Where is the cash?

I started to wonder where all the money was since the banks had to be rescued by the government, the automobile industry too, companies are laying off employees, people were facing foreclosures of their homes, repossessions of their cars, credit trouble, and so on. Apparently everybody run out of cash. So, who has it? It couldn't possible have banished. Somehow, my intuition has hinted me of this kind of crisis now and some years ago in Colombia. It's not that I'm an expert in Economics; I'm not even an economist but my training as engineer had given me the sense that a system can't grow without bounds and I was seeing too much growth in the demand for housing, all or almost all based on credit. So, what is wrong with that? Banks have money to lend; that's their business. Anyway, money was flowing and developers and people selling their houses were putting money in their pockets or investing it back. Where is the loophole, then? To answer that question I have to warn me readers that either, I'm too naive or the answer had been ignored for a reason I ignore. And how could people receiving or investing money get in financial problems? My answer is extremely simple: elementary economics law, supply-demand. Let me explain further with an example.

Suppose I buy my house during the growing demand period, say for US $100.000 and for simplicity sake, let's assume the bank lends me 100% of the value. After a few years the market value of my house is, for instance, $130.000 and during that term I have amortized $10.000. At that point in time my debt to the bank is $90.000 and since the market value of my house is $130.000, my equity is $40.000. So far so good. If I sell my house, then I can put $40.000 in my pocket, but if instead I use my excellent credit record to get a loan for, say, for $30.000 to buy appliances, a car, and travel, nothing is wrong so far. I still have an equity of $10.000, don't I?

Now my engineering training comes in handy. Money is not a boundless resource and housing demands drop, either due to market saturation or property is so overvalued that very few people can afford to buy. Economics says property value drops subsequently. To continue with my example, let's say the market value of my house drops to $90.000. Now I have $40.000 in debt for which I have no solid backing. Appliances and cars loose their value extremely rapid and the money I used for traveling ... well, it's now only beautiful memories and pictures, or movies if I bought a video camera with the $30.000 loan.

When these conditions occur, Economics also says that businesses slow down and unemployment grows. Economics also says that salaries tend to level off, hopefully they don't decrease and I don't loose my job. Chances are I could get in trouble if I start to pay my financial obligations late or cannot afford to pay the debt services in full. I start to accumulate debts in the form of late fees, interests, and other penalties, not to mention if I default on my loans altogether.

Let's be a bit optimistic and say that I can sell my house. I still have $40.000 in debt, which is worst than when I started my story. I have a large debt and no support other than my income. This is the result of loose credit approval and over-consumption which is what has happened, from my point of view.

Now, let's look yet at another scenario which has come to my mind as a result of my bumping from cell phone company to cell phone company, without my being consulted at all. Allow me to start with the story of my wandering through the atlas of cell phone companies. After a frustrating experience with a prepaid plan with a company with very little coverage out of the metropolitan areas of Puerto Rico and having made a good credit history I could get a cell phone in a good plan. I decided to do it with AT&T. Why? People told me it had a good coverage and service. I had also good memories of this company when I lived in Syracuse, NY, back in the 1980s. At that time cell phones were in the making, but the telephone service in my apartment, or should I say flat, was with AT&T and besides being very reliable and with lots of cool features their agents and operators were extremely nice, so I took a shot at AT&T cell. Some time afterwards AT&T was bought in many states of the USA by Cingular but in Puerto Rico this acquisition could not happen for some legal technicality.

Anyway, in Puerto Rico was Suncom who bought AT&T and AT&T vanished, even from tv; not only in Puerto Rico but in the USA I didn't see any commercial ads. Everything was Cingular and Suncom here in Puerto Rico. Sometime afterwards AT&T reappeared stronger and bought back Cingular and "now Cingular is the new AT&T" or so went the tv ad. In Puerto Rico too AT&T reappear but since I didn't have Cingular I continued with Suncom until a few months ago when, guess what? Suncom was acquired by T-Mobile. And that's my status as of today. Who knows what awaits for me tomorrow.

What does it all have to do with the economic crisis? Well, those dissapearances and reapearances of cell phone companies made me think how real those companies were because the stores, the infrastructure, even the people (employees of course) remained. The signs changed and the store and booth decoration did too. So, where do these companies go when they vanish, for example, where is Cingular right now? It looks to me as if many companies are just a bunch of investors buying and selling shares. Again, what does this have to do with the crisis?

The connection is not so straightforward but let me make a conjecture. My conjecture has to do with a simple economic law: Supply and demand. What if these companies (would it be fair to call them "paper companies"?) started to buy shares from each other every so often. Wouldn't it create an apparent demand on the stock market? From my point of view it certainly would. The result? With the demand, share prices rise and stockholders feel happy and as share prices rise banks are happy to lend money to investors. Looks like a good business, so banks feed this merry-go-round with fresh cash. Shares continue on the rise till...

That's right, till cash runs out. Overvalued shares, just like overvalued real estate. Years of apparent prosperity crash into reality. There is just so much money; it's a limited, a bounded resource; so, wake up. Game is over. Now, we have to face the consequences: yes, everybody, whether we like it or not. I guess, now it comes in handy the words of the Treasury Secretary Timothy Geithner as cited in the NY Times quotation of the day on Marh 27, 2009:

"Our system failed in fundamental ways. To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game."

A matter of simple economics

New York Times, March 26, 2009.
Quotation of the day:
"Our insatiable demand for illegal drugs fuels the drug trade. Our inability to prevent weapons from being illegally smuggled across the border to arm these criminals causes the deaths of police officers, soldiers and civilians."
SECRETARY OF STATE HILLARY RODHAM CLINTON, on a visit to Mexico.

Why hadn't the most capitalist of the capitalists realized that as long as there was demand there would be supply, not the opposite? It's Economics 101! What did it take for the USA government to admit that the problem was not just combating the supply? Was it that the violence generated by drug trafficking was too close to home and it started to massively enter their territory?

As a person born in Colombia, the most stigmatized country with drug traffic in recent history, I was surprised to read this quotation and the full article on that subject this morning. I was always puzzled by the way the "war on drugs" was handled. Millions of dollars were sent to producer countries to arm antidrug forces to destroy the marijuana crops, then coca and more recently amapola. And what about the spreading of glyphosate on those crops and its environmental impact. And what about the very high number of deaths in countries producing these kinds of plants or involved in drug smuggling? And what about the financing of terrorist organizations with drug money?

It's only till today that an American Government Official makes this admission publicly. And one can only wonder why not before? The war on drugs always looked like a waste of money because data indicated that the illegally crop-cultivated land was not decreasing; it has continued to grow. As long as there is demand for drugs there will exist supply. If the demand grows, prices increase, making the business more attractive. What interest was there that did not allow USA officials to see this simple economic principle. Was it a matter of image? Or was it some hidden interest?

What does it imply that Mrs. Clinton had made this admission? Would the war on drugs strategy change? It is my stronger desire it changes. If Americans cut their demand for drugs there is hope for a chain reaction: decreasing prices; production reduction; drug smuggling business becoming less lucrative and thus less attractive; decreasing income sources for illegal movements, including terrorist groups; decreasing political and economic influence of illegal organization; decreasing number of drug-related deaths, including American victims of overdose.

Do I have a reason for hope?