What Makes A Healthy Economy?

capitalists dilemnaA healthy economy makes everybody happy; in society, in business, in government. In a healthy economy there are plenty of jobs, everyone has disposable income, business thrives, and there is plenty of tax revenue for both political parties to implement their pet agendas. One could also hope there would be less need to borrow so much money just to fund the government Budget each year as well.

But what’s wrong? Why after so long are their so many people still out of work, notwithstanding the faux Recovery and the “prosperity” that no-one can seem to identify, at least in their own lives, nor in the lives of most everyone they know.

The answer lies in a common mistake. Tragically for us, this mistake is being made by the Federal Reserve.

The mistake is, confusing correlation with causality.

For forty years now the Federal Reserve has attempted to stimulate the economy by loosening the money supply, which lowers interest rates. The economy has generally responded, though increasingly more slowly in successive downturns since the early 1970’s, to the point of where we are today, five years after the financial crisis crashing the economy. The Federal Reserve is still pumping $65 Billion into the economy every month, though it is failing to move the needle on job creation and unemployment.

We are finally learning now, at the end game of Federal Reserve economic intervention, that loose money supply is only correlated with job creation and economic prosperity, it doesn’t cause it.

The evidence is there for all to see. Three Trillion dollars of U.S. Currency put into circulation since 2009, and real wages have fallen, middle class America is shrinking, and government assistance is needed by most families just to get by.

But if the Federal Reserve trying to fill the ocean with money does not create jobs, what does?

I don’t claim to know, but I heard the most credible explanation so far from Clayton Christensen in a video I saw on Youtube the other day called A Capitalists Dilemma.

Christensen is most famous for his theory of Disruptive Innovation. Here though he outlines, three types of innovation that occur, Empowering (Disruptive) Innovation, which creates jobs, Sustaining Innovations, which are job creation neutral, and Efficiency Innovations, which eliminate jobs.

What’s fascinating is, as Clayton Christensen points out, a combination tax law, financial deregulation, and the evolution of the banking industry have led to the point in time today where Wall Street banks have reached the point of Efficiency Innovation (which eliminates jobs), and are reinvesting the capital liberated by the efficiencies directly back into more Efficiency Innovations, instead of reinvesting them back into Empowering Innovations (that create jobs), which has been the norm until now.

One of the “efficiency” innovations of Wall Street banks are derivatives, into which they can deploy massive quantities of capital, and achieve huge returns on invested capital inside twelve months. On the other hand, an investment in a startup company, which can take only so much capital, has a high degree of uncertainty about it, and takes five to ten years to return the capital, pales in comparison from the standpoint of an investment bank allocating it’s capital, in pursuit of the highest returns with the shortest wait.

The result is that capital stays cycling through the exotic financial instruments of the big banks, like Goldman Sachs and JP Morgan, generating unfathomably immense profits, while start ups and entrepreneurs are having their loan requests and investment pitches denied, and can’t get funding for their businesses.

As you can see from this video, this is a problem of structure, and proper incentives, and there “is” a way out.

What causes job growth is companies building factories to try and meet demand for products they created which have disrupted an industry (think the Sony transistor radio in the 70’s, PCs in the 80s and 90s), not endless currency being pumped into an economy.

If you prefer to read, Clayton Christensen also wrote an Op Ed for the New York Times, where he lays out the problem and offers some very doable advice for a solution.

I’ll admit, this is a bit macro and big picture, but if economic prosperity doesn’t return to the country, for all, Apartment Entrepreneurs will have a harder time in the future as well.