One Programmer's View Of Our Broken Economy

Typescript logo Grand Marais, MN. Jan 2020.

As a programmer in the united states when I first started coding and really getting into the culture I felt the gravity of San Francisco pulling me in.

In the same way that aspiring actors must move to LA or those in finance need to go to New York, I felt like I needed to go San Francisco to get anywhere in my career.

I taught myself how to code and later ended up getting an associates degree after I started working as a Java developer, I didn’t have much formal training in computer science (I studied that later on my own) and so I realized I couldn’t pass a big-n interview and thus could not get a relocation offer easily.

I would have to move out there using my savings and figure it out hoping to get a job at a startup.

What are these crazy rent prices?

What stopped me was looking at rent prices. I was paying $500 a month for a decent apartment in my midwestern hometown slowly paying off my student loans.

How could I justify paying $2000 for a 1 bedroom in San Francisco when I didn’t even know how long it would take to get a job? Should I really quit my job, maybe not even be able to find a place to live, and maybe not even find a new job? I had a perfectly good job back home.

Checking back in a few years

So anyway, I waited and kept working in my hometown getting progressively better jobs and learning enough that I probably could pass a big-n interview.

But then later when I looked at San Francisco again, a 1 bedroom was now $3000 a month! Crappy houses were over a million dollars. And things were comfortable back home. I had just started making six figures and my expenses were low. Why should I move to a state where my expenses would quadrouple, my taxes double, and half my income come in the form of back loaded stock grants that act as golden handcuffs?

But in the meantime home prices in my hometown had doubled! Sure, they went from 100k to 200k and not 500k to 1 million like in California, but because I kept thinking I would move away in the back of my mind I kept avoiding purchasing a home and “settling in”.

But how did they double in a matter of a few years? I looked up the inflation rate and it says it was never more than 2.1% this entire time period. What gives?

Why is rent so high? Why are home prices so high? What gives?

This really started to bother me so I went down a rabbit hole learning about macro economics and what has been going on lately.

Here is what I think: our economy in it’s current state exists due to a complex mix of history, culture, and government. But, if I was to say there is one thing overall that can start to explain it that would be credit.

America runs on credit. And by credit, I mean debt. We borrow money for everything:

  1. Paying for tuition
  2. Buying a car
  3. Buying a home
  4. Repairing your home
  5. Starting a business
  6. Expanding a business

The list goes on.

Essentially all of this debt makes our economy grow faster and it can be good. Credit is a useful tool. You don’t need to wait 10 years to save to buy a home, you can buy it now on credit. People who want to get an advanced education can do it even if their families don’t have money. If you don’t have the money to start a new business a bank might lend it to you.

But what happens when there is too much debt?

Ah, well here is the rub. If you get too much debt built up in the system it can be difficult to add more and then growth slows.

This means everyone is tapped out effectively and just using their cashflow to pay down debt they have accrued.

It also means lenders might be reluctant to lend to you if you already have too much debt and they will start charging higher interest rates. They might see you as a risk and so they require more of a “reward” to take that risk, so they jack the rates up.

Eventually, this should self correct. People will borrow less, things will de-lever (debt will go down), interest rates will ebb and flow naturally and then we can start the cycle all over again.

What if we want to avoid this painful cycle?

Ah, interesting question. Can this painful cycle of paying down debt be avoided?

Why, yes it can. Enter central banks. They have the ability to set interest rates to a large degree. In fact, this is what has been happening over the last couple of decades.

If you keep lowering interest rates then people can continue to borrow.

Here is an example, let’s say you can afford to pay $1000 / month for a mortgage on a house. If you look at that across different interest rates on a 30 year loan you get drastically different amounts of money you can borrow to buy a home.

  1. At 10% interest paying $1000 a month –> $114,000
  2. At 5% interest paying $1000 a month –> $186,000
  3. At 2.5% interest paying $1000 a month –> $253,000
  4. At 1% interest paying $1000 a month –> $311,000
  5. At 0% interest paying $1000 a month –> $360,000
  6. At -1% interest paying $1000 a month –> ????

Historically, mortgage rates in the range between 5% to 10% in the united states were quite common. It’s only been recently that these rates have been forced down. This results in higher home prices, and in fact it should result in higher prices of all assets that produce income.

Also, did you notice I threw in a negative 1% mortgage? Well, that can happen (here in Denmark for example).

Yes, in Europe the regulators who control interest rates have been able to set them so low to avoid this painful debt deleveraging cycle for so long that they actually moved them into negative territory. At certain European banks you actually have to pay a fee to save money in your savings account.

What are the consequences of avoiding deleveraging?

Well, we are seeing it. We just continue to push asset prices higher and higher so that people, companies, and governments can take on more debt.

We are so far down this rabbit hole and nobody knows where it ends. Do we just one day cancel all debts and start over? Do we try to inflate away the debt by printing money? Do we default? Do we try austerity?

Do we keep pushing this farther to the point where central banks start buying debt directly in order to keep the merry-go-round going?

Actually, yes we are doing that right now - the buying debt thing, I mean.

Also, low interest rates encourage speculation.

This is a known side effect of low interest rates. Arguably this fueled the 2008 housing bubble (probably along with other government policies). Throughout recorded history interest rates were almost always much higher than they are now.

Here is a nice quote from “Manias, Panics and Crashes”, 7th edition to illustrate this point historically.

In France at the end of the Restoration and beginning of the July Monarchy - that is, between 1826 and 1832 - speculation was rife … Landowners earned 2.25 to 3.75 percent on their assets; industrialists tried to earn 7 to 9 percent on their fixed investments, 2 to 4 percentage points more than the long-term interest rates. Merchants and speculators in raw materials sought returns in the range of 20 to 25 percent. Charles wilson noted that earlier the Dutch were converted from merchants into bankers (accused of idleness and greed); they developed habits of speculation because of the decline in the rate of interest in Amsterdam to 2.5 percent. Large-scale conversions of public debt in the 1822 and 1824, and gain in 1888 led to a decline in the rate of interest and induced British investors to buy more foreign securities. Andreades observed that “When interest goes down, the English commercial world, unable to reduce its mode of life, deserts its usual business in favor of the more profitable, but on that very account more risky undertakings … speculation leads to disaster and must ultimately be borne by the central bank

So just as in the early 1800’s, that is how the S&P just (in August 2020) set an all time high in the middle of a pandemic.

The Consequences of the 2020 pandemic for small businesses.

Let’s circle back to debt and asset prices. When you have to shutter large parts of the economy for months (bars and restaurants) in a heavily credit driven system you get problems. Everyone is leveraged to hell and there is no room for cashflow to stop.

As it turns out, those small business owners don’t own the buildings they operate their businesses out of. They lease them from landlords. Why?

Real estate is too expensive! You can maybe scrape together 100k to start a restaurant, but you can’t get 2 million dollars to but the building you are going to open it in. Why was that building so expensive? Low interest rates pushing asset prices up.

So now you just pay $5,000 a month in rent. Or maybe $10,000 a month in rent! It’s a business, you can afford it… That is until you have to shut your doors and the cashflow coming in drops to zero. How many months can you last with zero cashflow? Businesses everywhere are finding this out now.

What about the consequences for people?

Well, people are leveraged too after all. Most people have 4 kinds of loans:

  1. Student loans
  2. Car Loans
  3. Home Loans
  4. Credit Card Loans

Federal student loans were halted until September 30, 2020. Also, federal home loans were mostly able to be deferred or modified for 6-12 months, so either September 2020, or April 2021.

But what happens to car loans? Credit card loans? What happens when the deferment period ends?

Well, we already have interest rates at zero. You can’t make it cheaper to borrow. And it doesn’t matter anyway with mass unemployment. If you don’t have the cashflow coming in you can’t pay the loans! Interest rates are meaningless if you have no cashflow at all.

Maybe we will modify everyone’s 30 year mortgage to be a 40 year mortgage?

Maybe we will just simply forgive all student loans?

What is likely to happen

After the crash of 1929 there was enormous deflation. This resulted in people’s debts actually growing relative to their earnings. Their money was worth more, but their paychecks were smaller. What didn’t decrease was the nominal debt they owed on their mortgages. The 30 mortgage was introduced in 1934 in wake of the resulting defaults.

Economists, central banks, and governments have learned that deflationary spirals like this are painful so they will do anything to avoid them.

As a result it seems likely that this time (as in 2009) central banks will increase money supply (printing money), and governments will create fiscal policies (spending money) in order to try to stave off deflation.

While they might be able to stave off deflation, it’s unknown if they can create enough inflation to reduce nominal debt loads. If inflation occurs in asset prices and wages, this effectively reduces debt loads on households.

Here is an example - if you have 10% inflation, in theory your paycheck would grow 10% to keep pace, you house would become 10% more valuable, but your mortgage would still be the same fixed amount. Effectively, your debt would have been reduced 10% relative to everything else. Do this every year for 5 years and the problem is minimized. Although, you might have other problems if you do this. Among other things it would destroy the returns of bond holders which is how many many retirees fund their retirements.

So it’s likely that central banks keep interest rates at zero, do more quantitative easing, and governments do more stimulus and deficit spending.

But it’s very unclear what will happen as a result of all of this. We did the same thing post 2008 and saw little CPI inflation, but asset prices sure did skyrocket. What will happen this time in the midst of both supply and demand shocks and an economy that is much more indebted and much less healthy overall?

Uncharted territory

If it seems like rent is too expensive, and real estate is too expensive, and stocks are too expensive, and college is too expensive, and everything and everyone is a bit crazy right now… well I think it might be a bit true.

What do you do when everyone has borrowed as much as they can and interest rates are already at zero? Well, we might have a solvency crisis rather than a liquidity crisis. How do you solve that? Bailouts for everyone? Debt Jubilee? Mass money printing and inflation?

I don’t think anybody knows where we are headed as a society now, or as a civilization, but I think it’s important to think about the situation we are in right now.

Additional Reading:

  1. Fixing the Debt Problem by Lyn Alden
  2. How the Economic Machine Works by Ray Dalio
  3. WTF happened in 1971
Written on May 27, 2020