Corrected GDP

 

We all know what the Gross Domestic Product or GDP is. It is as common as Fahrenheit or Celsius. It is on the nightly news everyday. It has a prominent role in most political speeches about the economy. Gross Domestic Product (GDP) throughout the world is the standard measure of the economic health of a country and particularly when divided by the population to get GDP per capita. Surprisingly, it is not an ancient measure. It was developed by Simon Kuznets in 1934 for a Congressional study. GDP was formalized at the Bretton Woods Conference in 1944 as the measure of a country's economic vitality. Today this calculation is performed by a government agency in each country across the world. Each country makes adjustments to fit their particular social environment, but largely the method of calculation is close enough for statistical analysis. In the United States the figure is produced quarterly by the BEA, Bureau of Economic Analysis.

The importance and wide use of GDP to provide a picture of the economic health of a country is accepted by political leaders across the world, but many economists have concerns. Austrian Economist, Frank Shostak, questioned the underlying assumption that all expenditures reflected economic growth. He provided the example of a pyramid built by a country. Today, we often assert these projects should be part of GDP since they provide income for people and profit for suppliers of construction materials. Frank Shostak's point was that the money was diverted from being invested by a business that could expand production and create "real" jobs into a boondoggle government project.

The idea that who spends the money makes a difference when growth is concerned is subtle, but very important in understanding how an economy actually works. The issue is that governments do not make "investments." When a government spends or "invests" it is not to create a revenue flow. While business does make "investments." Their purpose is to create a revenue stream of profits to repay the investment and a continuing revenue stream. If a company built a pyramid they would put up a billboard and advertise their products enabling them to earn a return out of the pyramid.

Government spending is like giving candy to children. It has no lasting effect. In children it only diverts their attention from playing quietly to demanding more candy. I call this type of government spending an example of the Candy Rule: Government spends to make people happy, not to make a profit. On the other hand, business spends to earn a profit and to make their shareholders happy.

What is the point of this article going into the world of children and candy? I am trying to explain government spending is not the same as business spending. Government spending differs in two ways. The money government spends is not earnings they generate, but earnings taken out of the hands of business. As a society if we allow this, we must do it because we feel government expenditures can use the money better than business can. The second difference is government spending is a dead end. The money is not repaid. It is not invested. Government only consumes money. Sometimes it is necessary to feed the giant, but ideally we would like most of the money to be used to feed the citizens.

Why is this distinction important? When you consider GDP it makes a huge difference. If a country allows their government to spend all the tax money collected each year plus additional borrowed funds, what would happen? Let's assume the government spends all the money on interest payments due foreign investors. All the money would end up in foreign hands. Eventually the economy would go bankrupt since there was no money available for their home businesses to earn a profit and pay a portion in taxes.

Now, let's assume the polar opposite. All the money is spent by businesses to expand production and pay their employees handsome salaries. The businesses make a huge profit and their employees spend their salaries in the local community. The businesses retain much of their profit to expand and grow. This stimulates further growth.

Clearly, it is easy to see that all the money spent in the second example goes toward economic growth. GDP is the total amount spent. In the first example of government spending none of the money goes into local economic growth. Yet, the way we calculate GDP today, all the money in the government spending example would also be calculated as GDP. GDP in both examples would be equivalent.

What does this say about the calculation of GDP? Let me simplify it for you. Instead of including government expenditures in GDP we should only include business and personal expenditures, but not the taxes they pay. It doesn't matter what or how government spends these tax dollars since it is not an investment. When a government borrows a trillion dollars it does not strengthen the economy. It only further burdens the individual citizen.

Governments like the United States and Japan are not as rich as they think they are. The wealth of their citizens is overstated by including government expenditures (especially debt) in the calculation of GDP.

Definition of Money

There are two common ways to characterize money. The first is the idea that money is a commodity like gold, silver or apples. And like any commodity when the supply increases the value or price declines. The second theory of money stated in my book, Rule of Money, defines money as a coupon equivalent to the work effort expended. Money, in whatever form, equals the work done to earn it.  Money is the physical evidence of earnings obtained by working for someone. It is a chit that can be exchanged for products equal to the value of the service provided to earn it. This right of exchange is guaranteed by law in most countries.

I define the Rule of Money as it must be earned to distinguish it from money created by the Central Banks of the world. I draw this distinction and show in my book that funds that Central Banks create do nothing to increase the wealth of a country unless the money is earned. If this was not the case countries with hyperinflation rates approaching 1,000,000% like Zimbabwe or Hungry and Greece after WWII would be the envy of the world with their currencies denominated in billions and trillions. When currency is stated in a billion or trillion Zimbabwe dollars or Hungarian pengo it is no longer connected to the value of work. It is only a point on an inflationary spiral. At this point money is no longer connected to reality. Money must be grounded in the value of work otherwise it is a meaningless value.

Money is not a new invention. It began as a way for Kings, Pharaohs, Sultans and similar political leaders to increase their wealth. They could make money for less than the value they stamped on the coin. The more they produced the richer they became. Most early inflation occurred when these Princes decided to reduce the thickness of a coin or insert lower valuable minerals during casting, but left the value stamped on the back unchanged. Their attempt to gain some unearned income usually failed. Most of the time this attempt to maintain the value of their coinage while reducing the precious metals inside was rejected by users of the coins resulting in currency inflation. The value of coinage dropped, but still reflected  the market value of the precious metals contained within the coins. If a monarch reduced the silver content by half, the value of the coin lost half its value.

When money is defined as a commodity it is subject to supply and demand pricing. Supply and demand pricing of money allows Central Banks to push the value of money up and down by adjusting interest rates for people or banks that have money. For people and companies that need to borrow money it makes their life more difficult and more expensive. Conversely, when money is defined as a receipt for work it is not affected by changes in interest rates.

Similarly, when money is defined as a commodity it is subject to inflation. The value of money fluctuates up and down with the commodity the currency contains or is redeemable for. On the other hand when money is defined as a receipt for work it is not affected by changes in commodity prices. It is affected by changes in labor rates. This is why in the 2000s inflation was low in western countries and high in Asian countries as labor rates adjusted.

One of the prevailing theories in modern Economics is the assumption that simply increasing the quantity of money in circulation causes inflation. When money is defined as a receipt for work it is not affected by changes in the quantity of money in circulation, because there is a one to one relationship to increasing earning and an increasing quantity of money.  On the other hand, when money is defined as a commodity the quantity of money in circulation is paramount, because an increase in a commodity reduces the overall value of the commodity in circulation. It is the level of supply that determines value. In conventional Economics, if a government increases the quantity of money in circulation the theory states the value of money will fall, because the demand for money is less relative to the supply. Whereas, N Theory states the quantity of money does not matter as long as the money is earned through work. But “unearned” money added to the money supply causes the value of all money to fall. One of the most prevalent kinds of unearned money is sovereign debt. Sovereign debt is unique among all other debt. It is not an investment, but only a promise to repay. It is not backed by an asset or redeemable by acquisition of collateral.

When a Central Bank like the Federal Reserve Bank in the U.S. decides to increase the amount of money in circulation they do so to stimulate business activity, thereby creating more jobs. But by modeling money as a commodity the Fed is constrained by their fear that increasing the amount of money in circulation will cause inflation. On the other hand, if the Fed understood money as only earned revenue according to the rules of N Theory they would not fear inflation. They would expand monetary assets by encouraging new business creation.

 

The way the Fed defines money affects how they manage the monetary resources of the country. The definition of money affects government policy. When money is considered a commodity the government is in charge of opening and closing the money spigot. Unfortunately, this opening and closing is governed more by a fear of inflation than by the factors of employment or business creation. On the other hand, when money expansion occurs according to N Theory employment is step one. Consequently, the justification for monetary expansion precedes the increase in the money supply effectively preventing currency inflation since there is no excess.

How should money be defined? Money is any object or equivalent electronic notation recorded to an account in a financial institution that is earned through work, and that can be exchanged for different products or services.

Redistribution

Adam Smith defined Economics as the process of wealth creation, but by the early 20th century the economists of the time stated a different purpose for Economics. Economics became the process of redistributing wealth. Redistribution is one of the cornerstones of Keynesian economic policy. The idea begins with the assumption that money is unfairly distributed. This is based on the observation that the amount of money possessed by some people does not seem to be based on fairness. This was definitely the case when Kings and Sultans possessed most of the wealth in their countries. This unequal distribution resulted from their control over the manufacturing of money. For hundreds of years money was simply a product of the monarchy. The common man earned money by doing things for the monarch. This traditional way of distributing money is still advocated by many economists as a solution to the disruptions of money flows during a financial crisis. Their logic is that the state creates the money, let the state decide who gets a share. These economists believe the state is much wiser at determining who gets what than the market system. Or that the market system is imperfect and can be improved by strategic monetary infusions by the state. This modified monetary structure is justified, because it is the right thing to do. The poor need care. The weaker members of the flock need shelter and food, and only the state can do so with the proper level of concern.

The origins of these traditions trace back to the concept of compassion. Compassion is a key virtue promoted by all major religions in the world. It is a quality that all religious people should seek to integrate into their actions. Therefore, the fact compassion permeates our economic traditions is no surprise. Likewise, it is no surprise that the competing secular philosophy of the market system is characterized as evil or godless. Such criticism is simply a protective religious response to a system that does not on first glance appear to have compassion at its heart.
 
Money must be distributed throughout a community for there to be a vigorous and robust economy. If money is left in the local bank or buried in the backyard, most people will not earn enough money to feed their family or pay their bills. Money needs to circulate and expand. Circulation or distribution can occur in two ways. A strong political leader can control all money through taxation or by managing the printing presses. Then it is a simple matter of determining who gets what. Most monarchies tried this method with greater or lesser degrees of success through the 19th century. Louis XIV used the construction of Versailles to distribute money in his society through the craftspeople and suppliers working on the project. Napoleon used his soldiers to spend money into the French economy. In other countries he used his soldiers to rob or plunder for survival. In the twentieth century Central Banks allowed private banks to make loans to emerging businesses to encourage economic expansion of the economy. The amount of wealth created in the twentieth century is greater than all the previous centuries combined. Clearly, no other system worked as well as the system employed in the 20th century when it came to the amount of wealth created. So what does history teach us? Based on the results obtained in the twentieth century versus the wealth creation in all previous centuries, it is clear the market system creates more wealth and quicker than any other system of wealth accumulation.
 
Redistribution is not a system of wealth accumulation. It is really a system of reengineering the last stage of the wealth accumulation process to redirect the final destination of the money accumulated. Redistribution ends up being a mirage even for those people who benefit from the redistribution. Why, because the government’s tax piece will be quickly replaced by higher prices and greater profits by the people who run businesses. This is why it costs more to live in New York or San Francisco (two of the most highly taxed communities in the country).
 
So, if I have convinced you redistribution is not a wealth accumulation process than what is the wealth accumulation process for the followers of the redistribution mantra? The wealth creation process for the business sector is capitalism. The wealth accumulation process for the government sector is the taxation process. One can argue that this is not really a wealth accumulation process since all the money is created by the market economy of the private sector.
 

The conclusion economists must draw from this process is that redistribution is not an effective wealth creation process. Redistribution just moves money from one side of the table to the other. It is a redistribution process like poker is a redistribution process without the fun. Just like a casino, government takes a fee for setting up the game.

Redistribution is not an economic concept. Redistribution is a justice concept. It is based on fairness and judgments about what is "right." This type of legal right does not belong in an economic discussion, because economics is not morally based. Redistribution is used as a justification for government to intervene in the market economy and correct the errors. This makes redistribution a government technique, not an economic principle. Redistribution may be the right thing to do, but that is only because the citizenry agreed it was.

To return to Adam Smith, redistribution is not a wealth creation process so it does not fit the definition of an economic process. Redistribution is a social process. As such redistribution should not be a consideration during optimization of the economic system. Many economists claim Economics is about a "fair" distribution of income, but it is not. Economics is about creating wealth.

Scarcity

Economics does not seem like the kind of thing that was invented by one person. It seems like it probably came together slowly as customs became established and slowly turned into rules.  Today it is an immensely elaborate and complex system. Many of the most interesting features are relatively modern. Transportation certainly began with a man or a woman simply walking between tribal settlements, but now involves planes, trains and ships of immense size and complexity. Although it began hundreds of years ago, the whole banking structure of trade in just the past one hundred years has evolved into numerous complex currency and interest rate swaps and loans of millions of dollars. Corporations begun in Roman times to share the rewards of collecting taxes are now multi-national organizations with factories across the world producing everything from Barbie dolls to industrial acids that can cut through metal. The intricate metallic machinery and robots involved in the manufacturing process seem to be the inventions of Hollywood.

Are we on the right path? Do you think this was the direction of the tribal councils of Africa who began this process? What were they trying to achieve? It seems like the motive would be quite basic.  One tribe has a surplus of fish, but would like to get more berries from their neighbor who has a large berry patch on their tribal grounds. It is easy to visualize this process evolving into a structure needing a system of weights and measures and then money, next more advanced techniques for growing crops, then improvements in tools, organizations to produce manufactured products and along the way a system to make more money. Bottom line, it does seem reasonable to assume our economic system evolved as a trading mechanism.

The reason I asked this question is the simple feature of our humanness that makes us more efficient and focused when we know what direction to go in to reach our goals.  No economics book I know about declares the foundation of economics is trade. In fact, almost all economics’ textbooks start by explaining economics is about allocating scarce resources, i.e., deciding who gets a fish and how often. I must disagree with the esteemed academic community. I think this process of deciding how the tribal bounty is divided is a political decision.

The fisherman who caught the fish certainly feels the fish belong to him and that he will decide who gets what.  It requires some political might to wrestle control of the fish away from the fisherman.  I cannot imagine a fisherman in a primitive society giving up his fish to the tribal leadership to be redistributed without some political force in play. It is also not as clear how that process leads to the creation of money or huge trading vessels. Therefore, I believe scarcity leads not to the creation of Economics, but to the creation of Politics.

Economics does not originate with scarcity, but the need to have an efficient and effective trading system.

Freefall Critique

Freefall published in 2010 by liberal economist, Joseph E. Stiglitz, is his analysis of the cause of the Great Recession of 2008, and the lessons he feels we should take from this catastrophic event and its aftermath. This is not a standard economics book. It is more like a newspaper article from a journalist with a strong viewpoint that he wants to spread. One of the key points Professor Stiglitz sets out to make in his book is that the Great Recession proves that the so-called self-correcting function of a market economy does not work: "One might have thought that with the crisis of 2008, the debate over market fundamentalism--the notion that unfettered markets by themselves can ensure economic prosperity and growth--would be over." (xiii) As somewhat of a student and victim of the Great Recession and Housing meltdown I find this conclusion off point. I believe the Housing meltdown as the acknowledged cause of the Great Recession is not about why markets did not self-correct, but what happens to markets when government mandates (HUD Affordable Housing Policy) require 50% of housing loans be made to marginal borrowers. The Great Recession is not about self-correcting markets. It is about government interference into markets to enforce an unrealistic social policy. Professor Stiglitz is trying to make the opposite point: he wants to show an economy in private hands doesn't work. He does that by seeking to find a private sector entity to blame for the crisis. Stiglitz chooses the banking system in his blame game.  He tries by accusation and through a circumstantial case to convict the banking system or at least to suggest a strict home monitoring system. The primary purpose of this effort is to make the case that the economy should be under the control of government, an idea first proposed by Keynes.

To make his case, Stiglitz creates his own reality. He repeatedly refers to the "financial system" as a "self-regulating apparatus." (xiv) As an ex-banker I know, for a fact, the banking industry is probably the most regulated activity in society. Nuclear energy has modest regulation by comparison. The Congressmen in control of the financial industry are household names to most Americans. Ask an American who the head of the Atomic Energy Commission is and they would not have a clue.  Ask them if they know who Ben Bernacke, Senator Dodd or Barney Frank are and people will explain their role in the financial crisis, and know some of the common accusations against them for complacency in the development of meltdown.

Stiglitz also creates his own history. He accuses believers in the market economy of arguing the financial crisis was the result of a few "rotten apples." (xix) I was in the middle of the financial crisis and I do not recall any traditional economist placing the blame on a few individuals. I do recall President Obama and Stiglitz blaming the financial industry for the crisis. Nevertheless, in this book Stiglitz is arguing the cause is "systemic." (xix) I am sure many traditional economists would agree with that assessment. They would argue the systemic failure was not in the private sector, but due to excessive regulation by the government housing agencies and specifically HUD. Stiglitz has the opposite view. He states it is government that saved "markets from their own mistakes." (xx)

When the book opens Stiglitz puts much of the blame for the crisis on a "deregulated market awash in liquidity." (1) The actual precipitating events of the Great Recession were just the opposite, a heavily regulated industry trying to comply with HUD requirements for subprime lending that reached 50% of a bank's portfolio in 2007, and a fear by other banks and lenders providing liquidity that these loans would not be viable. History would certainly prove their caution was justified, and that government mandates were unwise and the primary factor in magnifying risk. Stiglitz continues his attack on the financial industry by accusing them of developing residential loan products for "maximizing their returns," (5) when the truth is variable rate interest loans were first developed in Europe and that the bonds sold by Wall Street followed SEC regulations to the letter. The problem was not the types of loans, but the fact HUD regulations made it necessary to lower lending standards to serve the subprime borrower. The result was when the economy faltered these marginal borrowers could not refinance their loans or escape their obligation. Stiglitz also accuses the financial industry of "promoting securitization" (6) when the reasons large packages of loans were securitized was to sell them to Fannie Mae and Freddie Mac. The GSEs did not want to fuss with small bond packages. The government mandated the size of the securitized loan packages. The government was the main destination for most of these securitized packages.

Stiglitz blames the mortgage companies, banks and rating agencies for the financial crisis, but never mentions HUD's role in manipulating the system. If it is a systemic failure like he asserts we should look at the system architect and not at the carpenters. Some of Stiglitz's arguments against the banks and the mortgage originators are just simply untrue: "The banks jumped into subprime mortgages--an area where, at the time, Freddie Mac and Fannie Mae were not making loans--without any incentives from the government." (10) The banks were middlemen between the mortgage lenders and the GSEs, Fannie and Freddie. The banks assembled bonds to feed the GSE's appetite.  Fannie and Freddie were also victim's of HUD. Just like the banks they were mandated by HUD to have a certain percentage of subprime loans (35% starting in 1992 with passage of the GSE Act). Stiglitz is correct it was not an incentive, it was a mandate. Everyone involved made subprime loans since the government mandated the GSEs and banks finance a specific percentage of subprime loans each year. Failure to comply meant the GSEs and banks could not make prime loans. This was the main business of both entities.

This gets us to the "too big to fail argument." Stiglitz asserts that banks knowing "they were too big to fail provided incentives for excessive risk-taking." (15) Let's evaluate this common statement of liberal academic economists. Bankers make money by making loans that return a profit. Why would they push it to a point where the government takes over their business and kicks them out? They would not. "Excessive risk" is not appealing when the risk is losing your career, and your retirement investment in a company that has provided your livelihood. Mortgage bankers did not take on "excessive risk," because of a big annual bonus. They were forced into a no win situation by a government that required they make loans to people likely not to repay them (GSE & CRA Acts). Why did they make those loans? Loaning to subprime borrowers was a precondition of making loans to the most lucrative real estate segment, prime borrowers. The conflict between Stiglitz's argument that insufficient regulation is the cause of the Great Recession and the evidence that over regulation is the cause of the housing meltdown is not explained in Freefall.

Stiglitz clearly states the cause of the Great Recession is "the reckless lending of the financial sector, which had fed the housing bubble, which eventually burst." (27) I would suggest lending that the government required for participation in the prime market segment is not properly characterized as "reckless," but better described as a mandated risk.

Stiglitz indicates the solution to the Great Recession is a monetary stimulus coming from the government. Sitting here in 2012 it is clear that after two and a half monetary stimulus attempts this antiquated economic concept works no better today than it did in 1933. He argues a government stimulus provides a 1.5 multiplier while a bailout provides no stimulus: "Spending money to bail out the banks without getting something in return gives money to the richest Americans and has almost no multiplier." ( 62) Stiglitz provides no explanation for his comment, "gives money to the richest Americans," but whatever Bill Gates and Warren Buffet did with their "gift," I am sure it will spent on people in need throughout the world.

Eventually, Stiglitz admits the borrowers may have had a role in the financial crisis: "many of these borrowers were financially illiterate and did not understand what they were getting into." (78) This begs the question of where were the regulators hired to prevent such situations? It also brings us back to asking why HUD required banks and the GSEs to make such loans. Such logic misses Stiglitz as he continues to hurl vindictive and hyperbole at the baking industry: "The securitization process supported never-ending fees, the never-ending fees supported unprecedented profits, and the unprecedented profits generated unheard-of bonuses, and all of this blinded the bankers." (79) If the Great Recession made banks so wealthy, why did they cancel dividends, layoff thousands and let their share price slip to 30 year lows. Obviously, the stock market saw something entirely different from Joseph Stiglitz.

I must admit I am not above blaming a group of people, like Stieglitz does, for some of our problems. In my case it is lawyers, so I was delighted when I came across this statement: "Besides, many of those in charge of the markets, though they might pride themselves on their business acumen and ability to appraise risk, simply didn't have the ability to judge whether the models were good or not. Many were lawyers, untrained in the subtle mathematics of the models." (84) Stiglitz in Chapter Four proposes a few new ideas that totally ignore five thousand years of financial development. One of these ideas is his proposal of separating housing debt from the home owner's wealth called a "homeowners' Chapter 11, (where) people wouldn't have to go through the rigmaroles of bankruptcy, discharging all of their debts. The home would be treated as if it were a separate corporation." (103) Maybe I am overly critical, but isn't this just allowing the homeowner to escape their liability? He does propose an interesting idea for a tax credit rather than a tax deduction for mortgage interest. (105) Another intriguing idea taken from Denmark that Stiglitz proposes is the idea that the mortgage originator bares the first loss on a default or resale. (106)

The biggest flaw of this book is putting the blame for the Great Recession on the bankers like this statement from page 109: "The bankers who got the country into this mess should have paid for their mistakes." The case for blaming the bankers is unclear. In fact, the bankers and homeowners bore the brunt of the financial loss, but the evidence of guilt during the crisis seemes to indicate it was HUD and their partner in the crime, the U.S. Congress. These government institutions required banks to lend to homeowners who "were financially illiterate" and encouraged market products that were financially not viable. Are the banks to blame, because they took this mandated medicine so they could make prime loans? Similarly, it seems ridiculous to blame "illiterate" homeowners. It seems correct to blame the government institutions that got us into this mess.

The argument of Freefall is further eroded when Stiglitz ventures into a lecture on what is morally correct behavior for an economy. At one point he states, "Capitalism can't work if private rewards are unrelated to social rewards." (110) This line of argument is way out there! Capitalism is not a reward for moral behavior. Heaven is a reward for moral behavior. Capitalism is a wealth creation system. Besides line of argument fallacies, I question the application and use of some of the factual statements included in the book like the following: "In the United States, the magnitude of guarantees and bailouts approached 80 percent of U.S. GDP, some $12 trillion." (110) This sum is only reached by double counting the investments of money market funds in U.S. Treasury Bills that the government guaranteed when they were originally purchased. Likewise, the following statement from the book is at least an unfair, if not an outright lie: "But by now, it is clear that there is little chance that the taxpayers will recover what has been given to the banks and no chance that they will be adequately compensated for the risk borne," (112) As a taxpayer I feel more than compensated for the "risk borne" knowing the world economy did not collapse, even if all I received in return was the face value of the funds the banks borrowed for a couple of years. Also, Stiglitz gives the impression the banks did not pay back the face value of the loans which is untrue.

It is not surprising Stiglitz's solution to the difficulties the banks went through is for the "shareholders (to) lose everything; bondholders become the new shareholders." (116) My only question is what did the shareholders do to deserve this punishment? Stiglitz argues the taxpayer should not bear the cost of the bailout. There is no cost to the taxpayers since the banks repaid the funds lent to them. Oh, I am forgetting the $3 trillion dollars of bailout funds. Following Stiglitz's logic: the liberal economists who encouraged the government to spend"stimulus" money on new office furniture for government buildings should repay the poorly invested stimulus funds. The banks repaid the money they borrowed to restore the banking system. It only seems fair the government should repay the stimulus money they borrowed that did not help to restore the economy. Both investments are equally bad. Since the plan directed by the liberal economists did not work. It seems like the government has a responsibility to recover those consulting fees paid to the liberal economists for advise that was clearly flawed.

Halfway through the book, Stiglitz turns his venom on the Fed, "The Fed played a central role in every part of this drama, from the creation of the crisis through lax regulation and loose monetary policies through the failure to deal effectively with the aftermath of the bursting of the bubble." ( 141) Stiglitz does not explain the role the Fed played in the "creation of the crisis." That is an unfortunate oversight on his part since it weakens his argument. To support his argument Stiglitz resorts to some of the most discredited economic theories, like the idea of "trade-offs between inflation and unemployment." (142) Finally, Stiglitz blames the computer programs written to evaluate the real estate products offered for sale: "Valuation of the complex products wasn't done by markets. It was done by computers running models that, no matter how complex, couldn't possibly embrace all of the relevant information." (160)

Stiglitz's solution to the Great Recession is more regulation and more government; "will require government taking on a larger role." (185) "Deregulation played a central role in the crisis, and a new set of regulations will be needed to prevent another crisis and restores trust in the banks." ( 216) Regulation is just policing. The issue is why did homeowners run the red light? More police does not alter the action of the inattentive driver. Logic insists that the cause of the Great Recession must be an action taken before the value of Residential Mortgage Bonds collapsed. The collapse was due to homeowners defaulting on their mortgages. Why did homeowners default? They could not pay the increasing cost of their mortgages. So the crisis comes down to who encouraged homeowners to purchase mortgages they could not afford. Even after Professor Stiglitz's explanation it still looks like HUD's reduced borrowing standards went too far. A policy to encourage expanded home ownership reduced all the standard economic safeguards.

Stiglitz expands his arguments into the absurb. At one point he declares that people do not make economic decisions in a "rational" manner: "The belief in rationality is deeply in grained in economics. Introspection--and even more so, a look at my peers-- convinced me that it is nonsense." (248) I personally have a hard time believing in an economic system not based on rationality. How could you model a person's expected response if you do not expect them to act rationally. I suppose life in an insane asylum would be a good model. I only hope that is not what Stiglitz is suggesting.

Let me end this  critique with a quote from Joseph Stiglitz since it aptly describes his book and his life: "The best ideas do not always prevail, at least in the short run." (274) Later he argues that "materialism" has "led to rampant exploitation of unwary and unprotected individuals and to an increasing social divide." (276) This 1920s liberalism is not a very potent argument in a world largely composed of a single middle class (the 99%). Stiglitz argues one of the probelms is the community defines our social structure by their choices in the marketplace. He is appalled that we "allowed markets to blindly shape our economy." In Stiglitz's preferred world the government makes those choices. Apparently, allowing consumers to influence the market is morally wrong. Since as Professor Stiglitz points out, "the unrelenting pursuit of profits and the elevation of the pursuit of self-interest may not have created the prosperity that was hoped, but they did help create the moral deficit." (278) It must be this "moral deficit" that caused bankers throughout the world to risk our economic prosperity for their personal pursuit of profits. I do not know about your personal banker, but mine is a guy who watches his kids play soccer on the week-end and mows his lawn with a push mower. If he is part of the moral deficit, he hides it very well. I should give Stiglitz a break.Part of his problem is his New Yorkcentric world view.

News blast: New York is not the center of the universe!

Stiglitz defines something he calls economic rights: "why should these economic rights--rights of corporations--have precedence over the more basic rights of individuals, such as the rights of access to health care or to housing or to education?" (287)  Stiglitz is confused over what a "right" is. Everyone has the freedom to obtain health care, housing or education. But, no one is entitled to receive these things without earning them. Being a human being is not an entitlement to an expensive education, housing or health care. These things like all products of society are a benefit of hard work.

Professor Stiglitz concludes his book by blaming particular segments of the private sector for manipulating our economic and social policy: "the special interest groups that shape American economic and social policy include finance, pharmaceuticals, oil and coal. Their political influence makes rational policy making all but impossible." (294) The only time I see industry representatives come before Congress is to be criticized and ridiculed. I am sure their message is delivered to Congress, but clearly employees of the government including Professor Stiglitz have much greater access and influence.

His entire book is an attempt to place blame on the bankers for the Great Recession. There is no tracing of events or causes that makes that argument persuasive. His arguments do not disprove that HUD caused the crisis by lowering lending standards and requiring an unrealistic large percentage of mortgage loans to be subprime. The book is simply a retelling of the events of the Great Recession, and then making a statement that the blame for these events lies at the feet of the banking system. Stiglitz's solution of more regulators and government power over the banking industry is not persuasive. In fact, Professor Stiglitz's shaky case adds credence to the opposite theory that the events of the Great Recession occurred because of government interference in the residential real estate market.

Say's Law correctly stated

Say's Law is one of the cornerstones of modern Economics.  Unfortunately, the most common description of the Law is an incorrect restatement by Keynes. Consequently, Say's Law lost its place as one of the foundation principles of classical economic theory. Beginning in the 1920s Say's Law was largely ignored by most economists.

The importance of Say's Law can be seen in its application by Say. Jean Baptiste Say proposed an explanation for all financial downfalls like the Great Depression and the Great Recession. Had his thesis been understood and popularized by economists in the 20th and 21st centuries much of the stagnation of these economic collapses could have been avoided. Likewise, the ineffective remedies proposed by Keynes and others would not have been followed fruitlessly by governments in Europe and the United States.

What was this magic remedy Jean Baptiste Say proposed? He simply stated in his explanation of Say's Law that private sector profitable production was the only catalyst to economic growth. He further stated that public sector expenditures would slow economic activity and decrease employment. History has shown that Say was right.

Keynes recognized he and Say were diametrically opposed. Keynes aggressively argued for the repudiation of Say's Law. He criticized it in the terms of his favorite economic model, but by doing so ended up by misstating Say's Law. Even so, Keynes' glib description of Say's Law as "supply creates its own demand" was the often quoted definition of the Frenchman's principle. In fact, Say's Law is not about demand. It is about wealth. Say was stating that private sector product creation increases wealth. Say's Law could be stated as product sales create wealth. He wanted to make the point product exchanges include a wealth upside, namely profit. Products embody a profit when they are valued and exchanged. Each sale increases a societies' wealth by the amount of profit. Very simple, but when applied in a financial crisis it changes the focus from government lowering interest rates and borrowing to increase the money supply to making private sector business profitable.

Keynes theory, on the other hand, was that the wealth pump must be primed in a financial crisis. Keynes' theory resulted in government printing new money or borrowing to increase government employment. Keynes and his followers argued more government employment or government projects like road infrastructure would put money into the economic system. This increase in the money supply would stimulate an increase in demand for products (aggregate demand).  Unfortunately, the idea that circulating more money would stimulate businesses to expand did not work. The wealth was in the wrong hands. The wealth was not in the hands of business people to be used to expand their companies, but in the banks controlled by people unsure of the economic direction.

Government production did not include a profit component. Without profit there was no wealth creation. The other element of government "make work" projects was that they are temporary. No private businessman was going to invest in a temporary market. Business required a sustainable income stream. Government projects do not provide that.

According to Say's Law this is what happens in the wealth creation process. A government can borrow and inject money into the economy by building bridges, for instance, to increase the quantity of money in circulation. But there are consequences. The first thing to consider is the debt the government incurs. The amount to be paid back, initially exceeds the amount circulating. If the circulating money is used to purchase products according to Say's Law it (wealth) will grow. Say is just pointing out each sale results in a profit. If the money circulates rapidly and many products are sold, the profits made will increase and greatly exceed the amount of the debt to be repaid. The government can then tax the private business to repay the debt they incurred.

Let's consider a different scenario. Suppose, the government borrows to pay unemployment insurance. The unemployed person uses their payment to pay their rent in a government subsidized apartment. No profit is made. The cost of borrowing exceeds the amount the government gets back in rent. Over time government debts accumulate until the government goes bankrupt.

Say's Law explains why a country can only extract itself from a financial crisis when the private sector is actively expanding (investing). Private sector investment is not an indicator of a vibrant economy, it is the vibrant economy. Government spending has the opposite effect unless it spikes private sector investment.

The following section includes a number of quotes of Jean Baptiste Say. All the quoted material comes from the fifth American translation of his book, A Treatise on Political Economy published in 1832. In history books and economic articles you will find numerous quotes from Jean Baptiste Say, but his most important quotes are often not listed.

"It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value." In this brief statement Say is making the point that it is a product or service that earns a profit and expands the wealth of a society "to the full extent of its value." The term "full extent of its value" refers to the cost of producing the product plus the profit the seller can make above product costs.

Keynes misunderstood Say's Law. Keynes believed Say's Law occurred in a barter economy, but it actually defined the difference between a barter economy and a monetary economy.  A barter economy does not have a profit. The importance of profit in wealth creation is the key contribution to Economics by Jean Baptiste Say. It is profit that energizes an economy and allows it to grow. As Say noted, "The success of one branch of commerce supplies more means of purchase, and consequently opens a market for the products of all the other; branches." The "more means of purchase" are the profits embodied in every sale of a product or service. Say was making the point that each product sale was increasing the wealth in an economy. Keynes thought it was the cost (interest rates) of money available to purchase products that invigorated commerce. Keynes' failure to understand profit is not surprising since he came from the public sector where profit was not part of his world. Say, on the other hand, was a businessman and knew the critical importance of profit to the functioning of the economy.

Say's understanding of the economy allowed him to understand what was occurring during economic downturns. He realized that "people... bought less, because they have made less profit." What could be more obvious? The economy slows when people have less money or less confidence to spend. Somehow this idea was overturned by Keynes who argued "aggregate demand" determined the vitality of an economy. Say predicted Keynes argument when he stated people's demand for products does not rise and fall, but remains constant. Say made the further point that what rises and falls is a consumer's ability to afford the purchase.

Say went on to strongly criticize the men of government for taxing the economic vitality out of the economy: "The man, that lives upon the production of other people, originates no demand for the productions; he merely puts himself in the place of the producer, to the great injury of production." The greatest oversight of economic management is the failure of twentieth century economists to appreciate Say's analysis of the ineffectiveness of government efforts to increase "aggregate demand" by spending: "the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption." If a government wants to extract their citizenry from an economic crisis they need to focus on the "means" of wealth creation and not the circulation of money.

In simple terms Keynes felt that public sector spending could vitalize an economy by circulating more money. Say argued money alone was insufficient. For an economy to circulate money required the creation of new products people desired. Say argued it was private sector production alone that could sustain and grow a vital economy. For over 100 years the governments of the western world have followed Keynes and ignored Say. What is the result? Most western governments are nearly bankrupt from Keynesian borrowing, and their private sector productivity in tatters from lack of attention.

Isn't it time to reject Keynes and embrace Say?

How big of a government can a country afford?

Size matters! The larger the government the better, right? Of course, the larger the government the more expensive it is to maintain. Is it any surprise then that the largest government bureaucracies relative to their private sector tax base are in the most trouble? It might be since many politicians argue constantly for more money, more regulators, more military resources, more Park Rangers, more police, more wind turbines, etc. Certainly, politicians elected by their citizenry would not plead for "more' if it would endanger their country or would they? They might if their constituent base was primarily government workers. The more government employees are beholden to them for a job, the more secure their reelection would be. This is why dictatorships and totalitarian regimes throughout the world have the largest bureaucracies. These massive bureaucracies sustain corrupt regimes. Mubarak in Egypt had 30% of the populace beholden to him through government service in a poor country.

This chart shows the burden for the private sector. Paying for all these government employees must come from the private sector. China's figures can be thrown out since many of their industries are publicly owned and so their figure is not comparable to the others. You can see why Portugal, Greece, Italy and even France are in trouble. Especially when you consider some of these countries have nearly 20% acknowledged unemployment. The unemployment compensation they receive also comes from the government. To make this chart more informative the 20% unemployment should be added to the public sector employment or roughly half the people in many cases are supported by taxes. You can see it would take an extremely lucrative private sector to support half the population.

Imagine what the solution is to such a dilemma. It can only occur through massive private sector expansion, but these countries are notoriously anti-business. Many of them in their excessive desire to preserve their own salaries are sacrificing the future of their own country through surprisingly personal "greed."

The other choice is to massively reduce the size of government. N Theory makes the case that government should be reduced to maximize the growth possibilities of the private sector. Diverting funds now supporting government agencies to supporting growth of private business is unlikely. The bureaucracies of most western countries are too entrenched and powerful to embrace the sacrifices necessary to encourage private sector expansion. A large displacement of government funds would be necessary to encourage private business expansion. Maintaining the status quo is the simpler path.

Is there a solution? Yes. Government services and agencies must be privatized. This will preserve or actually convert many government jobs to private sector positions. This is a radical idea. Will it work? Let’s look at probably the most difficult case and see if it is even reasonable. What happens if the military is privatized? This simply converts a national military into a private mercenary force. The military becomes an entirely defensive provider. Now, the question is how much does the citizenry want to pay for security and not one of financing misdirected national pride. The military converts to a functional requirement of society like food and energy. This means the military budget is sized to need, not ego. These are the kinds of ideas that need to be explored if western governments are to survive.