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Money, Wealth and Inflation

The ubiquitous greenback, the balance in your checking account – your money. If you have a vault stacked with $100s, are you wealthy? What about bars of gold, or a crypto wallet with thousands of Bitcoin? Is money the same thing as wealth? Where does money come from? Where does wealth come from? Are they one and the same?

Money and wealth are both human creations. Wealth is the ability to consume goods and services that are of value to a person. Money is an object created by people, in agreed units, to serve as a store of value and a medium of exchange. Money has taken many forms over time, and across societies – giant disks of stone, sea shells, gold and silver coins, tobacco leaves, and digital code.

Money is created by governments to facilitate trade. The first modern money was created by King Croesus of Lydia (circa 560 – 546 B.C.) who invented standardized gold coins to replace the exchange of gold and silver that had to be weighed to transact each purchase or sale. Trade blossomed in his kingdom in Asia Minor and his people became rich beyond the ancient imagination – thus the phrase “Rich as Croesus.” Paper money was invented during the Song Dynasty in China in the 1100s.

Wealth, on the other hand, is created by people applying their minds and bodies to create goods and services that others find useful. Even for hunter gatherers, the deer in the forest has no value. They must cut sticks and attach sharp stones to create spears or arrows, and then go find and kill the deer before they can access the value of the meat, bones and hide for food, tools and clothing. Similarly, berries have no value until someone finds them, learns the difference between the edible and the poisonous, and goes out and collects them.

Money would have no value without the wealth created by human thought and action. In order for people to trade, each must first create something of value to give in the exchange. Economists call this Say’s Law, named for Jean-Baptiste Say who developed this concept in 1803.

Modern economists, beginning with Keynes analysis of aggregate demand as the cause of the Great Depression, have rejected Say’s law and focus on demand to grow the economy rather than supply. However, I find many problems with Keynes’ analysis. As the classical economist David Ricardo pointed out in a circa 1820 letter to Thomas Malthus, “Men err in their productions, there is no deficiency of demand.” (Malthus had become famous for his theory that human happiness was impossible because population growth would always outpace our ability to grow food.)

Today we label mistakes in production, malinvestments. The housing glut in China, with 65 million empty homes, would be a perfect example. China cannot create people out of thin air to fill all of the empty apartments and those still under construction. The economic problem is not lack of demand, but of producing without considering if there is a market for the product (largely due to government policies). China will now inevitably see a collapse of their housing bubble, beginning with the slow-motion default by Evergrande.

Similarly, the COVID stimulus packages that resulted in checks going to most Americas, did not create any wealth. Further, since many people were affected by lockdowns, U.S. production of goods and services was lower than normal, with GDP dropping 9.1% from an annual rate of $21.7 trillion in the fourth quarter of 2019, to a pandemic low of $19.5 trillion in the second quarter of 2020, and not recovering to pre-pandemic levels until the first quarter of 2021.

Source: https://fred.stlouisfed.org/series/GDP

During the pandemic, the government has increased the money supply approximately 35% from $15.5 trillion at the end of 2019 to $21.2 trillion as of October 2021. Note the sharp upward bend in the chart:

Source: https://tradingeconomics.com/united-states/money-supply-m2

The increase in money along with a restriction of production has caused our current bout of inflation. There is a third factor in inflation – the velocity of money, which is a complex topic I will address in another piece.

Further, many goods consumed during the pandemic have been imported from countries that have been able to continue production, particularly China. The monthly trade gap has increased from a range of $40 – 50 billion per month, pre-pandemic, to $65 – 80 billion per month during the past year. One wonders, how long exporters will continue to accept the depreciating dollar for their goods?

The bottom line is that government does not create wealth by handing out money. For the moment, the US is able to get other producing countries to accept our depreciating dollars in return for goods that can be consumed and are thus wealth. The government can shift future consumption into the present by borrowing, but that debt must be repaid in the future either by taxpayers, through tax increases, or by holders of financial assets, through inflation. There is no such thing as a free lunch.

Jim Miller, an alternate on the Lyme, CT Board of Finance, is an occasional contributor to CT Examiner.

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