Your Teacher Said What?! (6 page)

“Blake, would you rather have a dollar right now, or tomorrow?

“Doesn't matter.”

“How about a year from now?”

“Then I'd rather have it now.”

“What if I gave you a choice of a buck today, or two bucks a year from now?”

“I'd rather have the money today.”

“How about ten dollars?”

“Still rather have it now.”

 

Blake's time value of money is a little steep. Eventually, though, even she will get the idea that if you make the cost of lending money too high, no one will borrow any. But you (or rather, your happy-golucky government) can also make the cost too low; when that happens, too many people borrow money, and not all of them will pay it back. “Trust or belief,” indeed.

Debt.
Noun. An obligation to pay, at a later date, for assets acquired in the present; future purchasing power.

There are those who think that the ability to discount is at the core of modern capitalism, and the huge variety of debt instruments reflect this. From the simplest bank loan (fixed amount of money repaid at fixed rate of interest over fixed amount of time) to letters of credit (maximum amount fixed, but interest paid only on the money actually used) to corporate and government bonds, inflation-indexed debt, mezzanine obligations, syndicated loans—the list is endless. As are the zeros on the end of the debt currently owed by the United States to various creditors: more than $8 trillion. (It also owes more than $4 trillion to itself, in the form of future Social Security and the like.)

Debt is not always bad. If the only things people and businesses could buy were things for which they had cash on hand, there'd be a lot fewer factories, apartment buildings, commercial airplanes, and so on. Borrowing money against the future money-generating potential of an asset is a much better allocation of resources than saving it by burying it in the backyard (putting it in the bank is just lending it to someone else). However, the potential for, shall we say, overshooting the mark, seems obvious, and—to Blake—it is:

 

“Do you know what's wrong with debt, Blake?”

“Well . . . you can start here [she places her hand about belt high], but before too long you're here [her hand moves to just below her chin], and pretty soon here [hand above head; drowning noises].”

 

Depression, Great.
Noun. The worldwide economic collapse that began in the United States in 1929, spread around the world, and caused an unprecedented loss of wealth, income, and productivity for an entire decade, with unemployment between 25 percent and 30 percent, crop prices falling by more than half, deflation, completely frozen credit, and untold misery. For many decades, almost everyone seemed to agree that the Depression was the result of unregulated markets gone wild and that it was cured (or at least made less bad) by the policies and jobs programs of the New Deal. Today it is pretty respectable to argue that the Depression was the
result
of misguided governmental intervention (such as increasing tariffs) and that the impact of the New Deal was, at best, nothing—and that it was possibly even harmful.

The only good thing about the Great Depression is that it has made all other economic crises—including the current one—seem like a mild head cold.

Derivatives.
Plural noun. Agreements or contracts whose value is determined by the price of something else.

Futures, swaps, options . . . All derivatives are financial instruments that have no underlying value (how can they?), but that doesn't mean they have no
market
value, though the mathematical formulas used to calculate those values make subatomic physics look easy (see
CDO
). There's nothing intrinsically wrong with allowing people to gamble on the change in value of a stock or a piece of real estate (usually, actually a package of mortgages on different sorts of real estate), and a good case can be made that allowing people to bet that the value of one investment might not increase—the term is “hedging”—actually allows investors to insure themselves against bad outcomes (which is what insurance is for) and even makes even more information about pricing available—and the more information about how people value things, the more efficient the market.

Even so, derivative investments are not for the faint of heart. The fact that (a) hundreds of billions are wagered daily on contracts whose value moves in the opposite direction from the underlying investment; (b) some trades are derived from things that have
no
underlying market, like hurricane activity; and (c) some derivative contracts are worth hundreds or thousands of times as much as the underlying investment to which they are tied, means that small problems can turn into gigantic ones in the blink of an eye.

Efficiency.
Noun. In economics, the degree to which allocation of resources results in the maximum production of goods and services. A system is efficient
⁶
when markets are in equilibrium: enough supply and demand at every price point.

Since it is mathematically provable that a competitive market is also the most efficient, the kind of reflexive hostility to markets that are the hallmark of Progressivism requires either arguing that markets aren't competitive or defining true efficiency not as the
most
goods and services at the lowest cost but as a
socially desirable
amount. Progressives do this by arguing that
externalities
like air pollution or discrimination against women need to be counted in the price of everything. Everyone who makes this argument also argues that he knows what that price is.

Externalities.
Noun. In an economic transaction, costs or benefits that aren't incorporated into the price.

Anytime you hear someone talking about externalities, you are in the presence of Progressives, and you should count the silver before they leave.

Fair trade.
Noun. The belief that certain agricultural commodities need a minimum price, without which trade is, presumably, unfair to the farmers who produce them. No one has yet figured out how to establish such a price, much less make sure that it actually enriches farmers rather than the bureaucrats who decide whether a particular price is “fair.”
⁷

Fiat money.
Noun. Currency issued without any right to convert it to anything else.

Friedman, Milton.
American economist (1912–2006) who was the twentieth century's most prominent and effective advocate of free-market capitalism. Awarded the Nobel Memorial Prize in Economic Sciences in 1976. Author of dozens of books and articles, including 1980's
Free to Choose
, written with his wife, Rose.

Milton Friedman casts a ridiculously large shadow over twentieth-century economics, in technical areas like consumer behavior and monetarism (the idea that the only really important economic responsibility of the government is to keep the supply of money growing at a constant rate), but wouldn't be worth mentioning in this book if he hadn't also been the most successful advocate for the free market since
Adam Smith
. In fact, he went a lot further, arguing, among other things, for abolishing virtually every governmental agency and even the requirement that doctors be licensed.

People love to do the old compare-and-contrast game with Friedman and
John Maynard Keynes
, but the real key to understanding the importance of both men is the
Great Depression
, which persuaded a whole lot of people that free markets had failed (sound familiar?). For decades, the Keynesian solution to the great unemployment of the 1930s had been for government to spur demand by spending money. Hidden in all of this was the germ of the worst Progressive myth: Since people don't know best how and when to spend their own money, government employees need to do so on their behalf.

Friedman wasn't having any of it. Almost single-handedly, he revived the idea that people
do
make the best decisions about their own wealth, that they “maximize utility” (which is usually defined as choosing the highest-valued alternative available) not just in the short term but over their entire lifetimes. If he hadn't done anything else, this would have secured his position as
the
great free-market thinker of the era.

GDP.
Noun. Acronym for gross domestic product, the sum of all economic output in a single country or (less commonly) some smaller or larger political unit.

GDP is supposed to represent the market value of all goods and services that are made in a single year, but measuring something so complicated is, well, complicated. Economists and policy makers calculate GDP three different ways, each of which is supposed to add up to the same number and occasionally even does. The first one is a simple measure of the total output of every business, assembled by surveying; the second is the amount spent on that output;
⁸
and the third is the total value of all producers' incomes. Getting there means measuring national consumption, investment, government spending, exports, capital formation . . . You get the idea.

However the calculation is performed, the idea behind GDP is to measure a country's economic activity rather than its welfare or standard of living. This is, I guess, the reason that Progressives are so unhappy with it, and especially with the notion that more GDP is better than less GDP. It's so unsatisfactory for the stuff that
really
matters to the Progressive mind—things like environmental damage or sustainability or disparities between rich and poor—that inventing alternatives to GDP has become a growth industry all its own.

The Kingdom of Bhutan, for example, located north of India, has led the way in calculating something called GNH, gross national happiness, which surveys, among other things, how many antidepressants are prescribed annually (bad) or the percentage of voters participating in local democracy (good). Then there's the GPI, genuine progress indicator, a creation of the United Nations System of National Accounts, which records such measures as the loss of farmland or degree of noise pollution (both bad). Then there's the Happy Planet Index, which ranks countries on a scale of something called happy life years and places the Dominican Republic and Cuba far above Switzerland and Italy.

If these seem a little squishy to you, well, they do to me, too. GDP isn't a perfect measure of anything, but it has two pretty large virtues that make it superior to any of the competing measures—yes, even the Happy Planet Index.

The first of those virtues is that no one rigs GDP measurements so that a particular group's ideas about “the good life” are given extra points; though most of the games played with calculating living standards are intended to serve a Progressive agenda—happy life years include measures for (I swear) “Discrimination of Women,” “Brotherhood,” “Tolerance,” and “Social Justice”—it would be just as dishonest to rank countries by the number of hours the average person spends in prayer.

The second virtue is that GDP—especially per capita GDP, which is the total of goods and services produced by the average person in a particular country—unlike its competitors, actually
is
correlated with pretty much every aspect of human welfare that we can measure, including life span, infant mortality, and literacy.

Oh, there's a third reason to like GDP as a measure of national economic performance: It makes Progressives apoplectic.

Gold.
Noun. Chemical element Au, atomic number 79. Also the precious metal used to back currency anywhere that has used the gold standard.

 

“Dad?”

“Yes, Blake?”

“Why do all these commercials want to buy your gold?”

“Because they think they can make more money when they sell it.”

“But isn't gold a
kind
of money?

“Not anymore.”

“Didn't it used to be?”

 

Using a given sum of a precious metal as a way of calculating the economic value of a currency is thousands of years old. In its original form, the money in circulation actually
was
gold (or, more frequently, silver) but even paper currency, for most of its history, has been exchangeable for gold at a fixed price.

That all changed, like so much else, with the
Great Depression
. Through the first years of the Depression, the Federal Reserve still paid for dollars with gold, but after the banking panics of the era reminded every depositor that it might be a good idea to convert their bank deposits into something a bit shinier, demand exceeded supply, and in 1933, the United States announced that it would no longer agree to such exchanges.

This didn't mean that the United States, or anyone else, abandoned the gold standard; after World War II, most of the world's large economies agreed to fix their own currencies to the U.S. dollar, and the United States agreed to fix the price of gold at $35 an ounce. And so it stayed, until 1971, when President Richard Nixon announced that dollars would no longer equal a fixed amount of gold (and he didn't stop there, imposing a ninety-day freeze on all wages and prices in the United States), shocking the world's financial system and introducing the volatility that we've lived with ever since.

The volatility of the last forty years hasn't been a curse, but as blessings go, it is a pretty complicated one. Because once a dollar is unmoored from a given amount of gold—the term is “floating”—it starts to act like a share of stock, which means that its value is whatever a bunch of traders think is its future value. This kind of risk is hedged by
derivatives
,
CDO
s, and other complicated financial instruments, with a lot of potential for profit—and mischief.