Is Obama good for the American Economy?

So far I have avoided blogging about a topic in the overlap region between politics and and economics. But after watching a couple of YouTube videos I found on the website of Prof. Franz Hörmann, I have repeatedly asked myself the following question: if I were an American Citizen already and had the option to participate in the Presidential Elections come November, would I vote for Barack Obama? Do I truly believe that Obama is good for the American Economy? And if not, would Mitt Romney be better?

Well, I honestly cannot answer the question about who I’d vote for with certainty. I mean, really, who knows with absolute certainty who they will vote for anyway, if there are still weeks ahead with the potential to reveal important information pertaining both candidates… Yet, I have at least found my disappointment with the current President grow into a sense of disillusionment over the past few months. Here are my thoughts on why I would at least feel much less inclined to be voting for Obama, and why I think that, ultimately, Obama isn’t the President to spearhead the changes necessary to find a way to make a free-market economy work for the benefit of all Americans. What America needs is a President who is not afraid to stand up to the forces that have invaded, pervaded, and perverted the political process, transforming it into something similar to a anchor-hosted regular television show where two supposedly opposing teams vie for “who’s the fairest of them all”.

As far as I can see, the problem is systemic in nature. And my guess is that many people “in power”, both in politics as well as in financial institutions, are at least subconsciously aware of the fact that there is a problem waiting to blow up. Maybe some even have a good idea what the problem is, but it seems that, so far, playing by the established rules seems the preferable choice, and I can see several very good reasons why it seems that way… So, what is the problem?

In short: We, The People, have over time gotten accustomed to how the monetary system is organized to a degree that even just thinking about possible alternatives comes across as “communist”–which is maybe just a different way of saying something like “crazy”, “impossible”, or “un-American”. Furthermore, some of the collectively held beliefs about money are simply false but, given that they support the current system to a degree that were they to be questioned the economy might collapse, no-one dares to bring this up. Let’s start maybe with some of the reasons why we (think we) need money:

Exchanging goods in a free-market economy is simply impractical without a form of currency, some representational good that can be converted into any other good or service we require. In addition, based on the fact that the “good or service” we contribute to society, usually in form of performing well at a job, leads to the acquisition of only relatively small amounts of currency units at a time, an economy with a monetary exchange function gives the opportunity to “save” some units of currency for future transactions, in other words to delay consumption in favor of “investment”. Naturally, for this to work reasonably well, people must have faith and be willing to trust that the value of their savings will not decline too much, and this trust has to be earned, to some degree, by the experience of stable prices.

If those were the only functions of money, we probably wouldn’t be anywhere near this economic mess we are faced with at the moment though. So, what are the problems in the current system? Well, I can see a few of them, and some are probably mixed up, but I will try to single out the root as far as I understand the matter:

But first it is important to know that the control over the monetary system does not lie directly with the people or their representatives, but instead, at least in the U.S. economy, with the Federal Reserve, a public entity which all the same states on its website that, quote, “its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government”. While that in itself may not necessarily be a problem, so long as this entity is given a clear set of instructions and its performance is more or less closely monitored by the sovereign’s representatives, it means that the control over monetary policy is, for some reason, not considered something worth putting into the hand of the elected representatives. One of the typical arguments given is that if the government were allowed to print money, it could increase spending without limits. The misconception in this statement lies in the understanding of where inflation, the loss of value per unit of currency, comes from.

The real problem, I think, lies with the fact that while the central bank, the Federal Reserve, provides the economy with “physical” currency, every regular bank and every mortgage lender creates money out of nothing every time a loan is made. You don’t believe it? Well, here is how it works: if I go to my bank tomorrow and request a loan over $100,000 and the loan is granted, all the bank needs to do is add $100,000 to the number on file in a computer, my account, and that’s it. Well, not quite. In return for this generous act of creating $100,000, I must promise to pay back the money, which the bank generated out of nothing, and pay it back with interest. This promise is a debt the bank puts into their books as well. But from the day the number is added to my account, I have to pay interest, whether or not I convert this number into physical currency or not. And the true problem with this system lies in the fact that to pay back the money with interest, the total amount of money has to increase. And the amount by which it has to increase in any given amount of time, the interest rate, is not controlled by anyone, not even the central bank! It is “set” by the “market”, but in a free-market economy you have supply and demand, but since the money I took out on the loan didn’t even exist before I took it, the supply is endless, and the price should be much lower.

Also, the total amount of money in all regular banks must grow, regardless of whether and how it is spent, simply by the fact that it exists (in the banks’ computers). And given that banks have very little motivation in having people pay back their loans early, as that would lower their profits, both the interest rate as well as the suggested payments are in favor of prolonging the loan term and bank profits.

Now, it is often argued that the interest rate is the price for the risk of the bank, but what exactly is that risk? Given that the money was generated out of thin air only at the time the loan was made, the risk only materializes in the case of a default of the lender, in which case the promise the bank has put into their books has to be written off. But the people running the bank are unlikely to be personally liable should the case occur that a huge number of people default all at once. This has led, in the past, to the incentive of giving out more and more loans even to people who the banks sort of had to know would not be able to keep their promise of paying back the loan, because the risk is deferred to the future, and only threatens the bank, but not the people making the bad decisions. And to top it all off, those “bad loans” were then bundled together into “good packages” and re-sold to investors who wanted to put their profits, in part coming from interest payments of people already in debt of course, to “good use”.

Given that it is not the interest rate the Federal Reserve charges for central bank money but rather the average interest rate of lenders that determines the amount of additional money required in the system, any inflation that occurs–that is to say the ratio between money in existence and all available goods produced by an economy in a given time–remains largely invisible to the people, until the point comes when those who have profited from the system were to try and “cash out”. And until that point comes, those who “have” will always become those who “have more” and vice versa… In other words, while the current system lasts, all but those “invested” in financial market products will become disenfranchised over time. Even big industry players are suffering from this, which might be one of the reasons for the Koch brothers to support the Tea Party rather than the GOP establishment.

Finally, the belief that our economy is a free market driven by supply and demand is incorrect in at least two regards: First, money cannot be scarce, given that it is created by banks whenever a loan is taken out. And to pretend otherwise so as to keep people in the mood of paying a high price for it is, in my eyes, simply unethical. Second, if people truly had a choice about what “work” they could “offer” on the market, my guess is that certain jobs would pay much better than they do. And the reason that they don’t pay better doesn’t lie in the supply of those services or, put more accurately, in the willingness to do so, but rather in the fact that they seemingly do not require highly specialized training.

Given that our current economy requires people to sell their “workforce” to either acquire currency (cash) or the “right” to obtain money from a bank by having someone “deposit” money into their account, this in the end leads to the potential for a modern-day slavery system, where those people without preexisting means, such as owning monetary wealth or other ways to generate income, or specialized knowledge are essentially forced to sell their workforce at “market value”, which in a industrialized economy drops to ever lower amounts if those who can offer unprivileged services increase in number.

But contrary to talent-searching shows on TV, people who really matter in our daily lives, such as policemen, teachers, security guards, or simply the person who always holds the door open when someone doesn’t have a free hand to do it themselves, will never appear during prime-time, and yet it is those people who truly make our lives better. If our economy were to go through another recession, which it very well might if the burden of debt isn’t brought down to bearable levels, who is going to have a greater impact on my life with their talents? Some “talented” rich kid with the added bonus of being able to impeccably smile in front of the cameras, or yet the hard-working, honest average American who does not expect the system to provide luxury but a simply a decent way of living? I put my bet on the latter “talent” any old time!

And as long as the political debate solely focuses on how to improve the economy for those who are already in power and well off, the general population will hardly ever see any real improvement. So, who would I vote for? At the moment I would say: I wouldn’t vote at all. Maybe if enough people send the message that neither candidate is worthy to lead America out of this mess, the required momentum to rebuild the political process and debate from the bottom up will finally come together. But it seems that we rather prefer to support a broken system based on partially false beliefs, because that way we can at least dream of being rich, instead of being free and happy. What did the Declaration of Independence say again…? I think I have to do some reading!

2 thoughts on “Is Obama good for the American Economy?

  1. Jochen, while the Federal Reserve can effectively “print money”, there’s a very real practical limit to how much money banks can “create” by giving out loans. Say you deposit $100 in a bank, and I take a loan out from that bank for $100. Voila, the bank’s created $100 from thin air, right? But they can’t create more than $100, simply because if we both want our $100 in cash right now, the bank has no way to pay us both. To keep that (a bank run) from happening, they have to give us the belief that we can take out our money later; in practice, this means that banks can’t lend more than a fraction of their deposits. Sure, I can take the money and deposit it in another bank, and create another bit of money, but there will inevitably be a diminishing return, which means that the money supply is capped. So while the Fed cannot control exactly how much money there is in existence, the money supply is definitely finite (and they can control how much banks are willing to lend by controlling how costly it is for them to borrow money – thus the whole “inter-bank lending rate” scandal that’s going on now).

    In more abstract terms, there’s a finite amount of stuff in the world, and a finite amount of human work – money is simply a means of storing the value of goods/labor, which is great because it allows us to specialize. Imaging trying to trade neuroscience research for food! Banks allow us to employ money that would otherwise be stored as savings to allow some people to borrow goods/labor to achieve some productive result earlier. I agree in that it seems really odd how as a result, we value throwing and catching a ball really well much more than teaching kids, and even more odd that we are okay with massive wealth inequalities in society.

    There are instances in which the free market works great, and other instances when it doesn’t. For instance, the point of having competition between different companies making the same product is to reduce the cost to consumers. When companies report “record profits”, that’s a sign that the free market isn’t working. If companies are taking more profit, then it means that the benefit that would otherwise accrue to consumers (in the form of cheaper stuff) is being taken away. In an efficient free market system, profits on existing products should go towards zero as more competition reduces the margin, companies should need to come up with better products to maintain profitability. A great blindness in this day and age is the unwavering belief that the free market will solve all economic problems. It can’t. Government has a very real role to solve the problems of the free market.

    • Hello Lok-Kin, great of you to join the site, and nice to hear from you 😉 Well, I am not entirely sure whether the description of the Reserve requirement is still up to date and entirely correct, but from how I understand it, the “rate” the banks must comply with is that it must hold a specified fraction of “reserve” (usually cash, but if I understand correctly, a deposit at the Federal Reserve, such as from borrowing actual cash from the Fed and simply keeping it in their vaults/central account will do as well) for loans they give out. In the U.S. this fraction is currently 10%, which means that with a $100 deposit at the Fed, a regular bank can give out loans totaling $1,000 to borrowers. From all I can tell, it is the case that only cash deposits (i.e. when I go to the bank and actually hand them cash) and money borrowed from the Fed count towards this fraction. If, on the other hand, I deposit “electronic money” in my account, this money does not add to the reserve (for obvious reasons). However, such deposits still add to the “assets” of the bank (balance sheets, but naturally on both sides, as the bank owes me that money).

      Overall, I still don’t see why the money supply is “limited” in the sense that a free market defines a limited supply that determines a price. In your example, if you deposit $100 and I am able to take that money out as a loan, both you and I then have $100 in our accounts! And I can then use the $100 to pay for a new suit. The person receiving the money deposits it in a bank again and the bank could then again loan the “same” $100 to another person. In fact, you could be the person selling me the suit. In other words, you deposit $100 with the bank, I take it out as a loan and give it back to you, and you simply deposit my $100 into your account (and then have $200 in your account, whereas I have $0). But the bank can then give out another $100 in loan to someone else… It doesn’t work just that way (because, as far as I know, banks can only loan out a fraction of non-cash deposits to borrowers, but that fraction is more on the order of 90% than 10%, given that the bank must put 10% into the account at the Fed). All I am saying is that for all intends and purposes, banks are “creating” money, at least that is what all economic texts, including the page on wikipedia (first sentence of the second paragraph) say…

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