• Government Rules

    Aug 1 • Businesses, Economic Debates, Households, International Trade and Finance, Money and Monetary Policy, Regulation, Thinking Economically • 404 Views

    What is a “systemically important” financial institution? 2300 pages of financial regulation do not specifically tell us. Instead,regulatory agencies will have to decide. One study indicated that implementing new Dodd-Frank financial legislation will require details for more than 243 new financial rules.

    Already, firms have begun responding. Legions of lobbyists are trying to influence agency decisions. Concerned about liability for an inaccurate credit rating, Moody’s and other ratings agencies have asked financial firms not to use their data when filing with the SEC even if a mortgage related security, for example, is required by law to have a rating. Jamie Dimon, Chairman and CEO of JPMorgan Chase responded to regulatory changes with, “If you’re a restaurant and you can’t charge for the soda, you’re going to charge more for the burger.” Email has also been affected with Goldman Sachs prohibiting all profanities.

    The Economic Lesson

    In a wonderful Teaching Company course of 36 half hour lectures, “Thinking About Capitalism”, from Professor Jerry Z. Muller, the never ending debate about the validity of profit seeking self-interested behavior consistently resurfaces. As I heard a chronological sequence of economic thought, starting with early Christianity and continuing with such thinkers as Edmund Burke, Voltaire, Henri Rousseau, Alexander Hamilton, and Karl Marx, back and forth the argument went between the costs and benefits of the market. With new financial regulation, isn’t the pendulum swinging toward constraining the market’s self-interest?

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    Euro Notes

    Jul 31 • International Trade and Finance, Money and Monetary Policy • 436 Views

    $1 million in $100 bills weighs 22 pounds. In $500 bills, $1 million would weigh 4.4 pounds. But the U.S. does not circulate $500 bills.

    The EU does.

    According to the WSJ and NPR’s Planet Money, people engaging in illegal activities prefer large denomination bills that can travel. If you are a smuggler, a money launderer, a drug dealer, or someone living in a country with a hyperinflated currency, you might select the €500 bill. Weighing close to 4 pounds per million euros, it would be your chosen currency. Today, the €500 is equal to $652.55.

    This takes us to the value of the euro. It has been suggested that the international value of a currency is a “leading indicator” of that region’s financial health. Traditionally, financial health relates to a rising GDP, fiscal moderation, and monetary stability. Also, we can look at the balance sheet of the central bank.

    The European Central Bank (ECB) has been called “super-solvent” because of the money it “earns” from its €500 and €100 notes. The money that a central bank earns on the currency it issues is also called seignorage.

    The Economic Lesson

    Most simply defined, seignorage refers to the money a central bank can make when it issues money because it costs so little to print it. The central bank gets the currency for the amount it costs to print it and then receives a market value return when it circulates it. Very hypothetically, we could say that it costs $1 to print a $100 bill. Then the Fed gets 5% interest on the $100 if it buys a treasury bill from a bank with that money. The seignorage is $4.

    The WSJ estimates that 35% of the euros in circulation are in high denomination notes. The seignorage on these notes can be considerable. For that reason, the title of the WSJ article is “How Gangsters Are Saving Euro Zone.” 



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    Son Preference

    Jul 30 • Demand, Supply, and Markets, Developing Economies, Economic Thinkers, International Trade and Finance • 390 Views

    If there are 122 men for every 100 women, how do you find a wife? According to a Columbia University professor, in China, you save.

    Economists have been asking why Chinese households save so much–30% as compared to a current 6% rate in the U.S. One answer starts with the hypothesis that too many Chinese men have too few women they can marry. How to compete? Become richer by saving. To prove their theory, researchers gathered data and found that savings rates appeared to vary with an area’s male/female ratios. Or, as expressed by one social scientist, it was all about “keeping up with the Zhangs”. 

    Why does all of this matter? 

    1. Domestic saving relates to an undervalued yuan. More saving in China has helped their current account surplus grow. This surplus helps the yuan remain undervalued. An undervalued yuan perpetuates a U.S. trade deficit as the U.S. continues to buy Chinese exports.
    2. Domestic saving also relates to women’s rights. With China’s one child policy and son preference leading to male births, the result was “missing women” and a social issue becoming an economic concern. Defined, “missing women” is a gender inequality phenomenon in which a country’s demographics become artificially skewed toward male births and male survival. (You might want to look at nobel laureate Amartya Sen’s comments.)

    The Economic Lesson

    An undervalued Chinese currency has become an economic and a political concern. Just like we might purchase a sweater when it is cheap, we tend to be attracted to less expensive currencies. Owning the currency enables us to buy that nation’s exports more cheaply. Hence, we buy Chinese goods, look to Chinese factories, and inflate our trade deficit.

    But what is the cause of the problem? Some say we should focus less on the Chinese government’s control over the yuan and more on their social policy toward women. 

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    Kindergarten Matters

    Jul 29 • Macroeconomic Measurement, Thinking Economically • 407 Views

    Several months ago, we asked if law school was a good investment. Now we can ask the same question about kindergarten.

    Saying that adult outcomes count while test scores do not, Harvard economist Raj Chetty and 5 colleagues researched the impact of kindergarten teachers on their students’ college attendance, tendency to become single parents and to save, and on income. With a 1980s Tennessee study providing a wealth of data about 11,571 young students, recent tax related information told the research group about many of the same individuals now.

    As their slide show indicates, classmate results clustered. Students whose test scores jumped from average to the 60th percentile during kindergarten could expect to earn $1,000 more a year than a child who started and concluded kindergarten with average scores. Children whose scores jumped during kindergarten also wound up having a greater chance of attending college, of not being a single parent, and of saving for retirement. Summarizing the kindergarten impact on earnings, one teacher created, per class, $320,000 of extra income during a lifetime.

    The Economic Lesson

    An economist would say that good kindergarten teachers have added substantially to society’s human capital. In this context, capital refers to one of three factors of production: land, labor, and capital. Rather like a recipe, we can say that all goods and services are made from different combinations of land, labor, and capital.

    Capital can be divided into two categories: Physical capital and human capital. Physical capital includes machinery, tools, buildings and inventory–the technology made by people that we use to become more productive. Human capital relates to the job training and education that make people more productive. To produce physical and human capital, society has to be patient. As each is developing, the resources needed to create them have little impact. Afterwards, though, they become growth engines.

    Talented kindergarten teachers appear to be skillful human capital developers. Remembering that our resources are limited, we need to decide where to do less so that we can do more at the kindergarten level.

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    Mortgage Backed Securities (Insecurities)

    Jul 28 • Financial Markets, Money and Monetary Policy, Regulation • 525 Views

    NPR’s Planet Money has been looking for the people behind a mortgage backed security. The story, almost like a page turner mystery, began with a $1,000 purchase. With $1,000, Planet Money reporters purchased a tiny piece of a mortgage backed security composed of loans on 2,000 mortgages. Like most investors, they hoped to make some money. In this example, they would profit if the owners of the properties continued to pay the interest and principle due on their mortgages.

    A mortgage backed security begins its life when a mortgage broker or a bank or some group says, “We can lend you the money to buy your house.” From there, probably, the lender sells the loan to a second group who combines it with other loans and then sells it to someone else as a mortgage backed security.

    You can see the cash flow here. When loans are sold, the seller gets more money to make more loans and then sells them and gets more money to do it all over again. The money made is from the transactions. The incentive? More transactions.

    Their podcast was especially good because the mortgage backed security–essentially a computer printout–became human when Planet Money went to Florida to find the people with the mortgages. One couple, 82 years old with a dog named Muffin, had purchased their dream retirement home. However, when its value plunged and they had to choose between maintaining their lifestyle and paying their mortgage, they defaulted. A real estate speculator had purchased multiple properties for resale and then defaulted. A third group was being investigated by the FBI for fraud. And this was only the beginning. If the Planet Money reporters had continued, they would have found a different story behind each mortgage.

    The Planet Money story reminded me that so many people relate to a mortgage backed security. In addition to the individuals who initially borrowed the money, we have the mortgage sellers, the mortgage packagers, and the investors. We can look at government and Fannie Mae and Freddie Mac. We can investigate private businesses, families, investment banks, and hedge funds. And still there is more. The group is huge, it is diverse, and its spans the world. 

    The Economic Lesson

    Mortgage backed securities enabled a financial bubble to inflate because they funded house sales with more money than otherwise would have been available. More dollars chasing the same number of goods inflates prices. As with all bubbles, eventually prices cannot move any higher. At that moment, the bubble pops and prices descend. 

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