"No such thing as a low-energy high-income country"

A gentle reminder for everyone: You may have a low-energy low-income country or a high-energy high-income country ---- but you will go a very long way to find any place with that link reversed.

"Economic theory has identified four sources of economic progress"

In January Javier Milei explained to a room of Davos delegates to the WEF forum how the world works, and how economic progress and prosperity happens. This is an excerpt. [Milei's speech was originally in Spanish, and the English version at the WEF website has been transcribed by AI. I have edited slightly it for smoothness and clarity. Emphases mine]

As early as 380 BC, Xenophon pointed out that economics is a form of knowledge that enables men to increase their wealth while arguing that private property is the most beneficial vehicle for the life of individuals.

Xenophon ... [first] highlight[ed] the benefit of private property by stating that the owner's eye fattens his cattle. [Or as the English saying has it: "It's the master's eye that makes the mill go"]... Xenophon then delves into the dynamic realm, noting that efficiency also entails increasing wealth: that is, increasing the available quantity of goods through entrepreneurial creativity, namely through trade, innovation, and recognising opportunity. ...

"[T]he institution of private property deserves a separate chapter. By focussing on it, the Austrian School of Economics from Mises, Hayek, Rothbard, Kirzner and Hoppe to Huerta de Soto has demonstrated the impossibility of socialism, thereby dismantling the illusory idea of John Stuart Mill that postulated independence between production and distribution; a form of academic deafness that led to socialism, and cost the world the lives of 150 million human beings -- while those who managed to survive the terror, did so in absurd poverty.

In line with [those writers'] previous remarks, and consistent with Xenophon's second [point], economic theory has identified four sources of economic progress.

First, there's the division of labour, which was illustrated by Adam Smith through the pin factory example. At its core, this is a mechanism that generates productivity gains, manifested as increasing returns. Although its limit is determined by market size, the size of the market is positively affected by this process. However, it is also worth noting that this virtuous process is not infinite and that its ultimate limit lies in the endowment of initial resources.

Second, there is the accumulation of capital, both physical and human. With regard to physical capital, the interaction between saving and investment is crucial, highlighting the fundamental role of capital markets and of the financial system in carrying out such intermediation. On the human capital side, the focus should not be limited to education alone, but should also include the development of cognitive capacities from birth, as well as nutrition and health, basic elements for gaining access to education and the labour market.

Third, there is technological progress, which consists in being able to produce a greater quantity of goods with the same amount of resources, or to produce the same output using a smaller quantity of inputs.

Finally, there is entrepreneurial spirit, or rather the entrepreneurial function, which, according to Professor Huerta De Soto constitutes the main driver of the economic growth process. Because, although the three factors mentioned are important, without entrepreneurs, there can be no production, and living standards would be extremely precarious.

In fact, the entrepreneurial function is not so much focused on short-term efficiency, but rather on increasing the quality of goods and services, which, in turn, leads to higher standards of living. On this basis, what truly matters is to expand the frontier of production possibilities to the maximum extent possible.

Thus, dynamic efficiency can be understood as an economy's capacity to foster entrepreneurial creativity and coordination.

In turn, the criterion of dynamic efficiency is inseparably linked to the concept of the entrepreneurial function, which is that typically human capacity to perceive profit opportunities that arise in the environment and to act accordingly to take advantage of them. This makes the task of discovering and creating new ends and means fundamental, driving spontaneous coordination to resolve market imbalances.

Moreover, this definition of dynamic efficiency proposed by Huerta de Soto coherently and appropriately combines Schumpeter’s idea of creative destruction with North's concept of adaptive efficiency.

Naturally, given the role of the entrepreneurial function, the institutions under which it develops are of vital importance. In this regard, both Douglass North and Jesús Huerta de Soto consider one of the key functions of institutions to be that of reducing uncertainty.

So, while North presents them as a set of humanly devised constraints that structure social interaction in a repetitive manner, Huerta de Soto considers that these institutions, conceived by human beings, emerge spontaneously from a process of social interaction without being designed by any single individual, and that they reduce uncertainty in the market process.

As Roy Cordato points out, the appropriate institutional framework is one that favours entrepreneurial discovery and coordination. Accordingly, within this framework, economic policy should aim to identify and remove all artificial barriers that hinder the entrepreneurial process and voluntary exchanges.

Given the decisive influence of institutions on economic progress, this directs our attention to the importance of ethics, as societies that adhere to stronger moral values and ethical principles in support of institutions will be dynamically more efficient and will therefore enjoy greater prosperity.

Accordingly, the fundamental ethical problem is a search for the best way to foster entrepreneurial coordination and creation.

Therefore, in the field of social ethics, we conclude that conceiving human beings as creative and coordinating actors entails accepting axiomatically the principle that every human being has the right to appropriate the results of their entrepreneurial creativity.

So the private appropriation of the fruits of what entrepreneurs create and discover is a principle of natural law because if an author were unable to appropriate what they create or discover, their capacity to detect profit opportunities would be blocked, and the incentive to carry out their actions would disappear. Ultimately, the ethical principle just stated is the fundamental ethical foundation of the entire market economy.

So, what we've just demonstrated is that free enterprise capitalism is not only just but also efficient and also that it is the one that maximises growth.

[Full speech here]

RELATED: Here's Per Bylund at the latest Ludwig Von Mises conference explaining that it's entrepreneurs, not politicians, who change the world for the better.

Thank you Adam Smith

It's a busy week. This week also marks the 250th anniversary of Adam Smith's Wealth of Nations, the first in-depth exploration and explanation of (in PJ O'Rourke's words) why some nations are prosperous and wealthy and other places just suck.In honour of the anniversary, here are several of Adam Smith’s most insightful observations:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages. [The Wealth Of Nations, Book I, Chapter II]

It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. [The Wealth Of Nations, Book I, Chapter I]

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things. [Lecture in 1755, quoted in Dugald Stewart, Account Of The Life And Writings Of Adam Smith LLD, Section IV, 25]

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. [The Wealth Of Nations, Book IV Chapter I]

By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? [The Wealth Of Nations, Book IV, Chapter II]

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. [The Wealth Of Nations, Book IV Chapter VIII]

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices…. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary. [The Wealth Of Nations, Book IV Chapter VIII]

To widen the market and to narrow the competition, is always the interest of the dealers…The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution... It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it. [The Wealth Of Nations, Book I, Chapter XI]

It is the highest impertinence and presumption… in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense... They are themselves always, and without any exception, the greatest spendthrifts in the society. [The Wealth Of Nations, Book II, Chapter III]

There is no art which one government sooner learns of another than that of draining money from the pockets of the people. [The Wealth Of Nations, Book V Chapter II Part II] 

Every individual... neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
    Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. [The Wealth Of Nations, Book IV, Chapter II]

What improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. [The Wealth Of Nations, Book I Chapter VIII]

Mercy to the guilty is cruelty to the innocent. [From his 1759 work, The Theory of Moral Sentiments]

The man of system…is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it… He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. [The Theory Of Moral Sentiments, Part VI, Section II, Chapter II]

The Return of Chloe's Wealth Tax

Watch any rant by Chloe Swarbrick and, after the obligatory nods to te reo, to Palestine, and to passing laws to change the weather, she'll tell you that it's time for "the wealthy" to fund everything every government could dream of. 

It's really the only substantive policy she can articulate. Yet she remains blithely unaware that the fortunes she want to sack are not gold bars under the mattress but ownership stakes in operating companies, real estate, and other productive assets, so her Wealth Tax would function as a direct penalty on those investments. That penalty doesn’t remain confined to the wealthy. Capital formation is what drives productivity growth and wage gains, and policies that discourage it ultimately leave everyone worse off.

As Adam Michel explains in this Guest Post, the chronic government spending growth she advocates cannot be paid for by ever more aggressive taxes on a narrow subset of high-income taxpayers.  Not even in a US more stocked with billionaires than she'll ever see here ...

The Return of the Wealth Tax, Evidence Against Them Is Stronger Than Ever

by Adam Michel

Wealth taxes are back in the policy conversation— a good opportunity to review how wealth taxes work and why they have been called “one of the most harmful taxes ever created.”

Wealth taxes are unique in that they are not levied on an annual flow of income or consumption (like a sales tax). Instead, wealth taxes apply to a stock of assets and are usually intended to be primarily redistributive, aiming to reverse a perceived inequality in the distribution of resources.

Wealth taxes promise redistribution but more often deliver high economic costs, administrative complexity, and disappointing revenue. California’s proposal  to impose a broad-based wealth tax on the state’s billionaires illustrates how these taxes distort investment decisions, magnify fiscal volatility, and tend to evolve from one-time levies into permanent features of strained budgets.

Wealth Taxes In the Real World

Wealth taxes impose an additional layer of tax on the income generated by the underlying asset. Most wealth consists of productive assets deployed in the economy, such as active businesses and other physical investments. The annual income streams generated by the underlying assets—capital gains, dividends, and interest—are taxed through the normal income tax system.

The existing tax system already charges the wealthiest Americans high tax rates. A Biden administration Treasury study found that the wealthiest 92 Americans faced total state, local, federal, and international income tax rates of 59 percent. Recent research by four prominent liberal economists concludes that US billionaires pay higher tax rates than their counterparts in the Netherlands, Sweden, Norway, and France, and, contrary to the headline claim, the wealthiest taxpayers also pay the highest tax rates among all Americans.

Because wealth taxes are assessed on a stock instead of an annual income flow, expressing the tax rate as an equivalent income tax rate is more informative. Unless the taxpayer is expected to slowly sell off their underlying assets, the tax will be paid from annual income. Table 1 shows the equivalent income tax rate on underlying assets with different rates of return at different wealth tax rates. At the California top wealth tax rate of 5 percent, any asset earning less than a 5 percent annual pre-tax return would face income tax rates above 100 percent before paying other taxes. Bernie Sanders’ 2020 campaign proposal included a top wealth tax rate of 8 percent.

Net wealth taxes have been tested in other countries and repealed due to high economic costs and administrative burdens. Peaking at 12 in the 1990s, only four Organisation for Economic Co-operation and Development (OECD) countries still impose broad-based net wealth taxes today: Colombia, Norway, Spain, and Switzerland. The figure below shows the trend of wealth taxes over time.

Economic and Administrative Costs

Wealth taxes can impose confiscatory effective tax rates with predictable economic consequences. By directly reducing the after-tax return to saving and investment, they weaken incentives to build businesses, expand productive capacity, and take entrepreneurial risks. Because most large fortunes are not gold bars under the mattress but ownership stakes in operating companies, real estate, and other productive assets, a wealth tax functions as a direct penalty on those investments. That penalty doesn’t remain confined to the wealthy. Capital formation is what drives productivity growth and wage gains, and policies that discourage it ultimately leave everyone worse off.

Wealth taxes also distort capital allocation. Investors have a strong incentive to shift portfolios toward assets that are harder to value, easier to shelter, or more mobile across borders, rather than toward their most productive use. This encourages tax avoidance rather than genuine economic activity. It can mean less investment in long-term projects, more leverage, and greater reliance on complex financial arrangements to reduce reported net worth.

Wealth taxes are also administratively complex. Valuing a broad range of assets every year is extraordinarily difficult. Unlike easy-to-value publicly traded stocks, most wealth is tied up in closely held businesses, partnerships, real estate, artwork, and other illiquid or unique assets. Annual valuation invites avoidance and disputes, which raises compliance costs for both governments and taxpayers. It took 12 years for the IRS and the Michael Jackson estate to reach a court-mediated agreement on the value of its taxable assets. Going through such a process every year for all taxpayers with assets above or near the tax threshold is administratively impracticable.

Because of persistent administrative difficulties and taxpayers’ behavioural responses, wealth taxes raise comparatively little revenue. Countries that experiment with wealth taxes repeatedly find that taxpayers adjust their behaviour or move in large numbers, undermining optimistic revenue forecasts. Before France repealed its net wealth tax in 2018, the government estimated that “some 10,000 people with 35 billion euros worth of assets left in the past 15 years.” 

Spain experienced a similar behavioural response following the 2023 “solidarity tax,” which raised just 40 percent of the projected revenue. Cato’s Chris Edwards summarises that “European wealth taxes typically raised only about 0.2 percent of GDP in revenues. Given the little revenue raised, it is not surprising that they had ‘little effect on wealth distribution,’ as one study noted.”

California’s Proposal Is a Warning for the Country

California’s proposed 5 percent wealth tax is especially notable because it would layer on top of the most progressive tax system in the OECD. The state already relies on taxpayers making over half a million dollars a year (the highest income 2.5 percent) to pay 49 percent of income tax revenue. They do this by combining high marginal income tax rates and heavy reliance on capital gains taxation, which makes revenues volatile and highly sensitive to the fortunes and domiciling decisions of a small number of taxpayers.

The initiative’s own findings make clear that this will not be a one-time tax. The ballot text explains that the wealth tax “would only modestly slow” the growth of billionaires’ fortunes in California. That admission undermines the premise that the tax solves any underlying fiscal or wealth distribution problem. If a tax leaves wealth largely intact, political pressure to repeat, expand, or permanently extend it is inevitable. This is what happened in Spain, when its “exceptional and temporary” wealth tax became permanent. California’s proposal should be understood in this light, not as a one-off correction, but as a test case for permanent wealth confiscation.

The lesson extends beyond California. Chronic spending growth cannot be solved by ever more aggressive taxes on a narrow subset of high-income taxpayers. Wealth taxes are not a solution to budgetary or economic gaps; they are a symptom of a broken fiscal system grasping for short-term revenue while postponing the difficult but necessary work of restraining spending growth. 

* * * * 

Adam Michel is director of tax policy studies at the Cato Institute, where he focuses on analysing the economic and budgetary effects of taxation in the United States.
    He is widely published and quoted in the Wall Street Journal, the New York Times, the Washington Post, and elsewhere. He has also appeared on Fox News, CNN, and CNBC to discuss tax policy and its economic effects. In addition to numerous book chapters, his scholarly work has been published in the Journal of Public Budgeting and Finance and Tax Notes.
    His post first appeared at the Cato at Liberty blog.

"Since wealth is the only thing that can cure poverty..."

"Since wealth is the only thing that can cure poverty, you might think that the left would be as obsessed with the creation of wealth as they are with the redistribution of wealth. 

"But you would be wrong."

~ Thomas Sowell from bis 2006 column 'Political left has no interest in creating wealth' [hat tip Ira P]

'Eat the rich' never targets the real parasites, only producers

"The most revealing truth about modern politics: 'Eat the rich' never targets the people who actually got rich by taking your money through taxes, regulations, and crony deals. It targets the people who got rich by creating products and services you voluntarily chose to buy because they improved your life. 

"Jeff Bezos became wealthy because millions of people decided Amazon made their lives better. Meanwhile, career politicians become wealthy by redistributing other people's money while producing nothing of value. Guess which one gets labeled the villain?

"The real parasites are the ones who get rich through political power rather than voluntary exchange. They use government force to transfer wealth from productive people to themselves and their allies, then convince you that the problem is the people who actually earned their money.

"This misdirection is intentional. If people understood that politicians and bureaucrats are the real wealth extractors, they might start asking uncomfortable questions about where all those tax dollars actually go and why the government keeps growing while problems never get solved."

~ Students for Liberty/Rock Chartrand

SOWELL: 'The Fallacy of Redistribution'

“The history of the 20th century is full of examples of countries that set out to redistribute wealth and ended up redistributing poverty.” 

~ Thomas Sowell on 'The Fallacy of Redistribution'

The crucial - and unappreciated - function of wealth in an industrial economy

 

“A widespread ignorance of a crucial economic issue is apparent in most discussions of today’s problems: it is ignorance on the part of the public, evasion on the part of most economists, and crude demagoguery on the part of certain politicians. The issue is the function of wealth in an industrial economy. 

"Most people seem to believe that wealth is primarily an object of consumption—that the rich spend all or most of their money on personal luxury. Even if this were true, it would be their inalienable right—but it does not happen to be true. The percentage of income which men spend on consumption stands in inverse ratio to the amount of their wealth. The percentage which the rich spend on personal consumption is so small that it is of no significance to a country’s economy. The money of the rich is invested in production; it is an indispensable part of the stock seed that makes production possible. ...

"In view of what they hear from the experts, the people cannot be blamed for their ignorance and their helpless confusion. If an average housewife struggles with her incomprehensibly shrinking budget and sees a tycoon in a resplendent limousine, she might well think that just one of his diamond cuff links would solve all her problems. She has no way of knowing that if all the personal luxuries of all the tycoons were expropriated, it would not feed her family — and millions of other, similar families — for one week; and that the entire country would starve on the first morning of the week to follow . . . . How would she know it, if all the voices she hears are telling her that we must soak the rich?

“No one tells her that higher taxes imposed on the rich (and the semi-rich) will not come out of their consumption expenditures, but out of their investment capital (i.e., their savings); that such taxes will mean less investment, i.e., less production, fewer jobs, higher prices for scarcer goods; and that by the time the rich have to lower their standard of living, hers will be gone, along with her savings and her husband’s job — and no power in the world (no economic power) will be able to revive the dead industries (there will be no such power left).”

~ Ayn Rand, from her 1974 article 'The Inverted Moral Priorities,' collected in The Voice of Reason 

"People condemn the wealth-generating institutions to which they themselves owe their existence."

"An anti-capitalist ethic continues to develop on the basis of errors by people who condemn the wealth-generating institutions to which they themselves owe their existence.

    “Pretending to be lovers of freedom, they condemn private property, contract, competition, advertising, profit, and even money itself.

    “Imagining that their reason can tell them how to arrange human efforts to serve their innate wishes better, they pose a grave threat to civilisation.”

~ F. A. Hayek on anti-capitalism sentiment in the West, from his book The Fatal Conceit: the Errors of Socialism 

 

The problem of knowledge in society

"The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate 'given' resources—if 'given' is taken to mean given to a single mind which deliberately solves the problem set by these 'data.' It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilisation of knowledge which is not given to anyone in its totality."

~ third paragraph from F.A. Hayek's Nobel Prize speech from 1972. David R. Henderson reckons the published speech "is one of the ten most important articles published in economics in the last 80 years. So, it’s worth the effort." And the most important paragraph in this article, he reckons, is this third paragraph — and the most important sentence in the whole article being this paragraph's first sentence. Henderson himself helps to untangle Hayek's German locution in his own teaching notes. With all appropriate humility, I have a go below at translating it into plain English ...

MY 'TRANSLATION':

"Specialist knowledge is distributed throughout society — knowledge of particular circumstances or opportunities, 'local knowledge' if you like, which specific separate individuals possess and which will often appear contradictory. (There is after all no such thing as a 'collective brain' that knows or can know and integrate every single discrete circumstance.)

    "Yet in a rational economic order, those specific morsels of local and focussed knowledge are being put to use at every moment across society to find, transform, produce and distribute resources for ends whose relative importance only individuals know. And from that process comes the things we each value, produced by minds none of whom can ever see the whole.

    "To put it briefly, it is a little-recognised miracle of the integrated utilisation of morsels of local knowledge, none of which is given to anyone in its totality, to create the wealth on which we all depend."

Wealth taxes = loot + plunder

"The progressive personal income tax, the corporate income tax, and the capital gains tax all operate in essentially the same way as the inheritance tax. They are all paid with funds that otherwise would have been saved and invested. All of them reduce the demand for labor by business firms in comparison with what it would otherwise have been, and thus either the wage rates or the volume of employment that business firms can offer. For they deprive business firms of the funds with which to pay wages.
    "By the same token, they deprive business firms of the funds with which to buy capital goods. This, together with the greater spending for consumers’ goods emanating from the government, as it spends the tax proceeds, causes the production of capital goods to drop relative to the production of consumers’ goods. In addition, of course, they all operate to reduce the degree of capital intensiveness in the economic system and thus its ability to implement technological advances. […] [T]hese taxes, along with the inheritance tax, undermine capital accumulation and the rise in the productivity of labor and real wages, and thus the standard of living for everyone, not just of those on whom the taxes are levied. ...
    "Of course, many people will the line of argument I have just given as the 'trickle-down' theory. There is nothing trickle-down about it. There is only the fact that capital accumulation and economic progress depend on saving and innovation and that these in turn depend on the freedom to make high profits and accumulate great wealth. The only alternative to improvement for all, through economic progress, achieved in this way, is the futile attempt of some men to gain at the expense of others by means of looting and plundering. This, the loot-and-plunder theory, is the alternative advocated by the critics of the misnamed trickle-down theory."

~ George Reisman from his book Capitalism: A Treatise on Economics (pp. 308-310.) Hat tip Per-Olof Samuelsson, who observes: "The productive rich (think Rockefeller, Carnegie, Ford, Bill Gates, Steve Jobs, etcetera, etcetera) actually flood the rest of us with wealth (and themselves become wealthy in the process). Taxing or expropriating them simply means to dam this flood. And this may make it appear 'trickle-down' – because governments and politicians will only allow a small portion of this wealth to trickle down to us; the rest of it lands in their own pockets."

There's only one way to truly make poverty history

"Don’t dare say that you want to 'make poverty history' when you hate capitalism. The only way to end poverty is to create more wealth, and the only way to create wealth is by the free market."

~ Alice Smith [hat tip Ele Ludemann]

"Free markets are the only — the *only* — cure for poverty."

 

Transcript here, from the Yaron Brook Show.

"The argument is that 'wealth is a privilege, and with it comes the obligation of paying tax to benefit society'."

"The argument [is that] 

Wealth is a privilege, and with it comes the obligation of paying tax to benefit society.   

"This is, obviously, piffle. For what is being said there is that only by paying tax does wealth benefit society. Which is, obviously, that piffle.
    "It’s actually true that wealth is the product of having benefitted society. As in the William Nordhaus paper about who gains from entrepreneurial activity, it’s us out here, us consumers, who gain the vast, vast proportion of it. The entrepreneurs themselves gain some 3% or so of total value created. Only 3% too.
    "As an example, Jeff Bezos has some $200 billion. A lotta cash, agreed. It’s also true there’s been the 'Amazon Effect.' By making the retail system more efficient the simple existence of the company has knocked 0.1 to 0.2% off the inflation rate. Every year for two decades. No, not 2 to 4% off retail sales that is, but 2 to 4% off the whole cost of living for everyone. That’s a sum vastly larger than the Bezos pile - especially when we convert that annual benefit into a capital sum so as to be able to compare it with the Bezos capital sum.
    "It simply isn’t true, not in the slightest, that the justification for wealth is the tax paid upon it. It’s how much better off are we made by someone having made that wealth?"

~ Tim Worstall from his post 'If people don’t grasp the basics then….'

 

How often do we hear that government "austerity" is destructive —that it is the job of government, or their central bank, to "stimulate demand"? Or that growth can be gussied up by gobs of government cash? In this guest post, Frank Shostak is here to dismantle those ideas, and to explain that monetary pumping does not create new wealth, it destroys it ...

Does Government Spending and Money Expansion Create New Wealth or Destroy It?

by Frank Shostak

Many economists claim that economic growth is driven by increases in the total demand for goods and services, additionally claiming that overall output increases by some multiple of the increase in expenditures by government, consumers, and businesses. Thus, it is not surprising that most economic commentators believe that a fiscal and monetary stimulus will strengthen total demand, preventing an economy from falling into a recession. [And conversely, that a withdrawal of govt spending will send it there. - Ed.]

These economists believe that increasing government spending and central bank monetary pumping will increase production of goods and services and strengthen total demand. This means that demand creates supply. However, is this the case?

Why Supply Precedes Demand

In the market economy, producers do not produce solely for their own consumption. Some of their production is used to exchange for what others produce. Hence, in the market economy, production precedes consumption. Something is exchanged for something else. This also means that an increase in the production of goods and services leads to an increase in the demand for goods and services.

According to David Ricardo,

No man produces, but with a view to consume or sell, and he never sells, but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person.

An individual’s demand is constrained by his ability to produce goods. The more goods an individual can produce, the more goods he can demand. For example, if five people produce ten potatoes and five tomatoes, this is all that they can demand and consume. The only way to consume more is to produce more.

James Mill wrote,

When goods are carried to market what is wanted is somebody to buy. But to buy, one must have the wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation that constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation. . . . Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate.

The Expanding Pool of Real Savings Key to Economic Growth

Without the expansion and enhancement of the structure of production, it is impossible to increase the supply of goods and services in accordance with the increase in total demand. Expanding and enhancing the infrastructure depends upon expanding the pool of real savings, which is composed of consumer goods and supports those employed producing those necessary goods and services.

Consequently, it does not follow that increasing government spending and employing loose monetary policy will increase the economy’s output. It is impossible to lift overall production without the necessary support from the real savings pool.

For example, a baker produces twelve loaves of bread and saves ten loaves. He then exchanges them for a pair of shoes with a shoemaker. In this example, the baker funds the purchase of shoes by means of the ten saved loaves of bread, which maintains the shoemaker’s life and well-being. Likewise, the shoemaker has funded the purchase of bread by means of shoes that he had produced.

Assume that the baker has decided to build another oven to increase production of bread. To implement his plan, the baker hires the services of the oven maker, paying the oven maker with some of the bread he is producing. If the flow of bread production is disrupted, however, the baker cannot pay the oven maker, so the making of the oven would have to be abandoned. Therefore, what matters for economic growth is not just tools, machinery, and the pool of labour but also an adequate flow of consumer goods that meet the producer’s needs.

Government Does Not Generate Wealth

Government does not produce wealth, so how can an increase in government outlays revive the economy? People employed by the government expect compensation for their work. One way the government can pay these employees is by taxing others who are generating wealth. By doing this, the government weakens the wealth-generating process and undermines prospects for economic growth.

According to Murray Rothbard, 

Since genuine demand only comes from the supply of products, and since the government is not productive, it follows that government spending cannot truly increase demand.

If the pool of real savings is large enough to fund government spending, then a fiscal and monetary stimulus will seem to be successful. However, should the pool of real savings decline, then regardless of any increase in government outlays and monetary pumping by the central bank, overall real economic activity cannot be revived. In this case, the more government spends and the more the central bank pumps, the worse off wealth generators will be, eliminating prospects for a recovery.

When loose monetary and fiscal policies divert bread from the baker, he will have less bread at his disposal. Consequently, the baker cannot secure the services of the oven maker, making it impossible to increase the production of bread.

As the pace of loose government policies intensifies, the baker may not have enough bread left even to sustain the workability of the existing oven since he no longer can afford the services of a technician to maintain the existing oven. Consequently, the production of bread will actually decline.

Because of the increase in government outlays and monetary pumping, other wealth generators will have fewer real savings at their disposal. This in turn will hamper the production of their goods and will weaken overall real economic growth. The increase in loose fiscal and monetary policies not only fails to raise overall output, but on the contrary, it leads to a general weakening in the wealth-generation process.

According to J.B. Say, 

The only real consumers are those who produce on their part, because they alone can buy the produce of others, [while] . . . barren consumers can buy nothing except by the means of value created by producers.

Conclusion

Most economists and economic commentators claim that increases in government spending and central bank monetary pumping strengthen the economy’s overall demand. This, in turn, sets in motion increases in the production of goods and services. Thus, demand supposedly creates supply.

However, to be able to exchange something for goods and services, individuals must first have something by which to exchange. To demand goods and services individuals first must produce something useful. Hence, supply drives demand, not the other way around.

Increases in government spending divert savings from the wealth-generating private sector to the government, thereby undermining the wealth-generating process. Likewise, monetary pumping results in wealth diversion from wealth generators toward the holders of pumped money. Far from stimulating economic growth, government actions hinder it.

* * * * 

Frank Shostak has over 40 years experience as a market economist and central bank analyst. He is an adjunct scholar of the Ludwig von Mises Institute and a member of the board of editors of the Quarterly Journal of Austrian Economics. He is highly regarded for his skills to convert complex economic issues into plain English. He has written articles that have appeared in The Wall Street Journal and in academic journals in Europe and the US. A follower of common -sense economics and damage inflicted from reckless money creation, his Sydney-based consulting firm, Applied Austrian Economics, provides in-depth assessments of financial markets and global economies.

His post first appeared at the Mises blog.

Note for the Greens: 'How the 0.7% Provide the Standard of Living of the 99.3%'

 

The Greens's Wealth Tax is being attacked for its unfairness (an effective marginal tax rate of 95%) for its incoherence (how can a retired home-owner with little income pay the impost?) for its spread (almost anyone with even an average-priced house in a trust is also hit) for its inefficiency (the revenue gained won't be spread far enough to matter) and for the likelihood of so-called "capital flight" -- of the wealthy simply upping sticks and taking their capital with them. 

All valid criticisms.

Some are even rightly criticising the morality of the impost: 

But what even the Wealth Tax's many critics often fail to understand, as George Reisman explains in this reposted Guest Post, is that the "top 0.7%" of wealth-owners provide the standard of living of the other 99.3%. What is the role of great wealth in a capitalist economy? No, not exploitation, but further prosperity...

How the 0.7% Provide the Standard of Living of the 99.3%

by George Reisman

The overwhelming majority of our contemporaries, ranging from the illiterate to the highly educated, are utterly ignorant of the role of privately owned means of production—capital—in the economic system. As they see matters, wealth in the form of means of production and wealth in the form of consumers’ goods are essentially indistinguishable. For all practical purposes, they have no awareness of the existence of capital and of its importance.

Thus, capitalists are generally depicted as fat men, whose girth allegedly signifies an excessive consumption of food and of wealth in general, while their alleged victims, the wage earners, are typically depicted as substantially underweight, allegedly signifying their inability to consume, thanks to the allegedly starvation wages paid by the capitalists.

The truth is that in a capitalist economic system, the wealth of the capitalists is not only overwhelmingly in the form of means of production, such as factory buildings, machinery, farms, mines, stores, warehouses, and means of transportation and communication, but all of this wealth is employed in producing for the market, where its benefit is made available to everyone in the economic system who is able to afford to buy its products.

Consider. Whoever can afford to buy an automobile benefits from the existence of the automobile factory and its equipment where that car was made. He also benefits from the existence of all the other automobile factories, whose existence and competition served to reduce the price he had to pay for his automobile. He benefits from the existence of the steel mill that provided the steel for his car, and from the iron mine that provided the iron ore needed for the production of that steel, and, of course, from the existence of all the other steel mills and iron mines whose existence and competition served to hold down the prices of the steel and iron ore that contributed to the production of his car.

And, thanks to the great magnitude of wealth employed as capital, the demand for labour, of which capital is the foundation, is great enough and thus wages are high enough that virtually everyone is able to afford to a substantial degree most of the products of the economic system. For the capital of the capitalists is the foundation both of the supply of products that everyone buys and of the demand for the labour that all wage earners sell. 

More capital—a greater amount of wealth in the possession of the capitalists—means a both a larger and better supply of products for wage earners to buy and a greater demand for the labour that wage earners sell. Everyone, wage earners and capitalists alike, benefits from the wealth of the capitalists, because, as I say, that wealth is the foundation of the supply of the products that everyone buys and of the demand for the labour that all wage earners sell. More capital in the hands of the capitalists always means a more abundant, better quality of goods and services offered for sale and a larger demand for labour.

The further effect is lower prices and higher wages, and thus a higher standard of living for wage earners.

Furthermore, the combination of the profit motive and competition operates continually to improve the products offered in the market and the efficiency with which they are produced, thus steadily further improving the standard of living of everyone.

In the alleged conflict between the so-called 99.3% percent and the so-called 0.7% percent, the programme of the 99.3 percent is to seize as far as possible the wealth of the 0.7% percent and consume it.

To the extent that it is enacted, the effect of this program can only be to impoverish everyone, and the 99.3 percent to a far greater extent than the 0.7 percent. To the extent that the 0.7 percent loses its mansions, luxury cars, and champagne and caviar, 99.3 times as many people lose their houses, run-of-the mill cars, and steak and hamburger.

In the realm of economics and politics, there is probably nothing of greater importance than recognition of the very profound yet utterly simple truth that the existence of wealth in the form of privately-owned means of production is of economic benefit to everyone, i.e., not only to the owners of the means of production, but also the non-owners as well, that is, to the buyers of products in general and to the sellers of labour.

Finally, the essay also shows how the accumulation of great business fortunes generally requires a series of important innovations that are the source of continuing high profits that are in turn needed as the source of the continuing high rate of saving and capital accumulation needed to build a business fortune.

Q: What essay? Why, Reisman’s full essay on Kindle, of course.  Read more.

NB: Businessman and founder of Animation Research Ltd Ian Taylor gets it. And, yes, I've changed the original title etc. from 1% to 0.7% to reflect the Greens's latest target ....

“Giving back” really is a terrible phrase

The phrase “give back” is as common as it wrong. It implies that something was taken in the first place. It paints the successful entrepreneur as a taker who through their success has deprived us of something that must be returned. Even worse, as philosopher Stephen Hicks explains, "the phrase also denies the benevolence of the giver. If you are only giving back what is rightfully someone else’s, then you do not deserve any special praise for your action. Your benevolence need not be acknowledged or honoured."

Jacob Hibbard picks apart the nonsense in this guest post.

Why People Should Stop Saying CEOs Have a Duty to 'Give Back' to Society

by Jacob Hibberd

It is not uncommon for successful businessmen, entrepreneurs, and celebrities to talk about what they are doing to “give back” to society or how they feel a need to “give back.”

Kelli Richards for example, CEO of The All-Access Group, maintained in a 2017 Inc. article  that “companies and individuals who [have] done well financially [are] honour-bound to look around and philanthropically offer a helping hand to those who weren't as fortunate—to honour the greater good.”

While it is can sometimes be praiseworthy for entrepreneurs and successful individuals to engage in non-sacrificial philanthropy, the idea that successful innovators need to “give back” in order to honour the "greater good" is faulty and ultimately immoral.

First, the phrase “give back” implies that something was taken in the first place. It paints the successful entrepreneur as a taker who, through their success, has deprived the rest of us of something that must be returned. This could not be further from the truth.

Jeff Bezos isn’t roaming the country with his brute squad demanding your business or your life. No taking has occurred that would require “giving back” as compensation. Instead, innovators and entrepreneurs— including the derided billionaire class—are creating immense value for us, not only by providing goods and services, but also by creating jobs that allow us to earn a living. 

In a capitalist society with the rule of law where individual rights are secured, wealth or success is not taken, it is produced, earned, and voluntarily given through mutually beneficial trade. Innovators create products and provide services that we, the consumers, value more than the dollars in our pockets and enter into voluntary transactions to acquire. The idea that the resulting wealth, peacefully acquired, comes with it a demand to "give back" is as wrong as it is insulting to producers.

The concepts of the duty to “give back” and serving the “greater good” also lead to greater resentment in society and ultimately lead to immoral policies. When we embrace the idea that the successful have a duty to “give back” to us and serve an amorphous “greater good,” we begin to resent the innovators when they do not “give back” in the ways that we want them to. It’s too little, people say; or, it’s to the wrong people; or, it’s serving the wrong sort of greater good -- and of course the complaint that it’s not being given to me.

This resentment festers until we turn to our common agent, the government, and demand that it uses force to take the wealth of the successful and “give it back” in the way that "we" judge best, serving our vision of the “greater good,” violating the rights of the successful and perverting the government from its proper role.

Societies built on resentment and the plundering of the successful in the name of the “greater good” implode. If you want to see it in real time, look at what’s happening to California now. Innovators are fleeing due to burdensome regulations and taxes.

So instead of demanding that entrepreneurs and innovators “give back,” and resenting them when they don’t use their wealth the way we like, let’s strive to have some gratitude.

Let’s recognise the immense value that Jeff Bezos, Steve Jobs, and Elon Musk (in his non-grifting mode) have created for us and society. They give us a greater quality of life when they create the next Amazon, the next smartphone, or open the next factory that creates thousands of jobs. They don’t need to be forced to help society. They are already helping.

* * * * 

Jacob Hibbard is the Grassroots Director for Americans for Prosperity Utah and a first year law student at Brigham Young University. His op-ed first appeared at the Foundation for Economic Education. It has been lightly edited.

[Hat tip to Stephen Hicks for the link and post title.]

QotD: "Government spending does not create wealth but devours it." [updated]

"Government spending does not create wealth but devours it."
    ~ Manuel Suárez-Mier, from his (Spanish-language article) 'Fighting Against Poverty'

UPDATE:

"Real, sustainable economic growth is not the result of high taxes, but of long-term sustainable capital growth and accumulation—and hence, ever-greater and ever-increasing productivity.
"Since government spending is overwhelmingly thrown away on consumption spending instead of on productive spending, however –practically every dollar that governments spend is consumption spending -- capital growth is hampered rather than helped, by high government spending. It’s a handbrake, not a help-mate."

.

REPRISE: How the Stock Market and Economy Really Work

As the president and his supporters tout the inflating stock market bubble as a sign of prosperity, reprising this myth-busting guest post by Kel Kelly could not be more timely.
[NB: An MP3 audio file of this article, narrated by Keith Hocker, is available for download.]

                                                                                                                                                                                                                                                                  

"A growing economy consists
of prices falling, not rising."

The stock market does not work the way most people think. A commonly-held belief — on Main Street as well as on Wall Street — [and in the White House as well as CNN] is that a stock-market boom is the reflection of a progressing economy: as the economy improves, companies make more money, and their stock value rises in accordance with the increase in their intrinsic value. A major assumption underlying this belief is that consumer confidence and consequent consumer spending are drivers of economic growth.

A stock-market bust, on the other hand, is held to result from a drop in consumer and business confidence and spending — due to either inflation, rising oil prices, or high interest rates, etc., or for no real reason at all — that leads to declining business profits and rising unemployment. Whatever the supposed cause, in the common view a weakening economy results in falling company revenues and lower-than-expected future earnings, resulting in falling intrinsic values and falling stock prices.

This understanding of bull and bear markets, while held by academics, investment professionals, and individual investors alike, is technically correct if viewed superficially but,  because it is based on faulty finance and economic theory, it is substantially misconceived .


In fact, the only real force that ultimately makes the stock market or any market as a whole rise (and, to a large extent, fall) over the longer term is simply changes in the quantity of money and the volume of spending in the economy. Stocks rise when there is inflation of the money supply (i.e., more money in the economy and in the markets). This truth has many consequences that should be considered.

Since stock markets can fall — and fall often — to various degrees for numerous reasons (including a decline in the quantity of money and spending); our focus here will be only on why they are able to rise in a sustained fashion over the longer term.

The Fundamental Source of All Rising Prices

For perspective, let's put stock prices aside for a moment and make sure first to understand how aggregate consumer prices rise. In short, overall prices can rise only if the quantity of money in the economy increases faster than the quantity of goods and services. (In economically retrogressing countries, prices can rise when the supply of goods diminishes while the supply of money remains the same, or even rises.)

When the supply of goods and services rises faster than the supply of money however — as happened during most of the 1800s — the unit price of each good or service falls, since a given supply of money has to buy, or "cover," an increasing supply of goods or services. (See Fig. 1)

Fig 1: NZ & British Price Level, 1860-1910

For those lost in the bewildered state of most presidents or modern economists, this may still seem perplexing, but could not be more straightforward mathematically -- George Reisman derives the critical formula for the formation of economy-wide prices:¹ In this formula, price (P) is determined by monetary demand (D) divided by supply of goods and services (S):

P=D/S

The formula shows us that it is mathematically impossible for aggregate prices to rise by any means other than (1) increasing monetary demand, or (2) decreasing supply; i.e., by either more money being spent to buy goods, or fewer goods being sold in the economy.

In our developed economy, the supply of goods is not decreasing, or at least not at enough of a pace to raise prices at the usual rate of 3–4 percent per year; instead prices are rising due to more money entering the marketplace.

The same price formula noted above can equally be applied to asset prices — stocks, bonds, commodities, houses, oil, fine art, etc. It also pertains to corporate revenues and profits, for as Fritz Machlup states:

It is impossible for the profits of all or of the majority of enterprises to rise without an increase in the effective monetary circulation (through the creation of new credit or by dis-hoarding).

To return to our focus on the stock market in particular, it should be seen now that the market cannot continually rise on a sustained basis without an increase in money — specifically bank credit — flowing into it.

There are other ways the market could go higher, but their effects are purely temporary.

For example, an increase in net savings involving less money spent on consumer goods and more invested in the stock market (resulting in lower prices of consumer goods) could send stock prices higher, but only by the specific extent of the new savings, assuming all of it is redirected to the stock market.

The same applies to reduced tax rates. These would be temporary effects resulting in a finite and terminal increase in stock prices. Money coming off the "sidelines" could also lift the market, but once all sideline money was inserted into the market, there would be no more funds with which to bid prices higher. The only source of ongoing fuel that could propel the market — any asset market — higher is new and additional bank credit. As Machlup writes,

If it were not for the elasticity of bank credit … [then] a boom in security values could not last for any length of time. In the absence of inflationary credit, the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and current amortisation allowances is fairly inelastic.… Only if the credit organisation of the banks (by means of inflationary credit), or large-scale dishoarding by the public make the supply of loanable funds highly elastic, can a lasting boom develop.… A rise on the securities market cannot last any length of time unless the public is both willing and able to make increased purchases. (Emphasis added.)

The last line in the quote helps to reveal that neither population growth nor consumer sentiment alone can drive stock prices higher. Whatever the population, it is using a finite quantity of money; whatever the sentiment, it must be accompanied by the public's ability to add additional funds to the market in order to drive it higher.⁴

Understanding that the flow of recently-created money is the driving force of rising asset markets has numerous implications. The rest of this article addresses some of these implications.

The Link between the Economy and the Stock Market

The primary link between the stock market and the economy — in the aggregate — is that an increase in money and credit pushes up both GDP and the stock market simultaneously.

A progressing economy is one in which more goods are being produced over time. What represents real wealth is not money per se [not even crypto-money], but real "stuff." The more cars, refrigerators, food, clothes, medicines, and hammocks we have, the better off our lives. We saw above that if more goods are produced at a faster rate than money then prices will fall. With a constant supply of money, wages would remain the same in money terms while prices fell, because the supply of goods would increase while the supply of workers would not—meaning higher real wages. But even when prices rise due to money being created faster than goods, prices still fall in real terms, because wages rise faster than prices. In either scenario, if productivity and output are increasing, goods get cheaper in real terms.

This is what rising prosperity looks like.

Obviously, then, a growing economy consists of prices falling, not rising. No matter how many goods are produced, if the quantity of money remains constant then the only money that can be spent in an economy is the particular amount of money existing in it (and velocity, or the number of times each dollar is spent, could not change very much if the money supply remained unchanged).

This alone reveals that GDP does not necessarily tell us much about the number of actual goods and services being produced; it only tells us that if (even real) GDP is rising, the money supply must be increasing, since a rise in GDP is mathematically possible only if the money price of individual goods produced is increasing to some degree.⁵ Otherwise, with a constant supply of money and spending, the total amount of money companies earn — the total selling prices of all goods produced — and thus GDP itself would all necessarily remain constant year after year.

"Consider that if our rate of inflation were high enough, used cars would rise in price just like new cars, only at a slower rate."

The same concept would apply to the stock market: if there were a constant amount of money in the economy, the sum total of all shares of all stocks taken together (or a stock index) could not increase. Plus, if company profits, in the aggregate, were not increasing, there would be no aggregate increase in earnings per share to be imputed into stock prices.

In an economy where the quantity of money was static, the levels of stock indexes, year by year, would stay approximately even, or even drift slightly lower⁶ — depending on the rate of increase in the number of new shares issued. And, overall, businesses (in the aggregate) would be selling a greater volume of goods at lower prices, and total revenues would remain the same. In the same way, businesses, overall, would purchase more goods at lower prices each year, keeping the spread between costs and revenues about the same, which would keep aggregate profits about the same.

Under these circumstances, ‘capital gains’ from speculation (the profiting from the buying low and selling high of assets) could be made only by stock picking — by investing in companies that are expanding market share, bringing to market new products, etc., thus truly gaining proportionately more revenues and profits at the expense of those companies that are less innovative and efficient.

The stock prices of the gaining companies would rise while others fell. Since the average stock would not actually increase in value, most of the gains made by investors from stocks would be in the form of dividend payments. By contrast, in our world today, most stocks — good and bad ones — rise during inflationary bull markets and decline during bear markets. The good companies simply rise faster than the bad.

Similarly, housing prices under static money would actually fall slowly — unless their value was significantly increased by renovations and remodelling. Older houses would sell for much less than newer houses. To put this in perspective, consider that if our rate of inflation were high enough, used cars would rise in price just like new cars, only at a slower rate — but just about everything would increase in price, as it does in countries with hyperinflation. The amount by which a home "increases in value" over 30 years really just represents the amount of purchasing power that the dollars we hold have lost: while the dollars lost purchasing power, the house — and other assets more limited in supply growth — kept its purchasing power.

Since we have seen that neither the stock market nor GDP can rise on a sustained basis without more money pushing them higher, we can now clearly understand that an improving economy neither consists of an increasing GDP nor does it cause the overall stock market to rise.

This is not to say that a link does not exist between the money that particular companies earn and their value on the stock exchange in our inflationary world today, but that the parameters of that link — valuation relationships such as earnings ratios and stock-market capitalisation as a percent of GDP — are rather flexible, and as we will see below, change over time. Money sometimes flows more into stocks and at other times more into the underlying companies, changing the balance of the valuation relationships.

Forced Investing

As we have seen, the whole concept of rising asset prices and stock investments constantly increasing in value is an economic illusion. What we are really seeing is our currency being devalued by the addition of new currency issued by the central bank. The prices of stocks, houses, gold, etc., do not really rise; they merely do better at keeping their value than do paper bills and digital checking accounts, since their supply is not increasing as fast as are paper bills and digital checking accounts.
"An improving economy neither consists of an increasing GDP nor does it cause the overall stock market to rise."

The fact that we have to save so much for the future is, in fact, an outrage. Were no money printed by the government and the banks, things would get cheaper through time, and we would not need much money for retirement, because it would cost much less to live each day then than it does now. But we are forced to invest in today's government-manipulated inflation-creation world in order to try to keep our purchasing power constant.

To the extent that some of us even come close to succeeding, we are still pushed further behind by having our "gains" taxed.
The whole system of inflation is solely for the purpose of theft and wealth redistribution. In a world absent of government printing presses and wealth taxes, the armies of investment advisors, pension-fund administrators, estate planners, lawyers, and accountants associated with helping us plan for the future would mostly not exist. These people would instead be employed in other industries producing goods and services that would truly increase our standards of living.

The Fundamentals are Not the Fundamentals

If it is, then, primarily newly-printed money flowing into and pushing up the prices of stocks and other assets, what real importance do the so-called fundamentals — revenues, earnings, cash flow, etc. — have? In the case of the fundamentals, too, it is newly printed money from the central bank, for the most part, that impacts these variables in the aggregate: the financial fundamentals are determined to a large degree by economic changes.

For example, revenues and, particularly, profits, rise and fall with the ebb and flow of money and spending that arises from central-bank credit creation. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase.

Specifically, how this comes about is that new money, created electronically by the government and loaned out through banks, is spent by borrowing companies.⁷ Their expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lags behind in time because of technical accounting procedures, such as the spreading of asset costs across the useful life of the asset (depreciation) and the postponing of recognition of inventory costs until the product is sold (cost of goods sold). These practices delay the recognition of costs on the profit-and-loss statements (i.e., income statements).


Since these costs are recognised on companies' income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognised. For example, if a company recognises $1 million in costs for equipment purchased in 1999, that $1 million is worth less today than in 1999; but on the income statement the corresponding revenues recognised today are in today's purchasing power. Therefore, there is an equivalently greater amount of revenues spent today for the same items than there was ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency).

"With more money being created through time, the amount of revenues is always greater than the amount of costs, simply because most costs are incurred when there is less money existing."

Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed.

In summary, credit expansion increases the spreads between revenue and costs, increasing profit margins. The tremendous amount of money created since 2008 is what is responsible for the fantastic profits companies had been reporting (even though the amount of money loaned out was small, relative to the increase in the monetary base).

Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit.⁸

During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.


It is also new money flowing into industry from the central bank that is the primary cause behind positive changes in leading economic indicators such as industrial production, consumer durables spending, and retail sales. As new money is created, these variables rise based on the new monetary demand, not because of resumed real economic growth.

A final example of new money affecting the fundamentals is interest rates. It is said that when interest rates fall, the common method of discounting future expected cash flows with market interest rates means that the stock market should rise, since future earnings should be valued more highly. This is true both logically and mathematically. But, in the aggregate, if there is no more money with which to bid up stock prices, it is difficult for prices to rise, unless the interest rate declined due to an increase in savings rates.

In reality, the help needed to lift the market comes from the fact that when interest rates are lowered, it is by way of the central bank creating new money that hits the loanable-funds markets. This increases the supply of loanable funds and thus lowers rates. It is this new money being inserted into the market that then helps propel it higher.

(I would personally argue that most of the discounting of future values [PV calculations] demonstrated in finance textbooks and undertaken on Wall Street are misconceived as well. In a world of a constant money supply and falling prices, the future monetary value of the income of the average company would be about the same as the present value. Future values would hardly need to be discounted for time preference [and mathematically, it would not make sense], since lower consumer prices in the future would address this. Though investment analysts believe they should discount future values, I believe that they should not. What they should instead be discounting is earnings inflation and asset inflation, each of which grows at different paces.)⁹

Asset Inflation versus Consumer Price Inflation

Newly-printed money can affect asset prices more than consumer prices. Most people think that the Federal Reserve and other central banks have done a good job of preventing inflation over the last twenty-plus years. The reality is that it has created a tremendous amount of money, but that the money has disproportionately flowed into financial markets instead of into the real economy, where it would have otherwise created drastically more price inflation.

There are two main reasons for this channelling of money into financial assets. The first is changes in the financial system in the mid and late 1980s, when an explosive growth of domestic credit channels outside of traditional bank lending opened up in the financial markets. The second is changes in the US trade deficit in the late 1980s, wherein it became larger, and export receipts received by foreigners were increasingly recycled by foreign central banks into US asset markets.¹⁰ As financial economist Peter Warburton states,

a diversification of the credit process has shifted the centre of gravity away from conventional bank lending. The ascendancy of financial markets and the proliferation of domestic credit channels outside the [traditional] monetary system have greatly diminished the linkages between … credit expansion and price inflation in the large western economies. The impressive reduction of inflation is a dangerous illusion; it has been obtained largely by substituting one set of serious problems for another.

And, as bond-fund guru Bill Gross said,

what now appears to be confirmed as a housing bubble, was substantially inflated by nearly $1 trillion of annual reserve flowing back into US Treasury and mortgage markets at subsidised yields.… This foreign repatriation produced artificially low yields.… There is likely near unanimity that it is now responsible for pumping nearly $800 billion of cash flow into our bond and equity markets annually.

This insight into the explanation for a lack of price inflation in recent decades should also show that the massive amount of reserves the Fed created in 2008 and 2009 — in response to the recession — might not lead to quite the wild consumer-price inflation everyone expects when it eventually leaves the banking system but instead to wild asset price inflation.

One effect of the new money flowing disproportionately into asset prices is that the Fed cannot "grow the economy" as much as it used to, since more of the new money created in the banking system flows into asset prices rather than into GDP. Since it is commonly thought that creating money is necessary for a growing economy, and since it is believed that the Fed creates real demand (instead of only monetary demand), the Fed pumps more and more money into the economy in order to "grow it."

That also means that more money — relative to the size of the economy — "leaks" out into asset prices than used to be the case. The result is not only exploding asset prices in the United States, such as the NASDAQ and housing-market bubbles but also in other countries throughout the world, as new money makes its way into asset markets of foreign countries.¹³

A second effect of more new money being channelled into asset prices is, as hinted above, that it results in the traditional range of stock valuations moving to a higher level. For example, the ratio of stock prices to stock earnings (P/E ratio) now averages about 20, whereas it used to average 10–15. It now bottoms out at a level of 12–16 instead of the historical 5. A similar elevated state applies to Tobin's Q, a measure of the market value of a company's stock relative to its book value. But the change in relative flow of new money to asset prices in recent years is perhaps best seen in the chart below, which shows the stunning increase in total stock-market capitalisation as a percentage of GDP (figure 2).

Figure 2: The Size of the Stock Market Relative to GDP Source: Thechartstore.com

The changes in these valuation indicators I have shown above reveal that the fundamental links between company earnings and their stock-market valuation can be altered merely by money flows originating from the central bank.

Can Government Spending Revive the Stock Market and the Economy?

So, can government spending revive the stock market and the economy then? The answer is: yes and no. Government spending does not restore any real demand, only nominal monetary demand. Monetary demand is completely unrelated to the real economy, i.e., to real production, the creation of goods and services, the rise in real wages, and the ability to consume real things — as opposed to a calculated GDP number.

Government spending harms the economy and forestalls its healing. The thought that stimulus spending, i.e., taking money from the productive sector (a de-accumulation of capital) and using it to consume existing consumer goods or using it to direct capital goods toward unprofitable uses (consuming existing capital), could in turn create new net real wealth — real goods and services — is preposterous.

What is most needed during recessions is for the economy to be allowed to get worse — for it to flush out the excesses and reset itself on firm footing. Recession is a process of recovery from earlier gross misallocations. Broken economies suffer from a misallocation of resources consequent upon prior government interventions, and can therefore be healed only by allowing the economy's natural balance to be restored. Falling prices and lack of government and consumer spending are part of this process.

Given that government spending cannot help the real economy, can it help the specific indicator called GDP? Yes it can. Since GDP is mostly a measure of inflation, if banks are willing to lend and borrowers are willing to borrow, then the newly created money that the government is spending will make its way through the economy. As banks lend the new money once they receive it, the money multiplier will kick in and the money supply will increase, which will raise GDP.

"What is most needed during recessions is for the economy to be allowed to get worse — for it to flush out the excesses and reset itself on firm footing."

As for the idea that government spending helps the stock market, the analysis is a bit more complicated. Government spending per se cannot help the stock market, since little, if any, of the money spent will find its way into financial markets. But the creation of money that occurs when the central bank (indirectly) purchases new government debt can certainly raise the stock market. If new money created by the central bank is loaned out through banks, much of it will end up in the stock market and other financial markets, pushing prices higher.

Summary

The most important economic and financial indicator in today's inflationary world is money supply. Trying to anticipate stock-market and GDP movements by analysing traditional economic and financial indicators can lead to incorrect forecasts. To rely on these "fundamentals" today is to largely ignore the specific economic forces that most significantly affect those same fundamentals — most notably the changes in the money supply. Therefore, the best insight into future stock prices and GDP growth is gained by following monetary indicators.

---

Kel Kelly is the Head of Economic and Commodity Research at an international energy and agribusiness firm and the author of The Case for Legalizing Capitalism. Kel holds a degree in economics from the University of Tennessee, an MBA from the University of Hartford, and an MS in economics from Florida State University. He lives in Atlanta.
A version of this 2010 article first appeared at the Mises Daily


NOTES 
1.See G. Reisman, Capitalism: A Treatise on Economics (1996), p.897, for a fuller demonstration. Most of the insights in this paper are derived from the high-level principles laid out by Reisman. For additional related insights on this topic, see Reisman, "The Stock Market, Profits, and Credit Expansion," "The Anatomy of Deflation," and "Monetary Reform."
2.F. Machlup, The Stock Market, Credit, and Capital Formation (1940), p. 90. 3.Ibid., pp. 92, 78. 4.For a holistic view in simple mathematical terms of how the price of all items in an economy may or may not rise, depending on the quantity of money, see K. Kelly, The Case for Legalizing Capitalism (2010), pp 132–133. 5.Price increases are supposedly adjusted for, but "deflators" don't fully deflate. Proof of this is the very fact that even though rising prices have allegedly been accounted for by a price deflator, prices still rise (real GDP still increases). Without an increase in the quantity of money, such a rise would be mathematically impossible. 6.To gain an understanding of earning interest (dividends in this case) while prices fall, see Thorsten Polleit's "Free Money Against 'Inflation Bias'."
7.Most funds are borrowed from banks for the purpose of business investment; only a small amount is borrowed for the purpose of consumption. Even borrowing for long-term consumer consumption, such as for housing or automobiles, is a minority of total borrowing from banks. 8.The other main reason for this, if the country is poor, is the fact that there is a lack of capital: the more capital, the lower the rate of profit will be, and vice versa (though it can never go to zero). 9.Any reader who is interested in exploring and poking holes in this theory with me should feel free to contact me to discuss. 10.This recycling is what Mises's friend, the French economist Jacques Reuff, called "a childish game in which, after each round, winners return their marbles to the losers" (as cited by Richard Duncan, The Dollar Crisis (2003), p. 23). 11.P. Warburton, Debt and Delusion: Central Bank Follies that Threaten Economic Disaster (2005), p. 35. 12.[12] William H. Gross, "100 Bottles of Beer on the Wall."
13.It's not actually American dollars (both paper bills and bank accounts) that make their way around the world, as most dollars must remain in the United States. But for most dollars received by foreign exporters, foreign central banks create additional local currency in order to maintain exchange rates. This new foreign currency — along with more whose creation stems from "coordinated" monetary policies between countries — pushes up asset prices in foreign countries in unison with domestic US asset prices.