Christmas Risk

Behold, wise men from the East came to Jerusalem, saying, “Where is He who has been born King of the Jews? For we have seen His star in the East and have come to worship Him.”(Matt 2:1-2).

God took a huge risk in sending Jesus into the world as a baby, at a time when his authority on earth was still precarious. He was counting on various people being willing to listen to the Holy Spirit and do God’s will.

• Mary had to be willing to care for a baby. This was a huge burden for a young women.

• Joseph had to listen to his dreams and be willing to obey them. He had to be willing to flee to Egypt for safety, which was scary for a Jewish family.

• Anna and Simeon had to be ready to pray and prophesy as required.

• The wise men would have to come and provide the Mary and Joseph with economic security. They did not give Jesus toys for his play. They provided his parents with commodities that could be sold in any economy at any time. They understood that precious commodities are essential for survival in troubled times.

If any of these people had failed to fulfil their calling, God’s plan would have turned to custard. The devil could have come in and killed Jesus, and removed the son of God from the earth. The wise men nearly set the cat among the pigeons when they went to Herod to find the king, instead of following star to Bethelem.

Three Mountains (12) - Risk is Real

Risk is unavoidable for people who are finite and free. God has made us free, so we have to make decisions. We are finite, so do not have perfect information on which to base our decisions. Hindsight is more perfect, so it proves many of our decisions wrong. An important aspect of decision-making is minimising the risk of bad consequences.

Risk cannot be eliminated, but it can be transferred to others.

• Insurance is tool for minimising the risk carried by one person, by sharing it between a much larger group.

• Limited liability transfers some of the risk of business failure from the owners to the clients of the business.

• Financial derivatives can be used as tool for transferring risk from one institution to another.

• Deposit insurance shifts risk from the banks to taxpayers.

Governments attempt to eliminate risk, but they actually transfer it to other people. Their regulations often encourage people and institutions to ignore risk.

The Global Financial Crisis was the result of bad judgement based on failure to understand risk. This foolishness was widespread throughout the economic and political system (see Credit Crunch Characters).

• Households took on massive risk by paying ridiculous prices for houses, because they assumed that house prices would keep up going forever.

• Households took on big mortgages assuming rising prices eliminated the risk.

• Governments encouraged banks to ignore risk and give mortgages to people who could not afford them.

• Banks assumed that insurance against default had eliminated the risk, so they purchased these financial instruments as if they were risk free when in reality, they had swapped one form of risk for another.

• Financial institutions bought CDOs, assuming that clever mathematical models had eliminated all risk.

• Investment banks boosted their profits by being levered up to thirty to one, but ignored the risk of a decline in asset values.

• The risk of a large monoline insurance company failing was ignored.

• The risk of that credit ratings agencies might be wrong was wrong.

Foolishness and stupidity were rampant in the financial system, but good times make fools appear wise, so risk was totally ignored.

Foolishness cannot be eliminated regulation. Regulations cannot stop foolish behaviour. The only cure is for people and institutions to get a better understanding of their risks and make mitigation.

Better banking is a key. Two questions should be asked before a loan is made.

• Will the borrower be able to pay the interest and repay the loan when it comes due?

• What assets is the borrower offering as collateral for the loan?

These questions have been forgotten over the last decade, but they will become more important again. To get finance, businesses and households that demonstrate an ability to make the repayments will be able.

Money is Risky

Holding money does not guarantee that I will receive back the same value that I gave up. I bear the risk of the money devaluing between the time when I give up my goods or services in exchange for money and the time when I use the money to purchase other goods or services.

If prices have risen I may not be able to obtain goods or services of the same value to me as those I have given up. Of course, if prices have changed in my favour, I may gain additional value. My only risk is the effects of changing relative prices between the time of selling and the time of buying. However, I can be certain that if I sell my goods or services, I can buy some goods and services from some other people (provided I can find someone willing to sell at a price agreeable to me).

Trade will only expand in a society if this risk is relatively low. This is why reliable money is so critical for economic development. If the risks associated with holding money are too high, then people will tend to make do with what they have, rather than attempt to sell it and buy something better. This will have a limiting effect on economic activity.

Money is a social phenomenon. No one has their own personal money. Money only functions if it is recognised and accepted throughout society. If it loses this property, because the owners are no longer unwilling to exchange it for their goods and services, it has ceased to be money.

The problem with any form of money is that people will only accept it if they are sure it is reliable. In a fallen world, there will always be some people who try to obtain money without working to produce goods or services, which can be exchanged for it.

Free Markets (9) - Economic Risk

Participation in a market economy is risky, because no one knows the future. The safest way to live is in subsistence. If I grow all my food and and produce all my clothing, I have a high degree of security, because I am not dependent on anyone else. By putting in a water storage system, I could even eliminate my dependence on the weather. However, subsistence living is very inefficient, because producing food would take so much time that I would have very little time for making other things that I might want. The subsistence lifestyle provides security, but the cost is a very low standard of living.

Most people will prefer to specialise in something that they are good at. They will produce more than they need and sell it on the market (often their labour). The can buy the other things that they need with what they earn. This raises their standard of living, but it increases the risk, because they are now dependent on other, unpredictable people. If the other people lose interest in what I am producing, I may find that the price falls, or I am left with a surplus that I do not need and cannot sell. My standard of living will decline rapidly. I may even wish that I had stayed with subsistence living.

I may look for someone to blame, but no one has done evil to me. The people who stopped buying what I produced, because they could get something better elsewhere, did no wrong. I made a decision in the face of future uncertainty and got it wrong. I acted on the assumption that I would continue to be able to sell my surplus. Because my guess about the future proved to be wrong, I will suffer (just like the football player entering a collision).

I may want to blame someone, but no one is morally responsible for my plight. I cannot even say that I sinned. Making a mistake about the future is a human frailty, and not a sin. Only God knows the future. It may be that he warned me that my decision was a mistake and I ignored his warning, but I am not sure that he always does warn us in this way.

Participating in a market is always risky because the future is uncertain. I could avoid the risk by staying out of the market and producing all that I need for myself. But the returns to the risk of participating in a market economy are so great, that most people prefer to take the risk. It would be great if that risk could be eliminated, but the risk free life is a poor one.