Wealth, Prices, and Public Education (Phantom Wealth & Phantom Education)

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The increasing securitization of everything under
the sun within a framework of a fiat money economy raises many interesting
questions with respect to the nature of wealth. The value of a company
is measured by its “capitalization”, whose value is achieved by
positing that the aggregate value of its shares is simply determined
by the price of the most recent sale of one of its shares. Certainly,
prices are determined on the margin, but does the wealth of a company
increase when its share price goes from $20 to $25 without any increase
in profit, or future expectation of such?  Let’s look at the
housing stock of a country. Within the last few years, many homes
have sold for twice the price of what they fetched, say, 5 years
ago. OK, so does that mean we can extrapolate these marginal prices
to infer that the value of our housing stock has doubled, and hence
we as a nation are wealthier? Looking only at the housing stock
that existed 5 years ago, has its utility increased? How does wealth
relate to prices?

According to the Fed, these price increases are evidence of the
robustness and health of the American economy. We are now supposedly
wealthier. But isn't this like referring to increasing “No Child
Left Behind” test scores to answer the question of the day: “Is
our children learning?” A given house has a fixed utility. Its utility
does not go up simply by having occupied it for the last 5 years.
If its price has gone up dramatically, is one dramatically wealthier?

Wealth, it seems to me, is related to the production of goods (and
services) that people want to have (essentially manufacturing) and
is not determined by prices, although price movements may be indicative
of changes in wealth. If that were so, what would the relationship
be?  If increasing the supply of goods that people want to
buy, whether through importation or domestic production, means more
wealth, where would price fit into this picture of wealth measurement?
Let’s go back to housing.

To some degree, increasing the manufacture of houses
would increase wealth, but this would, ceteris paribus, have
a depressing effect on house prices. So I reason that falling prices
is a good measure of wealth creation (such as the prices of electronics
and computer hardware). In the 19th century, there was a slow decrease
in the price level over the entire century (excepting the Civil
War era — think of Lincoln’s greenbacks, which were later declared
unconstitutional). It would seem to make sense that with a steady
amount of money, individual ingenuity (human action) is going to
tweak the production process every year to make it more efficient
(less resources for a given output) to produce a given good, which
will tend to lower the price. The price reduction for this good
will free up capital to produce other, or better goods — all within
a framework of falling prices.

In a 100% reserve gold-based monetary system, the amount of money
is relatively fixed over a medium range period of time, so as increasing
innovation tweaks the production process, this increased efficiency
— savings of inputs for a given output — is reflected in the price.
The price reflects the decreased inputs by, well, decreasing. Decreasing
prices simply means that your dollar (or whatever monetary numeraire
is in use) buys more. The more your dollar buys, the wealthier you
are! Sort of makes sense, doesn't it, or do you prefer your dollar
buying less? Over time you can buy 3 loaves of bread for a buck
instead of 2. But wait you say, that means that the price of bread
has decreased from 50 to 33 and that's deflation. You want price
stability. OK, that can be fixed by just taking away one of your
loaves of bread — either through strong-armed robbery or via a more
gentile thievery — inflation. The result is the same, now you still
have only two loaves of bread for your dollar — no more deflation!
Happy? By increasing the amount of money into the system, the sovereign
benefits from efficiencies that have been earned by increased productivity
— not the economic actors who have earned it. One can anticipate
the objection here that there isn't really any inflation, because
prices have been "stabilized". But inflation is just theft
by another name and the theft of the increased production (resulting
in a stable remainder) is theft all the same.

Now consider your exuberant neighbor coming up
to you and exclaiming that he just got a $1.2M offer on his house
(a 1200 sq. ft. cottage). Well, dare and double dare. Tell him you
can top that, your grandfather back in Weimar Germany got more than
that for a loaf of bread! Exuberance becomes consternation. (Yes,
if he sold now before others prices reset, he would be better
off, but that begs the question of whether we as a nation are wealthier
overall because of this price increase.)

Why
the confusion? Because we have no guiding star by which to navigate
within a fiat money economy. With a relatively fixed-base monetary
system, the economy can be pictured as a pie of a given fixed size.
The diagram to the right reflects a simple economy meeting needs
of shelter, food, and medicine — represented by the different colors.
The size of the sector represents the monetary value of the inputs
needed to meet the needs of society in that area. As efficiencies
set in, a given sector becomes smaller — requires less resource
input to satisfy our need, and other products comes into being to
take up the empty space, so to speak. We now can allocate those
freed up resources, say, to a cosmetics industry. Also, within a
given sector, as more units are added without the sector growing
overall (more output but the same overall input — increased efficiency
within the industry), the sub-slices will get smaller. A sub-slice
fulfills the need of a given person, for example, a housing
unit. The pie is a fixed size, so the size of the "slice"
is related to price, and since the size of the pie doesn't change,
the relative sizes of the slice over time readily signals changes
in price. Each dollar, which represents a set percentage of the
overall monetary base, and hence is also of a fixed size, can be
exchanged for more goods as efficiencies work themselves into the
economy — the slices become smaller. With this sort of system, we
can know whether our wealth is increasing or decreasing by observing
prices — lower prices means more wealth. What happens inside the
pie when it begins to change size is beyond the scope of this article,
but suffice it to say, that the entity that benefits is the entity
that is adding the monetary base matter to the pie that causes it
to grow.

So, to go back to the question raised in the beginning of this
article as to the relationship between prices and wealth, I do not
believe that one can put a number on the wealth of an economy, nor
would it have any meaning if one did. Prices exist only within a
framework of trade. However, trade operates at the margins of each
trader's diminishing marginal utility, and these are constantly
in flux and prices are merely signaling devices wherein these values
of diminishing marginal utilities find expression. So the relationship
between prices and wealth is similar to the one between speed and
acceleration. It is not the value of speed that is in any way related
to acceleration, but only the changes in speed that are relevant
in contemplating acceleration. So it is with prices. Price level
in no way relates to wealth. The relationship is one associated
with the change in prices. Changes (decreases) to the general
price level of a fixed set of goods (within our fixed-based monetary
system) relates to positive values of wealth creation. So when the
Fed talks about asset prices and economic robustness and all, it
isn't so much wrong as it is just plain meaningless. I view much
of the pronouncements of the Fed as nothing more than the blather
that goes on between the dealer and his mark in a game of three-card
monte. Its purpose isn't to communicate, rather it's to distract
one's attention from the action at hand.

Now people might still argue that if a person buys,
say, a house and then 10 years later its price is 5% less, he is
poorer. They still believe that lower prices means less wealth.
Rubbish! People are still going to be consumers of housing (shelter)
and if its relative price has fallen — society is richer. Look at
the extreme case where 90% of a workers salary goes to provide shelter
compared to just 50%, or 40%, or 20% of his total salary. Is he
wealthier for having paid more, or less, for a given good? 

But this is static analysis, that $0.05x of capital has been freed
up because housing costs less, can go to produce, or improve, other
things — tweaking that goods’ production efficiency and lowering
its price. Keep in mind we are assuming that his income is the same
(no COLAs or inflation), so he can now actually buy MORE with his
$0.3x of annual income because prices have fallen overall. He is
better off?  (As the efficiencies accumulate, so will capital,
and wages are positively correlated to capital/labor ratios, so
on the whole, relative labor rates would increase.) Falling prices
are indicative of increasing wealth!

Does that mean that rising prices mean decreasing wealth? In a
relative sense, yes! Relative to a stable price regime, people are
less wealthy than they would have been. Prices can rise by
2 means:

  1. Decreasing productivity. The relative cost of the inputs
    FOR WHAT PEOPLE WANT TO BUY increases due to scarcity. For example,
    people don’t want to buy war or its implements, so a war economy
    means decreasing wealth as it siphons off resources from
    what people want to buy. No guns AND butter — imagine that! (Yes,
    an economy can have both guns and butter  — at the cost of
    leisure, which cost may be voluntarily paid, if the society were
    attacked, for example. But this is usually not true for wars of
    imperial aggrandizement.)
  2. Inflation. Historically inflation was caused (within
    a regime of precious metal coins) by the sovereign shaving some
    of the metal off the rim of the coin (that’s why coins have ridges
    on the end). So as the agent of inflation skims off wealth they
    became richer – effortlessly. Historically these people use
    that (stolen) wealth nefariously to attempt to increase it some
    more through aggressive war. Indeed, inflation has historically
    been the chief means of financing wars, because a people oftentimes
    will not tolerate the levels of direct taxation that aggressive
    wars require.

If decreasing prices signifies increasing wealth and rising prices
are indicative of a society organizing itself in such a way that
results in less than optimal wealth creation, or indeed wealth destruction,
why is it that the prevailing perception that rising asset price
levels and ever-increasing levels of debt are indicative of increasing
wealth? If the reason is, as I have alluded to above, the lack of
a guiding star. Why aren't our schools helping us to look up at
the stars towards a true Polaris?

What role has public education and a centralized
educational bureaucracy played in all of this consternation? Why
do I say that? Do I believe that a private school is going to simply
be automatically better than a public school? NO! But in a private
educational regime without a centralized grant-giving educational
bureaucracy, different schools of thought are equally free to express
their own theories of wealth creation (or any other topic). Wealth
is produced by worshipping the moon and she enjoys sacrifices of
otters and rabbits. OK, could be. How would I know? I was born naked
and ignorant.  Somebody else may have some other silly idea
like eating less wheat this year so next year we don’t have to work
from dawn to dusk. Rather, we could spend an hour a day on improving
the plow (maybe metal works better than wood?). An hour a day tinkering
around like that means less production, but then we can live off
of what we had saved before. Maybe the metal plow will mean that
we can plow the fields quicker — same output for less input. Then
we can spend the time we saved drinking moonshine and getting drunk.
Are we better off? You bet. More leisure. Maybe somebody else will
use that spare time (additional resource) for more tinkering around
and creating a whole positive feedback loop of productivity increases.

Sounds silly. Well, who knows. Some people will slaughter rabbits
and otters; some will mess around with the plow. Nobody knows —
but the truth will out!  In the public education system, and
within the centralized educational bureaucracy, diversity of ideas
is suppressed. (Note! I am not attacking them for what they teach
or support. Who am I to say that these professional educators know
less than I?) It is what is not taught that is the problem.
Both schools of thought — fiddling with plows and slaughtering rabbits
— must find their expression.  But monopoly education, like
Marxism, hews to a party line approach and the true dialectic of
competing ideas is never allowed to materialize. It is the very
process of public education that diminishes and debases society’s
knowledge. It is not a personal thing. The point is not whether
public school teachers are good or bad, or are paid way too little
— or way too much. It’s a systemic thing.

Referring to our public education system as monopoly education
is really misleading because the competition of ideas will still
exist, just at a different level. Japanese, German, or Chinese citizens
may be taught other schools of thought (either in another monopoly
regime or within a diverse private regime — it doesn’t matter which,
there will still be competition — globally).  Some society
will hit upon the plow-tinkering theory and succeed, while the moon
worshippers won’t, or vice versa. Over time, a society may hew to
an entirely different school of thought, but without the competition
of ideas, it won’t know what is optimal. So it goes, the ebb and
flow of civilizations. This process is inevitable, but the periodicity
of it is highly dependent, it seems to me, on the relative freedom
of its educational and intellectual environment.

June
21, 2006

Paul
Tolnai, MBA USC [send him email]
recently moved from California to Texas in order to be close to
his two daughters after a family law court permitted them to be
moved there. He is currently looking for a job in the DFW area.

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