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Author Topic: Explain the failing economy to me  (Read 2590 times)
Navigator2001Plus
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« on: March 08, 2010, 08:38 pm »

In my non-expert opinion, it looks like much of the problem is big corporations cutting jobs and hours and pay as much as possible to increase profits. This leads to the working class not being able to afford the products these companies are selling, leading to them needing to cut even more jobs, and a vicious cycle gets started.

Is that close to accurate? What other factors are there that I'm not thinking of? How would you fix the economy if you could magically control every company? Or does the problem lie more with government policies?

In my (again, non-expert) opinion, things would be alright if somehow you could get every company to not cut jobs and increase wages a little bit, at the expense of some profit, but you'd see bigger returns later on as those workers would have more disposable income. Is this stupidly naive?
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« Reply #1 on: March 09, 2010, 03:08 am »

It is not just about profit margins. When we had that run of bank collapses, credit tightened up, and taxes did not decrease - some business tax rates actually went up as the various governments tried to claw back some of the bailout money.
So any business now is paying more in tax, selling less, has a difficult time getting credit for expansion and overheads, and in a lot of cases is having to chase payment for goods already shipped. All while banks are demanding repayment of outstanding financing.

The logical thing is to ride it out, but corporations have, by law (here in the UK and I assume it is the same in the US) to have enough cash to cover their operating costs. Businesses which don't get put into administration. The big 4 accountancy firms here have been milking this for all it is worth, as they report a company, then get guaranteed fees for winding it down.
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Karlski
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« Reply #2 on: March 09, 2010, 08:49 am »

You also need to realise that businesses as a general rule don't like having actual cash money. If they have money sitting around waiting to be spent, then that is basically costing them money because it could be being used to make more money - what's called opportunity cost. So most businesses run on credit, of a sort; they get their goods or whatever that they use to make money and then pay their suppliers at the end of a set cycle.


Now, if credit dries up - if the suppliers don't have credit to run their businesses until they get money from the businesses in question - then the suppliers can't extend credit to the companies, the companies can't get the capital needed to get supplies to continue trading, and everything falls over in a heap.
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« Reply #3 on: March 12, 2010, 03:09 pm »

big corporations cutting jobs and hours and pay as much as possible to increase profits.

That is actually a reasonable definition of competitive capitalism. Companies have to always hone costs (staff, infrastructure, logistics etc) just to keep up with or try and get an edge over their competitors.

In good times it's no problem; more profitable companies will expand and increase or improve the products or services they offer, so leading to new job opportunities, and it gives existing employees a chance to move up the corporate ladder or jump ship to someone else.

The problem now, as Karlski pointed at, is credit. Most corporations use borrowed money, and lending & borrowing money all comes down to confidence. If a lender doesn't have confidence that they'll get their money back, they won't lend, or will charge higher rates to reflect the perceived riskyness. That means the company has either less money to spend, or has to devote more cash to servicing it's debts.

At the moment, there is tons of money swilling around the worlds financial systems, but a lack of confidence means it isn't being used productively.
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MWB
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« Reply #4 on: March 13, 2010, 06:06 pm »

You need to listen to these episodes of This American Life:

The Giant Pool of Money

the second part of Return to the Giant Pool of Money

Bad Bank
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MWB
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« Reply #5 on: March 13, 2010, 07:05 pm »

oh and also Another Frightening Show about the Economy
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Parcae
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« Reply #6 on: March 27, 2010, 05:18 am »

Nav, the problem you're describing is called underconsumption. It is not specific to this economic cycle. Marx thought that it would be the death of capitalism, as a larger and larger gap opened between demand and supply. It was in fact the main basis of his critique of capitalism.

The reason why this does not happen over long periods is called Say's Law: supply creates its own demand. It works something like this:

An economy produces only two things: laptops and hamburgers. A laptop factory fires a worker to cut costs. It makes more profit. The profit goes to the shareholders. The shareholders buy celebratory hamburgers with the money. The hamburger place needs to expand to meet this demand, and therefore hires the worker who was fired.

The basis of Say's Law is that money does not evaporate. If a business sells something (supply), the money from that sale goes to people who will use it (demand).

Keynes modified Say's Law by introducing a factor he called "animal spirits." To revert to the example above, during a downturn, the shareholders might save their windfall profits from firing the worker because they're worried they might be fired themselves. The hamburger place might not hire a new worker to meet the new demand because they're afraid that they might get hit by the recession, even though it makes long-term economic sense for them to hire. Therefore, in the short term, the money actually does evaporate - or rather, it's put in savings accounts, which amounts to the same thing. Keynes did not dispute that Say's Law operates in the long run, but as he put it, in the long run we are all dead. In the short run, governments need to intervene to make up the demand shortfall. That is the reason for Obama's stimulus package.

Businesses making cost savings by firing workers is part of the normal process of innovation. All efficiency gains, from factories to computers, by definition mean that the same job can be done by fewer people. Problems only arise when new jobs aren't created to replace the old ones.
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« Reply #7 on: March 28, 2010, 12:50 am »

Businesses making cost savings by firing workers is part of the normal process of innovation. All efficiency gains, from factories to computers, by definition mean that the same job can be done by fewer people. Problems only arise when new jobs aren't created to replace the old ones.

Wrong. Let's say I run a 3PL transport company. I decide I am going to boost efficiency by replacing my fleet with newer vehicles and optimising their travel paths and loading/unloading points. I am now able to do more shipments per day with the same number of vehicles and staff, thus boosting shareholder value without removing any workers.

I know it's a nitpicky point but it is an important one.
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« Reply #8 on: March 28, 2010, 01:44 am »

In your example, more can be done by the same people, which is equivalent to saying that the same can be done by fewer people. If you have the market for more shipments per day, you'll make them. Otherwise you'll cut workers.

Productivity is defined as output per worker. Leave the output fixed and you have fewer workers.

The basic point that I'm trying to make is that businesses have been cutting workers to lower costs since Imhotep noticed that he would only have to work 1,000 slaves to death instead of 10,000 if he used rollers for the big blocks of stone. It only becomes a problem when there's a problem with new job creation.

(It can also create income distribution problems, but that's not the point that the OP was making. I think.)
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« Reply #9 on: March 28, 2010, 03:05 pm »

I don't know if anyone's shown you this yet, but if you don't have a solid grip on the whole credit crisis thing, this was incredibly helpful for me. He does a great job visualizing everything and it makes the explanation far easier to understand.
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MWB
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« Reply #10 on: April 19, 2010, 06:37 pm »

Over the weekend you may have heard how the US Government is suing Goldman Sachs for creating mortgage-backed securities that were literally designed to fail. These securities consisted of risky mortgages lent to people who would almost definitely never be able to pay them back.

Why would Goldman Sachs create such a shitty investment? Because they were in cahoots with hedge funds that were betting against the securities, buying insurance policies that would pay off big time when they failed. They pumped the market full of these things, made everybody think they were safe, then when homeowners started defaulting, these bankers and hedge fund managers made billions while everyone else lost their shirts.

A week before the announcement This American Life had a story about exactly that kind of scheme, told in very clear layman's terms. It is a must listen.
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