Is Money a Commodity?

One of the most critical issues in Economics is whether money is a commodity. All the major schools of Economics: classical, Keynesian, Austrian and Behavioral agree money is a commodity. Why? Economists observed governments issuing new or additional currency that caused a devaluation of the currency already in circulation.  Another example they looked at was common commodities and observed price movements. It didn't matter if the commodity under the spotlight was gold, silver, oil, corn, sugar, wheat or cotton they all seemed to act the same way when the quantity in the market moved up and down. Looking at the history of money economists found a parallel. When governments increased the supply of money the value of other money seemed to decrease. Money seemed to perform just like cotton. The larger the cotton harvest the less valuable. So economists concluded, if it walks like a duck it must be a duck. Money was declared a commodity.

To simplify the economic logic of money as a commodity you must believe the value of money fluctuates just like the value of apples, the classic example of a commodity. Both act like they may be influenced by the forces of supply and demand. The more apples (Supply) on a store's shelves it is necessary to drop the price (increasing Demand) to encourage a higher rate of purchase. One of the great fears of private economists during the Financial Crisis of 2008 was a fear of inflation from the Fed's strategy of injecting two trillion dollars into the economy. Fortunately, that fear was not realized.

This experience from the Financial Crisis was counter to the money as commodity theory, but few people took notice. Maybe, money is not a commodity. Let's look at money in the marketplace to see the parallels with apples. Clearly, money is not a fruit. Money does not grow on trees. Money is not harvested by farmers. Money is not sold on grocery store shelves. Money is not seasonal. Money is not perishable. Money doesn't taste good or provide a nutritious snack. Does this deductive track lead anywhere? It is interesting, but leads only to a baffling syllogism. Money is called a commodity, but money does not share features with other commodities, therefore money is not a commodity. The question about what money is remains unanswered.

Let's delve into that question. Money seems as mysterious as an alien from outer space. If we encountered a space alien how would describe what we saw? First, we would describe what it is similar to "about the size of a dog, but walking upright and carrying a rifle like object in its four hands." We can make a description of money, "Two and a half inches by eight, made of paper, printed on both sides with a picture of a politician on one side and a building on the other." The description tells us nothing about what it is used for or how it works in the economy. It seems like part one might be a description, but part two needs to be an explanation of the role it plays in the economy. I can see some of you wiggling in your chairs to tell me money is a 'a medium of exchange.' I bet you can even explain how the barter system needed a reservoir of value if a seller did not want to make a product for product exchange, and that prompted the creation of money. True, but money is more. Money can be thought of as an equality of value. What? Money represents value. The value of the chicken you traded or the work you did in the field.

Money is a value equivalency. If I do 'x' you will give me six of those green bills. Done. It is not a commodity that will change value, or age and spoil. It is money, a marker of value usually earned through the accomplishment of work. Why is that important? It creates a connection between work and money. So money can not be circulated unless there is a work product to anchor its value.

Think about this for a moment since it radically alters conventional Economics. This concept is the basis of my textbook, Rule of Money.

Do low interest rates stimulate economic growth?

Starting in the mid 1990's Japan pursued a low interest rate policy. Unfortunately, the reason the Central Bank lowered rates did not have the intended result. Japan's finance ministers wanted to induce economic growth. Instead the economy faltered. Why? Don't lower interest rates reduce the cost of borrowing for companies? Of course, but unless the companies need to borrow, low interest rates have no effect. Often low interest rates are imposed in times of economic stress. Many companies are unwilling to borrow in such perilous times. Consider the effect of a stagnant economy on Japanese business. In Japan the size of corporate debt went from 147% of GDP in 1990 to 99% in 2011 (Mariko Oi for BBC News, Tokyo, 17-09-2012). One should conclude low interest rates actually reduced corporate borrowing by 50%.

Although Keynesian Economics argues low interest rates are the cure for economic malaise, the facts indicate the opposite. Why? Keynesian Economics is built on the assumption of interest rates driving the economy. The fact is other economic conditions weigh heavier on markets than interest rates. What are these economic conditions? First, it is the confidence in the future of economic management, i.e., the government's ability to manage the economy. Keynesians take this as a given, but business people see it quite differently. Low interest rates are a perfect example. Keynesians see low interest rates as an inducement to business to expand. Business people see low interest rates as an indication of a stagnant economy. Governments see a stagnant economy as an opportunity to utilize Keynesian debt strategy to spark a recovery.  A government supported by an economic theory that lauds their economic prowess is a strong inducement for government to increase their borrowing and the national debt. Unfortunately such a strategy did not work during the Great Depression or the Great Recession. It did solidify the business sector's opinion that the economy was in a downward spiral. In the same article noted above Mariko points out public sector borrowing went from 59% of GDP in 1990 to 226% in 2011.

Even if governments behave themselves and do not increase debt, low interest rates are not good for the economy except in the short term. The short term being a couple of years to induce capital purchases put off because of the weak economic situation.  I would argue it is never good for the government to try and manipulate the market. But there are other reasons besides my opinion. Low interest rates encourage marginal loans. The group of business ideas that work with a 1% interest rate is not the same quality as those that work at 5%. In addition, the origination revenue banks obtain from low quality loans and 1% interest is marginal at best. A healthy banking sector is fundamental for a vibrant economy. Banks play an essential role in taking the new money creation allowed by a central bank and finding places to invest it. If banks buy notes from the Treasury of a country to earn interest no new business is created that can grow. The interest banks earn in the feedback loop and new business creation expands the economy. It is tax paying job creating business that expands the economy; not money creation by the government. A strong economy can not exist supported on a thin feedback loop. The thinnest possible loop is a low interest government bond.

Who creates Money

Does the origin of the money in your wallet make a difference? Often. If the money is counterfeit you may have your money confiscated before you can spend it. If your money was manufactured by certain countries you may find it impossible to get the face value in other countries. For instance, the 5 trillion note issued by Zimbabwe will never be equivalent to any other currency. Why is that? The value of a currency is not the value stated on the bill, but is the value when used to make a purchase. If the note from Zimbabwe can be exchanged for a new Xbox, then is equivalent to $319 US dollars since that is the amount of currency necessary to purchase the product in the United States. The comparative value of a currency defines a currency into a known item. Think about "one." Your first question is "one" what? In the case of currency the "one" is the number of another currency.

There is one unique difference about paper money. Other products get a value when they go to market. Walmart will put a product on their shelves at a price they hope the product will sell for, but if it doesn't sell, they will reduce the price until a value is found that customers accept. Money has a value printed on the front of each bill, but banks will not reduce the notational value on the face to get their depositors to take the bills out of the bank. In fact the government dictates the currency must be accepted at the face value. Consequently, if the currency value is greater than the public will accept the product value must go up. This situation occurs everyday throughout the world to various currencies. What do banks do? If they are exchanging one currency for another they adjust the exchange rate. If a customer is withdrawing funds to make a now higher priced purchase, they will complain to the bank, but are powerless to restore the value of their currency. The result is what we call inflation. These movements in the value of currency are very destructive to a stable economy. Stability is extremely important. Why? Pricing is based on convention and forces that upset or change economic conventions often result in economic stress and uncertainty.

How do the institutions in the United States attempt to maintain stability? The Federal Reserve does not give money away to individuals, they use the private banking system to distribute it. The Fed distributes money through banks or federal agencies to maintain control. Ignore distribution through federal agencies for the moment. Most money is distributed through banks so let’s look at that process. Physically the money does not exist until it is utilized. The Fed sets certain rules to ensure more money is not created by the banks than products. The Fed creates potential, but money only comes into existence when a bank takes it figuratively out of the Fed. And, this is the most important point, banks only take it out when they have a borrower able to repay the funds. The amount of dollars requested by the borrower sets the value of money created. Let's look at that from a slightly different angle. The federal government does not create money, the Fed does not create money, the banks do not create money; borrowers create money by agreeing to expand the quantity of circulating currency by starting a profit earning business or investment, and repaying their loan. Note the importance of profit. It is one of the most important economic concepts. Note the insignificance of government printing presses and regulatory restraints or incentives. The final judgment is in the hands of a country's entrepreneurs. The cleverness of entrepreneurs determines the growth rate of a society not a government agency.

Now you can see why rising interest rates is an effective deterrent to economic expansion. Higher interest rates place a roadblock in the way of the money creators, the borrowers.  But let me return to the point of this brief article. Money creation by the government is meaningless unless the money is utilized by borrowers. Most governments outside the top twenty focus on the wrong strategies to grow their economies. They buy things: roads, bridges, schools, military equipment, etc. to increase the appearance of government. Nothing is wrong with these acquisitions, but building wealth in the private sector is the only way to put in motion a mechanism to pay for such purchases. Public services and facilities are great, but if a private sector does not exist to pay taxes then the facilities will not be maintained. Governments should put the focus on creating entrepreneurs. This is the strategy China is utilizing to grow their economy.

Lessons from the Great Depression

Here we are in the sixth year the economic plague we call the Great Recession. Although the Great Depression lasted twice as long it did not infect as much of the world. Are there lessons to be learned from this earlier crisis? The classic work on the Great Depression is The Great Crash 1929 by esteemed economist John Kenneth Galbraith. Professor Galbraith’s book is a magnificent work of research and his account of the events surrounding and contributing to the cause of the Great Depression is greatly admired and studied. His description of the events from 1928 to 1940 is enthralling and enhanced by his elegant language. A very high standard for economic literature, but does his analysis rise just as high and does it help us understand our current financial crisis?

It is acknowledged by Professor Galbraith and most other economists that the trigger event of the Great Depression was the loss of money in the stock market. Investors were stopped out of their margin accounts when the market suddenly declined. These margin accounts were constructed by using broker’s loans (loans collateralized by the securities purchased on margin).  The popularity of this type of loan increased substantially during the 1920s from one billion early in the decade to more than 6 billion in 1928. A billion in 1929 is equivalent to a 100 billion today. Banks were not deterred from making these loans since they could “borrow money from the Federal Reserve Bank for 5 per cent and re-lend it in the call market for 12.” Not unlike the sweet arbitrage the banks could make in the prelude to our Great Recession by packaging mortgage loans into large bonds and turning a substantial profit by holding the bonds for a couple of years. During both periods people realized there was a speculative bubble, and that eventually the bubble would burst. This fact did not deter speculation even though voices were warning of impending disaster. Paul M. Warburg of the International Acceptance Bank in March 1929 predicted unless the “unrestrained speculation” was halted an eventual collapse would “bring about a general depression involving the entire country.”

The irony is everyone benefited initially from the bubble’s rise. Caution was not a serious concern. There was a general feeling among speculators that the market was supported by three strong legs. The action of speculators was one leg of support for the market. The second leg was the upward momentum of exuberant expectation of a continual rise. The third leg of support was a general sense that there was nothing to fear since who would move to deflate the bubble. In other words ineffective regulation was seen as support for the market since the government was unlikely to act and everyone in the market was benefitting from the rise.  Unfortunately, no one stopped to consider how other investors would react if the market turned downward and whether there would be time to exit.

After the Great Depression, Professor Galbraith pointed out, “it has become obligatory for the regulators at every opportunity to confess their inadequacy, which in any case is all too evident.” In March of 1929 the Federal Reserve Bank began daily meetings. They did not inform anyone outside the Fed what the subject of the meetings concerned. Suspicion and rumor focused on the stock market, but that was unconfirmed. During 1929 there were some breaks in the market caused by rumor, but overall the speculative stampede continued. Corporations and even wealthy individuals lined up to provide more liquidity as the banks struggled to provide more and more funding for brokerage loans. By that summer these loans were growing by “$400 million a month.”  There was concern about the degree of speculation that these brokerage loans implied. These concerns were dismissed as coming from people who “simply did not know what was going on.” The 1920s were the period when Wall Street arose as an investment opportunity for the public. It was a very immature industry without a history and a culture of caution and restraint. This exuberance was supported by the highly-regarded academic community. In the autumn of 1929 the foremost American economist of the time, Professor Irving Fisher of Yale made his often quoted estimate of the market, “Stock prices have reached what looks like a permanently high plateau.”

Irving Fisher’s comments reflected the fact that stock speculation had become part of the culture. This trend during the 1920s legitimized an activity that had not earned a place in the economic system through trial and error. Likewise, in the Great Recession housing speculation and expansion of the mortgage market to include lower and lower income participants would also prove disastrous. When A&E launched the TV show Flip this House in 2005 starring Armando and Veronica Montelongo house speculation or flipping was an accepted get rich scheme. Two years later the Housing Bubble burst.

One of the most interesting sections in Professor Galbraith’s book is his debunking of the suicide myth surrounding the Crash of 1929. He shows that statistical analysis supported a slight rise, but nothing to justify the media's characterization of crowds standing on sidewalks waiting for the next businessman to jump to his death. The media similarly misled the public in explaining the cause of the crisis. Instead of looking at the government they focused on finding someone in the private sector to blame. There were Bernie Madoffs in the Great Depression, but like Madoff they were crooks not promoters of speculation.

The real tragedy was the Press’ failure to understand what happened and outline what to watch out for in the future. Professor Galbraith made it clear in his 1954 summary, “It would be unwise to expose the economy to the shock of another major speculative collapse.”  Do you recall anyone in 2006 drawing a parallel between the Housing Bubble and the Stock Market Bubble of 1928? I do not. Why? It is because the gurus over complicated it. We would be better off to simply look into get rich quick schemes and asset bubbles for the next financial crisis rather than a trend line of monetary expansion.

There is no quick way to riches. There is only hard work and slow steady returns. Blaming the cause of financial disasters on lack of self-control or greed is counter-productive. These are characteristics of the human species. Criticism is better directed at the people who create our economic institutions and fail to structure them to constrain speculative impulses and greed. Speculation is only a problem when the economic system lacks proper controls. The problem is an economic system without proper curbs, not people who lack adequate self-control.

When Professor Galbraith asks himself what the cause of the Great Depression is he looks first at why business activity slowed. He finds his answer in the unequal distribution of income. His argument is that if the middle class had more money they could sustain the economy. Isn’t it much more likely that with the financial shock of their monetary loss in the Crash many wealthy investors lost their appetitte for new investment? Looking back we know private investment collapsed reducing job creation and economic growth. These two factors are the cornerstones of business activity. Professor’s Galbraith’s explanation lacks credibility since middle class income levels did not change until after business activity slowed. The Great Depression was led down and kept down by business people unwilling to take risk.

What we can say definitively is that people lost money. Losing money has quite an impact on people. Imagine a gambler from New Jersey arriving in Las Vegas with hope and cash-filled pockets. He leaves his bags with the front desk and goes straight to the tables. Six hours later he has lost 75% of the money he brought along on his vacation. How enthusiastic is he going to be to go back to the tables after dinner? This is precisely what happens after a financial bubble bursts. The shell-shocked business people and investors are not going to charge out of their trenches into the battle again. They are going to hunker down, reassess and wait for a “real” opportunity. Professor Galbraith misses the real causes of the Great Depression and misunderstands the pivotal role of banking and business in making the system work. The problem is the system, not the people in the system.

Rereading this book made me realize Professor Galbraith focused on stock speculators and not on the characteristics of the financial system which nurtured speculation. We now know that the crisis would not have occurred if margin loans were disallowed. We also know that the stock exchanges could have employed curbs to retard large daily movements. Risk curbs also could have been created to protect novices in the market by tying their investment actions to the facilitating brokerage firm. In other words, if the clients of a brokerage firm lost a certain percentage of their client’s money, funds could be removed from a reserve account required to be held by the brokerage firm to reimburse their clients for bad advice. This technique would tie an investor’s risk to a firm’s risk, making both parties act with more caution. Another problem in almost all financial crises is excessive leverage.  Leverage is easily regulated by market rules.

When economic conditions are not persuasive for business expansion investment is going to dry up. Without new investment an economy is going to slowly decline as loans are repaid and money is removed from the economy. It is not the potential for investment that matters, but actual new money coming from banks to create new business lines. More investment means many more jobs and more money looking for products to purchase. Whether this money is equally shared is not significant. One rich man spending an extra $100,000 or 100 people spending an extra $1,000 makes no difference to an economic system. 

Seventy-seven years later a speculative bubble again devastated the economy, an event we now call the Great Recession. The two events are almost twins. The approach of the Great Recession could be seen by a blind economist, but not by a sighted economist looking for help from a government regulator. Sighted and blind economists before and after both crises suggested fine tuning government action was the key to avoiding a repetition. The whole idea of government action doing anything to improve an economy is an inheritance from Galbraith and Keynes. Their focus on government as our financial savior implies the coach is more important than the players. It is the team on the field that plays the game and determines the outcome, not the coach. When the players refuse to play a loss is inevitable. Even if the coach implores the players to play harder and the general manager increases their compensation, if the players decide not to expend all their effort in a game, the team will lose. Speculators did not cause either crisis. The economic field was not prepared properly for the intensity of the game.

 

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.