Thursday, July 2, 2015

Cost and inconvenience


Krugman, from the textbook:
Economists use the term money in its narrowest sense to refer to cash and bank deposits on which people can write checks. People and firms hold money because it reduces the cost and inconvenience of making transactions.

"Cash and bank deposits on which people can write checks" is M1 money. That's the money I use.

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The convenience of making transactions has a lot to do with technology. I was amazed a few years back when the TV commercial showed that you can deposit a check in the bank just by taking a picture of it with your phone. It still amazes me these days, when people at work actually deposit paychecks that way.

I don't do that. I don't live in the future. I prefer to have money in my pocket. Not in a device. I don't buy things on the internet. I don't pay bills on the internet. I don't deposit my paycheck with my phone. I don't have a phone.

The future has increased the convenience of using money. There's no denying that. They make it easy as hell for you to spend money.

Convenience and inconvenience aside, there is the matter of cost: People and firms hold money because it reduces the cost of making transactions.

That's my focus, cost.

Let's look at cost. Let's look at a simple world where there are two places you can keep your money: You can keep it where it earns interest, or you can keep it where it is available for spending. Granted, that distinction has blurred in recent decades because of technology and because of the deregulation of finance and because that is the long-term trend and because this is the future. But if the line blurs so much that you can't tell when you're paying interest and when you're not, things cannot end well.

If we could zero out embedded interest costs, the world would be a better place.

8 comments:

The Arthurian said...

I expect somebody wants to tell me interest rates are already at zero.

Well, they're near zero. That's not the same thing. And interest rates are not the same thing as interest costs. At a near-zero rate, the interest cost on a borrowed dollar is almost nothing. But a near-zero rate applied to infinite debt generates infinite interest cost.

We can't solve this problem by focusing on interest rates. We have to pay attention to accumulated total private debt. If you want to focus on the public debt, you'd best make it public and private debt.

Interest cost is a function of not only interest rates but also debt accumulation.

Oh, and let's revise my last line:
If we could reduce interest costs by half or more, the world would be a better place.

Oilfield Trash said...

Art

Only the government can lend at rates you want. I do not know if I want the public sector in control of credit markets. Regulate yes control IDK.

The Arthurian said...

I don't care about the rate of interest. I care about the number of dollars in the economy that people have to pay interest on.

Most of the money goes into the economy thru the creation of private sector debt. Most of it should come out of the economy by the paydown of debt. But it doesn't. Most of it comes out (I don't know, let's say) by additions to private sector saving.......

So, some people put money into circulation and pay to keep it in circulation. Some people take that money out of circulation and sit on it, and collect much of what those others are paying to keep it circulating.

When I borrow a dollar and spend it, there is the implicit assumption that that dollar (or an equivalent one) will come back to me at some point so I can pay off my debt. This assumption -- and the whole economy -- is undermined by savers.

The problem can be measured as outstanding private sector debt.

It *may* be that only the government can put enough money into the economy to solve this problem. But I can't tell if that's true, from the evidence.

"I do not know if I want the public sector in control of credit markets."

I know that if we have policies that encourage the use of credit, then we need policies that encourage the repayment of debt.

jim said...

Art wrote:
"When I borrow a dollar and spend it, there is the implicit assumption that that dollar (or an equivalent one) will come back to me at some point so I can pay off my debt."

How good the assumption of being able to repay loans depends on the nature of the loans. If the majority of lending comes to fund asset inflation instead of GDP growth eventually it will blow up and loans won't be able to be repaid.

And then wrote:
"This assumption -- and the whole economy -- is undermined by savers."

Prudent and wise loan contracts tend to be repayable and foolish loan arrangements tend to not be repayable. Savers have nothing to with whether you can repay your loan.

If you borrow and use the money to increase your income by more than the cost of the loan, it is likely you won't have problems repaying the loan. If you borrow to buy a house and the result is costs of owning the house are less than the cost of renting it is likely you won't have problems repaying the loan.

OTOH, if you borrow to buy a house that is bigger than you need under the theory that the rising price of the real estate will more than cover the added cost of ownership and if millions of others do the same and house prices don't go up as expected, then suddenly millions may find it difficult to pay for all the added energy, maintenance, interest, tax and insurance costs that go with owning a house bigger than they need. At that point it becomes obvious that the dollars needed to pay off old loans that were chasing asset inflation were coming mostly from new loans chasing asset inflation and when the asset inflation stopped and thus the borrowing that was chasing asset inflation stopped the money available to pay off loans was greatly diminished.

The Arthurian said...

Jim: "How good the assumption of being able to repay loans depends on the nature of the loans."

Yes, and also on the state of the economy. But "the nature of the loans" is off-topic. The state of the economy is the topic. I am trying to direct your attention to this topic. In particular, to the quantity of money on which interest must be paid, relative to the quantity of money on which no interest must be paid. You know: Debt per dollar.

Jim: "Prudent and wise loan contracts tend to be repayable and foolish loan arrangements tend to not be repayable."

As a rule, sure. But when the DPD ratio is low (see the linked graph), even "foolish" loans are for the most part payable. And when the DPD ratio is high, even "prudent and wise" loans tend to become unpayable.

jim said...

But "the nature of the loans" is off-topic. The state of the economy is the topic.


The state of the economy is a result of the nature of the loans. If there had not been so many foolish loan arrangements the state of the economy would be a lot better. Had the loans contributed to

In 2007-2008 private debt was growing at a rate of $1 trillion every 3 months. Much of that debt was foolishly chasing after asset price inflation. When the asset prices collapsed the whole house of cards came down.

Currently, Debt per dollar ratio is close to half what it was in the middle of 2008. Back then when the debt per dollar was high it was much easier to pay off foolish loans.

The Arthurian said...

jim: "In 2007-2008 private debt was growing at a rate of $1 trillion every 3 months. Much of that debt was foolishly chasing after asset price inflation."

At that time, that was about the only way left to get a decent return on one's money. Most all the other options were not providing a decent return because so much of the return was going to cover embedded interest costs -- because the level of accumulated debt had grown to such a high level.

jim said...

"At that time, that was about the only way left to get a decent return on one's money."

Yes that nicely expresses the foolish belief that was driving the foolish investments. Many people now understand why it doesn't provide a decent return, although some are starting to forget that lesson.

" Most all the other options were not providing a decent return because so much of the return was going to cover embedded interest costs -- because the level of accumulated debt had grown to such a high level."

Well yes if borrowing is directed at asset inflation instead of contributing to growing output, it will always eventually choke itself. That is reason that type of credit is foolish in the long run.


Govts took over the numbers rackets because there was no preventing that foolishness. It seemed like a good idea to have the foolishness serve some public purpose (like funding education) rather than lining the pockets of mobsters. But it is a mistake to attribute people's inclination to play the lottery to govt policy. The numbers racket will exist whether or not the govt participates.