Why Another US Recession Is On The Cards (and possibly worse)

During the recent US political bickering about its national debt, I’ve had many conversations and read many articles about everything from causes to potential solutions to downright frustration. I was thinking about writing an economics focused blog post for a while, and the current debacle has given me some motivation to write about.

So, going back to the title of this post – I agree with those who are contemplating that another US recession might be right around the corner. The one thing we do know for sure is that the US is still in recovery mode from the Great Recession caused by the financial crisis in 2008. And now, we have all been witnesses to the US government being on the verge of default. Thankfully, Congress came to at least some sort of agreement and was able to increase the debt ceiling. Unfortunately, it wasn’t enough to convince S&P Credit Ratings Agency to downgrade the US debt from AAA status to AA+ (basically from complete assurance that the US government would pay the interest on its debt on time to some assurance. The world markets responded in dramatic fashion, with major stock indexes around the world falling more than 5% in single day’s of trading. They financial markets certainly did not behave as if “the US still has an AAA rating”, as President Obama said in a recent speech. I’ll come back to this debt assurance downgrade in a bit

The proposal finally accepted by Congress when the debt ceiling was increased consisted entirely of spending cuts with no tax increases. Right after one recession, such fiscal policy is risky. Unemployment is already high, and GDP growth (economic growth) has relatively stagnated. Because government spending is a direct injection into the economy which increases GDP, from a purely economic standpoint these cuts will hurt the economy more than any equivalent tax increases. Tax increases provide additional income to the government which can be reinvested into the economy. During tough times, people save more and invest less…so by tax increases the government would be reducing savings, and injecting those foregone savings back into the economy. What I’m basically saying is that tax increases would hurt the economy less than spending cuts. Either way though, by trying to balance its budget during non-boom times, the government is risking putting the economy back into recession.

Back to the ratings downgrade – because of all the political bickering on Capitol Hill and an unsatisfactory solution by Congress to the debt problem (complete solution the problem has once again been postponed), The US’ creditworthiness has been put into question. It will now be much harder for the government to borrow more funds in the future, and it will only have to pay greater interest on the bonds it issues. (The US government borrows money by issuing IOU bonds to investors and promising interest on those bonds). With increased borrowing costs, the government will have a much harder time fiscally stimulating the economy the way it did back in 2008…so even if somehow politicians unilaterally accepted that for the sake of economic recovery more spending is needed…the government would only make a lesser impact than with an AAA credit rating.

Another option the government has for spurring economic recovery is expansionary monetary policy…but that has its own problems attached such as increased inflation. Now, inflation would be good for the government as its debts would be worth less, but high inflation would harm the economy overall. Another interesting solution I’ve read about involves the Federal Reserve (the bank the government borrows lots of money from) just forgiving the almost 2 trillion dollar debt the government owes it. This sounds like a great idea, but I’m unsure what negative consequences this would have. Perhaps the Fed’s weakened ability to loan funds to banks?

The fact of the matter is that the US economy is once again in peril. Spending cuts will hurt the economy overall, and tax increases wouldn’t do much better (they would still hurt the economy overall). The government could inflate its way out of debt, but that has potential catastrophic results for the public which suddenly will be able to afford less goods. In my humble opinion, the government should go for a mixture of all three policies and hope for the best in terms of corporate economic growth. Otherwise we may be heading for the collapse outlined so convincingly in this awesome video: http://www.youtube.com/watch?v=Jjv-MtGpj2U

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Why Absolute Selfless Altruism Does Not Exist

I have often had conversations with people who maintain that charitable or altruistic acts sometimes are committed in the strictest sense of selflessness – without any gain to the charitable person. I like to disagree. After discussions every now and then with family, friends, and teacher’s I’ve developed some reasoning to back-up the statement: absolute selfless altruism does not exist. I’m going to be referring to utility in the economic sense, so if you are unfamiliar with it, this is a good starting point to learn more.

I’m going to stay away from biological evolutionary altruism for the time being and focus on the everyday ethical notion of altruism. So, here goes – selfless altruism doesn’t exist because of the very existence of a motivation for the altruistic act. The person helping concludes that his/her help will make someone better off than before. And it is this knowledge which makes absolute selflessness (change in utility < 0) impossible, because this knowledge is in itself a utility gain to the helper. I’m basically arguing that from an economic standpoint, the person helping is always gaining something – it may be a concrete sense of goodwill, or just the simple knowledge that they have helped someone (this knowledge implies (at the very least, some) satisfaction, and hence I consider it to be a utility gain). Therefore, I contend that all acts of generosity have some degree of self-interest attached.

A counter-example I was given to this reasoning was the story of a boy who lost his life saving his younger brother in a flood (the younger brother survived). But how could the boy have been acting with self-interest if he risked his own life you ask? I responded that this example too fits in within my reasoning that selfless altruism does not exist. But how could the boy have been acting with self-interest if he risked his own life you ask? (Please note now, that I highly admire the courage of the boy, and in no way mean to disrespect his efforts in saving his younger brother) My answer is the following – it’s not the question of what the boy gains from death that’s important, but the notion of  absence of gains from living, i.e. the boy subconsciously concluded that surviving and losing his brother would be much, much worse for him, then death and the knowledge of the survival of his brother (or the possibility of both of them surviving somehow).

At the heart of this argument is idea that economic self-interest reigns supreme in all decisions. And by no means do I want to discredit any acts of generosity as purely selfish (they’re obviously not). What I do want to discredit though is the negative connotation which often arises when someone mentions self-interested altruism. Humans are self-interested as well as social animals. This is not a dichotomy, nor a paradox. Humans can help others while being self-interested and vice versa. In fact, I’d love to see an economic theory one day which is not based around maximizing personal utility, but based around maximizing a mixture of personal and group utility. I believe that there is nothing wrong with helping someone to feel good. From a utilitarian perspective, such acts of generosity are extremely efficient and effective. And even from a moral one, I don’t think there’s anything immoral in this. In fact, under some schools of philosophy, this is completely moral.

Continuing with a connection to a previous blog post in I mentioned Ayn Rand and individualism – although Rand considered herself the ultimate individualist, I don’t consider her to be such at all, because the ultimate individualist should appreciate the self-interest present in altruism. Rand abhorred philanthropists and in The Fountainhead, on numerous occasions mocked them for being charitable only to feel good. What Rand ironically missed is the individualism being displayed by the philanthropists. In fact, the feel-good-factor itself undermines Rand’s distaste for the altruistic.

I sincerely hope that I have convinced those initially disagreeing with me that ‘selfless’ in the everyday sense is actually meaningless, and that there is nothing wrong with the idea of self-interested altruism. I encourage people to be as charitable/generous/philanthropic as they can, because they will be maximizing not only the additional utility they can give to someone else, but also to themselves.

On the Value of Value Investing

In my last blog post, I mentioned that largely individual disregard for negative externalities and high risks was a major cause of the financial crisis of 2007-2010 in which institutions engaging in trading complicated CDO (collateralized debt obligations), ABS (asset backed securities) and other similar synthetic financial ‘products’ managed to derail the entire global financial landscape forcing governments to step in and clean up the mess left by high risk, short-term oriented financial strategies. For an industry which lauds free-market principles, government intervention must have been a real blow to the strict belief in ‘market fundamentalism’. An article by Joseph Stieglitz, renowned economist, which asserts the relevance of Keynesian economic policies today also mentions the “incompetence of financial institutions in assessing risk and creditworthiness” – functions which should be paramount to any monetary lending activities.

While I will focus on the importance of reevaluating Keynesian policies over supply-side economics in a future post, I’m going to make the rest of this post be about niches of the finance industry which do focus on the long-term, try to assess external risks and creditworthiness meticulously, and why more of such practices are useful for any macro-economy.

This niche that I am talking about are institutions and individuals engaging in value investing – investing in stocks and equity based on their perceived intrinsic value and a future rise in this value. Benjamin Graham was one of the prominent founders and proponents of the theory of value investing beginning in 1928, and he was also the mentor of the most famous and successful value investor today – Warren Buffet (Buffet has ventured into the exotic credit derivatives world too, but for the most part he has been a value investor).

While value investing offers significantly less returns than high risk trading, the lower individual risk also corresponds with lower losses and ultimately lower risk to the external financial environment. The great upside to this investment strategy though is that it incentivizes investment in firms with perceived high value (optimistic future prospects (vision), stable management etc) and also provides incentives to firms to engage in activities which raise their value. If a high value is associated to firms with a perceived net positive on the world, then this form of investing can be considered a representative of the compromise of individual- and group-interest for the realization of both private profits and community profits (i.e. economic growth, more jobs, technological development etc). Examples of where the value investing mentality has made tremendous impact is in start-up technology companies. Companies such as Facebook and Google have through initial funding based on (at least some) value investing principles grown into organizations with widespread positive social impact (just think of the recent Arab revolutions), and in the case of Google have already churned out massive profits.

With the boom in internet companies and increasing interest in renewable energy, value investing in the form of increased venture capital and growth capital should lead the way and signal to other large financial institutions (such as investment banks with private equity departments) that value investing can yield long-term private profits and social profits too.