Meditation VI, Juno Moneta – The Limitations of Wealth and Money

~ King Solomon, son of King David is commonly associated with wealth and wisdom. But if wealth and wisdom is the key to solve all problems, why did King Solomon’s kingdom fall after his death and why is it not possible for his descendants to continue to grow richer and more powerful?

The Idea Behind The Wealth of Nations

Empires rise and they inevitably fall. As I have argued in the third meditation, mankind has and will probably never achieve a state of Utopia on Earth. No government or political system has been able to outlive its usefulness. The system of the state would inevitably fail due to external or internal factors. We have taken a look at the external factors in the fifth meditation.

However, external factors which normally come in the form of military aggression is not without limitations and is therefore unsustainable in the long-run. War is an expensive business and the state’s coffers may not be replenished as fast as required. Among the internal factors that I have identified, the most important one of all is wealth.

In 1776, moral philosopher Adam Smith published his book called An Inquiry into the Nature and Causes of the Wealth of Nations. More commonly known as the Wealth of Nations, the book is often credited with the launching of free market capitalism and the Industrial Revolution, and over two centuries of unprecedented economic growth.

In his book, Adam Smith argued that free trade was the best way to prosperity. According to Smith, the adoption of free-trade policies would enrich and bind all of a nation’s citizens, and ultimately extend those benefits and ties to all the peoples of all nations of the world who practiced free-trade. The logic behind  the success of free-trade according to Joseph Schumpeter was creative destruction.

Schumpeter argued that a market economy will incessantly revitalize itself from within by scrapping old and falling businesses and then reallocating resources to newer and more productive ones. This means that the market economy or an economy of which prices of goods and services are set by supply and demand would force an obsolete company to go out of business and forcefully reallocate resources of the fallen business to businesses that will have better use for them.

Alan Greenspan agrees with this line of thought and states that the failure of a centrally planned economy whereby prices and distribution of goods and services were set by central planners, lack the important ingredient of creative destruction.  Furthermore, Greenspan points out that centrally planned economic systems have great difficulty in raising standards of living and creating wealth.

The reason for the failure of centrally planned economies was ultimately the lack of an effective market to coordinate producers’ supply and consumers’ demand. This imbalance and disequilibrium cause the economy to produce a large quantity of products that people do not want (a surplus) and a huge shortage of products the people do want but lack (a shortage). Consequently, the centrally planned economy fails as the economy fails to deliver the right products at the right quantities to the right people.

The Historical Evidence

In line with the thoughts of Smith, Schumpeter, and Greenspan, history has shown us that all the early civilizations had achieved incredible feats through creativity and  innovation that brought forth a period of prosperity and economic growth. The ancient Mesopotamians gave the world the wheel, and the ancient Egyptians geometry and papyrus. More importantly, the early civilizations perfected the art of irrigation that enabled farmers to produce more food than they need.

The emergence of the agrarian economy did not solve all problems under the sun. Of the four (earliest) ancient civilizations, only the Chinese civilization continues to endure (China continues to use the same written language for the last 2,500 years). Yet even the Chinese civilization’s political system and form of government would change over the years and the ancient line of Chinese emperors broken many times in history.

The later civilizations like the ancient Greeks, Persians, and Romans would also follow a period of rapid expansion, decline, and eventual collapse. The eternal city of Rome may still exist today in Italy but the old inhabitants, the ancient Romans are long gone and normally forgotten. Almost every civilization fell not only because of pressure coming from external forces but because of an internally weakened economy.

In studying economics and looking back at history, we should ask ourselves an important question. If the ideas of Adam Smith and Joseph Schumpeter were correct, why did these civilizations fail to maintain their economic growth? A similar argument could be made against the Western renaissance, and the Industrial Revolution. Both periods brought a period of high economic growth that was in the end unsustainable.

GDP, Inflation, and Unemployment

In order to pursue this subject further, one must understand that in economic, one uses the country’s gross domestic product (GDP) to calculate economic growth. GDP is the total market value of all final goods and services produced annually within a country’s borders. GDP per capita to which a country’s GDP is divided by its total population is usually a measure of the standard of living.

Closely linked to GDP is inflation and unemployment. During periods of high economic growth, high rates of inflation (a continuous rise in price level) are a constant threat. High rates of inflation are undesirable as it erodes the purchasing power of money and causes a drop in real income (and standard of living). High rates of inflation are almost always present during times of high economic growth because the demand for resources like assets and labor is high.

On the other hand, periods of high economic growth normally comes with full employment and a rise in real wages (workers can demand higher pay). Following this logic, if high Real GDP growth leads to high inflation and low unemployment, this means that high inflation should generate low unemployment. While this is possible in the short-run, Milton Friedman attacked the assumption that low unemployment can be ‘bought’ with high inflation in the long-run.

In Friedman’s Noble Prize lecture in 1976, Milton Friedman proved that the Philips curve stable negative relation between the level of unemployment and inflation. In the long-run, the negative relationship between inflation and unemployment is unsustainable because workers in an attempt to maintain the purchasing power of their money demand higher wages (with no changes in the level of unemployment) and the stable relationship of the Philips curve collapse.

According to Frederic Mishkin (1997), price stability (a low and stable inflation rate) is the appropriate long-term goal for monetary policy as it promotes a more efficient economic system. Periods of hyperinflation experienced in Germany have given us ample data of the potential destruction should inflation be left unchecked.

The Limits of Economic Growth

High economic growth is not sustainable in the long-run. The Real GDP of an economy (GDP indexed to inflation) normally goes in a roller coaster trend which economist commonly refer to as the business cycle. In normal cases, the Real GDP goes from a peak into a period of contraction, a trough, and then enters a period of recovery before of expansion (to form another peak). This process repeats itself again and again throughout history.

Consider this simple explanation, when we start playing a game of monopoly, the board is empty and none of the players own any parcel of land on the board. As the game progresses, each player then buys different parcels of land. During this period (the first few turns), all players are able to make Pareto improvements to which in gaining a parcel of land causes no harm to the other players (relatively).

In the later parts of the game, the whole board with all its parcels of land will eventually be owned by a single player (you win by owning all the land and buildings on the board and driving everyone else into bankruptcy) and this is a position that is pareto efficient. At this point of the game, every parcel of land one player loses (this may be due to the lack of money) becomes another players gain and thus the players are engaged in a zero-sum game. The lack of resources in the game (there are only 12 hotels and 32 houses) also reflects economic reality.

However, the economy in reality is much more complex than a game of monopoly. In the game, the size of the board, the number of players  and the availability of resources is subject to change. The five important causes of economic growth is the increase in natural resources, labor productivity, capital, technological advances, and property rights. All five may increase as a result of a discovery of a new oil field or a new technology that would yield more crops with the same amount of land.

During periods of high economic growth, the ownership of resources (means of production) would grow at a faster rate than the size of the economy (resources). This would lead to a form of market saturation and a zero-sum game with too many players fighting for too little resources. When an economy faces saturation of ownership, it must contract sooner or later.

Furthermore, during periods of high economic growth, the distribution of income is never equal. Some people who either by higher expertise, competence, and luck would inevitably be able to own more resources (assets) than people who are less able to manage their own finances or lack opportunities (extremely unlucky). Thus income inequality rises rapidly during times of rapid economic growth.

The other problem is demographics. One usually thinks of the aging population we face today as a challenge of the 21st century. This is incorrect as the exact same case of aging population happened during the last days of the Roman Empire (a contraction in economic growth). When the economy is booming, the number of children per family usually rises as there is more disposable income available (wages rise). The opposite is also true as families tend to have lesser children during times of economic crisis (less one mouth to feed).

This can be seen during the end of World War II whereby birthrates around the world was high. Children born between 1945 and 1964 are usually called the baby boomers (the economy was good). On the other hand, children born between 1965 and 1976 are usually called the baby bust (Generation X) as the number of children born each year was declining. This is followed by the baby boomlets (Generation Y) which are children born between 1977 and 1994 (the increase in birthrates was a result of the baby boomers having children.

From the demographic changes above, we can see that birthrates are variable and subject to the environment. This explains why the world economy faces periods of economic growth and also periods of economic contractions. When the world economy is growing, birthrates increase until a point where Pareto efficiency is gained and proceeds into a contraction phase. However, when the world economy is contracting, the children born when birthrates are high become adults and enter the economy.

Due to the fact that the world economy is generally contracting, most of these new adults would be unemployed or employed with the prospect of losing his/her jobs the next day (there are many substitutes). Idle citizens and citizens who live in fear of unemployment are not happy citizens. Furthermore, the periods of high economic growth may have caused a very high degree of income inequality, thus creating a major imbalance in the entire social structure.

The imbalances of income and underutilized workforce would result in the slow accumulation of social unrest triggered by perceived injustice. When the accumulated social unrest reaches a boiling point, it causes enough pressure to force reforms and sometimes a change in the political system governing a society. Hungry citizens as a golden rule almost never vote for the government.

Therefore, this explains why governments rush to secure economic resources either through trade or military means. The failure of a government to do so would mean its days are numbered. Bear in mind that what I am stating here is not a business cycle of 5 to 10 years but a supercycle. The period between the Great Depression to our current international economic crisis is an astounding span of 80 years!

There is however, one question that is left unanswered. If economic activities are carried out by individuals that are a part of the society, why do they make wrong choices? Is it not possible to make a civilization out of superior men who are intellectually and physically stronger than all other men? The next meditation would attempt to find out more on the individual and the freedom of choice.

__

Please Proceed to the Next Meditation: Meditation VII, Homo Sapiens The Limitations of Man

Or Go Back to the Meditation Page

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