towels, etc.  All stores, from Bed Bath and Beyond to Home Depot, were positively impacted.

    By making lending standards more stringent, and realistic, we should anticipate a huge negative multiplier effect. The reduction in loans being made will lead to less stimulation across many, many sectors of our economy.  This contraction across all industries can only be offset by a new driver, or stimulating industry. Without a big development, then we will be hard pressed in this country to offset the drop in real estate activity.

   HOWEVER- I am not advocating a reduction in lending standards- or any program that continues to allow misguided U.S. consumers to borrow money recklessly.

The last 10-15 years we saw our economy grow like never before. Lifestyles advanced.  The standard of living increased. Unfortunately, this growth was a result of negligent lending that created a multiplier effect.  Americans saw their business boom, and their property values increase. They were lulled into believing that this was the new normal.  Now that this reckless lending has been curtailed, the multiplier effect has been lost as well. 

   Economies require constant technological breakouts and innovation in order to grow. We benefitted from computers in the 80s; the Internet pushed us along in the 90s.  Then something changed. In the years that followed, our economy was fed a diet of artificial activity.  We borrowed and borrowed rather than created and innovated. We built houses with borrowed money. The lenders thrilled to be making loans. The borrowers thrilled to be buying a house. (Maybe the biggest problem we face/ buying outright vs. credit)

   It felt the same. The multiplier effects seemed real, and many of us developed a huge misconception of how strong the economy, our own finances, and our own businesses really were.

J.O.Y. TO THE WORLD        peter

Tags: lending, multiplier effect

Pop! Goes the Weasel

The Fed slashed interest rates. They dropped the rate that they charge to borrow money all the way below ¼ of a percent. My daughter has $100 in a kiddie account at the bank that pays ¼%. You cannot imagine the look on her face when she got her shiny quarter after waiting a whole year. The returns are so dreadful that people are forced to put the money to work elsewhere. That is how a Fed Easing Cycle works: they drain the pond. They drain the pond until the fish grow legs.

Does anyone see the paradox?

After a decade of reckless borrowing, the Fed is forcing us to engage in reckless lending.

The housing boom and subsequent bust was fueled by cheap money. The cure is even cheaper money.

This is far from over. The recovery is tepid at best; unemployment is not abating, and the average American has lost over 30% of their wealth over the past 3 years as housing prices have tumbled. Furthermore, the Fed has done all they can do. They can’t take rates negative.

Do not be confused because stocks are up 60% from their lows. Stocks are still far from the highs, and are starting to stall. We will not be able to regain the standard of living we enjoyed as a nation in the 2004-2007 years any time soon. That period was powered by poor lending standards and greedy borrowers. That period was not like previous booms. Prior booms were powered by innovation and technological advances– advances that caused real growth and real prosperity.

The last five years were not real growth that resulted from any advancements. Rather, it was an orgy of borrowing and bingeing that has resulted in a huge dislocation of credit and resources. Too many people now depend on real estate, mortgage finance and home building for careers. Without stupid lenders and greedy borrowers, the commissions and projects are fewer and farther.

The Fed has cut rates. Hopefully real growth will result. But it is doubtful. More likely, the Fed’s campaign will lead to a new orgy of borrowing and lending that will artificially inflate some other industry for a few years. Maybe that is why stocks are up 60%. It’s just one bubble replacing another.

Tags: credit, economics, Fed, interest rates, recession, recovery, stock market

Perpetual Motion Machine

As a child, I had a series of gears and cogs that could be assembled together. By placing small gears next to large gears, I could generate incredible speed or power, all with a simple turn of a crank. Over time I built an elaborate replica of a clock, complete with spinning soldiers. All of the spinning, turning and revolving was driven by one motor buried deep inside. The possibilities of different contraptions was limitless, but all were bounded by one simple fact: Either you had to have a motor, or a crank; the thing would not turn itself.

I likened it to the food chain that we all know from science class. The carnivores eat herbivores. The herbivores eat plants. The plants get the energy from the sun. Plants use the sun’s energy to create carbohydrates out of carbon and water. This process of photosynthesis is the crank, or the motor, that powers 99.9999% of all life on the planet. Like my elaborate system of gears all connected to the crank, each animal connects, one to another, leading all the way back to the power source- the sun.

People are engaged in a huge interconnected economic system like my homemade clock or the food chain. Each person’s profits are derived from the people that they interact with: just like a gear’s rotation is a product of the gears with which it is meshing. All economic activity needs a crank, or a power source. Our economy is driven by a motive force at the beginning of a great big system of intermeshing companies. All businesses are dependent on that source.

Consider a mining town that is thriving. There are restaurants, car dealerships and all sorts of businesses. Yet, as soon as the mine stops producing, the town begins to implode. The stored wealth in the resources was being unlocked, and the town was profiting. Without the stored wealth in the coal, the town’s commerce grinds to a halt. The same as stopping the crank on a series of gears, they all grind to a halt.

Before the Industrial Revolution, our economic machine was much simpler. In the late 1800s, human beings engaged primarily in farming and ranching. Then with the invention of the Fulton Steam engine, and soon after internal combustion engines, we began to produce all types of amazing new tools. We left the farms, and began to create industries. The first industries were making tools to help the farmers. Then we had industries that made tools to help the people who made the tools. Each business and company connected to other companies and joined the chain.

The transition from an agrarian society, to an industrialized society, reminds me of getting a new and bigger set of gears as a kid. I would add more and more gears to my elaborate designs, making them larger and more complex. Eventually the table would be so loaded with gears meshing with other gears, it became difficult to know where it all started. As we industrialized society, we added more and more businesses to the chain, and made our economy larger and more complex. We made it so complex that most people are completely ignorant about our economy and the forces that drive it.

Joy to the world - Peter

Tags: economics, food chain, gears, income, industrialization

Manhattan Project: REDUX

We need to consider a “Manhattan Project” type of approach:

During WWII, from the years of 1942-1946, under the control of the U.S. Army Corp of Engineers, our government led a project to develop the first atomic bomb. The “Manhattan Project” was run by General Groves. On September 17, 1942, Groves, who was only a colonel, was given control of the entire project. He took control of all the scientists and assembled the nuclear research. The project was completely organized and managed by Groves. It was Groves’ genius of organization that combined Fermi’s work at the University of Chicago with corporations like DuPont and Kellogg’s. Over the next four years, the efforts of over 130,000 people were harnessed to solve the problems and tackle the obstacles, all in an effort to build the bomb.

Our country has new problems and new obstacles to overcome.

Our ridiculous reliance on fossil fuel, and specifically crude oil, has funded terrorists, despots and thugs. Our ridiculous reliance on fossil fuel is polluting our atmosphere. Our ridiculous reliance on fossil fuel threatens our very existence, and yet we do nothing. We should be outraged, we should be ashamed.

Our government should oversee a project to develop new ways of powering our lives. Private industry will not be able to solve the problems. Public corporations will not invest the money to overcome the obstacles. The private sector cannot afford to think about problems on this scale.

Only a government that is charged with the mission of developing a new and better system can harness all of the resources and combine all of the elements in an efficient and organized manner.

This is the role our government should take.

When the U.S. wanted to solve nuclear physics, it was solved.

When Kennedy said “TO THE MOON,” we went.

Now we need to define a new mission.

Our country is at a key point in its history. Our standard of living is eroding. We cannot tweak interest rates and borrow our way out of this problem.

We need to think big. We need to take big steps. We need to focus our energy and talent in order to make this happen. Our economy, our safety, our future will all be brighter.

J.o.y. to the world - Peter

Tags: globalization, government, inventions, science, technology

Monday Oct. 26

In today’s trade, we saw a dramatic reversal in equity prices. After opening strong and rallying early in the session, the market tumbled. The sell off was attributed to heightened concern in the financials.  The weakness in equities stemmed the sell off in treasuries.

peter

Cars- Obviously, we are morons.

My daughter asked me one morning, as we made our way downtown, “What do cars eat for breakfast?”

I played along, knowing that she had a new pun, “What do they eat?”

“Traffic JAM!” she said, as she giggled.

My then-7-year-old knew that traffic jams stunk, and making jokes when things stink is what we are famous for.

However, I have to fight traffic like so many others, twice everyday, and after a while, you run out of jokes.

It is really ridiculous though…

I drive to work in my family room. Two heated leather recliners, a small sofa and an awesome stereo- I look left, and I look right, and there are even more idiots driving family rooms too.

What are we doing?

I am driving 2000 pounds of metal, with seating for five. Spewing poison into our atmosphere, so I can get to my place of business. That’s the best we can do? Every day hundreds of thousands of us clog the streets and pollute the air. Each of us burning fossil fuel to cause explosions to push pistons to turn drive shafts to propel a vehicle that is much larger and heavier than we need.

It is crazy.

Then consider the fuel.

Gasoline contains benzene, one of the most carcinogenic substances ever discovered. It is derived from petroleum, or crude oil. We buy a substantial portion of our oil from foreign countries. Several of these countries aid and abet (as well as fund) terrorist groups. The very groups that have sworn, “Death to America.”

Come on America!

We need to see the forest for the trees. We need to rethink transportation systems, and cars. We need to step outside of the box and develop a new way of moving people around, and leave the rest of the furniture at home.

J.o.y. to the world - Peter

Tags: cars, fossil fuel, traffic

More on Money

(not to be confused with moron money)

There is a healthy discussion with regard to the “Saving the Dollar” taking place right here at PeterYastrow.com. I am psyched reading all of the comments. However, I think we need to set a few things straight.

Lower rates make an economy go faster.- No debate.

BUT, there is a cost to lowering rates- No debate.

Otherwise everyone would keep rates at zero- but like all things economic, there is a golden mean, an ideal level.

So, let’s not get all crazy. There are costs associated with cutting rates to zero. We can debate whether or not it is fair; who will feel the most pain, and how the costs will manifest (will it be inflation, depression, stagflation…?).

We can also agree that rates are low. Historically, in nominal terms, they are low. In real terms, they are low. But, if there is massive deflation coming… they ain’t low enough.

I like to think of supply and demand. There is a huge supply of money. Demand is weak. The pain is being felt by savers.

The analogy I like is a cancer patient. We have performed financial chemotherapy on our very sick economy. The weakness in our currency is akin to the patient feeling weak, sluggish and rundown. However, we all understand that there are terrible side effects from the most powerful cures.

J.o.y. to the world - Peter

Tags: demand, discussion, interest rates, money, recession, supply

10,000 in the DOW

The charts indicate that we need to be aware of the bigger picture. Our recent rally really fizzles when we see it in context of the last 10 years. The recent 3000 point rally is not quite as impressive when we see it next to the 7000 point drop that preceded it.

The technicals suggest that we are not out of the woods. Traders and investors need to be taking advantage of this fantastic bounce and sell some holdings. Further rallies from here will be met with tremendous resistance, but sell-offs could be quite dramatic.

J.o.y. to the world - Peter

Tags: daily outlook, DOW, investing, rally, stock market

Saving the Dollar – a Recipe for Disaster

Australia’s increase in rates caused an immediate rally in the Australian Dollar. It also caused a stir in the U.S. I was interviewed yesterday by a reporter eager to complete a story about the possibility that the U.S. would have to raise rates to protect the dollar. I almost puked.

Later as the evening wore on, I hear this ridiculous notion being bandied about, “That We Should Raise Rates, to Protect the Dollar.” The only lesson that we learned from the Great Depression was that we should not choke off credit in difficult economic times. During the Great Depression, the effort to protect the dollar, along with protectionist legislation, combined to crush the U.S. economy. This lesson is well known among economists. Our very own Ben Bernanke, Chairman of the Federal Reserve, did his Master’s thesis on the Great Depression.

There is no chance that our Fed is going to make the same mistakes that were made in the 1930s. They are not going to raise interest rates to improve our exchange rates. They are not going to try to strengthen the dollar and risk sending the global economy into a massive depression.

As for our government, that is a different story. There is a growing cry to protect our jobs and our industries. Our politicians could cave in to pressure and begin enacting tariffs and trade barriers. This would be the biggest mistake our nation could make at this juncture. Our country cannot raise the standard of living by taxing and impeding the flow of goods and services. Stopping or slowing foreign products from flowing into our country will do more harm than good. But politicians are not always so good with economics.

J.o.y. to the world - Peter

Tags: Australia, Ben Bernanke, credit, dollar, economics, Fed, Great Depression, recession

Our Economy Needs a Burst

The first time I went up in a hot air balloon was amazing.

The balloon was so enormous and vibrantly colored.

The pilot pulled a large chain, and a thundering plume of flame exploded upwards.

Every so often the pilot would yank the chain again, and the flames would super heat the air inside the “envelope” again. The hot air kept the balloon inflated and kept us airborne.

The balloon is a great analogy of how economies move along.

The balloon will not stay aloft forever; it requires bursts of energy. The pilot opens the valve, and the gas ignites, making all of the molecules move faster. Over time, the air cools; the molecules slow, and a new burst of energy is required to maintain altitude.

Economies are like great balloons that require bursts of energy from time to time to maintain the standard of living, like a balloon needs bursts of energy to stay at the same height. These bursts come in the form of technological breakthroughs. These bursts come from innovations and creation of labor saving devices. These bursts come from better tools.

The analogy is also accurate when we consider the velocity of the molecules. Just like the cooling of the air slows the molecules, without bursts of creation and innovation, an economy will slow. This slowing manifests in a lowering of the standard of living and an erosion of profits. (See the Most Important Economic Lesson.)

Societies must have technological advancement and increases in productivity in order to maintain and gain altitude.

We are so high.

With the bursts from the personal computer, the mobile phone and the internet, the United States at the end of the 1990s saw the highest standard of living ever in the history of the world.

In the early 2000s, we maintained our standard of living by borrowing- we kept the balloon aloft. Now that the fuel from stupid credit is no longer available, we are in need of the next burst.

The government stepped in and has used a stimulus package to give another burst.

But the point is, we always need a burst.

We are in a crisis. The last two bursts were from stupid credit in the mortgage arena, then an artificially created burst from the stimulus package. Now, the problem before us is enormous. And unless you want to see the big red white and blue balloon bumping along in the dirt, we better get started. Profits are grinding down. Our standard of living is dropping, and the business landscape has never been more competitive. Many are awaiting some big rebound, but economies don’t rebound. They float along like great balloons, constantly requiring bursts to stay aloft.

J.o.y. to the world - Peter

Tags: economics, hot air balloon, innovation, inventions, recession, technology