Monday, August 23, 2010

Supply or Demand

Its taken a while to figure out what is worth posting about. My recent obsession with all things economics has left me with much to ruminate about, not being an economist, and not as much to talk about. Most economists have already thought about the things I roll around in my head and have models and equations to express them. . Stories and thought experiments/analogies are what has been the most informative to me in my explorations through the economics blogosphere. Things just have to make sense when you think about them and be consistent with how other systems in our universe work. I find supply side economics to be one of those things that doesnt ring true. Not that it has nothing useful to say or that looking at the supply side is not informative but to build an economic edifice around the supply side seems woefully incomplete.

Now, one could say the same thing about the demand side. Its only one side of the coin and doesnt explain everything. Agreed but my quest is not to find the economics equivalent of the physicists quest for the theory of everything, its simply to find what came first. My question is just about the "prime mover" in economics. This seems to me the ultimate question. Were we designed as demanders or suppliers? Some may say that this is a silly quest to be on because its not answerable. Perhaps. I have no illusions that supply siders will read this and go, "My gosh Ive been bamboozled all these years I must rethink my position". Mostly this is because many supply siders (I think) are simply extreme tax cutters in economist clothes. They hate the notion of a bureaucracy "stealing" their hard earned dollars. So they have used a lot of fancy math and models to show that letting citizens keep more (ALL) their money will lead to a more vibrant and growing economy. But its also because I myself dont think the demand side answers everything. Only a complete view, coherent with consideration of human tendencies, has a chance of being explanatory and embraced by more of a consensus than we have today. Today the number of "camps" is ridiculous and mostly they talk past each other, content to worship their "god" of Hayek, Keynes, Ricardo, Marx or Smith. I wish someone could just say "Stop it!.. Cant we just agree on THIS!!!!"

The large issues are employment, and how to stimulate it, the nature and utility of money and how to preserve something for later so not to just have a large fight today to see who can get "it" all now. On these large issues all the forementioned "gods" were in quite different places I would say. Some said money came about naturally in the form of gold, unemployment is simply someone expressing the will not to work and savers are the SAV-IORS of society. Others might say money is a man made object, more political than anything else, unemployment only happens when a person is required to chase currency via the route of a job and no job is available and savers while good are no more important than borrowers to a modern society they are two sides to the same coin. Just like an exporter needs an importer a saver needs a borrower. There is likely a mix and match of these views within schools of thought but it appears to me that most arguments seem to settle around these areas.

Okay, now to my main topic. Are we first demanders or suppliers? Are we A) primarily demanders and suppliers will arise to meet our wants or B) do we sit around and dream of things to supply and spend our time trying to convince everyone else they will be a better human for it? This is the "prime mover" question. The proximate cause for just how we became homoeconomicus. Most people are quite aware that while blood flow and tissue health are intimately related many dont understand the nature of supply and demand of blood flow in the body. The heart (the supplier) gets all the attention. We pay men hundreds of thousands of dollars a year to keep the pump going (good thing too) but the heart is an organ because the complexity of organisms got to the point where it DEMANDED a heart to keep it alive. The hearts purpose is to keep tissue alive and it gets its signals for what to supply from tissue demand. When tissue need more the heart supplies this. Now, we exist today in the middle of all that. We dont really care as long as someone understands the ins and outs. But we are only an organism when we have tissues demanding blood from a pump. Pump only...... no organism. There are organisms without pumps(not very complex ones) they respire in different ways, but there are no pumps without organisms. So if someone were to hear someone argue that "All we need to look at is cardiac output (Heart function), and remove all restrictions to cardiac output we will have a healthy body. Cardiac output is the determiner of health and any time we see the patient getting sick we are going to increase cardiac output" they would not be doctor you should go see. You need someone with a more complete view of how our body operates. Its not quite that simple.

How does this knowledge help us? I'd like to posit that our economy is much more naturally like our body. It has flows of money and works off of people wanting/desiring stuff and services, and that when it is healthy (if its ever been) we have a supply that is truly in tune to our wants. We can, I think, use the circuitous nature of life sustaining blood in our bodies to help understand the circuitous nature of life sustaining goods and services in our societies. Knowing the direction of flow is critical I think. In our economy its not quite as simple and consistent as the direction of flow in our bodies, but there is a direction or more accurately, there ARE directions. Things move from somewhere to somewhere else in a very definable direction in a lot of places in our economy and getting flows right is paramount in making proper interventions. For example, loan origination at banks, is primarily driven by a demand for loans from customers, not by a supply of money to be lent. On a system wide level it is demand which drives it. A particular bank might be in a bad financial spot and not give credit to someone they would have a few months previous but system wide it is the financial health of the consumers which drive loans not the financial health of the banks. The banks got sick because their consumers stopped paying, the consumer got sick first. Knowing this, one would never simply give more money to banks to help the credit markets. It will never work and it hasnt worked.

Today, the rut we are stuck in is calling out for more demand. Where does demand come from? Income. Where does income come from? Someone elses non saving. A person who is saving is depriving an income to someone else. We all thrive on someone else not saving. This isnt to say saving is bad but we must understand the consequences of our decisions. Austrians and others argue that it is the savings which result in future income for others through investment. If you look at the flows this doesnt quite bare out. The investment happens first and a residual savings is left. Yes the two equal out but the direction tells you why increasing saving first can only result in recession. Savings is viewed as a supply which will be met by the demand later, but investment is the supply properly RESPONDING TO the demand and leaving behind some savings. This can be explored here . Warren Mosler also does a nice thought experiment here:

Consider this extreme example to make the point:
Suppose everyone ordered a new pluggable hybrid car from our domestic auto industry. Because the industry can’t currently produce that many cars, they would hire us, and borrow to pay us to first build the new factories to meet the new demand.
That means we’d all be working on new plant and equipment - capital goods - and getting paid. But there would not yet be anything to buy, so we would necessarily be ‘saving’ our money to buy the new cars when they rolled off the new assembly lines. The decision to spend in this case resulted in less spending and more savings. And the production of capital goods, which constitute real investment, led to an equal amount of savings. I had this discussion with a Professor Basil Moore in 1996 at a conference in New Hampshire, and he asked if he could use that expression in a book he wanted to write. I’m pleased to report the book with that name has been published and I’ve heard it’s a good read.

Unfortunately, Congress, the media, and mainstream economists get this all wrong, and somehow conclude we need more savings so there will be funding for investment. What seems to make perfect sense at the micro level is again totally wrong at the macro level. Just as loans create deposits, investment creates savings.

What most people refer to as investment today simply is buying an already existing financial asset, stock or bond, and adding income for a broker. Not actually creating anything new at all. This is a fine, legal, ethical and sometimes fun and profitable activity, but it is often sold to us as something else. We need new investment now, to help put people back to work and start producing near capacity. Your 401k is not doing that. This is another flaw in the story that our savings is good and will (by magic) create the opportunity for those future new jobs. This story does not pass the smell test.

Some say we have a supply glut today and we should just let supply contract to meet demand and then we build from there. Well, we were demanding those things a few years ago and thats why the supply grew, now we just have a financial crisis and some people think we dont have money anymore. How could we not "have" the money now? Money is created when there is a demand for it. Money came along when we as a species demanded it. We didnt walk along the road one day and go "Look, there's some money, I think I'll go use this to buy me some wheat and a new tunic" It was our creation. We started out as demanders of money (and then the supply of it was hijacked by the Machiavellians of our societies). When we started out in nonmonetary societies we simply traded things we thought were mutually useful but the only things we took from someone else was something we wanted(demanded). The next time we met up with that tribe they likely had what we demanded the last time. Our forefathers, way way back forefathers not Ben and Thomas and the lot, simply consumed everything they needed from mother earth. They didnt supply anything. It was all supplied and in abundance (somewhere) they just needed to seek it. It was a while before we had any suppliers.

I hope Ive pointed to some of the inadequacies of supply side thinking which seems to dominate our discourse today, at least amongst those in power. Do you think it has anything to do with the fact that those in power are the suppliers?....... hmmm. It takes little effort to make gods in your image, the effort is in convincing others to worship those gods.