Tuesday, July 17, 2007

Can printing money create "real" wealth?

There is an interesting op-ed by Bob McTeere in today’s WSJ (subscription required): Don’t Dismiss Our Dismal Savings Rate. Excerpt:

The main fallacy in monetary theory and policy is the confusion of money and wealth. Money is wealth from the individual perspective since individuals can usually exchange it for goods and services. Money -- and financial assets easily converted to money -- may not be wealth for society as a whole if the production of goods and services has not kept pace with claims on it. Early spenders may have some success, but inflation will dilute the buying power of others. The bottom line is that real wealth has to be produced; it can't be printed.

The paradox of thrift says that attempts to save more in the aggregate reduce consumption spending, which, if not offset by increases in other spending, will reduce total spending and income. The paradox comes in when attempts to save more results in reduced saving out of lower incomes. The irony is that policy makers advise more saving but those who take the advice will benefit only if most of us ignore it, and policy makers are implicitly counting on that outcome.

A parallel is the farmer who hopes for a good crop year. But, if all or most farmers have a good crop year, the decline in prices may more than offset higher yields. What our farmer really needs is a good cop in a bad crop year. Then he could look for a popular restaurant that isn’t crowded.

A penny saved may be a penny earned, but it matters whether it was earned by producing more or by a rise in price of existing financial assets. A stock or housing market boom creates apparent wealth in the form of capital gains, but trying to convert it to real wealth en masse can make it disappear.

Alan Greenspan has been one of the few economists to explain these matters correctly and understandably, usually in the context of entitlement reforms. He frequently pointed out that any solution to the problem had to include real economic growth. With claims on output growing rapidly, output has to grow equally rapidly or the claims are bogus. Any solution -- to entitlements or the savings rate -- must include a bigger, more productive economy in the future…

The problem goes beyond government entitlement programs. Consider the baby boomers whose IRAs, 401(k)’s and personal investments helped drive the stock market to record highs. What happens when cash-in time comes? There will be a mountain of paper claims on output, but will there be an equally tall mountain of output?

This simple thesis helps to explain a lot of what confuses me about all of this new “money creation” we hear about constantly. For years now global money supply has been increasing much faster than the rate of global growth. Of course, defining “money” has become so much more difficult because of the velocity effects of increased global trade, not to mention derivatives. This is partly why the Fed has stopped publishing the M3 measure of money supply – it’s just too hard to quantify the broad monetary base.

Nevertheless, most of this new money has sloshed into assets, pushing up their prices. I have commented before that rising asset prices are not good for most people. For lower and middle class people who don’t own a lot of assets, they have not benefited much at all. Many of these people are actually worse off because they borrowed a ton of money against an overvalued asset.

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