market economics Archives

Saving

submitted by jwithrow.

We have been hearing all about how most Americans are living paycheck to paycheck and not saving any money as justification for the brilliant (*cough*) myRA government savings plans so we felt that it would be prudent to take a deeper look at what ‘saving’ is.

You see, we don’t think that saving is about money. Money is involved, but it is not the focus. Saving is really about storing our productive efforts.

It goes back to the days of barter…

Back then the fisherman would catch extra fish in the morning and take them to the market in the afternoon to trade his extra fish with the farmer for vegetables. His wife liked to have vegetables with her fish for supper so he had to trade for vegetables instead of the painted rock that he really liked.

The fisherman had learned that fish would start to smell bad the day after being caught so he had no choice but to trade all of his extra fish every afternoon and go fishing for more again every morning.

Until the fisherman discovered gold. Then the fisherman could trade his extra fish for gold and take the next day off. The fisherman didn’t really care about amassing gold; he just figured out that gold would let him store his production so he didn’t have to go fishing every single day to feed his family. And it turned out that three day old gold smelled much better than three day old fish – this was a bonus.

So saving was born!

Somewhere along the line we forgot this and started to think that saving was about amassing money. And on top of that we started to think that money was paper and not gold. We are so forgetful!

So when saving became about money and not about production we opened the door to debt. We started to think that instead of saving we could just borrow whatever money we needed. After all, the credit money still bought stuff just like the saved money except we didn’t have to wait to use it!

But then when we had to start using our entire paycheck to pay back all of the credit money we found out that we had to be even more productive now than before we went into debt. Our plan backfired.

We didn’t learn from our smart fisherman ancestor and now we had to go fishing both in the morning and in the afternoon to have enough fish for our supper and also enough to trade for vegetables so our wife won’t get mad and also enough to give to the banker to pay him back for the credit money that bought us the really neat painted rock.

Darn painted rocks.

Debt Impedes Economic Recovery

submitted by jwithrow.

Debt is nothing more than an obligation to pay for present spending with future earnings.

A little bit of debt used to increase future earnings is a good thing. A little bit of debt used to increase present spending at the expense of future earnings is not a very good thing. A lot of debt used to increase present spending at the expense of future earnings is a good way to make it very difficult for there to be any earnings in the future at all.

At the macroeconomic level, the U.S. has chosen option three. Japan and Europe have done the same.

The great thing about economics is that there is a ‘response’ system built in that maintains a sort of chaotic order in the general market.

When there is significant capital formation within the system, interest rates go down. Decreasing interest rates send a signal that it is a good time to borrow so homes are purchased and businesses expand.

Interest rates then rise as more debt is taken on and thus capital available diminishes. This sends a signal that it is not a good time to borrow so mortgages are paid down and business debt is reduced. This leads to gradual capital formation within the system that will trigger a decrease in interest rates and the cycle perpetuates.

But guess what happens when you have an Ivy League graduate that thinks it is his job to force interest rates lower and keep them suppressed?

That’s right! The market does not receive the proper signal and it looks like it is still a good time to borrow. So even more homes are purchased and businesses keep on expanding.

Then we get the idea that home prices should always go up, stock prices should always go up, businesses should always expand, and GDP should always grow.

And we end up with more debt.

U.S. debt has grown by more than 60% since the financial crisis began in 2008. Global debt has grown by more than 40% in the same time period.

It turns out that a problem of too much debt cannot be solved by taking on more debt.

The events of 2008 sent a signal that it was time to stop borrowing and to liquidate debt but we didn’t listen. The economy will undoubtedly blow up again and the next crisis will be even bigger because the debt is now even bigger.

The only way for the economy to truly recover is for a mass-liquidation of debt to occur. Until then we can expect the Fed to keep fudging the numbers and blaming economic stagnancy on the snow.

We happen to like snow and find it to be much more desirable than the Fed, both economically and ascetically.

What We Forgot About Free Market Capitalism Part Two

submitted by jwithrow.

Failure is just as much a facet of free market capitalism as success is.

In a free market economy, well managed businesses with desired products and services will succeed and poorly managed business with undesired products and services will fail.

Consumers, when well informed, will make decisions based on their individual preferences; they will either buy the highest quality product at the lowest price for which that product is available or they will buy a lower quality product for a price lower than the higher quality product. Consumers are typically not very interested in paying high quality prices for low quality products.

So, in the free market, businesses must constantly strive to either offer the best product at the lowest price or a suitable product at a very low price. This requires businesses to focus on improving efficiency and decreasing costs without sacrificing product quality. If a business cannot offer competitive products at competitive prices then it will not be in business for very long.

This model aligns the interests of both businesses and consumers and creates a self-regulating incentive structure.

In the free market system, businesses have an incentive to offer quality products to customers at the best price and they have a disincentive to offer poor products at poor prices. While this is a simple representation, the incentive structure is one of the core principals underlying the free market system.

But what happens if businesses are not allowed to fail due to government intervention?

We have seen numerous cases of this scenario in recent years. The “too big to fail” banks were propped up by the federal government when they came to the point of failure. Fannie Mae and Freddie Mac were taken under receivership by the federal government when they came to the point of failure. General Motors was temporarily taken over and propped up by the federal government when it came to the point of failure.

This is moral hazard.

Oh, and we should probably mention that the federal government cannot actually bail anything out with its own capital. To fund the bail-outs, the government has to appropriate capital from the private sector in the form of tax dollars and it has to borrow money from the Federal Reserve that was created out of thin air.

So the business losses were socialized but the profits remained privatized – this is fascism in action.

By creating moral hazard in this way, the disincentive piece has been removed from the system and the incentive model has shifted away from a consumer focus and to a focus on generating high profits with no regard for risk. Such a model is a win-win for the favored businesses and the government cronies that they support. The losers are everyone else as the economy turns to mush.

Coming full circle, failure is a welcome facet of free market capitalism. Maybe not for the companies’ doing the failing, but failure is a force for creative destruction that serves to weed out the businesses that cannot offer quality products at reasonable prices.

This is why it is ridiculous to claim that any company is “too big to fail” as justification for bail-outs. Sure there would be temporary hardship were the major banks to fail, but this would eventually free up capital and clear the way for sustainable banking practices to be implemented.

Feel free to read more on the matter here and here.

What We Forgot About Free Market Capitalism Part 1

submitted by jwithrow.

One of the most important elements of free market capitalism is the price system. The capitalist price system provides information on supply and demand in the marketplace and individuals make business and investment decisions based on this information.

The economic system that America now employs is not free market capitalism and there are legions of regulations in place that distort the market pricing system every step of the way.

The most insidious price distortion is the suppression of interest rates.

Interest rates are simply the price of money. Like everything else in the market economy, interest rates are self-regulated by the forces of supply and demand. If there is a high quantity of capital in the system available for lending then interest rates will naturally be low. Low interest rates will entice borrowers to engage in long term financing – purchasing homes, expanding businesses, etc. Interest rates will then naturally rise as the capital available for lending diminishes. High interest rates are not attractive to borrowers so individuals and businesses will focus more on short term projects. This will lead to increased capital formation within the system which will gradually trigger falling interest rates.

But what happens when a central bank suppresses interest rates and keeps them near zero for an extended period of time? Well, this destroys the entire pricing system and distorts the entire market system.

Artificially suppressed interest rates send a false signal – which is exactly why they were suppressed in the first place. Artificially suppressed rates still entice borrowers to take engage in long term financing but this is a Keynesian trap. The problem is that there is not sufficient capital formation in the economy to warrant the low interest rates and thus there is not a true demand for all of the long term projects undertaken.

This is called mal-investment.

“If you build it, they will come” is a great catch phrase in the movies but it’s just not how the real world works.

Despite what the economics textbook says, there is no such thing as a ‘mixed economic system’. There is simply no room for the suppression of interest rates or the distortion of prices in a capitalist system.

There are only two choices:

Free markets
Central planning

Free market capitalism presumes an honest and functional price system that is not manipulated by a central bank.

Oh, we should probably mention how interest rates are suppressed.

The Federal Reserve creates currency units out of thin air and uses them to buy long term Treasury bonds at low rates. What could possibly go wrong?

By the way, you can read more on this topic here, here, and here.

Non-Profit Skepticism

submitted by jwithrow.

We think that the idea of non-profit organizations, as the 501(c) code exists, is un-American.

Hold on! Hear us out on this one before you call us heartless capitalists – we have a good reason. Actually several reasons.

The non-profit structure as it currently exists violates the equality under law principle upon which America was founded. 501(c) organizations receive favorable treatment by law relative to for-profit organizations.

But the American vision of limited government was such that it should protect equality under law rather than promote inequality by law. Equal opportunity as we used to say.

Additionally, the 501(c) structure reinforces Marxist principles in the minds of Americans in a very devious way. This we really don’t like.

The Marxist ideology is opposed to profit because it violates their “from each according to ability, to each according to need” credo.

In granting favorable status to non-profit organizations the government is actually supporting the belief that non-profits are more desirable than for-profit organizations. Think about it – why else would 501(c)’s be granted privileges if they weren’t seen as deserving of such favoritism? So in a sneaky kind of way this sows the seeds of Marxism by silently stating that the profit motive is not to be commended while the non-profit motive is superior ideology.

Which brings us to our last point:

The whole non-profit part of 501(c) organizations is fraudulent!

Sure, the organization itself does not show a profit but have you ever looked at the executive salaries at these “non-profit” organizations?

We have.

They are systematically much higher than average wages. MUCH higher.

Sure looks like profit to us.

Now there are some very good non-profit organizations out there. We have donated to some good ones that we knew were good because we knew the people running the show and we could see the charitable work being done. But most of the giant non-profits are frauds and we would steer clear of them. A good rule of thumb is that if a non-profit has a commercial on television then it is probably not worthy of your attention. Otherwise it wouldn’t need a commercial on television.

Also, don’t get us wrong, we like the fact that non-profits are tax-exempt. The less money appropriated by the Feds the better, in our opinion.

But we think that a much better idea would be to get rid of the corporate income tax altogether. Then you wouldn’t have a need for special non-profit treatment. And you might even notice some jobs sneaking back into America also – as long as the corporate income tax was repealed and replaced with nothing.

Of course this is just our humble opinion. Maybe the bureaucrats know better than we do.

Distinguishing Wealth from Money

submitted by jwithrow.

At Zenconomics we feel like it is extremely important to differentiate wealth from money. Pop culture and mainstream personal finance relentlessly tell us that the two are one in the same but they are mistaken.

The key to differentiating wealth from money is to understand the difference between exchange value and use value. You already implicitly understand this difference but it is not immediately apparent in our culture today.

Money, by nature, holds an exchange value. You can exchange money for goods and services and the quantity of goods and services for which you can exchange money is determined by the value of your money. But this is all that money is good for – serving as a medium of exchange.

Wealth, on the other hand, holds both exchange value and use value.

You can exchange wealth for goods and services and the quantity of goods and services for which you can exchange wealth is determined by the accepted value of your wealth. Wealth in most forms, however, is not as easily exchanged for goods and services and this is precisely why money plays a vital role in a developed economy.

Unlike money, wealth also holds a use value. You can ‘use’ wealth in some capacity. Take real estate for example.

If you own residential real estate then you can either live in the home or you can rent the home out to a tenant to generate income. These actions both utilize use value. Of course, you can also sell real estate for money which utilizes exchange value.

Maybe your real estate consists of farm land which could be used to produce food. Now your real estate, which is wealth if owned outright, can be utilized to produce additional wealth in the form of food. Now your food has both an exchange value and a use value. You can take your fruits and vegetables down to the farmers market and exchange them for money if you want to utilize the exchange value. Or you can eat your fruits and vegetables if you want to utilize their use value.

It is important to point out that an asset must be owned free and clear of an attached debt in order for it to be considered personal wealth.

If you own a home with a big mortgage on it then you are one financial emergency away from losing the home and thus the case could be made that you do not truly own the home yet. This is not to say that taking out a mortgage to buy a property is a bad idea, but be cognizant of the fact that you will need to satisfy the mortgage before the property can truly be considered wealth.

It is also important to point out that some forms of wealth may hold better exchange value than others. A classic car collection may be extremely valuable to the owner but it may be difficult to find a willing buyer if the owner wished to exchange the collection for money in the future.

To reiterate, money is not wealth.

In fact, the only reason to hold money is to use it to purchase desired goods and services. There is no other use for money.

And if you want to maximize your own wealth, you must wisely use money as a tool to acquire wealth.

**For more of Joe’s thoughts on the “Great Reset” and personalized asset allocation please read “The Individual is Rising: 2nd edition” which will be available later this year. Please sign up for the notifications mailing list at http://www.theindividualisrising.com/.

The Stock Market Deception

submitted by jwithrow.

The stock market is comprised of numerous exchanges through which buyers and sellers can trade securities. The New York Stock Exchange is the world’s largest stock exchange followed by the NASDAQ. The Tokyo Stock Exchange and the London Stock Exchange are third and fourth in terms of market capitalization.

As we mentioned, the exchanges enable buyers and sellers to trade securities with one another.

We repeat this statement to emphasize the next one:

The exchanges are not where businesses raise capital unless an initial public offering (IPO) is taking place.

We think it is important to recognize this fact.

The vast majority of trades on a stock exchange are simply speculative – there is very little productive activity taking place. Even IPOs are usually not terribly productive as the intent is often not to raise capital for business operation but rather to enrich the owners and private investors.

So if most trades are just speculation then why do we view the stock market as a gauge of economic health? Why do we assume that the underlying economy is good when stock prices go up?

We do not assume that the economy is good when corn or oil prices go up. But corn and oil contracts are also traded on futures exchanges and there are speculators who profit when their price rises.

Conversely, why do we assume that the underlying economy is bad when stock prices go down?

Nothing real is destroyed when stock prices fall. Buildings don’t collapse. Equipment doesn’t break. Goods don’t go up in smoke. Engineers don’t lose their knowledge.

Maybe there was a time when stock prices somewhat reflected the financial health of individual companies, but those days are long gone. With mark to unicorn accounting, leveraged stock buy-backs, and all other manner of financial wizardry, CEO’s can and do manipulate stock prices regularly.

Additionally, the Federal Reserve has spent the past three decades ensuring that liquidity flows directly into the stock market so that equity prices continuously rise in unison over time.

The point is that there is a huge disconnect between the stock market and the productive sector that mainstream finance pays no attention to. In fact, mainstream finance has convinced most people that speculating in the stock market is the _only_ way to invest for retirement.

There may be a place for stocks within your asset allocation model, but it is important to recognize the stock market deception for what it is and understand the game you are playing if you do delve into the market. I would highly recommend enlisting the services of independent financial analysts if you do allocate some of your capital to the financial markets.

As we have touched on in a number of other essays here at Zenconomics, financial planning should be comprehensive and diversified according to your own unique circumstances. Simply amassing paper equities denominated in fiat currency is a very fragile plan.

As Nelson Nash says: “If you know what’s going on, you’ll know what to do.”

Be wary of the stock market deception and plan accordingly.

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Qualified Retirement Plans

submitted by jwithrow.

Qualified retirement plans have their roots in the Employee Retirement Income Security Act (ERISA) that was enacted in 1972.

The most common qualified retirement plans are the 401(k) and the IRA (individual retirement account). These plans allow individuals to contribute funds to their account on a pre-tax basis to be invested predominantly in stocks, bonds, mutual funds, and exchange traded funds. Taxes on investment gains are allowed to be deferred until distributions from the account are taken. Individuals may begin to take distributions without an early withdrawal penalty once they reach age 59.5. Any distributions prior to age 59.5 will be subject to a 10% early distribution penalty. Individuals are required to take a minimum distribution annually once they reach age 70.5. Distributions will be taxed at the individual’s ‘ordinary’ tax rate.

Mainstream financial thinking suggests that qualified retirement plans are the absolute best way to save for retirement because these plans enable you to invest funds on a pre-tax basis during your peak earning years and the investment gains can grow tax-deferred until retirement when your income is lower.

This way of thinking makes a number of assumptions.

The first assumption is that the investments held within the qualified retirement plan will consistently grow in value and they will not experience any significant losses to principal at any time which would serve to stunt the plan’s growth.

The second assumption is that the individual is not capable of effectively using capital during his/her peak earning years to develop diversified income streams that would provide significant income during retirement years. Maybe this would better be stated as the assumption that there is actually a “peak earning period” in an individual’s life.

The third assumption is that the rules governing qualified retirement plans will never change. Mainstream personal finance assumes that the early-distribution penalty will always be 10% and the qualified distribution age will always be 59.5. Mainstream personal finance assumes that ‘ordinary’ tax rates will always be what they are currently. (We say that there is nothing ordinary about the income tax at all!)

What’s overlooked here is the fact that qualified retirement plans are a government-created solution to government-created problems: Onerous taxation and a constantly devalued dollar that make it very difficult for the average American to save for retirement.

Pay very close attention to the language that must be used to discuss qualified retirement plans. In talking about these plans one must use words like allow, may, require, and penalty. In other words, these plans consist of permissions and requirements. People are given permission by the government to contribute funds on a pre-tax basis. And they are given permission to defer taxes on their investments. But they are required to leave all funds in the account until they reach a certain age or they will be penalized.

Any time permission is required to do something it follows that the permission could also be withdrawn at some point in the future. Otherwise one would not need permission to do whatever it is.

If you recognize that qualified retirement plans are a government-created solution to a government-created problem then a very important question must be asked: What happens if the government decides that there are bigger problems than Americans saving too little?

For example, what if government’s biggest problem became the need to finance out of control spending?

Cyprus and Poland have provided two possible answers to that question and the trend suggests that the rules governing qualified retirement plans could very suddenly become less favorable for the individuals using them at some unknown point in the future. The “myRA” proposal seems to be the first step in this direction.

So we can’t help but be skeptical of qualified retirement accounts. It just doesn’t add up. IRS approved tax shelters as a government solution to taxation and inflation? It seems to us that cutting spending, cutting taxes, cutting inflation, and returning to sound money would be a much better solution.

So we will continue to stay away from qualified retirement plans in favor of the IBC strategy for maximizing capital. This strategy, if implemented correctly, does not expose our principal to loss, it offers us access to our capital at any time for any reason, and it offers favorable tax treatment as well. All without requiring us to adhere to silly IRS rules about what we can and cannot do with our money depending on how old we are.

It just makes more sense.

Minimum Wage Cannot Fool the Free Market

submitted by jwithrow.

An important facet of a dynamic market economy is a flexible pricing system where prices can freely adjust in response to changes in supply and demand.

Wages are no exception to this rule. You see, wages are simply the price of labor and this price fluctuates with supply and demand in the marketplace – just like any other price.

When it comes to the jobs market, employers seek to hire employees at a wage which will allow the employer to profit on an employee’s labor. As such, the employee’s salary must necessarily be priced lower than the total value of his or her production. Otherwise the employer would not have a need for the employee’s services.

If this seems callous to you then please ask yourself a question:

Are you willing to pay someone $100 to do a job that is only worth $50 to you?

Well most employers aren’t either.

So, employers are willing to offer a salary within a specific value range according to the nature of the job function. The employee may be able to negotiate a higher salary but only up to the employer’s ceiling price beyond which the employer would not be able to justify the hire.

Minimum wage laws, however well-intentioned they may be, have no place within a free market system. Minimum wage laws distort the market pricing system and they fail to achieve their stated intent – they serve only to increase unemployment. Employers will trim their workforce to account for forced wage increases and individuals who would otherwise be willing to work for pay beneath the minimum wage will be priced out of employment.

What’s lost in the clamor for an increased minimum wage is the fact that wages are not the common man’s problem in the first place. U.S. median household income in 1970 was $7,651. It was $22,109 in 1985. And $41,262 in 2000. And median household income in 2012 was $50,099.

Wages have skyrocketed!

But wages don’t buy nearly as much as they used to, do they? Sounds to us like inflation is the common man’s biggest problem – let’s pass maximum inflation laws!

Or better yet, let’s End the Fed and get back to Sound Money.

Sound Money

submitted by jwithrow.

The most important facet of free market capitalism is sound money. If you don’t have sound money then you don’t have free market capitalism – you have something else.

Sound money is simply money that serves as a reliable store of value. Put another way, sound money is money that does not constantly lose its purchasing power. Sound money affords one a reasonable expectation that one unit of money today will buy the same amount of goods and services as one unit of money tomorrow. And next month. And ten years from now.

What a novel concept!

Anyone who has taken a finance course is familiar with the time value of money principle. In finance class, we learn to discount our money over time based on the inflation rate. We are taught, correctly, that present dollars are worth more than future dollars.

What we are not taught is that this is a deformation of free market capitalism!

The general market has chosen gold and silver to serve as money throughout most of history because the precious metals are particularly well suited for this purpose: they are limited in supply, they have functional utility outside of the monetary system, and, unlike our money today, they cannot be created from nothing.

Make no mistake about it, that’s where our money comes from today: nothing. It is created from nothing and then loaned into existence at interest. See the Hidden Secrets of Money video series for a more thorough examination of our money.

You see, money should not be a function of government nor should it be a function of a central bank behind closed doors. And it certainly shouldn’t be created from nothing. This is why the U.S. Constitution only authorizes gold and silver as legal tender; the Founders knew well the virtues of sound money and the dangers of fiat currency.

Did you know that the U.S. dollar was defined by the Coinage Act of 1792 to be 371.25 grains of fine silver? This act set the standard weight and measure of the dollar in terms of silver and individuals in the market were still free to accept or reject coins of differing weights and measures as they saw fit.

But we digress.

Here is why sound money is important to you:

Every dollar to your name is constantly losing value and there is no way for you to predict how much value your savings will lose over time.

This is a direct result of the monetary system that is in place whereby central banks create money from nothing and then lend that money to governments and to commercial banks at interest. That money then enters the economy when governments spend it and when commercial banks lend it out to customers. This is done constantly and it is why your money constantly loses value. Such a system has a profound impact on people from every walk of life.

How can we accurately plan for anything long-term if our money is constantly losing value? We can only guess.

What we do know from history is that sound money leads to a stable economy while fiat money leads to booms and busts.

The general market prefers the former while big government prefers the latter.

For more information on the sound money principle see the article links below. For a lot more information on sound money and monetary history see the book links below.

The Principle of Sound Money

The Simplicity of Sound Money

An Introduction to Sound Money