The most common way of measuring how productive an economy is at any given time is Gross Domestic Product, or GDP. It is, in short, “How much work got done”. Work by people, by machines, by nature (such as filling a hydroelectric facility with rainfall to make electricity and boating).
For a very long time, folks have known that GDP “has issues” in measuring “good vs bad” work.
For example, if I go break a window, then someone fixes it, that is an “addition” to GDP. Yet, my net wealth did not go up. I had a window, and I still have a window. As an economy, we have less net wealth. Where before we had 2 window panes of glass (one installed, one as ‘parts inventory’) we now have only 1. Furthermore, the time spent putting in that window could have been used putting a window into a new home instead.
While it’s obvious to the average Joe or Jane that running around breaking and fixing windows does not add to our wealth (and in fact consumes our wealth) the GDP number is blind to that fact.
Then politicians (having taken, if we are lucky, one intro Econ class) look at GDP and ask “How can we increase it?” and commence to hire folks to run around breaking windows…
http://www.clickondetroit.com/news/22912392/detail.html
Mayor Readies Detroit Demolition Plan
Details Come Tuesday In State Of The City AddressPOSTED: Monday, March 22, 2010
DETROIT — Detroit Mayor Dave Bing is preparing to unveil an ambitious plan to demolish thousands of dangerous abandoned houses across the city in his State of the City address Tuesday evening.
The mayor has said in the past that the city must be downsized to reflect its loss of population.
One step along that path is to tear down empty, abandoned and dangerous homes in neighborhoods across the city.
Bing To Layout Detroit’s Demolition Plan
[…]
The city has $40 million available for the demolition project. As a cost of $10,000 per house, that means 4,000 homes will be torn down.To find out if your home is in the demolition zone, click here.
Yes, you can “click” to find out if your home is in the demolition zone… Nice of them to provide that service, eh?
The mayor envisions clearing out large swaths of the city that could be turned back into fields or farmlands. The smaller residential areas will allow essential services like police and fire to respond more quickly. Residents still living in those areas that are being cleared out might resist an appeal to have them move.
Brown said the city must be ready for that.
“We could give them a new home in a viable neighborhood that’s worth five times the value of the one they’re living in now for instance but we’re going to have to give people incentives to move into viable neighborhoods,” Brown said.
Even if the demolition program proceeds as scheduled, it will only address housing. The city is also challenged with abandoned schools, businesses and commercial buildings that will also have to be torn down.
Creative Destruction?
Frankly, I lay a lot of this stupidity at the feet of the “Creative Destruction” meme.
http://en.wikipedia.org/wiki/Creative_destruction
Creative destruction is a term originally derived from Marxist economic theory which refers to the linked processes of the accumulation and annihilation of wealth under capitalism. These processes were first described in The Communist Manifesto (Marx and Engels, 1848) and were expanded in Marx’s Grundrisse (1857) and “Volume IV” (1863) of Das Kapital. At its most basic, “creative destruction” (German: schöpferische Zerstörung) describes the way in which capitalist economic development arises out of the destruction of some prior economic order, and this is largely the sense implied by the German Marxist sociologist Werner Sombart who has been credited with the first use of these terms in his work Krieg und Kapitalismus (“War and Capitalism”, 1913). In the earlier work of Marx, however, the idea of creative destruction or annihilation (German: Vernichtung) implies not only that capitalism destroys and reconfigures previous economic orders, but also that it must ceaselessly devalue existing wealth (whether through war, dereliction, or regular and periodic economic crises) in order to clear the ground for the creation of new wealth.
From the 1950s onwards, the term “creative destruction” has become more readily identified with the Austrian-American economist Joseph Schumpeter, who adapted and popularized it as a theory of economic innovation and progress. The term, as used by Schumpeter, bears little resemblance with how it was used by Marx. As such, the term gained popularity within neoliberal or free-market economics as a description of processes such as downsizing in order to increase the efficiency and dynamism of a company. The original Marxist usage has, however, been maintained in the work of influential social scientists such as David Harvey, Marshall Berman, and Manuel Castells.
So, just remember, that when someone talks about the need for “creative destruction” they are leveraging off of a communist idea to justify economic destruction in the hope that better things can be done afterwards. As you know by now: “Hope is not a strategy. -E.M.Smith”…
So we have a large number of folks who have heard the phrase “Creative Destruction” and think it is somehow part of valid economics. That it is more than just a “thought toy” of Marx, Engles, Shumpeter, and Sombart.
But re-read that one key sentence:
“development arises out of the destruction of some prior economic order”
When you hear that, remember that it comes right out of the Marxist play book.
Net National Wealth
There is another metric. Net National Wealth. This is typically phrased in terms of money.
http://en.wikipedia.org/wiki/National_wealth
National (net) wealth also net wealth (in Singapore), national net worth, gross national wealth (GNW) is the total sum value of monetary assets minus liabilities of a given nation, also National wealth” refers to the total value of wealth possessed by the citizens of a nation at a set point in time. This figure is an important indicator of a nation’s ability to take on debt and sustain spending, and is influenced by not only real estate prices, but also by the stock market, human resources, technological advancements which may create new assets or render others worthless, national infrastructure and exchange rates. The most significant component by far among most developed nations is commonly reported as household net wealth or worth and reflects infrastructure investment, a figure regularly reported by the Federal Reserve of the US. National wealth can rise and decline, as evidenced in the US following the 2008 financial crisis. In resource rich nations, hydrocarbon reserves can vastly outweigh the value of infrastructure.
In terms of “National Wealth” it is pretty clear that breaking windows to replace them or tearing down functional housing does not add to the nations store of goods and wealth.
(So, for example, why doesn’t Detroit find a way to attract new citizens? Perhaps by having “tax free economic zones” near those empty houses? Then capital would flow in to build net wealth, homes would be desired, population increase and a larger tax base formed… Net wealth would be created, instead of destroyed. Perhaps because that does not fit with the “creative destruction” Marxist dialog?…)
Toward Net Wealth Creation
As a minor aid to politicians who have no clue how an economy works, and less clue about how wealth is created, I’ll provide a bit of a “roadmap” to wealth creation. But I’m not going to focus on monetary counters. I’m going to look at it in terms of “Physical Wealth Creation”. What is the PWC capacity of any plan you put in place? Is it a net POSITIVE PWC, or a NEGATIVE? That is what you ought to be asking. Not “how many windows can we break in a day”…
Things that create physical wealth. Generative / Creative.
These are sectors of the economy that, at the end of the day, result in something you can sell. It’s really a pretty simple question to ask. At the end of the process in an industry, do I have more “stuff to sell” or less?
Agriculture:
In many ways, the most obvious. I plant one kernel of corn, and I get 2 ears of corn with a few hundred kernels on each. I have a net increase in “stuff I can sell”. This process is a wealth creating one. (Though, in fairness, one must look at total resources used in the process to see if it was a NET wealth creation. That is why running as a capitalist enterprise subject to profit and loss forces matters. It prevents calling something a ‘net wealth creator’ when it is run so badly that it consumes more wealth than it creates… So planting Corn in the Mojave Desert is not as bright an idea as planting it in Iowa. And using Iowa corn to make gasoline, instead of feed for pigs and chickens, is also not so great an idea; so needs “subsidy”.)
Mining & Refining:
You dig up some rocks, and turn them into something of value. Copper. Iron. Diamonds. Coal. Even just a bucket of salt. At the end of the day, you have something you can sell.
Construction:
The building, especially of factories and manufacturing facilities, results in something that has increased your net wealth. Building houses, schools, and government buildings is a bit “stickier” as a question. Living in a home tends to consume it (over about 50 years), and a government building such as a Police Station is not exactly going to have a large market. But, in fact, they have a wealth value. They could be reused for something else, if desired. They could be sold. I have an office in my home, for example, and create net economic benefit from that office. But we are starting to see just a bit of the “ambiguity” that creeps in to some of the goods as you get further from the clear cases of ag, manufacturing, mining… Still, at the end of the day, a structure is an embodiment of wealth.
Manufacturing:
As distinct from the USE of the manufactured goods. At the end of your factory line, something comes out that you can sell. You have created something of worth. It increases your wealth to make more “stuff”. We can “break it down” into sub-categories that have more, or less, total net-wealth creation in them if desired. So, for example, a “Tool Maker” would be at the top of the heap of “net wealth creation” as those tools go on to create even more increase in net wealth. At the bottom of the heap would be Movies and Munitions. Yes, a movie can make a lot of money. Yes, you can sell bullets and bombs for a lot of money. But in the case of the movie, when used, it consumes time that could be spent making added wealth. The creation of the movie is an increase in wealth, but the watching of it reduces wealth, to the extent power is consumed, seats worn, etc.; while removing potential labor time from wealth creation. Bombs pretty clearly reduce wealth in their “consumption”…
So I’d rank them more or less like this:
Tools
Materials
Durables
Non-Durables
Writing and Printing (as it comes in two forms – one that increases wealth via knowing how to do things, the other consumes time as a diversion)
Movies & Music recordings production (note: as distinct from the consumption of them)
Consumption goods (such as coke and cosmetics)
Weapons
This list is just an example, but you get the idea. To the extent our society makes more tools and materials, we have a faster increase in national physical wealth than if we are making weapons and movies.
Power Generation & Fuels:
In many ways one of the most foundational of net wealth creators. It lets us drive all our other tools and factories. So we can drill for oil, use natural gas or uranium to make electricity, turn garbage into fuels. It’s a very long list.
But at the end of the day, you have something you can sell. Especially for fuels, that is obvious. For electricity it’s a bit less clear to see. We can’t see the electricity, but it is real. We in the USA buy large quantities of electricity from Canada. Also, while some electricity is used to drive TV sets and lawn mowers; very large quantities are used for refining Aluminum and building cars.
So power generation and fuels fabrication / refining are key parts of the wealth creation process.
Logistics:
As one of the hardest categories to put in this list, we have “logistics”. Note that this is not just “transport”. Transportation is often an important part of logistics, but transport can also be a country drive to see the sights with nothing to sell at the end of the trip…
Logistics is focused on getting things where they need to be, at the time they need to be there, so that manufacturing (or consumption) may happen. Steel is shipped to the car makers. Actors fly to the filming location. Joe and Jane Sixpack drive to work. The pipeline delivers the natural gas to heat homes, and the natural gas to make plastics.
At this point we start to hit the “need to divide” even more strongly. That same “commuter car” can be used to drive to the beach and play. That same natural gas company delivers a product making material to the chemical factory and delivers the gas that gets burned in the decorative fireplace in the livingroom. So you can’t just put “gas company” here. Only PART of the gas company.
In planing things like rail systems, bus lines, and the other “transportation infrastructure” that politicians like to fund; that distinction is often lost. We get “bridges to nowhere” and even “busses to nowhere” with no one on them and we get airports built near a senator’s home, but not useful for logistics. You simply must ask “Who will move what on this transport system; and is that creating or consuming net wealth?”. It is NOT enough to ask “Will jobs be made?” or “Will construction happen?” or even “Will busses cost less than private autos?”. Those are largely “how many windows can I break?” questions…
A nice “light rail” line that connects lots of free parking near suburban homes to a set of office and manufacturing facilities is part of the “logistics” of getting workers to where they can create net wealth. Empty busses on suburban streets running too and fro and taking 2 hours to carry me to the grocery store are rather useless.
OK, at this point, I think we’ve got enough examples of “wealth creators”. Time to move on to the other extreme.
Things that consume national wealth. Consumptive
This is a VERY large group. Please note that I am not saying that these things are bad, evil, wrong, suboptimal, etc. The whole GOAL of most economic activity is to end up with enough “stuff” left over that you can do more of these things. This is, most often, the “stuff” we really want. It most definitely is a “goods” to go out to dinner and a movie. But, at the end of that night out, you have nothing of value to sell. Your money has gone away to someone else who cooked that meal and ran the movie theatre and cleaned the floors and seats. It was an act of consumption not wealth creation.
So we do want these things. It’s just that if all we do is ‘make’ this class of stuff in our effort to increase GDP, we end up impoverished as we squander our Net National Wealth. You simply can not make an economy out of “these bits”.
As it’s a large group of diverse things, I’ll list some for “flavor” but it simply can’t be an exhaustive list.
Watching movies, TV, plays, entertainment:
We are consuming power and facilities, not creating.
Cleaning, washing cars, janitorial:
Yes, we like things to be clean. But at the end of the day you do not have something of increased value. You have just gotten back to “even” from the negative act that lead to the need to clean.
Medical Care:
A similar “getting back to even” if you are lucky. We consume surgical trays of sutures and tubing, drugs and bandages. When you get a broken arm set, or even new eyeglasses, you do not have something of value to sell at the end of the process. As valuable as those glasses might be to you, and as much as they might help you at work, they are simply not an increase in net wealth. (Benefit, yes… but the wealth creation comes AT that job, not from the act of buying glasses). So we consume medical care.
Vacation and Sports:
A much more clear example. Spend a week at the beach. Not much to show for it at the end of that time. Fun, yes. Profitable? Not so much… Watch a football game while drinking beer and having a Polish Dog with Kraut and Mustard. (Health food ;-) as we saw before…) It’s fun entertainment, but at the end of the day neither the fans nor the football team has made something to sell. (As distinct from the process of making a DVD of the game and selling that as a “highlights” disk. So you can see why I make the distinction between manufacture of movies / DVDs / CDs and the performance of the material that goes into them).
Restaurants and dining out:
Pretty clear that “in the end” it’s not an increase in wealth…
Trash Disposal and Recycling:
Yes, it’s a “bad thing” if the stuff stacks up, but not a lot to sell comes out of moving it to the dump. Recycling does eventually result in salable materials, but at a net cost, not a profit (thus the ‘deposit’ on cans and bottles…)
Personal Services:
All those hair cuts and nails trimmed. Tanning salons and fitness trainers. All are things we enjoy. All are consumption activities. This is a broad list that includes things like tax preparation, legal services, career advice, etc. They may be helpful to you, but they are net consumers of time and “stuff”.
Education:
I’m sure folks have been soaked in the idea of education as “investment”. The notion of “human capital” and of “increasing personal worth”. I’m all for education as a benefit. But just like a good suit and a nice haircut can help me get a job and are not a ‘salable wealth’, so for education. We consume time and facilities. We are kept OUT of other activities (such as mining or making tools) that would increase net national wealth. We hope that at the end of it all we will make more money. But for every MD or JD minted, there are a few tens of thousands of “Liberal Arts” and “Education” degrees issued. Also, “Hope is not a strategy. -E.M.Smith”… So we consume education services and we hope that in the end we can make back more than it consumed… (Don’t like this one? Need I point out the number of “wealth creators” who have founded companies without college degrees? Woz eventually got his, but AFTER he was up to his eyeballs in wealth he created… Don’t get me wrong, my Econ Degree was a nice thing to get; but frankly was useless at work. I’d have created more “net national wealth” going directly to my first job – customer service – out of highschool.)
If it really bothers folks, I suppose one could indulge in a “food fight” over the relative merits of the different degrees and sort them into “wealth creative” and “not”… Engineers vs poets and business majors vs sociologists… I just don’t see the benefit of the food fight. Easier to say “Being an engineer creates wealth, becoming one consumes wealth”.
The Harder Cases
OK, I think the “Generative / Consumptive” contrast is pretty clear.
I just note in passing that governments seem hell-bent on pushing / subsidy for many consumptive processes as “economic stimulus”. We get cities fighting over sports teams and all the restaurant and party business they will bring. (And they forget the net consumption of wealth aspect). We have massive subsidies for “infrastructure” that builds bridges to nowhere and funds busses of empty.
Far less common is funding to increase power generation or to support manufacturing.
Typically, taxes are applied to agriculture (land), production (labor), and manufacturing (profit / capital gains). Extractive / mining industries are heavily taxed.
At every turn, government discourages production of national wealth and encourages the consumption of it. Sometimes via direct condemnation and bulldozing…
But there are some activities that are more “neutral” in character. The don’t create wealth, but just move it around. They are “distributive” or “re-distributive” in nature. There are also activities that protect life, property and wealth. They are not creating it, but are preventing the destruction or theft of it. We would be better off (more wealth creation) if we did not have to spend time and treasure on these things. But we don’t have that choice as much as we would like.
So I add those two “buckets” as well. It would be better to move effort into wealth creation and out of these areas; but you sometimes don’t have that choice.
Protective:
Military
Police
Fire
Private security
Internet security and firewall tech
Anti-virus
Preventative / Public Health Medicine.
I think it’s pretty clear that A LOT of government money flows into this area. We are in many cases being “protected to death”. Obamacare is being pushed based in part on the notion that the Preventative Medical spending can reduce the money spent on consumption of medical services later. (Note that both the preventive and the consumptive medical care are wealth consumers).
All those “drug crimes” from the “war on drugs”? All those prisons full of folks being fed, cleaned, kept warm and kept unproductive along with all the guards watching them (and eventually getting pensions). Not a scrap of it contributing to ‘wealth creation’.
As it can be sold with the banner of “protection” or “safety”, governments fund much more police and fire service costs than are really justified, IMHO. We need more sprinklers in garages and fewer firemen. More private security agencies and fewer cops on the street. And we need a whole lot less Military Adventurism…
(Re)-Distributive:
Retail:
Macy’s and Walmart make it comfortable and easy to “get the goods”. They cut the costs of traveling to a dozen small shops or having UPS deliver to your home. But in the end, all they do is distribute goods to where they are desired. They do not result in more stuff to sell at the end of their process. They do not create wealth, just move it about. While this is a benefit, it is not a creation of new wealth.
Financial Services:
Trading does not create wealth. Even a stock IPO does not create wealth. Selling bonds, trading corn futures. The whole lot of it is just moving the wealth around in the form of financial instruments. Insurance too. The massive quantities of money washed through various forms of insurance is just moving money and wealth between different groups of people and sometimes from one point in time to another for the same person ( various kinds of annuity). Real Estate sales too. It’s just redistributing where the wealth is, not making new added wealth.
Taxes and Government Services:
Pretty clearly the government does not create wealth. It takes wealth from some folks and gives it to others as “transfer payments” (social security, medicare, federal retirement pay) and it uses some of the money to buy services (such as road repair or PSA Public Service Announcement advertizing).
In some cases the “service” has a benefit (such as Air Traffic Control), in others, much less benefit can be shown ( various boards and agencies that long ago stopped being of any importance). Does the FDA really make drugs safer than a very strict liability law? Or does it just make the process more indirect? Is that a “protective” function? Or just a transfer of taxes to folks reading drug test result reports? Is the TSA really providing any net increase in “protection”? Even if it did, is that “service” creating any net wealth? Pretty clearly having the “Porno Patdown” does not result in much of value you can sell… In other cases, like Amtrak, you do get a transportation service, but the costs are high and, at the end of the day, it was a consumption of wealth, not a production.
Even things like the Federal Highway System are a bit questionable. I’d likely count them as a net asset. Clearly they can be sold (as many governments have started doing, selling off the taxpayer funded investment to private companies who then charge us to use the roads we already paid to build…) So I’d say that Highway Taxes do result in wealth creation. Just at rather low efficiency. Is it a NET wealth creation? Much harder to say (but I think so).
But when looking at government expenditures, by far, the largest parts are Transfer Payments (medicare, Medicaid, welfare, food stamps, crop subsidy) and Military / Defense. Shortly to include “debt service” as interest on the national debt balloons out of sight and the rest of the medical industry as nationalization proceeds to the inevitable conclusion.
So exactly which of those things create net national wealth? None of them?…
In Conclusion
That is, IMHO, the core of the problem.
Government goes out of the way to tax and punish net wealth creation (or even the possession or transfer of it – i.e. death taxes and capital gains taxes and property taxes and…) while at the same time paying large sums to increase wealth consuming activities.
From the local city building sports stadiums, to the wars abroad, to the consequences of the “war on drugs”, to welfare and Medicaid payments, and even to the massive government education industry. All along the way, wealth destruction and consumption are subsidized while wealth creation / possession is discouraged or destroyed.
“Creative Destruction” indeed…
So is there any hope that we can find a way to change the perception that “any job is a good job” and “government must make jobs at any cost” (even at the cost of our national wealth)?
Can we get government to realize that it needs to focus on polices that create wealth, not just redistribute it?
Can we put a spike in the notion that having all the mining in 3rd world countries and shipping all the manufacturing to China and India can leave us with a “service economy” that creates wealth?
Can we stop attacking our energy creation infrastructure and demonizing logistics and transportation?
In the end, can we just get Government to get the hell out of the way and let the productive parts of the economy produce?
Sadly, I think not.
People can be incredibly hard to ‘retrain’, and we’ve got a generation that has grown up thinking that “Creative Destruction” is a good thing, that digging holes to fill them in is “job creation”, and that “service industries” are wealth creators, not just redistributors. I fear it will only be turned around after all the creation has gone, and the redistribution and consumption have wound down the remaining National Wealth. Perhaps, with luck, we won’t have to hit rock bottom before we decide to put a cork in that particular bottle… but a study of other addicts shows that is usually not the case. And make no mistake about it: Our political class is addicted to the notion of “spending to make money and jobs”. If Quantitative Easing didn’t make that clear, and if QE-2 didn’t drive the idea home, then the fact that they are talking about maybe doing a QE-3 ought to make it very clear.
In the mean time, I think I need to see if MY town has a web site up listing where they will be bringing “Creative Destruction” to a neighborhood near me… If only the Feds would have such a place where you could see what they plan to destroy next…
Perhaps after a generational change we can focus on PWC Physical Wealth Creation and not just on GDP as re-distributing the deck chairs on our Titanic Economy.
Musings from the Chiefio 
The Broken Window fallacy is famous, and famously wrong. And it is being used by politicians today (June 9) to excuse the poor job numbers and at the same time to be the cause of better job numbers.
I like your write-up. One suggestion: you might amplify, perhaps in a separate post, the role of futures as protectors of wealth through hedging. Here, you simply note that futures do not create wealth but say little more about that issue.
“Speculation” has such an oddly vilified reputation now (when oil prices are high) and it’s probably time for a reminder of how it really works, and the positive (and crucial) role that such speculation plays.
===|==============/ Level Head
@Level_Head:
FWIW, I try to keep a bit of division between ‘trader talk” articles and “econ for Joe and Jane” articles. Probably not needed, but as only about 1 in 100 readers ever comment, I have to guess about the makeup of the ones who “look but don’t talk”.
At any rate, yes, futures and options are best used for “insurance” policies, just short term ones. So a farmer has a field of wheat. He can make a profit at $4 and prices are presently $4.10. He sells his wheat for “future delivery” at $4.10 and is guaranteed he gets to keep some of the wealth he has created. A baker can make a profit with wheat under $4.50, so buys wheat for future delivery at $4.10 (so locks in profit, and both are happy).
Now it does not matter if wheat at harvest is selling for $3 or $5. Nobody is losing money.
Add the speculator. He buys the $4.10 wheat future and holds it. If prices are $3 he’s fleeced (as he is delivered wheat at $4.10 and can only sell it for $3 and loses $1.10). IFF wheat is $5 at harvest, he’s made $0.90 for providing that “insurance” to the farmer. Same thing for the baker. Speculator SELLS the wheat future for $4.10 and if wheat is at $3, he makes $1.10 for the insurance. If it’s $5, well, he has to pony up the extra $0.90 from his pocket….
So what the “speculator” does is take on the risk. The “natural buyers and sellers” get to decide if the insurance is worth it, or not, and by “hedging” (as opposed to speculating) can get a risk free profit guaranteed.
It is a large “benefit”, but does not create new wealth. (In this case, it does the rather interesting thing of preventing the redistribution of the wealth via price flux, as the hedge locks the price at a profitable point).
(You and I are writing for general purposes, obviously.)
It locks in profit, and prevents catastrophic losses, for both producers and buyers, trading off some possible profit to avoid a worst-case scenario. And it does it at an amazingly low cost, thanks to speculators.
This only works to the extent that the hedge arrangements matches the quantity of the goods that you plan to produce or need to buy, but the commodities market has long since worked this out and the transaction is simple, costs pennies, and takes only seconds to complete.
These days, most of the market (far past 90%) is speculators, rather than actual producers and consumers, and they provide a mechanism for reliably determining the value of the goods involved.
Where this reliability fails is when the government steps in, not in the derivative markets per se.
The various derivatives don’t bother me, actually. The problem there was the assumption that the guarantors — Fannie Mae and Freddy Mac, the “quasi-government” lenders — knew what they were doing. That was demonstrably proven to be untrue, but you had government incentives (and requirements) dictating that you accept the government’s wisdom here.
We saw required asset ratios of 10% — which would have allowed 10% of the mortgages to fail without crashing the system — drop to 2%. So the system became easy to crash, but you risked being sued if you did not participate.
The fragility became obvious, and the crash was no surprise. What was a surprise is how hard Obama and company have worked to keep the crash going, so that they can accomplish things and keep this crisis from going to waste.
Incidentally, I found an excellent video of a rap music production called "The Fight of the Century.". It doesn’t sound like much—but the fight is between John Maynard Keynes and F. A. Hayak, with the two men comparing and contrasting their approaches to a rather catchy beat. They did a creditable job on it, I thought.
===|==============/ Level Head
Sounds like the UN’s Agenda 21 at city scale!!
Good article – but one flaw. Assuming politicians have had ANY Econ classes. If they did, they got D- like Gore’s climate class.
I was hoping for one of your famous graphs showing what has been happening to net worth of the USA (in constant dollars) over the last 10 years.
While the theory is interesting…… \Where’s the beef?
Yes, we have to get back to the glory of the Clinton surpluses (sarc). Actually, when was the last time the U.S. debt did not increase yoy?
@Gallopingcamel:
I’m not convinced anyone has valid data.
This graph:
has a bit of a clue. Notice it ends in 2009, so add 2 more years of decline to the “blow off top” exponential… then collapse.
@R. Shearer:
Clinton had the brilliance to “accellerate income” into the present. So Roth IRA conversions gave massive tax income then, at the expense of now. Fanny and Freddy gave massive capital gains flux (until the collapse). Etc. Juice Juice JUICE!….
Yes, we’d all like that dot.com bubble housing bubble drug again… But for every shoot up, there is a “crash”… The “trick” is to stick the Republicans with the Crash…. Too bad for Obama that this crash didn’t pop back up on schedule…
Chiefio,
Great post – I think along the same lines and my thoughts have been as follows: value is created when you dig something up; grow it; or make it. When it comes to making it, it is more productive to make a car vs. an ICBM because the ICBM will (hopefully!) just sit in the ground forever once it is made while the car will need more parts, maintenance, as well as serving a daily value creating function.
Movies and other entertainment I also understand similar to your presentation here.
I also like your extended listings and rationale.
One question stays with me though, and I guess it is a sort of entertainment kind of economic activity. And that is various forms of artistic, musical, and literary masterworks. What is the economic valuation of a Beethoven piano sonata? Those sonatas are still published and sold – for example the Moonlight sonata was published in 1801 and I bet you can hear the melody in your head just reading this. Not what is their artistic or other merits; but their economic value. The sheet music is bought and sold; concerts are held; recordings made and sold…is this stuff “worth” anything as far as creating economic return?
What is really needed is “creative destruction” of government bureaucracies. pg.
“Can we stop attacking our energy creation infrastructure and demonizing logistics and transportation?”
Indeed, energy is the verb of every economy. If you want a vibrant economy, do all possible to lower the cost of energy, the life blood of production. Currently much of the world is doing all possible to increase this cost; a world gone mad. Obama and his policies are, of course, instrumental in this madness. The only real hope I see of avoiding a far worse double dip, if one can call it that, is doing all possible to lessen the cost of energy in all its efficient sources.
Per E.M. and level head, thanks for the educational conversation. I suppose that one can argue that any inflation, related to speculation,is an advance warning to a system that problems are ahead, a warning that may in fact lessen the severity of a future problem. As far as investing in general though I have some concern / questions, in regard to the very short term investing in the markets. I presume that the primary purpose of stock markets is to provide capitol for the production of goods and services. I do not understand how the investment of capitol for very short periods provides benefit to a company. If I wish to grow a business, and you give me $100,000. today, and take it all back in a hour, a day, or just weeks, how does this help me? it appears to me that the value to me of your investment is directly related to how long you leave it under my mangement, but this appears poorly reflected in the markets. Modern technology has increased this concern.
@Greg O:
That’s why I divided the writing and creating of a work from the performance of it. To allow that there is a kind of “wealth” embodied in that creation. But sitting in a theatre listening to it is an act of consumption…
Make a statue? Creation. Look at it? Consumption.
It all comes back to that basic question: After doing this act do I have more stuff to sell or less? Creating a symphony gives sheet music to sell. Spending the night listening to it? Pleasant, but you have slighly more worn seats, instruments, etc. and not a lot to sell from it. (IFFyou then wrote a review of the presentation and sold that to a paper, that would be a new act of creation of something with value… even if more fleeting.)
@P.G. Sharrow:
Oh! I love it… Go all Schumpeter on them ;-)
@David:
Yup, it’s crazy to do what they are determined to do…
Per Speculation: It can change the RATE of price discovery, but not the result. So you get a price that would rise from $3 to $5 over a 6 month “harvest and auction” cycle being reflected in 4 hours after “news hits” about expected future crop losses. Speculation moves faster, but not further, than demand / supply.
Per stock markets / investing:
ABC Company wants to build a new business. They issue a bunch of new shares. (You can think of this as “printing their own money” if you like). These shares are offered to the stock market in an IPO Initial Public Offeriing if the company has never listed shares before or in a Secondary Offereing if they are already public. So they sell A Million Shares at $20 each and bag $20,000,000.00 that they now use to build their new business.
From that moment forward, the company does not care at all what happens to those shares. They’re sold and gone. Cash is in the bank.
So those shares may be bought, sold, traded, put in a mattress, gifted to your grandkids, etc. Makes no difference to ABC. They don’t have to EVER buy those shares back.
Time passes. You HOPE that ABC makes a ton of money out of that $20 M. Enough to pay a fat dividend (as you are hoping for a return on that purchase of ABC Stock). Sometimes a company may decide to reward you indirectly, by purchases of some of their own shares in the open market (in the expectation this will raise the price generally; but it doesn’t always work… short sellers and all…) To the extent the company is seen as making money, the price of ABC stock will rise (and you can sell it to someone at a profit).
To induce the company to care about the stock price, executives are usually granted stock ownership or options. In the very long term, a company may want to have other Secondary Offerings, so would like to keep the prices high so that they can get more money from their sale of added paper…
But generally, once the stock is sold, the day to day changing of hands means nothing to the company.
Put in short form:
Buyers of an IPO or Secondary are the only ones who actually “invest” in the company; everyone else is just “speculating” on the price of the stock certificate…
The Song of a Generation…
Through early morning fog I see
visions of the things to be,
the pains that are withheld for me
I realize and I can see…
that suicide is painless
it brings on many changes
and I can take or leave it if I please
(I think, I think, I think..
and I can take or leave it
if I pleeeeeeeeeeezzze;-)
“Suicide is Painless” by Johnny Mandel
http://www.stlyrics.com/lyrics/televisiontvthemelyrics-50s60s70s/mash.htm
Nice post, E.M.
That’s pretty much the way I learned it except it was, “The only true sources of wealth are mining, manufacturing, and agriculture.” They are indeed the base of the wealth pyramid.
GregO uesed the phrase “value is created” and he sort of hit on the the point I wanted to make involving the popular phrase, “value added.”
So long as someone is adding value to the base of the pyramid (note: manufacturing is in the base because of tools; not much mining or agriculture goes on without at least a shovel for the ore and a pointed stick for poking holes in the ground.
But the concept of value added produces a blurry line. When does value stop being added? Take logistics for example. All the wheat in Kansas isn’t worth a plugged nickel if it doesn’t get to the mill. All of the mills could send someone to Kansas, get their wheat loaded up and head back to the mill. It’s a ‘duh’ that there is a great value added for grain cars to distribute wheat to mills (and mills to ship to bakeries, and bakeries to deliver to stores). That’s wealth creation from logistics.
But how about the guy wealthy who gets his Krispy Kreme donut and coffee brought up to the conservatory by the butler, who had the cook order the maid to call the bakery to have the delivery person bring the donuts to the house? It’s all value added to him. Where do you draw the line between where consumption starts and adding value ends? There is a line in there, somewhere, and different for every person.
That throws utility into the picture. Wheat has a basic utility on the value added chain up to the point where it can be used to sustain the need for food. Consumption (and wealth reduction – it costs money to live) starts there, but where is “there?”
(Just stirring the pot a little E.M.)
@H.R.:
Yup, that’s the problem. In reality, we need a different set of buckets that divide on the “creation” vs “consumption” metric. Per the pastry, dlivered et.al.:
I’d count it as value creation right up to the point of consumption, then the “value consumed” is that same elevated value. As opposed to the pastry on the shelf bought by the walk in diner. There IS value in having a very highly paid person focused on work and having “logisitcs” bring stuff to them (keeping their time more productive). But you need to recognize their “consumption” as more expensive too…
Pascvaks,
I was watching MASH all those years without understanding where the intro came from.
Thanks! You are a gentleman and a scholar.
Regarding 10 June 2011 at 1:24 pm E.M.Smith
.
“Per stock markets / investing:
ABC Company wants to build a new business. They issue a bunch of new shares. (You can think of this as “printing their own money” if you like). These shares are offered to the stock market in an IPO Initial Public Offering if the company has never listed shares before or in a Secondary Offering if they are already public. So they sell A Million Shares at $20 each and bag $20,000,000.00 that they now use to build their new business.
From that moment forward, the company does not care at all what happens to those shares. They’re sold and gone. Cash is in the bank.”
“So those shares may be bought, sold, traded, put in a mattress, gifted to your grandkids, etc. Makes no difference to ABC. They don’t have to EVER buy those shares back.”
“Buyers of an IPO or Secondary are the only ones who actually “invest” in the company; everyone else is just “speculating” on the price of the stock certificate…”
Thanks, and this does make sense, and, of course, price fluctuates to a degree on the balance of buyers and sellers. I never understood the math of exactly how a stock price was calculated. (Thousands of buy / sell orders come in, a $100 stock move up 2 cents, how was this calculated? )
At any rate your answer surprised me somewhat. I assumed that when one purchases a stock (normal purchase, not part of the IPO) those funds still became available to the company to use, that someone was actually investing in the company;. XYZ company takes off after the initial IPO, within a year the twenty million is worth two hundred million, these funds are available to the company to increase business opportunity, are they not? If not of what value to the company are dividends paid to “speculators”, trading with each other, betting for or against a company? Perhaps a better understanding of what happens to company XYZ if, years later, business goes south in a big way and investors/speculators all bail, would help my lack of clarity here.
David:
Sometimes it’s true, but that’s not the typical situation. It depends on who you are purchasing the stock from.
Unlike the trend in modern monetary policy, company shares ARE backed by something; the total ownership of a company is always 100%. This is as true for my little corporations as it is for Microsoft, and neither of them can sell more than 100% of their shares, nor can ownership ever total less than 100%.
Stocks are not as tangible as gold, but there is still an inhererent limit to the supply. And, with luck, some value to the item. In a sense, the shares ARE the gold, as it’s a representation of a percentage that doesn’t have to be “exchanged” for something. You can exchange your account ownership for an actual share certificate, but few bother with this; these are decorations only. In a sense, the shares ARE the gold, even when represented electronically.
But back to who gets the money: During the IPO, the Initial Public Offering, a portion of the company is offered to the public to become partners. The company is the seller of part of itself, and obtains the cash resulting from it (after legal expenses of typically a couple of million dollars, and commissions). There is usually a restriction of a year or two for these new “partners,” after which they can sell their shares to others if they want.
But later on, when one of the “partners” (i.e., a person who bought some IPO shares) decides to sell, he gets the cash when he sells it to a second person who wants in. The company is aware of the transaction only distantly; they’re informed of it, but not involved, as it’s handled through brokers.
The “secondary” mentioned is one or more additional offerings of stock, to raise additional cash by the company. Because the company is always owned, 100%, by someone, these new shares can come from one of two places—and either one has complications.
If one of the existing original owners (who kept the part of the company not offered to the public) sells a chunk of her holdings to raise cash, the money comes to her, not to her company—and can only get to the company through a loan or investment, while she is responsible for the income tax.
If the company simply “prints” new shares to sell, then it means that all other shares now represent a smaller portion of the company, since the total is always 100%. So, the value of everyone else’s shares in terms of percentage is “diluted”—and they often have no say in the matter. Smaller, shadier companies do this sort of repeat offering many times.
Stock splitting is not a problem for shareholders, though–if you had one share at $120, you wind up with two at $60 and worth the same percentage of the company as before. The split is (generally) to keep the price at a level that people would purchase, as many people for example don’t by shares that cost more than $100. Reverse splits combine the value/percentage of several shares, usually to keep the price above $1 or $5—requirements for certain types of listings.
But almost all of the trading that goes on every day is just one person convinced to sell a bit of partnership, and another person convinced to buy it, and the company does not directly benefit.
Of course, a rise in price benefits all of the holders of those partnership bits, if they sell at the higher price. Otherwise, it’s “assets on paper” (we’ll ignore tax issues here). One other use for the higher value is as collateral in loans—and it was this loss of the collateral value of stock that triggered the first business collapses in the 2008 crash, when companies who borrowed many millions overnight were suddenly cut off because the value of their stock could not serve as sufficient collateral.
All of this is for “equities” — i.e., stocks in companies. The other two large areas, futures and options, work differently. There are even “futures” on “equities” and “derivatives” on many sorts of assets — but they work like futures, not like partnerships in the entities involved.
Does that help?
===|==============/ Level Head
@David:
If the company issues $20 M of stock, then the “value” in the market goes up to $200 M, the company gets NOTHING of that increase. It is all value added to the original buyers.
Now, the company MAY have decided to only IPO 1/2 the total stock, in which case the “treasury shares” it holds would also go up. Then it could sell those shares ( a secondary offering) and get 10 x a much per share as in the IPO. Or, if it issued all the original shares, it could announce a “New Secondary” and dilute the old shareholders.
So sometimes you see XYZ company announce a “Secondary stock offering” and the stock commences to drop in price. Why? Well, say originally you owned 10% of the company and now they are going to double the total shares. You end up owning only 5% of the “new” company… The hope, of course, is that the revenue from the “new” shares will make the company bigger by more than your dilution… but that is not guaranteed…
Why pay dividends? Because if you don’t do anything to “return shareholder value” your stock can be seen as “worthless” and someone will buy it all up for $10,000 and tell you you are fired as they are the new owner… So companies do a variety of things to “keep the stock price up”, or the get taken over. (Say I have $1,000,000 of value in a gold mine and my stock total value is $500,000. Doesn’t take long for a “takeover artist” to see they can buy a gold mine for 50 cents on the dollar… But if I’m issuing a dividend so my shares have a 5% Return, it’s much less likely that the price would drop like that, as someone will want that return…)
Now, say XYZ owns that mine, and the management is just sucky and spending days at the Beach Party and not paying a dividend and not expanding the mine and generally making small losses each year (as that expense account racks up the costs and the investment in the mine is near nothing…) The stock gets dumped by “investors” who see no return. Price plunges. Someone says “Hey, if I can their asses and put in my guys I can double my money in a year” and they get “mergered”… If there are no valuable assets, the company making losses has the stock price drop to “penny stock” levels, then eventually any bond holders or the bank who have priority loans get to file papers and takeover the assets in bankrupcy court. Unless you are GM, then you get given to the Auto Workers Union as a political gift to buy votes…
How is the stock price set, moment to moment? Not the way you think…
There are THREE parties to the transaction. Buyer. Seller. Market maker
The market maker is a specialist in that stock. His whole job is to balance buy and sell orders. He has a “book of trade” and in it, has a list of buy orders, and sell orders. Many are “at a price” (limit orders) some are “now” (market orders). SO he looks at the balance, or imbalance. If he has 10,000 “sell at market” and price is $40, but he doesn’t have enough “buy at market” to match it, he moves the price down until enough “limit” orders to buy are triggered to add up to 10,000 shares. If he has 10,000 “buy at market”, but only 2,000 on offer at $40, he will move the price up to trigger enough “sell if touched” orders to make up that 10,,000 shares.
In very thin stocks, he may get “Sell 1,000 market” and have NO standing orders on the books that will soak up that much. He then makes a decent guess what price will ‘clear’ by the end of the trade window and HE makes up the “other side” of the transaction. (“Buy for his own account”). This is, IMHO, the key to understanding why prices move and how.
So “bad news” hits CNBC. 1,000,000 people say “Sell my HPQ” (as it got a new CEO). The specialist has, maybe, 50% of that volume covered by existing buy orders and some “large institutions” that said they would like a call if it gets cheap… He then “sucks it up” and buys the rest (as required by his special position as “specialist”). BUT, he can set the price anywhere that does not get an ethics charge against him by the SEC… So if HPQ was $42 bid. It might drop to $40 bid clearing out the existing orders, then $38 bid as he “dials for dollars” with the institutions. Then he sucks up the rest at $35 knowing that after the news is past and a day or two later he can sell it at $38+ to some more ‘value investor’ whales.
Watch stock prices on ‘bad news’ and you can see this dynamic play out. A drop, a pause, another drop, a plunge, then a slow rebound over the next 3 days.
Yes, the Specialist has to have a pretty good eye for what is “real value” and know when it’s OK to ‘buy for his own account” in volume. “Trading WITH the market maker” is a very nice trade. So if you can learn to think that way, and spot when “The Market Maker is buying for his own book now” and buy with them (instead of panic selling) you can make some nice jingle.
HOWEVER: Realize that he may be expecting to run it back up all of $1 over two days, sell out, then let drop another $5 if the news does not improve… Basically, the market maker is, by definition, day trading, not investing… So don’t expect “Friend of the Market Maker” trades to be over a 1 year time line…
@E. M. Smith:
True enough, with the subtle and indirect exception of the collateral business. If the company’s remaining holdings are worth more because of this massive increase in share price, they are often able to borrow using this as collateral. So they have the use of millions of dollars, and can presumably earn a profit on it, based on nothing more than the publics’ (and then a lenders’) belief that this newfound value is intrinsic and long-lasting … or at least long enough to get paid back.
Of course, sometimes such collateral can be worth nothing more than “goat poo” (a phrase attributed to Americans in this case which would not have been used here).
Yes, that transaction involved other sorts of collateral as well, but the expression amused me.
===|==============/ Level Head
Dear E.M. and Level head,
Thank you for your replies. My ignorance is cured. (At least in this one area)
@E.M.
Sooo… the butler did it, in the drawing room, with a donut. See, I have a “Clue”(TM) ;o)
Seriously, when discussing where wealth creation ends and consumtion begins, isn’t the butler, maid, delivery person just helping the rich old guy consume? You mentioned that at the end of your comment, but I’m trying to get a bead on the exact point when consumption begins.
There are a lot of activities that seem to be value-added but they are just part of the wealth-consumption process; no new wealth was created.
P.S. This has been a fun thread to just let percolate in the background; fun and interesting post and comments.
Speaking of GM, On “Morning Joe” this morning I heard that dreaded creeping socialist Bob Lutz praise the government bail-out as the only way to save a company that was viable except for the devastating effect of a temporary 40% fall in industry sales due to factors beyond their control (the almost depression that was somehow caused by Democrats after 8 years of Republican government), and note that GM management would not have needed the bailout if the crash had come 2 years later as the steps had already been taken to get their house in order, but the biggest step didn’t go into effect until 2010.
@H.R.:
I suspect that your point is the reason WHY this approach is not looked at more often.
Education is an example. It is “investing in human capitol”, but at the end of the process, resources and labor were consumed. Is the “sale” of the (now, supposedly, higher valued) labor of the student a “wealth product”? Or is the salary of all the professors and the cost of the campus a “consumption”? (I would say “yes”…)
So I would count the labor of an engineer as a “wealth production” and the education process as a “consumption” and let the net of the two determine net national wealth increase… Yet… As this is an education process that takes decades, then a work lift that takes decades, you could have a nation “investing in education” for 20 years at a large net loss, only to THEN have great gains for 40 years as those folks go to work. How to properly account THAT in an annual “wealth creation” report?
“The Butler” is also a great example. Clearly a “personal service” butler is “consumption” by proxy… But what if the “butler” is at a meeting of the IMF? How about if he is working the dinners / lodge at a “Manhattan Project”? Does the “service staff” at a wealth creating company or project not contribute to the creation? (This matters a LOT for things like I.T. staff. They are, basically, “electronics buttlers”, or, as I’ve sometimes called myself, the “computer janitor”… so are they a “service” to the Engineers and Managers? Enhancing consumption of web browsing and tweeting? Or are they an integral part of the engineering creation and management wealth creation process? I’ve been told my department was both from time to time…)
So that “accounting and sorting out” process gets murky in some important places. I suspect that’s part of why the idea gets left to lay about… Yet we have a load of similar things aready handled in accounting…. (WHEN is it a capital gain vs an expenditure? What is a “business expense” vs personal. The tax code is full of such things.)
Yes, plenty to ponder. Glad you enjoy the pondering ;-)
EM Good exposition overall, but I think missing a few items. I think you are saying that fundamentally only things that can be bought and sold represent wealth, and you have a bias toward tangible things. Manufacturing creates wealth by adding value or utility to a less useful or desireable thing or material. OK so far. What about maintenance that restores utility destroyed by wear and tear? Does it just return the status quo ante, and thus not add wealth? A machine tool that can add value and can be bought or sold clearly represents wealth. What about a wrench that is only used to maintain the machine tool? Consider a point in time when a plant has x value, after considerable use. At a time a few hours later, after restorative maintenance, does it have more value?
Consider my productivity after considerable vision loss. Does not buying glasses that restore my vision and productivity add wealth? I think you have to add that any overcoming of entropy is also value adding. Similarly medical intervention adds value.
What is the value of the productive individual? Does a better educated and thus more productive individual represent more value and thus increase national net worth?
I would like to see some refinement of your treatise. Cheers, Murray
@Murry:
What you are calling “adding value” is what I’m calling “has benefit”. Yes, it does “have benefit”. Yes it does “add value”. Not, it does not increase my, or anyone else’s, wealth to restore things to what they were prior to some consumption / wear / use.
Take a tractor. I count the creation of the tractor as “creating wealth”. I count the consumption of that tractor over a 20 year lifetime (“depreciation”) as “consumption”. If you make the life 30 years via “maintenance”, you could count it either as adding some “value” in the middle, that you would then need to subtract out at the end, or you could just extend the depreciation from 20 years to 30 years…. I’d rather just say “created on date”. “Consumed after 30 years, maintenance included”.
In the end it doesn’t matter much which way you do the accounting.
Also note that I do account such intangible work as writing to be “creation of wealth”, but account for it as the product of books or DVDs, not as simple “mental wealth as I admire my manuscript”. (For the simple reason that I’ve got a lot of manuscripts here and not one of them will buy me a new car or put gas in my old one, no matter how “mentally wealthy” I might imagine myself to be…) Y es, they are a “benefit” to me if I’m just admiring them, but they become “national wealth” when printed and published… Similarly, your glasses are a great benefit to YOU, but only become “national wealth” when, using them, you go to work at a job you otherwise would not have and create something you otherwise would not make. SImply enjoying the TV or reading books again does not “create wealth” no matter how much it benefits you as an individual in your consumption. (As noted, the use at work shows up in the “work product”, so adding an kicker for “glasses let me work” would be double counting the benefit of the glasses).
Also note that while most of the examples I gave are tangible wealth, my description of it was that it was “something you could sell”. So, for example, the Trade Secret of how to make Doctor Pepper was “wealth”. So much so that when Mr. Pib was a complete failure, Coke bought the Dr. Pepper company. (Years later, having ‘the secret’, they then sold Dr. Pepper company to, I think, 7 Up company). That “Trade Secret” was marketable wealth, even though only an idea.
Why be such a sticker on “has a market value”? Because otherwise you get into “immaginary wealth” and you end up with a lot of “double accounting”. You see this run rampant in the Government, and the whole idea here is find a way to cure that.
So, the government way:
Making the Glasses: $100
Using the Glasses at home: $10,000
Using the Glasses at work: $100,000
Replacing the Glasses: $100 / year
Enjoyment of LIfe: $1,000,000
“Benefit” from pair of Glasses (per year): $1,110,300
They then ALSO count your $100,000 job as GDP, and thus double count it… They will also count each yearly $100 new pair as “more benefit”… at the end of 10 years, you have $1000 of “glasses GDP benefit”…. but only one pair of glasses that work…
My way:
Making of Glasses (first time): $100 increase in “wealth” or “value net”
Using the glasses to get job: $100,000 (accounted for in work product OF the job)
Replacing the Glasses: $100 creation -$100 depreciation of old pair.
Net “benefit” from making glasses directly attributable to the glasses: $100
National Wealth increase FROM the glasses: Whatever the net work product is of your job. Presumably about $100,000 but it could be that it sells for $200,000 and the other $100,000 shows up as added wealth to stock holders of the company. Shows ONLY as increase in company sales and capital gains of stock, not as “glasses”…
IMHO, my way makes it clear that replacing all the glasses every 6 months does not increase national wealth, nor would it increase national wealth by $1,110,300 per person to break all their glasses and give them new ones. Yes, government accounting often DOES reach that kind of very stupid conclusion. Look at the “projected benefit” from all sorts of “urban renewal” and “government works” programs, then look at what is actually created in the end… So while I may LIKE sitting in a stadium watching a sports team play, then being served dinner in a nice restaurant: At then end of that experience, the world has LESS total wealth, not MORE. I have more pleasant memories, but “stuff” is consumed or worn out. Subsidy to make 300,000,000 sports stadiums will NOT make our nation a nation of Millionairs, it will only consume $millions per person…. (yes that’s a reductum ad absurdum, but if it were true in the small case that it created wealth, then it would also be true in the large case…)
And yes, requiring that something have a market value to be “WEALTH” is a very good way to filter out a lot of the BS. It avoids assigning ‘wealth value’ to all the “psychic dollars” of the world…
@Murry:
Oh, and per this last economic crisis: It was about 30 years in the making, and both Repubs and Dems contributed. Clinton and friends started it rolling with the CRA that mandated lending to unqualified borrowers, the Repubs accepted that, but required in payment the removal of Glass Steagal (that had kept us safe for a generation) and the ability to pedal the SIV Trash mortgages all over the globe. It then took about 30 years to blow up in their collective faces.
So yes, Democrats are responsible for breaking up all the furniture, putting it in a pile, and dumping gasoline on it. Republicans are responsible for removing the fire alarm and sitting down in the room to have a smoke….
This kind of housing / mortgage ‘crisis’ is NOT new. It happens about once per generation. Last one was the “S&L Crisis”. First one known to me is the “Business Crisis of 33 A.D. in Rome”.
https://chiefio.wordpress.com/2009/07/04/business-panic-of-33ad-things-never-change/
They always take about a generation to develop. They always arise at the intersection of political stupidity with banking greed. (Politicians demanding money that doesn’t exist, or not understanding long term economics, or demanding homes be given to folks who can’t pay for them, or…) and bankers by definition borrowing money short term to lend long term and sporadically getting squashed when they loan too much and then the political class “stirs things”. Politicians then, typically, back out the stupidity THEY did that was the root cause, flush the system with cash to try and save it, blame the bankers, and try to sweep it all under the rug.
I strongly suggest reading that 33 AD link before attempting to lay this “crisis” at the feet of Republicans. THEN look in depth at the mandates of the CRA signed by Clinton and the complete fiasco of laws pushed by Barney Frank over the years. If you were TRYING to break the economy you could hardly do more than what his committee has done. From removing Glass Steagal (as payment to get some Republicans to vote for the CRA) to the CRA itself, to the “fix” of the “regulatory reform” they are pushing now. It’s all just quite simply broken.
@E. M. Snith:
You’ve used “Clinton” a couple of times above, referring to the Community Reinvestment Act, when you meant “Carter.” I think you were thinking Carter, but one c-type Democrat blended into another…
The CRA was, indeed, a fuse-lighting event for all of this, a generation ago. But the over-leverage of Fannie and Freddy changed it from a very expensive liberal dalliance to an economy-wrecking global explosive.
The people in charge — headed by Dodd and Frank in Congress — changed the leverage from their mandated 10 to 1 ratio up to more than 40 to 1 (meaning that they were guaranteed to be in trouble if even one out of forty mortgages went bad).
Forcing loans to people who could not afford it was bad, and done for political purposes. Arranging so that the US could not afford for those loans to fail was criminally stupid.
The business side of this, though getting much attention, was no real surprise. That banks and other enterprises set themselves up to take advantage of the government’s programs was to be expected. It WAS expected.
The government (through regulatory requirements and through the FMs, the Fannie Mae/Freddy Mac entities) incentivized this behavior, though part of it was in the “unintended consequences” arena. One could wonder how much of the damage was intentional, based on how precarious things were if the loans were to fail.
The loans failed — of course — and it was the FM’s leverage that did most of the damage, and prevented reasonable market recovery. We’re STILL pumping billions into the FMs. This was the cashflow projected back at the beginning of the year, which was based on Obama projections that the housing market would recover quickly. (The housing market, now, has segments that have fallen worse than even the Great Depression, making this economy, by that measure, the worst in history.) But the projections were rosy:
===|==============/ Level Head
A pity that the image did not display. The link to the CNN article on the FMs (from February 2011) is here.
===|==============/ Level Head
@Level_Head:
I presume that chart was the one you were trying to display. (I added the link)
I’m basically pacing the ‘start’ of it off of the “liberalizing” of it under the Clintons. Yes, it was passed in a more muted form earlier, but the “renewal” was where the fire was fully lit. To some extent, the earlier version was just the camel’s nose in the tent. We had an early bit in the 1992 “tweak”, then when Clinton came in in 1993 it picks up steam:
http://en.wikipedia.org/wiki/Community_Reinvestment_Act
In other words, the Banks HAD to loan money on bad properties, so the government made it easier to do it, and show that you were making a lot of “Liar Loans” and shoving that cash out the door… So the banks began to shovel. And invented all the “exotic” SIVs and mortgage bundles to get that (Government Mandated) crap off their books.
But, the Coup de Grâce came in 1999:
That was where the Deal From Hell was struck. In exchange for forcing ALL banks to be under the CRA, the banks demanded Freedom To Commit Merger on each other. Glass Steagall was done in. Investment Banks and Money Center Banks were made into one big bucket; so places like Lehman Brothers and Bear Stearns that were in the Investment Banking side (i.e. not banks making mortgages) could get into the mortgage business….
What they “forgot” to do, was let the Investment Banks apply to the The Fed Discount Window for emergency money in a “run”. “Regular” banks could do this, not investment banks.
Never mind that BOTH could do any and all of the same lines of business. It’s just a detail…
Except when a run happens. THEN the investment bank will collapse. Just as the Roman banks of 33 BC (until the Sovereign ponied up some cash to prop them up).
SO Citybank could make mortgages, and if a run happened, go to The Fed and get a bucket of bailout money. BSC and LEH could not. BSC and LEH went “POOF!” instead, precipitating the crisis, and resulting in ALL the other large investment banks (even Goldman Sachs) petitioning almost overnight to become money center banks instead of investment banks, then queueing at The Fed window for handouts…
And that is why I lay it particularly at the feet of Clinton and Frank (with honorable mention to “little Chucky Schumer” and Chris Dodd.
One Leg at a time, they chopped out the protections. The Banks knew they were going to be saddled with the crap loans, so conned the Republicans into demaning “freedom to merge and get rid of Glass Steagall” in exchange for the CRA “update” package. The end result was a regulatory quagmire of Investment Banks and Non-Investment Banks with different rules / “last resort funding” and equal market access / products. At that point, it was just a matter of time to the first run and the blow up.
So the Democrats demanded that the Crap be made in the first place, the Banks figured out how to package it in pretty wrapping paper and move it off THEIR doorstep, and the Republicans demanded the removal of Glass Stegall (and the Uptick rule and a couple of other Fire Alarms) at the request of the banks; lighting the match.
So, in my opinion:
Democrats MADE the problem. (Filled the space with gasoline)
Banks SPREAD it to everyone else.
Republicans turned off the alarms and took out the fire sprinkers, then lit the match.
A couple more summary facts to add which, IMV, shift the blame even further to the progressive side, although both bear responsibility.
One of the first things Clinton did was, via Webb Hubbell, fire all U.S. attorneys in 1993. Janet Reno instigated 17 major lawsuits against the Banks to enforce these loans. The Fed program, along with Fannie and Freddie, rewarded short tem profits at the expense of fundamental sound common sense lending. Obama participated in a CRA lawsuit in 1995, working with, who else, ACORN. Between Clinton, the Attorney General, ACORN, Chris Dodd, Schummer, and Barney running the senate finance committee, the banks went in the direction anyone would.
Obama was involved in more then one law suit . “In fact, intimidation tactics, public charges of racism and threats to use CRA to block business expansion have enabled ACORN to extract hundreds of millions of dollars in loans and contributions from America’s financial institutions.
The Woods Fund report makes it clear Obama was fully aware of the intimidation tactics used by ACORN’s Madeline Talbott in her pioneering efforts to force banks to suspend their usual credit standards.Yet he supported Talbott in every conceivable way. He trained her personal staff and other aspiring ACORN leaders, he consulted with her extensively, and he arranged a major boost in foundation funding for her efforts.
And, as the leader of another charity, the Chicago Annenberg Challenge, Obama channeled more funding Talbott’s way – ostensibly for education projects but surely supportive of ACORN’s overall efforts” Pasted to a word doc, so no reference, I think from Hot Air.
To his defense Bush did, after his initial support, try to put the brakes on Fannie and Freddie, but did not have the juice necessary with the Senate finance committee, or with the Senate. He should have tried harder.
Even without the Glass Steagall repeal, if common sense lending had happened, things would have been far better. Clinton to this day defends the Glass Steagall repeal. ( I do not, but find it interesting that Clinton does,) . It is also worthy to note that the Banks did all this in full view of federal regulators, the government has no excuse, and the Dems were in charge. Beyond that the GSEs of Fannie and Freddie fully participated (indeed Fannie led the way) in the over leveraged MBS loan packaging and leverage. Barney Franks lover received millions in bonuses.