Posted by PITHOCRATES - May 14th, 2012

Economics 101

Wealth is the Stuff we use our Talent and Ability to Make

Mercantilism gave us the United States.  For it was because of these policies that the British established colonies in North America.  And it was those same policies that led to American Independence.  Because those polices pissed off the Americans. 

The mercantile system came into being as nation states arose from feudal estates.  Kings arose and consolidated these estates into larger kingdoms.  Then one king arose to consolidate the kingdoms into a nation.  Creating Spain, France, the Netherlands, England, etc.  Enlightened thinking and better technology created food surpluses.  With food surpluses a middle class of artisans arose.  And manufactured goods.  People met in markets to trade their food and goods.   These markets grew into cities.  All of this economic activity created wealth.  Food.  And manufactured goods.  That we bought with money.  Often silver and gold. 

There was wealth.  And there was money.  Two different things.  Wealth is the stuff we use our talent and ability to make.  Food and manufactured goods, for example.  And the more food and manufactured goods a nation has the wealthier that nation is.  This is a critical point.  And the mercantile policies ultimately failed because those policies mistook money for wealth.  But money is not wealth.  It’s a temporary storage of wealth.  To make our trading of food and manufactured goods easier.  By reducing the search costs to find people to trade with.  Which is why the barter system failed in a complex economy.  It just took too long to find people to trade with.  Money solved that problem.  Because you could trade what you had for money.  Then trade your money for what you wanted.

England used the Positive Flow of Bullion to Finance the Building of the Royal Navy

Mercantilism focused on the money.  And used wealth to accumulate it.  Instead of the other way around.  The way most advanced nations do today.  These European nations accumulated money with international trade.  Beginning in the 15th century they started looking at the balance of trade between nations.  And did everything they could to maintain a positive balance of trade.  Meaning they tried to export more than they imported.  Why?  Well, nations often did trade with each other.  So they owed each other money.  And when you settled your account if other nations owed you more than you owed them there was a net flow of money to you.  Bullion.  Silver and gold.  Which is what they wanted.

To maintain a positive balance of trade the government actively intervened into the economy.  It set up monopolies.  It provided subsidies for manufacturers who exported their goods for bullion.  It placed tariffs on imports.  Or simply blocked the importation of any goods that they produced domestically.  They set up colonies to harvest raw materials to ship back to the mother country.  Which would use those raw materials in their factories to produced higher valued finished goods.  That they would export.  Especially to their colonies.  Which were convenient captive markets for their finished goods.  On the mother country’s ships.  Through the mother country’s ports.  Where they, of course taxed it.  Guaranteeing that at every step of the way they added to the positive bullion flow back to the mother country.

And it worked.  To a certain extent.  England used that positive flow of bullion to finance the building of the Royal Navy.  Which proved invaluable in the wars that followed in the mercantile world.  For mercantilism is a zero-sum game.  For every winner there had to be a loser.  Which is why this era was an era of world war.  To wrest control of those colonies.  And those sea lanes.  Great Britain came out the victor.  Thanks to their Royal Navy.  But it wasn’t all good.  For Spain found gold in the New World.  And they took it.  Shipped it back to the Old World.  Just like a good mercantilist would.  Which caused problems in the Old World.  Because money is not wealth.  It’s a temporary storage of wealth.  And when they inflated their money supply it took more of it to hold the same amount of value it once did.  Because there was so much of it in circulation.  And what happens during inflation?  Prices rise.  Because the money is worth less it takes more of it to buy the same things as it did before.  So by hording bullion to create wealth they actually destroyed wealth.  With wealth-destroying inflation.

With the Boston Tea Party the Americans Renounced Mercantilism and Demanded Free Trade

Spain was one of the greatest mercantile nations of the era.  But they quickly became a shadow of their former self.  Even though they had more bullion than their European neighbors.  For it turned out that those mercantile policies hindered economic growth.  Which is the true source of wealth.  Economic growth.  Where people use their talent and ability to create things.  That’s where the true value lay.  Not the money that held that value temporarily.  All those mercantilist policies did was raise domestic prices.  And allocated scarce resources poorly. 

It turned out free trade was the secret to wealth.  For free trade can increase wealth.  For both nations.  Thanks to something we call comparative advantage.  Instead of both nations manufacturing all of their goods they should only manufacture those goods that they can manufacture best.  And trade for the goods they can’t manufacture best.  This more efficiently allocates those scarce resources.  And produces a greater total amount of wealth.  By allowing people to buy lower cost imports they have more money left over to buy other stuff.  Increasing the overall amount of economic activity.  Which is why when Great Britain adopted free trade in the 19th century the British Empire went on to rule the world for a century or so.  And led the Industrial Revolution.  By creating wealth.  Goods and services people created with their talent and ability.  That changed the world.  And ushered in the modern era.  Something no amount of bullion could do.

But before Britain adopted free trade they were struggling with one of their belligerent colonies.  Their British American colonies.  Who were unhappy over taxation without representation in Parliament.  And the mother country forcing them to buy only British tea shipped on British ships at higher prices than they could get from the Dutch.  The British thought they found a solution to their problem.  By permitting their British East India Company monopoly to ship their tea directly to America without passing through an English port.  The tea was cheaper because of this.  But it also would set a precedent for taxation without representation.  Something the Americans weren’t about to accept.  So they threw that tea into Boston Harbor.  What we affectionately call the Boston Tea Party.  Renouncing mercantilism.  And demanding the right to engage in free trade.  Which they got after winning their independence.  And the mother country would follow suit in a few decades.  Because they, too, would learn that free trade was better than mercantilism.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Fiscal Policy

Posted by PITHOCRATES - February 6th, 2012

Economics 101

The Constitutional Convention in Philadelphia (1787) was about Money and Unity at the National Level 

Once upon a time in America federal taxes were small.  As was federal spending.  The Constitution called for little.  The only big ticket items being an army and a navy.  To protect the new nation.  But Americans didn’t like paying taxes then any more than they do now.  There wasn’t even a federal income tax until the 16th Amendment (1913).  So even maintaining an army and a navy was difficult.  Which led to a lot of problems.  For a nation that couldn’t protect herself got pushed around in the rough and tumble world.  And the U.S. took its share of swirlies and wedgies in her infancy.  Figuratively, of course.

Just as kings needed money to maintain their kingdoms, the Americans needed money to maintain their new nation.  Which was the point of the Constitutional Convention in Philadelphia (1787).  It was about the money.  And unity.  Which the new nation (that just gained its independence from Britain) had little of.  So we got a new constitution.  And a new nation.  And the federal taxing and spending began.  Which was small at first.  Too small for Alexander Hamilton.  But far too much for Thomas Jefferson.  In fact, Jefferson thought any federal spending above zero was too much.  And when he was president he slashed government spending.  To the point that it hurt the safety of the United States.  But he also bought the Louisiana Territory.  And used the Navy and the Marine Corps to protect American interests abroad.  These two items alone required enormous amounts of federal spending.  And borrowing.  Another thing Jefferson was dead set against.  And we’re talking sums of money that not even Alexander Hamilton had proposed.  Yet here was Jefferson, the limited-government president, spending and borrowing unlimited funds. Being more Hamilton than Hamilton himself.

Of course, things change.  Even for Jefferson.  The Louisiana Purchase was a deal that no president should have passed up.  Thankfully, Jefferson took that opportunity to more than double the size of the United States.  Without a war.  Unlike Napoleon who was conquering Europe.   But he was burning through money.  And he needed money more than he needed the Louisiana Territory.  Hence the Louisiana Purchase.  Which turned out to be quite the bargain in the long run for the U.S.  And the antimilitary Jefferson flexed America’s might by teaching the Barbary pirates a lesson.  By deploying the U.S. Navy and Marines to the Shores of Tripoli.  The first U.S. victory on foreign soil.  Giving the U.S. respect.  And a cessation of those swirlies and wedgies.

Keynesian Stimulus Spending may lessen the Severity of Economic Recessions

These things cost money.  And the lion’s share of the federal budget was defense spending.  Per the Constitution.  For that was one of the main things the several states could not do well.  Maintain an army and a navy.  Because they needed unity.  One army.  And one navy.  To protect one nation.  So the states and their people could pursue happiness without foreign aggressors molesting them.  So this is how federal spending began.  But you wouldn’t know it by looking at fiscal policy today.

Fiscal policy is the collection of policies that government uses to tax and spend.  But it’s more than just defense spending these days.  Federal spending had grown to include things from business subsidies to Social Security to Medicare to food stamps to welfare to income redistribution to farm subsidies.  And everything else you can possibly imagine under the sun.  None of which was included in the Constitution.  Because neither Jefferson nor Hamilton would have agreed to these expenditures.  But it doesn’t end with this spending.

Fiscal policy also ‘manages’ the economy.  Or tries to.  By trying to maintain ‘full employment’.  Which means they adjust tax and spend policies so that anyone who wants a full time job can have one.  Based on Keynesian economics.  And the business cycle.  The business cycle is the cyclic economic transitions between economic expansions and contractions.  The inflationary and recessionary boom-bust cycles.  No one likes recessions.  Because people lose their jobs.  And have to get by on less money.  So Keynesian economists say to lessen the severity of recessions the government can take action to stimulate economic activity.  They can cut taxes.  Because when people pay less in taxes they have more disposable income to spend on economic activity.  Which they say will keep people from losing their jobs.  And create new jobs.  Or the government can spend money.  Picking up the slack from consumers who aren’t spending money.  Thus saving and/or creating jobs.  Which stimulus depends on the political party in office.  In general, Republicans favor tax cuts.  And Democrats favor spending.

All Keynesian Stimulus Spending is Deficit Spending

But it’s not as simple as that.  Because during recessions tax revenues fall.  When people earn less they pay less in taxes.  Far less.  Especially if an interruption in their income puts them into a lower tax bracket.  And if you run through all of your unemployment benefits, it will.  So there’s more to economic stimulus than meets the eye.  For to stimulate a government must borrow money.  Or print money.  Because all stimulus spending is deficit spending.

Keynesians say this deficit spending is not a problem.  Because once the stimulus turns the economy around there will be plenty of new tax revenues to pay back the money they borrowed.  But that rarely happens with a tax and spend government.  Because they like to spend.  As is evident by the ever increasing federal debt.  And when they get more tax revenue they spend that tax revenue.  On anything and everything you can possibly imagine under the sun.  Often times cutting defense spending to help pay for all that other spending.  Despite defense spending being one of the few things enumerated in the Constitution.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,