The Financial Meltdown Using Economic Theory
I am assuming that whoever is reading this has limited to no knowledge of economic theory, it's not meant to be intellectually degrading only to clarify what I'm trying to say.
By definition the money supply, M, is equal to:
the price level, P, at time t, multiplied by the output, Q, at time t, divided by the frequency in which money is spent, V, in time t.
--or--
M =PQ/V.
Now, considering an entire economy, the sum of all the products' price multiplied by the quantity at which they sold in time t, that is, ∑ (P x Q), is just the Real GDP multiplied by the price level, PL, in time t, (RGP*PL), which is the definition of the Nominal GDP in time t.
Therefore if:
M=PQ/V
and
P*Q=NGDP
Then it also must be that:
M=NGDP/V
Or in words, the money supply in an economy is equal to the total units of money produced from selling those products divided by the velocity, V, or the number of times a dollar is spent in time t.
Don't worry, it looks like a lot, but it will all come together.
Okay, the Nominal GDP (the GDP in current dollars) or NGDP is equal to G (Government expenditures) plus I (Business Investment) plus C (Consumer expenditures) plus NX (Net Exports)
--or--
NGDP=G+I+C+NX
This accounts for all transactions in an economy.
The value of a dollar is a relative measure of the price level. That means that it is dependent on the price level. Since the value of the dollar is explicitly dependent upon the price level and the price level is dependent on the economy's output, the nominal GDP in time t, then the value of a dollar is dependent upon the level of GDP at any arbitrary period of time.
This can also be seen using calculus:
P*L(NGDP,...)
Where L is the aggregate work effort of the economy and the "..." of the function is the substitution and wealth effects during period t -- the error term if you're doing a regression analysis.
To clarify:
MV=PQ
PQ=NDGP
NGDP= G+I+C+NX
M = PL (NGDP,...)= M/L(NGDP,...) = P
The reason for the financial meltdown was due to the derivatives the investment industry built their portfolios on. The hot topic starting during the late nineties was mathematical finance. Math wizards would develop these elaborate quantitative equations for risk. Investment banks trusted the math and took on much more risk than the SEC would ever allow. The SEC didn't know how deep these firms were vested because they would use smaller companies they owned to to divert their debt before an audit, thus giving them or allowing them to keep a higher rating, which meant continual or more credit to make more money.
Most of these hedge funds were in high risk households, thus the name sub-prime. A large portion of the high risk borrowers began to stop paying their mortgages because the interest rates, floating or balloon interest rates, jumped 15 or 20 percent. This caused the firms that owned the mortgages to lose money. That meant that there would be a decrease in the supply of money.
So, using calculus we can see that the percentage change in the money supply growth plus the percentage change in the Velocity of money is equal to the percentage change in the price level (which is inflation), plus the percentage change in output.
--or--
%ΔM+% ΔV=% ΔP+% ΔNGDP
If M decreases, NGDP decreases, if NGDP decreases, then P increases, thus increasing the demand for money.
At the moment the Fed knew what was going to happen, they had to ask themselves an important, but difficult question: Do we stick with the free market approach, don't move forward on any type of regulation and let the businesses crash and burn. Note, if this were to be the option chosen, then, they would be, essentially, eliminating the private investment of the NGDP (the "I" of the G+I+NX+C equation). But the portion of the private investment they were dealing with was a large part of the US economy. So, electing a free market approach could have lead us to another depression. What other option did they have?
The one they chose: subsidize the debunked companies that have ginormous amounts of toxic investments. Particularly, save the ones that would be able to get back on there feet and pay the funds they received promptly. Although this was the idea chosen, it isn't any surprise that with the increase in the money supply there is the likelihood that these same banks could unload their excess reserves at the same time sending the price level crashing.
Given the empirical fact that this was the worst recession since the Great Depression, it is hard to believe that if we would have just let the free market reign and reallocate market controls everything would have been fine. Most free market economists would agree that we would be in deeper than we could handle right now if we would have just let the market correct itself and the decision the Fed made to buy the toxic assets, mandate an interest rate on bank reserves and give out interest free loans was our best choice. It's just now that we're out of this recession, the Fed has to deal with everything: inflation, deflation, unemployment and money supply.
The Value of the Dollar and Taxes
There was a concern that the value of the dollar would decrease. But a decreasing currency isn't a bad thing during certain times, like in a recession; it is actually something you want to happen. A cheaper dollar means cheaper prices on exports, which essentially increases output (NGDP), which is a function of work effort, therefore increasing the demand for labor and helping the economy return back to a safe state. The only issue with this, now, is that China's Yuan is keeping the dollar from rebounding (increasing in value). The Fed hasn't been shy at letting China know that they need that to go back up here soon.
I can foresee taxes increasing sometime soon. It's not hard to guess with a Democratic president, the Bush tax cuts expiring, and the new Health Care reform. But, the cost of a small increase in taxes relative to the benefit of not going into another depression in itself seems to be a fairly good trade off, for myself and my future generations.
Free Markets and Increasing Minimum Wage
Being both a supporter of free markets and an increase in minimum wage is counter-intuitive. The free market fixes itself by lowering the minimum wage to decrease the supply of labor. As soon as the government or a labor union steps in, it's not a free market economy anymore. My point is that an economy that isn't regulated by a governing body is doomed to fail the efficient individual. And conversely, an economy completely regulated by a government is doomed to fail the efficient individual. Just look into the articles on Fidel claiming that the "Cuban Model Economy is Dead."
In economics there is a theory called learning by doing. It just says the more that someone does something the better they get at it. There are many companies that pay their factory workers over twenty dollars an hour. Intuitively and historically this makes sense. The higher wage a person is paid the less likely it is that they will rent seek, or in other words, look for another job. Therefore, job retention at these higher paying jobs are, on average, higher than in other areas of the labor market. The higher wages are more than likely caused by Labor Unions. Labor unions restrict the amount of labor a firm can hire, therefore decreasing the supply of labor. This increases the firm's demand for labor. Since the firm is short on labor and the union legally prevents the company from hiring additional workers to decrease the average wage per worker, the wage of labor increases dramatically.
In general, Democrats and other pro-government parties support labor unions. Republicans should not support labor unions because it goes against their political ideology. Normally, they usually don't support increases in the minimum wage. This is a supported belief though, empirical economic facts debunk the widely held belief that a lower minimum wage impedes the working poor from attaining higher earnings. A prominent labor economist, Dr. William Even, finds that the majority of the workers making minimum wage are 16-18. And that as people get older the more their wages increase above minimum wage. Therefore, we would be better off to invest in training, education, or other ways of increasing the adult wage. Yes there are some in the labor force making minimum wage that are considered the "working poor," but the percentage relative to the aggregate is so low that there are a lot of other pertinent issues that must be dealt with. You can find Dr. Even's article summary here:
http://www.epionline.org/study_detail.cfm?sid=16
On the Abolition of the Fed
The idea of not having a central bank isn't a new idea. It's been questioned ever since its inception. The Fed regulates and maintains the general health of the economy very well. I might add, relative to its complexity. They are experts, where as our representatives and congress people are not. There have been less bank panics since the fed has been in charge, which seems to suggest that they also play the part of a sort of psychological factor. Although I agree that the Fed's power is outrageous, I do not believe that it should be abolished. They play too much of a useful role in our economy. This doesn't mean that I think they should be allowed to do as they wish. There needs to be a way of complete and total transparency with a watchdog that is accountable to other balances of power. But then again, they would probably pay everyone off to pass a law that would give them an equivalent of executive privilege. Although the stunt they played during the melt down - pressuring congress into passing a bill for trillions of dollars four days after the meltdown began - wasn't too far off of it.
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