Sunday, November 27, 2016

Electoral frauds

Due to the emigration increase in recent years (as we have covered extensively here, with the right figures, quite different from the optimistic numbers released by official media), the votes of those Italian citizens living abroad may be decisive for the outcome of political elections and referendums.

Just consider that at present there are more than 4 millions of Italians living abroad: those who are more than 18 years old, can vote. Let's suppose that they are roughly 3 million.

Typically elections are won by a party that gets a few hundred thousand votes more than the opponent.

So, the more emigration rate from a country, the more important the votes of those living abroad become for the outcome of elections of referendum. We can say that they hold the balance of power to steer the elections towards the government

If you live in Italy, and you go to the local polling station, before effectively voting inside the polling booth, you have to:

1. show your ID
2. put your sign to the local election ledger

So, one ID, one signature, one vote.

I have recently moved to live to the Netherlands, and I got all the papers to vote by mail for the next Italian referendum on 4 December 2016.
You see, I put a vote on the voting paper, but:

1. no ID required
2. no signature required

Theoretically, I could have grasped 30 voting papers from some friends of mine and put my vote on them, and send them all from the postal office of my town.

There is something that is even worse: the papers are printed not by the Consolate, but by an external real estate company. Who controls how many of these voting papers are sent and to whom, in particular the cross-check between the address of the person reached by the mail and the vote? I can tell you more: nobody can tell that the external envelope, addressed to the local Consolate, was coming from me or from somebody else.

Welcome to the Italian Banana Republic: everybody talks about the importance of Democracy but nobody is aware of the tricks that may compromise the only and most import tool of Democracy:

one adult = one vote

I do not think there is any conspiracy theory: dilettantism, superficiality and ignorance in the public affairs, and, whenever there is a combination of these three ingredients, somebody will take advantage.

Tuesday, November 22, 2016

Why poor get poorer

Today I was thinking about one of the reasons why poor people get poorer.

Of course there may be many different reasons: education, government policy, de-industrialization caused by globalization, etc.

But, for a family, there is indisputably a key factor that makes things better or worse: the access to cheap credit.

Let's make an example: let's suppose that your monthly salary is  2,5 k€. Now, you want to apply for a mortgage. Let's suppose that the mortgage you need is for buying a house which is worth 300 k€.
The bank tells you that if you ask for a mortgage which covers no more than 60% of the value of the houe, ie you have savings for the remaining 40% , then you are given an interest rate of 3%.

Instead, if you ask for a full mortgage, that is the mortgage covers the full price of the house, they ask you 4.5% of interest rate.

For a thirty years old mortgage, let's see what this means.

First case: you have savings. Monthly payment: 912 €

Second case: you don't have savings. Monthly payment: 1520 €

In the second case, the monthly fee is 67% higher.

In the case "no savings", the weight of the monthly payment becomes 60% of your salary, so it is likely that the bank will not even give you the mortgage, unless they are provided with extra-collateral, ie not only the house that you are about to purchase, but also the house of your parents.

And, if the real estate market is in a bubble condition, so prices are high, and you cannot provide extra collateral, chances are you will be obliged to stay under rent. So, your landlord will become richer and you will become poorer because you are paying the landlord.

You can imagine that in such conditions, poorer will become poorer.

So you may end up saying that a policymaker that eases, thanks to low interest rates from the banks, the purchasing of property for poor people is a hero. This is wrong. You see, you should FIRST ask yourselves why real estate prices have risen so much in the last twenty years, with respect to stagnating wages. If you grant, by means of a political decision, easy credit to everybody, everybody will buy a house, and prices will skyrocket so we will only generate a bubble that, sooner or later, will pop leaving families without a house, since the residual value of their dwells will not cover the mortgage they still have to pay. This is exactly what had happened in 2008 in the USA. As soon as the teasing mortgage period ended, ie you had to start paying back the principal AND the interest, not only the interests, families could not pay back the monthly fee and, since there was no more demand for extra houses (because everybody had been speculating on buying a first, second and maybe a third house) they could no long sell the old house at a price that was higher than the original price they had paid for at the beginning. The house of cards collapsed. Everything was generated i) by the silly political decision to grant a house to everybody and ii) the large use of financial instruments that kept hidden the risk of a collapse. Again, these financial tools had been de-regulated by the government and their used spread out without control. Again, with the ok of the government, that turned their eye to the other side.

The real issue, here, is that real estate has grown much more than wages. This has prevented many families from affording to buy a decent house in a decent district in a decent town for years.

In a nut shell, one of the most important reasons behind having middle class people getting poorer is the fact that real estate market has skyrocketed, wages are flat, no possibility for extra savings, so high cost of credit from banks, or longer duration of mortgages.
Don't believe government when they say they grant easy money and easy policy for common people: it is going to have a very temporary effect. Stay out of debt for easy consumption or for expensive houses and keep savings for project that will lead to an increase of income in the future.

Monday, November 21, 2016

Why there is no inflation?

After taking a break, discussing how inflation is measured by the government (and the methodology is completely wrong and meaningless for an average family), it is time to spend some words on the reasons why inflation has dramatically decreased in the past years.

We have already seen that commercial banks expand their balance sheets when they create loans and mortgages to people and firms. Then, this money can be further multiplied according to the fractional reserve mechanism.
The money that a bank makes available to the people, is money that people can spend on houses, goods and services, so, unless it is saved, it concurs to inflation of assets, goods and services. If there is contraction of the money that is lent out, then what happens next is simple: since the money of the interest has not been created yet, credit contracts, and the values of assets like houses decreases because people have not money to buy things. This is a very simple yet effective explanations.
Let's make it clear: this is not the only cause of deflation. Deflation, ie negative inflation, is caused by many drivers, like:

  1. Globalization, so well-paid manufacturing jobs moves to Asia or to developing countries: unemployment in Europe and USA raises, people have less money, and they cannot afford the same standard of living they used to have years before.
  2. Previous excess of credit: thanks to government and central banks policies, banks used to give credit to people who would hardly pay the debt back. Thanks to this kind of stimulus, people made debt over debt, until the values of the assets (houses, mainly) was so high that people could not pay the principal back with the interest. This is what happened in 2008.
  3. Credit has been mainly confined within the financial domain since 2008, ie too little money for long-term investment, Research and Development, real jobs. Thanks to financial deregulation, for banks it has been much more profitable and less risky to invest money into financial products for many many years in a row than to give credit to firms and enterprises, that could default. This has caused a huge disparity between the richness of finance, ie the banking system, and the people. A rich guy, who earns 1000 times an normal family, does not need 1000 mobile phones, 1000 houses, 1000 cars and so on. So, the shrinking of the middle class is one of the most important drivers to deflation. 
  4. Robotics: this point is still not so known, but if in a factory you can replace 1000 workers with a few robots, you can understand that, unless the demand of products skyrocket because people with a decent salary are increasing in number, or the jobs created by the use of robots compensate for the loss of manufacturing labor, then things are going to cost less and less. Since there is overcapacity everywhere, a further excess of supply will only decrease the cost of the product. Unless China, India and others start consuming like developed countries and become net importers, no more net exporters. This will not be the case for many, many years to come.
  5. Shale oil and shale gas: this is part of technology innovation, again. There is a gut of oil supply thanks to new technologies and this situation may not reverse for some years.
The main reasons why we do not see inflation in USA and Europe, even now when Central Banks have put trillions of dollars, yens and euros into the banking system, is because this money has been confined to the bank reserves, invested in financial products, while at the same time globalization has kept salaries low and there is no more room for families to get extra debt: it is difficult to get a 40 years mortgage if you are 35. There is limit to the duration and entity of a debt, since an average family father cannot work for 50 years to repay a mortgage. 

Can inflation raise again? yes, if:
1. Protectionism raises: if the USA start imposing tariffs on imported goods, inflation will raise, since the USA are dependent on China for many goods.
2. Central banks start putting money into people's bank accounts. People will start spending, and inflation will raise. Of course, they will buy China stuff, so China will be super happy of such a silly decision.
3. the USA decide to invest trillions in R&D, so in fields with a high added value, on repairing also bridges, roads, etc. So, if the USA starts to run important deficits. People, again, will spend more and will buy Chinese.

In any case, I decided to fix my variable mortgage rate for the house I have in Italy, and take a fixed mortgage rate. I think it is time to move from a Euribor indexed mortgage to a fixed one: even if interests should go down further, I think it is a wise move now to block the monthly payment to a known sum, which is now very low. I succeeded in getting 1.5% for a fixed rate mortgage, 13 years duration. It was 2,2 six months ago, so I think it is time to go for it.

And it is time to buy a house in the Netherlands: of course, at a discounted price, since there are many people who may go to retirement and need cash to provide for their pensions. Whether or not I can get a house at a 20%+ discount, that's another story.
It is also possible that between 2017 and 2019 another collapse may come, due to another eurocrisis, or to the students' and corporate debts in the USA. I don't have the crystal ball. So to get a 20% discount on the price of the house may also be a buffer for another real estate crisis.

Let's see.

Friday, November 4, 2016

Inflation: lies and reality

What is commonly referred to as "inflation" should be the general raise of the price of goods, services and assets.
The American Bureau of Labor Statistics defines inflation as "a process of continuously rising prices or, equivalently, of a continuously falling value of money".
As we already saw, the typical gauge for measuring inflation is the CPI, ie the consumer price index.

Unfortunately, this indicator is, to use an euphemism, biased as a minimum. The government has all the interest to keep this metric as low as possible.

Now, the average citizen may be confused: once we are told that inflation, measured by the CPI, should be as low as possible since it is a kind of hidden tax for the population.
This blog was born to help those people, who are not experts in economics, to understand the world we are living in today, from a different perspective. This blog is aimed at helping the family father, and especially those people questioning about the origin of this epochal change that media continuously refers to as "crisis", those people who had to emigrate from Italy to find better opportunities. I am not an academic, I did not study economics in a college, I am an engineer and I like the fact that I study things with my personal lens. I try to explain complex things in an easy way, focusing on what really matters. So, you won't find "conventional"explanation of what inflation is, how money is created, that you can find in all mainstream media (if it was possible...). I follow my ideas, simple as that, and I document my findings. In any case, this approach let me leave Italy, change job, find a house, etc. and I couldn't have done it had I been attached to my previous "economic"convictions.

Note: we have already seen that the real problem with inflation is "who gets the new money first?" dilemma. Nobody talks about this.
Then,  we are told we are in risk of deflation, ie negative inflation, ie the prices are lower today than one year ago, we are told it is a terrible thing because people don't spend today but will wait for the prices to go down before doing purchases.
Note: The real issue here is the capability of a government to repay its debt, but it is a long discussion that we will cover in another post.
So, we are told that a good inflation is around 2% per year. Why exactly 2%? that's the first mystery.

There are many points here that are incorrect as a minimum. And I think it is worth to spend some words to clarify a bit the whole subject. Today we are going to cover a bit the CPI, to give some hints and clues for a curious family father to investigate further in the topic.

The CPI is a gauge that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. "Weighted" average means that, if we consider the ingredients in the basket, some are more important than others when considering the final average. The CPI indicator is reported periodically by the Bureau of Labor Statistics of a country.

Does the CPI make sense?
This is a one million dollar question. To use the words of Steve Seville, "averaging the prices of a car, a potato and a visit to the dentist makes no more sense than averaging the goods/services themselves. Clearly, a car, a potato and a visit to the dentist cannot be averaged."
In other terms, there are things that cannot be averaged because they are completely different. Nevertheless, they are averaged and end up in the CPI index.

Further to that, just suppose you buy a brand new OLED TV screen. How do you compare prices of a new light TV screen, which has bluetooth, internet connection, different display technology that is completely digital against an old analog, bulky, cathode ray tube? Of course it is not possible. Yet, the magical alchemy of CPI calculation does this job. By means of a mathematical approach called "regression", it is possible to turn the price of a thirty years old cathode ray tube into an equivalent today's price. In this way, technology obsolescence is supposed to be taken into account. 
Instead of a TV screen, you may consider a car. Well, it turns up that today's cars, even with all the accessories that were not available thirty years ago, are still cheaper, even without taking into account complex regression models. This is due to technology deflation, on one hand, and to globalization, on the other, since factories have moved outside the developed countries, to lower the cost of labor.

So, a huge variety to be measured by a single metric! the ubiquitous CPI.
It is not over yet. We have seen that in recent years, the prices of houses, stocks, bonds etc have skyrocketed or have recovered from the bottom of 2009. Yet, inflation is low or even negative. How's that possible?
It is possible because inflation, as we said before, is mainly measured by the CPI, consumer price index, so it does not take into account the price of houses, stocks, bonds and land.
We can all agree that, on average, the most important debt you do in your life is the mortgage to buy a house: so, if a house doubles in price, you need to double the mortgage, so to increase the debt and/or the duration of the mortgage. Yet, despite this, which has a tremendous impact on our lives, inflation, measured through the CPI, is not impacted. 
And the CPI is the most important government statistics since it affects a number of public programs and is used as the basic benchmark to set public policy.

You can imagine that all this mathematical alchemy is, as minimum, questionable.

To recap:
  • The government and the Central Bankers consider the CPI as the most important benchmark to steer decisions on monetary policies, fiscal policies, and public policies.
  • The CPI is completely fictitious, and can be easily manipulated. 
  • The CPI does not consider the price of houses, land, or other assets, like bonds and stocks and life insurance.
Now, you can understand that, following this, the CPI does not come even close to measuring the falling value of money. It simply measures the consumer's spending habits. Even better: what the consumer is supposed to spend for a living on an almost daily basis.
So, a house can increase by 10%, yet the inflation rate, measured by CPI, can turn negative, like -0.1%!

You may question: why the hell is the inflation most important indicator, that is CPI, ignoring the raw cost of houses? For the sake of simplicity, let's not consider the land (which is included in the cost of the house) and the stocks and bonds, since they are by definition investments. But the house?
Statisticians argue that a house is an investment in any case, so it is outside the basket of the cost of living index. So, homes are considered like commodities? Maybe this is true for rich people who buy properties across the globe but generally you buy a house to live in it. You buy the furniture, pay the maintenance etc. I do not think you pay the maintenance on a stock or a bond or a bare terrain.

The bitter reality is that if the government took into account the cost of houses, the inflation index would skyrocket: that would create a huge pressure on policymakers, since it would make evident that wages, which have not kept the pace of normal raising prices in the last 45 years even when measured with the standard CPI, would look ridiculous low.
Plus, the Central Banks would be obliged to raise the interest rates...but that's another story that we will cover in the future.