Welcome login | signup
Language en es fr
OccupyForum

Forum Post: The Inflation Scam

Posted 2 years ago on June 20, 2012, 2:37 a.m. EST by Misaki (893)
This content is user submitted and not an official statement

http://jobcreationplan.blogspot.com/

The financial markets are very complex. This complexity leads to a transfer of wealth from stupid people to smart people, but this is a specialized kind of intelligence that relies heavily on knowledge of how the system works and the status of many different variables at any given point in time. Inflation plays a special role in that it encourages people to participate who are not fully prepared on what to expect and penalizes those who save money outside of the financial markets.

The result is that people have an unrealistic idea of the gains that can be had from uneducated investment in financial markets and the true value to the nation from variations in prices offered in those markets. It is possible to make a profit from such an investment, but this is only because governments continuously spend money to redistribute wealth to the poor which also allows professionals in the financial sector to obtain an even higher return on investment. In a society without deficit spending or significant redistribution from taxes, many people would no longer see significant returns from investment and the best choice would often be simply to allow saved money to collect a low rate of interest in a bank account.

In other words, for some people to see realized profits—and not just future profits if prices are still high when the decision is made to exit the market—there must be other people who are losing money in the financial markets. At our current levels of productivity, workers in the financial sector and their wealthy clients end up with much more money than they can spend, removing money from circulation which leads to unemployment if prices do not decrease. It then becomes necessary for the government to provide the losers in the market with more money so this cycle, and the economy as a whole, does not stall. Fixing this situation requires ending the policy of continuous inflation so people do not feel the need to take risks which they underestimate, and also preventing harmful effects from occurring when someone does gamble away their money to the profit of other market participants.

It is important to understand that the use of the accelerated work week, which would reduce unemployment and inequality and allow for an end to inflation, could cause significant short-term harm in the markets as participants deleverage and long-term expectations of price increases fueled by government spending disappear. Retirement or other types of funds with insufficient agility due to complacent management could suffer large losses as prices drop.

Explanation of Leveraged Investments and Risk

The idea of financial leverage is relatively simple. You borrow money, but unlike when purchasing something using a credit card there is almost no chance that you will be unable to pay back the loan because the product you buy can be immediately resold at a very similar price. This means there is very little risk for creditors as you can be required to forfeit certain assets if current market prices require it. To succeed, then, requires not only knowing when to buy and when to sell but also how much risk to take on in the expected fluctuations of one or more market prices.

Since the investor takes on the risks, loans can be obtained at low rates and profits can be very high if the future market price, and variations on the way, can be accurately predicted in a way that other market participants have not done. However, these potential gains are also the source of market instability since that instability rewards those who correctly judge risk at the expense of those who underestimate risk in their attempt to maximize gain.

Due to the size and complexity of the financial markets, this instability compounds itself as opportunities for profit from misevaluation of risk occur momentarily throughout the system. While fluctuations smaller than the difference between buy and sell prices at any given moment cannot be profited from, the inherent tension between many opportunities for profit and the possibility of unexpected price changes of various ranges and durations prevent any participant from ever eliminating uncertainty about the best investment choice at any point in time.

What this means is that even a profitable investment would not be held continuously by an optimal participant. Momentary events elsewhere in the system mean that cash would best be used elsewhere, either to buy into something like a certain corporation's stock shares just before interest the stock attracts reaches a critical point with slightly less competent participants buying into the same stock a few moments later (to be sold at a peak to successively slower and less competent market participants) or to "short" a stock just before it drops drastically in price. That transaction completed, the funds would be shifted back to the previous investment which offers a slightly lower continuous rate of return for the amount of cash that is held in reserve for the expected level of risk.

You may think that, when investing in futures for example, it is best to use the maximum leverage ratio and retain only the cash reserve required in the contract terms that define the loan, but this underestimation of risk is exactly what allows other people to profit and you to lose your investment. Due to the competition for investment described above, timing is also important to understand future price changes and can depend not only on the product itself (such as cost of potential storage for a futures contract) but also factors that cause the market's attention to focus on certain products at any given point in time.

The complexity of the above factors are what make it difficult for any single investment manager to provide consistent returns above the market average. Any manager who did would be pressured to accept more funds, which would lead to more income for the investment manager but the number of opportunities they see for investment would not significantly increase, meaning that more recent investors in the fund would benefit at the expense of previous investors, driving down the effective rate of return until it is roughly the same as for every other investment manager.

The point of the above is just to show that taking on too much risk is just as bad as taking on no risk at all, and most people are not really suited to analyzing the financial markets nor should they need to. The end result of the profits of the financial sector is something which most people are already aware of—wasteful government spending on programs and jobs that people feel do not justify their cost to taxpayers or that lead to further deficit spending and inflation.

However, since many non-financial corporations also have high profits, we can't say that the financial sector (which includes investment banking and companies like Goldman Sachs) is a bad thing since it does lead to more jobs for smart college graduates. This is why job creation outside of government is necessary before ending the policy of continuous inflation and its indirect subsidy of financial profits.

Plan for the Future

It is not realistic to expect government agencies to spend less money. Suppose that jobs in the private sector provide on average X utility to society. You are the head of a government agency, and some people who work for you provide X utility while others only provide X/2 utility. The government is offering to give you even more money so you can "create jobs". Do you 1) Accept the money, and employ more X/2 utility workers. 2) Reject the money and let another government department have it. 3) Fire your existing X/2 utility workers so you can return even more money to Congress and taxpayers.

Suppose you chose the third option. Now, government has become very efficient but unemployment is even higher. The tax money went back to taxpayers, which mostly means the rich, and they already have plenty of money so even if they spend some of the savings it will probably just go to corporate profits and back to another rich person. As we can see from this example, and also from the Great Depression, "a more efficient government" does not really help anything when the 'problem' is high productivity and inequality.

So as you can see, we need a more innovative solution. The accelerated work week where high-income workers are given the choice to work less time would solve unemployment and reduce inequality in any country. For example, the main trading partner of Greece is Germany which has a reputation for high-quality products. Greece has one of the longest average workweeks of all European Union countries but a very high youth unemployment rate right now. If high-income Greek people were to work less, they might be more willing to purchase locally made products instead of high-quality but more expensive German products, reducing the trade deficit and causing money to circulate within the economy. This leads to more jobs and tax revenues to pay off debt. Meanwhile, unemployment in Germany rises due to lower exports to Greece, which increases German spending on social security unless they also start using the accelerated work week.

Here in the United States, the amount that people think the federal government wastes has risen to 50 cents out of every dollar. We must take a stand against inflation and wasteful government spending. Our political leadership must promise to make any necessary legislative changes in support of the accelerated work week. If they do not, we vote them all out of office no matter what party they are, and any candidate we vote for must promise to end the lifetime pension benefit for all past and future members of Congress as well as support the accelerated work week.

This will end unemployment, lead to reduced inequality by reducing profits for all corporations that sell to consumers in the United States, and allow a policy of no more inflation. This will lead to lower crime, allow us to give more attention to environmental issues, and have many other positive benefits. The younger generation understands that all of this is possible, and so this is what we should do.

28 Comments

28 Comments


Read the Rules
[-] 1 points by doitagain (234) from Brooklyn, NY 2 years ago

its very remarkable how money affect self esteem. people in europe has to suffer because of crisis in little deepshit country like Greece. so they exchange euro into greenback permit the feds machine operates. Although hanging like on the strings rating agencies does not allowed the country to have a big debt. So inflation always hits the poor class, no matter what you buying, if you have money you'll buy it anyway(later)

[-] 1 points by hchc (3297) from Tampa, FL 2 years ago

Many would say that we are actually in a deflationary period, and if the gov didnt keep printing the money, prices would be falling quickly.

[-] 1 points by Misaki (893) 2 years ago

Japan in the same situation (after a property bubble) did have deflation. Economists, however, generally rate the avoidance of inflation as a success, although the decrease in employment-to-population is a less laudable feature of the US's experience.

http://krugman.blogs.nytimes.com/2012/05/30/japan-as-role-model/

"For all its woes, Japan has never experienced the kind of employment collapse we’ve suffered. That’s the sense in which we’re doing far worse than the Japanese ever did."

[-] 0 points by Shule (2235) 2 years ago

I don't think anybody's work week has much to do with banksters ripping people off.

[-] 2 points by Misaki (893) 2 years ago

Well, if it's so obvious that they're unrelated (work week = high income = $100k per year going to retirement savings vehicles but let's ignore that), then how do you see banksters ripping people off?

Is it fees for having a low balance, or for using services like an ATM? If so, is it that hard to find another bank?

Possibly you do not personally think that there is anything immoral about how most of Wall Street makes its profits (it's not from ATM fees), but from what I have gathered other people on this forum do think it is a major issue and part of why they were not willing to support the accelerated work week because they thought the political system needs some kind of major change.

[-] 1 points by Shule (2235) 2 years ago

I do think there is something immoral about how wall street makes its profits. That is exactly my point. What ought to illegal, and was illegal up to a few years ago, is wall street's current mode of operations, and that has little to do somebody's work week. Yes we do need some major political changes.

I'm not against an accelerated work week. Its just that it is not the primary problem.

[-] 2 points by Misaki (893) 2 years ago

The argument of the first post is that inflation causes people to put their money into the stock market, and this is what allows Wall Street to make a profit.

If there was no inflation, people would not put their money into the stock market and anyone who LOST money would have only themselves to blame (as long as companies did not lie about their operations like Enron, of course).

Do you have any critiques of this basic argument?

If not, then you should be able to understand that the accelerated work week, which would create jobs, would also allow the government to stop its deficit spending and end the inflation policy.

The Fed has a "dual mandate" of maintaining high employment AND keeping inflation low. These goals currently conflict; the accelerated work week would mean it could concentrate solely on controlling inflation.

[-] 1 points by Shule (2235) 2 years ago

Most people put their money into the stock market for the same reason they go to the casino. It has nothing to do with inflation.
Contrary to their official mandate, the Fed can care less about employment, and inflation. Their real purpose is to keep major banks solvent.

[-] 2 points by Misaki (893) 2 years ago

Then think of it this way.

Some people make so much money from their job that they can gamble it away in the stock market, maybe because they like the excitement.

Other people make the exact same amount of money... but they don't gamble it away. Instead they just save it, or maybe spend it on brand goods because they don't have anything else to do with it.

Which is better for the country: we give people expensive government jobs with $100k/year pensions ... or we tell the person who doesn't waste their money, or more specifically the business they work for, that they should be encouraged to work less (at a competitive wage rate) so some college student working at Starbucks can be hired by that company instead of the government?

The person gambling away their money might continue working 40+, or maybe even 50+ or 60+ hours per week... but the second choice will lead to lower taxes or lower deficits.

And maybe you don't care about the size of the deficit, but for many people it is a significant issue which, of course, is why unemployment is still at 8.2%.

(Basically, you can think of this whole argument relating inflation to Wall Street profits as secondary to the unemployment problem.)

Actually, since in the previous comment you said

Yes we do need some major political changes.

What exactly do you think needs to change? If Wall Street's profits are just as moral as Las Vegas's profits, do you think we should somehow change the system while allowing the financial sector to continue making its same level of profits? Do you feel that any political corruption that exists at present would prevent the accelerated work week from reducing unemployment as it is intended to?

[-] 1 points by Shule (2235) 2 years ago

Whoever said Vegas is moral?

The change in politics most needed is ending the corruption in our government; that is ending the pandering to large corporations and lobby groups, especially foreign lobby groups. The government needs to tighten up banking regulations, enforce environmental and labor laws, establish fair trade policies, stop supporting the offshoring of jobs, invest in public infrastructure like schools, and above all stop making wars.

I'm not exactly sure how to enable political change, if I did I'd be running for President, but part of it I think involves us getting away from, to stop looking for solution in, and stop supporting the two party system which we have here in the U.S. today.

The reason why we don't have accelerated work weeks now in the U.S.A. is because each employee carries an overhead for his employer. As employers want to minimize this overhead, they try to get as much out of an employee as they can. Hence instead of hiring two employees working 35 hrs a week, they'll rather have one employee working 70 hrs/wk.

Some employers, like those who run fast food places, hire several workers part time so as to avoid having to pay their people benefits which are required by law if a person works a full 40 hrs. I don't think this is what you mean by accelerated work week.

Another problem causing high unemployment here in the U.S. is quite frankly that a lot of people are unemployable in the high tech jobs of today. They simply do not have the requisite skills and discipline for the jobs. So we have this weird situation where we have a labor shortage at the same time we have large unemployment. Many employers are addressing this by hiring qualified workers from overseas, having the qualified people they do have work more, or simply shipping their work out to places that have qualified workers. This is an immense problem that cannot be addressed by any accelerated work week. It can only be resolved by a massive overhaul of our current primary education system, and the way parents raise their children.

Like I said, I'm not against an accelerated work week. Many European countries already have such. In Sweden for example, it is usually looked on with distain when an individual works more than about 35hrs. It is perceived as cheating; sort of like continuing to work on a test after the teacher tells the class to put their pencils down.

In our political environment today, our government, neither congress or anybody in the executive branch, will seriously sponsor an accelerated work week. It's not in any employer's favor. Maybe a better way to go about it is popularizing distain of working too much; like maybe equating the working of overtime to being greedy. Maybe when the attitude of the employed population changes, the politics may follow.

(As for myself, I'm salaried and have a good education, I'm rarely in the office for more than 35 hrs a week, and I still get compensated very well. I wish my coworkers who make very little more than I would do the same.)

[-] 1 points by Misaki (893) 2 years ago

The reason why we don't have accelerated work weeks now in the U.S.A. is because each employee carries an overhead for his employer. As employers want to minimize this overhead, they try to get as much out of an employee as they can. Hence instead of hiring two employees working 35 hrs a week, they'll rather have one employee working 70 hrs/wk.

Interestingly, 'Obamacare' might end up encouraging businesses to use it. According to this article the $2k/year penalty for employers with more than 50 workers doesn't apply to part-time workers, even though part-time workers are included in the calculation of firm size based on total number of hours.

Some employers, like those who run fast food places, hire several workers part time so as to avoid having to pay their people benefits which are required by law if a person works a full 40 hrs. I don't think this is what you mean by accelerated work week.

McDonald's gives the option for a "mini-med" plan with just $2k or $10k coverage cap per year, I don't know about other businesses. Currently though, like you say most part-time workers do not get benefits.

The "well-paid part-time job" model is viable; that's pretty much what consulting is about but it's only used for a few industries since... culture reasons or something, probably. People are just too used to the idea that "employees with responsibility must be working full time!".

Many employers are addressing this by hiring qualified workers from overseas,

Perhaps in some job categories this is justified, but for scientists at least the reason is simply that they do not pay enough to PhDs to keep people from going into finance or other better-paying job sectors. Does the U.S. Produce Too Many Scientists?: Scientific American

And the point of the article is sort of that scientists know this, but politicians (and journalists) seem to be blithely unaware that the problem is a lack of science jobs, not a lack of scientists.

It's not in any employer's favor.

There are some jobs, like warehouse workers for online retailers, where this system might not be used (until unemployment goes down) for the simple reason they can get people to accept a lower average wage when they're working 70 hours/week; but for any well-paid job, the only thing preventing it from being used is people assuming that they need to work harder to "help the economy". The assumption, as revealed in polls, that "the economy is doing poorly" means that the US doesn't have enough wealth.

I don't think we need to portray working overtime in itself as being greedy, since it does help the employer. But cases like this one ($160k+ of overtime pay) are a bit excessive.

The reactions to "Bain Capital lays off workers" seem to be motivated by the idea that corporations SHOULD be nice, and implicitly that part of the reason that employees work hard is that they trust the corporation will use the resulting profits to be nice to other employees. Working harder, especially with the accelerated work week where you can't make an extra $160k/year (but not like salary where you make nothing from working harder) can be that way of "helping other employees" if those other employees would personally prefer to minimize their work hours to get the higher wage rate.

[-] 0 points by niphtrique (323) from Sneek, FR 2 years ago

It is important to understand the link between interest, risk and the economies of scale.

Local production and consumption are more efficient by default as they require less energy. Only because interest on money favours inefficient large scale centralised organisations, small organisations and local production appear to be less efficient:

http://www.naturalmoney.org/full-theory.html#usec

The public should not pay for the risk individuals and corporations take and people should not be lured into debt they cannot repay. The failure to allocate risk correctly makes the usury financial system a domain for opportunistic exploiters of information. Interest is an allowance for risk, so abolishing usury reduces the level of risk in the financial system:

http://www.naturalmoney.org/full-theory.html#fund

[-] 0 points by Misaki (893) 2 years ago

See: "economies of scale".

"If trade is largely shaped by economies of scale, as Krugman's trade theory argues, then those economic regions with most production will be more profitable and will therefore attract even more production. That is, [New Trade Theory] implies that instead of spreading out evenly around the world, production will tend to concentrate in a few countries, regions, or cities, which will become densely populated but will also have higher levels of income."

Paul Krugman won a Nobel Prize in 2008 for this understanding of international trade.

By the way, "natural money" which encourages 'investment' would have exactly the same flaw of increasing financial sector profits (and of leading to wasteful government spending to create jobs). Being able to save money is a good thing, not a bad thing, as long as people can find work in the private sector.

The public should not pay for the risk individuals and corporations

That is why Lehman Brothers failed, because the government did not take on that risk. Your wish was granted.

[-] 2 points by francismjenkins (3713) 2 years ago

Ironically, this is the one aspect of Krugman's theory I don't favor very much. It builds on the idea of absolute competition (first promulgated by Adam Smith), but goes far beyond what Smith would have endorsed. I seen an economist interviewed by Charlie Rose a long time ago (probably a year ago), and his theory was interesting. He believes that the US economy suffers from what he termed as "overspecialization" (that is, we've forgone production in virtually all labor intensive industries, and by shifting our focus towards capital intensive production, we've distorted the organic balance between consumption and production). Moreover, some obvious factors to consider. A movement towards centralized production increases the need to move goods large distances. It may be true, however, that the energy efficiencies we gain through economies of scale, can offset this, or even more than offset this, and result in great overall efficiency.

Nonetheless, what has become very apparent over time is that skewing the balance between consumption and production (within the sphere of a local or national economy) lowers quality of life, lowers wages, and lowers employment. Moreover, if we generated energy using renewable sources, used more advanced and efficient materials, etc., the "energy" aspect of the calculus would become less important. We would of course still desire energy efficiency, but we would have the luxury of devising more favorable parameters.

[-] 0 points by Misaki (893) 2 years ago

Moreover, some obvious factors to consider. A movement towards centralized production increases the need to move goods large distances.

http://www.channelregister.co.uk/2011/09/19/keith_tatlinger_shipping_container_inventor_dies/

"It certainly astonished me to find that in the 1860s, getting wheat from Chicago to New York cost 17 per cent of the Chicago wheat value, while getting it from New York to London only cost 12 per cent of that Chicago value of wheat."

Nonetheless, what has become very apparent over time is that skewing the balance between consumption and production (within the sphere of a local or national economy) lowers quality of life, lowers wages, and lowers employment.

A quiz! Which country has the higher standard of living: the US or China?

(this isn't necessarily an easy quiz, despite that there are many jobs in the US where you can reliably make more than $100k/year :P)

[-] 0 points by niphtrique (323) from Sneek, FR 2 years ago

What economists fail to see is the following:

  • economies of scale are driven by cheap energy and the unsustainable consumption of scarce natural resources;
  • economies of scale make many people unemployed.

The unemployed are also the people that have work but do not produce anything useful. They are often employed in bureaucracy, management, consultancy, trade and technology.

The most optimal or most efficient economy minimises energy and resource input and maximises employment to achieve a specific level of wealth.

When interest on money is charged, money in the future is worth less than money now. This has a major impact on investment choices. Interest promotes investments that are unsustainable and wasteful. If no interest was charged, sustainable investments would be more attractive.

http://www.naturalmoney.org/full-theory.html#sust

Natural Money could lead to full employment. Because money is circulating in the economy constantly, everybody who is able and willing to work should be able to get a job. If there is unemployment, this is not because of a recession or a depression. Examples in the past have shown that a tax on money creates extra employment. If income taxes are lowered while taxes on fossil fuels are increased, energy use will be substituted by labour and even more employment can be created.

http://www.naturalmoney.org/full-theory.html#empl

[-] 0 points by Misaki (893) 2 years ago

economies of scale are driven by cheap energy and the unsustainable consumption of scarce natural resources;

Economies of scale have always existed, even before fossil fuel use. Even sustainable consumption benefits from using economies of scale.

economies of scale make many people unemployed.

And the accelerated work week is the way to fix that.

Interest promotes investments that are unsustainable and wasteful

Putting money in a savings account is wasteful? How so?

Natural Money could lead to full employment

Only the same way that inflation does — by encouraging people to invest in financial markets, which is the direct cause of the financial sector's profits. You want Wall Street to remain how it is?

People are unlikely to accept a tax on fossil fuels unless inequality is lower, which the accelerated work week would do.

[-] 0 points by niphtrique (323) from Sneek, FR 2 years ago

There is enough in the world for everyone's need, but not enough for everyone's greed. The usury economic system favours large scale operations. During the usury economic cycle useful capital is replaced by useless capital. This works as follows:

  • If businesses leverage their balance sheet and make use of debt on which interest is paid, they need larger scale operations to achieve the same income level for the business owners because a part of the business income is going to the usurers. In good times businesses can borrow money to expand their operations. There is a reward for taking risk in the form of interest so there is a tendency to over invest.
  • When a recession sets in many businesses fail because demand falters and there is no credit available. If a larger scale operation fails it is often not liquidated but taken over at a lower price which makes it more cost effective for the new owners than smaller operations that are more conservatively financed.
  • When the economy recovers a smaller number of larger scale businesses have survived. They start to increase their capacity again and become even larger than they were before.

This cycle is repeated again and again so with usury large scale operations have the advantage. The usury economic cycle caused the division of labour to go further than it otherwise would have done. The effect of the usury economic cycle favouring large scale operations is amplified by the free flow of capital and free trade as this created a competition of everybody against everybody on a world wide scale. As a consequence dependencies have escalated and people have become less self sufficient. In this way "the system" has been created. Before the middle of the twentieth century most people lived in villages that were largely self dependent. Henceforth more and more people live in cities and societies have become more complex than they would have been without usury.

The usury economic cycle makes the economy less efficient because the functioning of markets is perverted by cycles of leverage and liquidation. During the boom phase useless capital is created. During the bust phase useful capital is destroyed. In this way useful capital is replaced by useless capital. As less and less people can have an income from real economic output because money lenders take an ever increasing share of the profits, productive jobs have been replaced by service sector jobs that do not produce a good or service someone needs. This is reverse economic development or the transformation to a third world economy.

[-] 0 points by Misaki (893) 2 years ago

If businesses leverage their balance sheet and make use of debt on which interest is paid, they need larger scale operations to achieve the same income level for the business owners because a part of the business income is going to the usurers.

Corporations take on debt because of the tax deduction. Somewhere I read that new investment financed by equity has an effective tax rate of about 35%, while if financed by debt it's something like -55%. This is a spread of 90 percentage points, while in other countries it's more like 60 points I think it was.

If a larger scale operation fails it is often not liquidated but taken over at a lower price which makes it more cost effective for the new owners than smaller operations that are more conservatively financed.

I am sorry, I don't understand what you are talking about. Especially what this has to do with interest rates.

Do you think we should put a ban on loans that would go above a certain interest rate? For example, credit cards cannot be issued if they would require an interest rate above 10% for someone with a certain credit risk?

[-] 1 points by niphtrique (323) from Sneek, FR 2 years ago

Q: Do you think we should put a ban on loans that would go above a certain interest rate?

A. Yes. If there is a tax on money and a ban on interest, there is a maximum risk allowance. The financial system now fails because of too much risk allowance.

Q: I don't understand what you are talking about. Especially what this has to do with interest rates.

A: Leverage is a result of risk allowance. If there was less leverage, because of less risk allowance, it would also reduce the intensity of economic cycles and further reduce risk.

If corporations take on debt because of the tax deduction then the tax system is problematic. I do not know how the situation in the US is. Normally leverage is taken because it amplifies profits. If you expect a ROI of 8% and you can borrow at 6% you can increase profits by taking on leverage. This is normally the incentive to take on leverage.

[-] 1 points by Misaki (893) 2 years ago

Oh well, that's a regulation problem. Not really an usury problem, because the point of leveraged investments is you DON'T pay high interest on the loan.

I don't really know much about why the interest deduction exists either...but the same could probably be said for the mortgage interest deduction. Apparently "owning a house" is supposed to be part of the American Dream™..? So the tax deduction is supposed to be a way of subsidizing it. Maybe the deduction for corporate loans could go away... but if all it does is require more accountants to be hired, it probably won't go away unless we create jobs in the private sector via the accelerated work week.

[-] 1 points by niphtrique (323) from Sneek, FR 2 years ago

Too much leverage is an interest problem because interest is an allowance for risk.

Setting a maximum interest level maximises risk that will be taken.

Even countries like Greece can still borrow money if they are willing to pay 30% per annum.

People that have no money could still buy consumer goods on their credit card and pay 25% per annum.

If they were not able to borrow then they had to reorganise their finances in an earlier stage and they would have had more money to spend as they did not need to pay interest.

[-] 1 points by Misaki (893) 2 years ago

Too much leverage is an interest problem because interest is an allowance for risk.

Leverage is based on the fact that (see the first post!) the borrower takes on the risk, not the lender. If markets fluctuate, the lender will almost always be able to recover their investment by taking possession of some asset, like a futures contract.

For example, a futures contract for 100 troy oz of gold might cost about $60,000, but someone might be required to have a margin of only $5,000. If the price of the contract drops by $5000, that person would need to provide more cash or the exchange will confiscate the contract to sell (or possibly to hold if the price bounces back up).

If they were not able to borrow then they had to reorganise their finances in an earlier stage and they would have had more money to spend as they did not need to pay interest.

Maybe they don't have a job, and a credit card is the only thing available to them. Limiting interest rates could mean they cannot buy anything.

If there are jobs available, there is no need to limit interest rates as long as they are openly stated with no deception and people have an "emergency" option of bankruptcy. Or, say, a small company that either uses too much leverage or takes on too much high-interest debt might go out of business, but if its employees can find a job somewhere else then things are fine. Of course, this is one reason it might not be wise to have a company "pension fund" instead of just getting paid at a higher rate (or have a tax-advantaged IRA or whatever).

[-] 1 points by niphtrique (323) from Sneek, FR 2 years ago

"the borrower takes on the risk not the lender"

The borrower is a risk to the lender and this is expressed in the interest rate.

The value of the asset often depends on the income it can generate. In good times the assessment of this income differs from the assessment in bad times.

If there is no risk to the lender then why should we bail out banks?

[-] 2 points by geo (2638) from Concord, NC 2 years ago

If the lender is holding collateral from the borrower of equal value to the loan, how can the lender justify charging higher interest rates to mitigate risk?

In real life a bank puts a lien on the home being mortgaged. If due diligence was performed and the value of the home is well known, then there should be no justification for 'subprime' interest rates which are high. Outside of this past crash which should have been seen by all as the results of a speculative bubble, home prices traditionally did not suffer but increased at the cost of living making them a good risk.

But in general, a lender who has secured collateral should not be charging exorbitant interest rates, no matter what the credit score is. Unsecured loans are a different issue.

Just a thought.

[-] 1 points by Misaki (893) 2 years ago

This is a nice explanation of the basic theory of risk and interest rates:
http://www.nextnewdeal.net/rortybomb/how-libor-impacts-financial-models-and-why-scandal-matters

"The rate of a loan consists of adding the "risk-free" rate to a risk-premium. If either the risk-free rate or risk-premium goes up, then the price of a loan goes up. If you are a particularly risky borrower, you will pay more for a loan. This is because your risk-premium, compared to other borrowers, is higher, and that is added into your loan rate. If the risk-free rate is 3 percent and your risk of not paying back a mortgage requires a 2 percent premium, then your mortgage rate is 5 percent. If your risk of not paying back unsecured debt on a credit card requires an 8 percent premium, then your interest rate on your credit card is 11 percent.

More complicated models include more types of risk-premia and other things, but this basic approach is how financial markets work. They all need a measure of what money costs independent of the risks associated with any specific loan. As a result, all the most complicated models have this "risk-free" rate at their core."

If there is no risk to the lender then why should we bail out banks?

Because banks were borrowing money, not just lending it. Any bank which uses "leverage" is, by definition, borrowing money. And one area they were lending money, the housing market, is one where there isn't really a fluid market for the underlying good, since they aren't commodities (the original post is about the financial markets which involve commodities).

This doesn't explain why we "should" bail out banks, just why we did. The President was trying to reform laws so that the government could break up banks that fail instead of bailing them out.

[-] 1 points by niphtrique (323) from Sneek, FR 2 years ago

There is no risk free return because there is always risk, so there is no risk free rate. If you build theories on false assumptions the outcome is unlikely to be correct (it could only be correct by accident).

The assumption of interest in itself carries risk, and this could be explained as follows:

If someone brought a 1/10 oz gold coin to the bank in the year 1 AD, and the money remained there until the year 2000 AD, collecting a yearly interest of 4%, the amount of gold in the account would have been 3.6 * 10^31 kilogramme of gold weighing 6,000,000 times the complete mass of the Earth.

Interest is a cause of financial instability and risk. There can be no risk free return by definition if you have interest.

No risk is often associated with getting you money back. You may get your dollars back but if 10,000 dollars buys one leaf of bread at the payout day, you have lost nearly everything.

[Removed]