Liquid Assets

Keynesian economics tells a couple of very important things. Many of his basic points have already been talked about and talked about. Mainly, that when total demand falls and the fed overnight rate falls to zero then a very sick cycle develops. Total demand falls and so supply contracts, which causes a further erosion of demand, which. . .

The thing that is not talked about as much his his idea of employment as it actually exists. The economic theory of the time said that people would withhold their labor if there was a fall in real wages. This is absurd because people don't stop working when inflation goes up. Of course if inflation is very high then people will begin to argue for increased wages and may stop working at a particular place if they can find a better wage at another place. But people react when their personal basket of goods goes up in price. People are very sensitive to increases in prices of food and fuel. They are less sensitive to the cost of say televisions. It seems that people think of their personal money supply as important in so far as it procures them what they've come to expect in terms of goods and services.

Access to cheap credit should be looked on as part of the individual money supply. It has to be paid back but most people think of that as a cash flow issue. I have x number of dollars coming to me every two weeks, if I get a loan for y value which has a pay back of z every month then the loan calculation becomes 2x-z=d if d satisfies my normal expectation of a basket of goods and the utility of the good y buys plus the basket of goods that d buys is higher than the total utility of the of x over a given time frame then it makes sense to take loan y and cash flow d. If credit is cheap and, in the case of many of the house loans taken out oddly cheap, then d will be high.

The problem of basing this on housing prices is two fold. First houses are a illiquid asset. Its not easy to sell or buy a house. Second no one thinks in terms of thirty years. No one. I'm 26, I've changed so much over my life time that I don't know who I'll be at 56, nor do I know what my cash flow will be. So if I were to get a thirty year loan my basic time horizon would probably be at maximum 5 years. y+d if credit is cheap will always have more utility then x for 5 years.

But even this is complicated by the aforementioned fact that houses are an illiquid asset. If the house that Y bought ceases to have the utility it once had because for example I move somewhere else in the country due to getting another job then the utility of y+d may be lower than 2x.

The problem if further complicated by the ability to trade equity for credit on a house. Giving that to everyone is like credit card crack. You still have the utility of what y bought and some fraction of y. Basically you still have a house and a cash flow of d+c where c is the credit from the house. d+c may actually be higher than 2x. But this is only sustainable over the short term. But like I said I don't think anyone thinks of anything over the long term.

Now some people might say that I'm being foolish in saying that people don't think long term. How for example could 401k's exist. I'd say that the actual calculation is if x minus contributions to a 401k satisfies the desire for a basket of goods then people will save. If not then they will not.

I'll write more on this later.