Posts tagged USA

Story of an Island named Earth: Making of Housing Bubble and Growth of Inflation

October 27, 2008 · Filed under Finance · Tagged , , , , , ,

This is a post specially meant for the uninitiated in economy and economics. I think this will be very useful for people who are not able to comprehend what is happening to their respective national economies, people who don’t understand what is the reason behind failure of banks and crash of stock markets world over, and people who are fond of living off on credit(loans/credit cards).

The following explanation, extremely simple and understandable, presents a clear picture of what happened to the US economy and what is happening right now. I got this as a forwarded mail and I thank the sender (ankur deshmukh) for this great mail:

“Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars as there were only two pieces of 1 dollar coins circulating around.

1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
2) B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
* The net asset of the country now = 3 dollars.
3) Now C thought that since there is only one piece of land in the country, and land is non producible asset, its value must definitely go up. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
*A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.

* Thus, the net asset of the country = 4 dollars.

4) A saw that the value of the land he once owned has risen. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The
payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.

* The net asset of the country = 5 dollars.

” A bubble is building up.”

(5) B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollars. The payment is by borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
* As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.

* The net asset of the country = 6 dollars; even though, the country has only one piece of land and 2 Dollars in circulation.

(6) Everybody has made money and everybody felt happy and prosperous.
(7) One day an evil wind blew, and an evil thought came to C’s mind. ‘Hey, what if the land price stop going up, how could B repay my loan? There is only 2 dollars in circulation, and, I think after all the land that B owns is worth at most only 1 dollar, and no more.’
(8) A also thought the same way.
(9) Nobody wanted to buy land anymore.
* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net asset is still 2 dollars, his heart is palpitating.

* The net asset of the country = 3 dollars again.

(10) So, who has stolen the 3 dollars from the country? Of course, before the bubble burst B thought his land was worth 4 dollars. Actually, right before the collapse, the net asset of the country was 6 dollars on paper. B’s net asset is still 2 dollars, his heart is also palpitating.
(11) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollars bad debt to B, but in return he acquired the land which is worth 1 dollar now.
* A owns the 2 coins; his net asset is 2 dollars.
* B is bankrupt; his net asset is 0 dollar. (He lost everything)
* C got no choice but end up with a land worth only 1 dollar

* The net asset of the country = 3 dollars.

************ **End of the story; BUT ************ ********* ******

There is however a redistribution of wealth. A is the winner, B is the loser, C is lucky that he is spared. A few points worth noting:
(1) when a bubble is building up, the debt of individuals to one another in a country is also building up.
(2) This story of the island is a closed system whereby there is no other country and hence no foreign debt. The worth of the asset can only be calculated using the island’s own currency. Hence, there is no net loss.
(3) An over-damped system is assumed when the bubble burst, meaning the land’s value did not go down to below 1 dollar.
(4) When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the losers. The asset could shrink or in worst case, they go bankrupt.
(5) If there is another citizen D either holding a dollar or another piece of land but refrains from taking part in the game, he will neither win nor lose. But he will see the value of his money or land goes up and down like a see saw.
(6) When the bubble was in the growing phase, everybody made money.
(7) If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A) and take part in the game. But you must know when you should change everything back to cash.
(8) As in the case of land, the above phenomenon applies to stocks as well.
(9) The actual worth of land or stocks depends largely on psychology (or speculation). “

I hope this helps everyone to understand the enigma of economics in the most basic terms..

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Russia calls for Europe to freeze out US

October 17, 2008 · Filed under Geopolitics · Tagged , ,

http://www.telegraph.co.uk/news/worldnews/europe/russia/3159998/Russian-president-Dmitry-Medvedev-calls-for-Europe-to-freeze-out-US.html

By Adrian Blomfield in Moscow
Last Updated: 6:33PM BST 08 Oct 2008

President Dmitry Medvedev speaking at the World Policy Conference in Evian, France

President Medvedev blamed Washington’s ‘economic egotism’ for the world’s financial woes Photo: AP

Confident that a spat with Europe prompted by Russia’s invasion of Georgia in August was over, Mr Medvedev arrived in the French spa town of Evian determined to woo his fellow leaders into creating an anti-US front.

Gone was the kind of war time rhetoric that saw Mr Medvedev lash out at the West and characterise his Georgian counterpart Mikheil Saakashvili as a “lunatic”. Instead Mr Medvedev spoke of a Russia that was “absolutely not interested in confrontation”.

Yet there was little doubt that Mr Medvedev was playing the divide-and-rule tactics of his predecessor Vladimir Putin by seeking to pit the United States against its European allies.

In a speech delivered to European leaders at a conference hosted by President Nicolas Sarkozy of France to discuss the international financial crisis, Mr Medvedev sought to show that the United States was at the root of all the world’s problems.

He blamed Washington’s “economic egotism” for the world’s financial woes and then accused the Bush administration of taking Europe to the brink of a new cold war by pursuing a deliberately divisive foreign policy. He also maintained that the United States was once again trying to return to a policy of containing Russia.

“After toppling the Taliban regime in Afghanistan, the United States started a series of unilateral actions,” Mr Medvedev said. “As a result, a trend appeared in international relations towards creating dividing lines. This was in fact the revival of a policy popular in the past and known as containment.”

While he called for a cooling of the noxious rhetoric that has blighted East-West relations in the past two years, Mr Medvedev clearly laid the blame for the deterioration on the United States, which he said was again viewing Russian through the prism of the Cold War.

“Sovietology, like paranoia, is a very dangerous disease, and it is a pity that part of the US administration still suffers from it,” he said.

To remedy Washington’s ambitions to play the global policeman, Mr Medvedev proposed an overhaul of the world’s security and financial structures.

In order to end the “unipolar” model in which the world depended on the United States, he proposed creating new financial systems to challenge the dominance of the International Monetary Fund and the World Trade Organisation, both of which had fallen under Washington’s spell.

Slamming the enlargement of Nato, which he said had advance provocatively towards the borders of Russia, he also proposed drafting a new European Security Treaty. While Russia has insisted it is not intending to supplant Nato, Mr Medvedev made it clear that the US-dominated alliance was partly responsible for the war in the Caucasus by its failure to rein in Georgian “aggression”.

If the tone was softer, the theme of the speech was familiar, and drew comparisons with an address by Mr Putin in February last year in which the former president, now prime minister, railed against US “hyperpower”. Many observers say that address heralded the beginning of a new era in East-West confrontation.

“Medvedev’s speech was more balanced than previous ones, but it was still permeated with criticism of the United States,” said Nikolai Petrov, a Russian foreign policy expert at the Carnegie Centre think-tank in Moscow. “He curtsies to Europe but what he proposes is ultimately anachronistic rather than constructive.”

To what extent Europe will warm to Mr Medvedev’s policies is uncertain. It is clear, however, that Russia’s diplomacy with Europe’s major powers – Britain aside – has been remarkably successful in the aftermath of a war that saw Moscow branded an international pariah, even by traditional allies like Germany.

The Russian president won fulsome praise from Mr Sarkozy after he announced that all Russian troops had been withdrawn from buffer zones around Georgia’s rebel enclaves of South Ossetia and Abkhazia before Friday’s deadline for a pull out.

Describing his guest as a man who had “kept his word”, Mr Sarkozy immediately declared that talks on an EU-Russia partnership deal, suspended as punishment for Russia’s military operation in Georgia, could resume.

Russia has also mended fences with Germany, concluding a new bilateral energy deal and winning assurances from Angela Merkel, the chancellor, that Berlin would not support granting Georgia or Ukraine Nato candidate status when the alliance meets in December.

While Russia may have pulled out of undisputed Georgian territory, Kremlin critics fret that the EU has won a pyrrhic diplomatic victory. Russia has doubled its troop presence in Abkhazia and South Ossetia in contravention of United Nations resolutions and in defiance of earlier EU calls, which now appear to have been dropped, to withdraw to pre-conflict positions.

Despite international condemnation, Russia has also unilaterally recognised the independence of both provinces, a fact that observers say could cause instability in the Caucasus for years to come.

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