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Economic History III: Seigniorage, Paying the Bills

Click here to be taken to Part I if you haven’t read the introduction.

There are several ways a government can finance its spending. One such method is to enact taxes upon the benefactors of the government’s services through both personal and business taxes, another is to sell government bonds to the public, and a third is to create money. Another term for printing money is seigniorage.

When the government prints a lot of money, they’re basically imposing an inflation tax upon all holders of currency. Due to the increased money supply, prices rise as money loses its value. A concise way of stating it is that this resulting inflation is like a tax on holding money (Mankiw, P.93).

Seigniorage accounts, on average, for less than 3% of America’s government revenue as opposed to other countries, especially those experiencing hyperinflation:

Source: Reid

But America didn’t always have private investors climbing over each other to loan the country money or purchase its bonds.  The 1775 Continental Congress found itself in dire straits as it explored different options for financing the Revolution. The French government, who was not particularly fond of Great Britain at the time, had lent some money to Congress, and some states had responded to the Congress’ requisitions upon the states, but even combined, this amount was not nearly sufficient (Woods).

John Witherspoon, a New Jersey clergyman and an official signee of the Declaration of the Independence, said this of the effects of the paper money in America, “For two or three years, we constantly saw and were informed of creditors running away from their debtors, and the debtors pursuing them in triumph, and paying them without mercy” (Woods). This is funny in retrospect, but one can only imagine the chaos of the time as people experienced their money losing value overnight. If only those creditors had held variable interest rates.

Wrap your mind around the actual amounts of newly issued continental currency over the years:

1775 $6 million
1776 $19 million
1777 $13 million
1778 $63 million
1779 $125 million

The continental dollar became nearly worthless as a result of this increased supply. It was thanks to Alexander Hamilton that Congress passed the Mint Act of 1792, which established gold and silver as the basis for the new system of commodity money (Mankiw, P.93). To read more about Alexander Hamilton, click here.

Sources:

  1. Mankiw, Gregory. Macroeconomics.
  2. Reid http://www.jstor.org/stable/pdfplus/2601207.pdf
  3. Woods, Thomas. http://mises.org/daily/2340
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Posted by on April 5, 2011 in Economic History

 

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Economic History II: The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

Click here to be taken to Part I if you haven’t read the introduction.

To this day, the Great Depression (1929-1939) remains one of the most fascinating periods of study to historians, political scientists, and economists. Despite extensive studies, however, there remains much about this time period which yet eludes us.

This serious drag in the country’s economic performance can be attributed to several events, many of which are interrelated. To begin, there was the Stock Market Crash of 1929—a product of inflated confidence in the market through most of the 1920s—which led to an approximate loss of $40 billion. Incidentally, some of the banks had fallen prey to these very same traps and lost the money they themselves had invested into the stock market. These events led to subsequent bank failures all throughout the country as debtors became unable to repay their debts. Economic growth and recovery were essentially brought to a grinding halt as the surviving banks became more cautious in their lending practices, leading to reduced expenditures and a decreased money supply (Anari, P.676). This was, in essence, a crisis of confidence.

Consumer spending was in decline, which meant there was less demand for goods in general, which led to businesses decreasing factory inputs, spurring the country’s annual unemployment rates to new heights.

When peoples’ standards of living are at stake, they expect their government to step up and take action. It was no secret how the public was dissatisfied with the president, Herbert Hoover’s, performance as the shantytowns were referred to as Hoovervilles and the newspapers used to shelter the homeless from the cold Hoover Blankets.

Hoover’s unsuccessful policies ushered Franklin D. Roosevelt into the office of presidency, a position he would hold on to for 12 years. In contrast with his predecessor, Roosevelt wasted no time in enacting his New Deal Programs. Here are some examples of how his administration tackled the problem of the day:

  1. To counter unemployment:
    1. 1933, Public Works Administration (PWA). Large-scale public works projects. Six billion dollars. Airports, dams, aircraft carriers, schools, hospitals.
    2. 1933, Civilian Conservation Group (CCC). Public works projects.
    3. 1933, Civil Works Administration (CWA). High paying jobs in construction.
  2. To combat the housing crisis:
    1. 1933, Home Owner’s Loan Corporation (HOLC). Services to refinance homes. One million people received long term loans.
    2. 1934, Federal Housing Administration (FHA). Regulated mortgages and housing conditions.
  3. Poverty upon retirement:
    1. 1935, Social Security Act (SSA). Still active. Addresses poverty among retired, wage-earning senior citizens.

The list continues, but you get the point. Essentially, Roosevelt was a president of action and direct intervention and, as a result, his popularity soared. But how successful were his efforts? Did these programs help dig the country out of its dire situation, or can the recovery be attributed to something else? How does this compare to our current financial crisis and can we learn anything from this?

P. 676 Ali Anari

The above graphs indicate exactly how rough the times were. Industrial production hit an all time low due to a combination of decreased demand, money supply shocks, and the rise in unemployment rates (Anari, p.770). As is shown on the graph, the recovery from the Great Depression began around 1934 with the U.S. economy reaching new heights upon the country’s involvement in World War II, when the economy returned to full employment (Romer P.758).

Studies conducted on the recovery, however, suggest that the New Deal was not necessarily the engine of recovery itself, but as something which cleared the way for a natural recovery (Romer P.758). In fact, many postulate that the greatest result of these policies seems to be the resurging strength of the federal government.

So flash forward about 80 years to today’s current financial crisis. Can we link the effects of the aggregate-demand stimulus of the recovery from the Great Depression to the government bailouts in 2007 and the years following?

Definitely.

The Federal Reserve Board invoked the same authority it had invoked in 1932 to aid in the stabilization of firms through monetary aid, which allowed the Fed to rescue AIG through loans, a move which is controversial to this day (Posner, p.1613 and 1629). Through the Emergency Economic Stabilization Act of 2008, the Treasury was granted $700 billion to buy mortgage-related assets along with many additional powers to deal with the crisis (Posner, p.1614).  After the fall of the Lehman Brothers, the government “began pumping liquidity into the system at unprecedented levels” in the hopes of bolstering confidence in the markets (Bartlett, A25). The financial institutions receiving government aid include, but are not limited to, automakers, banks, saving associations, credit unions, insurance companies, etc. (Bartlett, p.1633).

The government did not stop there either. Immediately upon being elected into office, President Obama began working towards securing stimulus money, accomplishing this in early 2009 (NY Times, Economic Stimulus). But has the $819 billion stimulus package requested by President Obama and passed by Congress helped or hurt us? (Yourish, Washington Post). The following is a breakdown of the tax cuts and the program’s intended recipients:

Data from NY Times

Economists have reported that the administration’s actions led to a decrease in taxes for most Americans (NY Times, Economic Stimulus). In early May of 2009, however, it was estimated that the package fell short of the administration’s optimist forecast of unemployment peaking at 8.5% and was estimated to have saved only 150,000 jobs of the promised 600,000—unemployment surpassed 10% at one point but dropped to 9% in January 2011 (Bureau of Labor Statistics). Other benefits include an increase in the rate of home sales, tax cuts to small businesses, and increased infrastructure spending similar to Roosevelt’s plans.

Much like Roosevelt’s New Deal, perceptions of the stimulus package’s effectiveness are wide-ranging and many. It is almost universally agreed, however, that the government’s actions, while not insignificantly increasing the country’s deficit, helped stem some of the worst consequences of the crisis. Economic optimism and activity have increased in recent months but perhaps all that remains now is hoping that Adam Smith’s “Invisible Hand”, the argument that free enterprise and self-interest benefit society when transactions are voluntary to both parties, proves true and that the economy arrives at optimal levels of employment and economic prosperity (Narveson, p.201).

This is not an examination of which political party’s ideologies are correct, but more so an exploration into the effectiveness of policy in times of economic crises. My data is specific to the time period of the Great Depression and our most recent circumstances, so any conclusions I would come to would be moot in the grander scheme of things, but that does not mean that there isn’t much to learn from the subject matter I have brought to light.

 

Sources:

Anari, Ali. “Bank Asset Liquidation and the Propagation of the U.S. Great Depression.” The Wharton Financial Instiutions Center.

Bartlett, Bruce. The New York Times. “How to Get the Money Moving. Dec. 24, 2008.

Narveson, Jan. “The Invisible Hand.” Journal of Business Ethics, Vol. 46, No. 3.

The New York Times. “Economic Stimulus.” Times Topics. Dec 15, 2010.

Posner, Eric A. “Crisis Governance in the Administrative State: 9/11 and the Financial Meltdown of 2008.” The University of Chicago Law Review

Romer, Christina D. “What Ended the Great Depression?” National Bureau of Economic Research, Inc. .

Yourish. The Washington Post.

http://americanhistory.about.com/od/greatdepression/tp/new_deal_programs.htm

 


 
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Posted by on April 2, 2011 in Economic History

 

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Economic History I: Introduction

Why the Past and the Present Are Inextricably Linked

“Those who cannot learn from history are doomed to repeat it.” – George Santayana

Click here to be taken to Part II if you’ve already read the intro.

Over the last few years, the most pressing issue on the minds of Americans, and many without the country’s borders, is the uncertainty revolving around the state of the economy.



Source: Bureau of Labor Statistics, U.S. Department of Labor

With January’s unemployment rate at 9%, both graduate and undergraduate students are being pressured, both internally and externally, to look to more practical and secure academic pursuits. As a second-year at the University of California at Davis, a mere 15 miles from Sacramento, the state’s capital, I have witnessed this phenomenon firsthand many times over. As an Economics major, I must confess that I too have—and continue to—experience this pressure. With each lecture, I find myself questioning whether the subject matter of the day, week, month, or quarter will provide me with the tools to become a success in my field.

To fulfill the requirement of achieving an A.B. in Economics at UC Davis, all undergraduates must take at least one Economic History course, though additional courses may count towards other major requirements. As can be expected, especially in times of recession, the first question most of my peers ask is: “How is this class relevant? What am I going to learn in here that’s going to help me succeed?”

I would never myself, for example, challenge the practicality of Econometrics which factors in mathematical formulae, statistics, and economic concepts to create mathematical models in an attempt to determine the statistical significance of findings to describe economic systems. Thus it seems only natural for majors within the Economics department to lean towards these branches of study as opposed to Economic History.

Economic History encourages its disciples to find patterns in the sequence of past events which will prove useful in making day-to-day decisions, determining policy, and anticipating the future. Individuals should leverage all of the resources they have at hand in order to make informed decisions. Why would you overlook the events of the past in making such determinations?

What can we learn from the collapse of the Soviet Union? Were there events that foreshadowed its failure? Can we use our findings to help us determine the success or failure of other countries?

How did the Federal Reserve first come to be? How has it adapted to different crises and is it effective enough at its regulation and oversight duties to justify its existence?

Mission Statement: The goal of this series is to explore and link events of the past with modern day issues in order to gain insight into the topics/phenomena at hand as well as those we might expect in the future.

This series has benefited from the supervision of Dr. Janine Wilson at UC Davis.

Additional sources:

  1. http://freepages.history.rootsweb.ancestry.com/~cescott/economics.html
  2. http://www.federalreserve.gov/pubs/frseries/frseri.htm

 

 
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Posted by on April 2, 2011 in Economic History

 

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Mutual Funds 101: Demystifying Investment

Definition: Mutual funds are an investment strategy which pools money from many, many different investors to construct a portfolio of stocks, bonds, real estate, and/or other securities, depending on its charter. Each investor in the fund gets a slice of the total pie.

What are the perks to investing in mutual funds? Diversification, one of the basic rules of investing in general is varying your portfolio. Diversification is a technique that mixes a wide variety of investments within a portfolio. This is meant to yield higher returns for lower risks because while you might take hits in some parts of your portfolio, the positives—if chosen correctly—will offset those.

“Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective level of risk reduction.” – Investopedia

Another pro to the mutual funds game are the relatively low minimum investment amounts. Some you can join with just a few hundred dollars, spreading the risk across to more people, allowing investors to make some riskier decisions with higher potential returns.

So, there’s active management and passive management.

Active Management:

Is the actual practice of picking your stocks and market timing to pick securities which will beat out the market. This is the most common type of management. The high volume of trading results in higher expenses.

Passive Management:

These funds do not attempt to meet the market, but to match the risk with the return of the stock market. These usually track a market index such as the S&P 500. Those that follow this index, for example, tend to hold the stocks within the S&P 500.

Advantages:

1. The percentage of fees paid to the company to manage and operate the fund is less in passive funds than in active funds.
2. Lower mutual fund capital gains distributions.

A good analogy I found regarding the difference between active and passive investment management is the distinction between the actions of one individual vs. the actions of the group as a whole. “Active investment is like trying to bet on who will win the Super Bowl, while passive investing would be the ability to profit as all the NFL teams collectively made money on ticket and merchandise sales.”

Now, let’s move on. There are two different types of funds I’d like to talk about today: stock (equity) funds and bond funds.

Equity Funds:

Mutual fund that invests primarily in stocks; equity funds typically have their own distinct styles. Some focus on the different sizes of companies such as the size of businesses (small-cap versus large-cap) and their geography while others might buy shares within particular sectors such as health care or entertainment. These are sometimes referred to as “specialty stocks.”

Bond Funds:

Bond funds come in many different colors as well. There are safe investments with lower yields such as government bond funds, high-risk (and hopefully high-yield) bond funds. These can get extremely complicated, but if this is something you’re interested in, click here to be taken to a page which does an adequate job of explaining what type of things to look for to determine whether or not these bonds will be safe investments.

But don’t forget to pay your taxes. Regardless of whether or not you sell your fund shares, if you’re raking in money, you could be hit by a pretty hefty tax for both your dividends and capital gains. That sounds pretty painful doesn’t it? What if I told you that you’re stuck paying taxes even when your funds have declined in value? Well, the truth of it is that you’re going to end up paying taxes regardless of how your fund performs, but since there’s not much to be done about that, my only advice here is to be aware of this undeniable truth. According to CNN Money, the most tax-efficient funds avoid rapid trading.

CNN Money also advises investors to not chase winners and to look for consistency in the long-term rather than those particular funds which might be ranked highly at this one point in time. Investors are also told to not be too quick to dump underperforming funds as any fund can have an off year. Just make calculated decisions, watch for a pattern, and come up with a few forecasts.

A VERY SUCCINT DISCUSSION OF A FEW DIFFERENT TYPES OF STOCK FUNDS:

1. Value funds: look for cheap stocks. Either big companies/corporations which have been suffering in recent days and are selling shares at lower, discounted prices, or smaller companies which have been beaten out by competition or other investors but could have brighter days ahead.
2. Growth funds: varies depending on how aggressive the investor might be. Tend to favor established names, but look for rapidly growing companies as well. Good for long-term investors who should build around such funds in their portfolios.
3. Sector funds: as I mentioned before, these investors focus on particular sectors such as health care, entertainment, technology, etc. Just be aware that entire sectors are also liable to head south.

A VERY SUCCINT DISCUSSION OF A FEW DIFFERENT TYPES OF BOND FUNDS:

1. U.S. government bond funds: bonds issued by the U.S. Treasury or federal government agencies. Seen as extremely safe, so you shouldn’t expect extremely high returns with these. The longer you hold on to the bonds, the higher your yield. So if you’re comfortable with sitting on them—they fluctuate with the interest rate—then you probably might as well be in it for the long run.
2. Corporate bond funds: bonds issued by corporations. Each corporation has a credit quality issued to them, the highest being AAA. The longer the average maturity, the greater the volatility.
3. High-yield bond funds: focus on smaller and/or riskier companies. Expect a few defaults here and there. Shouldn’t be a huge proportion of your portfolio unless you’re comfortable taking risks for the chance of seeing higher returns.
4. Municipal bond funds: issued by cities, states, and other government localities. Are tax-exempt. Don’t have much more to say about these myself, so just click through the link if you’re interested in safe, low-yield prospects.

Now that we’ve hopefully demystified mutual funds (or at least opened a few doors for you) you might be wondering why exactly some active funds underperform. The costs of research, administration, management salaries, and other expenses are borne by the shareholders.

If you’re new to the game and want to try to get your own slice of the market, explore U.S. Securities and Exchange Commissions’ page to get started. Look for more posts on the subject of investing in the days and weeks to come!

Sources:CNN Money, Investopedia & About.com

 
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Posted by on March 23, 2011 in Business/Technology

 

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YouTube vs. Hulu


It was only a matter of time before YouTube (owned by Google) made a definitive move to branch outside of its current role as merely a video hosting site. According to a New York Times article, last week (Monday, 03/07/2011), YouTube acquired Next New Networks, which is a video production company. It appears that YouTube hopes to break into the markets where sites like Hulu, which (legally) provides episodes of many television shows and movies. The appeal to Hulu is that viewers can depend on the site for providing the television shows and movies listed on the site, whereas YouTube can not necessarily make these same guarantees due to copyright laws, among other issues.

If my memory serves me correctly, YouTube provides a movie rental service as well, though this has not, apparently, garnered enough of the market for the company to remain satisfied. The acquired company was reportedly acquired for less than $50 million, which seems like a steal for YouTube. Next New Networks has already established itself among its various projects, including Barely Political, Indy Mogul, Hungry Nation, and it’s various works on iTunes and Vimeo.


One of the most visible changes viewers can expect from YouTube is the production value of the videos created and uploaded by YouTube’s many partners, who are determined based on how many unique hits they receive on their videos and how many subscribers they accumulate. But the bottom line is that Google has got its eye on bigger and better things and is currently preparing it’s visual media arm, YouTube, for war over the growing market segment currently dominated by Hulu and a few other sites. So long as this healthy competition breeds higher quality products and services, I don’t see how we can complain!

*UPDATE*
 
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Posted by on March 16, 2011 in Business/Technology

 

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LinkedIn Expands

LinkedIn, the social networking site used predominantly by professionals, has apparently felt neglected as of late. It’s been wondering why its 90 million users haven’t been giving it as much attention as they’ve been directing towards Facebook, Google News, and Yahoo News. LinkedIn has been taking this sort of abuse for quite some time now, but it appears that the site has finally decided to act on its dissatisfaction.

A New York Times article has announced the company’s new service which provides relevant links to and summaries of the daily news on its site in a move that places the site in direct competition with other new aggregators such as the aforementioned Google and Yahoo general news services.

“We want to give you what you need to know to be better at what you do,” said LinkedIn’s chief executive, Jeff Weiner.

To gain access to one of their newest features, “Maps,” click here!

 
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Posted by on March 15, 2011 in Business/Technology

 

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A Bittersweet Boon

To be honest, the subject of rape and sexual assaults make me greatly uncomfortable. The fact that I’m writing a post about an instance of rape surprises me to no end. But the reality of it is that these things happen all over the world, even in the most progressive and forward thinking societies. And unfortunately the small town of Cleveland, Texas, with a population of about 9,000, was no exception.

According to a New York Times article, a total of eighteen local males have been charged with participating in the gang rape of a young, eleven-year-old girl. The males range from players on the local high school basketball team, to middle school students, to previous felons, etc. What basically happened is that the victim, who had a history of hanging around older children – according to one interviewee- accepted a ride from a nineteen-year-old man who then kidnapped her and took her to a location where several other men were waiting for them.

There are, however, a few redeeming points to this story:

1. The victim walked away with her life and is attending school in a different district.
2. The perpetrators, or at least a great many of them, have been detained.

What makes this story remarkable is the way in which the crime was brought to light and the wrongdoers identified. Several (I’m using plural though it may have, in fact, merely been one person) of the individuals who were present at the time of the assault had taken video on their cellphones. This video circulated around the town, even permeating the elementary school. In fact, it was one of the girls in the elementary school who brought the video to the attention of a teacher as it included her classmate. I applaud this child who stepped forward and did the right thing at her young age, when dozens of others who had either witnessed the crime itself or heard about it later did nothing.Needless to say, it will be a long time before this little town recovers from these shocking events.

I came across this incredibly dimwitted poll as I was looking for an appropriate image for this post and thought I would include it to share with you all how ignorant some people can be: Poll: Is the 11 year old girl from Cleveland, Texas to blame for being gang raped?

For another post on defeating crime with cell phones, click here.

 
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Posted by on March 14, 2011 in Business/Technology

 

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