Challenges of virtual Consumption Banking Credits and Theory of Creativeness
Emzar Jgerenaia, Head of Quality Management Service at Tbilisi State University, Faculty of Economics and Business, Associated Professor
Monaco system in supply and demand, Bull Trend of modern banking and financing system
Exactly 10 years passed form the 1998 financial crisis. The crisis began on Asian markets (mainly in Korea) and covered economies of whole world – those of developing and developed countries. Everyone remembers Black August days in Russia – fall of ruble and sharp economic stagnation in Georgia. Gel exchange rate against USD and other main currencies fall, economic growth couldn’t reach 1997 level for years. Economists have been analyzing this process for a long time and they still study relations to Asian economies’ quick growth rate, growth of investment and their sterilization issues in relation to market boom common challenges. Analyzing these issues today, before next stagnation is an issue of utmost importance. Researches during recent years have clearly shown that formal or real reasons of the crisis in Korea and entirely in Asian markets lied in violating balance of law of supply and demand. Or amendments taken into the law of supply and demand, that was economists and businessmen didn’t take into consideration while making fundamental analysis. Let’s remember an episode namely, when capital import on Korean market exceeded demand of local market. First, market was not able to stand surplus investment, Second, financial obligations oppressed the country’s economy so that the main sphere became a debt service and it hampered the growth of economy. Third, sterilization of optimal investment didn’t take place and the fourth, provoked consumption, artificially created consumption turned into the bomb of delayed activities the crash of which was followed by the crisis.
What is the situation like today? Provoking consumption in the US, the epicenter of crisis, took place in two directions: the first on mortgage and the second on total commodity market provoking it with futures contracts, that caused price boom on commodity market. Here again the reason lied in an artificial increase of consumption. To put it short, what is the idea of scheme of increasing consumption artificially in hypothec? Credit debt of the US population is 8 times more than their real income. In England it exceeds 4 times. This is the first symptom of an artificial market, then why did sub-prime credit appear in the US. That means that according to old banking credit you are given hypothec credits without any additional guarantees and documentations with your real estate mortgaging, the cost of which is defined by future cost. This is a new term and a new notion. Cost in the future, when a house or an office will cost USD million in 2020 due to some experts calculations. In 2007 its value was only USD 100 000. So, according to this example we had real market volume of USD 100 000. The figure did not seem enough and we have simply created a market, so:
1) We have put the mortgaging in future and have created a hypothec with the future cost that resulted in 10 times increased market volume;
2) We have issued a credit on building with this guarantee;
3) We have issued securities with this paper mortgaging using different financial variations.
4) We have taken all these into consideration while calculating own capital and share rate. This is the way a circle was created and we have got a virtual economics, basing only on increasing prices on market – main trend of XXI century business. We have put rates on quality trend. Total growth of prices should take place! Otherwise our virtual economy will definitely face failure and the two factors condition each other.
You purchase thee or four houses, then sell one, get money, sell the second one, then you move to the third one etc. There is an illusion that three houses were sold – that demand is on three houses. Actually the demand is only on one house and three houses are sold to meet one demand. Accordingly, if the total volume of population and people interested in hypothec purchasing skill is Z, we define market volume M with Z multiplying in Z
MM=Z*K
Sum is Z, we define market volume M by Z multiplying in K
M=Z*K
K in this case is the coefficient of the population, ready to make this type of purchasing.
Our oponents may state that this may be simply corrected with indicaor, used by experts while analysing an open market. Its called Conditional value at risk (C-VaR)
C-VaR=(100-x)%/n
n _ period of time during which increased value correction is feasible; x _ feasible level of exceeding profit or loss (in our case 300%)
Despite my deep respect towards John C. Hull, I don’t find this famous formula enough to define virtual volume of cost and therefore we suggest the formula that will show total adequate cost. Let’s go back to our example. Let’s say that with this type of calculations based on classical and Samuelson and Mankiw definitions on supply and demand, 100 houses were demanded but this was not an enough object for the banking sector and in our example banking sector considered that three times more is better. Although the problem appeared: purchasing skills of clients. New scheme was created here as well as new definition of market in economy – artificially created market.
Property (in this case hypothec) was put with the increased estimation in guaranteeing. For this not 50 – 70 or 100 % of property was put in a guaranty but 300%. It means that notion of virtual cost appeared. Cost is virtual when it is based on technical analysis and creates value on the basis of forecasting. In case of such economic growth and such demand on real estate property the house or area will cost 300% more in 3 or 5 years. From the mathematical point of view, nothing is dangerous here as dynamics is a guarantee – this is a cost and demand will be real. But in case of any microeconomic change, situation changes and we get dreadful results by chain reaction. In this case the catastrophe equaled to USD 150 billion pure money in the US. Equal to virtual cost. We can call it a hollow system – something like they have in Monaco – highways under a city, growing a real area in a country.
We called it a Monaco System. The reason of it is that the pure economic system is based on finance capital (virtual) movement. The difference from the crisis that was ten years ago is that we (the world business) have changed a square/ place. We have tried it in a solid space – in the US. The authors of this model considered that it would stand the boom. Actually no one knows whether it would stand it or not to the end. Maybe it will! As space and time are optimally chosen and accordingly deep depression does not threaten the world market growth. Moreover, it may become a new style and method of market management. The US and England’s markets will be able to stand the new system – Monaco system. If the same happens in the above mentioned countries as it happened in Korea, then what will happen with the banks and countries that have reserve safes full of 4 trillion USD, or their economies the main customers of which are England and the US?
Calculations may be correct and the delta may be deciding for economic development. As within current prices and consumption growth stage it needs unreal consumption.
M=Z*K
M-1=(Z*k+DZ)*CR
Delta DZ is a virtual consumption, CR is a monetary course of a country and M-1 is Monaco scheme market demand indicator.
Our opponents may state that supply and demand is something that is fixed and it subjected to the classical law of supply and demand and it does not need to be torn into peaces like that. Well, my answer to it is the following: You are mistaken. Economy has changed enough during recent 6-7 years. Number of classical tractates were under question. Moreover, there are number of vague issues in classical theory.
Let’s go back to classical Supply and Demand:
Adam Smith stated that each person tries to use own capital so that his/ her product carries the biggest value. This time private interest are much more significant for him than social interests. The person is managed by invisible hand to reach the goal. I am not sure whether Adam Smith meant the Americans which mortgaged their houses as capital and tried to get maximal value, but the fact that they were managed by invisible hand, is true. It depended on the type of invisible hand, type and direction of the goal.
As Samuelson states in the begging of chapter II of ‘Economics’ all types are major for a society: what is being produced, how it is done and for whom. Therefore Samuelson defines supply and demand as a balance.
Supply and Demand Classical Scheme
Classical Scheme
He believes competitive balance is the only acceptable crossing point for price, supply and demand. Has anything changed in this table? Yes, it has. The problem of table formation itself.
1. Problem of demand and formation;
2. Price accordingly;
3. Supply peculiarity
Is a supply a bargain with futures on Chicago Market? It is and it is not! It is in case it is related to large business that purchases futures to maintain constant supply. It is not, if it is bull trend created by speculators and aims to re-sell, to invest capital and generally margin. In this case it doesn’t really matter whether it is wheat, coffee or fuel. This is a modern peculiarity of forming demand and price on market.
The world demand on sugar is 120 million tones annually, on rice it is 520 million tones, on wheat – 800 million tones, and on oil it is 27 000 million barrels per year (B – 159 L) the indicators have significantly increased in 2007 within 3 % growth of consumption. Why, you may ask. Because virtual consumption and futures have grown. Bull market trend on commodity market becomes deciding. It maintains spiral of virtual consumption.
The next peculiarity is that XXI competitiveness is substituted by merging and absorption. Merging is cheaper than competitiveness.
The third peculiarly is the quickest technical progress. Although organizing new researches and inventions require more sums, intellectual properties are quickly stolen. For example in leading Asian countries, in Georgia and in CIS countries, where intellectual property and brands are not protected, there is no standard control and state or non- state management mechanisms. This changes the classical scheme of supply, especially in digital technologies and on program technical goods (this is the peculiarity of XXI century). According to classical law of supply and demand, oil price on brunt fraction is USD 60-65 per barrel and USD 50 on Opec basket brand. As for wheat – it is USD 320-330 per tone. Prices today are dictated by Monaco scheme failure in the US. Therefore by problems and speculated capital movement. Speculation of capital causes its globalization and vice versa.
Here we can argue on the statement – ‘other equal conditions’ by classics, by Samuelson for instance. In this case we deal with the new scheme of market formation. Besides, modernized/ updated/ version of an old scheme is still in a force. This time we seal with a new case again. It was discussed in the works of Fisher and other famous economists – Price elasticity line within competitiveness. In my opinion, financial sector suggested entirely new scheme to the world.
USD and Euro rate dynamics are worth noting (See scheme). The scheme shows that prices on goods produced in the US are increasing and European export is falling. Therefore large business has to reduce production. Cheap USD increases demand and it is natural that it solves number of challenges in the US economy, the roots of which go back to virtual economy. According to G. Bush plan they reduce tax pressure and price of money in order to have less crisis affect. This is what Alan Greenspan did. As for B. Bernanke he does just opposite to sterilize results.
What is the situation like in Georgia? What are the virtual consumption scales and danger of stagnation or introducing new methods of managing and stimulating economics? We keep Gel rate at lower indicator; we strengthen it against USD and euro. Moreover, it is clear that Gel is a quasi converting currency and national Bank has a significant influence despite statements on non-intervention in fixing. The way currency exchange rate and supply and demand are defined is wrong. Supply and demand balance is fixed on stock exchange, where only 5 % of operations are done. Stock exchange has not been playing the role of monetary market for a long time. USD 6.5 billions were purchased in 2007 among Banks avoiding stock exchange and USD 600 million in boxes while USD 430 million value operations are registered on stock exchange and mainly with the participation of National Bank.
Is it possible that the stock exchange reflects real supply and demand? Cheap USD enables to reduce price on import and regulate inflation rate. On the other had, production is promoted, 60 % of which work on imported materials to have cheap calculation and competitive goods. It’s worth noting that less Gel is spent on sterilizing growing foreign investment. This will manage inflation. We can conclude that artificial regulation of prices and demand growth took place that is a part of virtual economy and does not give results in long term perspective. It is calculated for solving specific tasks. The fact that money is quite expensive in banks is added to it in Georgia. Commissions that have nothing to do with the risk are huge. Credit cost moves to commissions, for example commissions on getting credit, opening account, service and converting, card service etc. in the end all the above mentioned enable banks to collect amazing incomes and rise income to annual 20-25 %. In case we add insiders’ operation incomes the indicator reaches 40- 50%. This is the reason why Georgian banking system is attractive for foreigners. Investments are made not in entire economics, but in two spheres where the market growth is successfully maintained, by Monaco method according to theory of creativeness. These two sectors are building and banking businesses. 90% of artificial market are related to these spheres in Georgia and here is a wide range of getting income quickly. It’s natural that crisis influence risks are greater here.
Let’s analyze prices on money in the US during 2002-2007
It is clear that money value has drastically increased and Alan Greenspan was creating significant basis for Monaco system before Ben Bernanke appeared. It was followed by rising prices on inter bank credits and generally on credits. Its natural that official reason of it was ceasing production and managing inflation. But let us remember what happened on stock exchange during the same period.
Despite significant trend of increasing prices in the world, according to 2003-2004 World bank Analysis, economic growth rate is increasing. Does this circumstance prove the preciseness of supply and demand? No way.
Thesis that had to pass an exam: Samuelson, Fisher, Dorbush… All agree with the opinion that when the price is higher, demand on good is reducing. Price on fuel rises, although daily demand exceeded 88 million barrels. The same is true regarding wheat, sugar and etc. it may be stated that prices on goods and real estate property as well as on service increased 2-3 times in 2003-2008. But demand growth was the same. Here is the difference between old and new world economies. The most important issue is to find a buyer today, you can bring anything you want to if there is no political limitation. Before XXI century production was major, buyers were easy to find and they even queued. Therefore while increasing permanent prices economies grow as well.
Expenditures of all sates as well as economic growth rate is high. Rising prices do not reduce consumption. Moreover, quite often it is stimulating. Entire economy grows following increasing prices and the story on crisis classic phase is only a pessimistic sobbing. Well known economist Julian Simon writes: ‘It became fashionable to draw a person who is in panic due to lack of resources and it is presented to be a destroyer of nature. Exactly these type of people believe that the US population, being 5% of the world population use 40% of resources. Although as Julian Simon states, no one points the amount of resources produced by this 5%. resource is created and creativeness is a gift. Virtual consumption and real supply has been created as well. ‘The more resources are discovered, the more are chances of changes and moving forward’- Julian states. I dot want us to get the aim of creativeness and virtual consumption is panic or fear. That this will destroy the world economics and speculators will sacrifice market!! I would like to take out mind to the following direction: the theory of creativeness and virtual consumption exist as Monaco system and lets try to find profit for developing Georgia’s economy even by using economic growth provoking and not only in construction and banking spheres.
On the other hand, the coin has the second side. I don’t want anyone to consider me the admirer of Joseph Stiglitz, who was awarded the Nobel Prize in Economics, although I would proudly admit it. According to Stiglitz the major problem of the world economy is speculated capital and it can provoke recession.
Although positive side of artificial growth affect is not provided here. Is this condition caused by new demand formation? Is the way out of the current situation to create artificial demand and virtual market, when on one hand prices and consumption are rising, economic growth high rate should be kept on the expense of high rate of demand.
We could draw scheme here or circle GDP growth major parameters. we should make market attractive for investments not only in Georgia, but in the US as well, that is why Americans created ‘Prime’ attractive market in hypothec business. by this they kept high economic growth rate despite expenditures relate to war. Provoking market took place in Georgia as well, or if no, it should take place. Artificial increase of market leads to economic growth. It requires deep analysis; perhaps working with the new scheme is depended on optimal level artificial market, upper border of demand.
Let’s discuss financial anatomy of ongoing processes in Georgian economy and we can easily find out virtual market corresponding symptoms . Georgia’s population’s total income is Gel 2.2. Billion. Economic credit debt reached USD 4.5 billions. Dolarisation coefficient of economics is quite high and it reaches 65%. It’s worth noting that major debts are presented in USDs that causes the devaluation of major assets of our banks.
Hypothec market is a subject of separate discussion. It is different form the US analogue. We have been constructing houses and there was a 15-20% in hypothec. Situation changes form 2008. Hypothec credit growth exceeded 300%. This market definitely has extra capital, and at the same time the banking issue is quite active in Georgia. The problem of payment is important. Banks as well as developing companies try to create consumption growth system and increase market volume by crystal approach. Syndrome of creating artificial market in Georgia already exists as an embryo. What does it give to the Georgian economy? Should we destroy or should we support it? if the world economy is speculating , why shouldn’t we support it here? On the other hand, will Georgian economy stand permanent Bull trend? I believe the issue is worth researching. You may ask why?
Analysis of each trend gives us the motivation of conclusion, that in XXI century the main tool of economy was theory of creativeness. People have always been creating resources as well as deficit. they created new resources and new ways of getting them. Therefore creativeness maintains the universe and resources. The question rises: Where does the border of product prices and consumption indicator growth go? I can tell you that neither of them have borders.
Number of population as well as consumption will increase in the world and it is natural that prices will be regulated according to net and virtual demand. New resources will be created and substituents will be used.
From the above mentioned I believe a theory of creativeness is:
· Idea, substance – Maintaining higher market growth on artificially created consumption market to avoid hamper caused by grown prices trend than it is possible by means of natural economic development processes and therefore creating an artificial market.
· Goal – to widen consumption that will provoke economic growth and that will cover reduced consumption caused by grown prices. That will maintain grown profit.
· Place of activity – choosing the right place and time for the theory of creativeness is the major factor for its success. It should cover the most developed countries and developing countries , like Georgia, may participate in the processes on that market, and not on their own markets. Economic sector is a very important factor.
Time and space have a deciding role here. This is a major difference from 1998. That is why this stagnation’s results will not have destroying outcomes. Just on the contrary, it will be the beginning of new era for the worlds and naturally for Georgian economy as well.
If it is not a problem for Merill Lynch and City Bank to pay 12-8 billions even on the expense of their shareholders, the crash, caused by virtual economy and the world economy crisis will be quite strong in Georgia. Georgian Banking sector leads the creation of this new style economy , just like it is in entire world.
Two challenges remain in Georgian banking system: large volume of insiders’ credit indicators in reality and indicator of hypothec building credit volume in credit portfolio. Low level of asset diversification – this is the major tactic #1 challenge of banks. The second challenge is an attempt to create virtual market and low level of insurance. Especially when main large banks insures their assets. Opponents may rebuke regarding banking regulation and remind us Basel II requirements regarding capital and generally banking regulations. I would like to tell you that the above mentioned covers Georgian in correspondence with National Bank demand and opinions. There is no doubt that National Bank supervising has problems that is why time required reorganization of this sphere, there was more subjectivisms. Otherwise number of banks would find it difficult to execute general norms of the regulation from liquidity and financing insiders’ point of view. Recent growth of monetary masses’ volume is significant and nothing seems to be wrong in it. it may twice exceed GDP but not in a balanced way.
Therefore, in our opinion, we should introduce inflation indicator and move to more flexible, free but optimal exchange rate that will be the result of actual supply and demand. Besides, with the purpose of supporting creative theory we should create market institutions and tools, not virtual but real. The world market economy is pulling and has already pulled Georgian economy that can not be characterized as market economy. Accordingly, the only way to join integration process is to change form of economy.