Sunday, March 15, 2009

Finance Magic

In an article about the Obama Administration's problems in staffing the Treasury Department, Stephan Green, the Vodkapundit points out an interesting phenomenon:
According to a recent Reuters story, Blackstone Group CEO Stephen Schwarzman estimates that “Between 40 and 45 percent of the world’s wealth has been destroyed in little less than a year and a half.” Think about that. There was no 9/11 in New York, no nuclear bomb going off in London or Beijing, no fleets of bombers destroying factories — there has not been any physical destruction of capital whatsoever. Yet in the last 18 months, nearly half the wealth in the world has vanished into thin air.

Well, as every mother has said, at least once in her life, "Things don't just disappear, it has to be somewhere". So, where did nearly half the world’s wealth go? The answer depends on your view of reality. If the wealth was real, then it ended up in somebody’s pocket. If wealth is only a promise for future work, then it is not real. It can appear and disappear as easily as any other promise.

We are all familiar with optical illusions. Magicians make their living with them. Is there such a thing as a financial illusion?

You've worked and saved, and you're ready to buy a house. The work you have done is real. The money that was exchanged for your work is real; it is equal to the work you have done. So you plunk down 20%, and the bank covers the other 80%. Except, the bank doesn't have the 80%, they only have 2% on deposit with the Federal Reserve. The remaining 78% of the value of your house doesn't exist, not yet. But in the eyes of the banker, he has a note; a tradable commodity. He uses that commodity as a down payment on a bigger promise, and that commodity on an even bigger promise still.

All it takes to end the illusion is one broken promise; one call for a show of real wealth within a group of people who have none. When the illusion is over, what have we lost? You still have your house, your work, and you're keeping your promise. The banker still has houses and no real wealth. He's right back where he started.

I've heard we have lost our trust. Well, no kidding. Who would trust a magician?


cynthia s ryan said...

Very useful analogy - trusting a magician. At the end of the day, however, there still seem to be an endless supply of folks willing to step up to the CNBC/Wall Street/P.T. Barnum illusionarium.
And too, look no further than the Libertarians. What do they make out of all of this?
Which is why unrepentant liberals like myself think regulation could be a good thing.


Local So-and-so said...

Hi Maven, thanks for stopping by. I’ll agree that CNBC will never have problems finding Wall St. cheerleaders. But, lets not confuse Wall St. with Libertarianism. Any business will be for or against any regulation depending on the advantage/disadvantage relative to their competitors. Libertarianism was born when President Nixon took us off the gold standard. The Libertarian/Republicans are the remnants of the hard-money wing of the Republican Party. To find a libertarian style economy, you have to go back to the 19th century, and the further back the better.

As for what I make of the current situation, the bubble created by political manipulation will continue to deflate. As more trillions are pumped into the economy in a futile attempt to keep the bubble inflated, the end result will be hyperinflation. It is the willful destruction of the dollar. To what end, I don’t know. But unlike other Republicans, I don’t wish for President Obama’s failure, I expect it, and am planning accordingly.