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Does Investment Stimulate?

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February 23, 2009 – Comments (7)

I am thinking about a conversation with my 80 something year old neighbour around 2 years ago.  The conversation went something like me commenting that so much of my income went to mortgage that little of it went to stimulating the economy and that I thought the economy would grind to a halt if everyone had spending habits like myself. 

His reply surprised me.  He asked me what I thought happened to my mortgage money, it goes back to the bank and somewhere in the system it stimulates the economy and the whole thing gets cycled around.

This is part of the fairy tale fantasies of how the world works with this generation that frustrates me to no end.  On one hand how can they be so oblivious to the difference in where they were at say at my age and now?

I was told many lies growing up.  People believed them as truths, but time has proven them to be lies.  Go to university and you'll always have a job and you'll make good money is one.  I have seen tons of university educated people who's buying power isn't much different then what my mother's buying power was and she never finished high school.  There is no question that it is still better then not going to school, but that is what I've seen in an overpriced city.  The change isn't as dramatic everywhere, although the trend that way is everywhere.

So back to investment stimulating the economy.  Well, consider this man.  He owned 3 homes out right and got rental income from two of them.  Both he and his wife retired with pensions that I am sure were more then I was making because of my poorly timed choice to go into education at the beginning of a period where student teacher ratios increased by 10%.  It probably takes a new teacher 2-3 years of working full time to match his work pension, but then he also has his Canada pension, so make that about 6 years, so at about age 30 if one went straight through without any glitches.  But he also has those property's making an income, and 7 figures in the stock market, well, it was 7 figures when we had our discussion.

I lived my life with the believe if you scarifice and work hard early you will do well and I also expected by my age you'd have been mortgage-free for about 10 years.  I had the expectation that if I put my disposible income to my mortgage I'd have it paid off in my 30s.  This is what I taught to expect.  And at the rate I was going the mortgage would not be paid until I was about 60 and my entire adult life would be made of doing without things.  Crump, I had 3 homes and I never put window coverings in a single one, just left the developer blinds.

So, how exactly does my mortgage money stimulate the economy?  It doesn't, it goes to people with wealth and it sits there, as his money does.  It doesn't get recirulated at all.  And the transference of people with less paying people with more has been increasing over time.

If you want an active, vibrant economy all age groups need to have disposible income, and money that goes to mortgage does little to keep people in jobs.  The house they live in is already built.  

7 Comments – Post Your Own

#1) On February 23, 2009 at 1:24 PM, angusthermopylae (39.59) wrote:

I have long been skeptical of most theories of economics, especially when it comes to investment and the stock market.  If you were to look through my posts and comments, you would see things along the lines of "the stock market is a ponzi scheme", and "time is money, but not the way most people believe it is."

I think my father-in-law summed it up best:  "An economy can't be based on on everyone selling pizzas to each other."

What everyone forgets is that money, wealth, and value have to be based on the production of something...either original manufacture or real value added.   A farmer who raises and sells $100,000 worth of beef cattle has added a product with real value to the market.  It wasn't there before, and exists only because he put in the time, sweat, and skill to make it happen.

The same argument can be applied to steel manufacturing, IT hardware (and software...although it's fuzzier), home builders, auto manufacturers...the list goes on and on.  The list goes on and on, but it boils down to this:  Some hard asset was created through the labor and skill of a number of people.

(Or, in the instance of teaching, the "hard asset" is a child/adolescent with the basic skills to go forth and use their time and sweat to produce assets!)

Contrast that with other parts of our economy.  Take housing, for instance.  Homebuilders have been vilified, but at the end of the day, they have created a house.  Real estate agents and appraisers are important, but they only provide a service...that's it.  They do not add value, other than in the classic "Golden triangle trading route" sense.

Then there are the banks.  They "create" money through the loan process (yeah, it's one of the bases for our economy), and the whole process would be pointless without them...either only a few people would be able to afford a house outright, or people could only live in what they could afford to build (and living standards would drop precipitously.)

But when banks start bundling and selling mortgages to each other in CDOs and such, they are really producing absolutely no real value.  All they have done is rearrange the "value" added by your payments--and diluted them.

In essence, then, what happens is your mortgage is an IOU to the future, not the bank.  When the bank "creates money" by issuing you the loan, it has made a space in the economy that says "There is $300K of work going in here."  And you spend the next 30 years filling that space.

So yeah, your payments don't "stimulate" the economy, they attempt to fill a reserved spot with your time, skill, and sweat.  This may not be true in the "classic" sense of economics, but that's what it all boils down to.

In my humble opinion...but what do I know?  I'm just a goat-herder and blacksmith from Appalachia.

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#2) On February 23, 2009 at 2:27 PM, dwot (72.07) wrote:

I love your comment and it does go back to the basics, producing something.

Where do services fit in?  If I go for a massage there is nothing tangible.  How does that service differ from how the bankers would defend their services?  In my mind they differ a great deal as they are middle men.

I agree the home is a good thing, but when I look at the amount of labor that went it to making it and contrast to the amount of my labor to pay for it, well, it is way out of wack.

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#3) On February 23, 2009 at 2:51 PM, ByrneShill (76.90) wrote:

I agree the home is a good thing, but when I look at the amount of labor that went it to making it and contrast to the amount of my labor to pay for it, well, it is way out of wack

You are merely devaluing the homebuilder's work when you say that. And by homebuilder, I don't mean Toll Brothers inc., I mean the guy who actually hit the nails with a hammer. The carpenters, plumbers, electricians, etc... Building a house takes 1000's of man-hours, requires machinery (ever tried to dig a hole and build concrete foundations by hand? Didn't think so...), and then you have to pay for the building materials. I don't think anyone could possibly build a single modern-standard house in a lifetime if they tried.

And in the end, the biggest part of your house price (in BC at least) goes to... the land. Yep. For some reason someone decided that western Canada is running out of land. Never mind the facts that less than 3% of our country is inhabited and the technology to stack humans on top of each other for hundreds of meters exists, we're running out of land.

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#4) On February 23, 2009 at 3:14 PM, ByrneShill (76.90) wrote:

how the bankers would defend their services?

The service bankers provides is that of matching renters of money with loaners of money. Just like retailers who operate more efficiently (better distribution system, more desirable inventory, more catchy ads, etc...) make more money (eg Wal-Mart vs Loblaws), banks who operate more effectively (better risk management, better locations, etc...) make more money (eg Royal Bank vs CIBC).

 back to the basics, producing something

I agree, but you have to see "producing something" as larger than physical goods. For example, if I make an algorith to solve the traveling salesman problem, and apply it to the real world, I could potentially make any company who ever needs anything shipped (or shippers themselves like UPS or FedEx) save gazilions of dollars merely by optimizing shipping routes. Although in this case I have produced nothing (only optimized shipping routes), I have raised the productivity of a whole industry.

The same goes for the banks. By having extremely efficient money-renters/money-loaners matching operations, they lowers our cost of borrowing compared to what it would be if you had to knock on everyone's door to ask them to lend you money. Do not discount their services, for they are providing it, and they are providing it with great effectiveness.

On a final note, I'd like to say that finding myself defending the big banks is a very weird position to be in.

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#5) On February 23, 2009 at 4:32 PM, angusthermopylae (39.59) wrote:

ByrneShill,

I feel your pain:  " I'd like to say that finding myself defending the big banks is a very weird position to be in."   There aren't any absolutes ("All banks are bad" or "We should let them (whoever they are) just fail")

You are correct, and I agree, that "producing something" is larger than physical goods.  When I mentioned software, it was a nod along those lines:  All you are doing is arranging command for computers...perhaps in a novel form, but still just telling a computer to do what (almost) all computers are capable of doing.

Maybe a corollary to the "producing something" tenet would be "Valuable services are those that increase overall efficiency."  Take the aforementioned massage therapy vs. the aforementioned banking loan services as examples.

All jokes aside, a massage session is supposed to relax you.  If it works, and you work better, then there is arguably a value added (albeit a minor one) to the customer's life (and therefore society as a whole).  On the other hand, if it is a "perk" and is only a status symbol or a luxury expense, then there is little to no value added (of course, massage therapists need to eat, so they are getting something out of it.)

Now for the banks.  If arranging loans, moving money, and doing all the required paperwork and such to keep Uncle Sugar happy make the system work better, then you have a valuable service.

OTOH, if you have a system (or parts of it) that start to eerily resemble some of Tony Soprano's "business interests" (pushing loans with dubious or risky terms (no down-payment ARMs and Interest-Only mortgages, for instance), then have them bundle those packages and resell them to others ("Slick Willy has your tab, and he's wanting more vig!")....then you have a drag on the system.

...so, yes, I guess I'm defending bank practices, too.  Just not all of them.

**As a side note, I completely agree with your previous comment about the work that goes into actually building a house.  Those aren't skills the most people have.

OTOH, I'm not one to talk--the home I live in was originally built in 1834 as part of the Northwest territory settlement.  My grandparents bought it in the 1950s, and my parents bought it from them.  We have rebuilt, remodeled, and added onto it since we've moved in...and it has been mortgage free since the mid-90s. Last guess was that our is about four times the size my grandparents had, and its value (for tax purposes) was about $350K.

Would I suggest DIY houses as the way to go?  Only if that's what floats your boat.  It's hard work, unending work (my wife calls the house "Rose Red!"), and your local building codes may not allow it. And for lots of people, the time spent on building the house would be more "productive" doing other things.

But if you are inclined (and don't ever plan on moving  out), it's about the only way to get ahead without risk.

(And there is the main issue:  If you never move, then you can never "recover" the value....but you live in a big, expensive house.  Kind of goes against the grain, doesn't it?)

I also helped build my brother-in-law's house...which gave him a $90K+ house for less than $30K.   Again, long, painful process with good rewards.

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#6) On February 23, 2009 at 5:55 PM, dwot (72.07) wrote:

ByrneShill,

And you are devaluing the everyone else.  

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#7) On February 24, 2009 at 10:28 AM, ByrneShill (76.90) wrote:

Like it or not, you and me can't build our own houses with our bare hands. Neither can we build our own cars or even just our kitchen sinks.

And I'm not devaluing anything. If I work 1000 hours to afford something that took a bunch of skilled workers a total of 1000 man-hours to build I hosnestly think that's fair.

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