Wealth ought to come from the creation of value. That is, by designing and selling a better shovel, you make it easier for farmers to dig irrigation trenches which increases their yield. With your shovel, their output goes from 100 to 200 units a year, and so you, as shovel-maker get to benefit from a proportion of that 100 increase. It's "worth" giving you a cut, since your shovel added the value to their output. That, more or less, is the basis of capitalism. As time goes by, technology and methods improve, adding value, meaning we get more widget output per unit of resource input, and wealth increases.
There's another way to make wealth though, which is easier: by cutting costs, or essentially extracting value. Cutting staff, for instance. That means you spend less money per shovel, meaning profits increase, for a while anyway. Sometimes, though, that just fattens your bottom-line for a time, but strips out value from your enterprise, rather than adding it.
The third way to make wealth is to borrow lots of money. The problem is, eventually you have to pay it back.
Value creation should be a long-term and sustainable wealth-generation technique; value extraction is a short-term, unsustainable wealth-generation technique. Borrowing to make wealth is essential, but there are limits to how well this works. Borrowing too much is never a good thing. When too much borrowing is pervasive, it creates bubbles that eventually burst.
I've been thinking about value vs wealth in the context of the global economic meltdown. I don't have any answers at all but I am struck by the shape of the stock market curves for the past 40 years. Below is the S&P 500, between 1970 and 2009, a good proxy for the value of the economy.
It looks to me like there was a historically stable amount of value creation, reflected in the indexes, that for some reason in 1993/94 started to go a bit nuts. Two things drive it, I believe: low interest rates, meaning cheap debt flooding the market with money - corporate, personal, housing, financial; and increased global trade, namely with China, which kept prices and inflation low.
And it seems, based on this graph, that the wealth of the past 10-15 years was illusory, and that in fact the markets have dropped back to where they "should" be.
So the question is, what happened in 1993/94 that spurred such huge increases in stock asset valuation?
One answer comes from Niall Ferguson, in this fabulous (and scary) interview in the Toronto Globe and Mail:
"Monetary policy evolved in a peculiar way in the 1990s towards de facto or de jure targeting of inflation, an increasingly narrow concept of inflation - core CPI. I thought it was a mistake at the time because it seemed to me crazy to ignore asset prices. Why differentiate? What's the difference between pricing a loaf and pricing a house? Why do we care about one and not the other? In fact, we should probably care more about the price of a house than the price of a loaf, certainly in developed societies. I think there was a flaw in the theory there, that essentially you could call the Jackson Hole consensus. When the central bankers got together at Jackson Hole, the view that emerged from the debate in the late 90s was, we shouldn't really pay attention to asset prices in the setting of monetary policy." [more...]
Seems like they might have been wrong.
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There's nothing in the article about the source of this wool being sheared. The instruments created to deal with the perceived failure of Social Security.
While the names change, the pattern stays the same. The folks in charge thought that it would be a good idea to tax defer savings for retirement, and it was logically applied to stocks. In these times, we have millions of people who think that somebody else will buy what they bought, at a higher price. Ponzi mentality. And to lower your taxes at the same time was icing on the cake.
What we are witnessing is millions of sheep being sheared and slaughte red. Even the winners at the game are wondering if the monopoly money is still going to work.
I saw two beggars in front of me. One was a bum who wants a dollar. The other was an "investment counselor" who wanted a thousand. I'm paying a high price for my greed these days.
Do you think any of those people who bought a house they couldn't afford did so anyway with the idea that "it'll go up in value"? I bought it, therefore, somebody else will buy it for more.
2. Using a shovel that lets you dig ditches with less labor *is* cutting costs.
3. The main distinction isn't between producing more because of increased efficiency and producing the same amount with less input because of increased efficiency. That just depends on the shape of the demand curve. The distinction is between creating value and transferring it.
4. Borrowing doesn't create wealth. It connects people who want to buy now and pay later (e.g. homebuyers) with those who want to pay now and buy later (e.g. people saving for retirement). It also is one way of connecting saving with investment (in the economics sense of buying capital goods).
5. If borrowing per se tends to create bubbles at all, the connection is not straightforward.
6. Share prices are not by themselves a meaningful measure of much of anything over the time scale you're looking at, just whether revenue is reinvested internally or cycled between firms and shareholders. Total returns are much more meaningful.
Thanks.
I believe that none other than Dwight Eisenhower saw this coming, in its earliest form, when he coined the word "military industrial complex." He observed that "war, itself" would soon subsume every other social priority of government. He did not reflect upon just how all of that "war, itself" would be financed. I think that we understand, now.
"Money is not a Thing." Only a leprechaun thinks that money can be "invented out of thin air" (or from a pile of wet, smelly straw) and it actually "means anything." Only in a pipe-dream can a government "invent" more than $1 million a MINUTE and proclaim that they are not repeating 1930's Germany. But since 1994, and really before, that's exactly what we did.
tks for bringing our attention to the military industrial complex.
On top of everything else, the Military Industrial Complex became hysterical, after the fall of the Berlin Wall, about the lack of any new targets for our huge war machine.
Let us not argue about the wisdom of the size of our expenditures before the fall of the Berlin Wall. thos politics are past. Let us instead ask ourselves if we have not been fooled by the bureaucracry which, finding itself in place and in jeapordy when the Berling Wall fell, set forth to find new enemies which we did not need and are today fighting in the form of "islamic extremism".
When did the Islamic extremists not exist? The word "assassins" comes from a sect of Islamic extremists which existed millenia ago.
Is it not time to move on?
That $3000 was a very rough round number. We haven't had sustained growth of the money supply anywhere near that high.