The Economic Environment.

Over the last 150 years the economy has become a lot more complex and therefore harder to control. It’s almost that as soon as we get to understand the economy at any particular time a new layer of complexity is added, and we lose control once again. Economists have tried to figure out the best system of control from totalitarian central planning at one end of the scale through to total free markets at the other. The Marxist system has been tried under many guises and all have failed not only the economic test but also tests in the areas of freedom, human rights and corruption.

The building blocks of the economy are:

Assets.

Assets are a resource with economic value that an individual, corporation, or country owns or controls with the expectation that they will provide a future benefit.

Over the centuries the meaning and the form of assets has changed. For many years land was the only asset, but that was while there was a mainly agrarian economy. It make sense, if you want to grow something you need land. Then industrialisation came along and assets took the form of land, buildings, factories, machines, transport, anything that would give you a return in the new industrial world. Now we are moving to a digital world and IP (Intellectual Property) has been added to the list of things that constitute an asset.

Certainly on a personal level an education is an asset as if it is used properly it will provide a future benefit.

Capital.

Capital consists of assets that can enhance one’s power to perform useful work.  Capital is distinct from land and other non-renewable resources in that it can be increased by human labour, and does not include certain durable goods like homes and personal automobiles that are not used in the production of saleable goods and services. Adam Smith defined capital as “that part of man’s stock which he expects to afford him revenue“. In economic models, capital is an input in the production function.

Lifestyle Capital.

While capital is resources that give you a financial return, Lifestyle Capital is those resources which you use to give a lifestyle return. A swimming pool or tennis court is going to cost more financially than they will return, but you use resources to give you a lifestyle return. Nationally we build sports stadiums, swimming pools, arts centres not to give a financial return but to give us a lifestyle return.

Investment.

An investment is the purchase of goods that are not consumed today but are used in the future to create wealth.

Money.

Money is a medium of exchange that can also be used as a storehold of wealth. While money is associated with wealth is isn’t wealth. Money is not even an asset but can be used to purchase assets.

The point needs to be made that the average of holding interest-earning cash currency since 1850 was 1.2%.

Gold.

Unlike money gold is a commodity. The main point is that it is not an asset, accept in manufacturing, because it doesn’t provide a future benefit, unless it is traded. 

The real return of holding gold since 1850 has been 1.3%

Trading.

The action or activity of buying and selling goods and services.

Trading is another area of the economy that has changed dramatically over the last century yet we haven’t changed how we deal with it.

Centuries ago traders would get on ships, sail to the other side of the world to buy goods. They would then sail the goods back home and sell them at the price they bought them plus their costs plus a profit. This process added value to the economy. If everybody who wanted a coffee had to sail over to Brazil, Vietnam, Colombia or Indonesia to get a supply, that would be inefficient. By bringing the products to markets the traders provided a significant service to the economy. 

Now the vast majority of trading is done while sitting behind a computer. I can buy gold today and sell it tomorrow of next week. I have added nothing to the economy. As we observed above the return on gold over the last 170 years has been 1.3%, you wouldn’t get out of bed for that. Therefore to make money from gold you have to trade.

Computers have allowed us to bring in all sorts of other “commodities” we can trade. The problem is that all these commodities/products/derivatives are all zero sum games. That means at the end of the day the winners will match the losers. The majority of these trades are made by computers. In order to win you need to beat some really smart people with some really big computers good luck with that.

Gambling. 

A risky action to achieve a desired result.

Basic Parallel University Economics.

People create or are given assets. If you have worked through your education, you will finish education with assets in the form of qualifications and investments you have picked up along the way.

You then put those assets to work and expect a return on the assets in the form of a salary for your labour and a return on your financial assets. 

A basic investment should return 10 -15% on the capital invested. That return is normally divided into a share taken out as income and a share reinvested into the same or a new asset. If you are lucky enough to have salary that meets your expenses then you can reinvest 100% of the return, and hence the rich get richer and the poor use 100% of their income for expenses.

There are several critical points in the process.

1. You must be paying attention to the scorecard.
2. If the return is minimal, the law of diminishing returns leads you to lose interest.
3. If you start to do well your need to do better will kick in.
4. A return of 10 – 15% comes at an acceptable risk. A higher return normally means a cross over from investment to gambling.

So how does this play out in the real world.

There are those that struggle to make enough to meet their immediate needs = no savings = no investments.

There are those that manage to save and get a good job. Their combined income is greater than their expenses, so they divide their excess income into increased consumer spending, spending on lifestyle capital, purchase of further assets.

We need to see what happens when either that earned income or government welfare gets into the system and finds its way into consumer spending, lifestyle capital and asset building.

Consumer Spending.

Consumer spending is the total money spent on final goods and services by individuals and households for personal use and enjoyment in an economy. Contemporary measures of consumer spending include all private purchases of durable goods, nondurable goods, and services.

And here comes the first problem. Keynes thought all consumer spending was good and that in times of trouble government welfare going to people that then spent it on consumer goods and services would revive the economy. Certainly, this theory had many great successes after the second world war. On the other hand, Hayek said that government interference would simply lead to serfdom. 

The basic problem is that you have to more clearly define consumer spending, especially in regard to the multiplier effect. Keynes argued that $1 on government spending multiplied to $5 in the economy, however that is not always true. If the $1 is spent on locally made hand sanitiser then the $1 explodes in both directions. The manufacturer gives some to the farmer who grew the sugar which was fermented, some goes to the farmer and retailer who provided the food the manufacturer fed himself and his family with, and some went to the gardener that was tending the manufacturers garden while he was making the hand sanitiser. In this case there is a multiply effect and Keynes wins.

On the other hand if the government $1 went to a service provider who used it to buy Apple shares then there is no multiply effect and Hayek wins.

The point being that the economy is a lot more complex than it was 100 years ago yet we are still trying the same tricks that helped us out of the depression in 1930.

We constantly hear that we need to increase consumer spending to save the economy. Economists spend hours looking at consumer confidence and consumer spending and can’t seem to figure out why the figures they are seeing is not providing the modelled effect.

Consumer spending must be categorised into ranges of the multiplier effect because of the consequences.

If all consumer spending was a 5 factor in the multiplier effect Hayek would be right. Fiat currency poured into the economy would chase limited resources resulting in inflation. On the other hand if most spending was a factor 1 or 2 in the multiplier effect, with the money ultimately ending up in China from purchased goods or the US in Apple shares then Keynes would be right and inflation would not take off.

Lifestyle capital.

Either as an individual or a nation you have worked hard and made a lot of money. You don’t need all that money for consumer spending, you can only have so many holidays and so many restaurant meals so you decide to build a swimming pool, video games room, a football stadium or a vacation home. None of these are going to give you an income and therefore it is money that is taken out of capital and effectively hidden under a bush as far as the economy is concerned. 

The main concern here is that humans always want more of a good thing. Hence people spend more and more on lifestyle capital but their desires will never be satisfied. It is important that when thinking about lifestyle capital you first truly understand yourself and your desires.

Purchase of further Assets.

You have done really well and bought yourself some great toys as well as suppling all your consumer spending needs. What to do with what is left over. You can give it away or invest in further assets.

This is another fork in the road. Some people invest and others trade. If you are thinking of trading remember Pareto. 20% of the traders will end up with 80% of the assets.

Not only is Pareto a major part of investing so is the Matthew Effect. In today’s parlance, the rich get richer and the poor get poorer.

If you take your profits and re-invest them over a number of years you will slowly at first and then gathering speed grow your assets.

Concluding Basic PU Economics.

The economy requires assets to be used to obtain a reasonable return such that there can be sustainable growth. If the assets are not used, they disappear and then you do not get fed. If the government prints money two things can happen:

1. The money is used to obtain a reasonable return in which case if the government keeps printing money there will be inflation.
2. The money is wasted, sent offshore or buried in negative interest rate bonds, in which case the government will have to keep printing money. Otherwise known as MMT.

The problem then comes in the form of Pareto and the Matthew Effect.

Scenario 1.

On one side Pareto says 80% of the money will find its way to 20% of the people, and then Matthew says that those 20% will take that money and get great returns on it exacerbating the problem of inequality.

On the other side the 80% that have given it away through consumer spending will get poorer as inflation rises.

Scenario 2.

As the government keeps printing money the 20% will see it being destroyed and syphon the money offshore to a safer haven and wait for the reincarnation of Margaret Thatcher or Ronald Reagan. 

The 80% will accept with pleasure the UBI, sit at home become terribly depressed resulting in shocking mental health issues as people lose their dignity.

But the real problem is when there is a shifting balance between 1 and 2. This is where the government starts printing money and paying a UBI. The 20% take 80% of the money and build enormous wealth as inflation runs rampant. Then the government must slow down the rate of inflation by stopping printing money and leaving the 80% with no job, no UBI and no dignity.