Tuesday, October 14, 2008

Here I Go Again

... spouting off about things I probably don't understand...

The law of diminishing returns and fractional-reserve banking

I've been trying to figure out how exactly our world has come to this global financial crisis. A lot of people are blaming Capitalism. A lot of people are blaming Greed. A lot of people are blaming Bush. And a lot of other people are blaming a lot of other things. I've done a bit of blaming too. ;-)

While it's pretty clear that greed, corruption, and irresponsibility are very big parts of this problem, I have to wonder why it was so easy for those things to take control. A lot of people blame "deregulation" and the "free market." Well, I guess you can try to regulate away some of the bad motives and poor choices of people, but after all these thousands of years of civilization it's apparent that man-made regulations and rules don't always work.

And in a truly free market the bad things would fail anyway because the benefits of the cheating, etc., always follow the law of diminishing returns, and also because people would eventually figure out who are the corrupt people and would not give them their business. Of course, we have to have some way of keeping all the bad guys from getting together and creating mafias and such, but in reality it probably could be argued that even mafias are better managed than many government entities. ;-)

Anyway, it is wrong to say that greed and corruption are inherent qualities of Capitalism. I think looking at history will show us that greed and corruption occur in all kinds of systems, probably in close-to-equal proportions. Greed is not the same thing as desiring a fair profit from hard work. On the other hand, greed could be defined as not wanting someone else to have a fair profit from his hard work, as is a motivation of communistic systems because all people expect the same profit regardless of how hard they work themselves. Greed and jealousy are often the motives for desiring everyone to have "economic parity" because some people just can't accept that others will have more than they.

Well, all of that isn't really the point I want to make. I want to discover the source of all the bad decisions that led to the collapse of the global banking system. What it all boils down to is that all of these banks were lending more money than they actually had. The official name of that is "fractional-reserve banking." (Please click the link above so I don't have to spend time explaining it.) As a principle this "fractional-reserve" is not really a bad thing. It has many benefits. However, as with any other principle it has to be properly applied.

Let me go off on a tangent here about the law of diminishing returns. This is a perfectly natural law that is consistent with the reality and the Laws of Nature that shape reality. All systems have some entropy. Economies are not so special that they can break this law. Some "intellectual" economists apparently think it's okay and fine to drop the assumption of diminishing returns, and one of them has even been awarded a Nobel Prize.

I guess I'm not "intellectual" enough to see how that is worthy of any prizes. It seems pretty dumb to me because it looks about the same as some physicists deciding to drop the second law of thermodynamics in order to make their calculations add up. Incidentally, there actually are some physicists who try to do this and even try to say that we can reverse the arrow of time. Will this be the next big idea in Economics?*

Okay, back to the fractional-reserve. Somehow someone decided that it was a good idea for banks to lend out 10 times as much as their capital. I suspect that they are using similar methods and calculations as the previously mentioned Nobelist, and honestly, I just don't think it takes a genius to see that extending an order of magnitude of credit will result is some serious, exponential problems down the line. It would be much more realistic and less problematic to select a much lower amount than "times 10."

I mean, Lord have mercy, what kind of retarded idiot is going to believe that the Universe is going to magically unfold so that he suffers no losses from being completely unrealistic? Who was the dumbass who said that it was a good idea for banks to lend so much more than they have? I really want to know. He needs to be spanked very hard and possibly even imprisoned for being so stupid and causing this global meltdown. It does not take a genius to figure out that if you lend $10 for every $1 you actually possess it won't take long for it all to catch up with you, even if you're charging interest. (Unless you are in a mafia which breaks the legs of people who don't pay back their loans.) ;-)

Again, I want to say that the problem is not with banks and capitalism, per se. It is with the bad ideas and bad policies and bad practices that they've operated under. Somebody decided that these things would make the economies grow and make everyone rich and happy, or at least themselves rich and happy. But you know what? It was all an illusion and alchemy based on some dummies deciding that they have the power to overcome the very Laws of Nature.

Surely it must be apparent enough to everyone in the world who is witnessing our global banking failures to see and agree that ignoring the law of diminishing returns is just begging for disaster. Come on. It just doesn't take a genius to see how that works out.

*Okay, so here's my Nobel-worthy Economics idea. ;-) Let's just say "hocus-pocus" and turn back the arrow of time and erase all debt. Then we can just start all over again. But next time let's not drop the assumption of diminishing returns and let's not lend (or borrow) 10 times more than what we can afford. :-)


Anonymous said...

well written

Anonymous said...

I especially like the idea of spankings. Apparently, these bankers missed a few when they were little boys breaking into their sisters' piggy banks and blackmailing their parents for larger allowances. The Big Spank is long overdue.
~C in Alaska

Rae Ann said...

C in Alaska, yeah, the Big Spanks are definitely long overdue. And I think Putin, Chavez, and that Iranian guy need some big spankings too. ;-)

e. l. wood said...

the notion of (ir)responsibility you mention early in the post is something that is getting glossed over out there. this is something i deal with almost daily with students. kudos for bringing it up here.