Sunday, March 30, 2008

Reap What Your Sow


There are a lot of goofy statements eminating from the lips of so-called Wall Street experts. One I hear quite often is, "consumption is the driver of the economy" or something to that effect. To people who understand the very simple science of economics, a statement like this is akin to reasoning that the melting of an ice cream cone on a July afternoon drives the irradiance of the sun. It confuses cause and effect.



There is one economic axiom (Say) that cannot be challenged and it is: In order to consume something, it must first be produced. This holds for a peasant who plants so that he may consume grain just as well as it applies to the corporations that convert raw materials into consumable goods. Production must precede consumption.



Furthermore, capital investment (spending productive effort crafting the plow or the factory) must precede production of present consumables if you want to increase your FUTURE consumption.



If an economy produces nothing, it will eventually deplete its stores and will be unable to consume anything. If it makes no capital investment, its existing machinery, equipment and infrastructure will deteriorate and future consumption levels will be returned to a hand-to-mouth level. See: Zimbabwe for a current example.



So what defines economic health? The mercantilists (16th century Europe) and the Neo-mercantilists (modern China, anti-trade politicians) seem tho think prosperity is measured by how fat your trade surplus is and how much money you can stuff into your vaults. This was thoroughly disproven by Adam Smith and David Ricardo almost 200 YEARS AGO! What good is money if you don't exchange it for useful goods and services?



Economic health, simply put (to paraphrase Adam Smith): is the abundance and availability of goods and services. If more goods and services are available to you, the more healthy you are in economic terms. It is in fact, the present value of all goods and services you can or will consume in the future that determines your current economic health. If you exchange a little present consumption for investment in capital that greatly increases your future consumption you are better off (depending on your time preferences of course).



What the Wall Street experts should be saying is, "current consumption is possibly an indication of economic health" rather than the driver of it. It's an important distinction which underscores the pervasive economic ignorance in today's media (and even academia!).



Market bubbles like the recent housing mania have real effects on consumption but in ways that are much deeper than the talking heads explain. The problem with manias is that they pull investment out of tangible capital and into speculative paper by lure of high rates of return. When or even if the ponzi scheme fails is almost irrelevent. The point is that investment in capital goods like factories, roads, and machines is reduced during the mania which, in turn, curtails future production and ultimately, levels of consumption. I think the Austrian School calls this phenomenon malinvestment.



The billions of dollars invested in the real estate mania in the 2000s, tech stocks in the 1990s, junk bonds in the 1980s, and tulip bulbs in the 1500s represented billions of man hours of productive effort that could have went into tangible capital. Instead, it was vaoporized when the bubble burst- eradicated in a flash of write-down and liquidation, irretrievably wasted like the heat of a furnace that escaped through an open window on a frigid December night.



That is the problem with the so-called subprime crisis- not that the writedown of equity will curtail current consumption (which has its own marix of compounding impacts), but that the speculative investment in housing, that would have gone into tangible capital that produces consumables, never did and now we will have to accept a lower level of consumption going forward.



Perhaps the bible gets it best when it says that you "reap what you sow." The talking heads seem to think changes in consumption levels means you reap what you reap. Sorry, they're wrong.










Where Is All The Money Coming From?

So Federal Reserve Chairman Ben Bernanke is willing to pump $30 billion into Bear Stearns to prep it for fire sale to another "private" bank. And it plans to lend another $200 billion to unlock the reluctance of wary bankers to loan to one another. It's slashed its lending rate in response to the sagging Dow, and yet it continues to drop.

Where is it getting these billions from? The Chinese? What will happen when foreigners get tired of earning negative 1 percent (after inflation) on our treasuries? Where then will the next round of Wall Street welfare handouts come from?

I'll tell you: It will come from you and me in the form of an inflation tax as the Fed creates money out of thin air. Get ready for $5 gas.

Letter to the Editor of the Rocky Mountain News, 3/28/08