Archive for the 'Economics' Category

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What do the Belarusian Ruble and the U.S. Dollar have in Common?

While currency issues in former Soviet Bloc countries don’t usually make headline news in the main stream media, the devaluation of the currency of Belarus is worth reading about as a lesson in what is happening to the US Dollar.  On Monday, Zero Hedge reported “Belarus Just Devalued Its Currency By 56%”.  Zero Hedge comments:
Overnight 56% drop

At this point, it sucks (that is a technical term) to be holding any exposure in BYR. Luckily for those who held their “money” in the form of gold and silver, they just got an instantaneous 56% value preservation and a relative boost in their purchasing power with just one central bank announcement. Also, any and all indebted parties who have BYR-denominated debts are throwing one big party tonight, as their debt was just cut by more than half.

The change is effective 5/24/2011:
The National Bank of Belarus (NBB) is sharply devaluing the official rate of Belarusian ruble. The exchange rate as of May 24 was set at 4,930 rubles per dollar. A decrease of 56% from the 23 May.
Why should you care about the currency value of a country you probably have never heard of?  First, before you laugh too hard at the Belarusians, consult the following chart of the US dollar:
US Dollar 10 Year Chart
As you can see, since 2001, the US dollar has lost almost 40% of its purchasing power, relative to a basket of other currencies.  So while, our currency devaluation didn’t happen overnight, our central bank’s goals are quite similar to that of The National Bank of Belarus.  To understand what currency devaluation feels like, consider that in the last 10 years the price of oil is up over 400%, gasoline is up over 200%, corn is up almost 300% and gold is up almost 600% just to name a few.   The Belaursian central bank and US central bank are both using currency devluation to deal with massive debt problems. Those of you that have also been following following the bailouts of Greece and Ireland might add that if Greece and Ireland (and soon Portugal, Italy and Spain) were not a part of the EU and still had their own currencies, they would be doing the same thing as Belarus right now.  All of these countries (just like the United States) have massive, uncontrolled amounts of debt.  Debt that simply is too large to ever pay back with tax hikes and spending cuts.  The only real options are to not pay the debt back (default) or to pay it back by printing money (currency devaluation). The first option is deflationary in nature, meaning capital is destroyed and the price of things should decrease.  The second option is inflationary in nature, meaning the price of things will rise.  Both should result in higher interest rates, as investors demand more interest to protect from defaults, or they demand more interest to protect from inflation.  These markets, and indeed the world, is at a very precarious financial cross roads.
533027_cap_and_diploma - Image by Stock.Xchng

Education, the next bubble to pop?

One of the fundamental premises of Austrian economy theory is that markets must be free to allocate capital quickly and efficiently.  When governments or central banks instead try to control or influence the allocation of money, no matter how noble a pursuit, results in larger, more complex and completely unforeseen problems.  Call it the law of unintended consequences.

The problem with central planning, is that it generally indeed has the most noble of goals.  Some recent examples of the last 50 years include:

This video, while a little dramatic, does a great job of highlighting these unintended consequences:

The general methods for central planning are financial incentives, or regulations.  Focusing on financial methods, the government will either give you money to do something, give you money not to do something or penalize you for doing something. This can be found in the form of rebates, tax deductions, fees, penalties, criminalization, etc.

For this conversation, lets focus on the most common: giving or loaning you money to do something.  One of the most common and obvious side effects of government influencing the public to do something is an increase in prices related to that service.

Here is an example we are all now familiar with: housing.

Over the years, the government did a lot to promote housing.  This was undoubtedly done for both noble reasons (The American Dream, affordable shelter, supporting family structure, etc) and some more shady reasons (help builders, mortgage brokers and banks make a bundle in the process).  Regardless of the reasons, the government did what it does best – it threw money at the problem, either via tax credits or subsidized loans:

  • Mortgage interest tax deduction
  • Property tax deduction
  • Home sale capital gains exception
  • Fannie Mae and Freddie Mac
  • Federal Housing Administration (FHA)
  • US Department of Housing and Urban Developer (HUD)
  • Cheap mortgage rates
  • Tax rebates and credits (these were fortunately short lived)
  • Incentives to banks to lend to home buyers
  • Hyperbole and other rhetoric (Ugh – “The ownership society” is a great example)
  • Countless others…

The result of all these incentives were obvious: as more and more people had more and more access to larger and larger sums of money via loans, etc., the price of homes increased.  This is the basic law of supply and demand.

Education is no different. Just like housing, the government is encouraging and enabling the spending of money on education.  Through various programs such as guaranteed loans through Sally Mae, grants, scholarships and more there are ever-increasing amounts of people who can spend ever-increasing amounts of money on education.  The result is that prices rise.

It’s a vicious cycle:

  • Education is too expensive
  • Government provides loans so people attend school
  • The price of school increases as attendance grows
  • Education becomes too expensive
  • The government offers larger loans
  • The cycle continues…

The result: the cost of education rises faster than wages (people’s ability to pay) — and just about everything else for that matter.  Because the price continues to increase, and the government and society continue to demand (and subsidize) affordability, the government creates an ever-increasing array of payment options.  Including:

  • ESAs / Coverdell Education Savings Accounts – Like an IRA for education.
  • Education tax credits and deductions – If you spend more on education you can spend less on your taxes.
  • 529 Plans – Because you can’t borrow enough, you should also be encouraged to save for college in a tax advantaged account.
  • Various Federal grants and financial aid programs – Loans aren’t enough, we can just give you some money.
  • Pre-paid Tuition and Guaranteed Education Tuition Programs – Lock in today’s prices by pre-paying for tuition.  This is based on the premise that your state will make up the difference in the future.

Each one of these options all seem like a good thing.  After all, who doesn’t want to promote education and helping people achieve their potential? But… take a look at what has happened to the price of education as all of these incentives influence pricing.  The problem with incentives is that they focus only on enabling people to pay the rising prices, instead of asking why prices are rising in the first place.  This madness is one of the reasons, I do not plan on “taking advantage of” my states GET or other 529 plans.

Here is a graph of the cost of a 4-Year college tuition, when compared to median household income and the Consumer Price Index (CPI):

Comparing CPI, Median Income and the cost of education in US

As  you can see, since 1977, the median US household income has increased by almost 3.6x, while the cost of education has increased more than 10X, thus the rate of “education inflation” is several times that of regular inflation.   To enable this: government loans have filled the gap!

I think the fix to rising education costs and unaffordable education is for the government to simply stop “helping”, or at least help less.  The easiest way to do this would be get rid of Sally Mae, or perhaps alter the way it works.  The fact that Sally Mae backed loans (effectively all student loans in the US are Sally Mae backed loans), are 100% guaranteed and can never be defaulted on or discharged in bankruptcy is pure insanity.  Essentially, student loans have zero risk to the agencies and banks that provide them and 100% risk to the students that take them out and the tax payers that fund them. Thus banks have no incentive to give student loans only to credit worthy borrowers, or at least borrowers whose education plan make sense (spending $150k to get a job making $35k for example does not make sense, especially if you could get a job making $30K without the education.  You’ve just spent 150K before interest to earn an extra $5K per year).

Does this sound familiar?  Do mortgage-backed securities, NINJA loans, To Big To Fail and the housing bubble ring any bells?  Without risk, sanity is thrown to the wind.  If risk was slowly and surely re-introduced to the student loan market the supply of new money would decrease, the demand for education would decrease and the prices would decrease, thus allowing more people to afford the education they want without the need for debt.  And without an unlimited supply of applicants, colleges would have to become more competitive to command high education prices.

Much like the housing bubble, the education bubble is also plagued with consumers that have bought into the idea that education is worth the cost, no matter how high.  And like the housing bubble, the risk of default is theoretically solely on the borrow — although waves of defaults would still wind up hurting the taxpayer.  Many who borrow don’t know what it will cost to repay the loan, or even what their monthly payments will be, until the borrowing is already done.  And without requirements to provide Truth In Lending disclosures, it’s incumbent on the borrower to figure it out — the lender doesn’t have to tell you.

On a final note, check out the following infographic that has been making its rounds on various PF blogs.  It tells the history of students loans in the US, and might make you rethink the value of taking one out:

Why student loans suck Infographic

Round2

They’re back! Fight of the century: Keynes vs. Hayek Round Two

These videos are great, well produced and very informative.  If you missed the first one you can read about it and get a link to it here.