Unlike manna that just falls from heaven, wealth has to be created. A tree can only be turned into a house by adding to it some mix of labor and capital. The same is true for oil under the North Sea – it can’t power my car until labor and capital are used to improve it and get it to me in a usable form.

Wealth creation is a product of production, not consumption. If I wake up one day and say, “I want a pizza”, that doesn’t create wealth. The people who create wealth are the farmers who grow the wheat for the dough and tomatoes for the paste; those who harvest the milk for the cheese; the food processors who turn raw commodities into pizza ingredients; the entrepreneur who comes up with idea to sell pizza; the bank that decides to invest capital in a pizza store; and the delivery guy who brings the pizza to your door. Each of those actors creates wealth. Consumers then destroy the wealth that was created (in this case by eating the pizza).

Public policies that are geared toward wealth creation should not focus on ways to increase consumption; they should focus on ways to increase production. China’s economy is projected to grow at an annualized rate over 9% again this year. The focus of China’s economic growth in the last decade has been increased production, not increased consumption.

Borrow and spend public policies confuse consumption with economic growth. Handing out money to consumers doesn’t create wealth, it creates consumption and consumption consumes (destroys) wealth.

As of February 6.1 million Americans have been out of work for over six months and another 8.8 million are working part time for lack of a full time job. We need strong economic growth to put people back to work. Growth based economic policy must focus on ways to encourage (or at least stop discouraging) production.

To start with, the federal government should repeal prevailing wages laws and the minimum wage. Both policies increase unemployment and discourage the hiring of labor. Next the federal government should reform and simplify the tax code to stop punishing production. Payroll and income taxes discourage work. Sales or value added taxes discourage consumption. By replacing the former with the latter, the federal government would go a long way to stimulating production in the US and putting people back into the wealth creation process.

Senator Bunning recently held up an extension of unemployment insurance payments to the chronically unemployed. Americans in some states (no federal rules aren’t the same for people in every state) could receive 99 weeks of unemployment insurance benefits.

Like most decisions there are trade offs. The trade off of more generous unemployment insurance is that it stifles economic growth. Yes people can continue to consume more stuff if they get a check in the mail. That’s the point, to make unemployment less unpleasant. On the other hand, the less unpleasant something is, the less likely people are to avoid it. The more people avoid work, the less wealth is produced.

On the extreme, if an unemployed person could collect 100% of their salary for two years, I’m willing to bet that a number of people would voluntarily sign up for their two year sabbatical as long as the “looking for work” requirements aren’t too stringent. Few people like their jobs so much that they would show up for free. That is why it is called work, not vacation.

One wonders how long politicians will take to figure out that indefinitely paying people not to work harms economic growth. Remember, politicians already pay people not to grow stuff (farm set aside programs) retire at early ages (lucrative public union pension schemes), provide welfare payments that discourage work, and increase taxes which deter new jobs from forming.

In the 1990’s, President Clinton and Congress dramatically changed the welfare system to require work. Economic growth ensued. Perhaps it is now time to change the long term unemployment insurance program as well. Rather than just extending benefits we could require that people who collect unemployment insurance for more than six months have to go back to school to gain a new skill that will lead them to a new job. At least then the payments go to the creation of human capital.

People are unemployed for long periods of time because they lack the skills currently in demand by the market. People can sit around waiting for market conditions to change, or they can gain skills that are in demand. For instance, there is a huge unmet demand for registered nurses in the US. By requiring education in exchange for long term unemployment insurance, we can increase both short term and long term economic growth.

What makes a government a government is their monopoly power over legal force. Governments don’t like competition from other governments because it reduces said monopoly power. Nor do governments like private sector competition to government run businesses.

At the local level people can vote with their feet (the Tiebout Effect) and choose to live under a local government that provides their desired level of public services at their desired tax rate. This is much harder to do at the national level where renouncing one’s citizenship is often, rightly so, a big deal. As a result, the national government can suppress competition among state and local governments and employ larger amounts of force.

Those whose ideologies favor the use of government force always prefer the centralization of government. Decentralization of government, then, is the clarion call for those who want to limit the power of government.

For various reasons governments have gotten into running certain businesses. When they do so, it is not with the intention of increasing competition (producers never like competition). It’s almost funny (not in a ha ha sense) to watch Congressional leaders attack Toyota executives. Toyota sells more cars than GM (Government Motors) and Congress wants that to change. The more bad publicity Toyota gets, the more people will turn to GM cars (as indicated by January new car sales figures).

When I was a city commissioner, I was Chairman of the Bowling Green/Warren County Convention Center Corporation, a government entity that owned a convention center. My fellow elected politicians took active steps to prevent new private sector convention space from being built in Bowling Green because it would compete with the government product.

In the end, governments hate competition. Competition reduces the power of government and government officials. The more of the economy the government takes over, the less competition we will see - never mind that competition is great for consumers. Then again, if governments were trying to make consumers happier, they wouldn’t have to use government force to do so.

Note: The Capitalism Today blog will continue in March upon my return from Africa.

When politicians are allowed to set prices, almost everything is cheap/ free, and shelves are empty for lack of supply. What politician doesn’t want to promise that he/she can lower prices that people have to pay for products? It’s a sure-fire vote winner. I deserve more stuff and could buy that stuff if only it were cheaper.

The problem with government price setting is that prices are little bits of information. Prices tell you how badly people want products relative to their cost of production. Governmentally set prices don’t mean anything and so they send false signals to consumers and producers. These false signals end either in shortages or surpluses of products on the market.

To believe that a price can be “set” is to believe that some authority is omniscient, omnipresent, and in charge of the price setting. The irony is that an omniscient and omnipresent price setter, who is concerned with maximizing welfare, would act no differently in the setting of prices than does a perfectly competitive market. This is what Adam Smith called “The Invisible Hand”.

When politicians choose to ignore the invisible hand, the hand has a tendency to slap them in the face - think gasoline shortages in the 1970’s. When prices are set below equilibrium, more products are wanted than suppliers can afford to produce. The only effective price control is if it is followed by government mandated production – i.e. slavery.

President Obama this week called for a government cap on increases in health insurance premiums. Apparently he knows what the appropriate price is for health insurance. But if price caps mean that insurance companies choose to drop high risk people from their plans, we would get an increase in uninsured Americans. Alas, this is where the forced production comes in. The only way the government can set the price of health care is to mandate (control) its production – a production inevitably plagued with shortages.

It is just too bad that the good people of Greece don’t have such wise politicians as we have in the US. As interest rates on Greek debt continue to soar, US politicians would just mandate that they can’t. Oh wait, that would mean no one would supply more loans to Greece and they would have to balance their budget – stupid invisible hand.

I had never found spitting into the wind to be all that productive, so I was quite surprised in my high school physics class to learn that you could sail into the wind. On my recent trip to New Zealand, I did some sailing and there was reminded of the skill of tacking. A sailboat cannot sail directly into the wind, but it can use the force of the headwind to propel it gradually in the direction of the headwind.

As politicians look to steer our economy into an economic headwind, it is important to take the lessons we can learn from sailing and apply them to the economy.

Question: If you find that you are sailing directly into a headwind, and the headwind is pushing you in the opposite direction of where you want to go, what should you do?

1. Hoist a bigger sail
2. Keep your same sail up that you used when you had a tail wind, and pay people to row directly into the headwind
3. Realize that the shortest distance between two points is not a straight line. Use the power of the headwind to tack into the wind.

Correct Answer: C. Hoisting a larger sail will just make your sail boat go backwards faster. Wind power is strong. Paying people to row directly into the wind while keeping your sail up wastes both money and energy.

Related Question: If you find that your economy is sailing directly into an economic headwind (recession) that was brought about by high levels of government, business, and personal debt, what should you do?

1. Take on more government, business, and personal debt more quickly
2. Keep your same government policies, and pay people to engage in the production of goods and services that the marketplace doesn’t want
3. Realize that the shortest distance to recovery is not a straight line. Use the power of the economic headwind to tack the economy into the wind

Correct Answer: C. Taking on more debt will slow economic recovery and produce slower long term economic growth. While paying people to produce things that others don’t want looks good for GDP accounting (see Keynes’ suggestion of hiring people to dig ditches and hiring others to fill them in), it doesn’t move the economy forward. Wind and the invisible hand have a lot in common. Both are invisible in themselves, but their effects can be devastating when ignored. The right answer is to harness market forces to tack the economy into the economic headwind.

Let’s say there is a US car company whose cars people don’t want to buy. The invisible hand would tell the company to either produce cars that people want to buy at a price they are willing to pay, or cease car production. This would free up resources for those economic actors who will build things people want to buy at prices they want to pay.

Yet, the US government’s response went something like this, hmm, people aren’t buying GM cars, so let’s force people to give GM money via a government bailout and we won’t even give them cars in return. But wait, people still aren’t buying enough GM cars, so let’s pay people to demolish their existing cars. Note that the cash for clunkers rules said the cars had to be totaled – the government didn’t want working car parts to remain working – they insisted on the destruction of wealth. Still with all of this taxpayer money wasted, the problem is the same, unless a company can produce a product that people want to buy at a price they want to pay, the economy is better off freeing up those misallocated resources.

Sure US GDP numbers are up, but for the wrong reason – government spending is up dramatically. As the government borrows more money to produce goods and services that people don’t want (high speed rail to nowhere, etc.) it take resources from the private sector that the private sector could use to create products that people actually want. So rather than seeing increased GDP from government spending as moving the economy forward, it is just rowing with an ever increasingly large sail into the wind. The effect of which reminds me of why I stopped spitting into the wind.

In John Hofmeister’s  WSJ opinion piece, “The U.S. Needs an industrial Policy” (February 7^th), he suggests, “Since government is involved anyway [in business], let’s shift it from disablement to enablement.” Right, because governments know how to pick economic winners and losers. How could Mr. Hofmeister have missed how Japan’s industrial policy prolonged its economic slump of the 1990’s/2000’s?

Mr. Hofmeister is all to willing to cite “core” U.S. industries. Cores are for apples, not industries. “Core” is code for “all industries are equal, but some are more equal than others”. “Core” is code for yet another corporate CEO wanting to take a free ride at taxpayers’ expense. What company doesn’t think that what it does is “core”? We’ve just witnesses how the U.S. government spends taxpayer money on “core” banks, and now Mr. Hofmeister wants to extend “Goldman Sachs economic policy” to other industries?

The only thing that scares me more than the anti-businesses Washington crowd, is the “pro-core businesses” crowd. It’s like a pendulum that swings from socialism to fascism. Where, oh where, has the pro-market crowd gone? Where, oh where, can they be?

Former Fed Chairman, Alan Greenspan, in order to stoke the US economy took the Federal Funds Rate below 2% on December 11^th 2001. The rate stayed below 2% for nearly three years until November 10^th 2004. Money was virtually free and people acted accordingly. People took larger risks with larger amounts of money. Asset bubbles were created, and then expanded.

As it turns out, Chairman Greenspan is an avid bath taker. Is this a coincidence that he is most at ease when surrounded with bubbles? No need to worry about one bath bubble bursting if you surround yourself with thousands of bubbles, right? Think bubble wrap. If you are sending a fragile package you wrap it in bubble wrap. It doesn’t matter if one bubble breaks as long as they don’t all break.

While the bursting of baby bubbles isn’t a big deal, what if mega bubbles get created? Think kids’ inflatable jumping house. What if the only thing holding up the inflatable jumping house is hot air? What if the hot air was paid for with borrowed money? What happens to the inflatable jumping house when you no longer bother to pay the electricity bill? Well the hot air stops and the inflatable house collapses all around the screaming kids, and you hope that they don’t die from suffocation.

Once the kids are rescued from the deflated jumping house, the question becomes how do you build a new play house? Do you figure that your problem was that you didn’t borrow enough money to pay the current electricity bill (see current deficit spending)? Do you figure that the problem was that your air hose wasn’t big enough (see even lower interest rates from Bernanke than we got from Greenspan)? Or do you learn your lesson and only build a toy house of wood with money that isn’t borrowed?

Don’t expect anything but more bubble houses from Bernanke. Maybe his parents didn’t let him blow bubbles in the house as a kid, so now he’s taking it out on the rest of us. Who knows? Still the Asian asset bubble Bernanke is now building in currencies linked to the US dollar will pop as every other bubble before them have and when it does we will see another Fed generated global slowdown. Oh but this time it will be different….

The same story was true in New Zealand. Last year it took me 54 US cents to buy a NZ Dollar and this year it took me 73 US cents. That’s a 35% reduction in the value of the US dollar vs. the NZ Dollar in one year.

The problem: My food per diem is paid in US dollars. Last year I could get a schnitzel meal covered with my per diem. This year I couldn’t even cover KFC.

The cause: Excessive monetary easing by the US Federal Reserve.

Analysis: By expanding the money supply faster than our economy is growing, the Federal Reserve is creating a glut of dollars on the world market. This glut manifests itself in low short run interest rates and a weaker currency. The Fed is trying to trick businesses to invest and foreigners to buy our stuff to stimulate our economy.

In short, Federal Reserve policy over the last year has resulted in a massive wealth redistribution from holders of US dollars to holders of foreign currency. US consumers who want to buy products from abroad have seen their purchasing power radically decline. Since most Americans hold the vast amount of their wealth in US dollar denominated assets, this amounts to a large reduction in US net wealth in just one year.

I suppose that is change I can believe in, because I believe there is less change in my pocket.

I don’t have the numbers, but I would suspect that Neo-Keynesians text and twitter way more than their neoclassical counterparts. Now, is not just an important time frame, it is the only time frame that matters at all.

I know another group of people whose only concern is NOW – little children (mine in particular). Today was family picture day and I was trying to convince my two year old to smile. He insisted on getting a lollipop. I had no lollipop. That didn’t matter – he wanted one – now. Employing subpar parenting skills, I tried to reason with my two year old. “I don’t have a lollipop, and if I had one you wouldn’t get one because you refuse to smile for the camera. How about, if you smile for the camera, I’ll get you a lollipop when we get to the car?” His responded (or yelled, so I’ll paraphrase) that what he wanted was a lollipop now with no strings attached requiring good behavior.

Neo-Keynesians look at the current economy and demand lollipops (housing starts, industrial production) now. After all, lollipops are yummy. Does it matter that the market conditions don’t support lollipop production? No, because they want them – now. The neoclassical economist would say, if you want a lollipop (production) you must first engage in correct behavior (let the economy soak up the excess capacity of capital, reorganize labor markets, etc) before you can get a lollipop.

Economic growth to a neoclassical economist is the reward for hard work, saving and investment. For the Neo-Keynesian, economic growth is wanted, so we are entitled to it without hard work, saving, or investment.

Keynesianism is the philosophy of two year olds. Good parenting requires that we teach kids patience and perseverance to achieve goals. Good economic teaching requires that we teach policy makers patience and perseverance to achieve goals.

In this light, Neo-Keynesian economic advisors are like parents who tell their kids (politicians) that they can have everything they want - now - with no strings attached. Is it any wonder that politicians turn out to have A.D.D.?

Note: Capitalism Today will resume in late January when I return from Australia

Capital is a long term phenomenon while investment is a short term one. A decision to invest today, and by invest I mean building capital – physical or human, has ramifications for years to come. My previous blog focused on determinants of capital accumulation over time. This blog focuses on the determinants of capital accumulation in time.

There are two possible strategies for increasing capital accumulation now. The first is to provide incentives that make investment today more profitable than investment tomorrow. The second is to increase the rate of return to investment both now and later.

The first strategy doesn’t increase capital accumulation over time, but merely alters when in time investment occurs. For instance, if the Federal Reserve increases the money supply to lower interest rates, they lower the cost of borrowing with the intent of spurring current investment. Inflation neutral monetary policy dictates that today’s loosening of monetary policy necessitates a future tightening. In this way the Fed signals that today’s investment will cost less, and tomorrow’s investment will cost more, so tomorrow’s investment should be moved forward to today. Likewise, investment tax credits which apply to now, but not later, provide an incentive to move investment forward.

To the extent that this strategy is effective, you get more investment today accompanied by less investment tomorrow – call it the cash for clunkers effect where you can spike car sales for a given month, only to have future months’ car sales decline. Excessive use of monetary easing or investment tax credits can and do cause artificial investment bubbles that can and do burst.

To come out of the 2001 recession the Federal Reserve eased monetary policy, which caused businesses to bring investment forward. Because monetary policy was so loose for so long, a large amount of investment was brought forward. In fact, too much was brought forward leaving excess capacity in everything from industrial plants, to condos, to office space. This excess capacity caused investment to come to a virtual halt in the US helping to trigger our current economic recession.

To be surprised that investment caused by monetary easing came at the expense of future investment one has to wear economic blinders. What’s even funnier (no in a ha ha sense but in an ironic sense) is that many current policy makers say the following, “Oh investment has fallen, we better lower interest rates to spur investment”. In other words, they want to compound their investment bubble mistakes rather than let the economy catch up to the excess investment that already exists.

The second strategy to increase investment today is to meaningfully and permanently change taxes and regulations that affect the rate of return on capital. Capitalists will respond to permanent reductions in capital taxes (see the Irish miracle, the Pittsburgh comeback, or the Canadian surprise) and looser capital regulations (see India and China’s growth). If the tax or regulatory changes are seen by the capitalists as being temporary, they won’t take a chance with long term capital.

The benefit of the second strategy is that you aren’t providing current investment at the expense of future investment, but rather adding to both current and future investment.

Politicians like short stories because their time horizon is short. For political reasons they more often than not pursue strategy number one. The short stories I remember are the ones that end badly (The Tell Tale Heart, Flowers for Algernon, of Mice and Men, etc.).

In order for the long run story of US economic growth to end well, we need short stories with happy endings, and for this we need to pursue strategy number two.

To make a long story short (in theory if not in practice), if a government wants to increase investment it needs to embrace fiscal responsibility, provide low capital tax rates, support free trade, and reduce the cost of energy and labor and do it in such a way that the investment community is confident that the rules of the game won’t shift with political winds.