Saturday, November 6, 2010

Wealth Means Production, Not Consumption!

Wayyyy back in July (when I actually began writing this post), Peter Suderman of Reason Magazine posted a short article called: Economic Model That Estimated That the Stimulus Would Create Jobs Now Says It Did on Hit & Run... While not one of the wildest comment threads I've ever seen over there, our old friend "Tony" was about and yet again became a (moderately) useful Socratic tool on to which I dropped some knowledge.

Of the many idiotic things he said, he did finally ask a direct question. He said:
"Sean humor me, how are wealth and prosperity created?"
Being the magnanimous chap I am, and in spite of the fact that I have already explained as much to Tony on several occasions, I responded.

Then I realized, I haven't written/posted anything here in quite some time (3 weeks?) purely because I have been so ridiculously busy with my impending transnational move back to the East Coast, and feverishly working on the second Bill of Rights video...

By the way - "The Bill of Rights - Part I: Philosophy & Hiistory" is now available for sale at for a paltry $2.00! Please go check that out and help support more media creation.

At any rate, I've written repeatedly on this blog about things that government can do to rapidly destroy wealth and impoverish people... Price & wage controls, high rates of taxation, massive government spending sprees, fiat currency/inflationary monetary policy, high national debts, "regime uncertainty", subsidies/picking winners & losers... and generally anything that makes investors & businesses want to go elsewhere with their money, factories & jobs.

But I haven't written much overtly positive on how this all works... So here goes:

Where does wealth come from?

Wealth & prosperity can only be created via PRODUCTION.

Contrary to what a lot of people in the government and unthinking media hacks would like you to believe, there is no real difference between how you get rich as an individual and how you get rich as a nation. No one, and no government, can simply "spend" their way to prosperity... So let's abandon that ridiculous notion right now.

We must each produce wealth if we wish to increase the wealth in the world...

Most all politicians and a disturbingly large number of bad economists incorrectly believe that spending is the key for a few reasons.... For one thing, they frequently conflate money with wealth.

That's a big mistake indeed, but it's unsurprising when you consider that most of these people spend their lives thinking about the economy in terms of "aggregates" and mediocre proxies like Gross Domestic Product, which measures spending (i.e. money!) and not actual production - though to be fair, measuring real production is virtually impossible, especially on a large scale. Problem is, eventually it seems that a lot of people spend so long looking at the various proxies for wealth like money that they forget they aren't the same thing at all.

But if it's not money, then what is wealth? Well, the dictionary defines it as:
a. all things that have a monetary or exchange value.
b. anything that has utility and is capable of being appropriated or exchanged.
If you note the above definition, wealth isn't defined as "money" at all, but rather as all of the things that can be exchanged for money - loosely including goods, services, labor... and even, as tricky as this gets, other money in the form of investments.

However, this definition is extremely broad and doesn't fully express that not all goods & services which can be "exchanged & appropriated" are the same. A somewhat better definition would be that wealth is all the stuff that you and I have and use on a daily basis that improves our lives. Stuff like housing, food, clothing, movies, computers, restaurants, etc...

This brings me back to GDP.

GDP has a lot of problems... Most notably, it includes government spending, while assuming that said spending is economically productive, rather than destructive - which is more often than not the case. GDP cannot make any kind of distinction between economic activity that increases wealth & improves people's day-to-day existence and activity which does the opposite.

For instance, every few hundred million the United States government spends on roads and other elements of the infrastructure that might facilitate both production & trade, they're spending billions on blowing stuff up! Since bombs & tanks and such actually destroy wealth, they force producers to replace, rather than add to the available supply of goods in the world.

Unfortunately, just looking at GDP wouldn't show you the difference.

That's also, by the way, why a lot of people falsely believe that the United States finally broke out of its Great Depression when we entered World War II. If you look at GDP, government spending skyrocketed and unemployment most certainly went down. Except... Instead of people employed producing housing, food, clothing, and all that stuff needed by ordinary folks to live and thrive, people were employed building things that explode in order to destroy other people's things.

So it's not that difficult to see that war, given it's destructive nature, doesn't add anything to the wealth of the world. In fact, quite the opposite. Typically, at the end of any war, both sides have fewer available goods & services than it did before, while also having redirected all the "means" of production into destructive activities.

That's one of the many, many reasons that war just isn't that great. Economically speaking, it's just one gigantic "Broken Window Fallacy".

How does production happen?

Now that we know that it's production, rather than spending or the printing of money that creates wealth as goes a lot of the mainstream idiocy, we need to understand how production actually does happen.

To do that, we need to first understand the importance of underconsumption, better known as "savings".

Building factories, starting new businesses, and generally setting up all the things that an entrepreneur must do if he wants to start making something that other people will trade their hard-earned money for usually takes a lot of forethought, planning, time & money.

While all the planning, time, research, and everything else Getting the money to start up a new factory or a new business - which will eventually increase the supply of goods & services in the world (thus increasing wealth available & growing the economic "pie" for everyone) - can come from two sources, but both rely on savings.

Either that savings has to come from the entrepreneur herself, or as is often the case, if she doesn't personally have the money needed, she can ask to borrow it from others... Thus, credit enters the picture!

However... So do interest rates.

Most people probably think interest rates are just a function of the credit rating of the borrower. People who have a good track record of turning a profit and paying their debts, as well as those who have some collateral to promise up front get lower interest rates than those who are less trustworthy in the eyes of lenders. While this is true, interest rates (in a free market) are also a function of available capital.

Interest rates coordinate money with time-preference. And that's really pretty important!

When a lot of people under-consume - by which I mean, when a lot of people save their money instead of spending it - what they are demonstrating is that they value the utility money more in the future than they do right now. And there are a lot of excellent and important consequences to a high savings rate! For instance:
  1. Credit standards drop - with lots of money available to lend, each investment is less risky so more people are granted access to other people's credit, which means...
  2. Entrepreneurs seeking capital have an easier time starting their businesses and existing companies have an easier time expanding, which means...
  3. There will be higher levels of production, and higher levels of employment. And if those newly employed folks save their money, then...
  4. Individuals are better protected in the event of natural disasters or personal problems, and as such are in a better position to weather any minor market corrections or periods of unemployment
But "what about demand??" you say?

The dirty little secret Keynesians don't want you to realize is that demand is - essentially - infinite. No one wakes up one day and decides that they no longer want a better house, a nicer car, better quality health care, another week of vacation in Hawaii or anything else. Looking at economic activity in terms of "aggregate demand" is ridiculous. Demand doesn't produce anything. Our unlimited wants don't make those wants materialize. And no matter how much we might desire, our desires will never manifest themselves into something tangible. 

Not to mention the fact that it's impossible to buy something that does not yet exist. Unfortunately, Keynesian theories of production are horrifically incomplete and they fail miserably when you actually quit looking at demand as a meaningless aggregated statistic and answer the question, "demand for what?"

If demand drove the economy, then the only products that would be produced are products that already exist and are well known by consumers. But that's obviously false... Plenty of things are produced that no one has ever even heard of.

As such, entrepreneurs are ultimately the key to to all this... Their function is to anticipate specific future demands by reading the present and making assumptions about people's wants and needs over time. For example, when Steve(s) Jobs & Wozniak were tinkering with their little computer company in the 1970's, no one even knew they existed - much less actively "demanding" iPhones. Yet over the years Apple has proved to be remarkably successful at anticipating the wants and needs of future consumers. 

They did that. And they were able to do that because a similarly forward-thinking guy named Mike Markkula who happened to have several million dollars in saved money decided to risk his own capital on their idea. It paid off big, but none of it would be possible without Markkula's prudence and under-consumption.

There was no "demand" for their services in 1977. Yet last year they did almost $43 Billion in sales... What they created, ultimately was good enough to warrant sparking increased demand, but the demand for their goods could not have occurred prior to Apple's existence... But in order to exist at all, the company required someone else's savings in the form of credit.

Sadly, that's not where a lot of credit comes from anymore...

The problem with modern "Credit"

Here's the thing... In modern America (and most of the world), the money supply and the general interest rates is controlled by fiat by the government & their sanctioned operators like the Federal Reserve.

The power to simply print new money is a dangerous weapon wielded against the unsuspecting American public. And it utterly distorts the availability of credit, and subsequently, what that credit is used for. When credit comes from savings and under-consumption, the credit available is set by the real habits of millions of people. If people aren't saving that much, for whatever reason, less credit is available - and as a result, interest rates would rise and encourage more people to save. If plenty of people had saved lots of money, interest rates would drop as credit became more available, and that would encourage people to spend & borrow.

It's a self-regulating system.

But when you toss the central banking system into the mix, all bets are off! If in reality, few people are saving money, but the Federal Reserve decides that interest rates should stay low anyway, more people will continue borrowing and spending in spite of the fact that the money isn't actually in anyone's bank accounts. Surely you can see the long-term problem here?

Look at what's happened in America over the last few years. The Fed has held rates down, and even worse, ballooned the supply of money. So instead of slowing down spending, and starting to under-consume again by saving & investing, people go on buying more than they can afford and all on borrowed money. This is, by it's very nature, entirely unsustainable.

We got to see this clearly just a couple years ago with the financial collapse - and we're going to see it again very soon unless things radically change.

Now... Here's the other thing... When interest rates are high, that encourages *only* those who are going to make significant returns on the money to borrow it. So instead of getting that new Sears card, you and I and most all of us save our pennies for the new washer & dryer set. Whereas, someone who either A. can afford to bear a higher level of risk, i.e. someone who's rich, or B. an entrepreneur starting a business with a good plan to make a fair bit of money by producing something people value, will be allowed to borrow in the service of creating more wealth in the long term.

Lenders, when not having their loans guaranteed by the government at least, are generally smart enough to realize that if they only have a limited amount of money to lend out - they'd better give it to someone really likely to bring back a return on their investment.

The ones who aren't that smart go out of business pretty quick.

So sometimes high interest rates and limited credit are "good things" when they reflect the real availability of saved capital. High interest rates are just as important a market signal as low rates. But when rates are artificially controlled by some central authority, they encourage all sorts of malinvestments. They encourage entrepreneurs and lenders to make mistakes and anticipate future demand incorrectly. This is an immense waste of resources, and causes disruptions in employment and production that ultimately will need to be rectified rather painfully...

When I say "painfully", I mean, like having 25% of an industry lose their jobs and have company assets sold off at massive losses. Painful.

This wouldn't happen, or at least, would never happen on the scale it's happened in America lately without the Federal Reserve controlling interest & money. And that brings me right back home to wealth:

Wealth & prosperity are created by people actually producing things that people value.

This can't happen - or at least, it's seriously inhibited - in a consumer/debt based economy... WHICH, perhaps I should note is precisely why the US has gone from the world's greatest and wealthiest producer & creditor, to it's largest debtor who imports more than we export.

Instead of having a system where credit is based on real savings, we have a central planning authority which dictates he supply of money & interest rates. As a result, they are politically inclined to push for high inflation and continually easy/cheap credit by running the printing presses because that's what the political class wants and it's what keeps the bankers pockets stuffed with cash.

Problem is, the wealth of the world (i.e. all the stuff people want & need to live) hasn't increased one damn bit! Instead, only the amount of money has. So prices go up and up and up, while production actually stalls. Eventually this comes to a head and tips over... It's a disaster.

When people don't save, they aren't investing in the future. When they don't invest in the future, entrepreneurs and their lenders can only focus on short-term gains (i.e. all that "cheap chinese crap" a particular troll I know is always whining about), rather than on long-term development. We get the worst of both worlds this way - no meaningful investments, only consumption with the widely available credit, and the reality that the credit is built on money that just appeared out of thin air.

So... Right now... If interest rates were significantly higher - dare I say - if they were at the real market rate, instead of whatever artificially depressed level Helicopter Ben has decided on today, you and I would probably have a harder time getting a Sears card, no doubt - at least I know I would - however, our savings would actually be rewarded, so getting back on track financially would be easier instead of harder. And of course, investment in new businesses and new factories, etc. would be rewarded as well.

Thus the cycle continues. Businesses & Factories pop up. Factories actually produce things...

When more "stuff" is produced, the world becomes wealthier as there are more goods and the same amount of dollars, rendering everyone's money more valuable and increasing everyone's ability to live at a higher level. More wealth and production means more jobs as businesses are actually being created.

Thus... The cycle... Continues.

But what we've done in the US is encourage overconsumption, waste, and job loss. And that, by the way, is also what Tony was idiotically arguing for. Although, I'm sure he didn't realize it.

So............. Let me simplify all this one last time.
Low interest rates = Spending/Consumption
High(er) interest rates = Saving/Investment
Absent massive intervention, these things play off each other fairly well... Interest rates go up, people start saving again, investing in the future, then when enough money has been saved up, rates start going back down and that money starts to get spent more freely... When rates are high, only people who have been (by various metrics) deemed to be sound investments are extended credit - this means investing in good new business plans, successful existing businesses and people with a long track record of high credit ratings.

This is great - cause those people go off and start their businesses, create new wealth and employ people... Who in turn, take their salaries and continue to save a good deal of their money what with the high interest rates on their savings accounts.

...All while their money is appreciating in value as no one is messing about with the currency constantly, and the same amount of money is now chasing after vastly more available goods.

All around WIN.

Now... reverse all of that, and it's what a lot of people (including our government) are currently arguing for. Everybody spend everything they have, don't invest in the future, don't worry about producing anything, and when you run out of money - print more and just pretend it doesn't matter that you can't eat paper.

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