Tuesday, December 17, 2013

Wealth accumulation hinges on wealth destruction

Wealth must be destroyed. This is the hardest thing for any rational person, what more an economist, to accept. Strange as it may sound, modern civilisation wouldn't have existed if wealth accumulation hadn't been accompanied by wealth destruction. Whenever wealth is allowed to accumulate, it inevitably will lead to wealth imbalance, and the longer it persists, the more extreme the imbalance becomes.

If you've read some of my past posts, you'd be aware by now that past societies collapsed because wealth accumulation had become extremely imbalanced. Those that survived past such extreme wealth imbalance stage did so because they were smart enough to destroy wealth. To lend support to my contention that extreme inequality is the root cause of economic depression, read this illuminating article by Peter Turchin at Bloomberg.com.

Also the chart below taken from that same article is evident of the increased violence associated with the decline phase of each Kondratieff wave. Note that there was no violence spike in the US in 1820. The most plausible explanation for this is that the first Kondratieff wave (1780-1840) was initiated in Britain while in the US that wave occurred very late and was subsumed by the second Kondratieff wave (1840-1900). As for the fourth Kondratieff wave (1960-2020), the 1970 spike was related to inflation instead of deflation. The real spike has been deferred by the massive credit increase lasting from the Reagan administration to the first term of Obama administration. Now that the stimulus has run its course, we can expect more discord and possibly incipient signs of the breakup of the US. It's not something that the rest of the world should gloat simply because a similar fate also awaits them, and probably coming much earlier, too.

Even Obama has added his voice to the inequality issue with his recent economic mobility speech. However this inequality talk misses the point: it should have been about circulation, rather than inequality. Likewise the common perception among modern economists is that an economy is all about wealth generation, distribution and accumulation. Excluded from this list is wealth circulation though without it, the rest would cease. In any ecosystem or living organism, circulation is a precondition for the system's vitality. Without the water cycle, desertification will rule. Without ocean currents, life in the seas will perish. Without termites diligently destroying plant material, nutrients could not be returned to the soil to nourish new plants. But how do you circulate wealth when the flow has become a one-way street? You must destroy wealth, yes, wealth destruction to enable wealth circulation.

If you find it hard to grasp the significance of wealth circulation, the Monopoly board game serves as an excellent analogy. As the game progresses, wealth flows unidirectionally, from the losers to the winner, before the flow eventually seizes up and the game ends. You can continue playing only with a new game, meaning the wealth from the old game is disregarded, including no inheritance of wealth, which is a major cause of inequality. But our real life game has no closure unless one commits suicide, which is what an increasing number in most economically troubled countries have opted to.

Extreme wealth accumulation can hinder wealth circulation especially during the end phase of a Kondratieff Wave when wealth is no longer spent but saved. Credit growth which is the only means of distributing wealth is not sustainable as wealth from the credit growth continues to flow in one direction, with the government bearing the burden of increasing debt. Anyway the anaemic economic growth during this phase of the Kondratieff Wave is not caused by low credit growth but by the inability of the losers to earn enough incomes to afford consumption.

The falling incomes then suppress credit growth. To counter this, the politicians bear massive deficits to boost spending and in doing so, raises government debt. These fiscal deficits will fail once the money runs out as it does now. Meanwhile, the policymakers work on lowering the interest rate, hoping that the private sectors will continue borrowing. It does encourage borrowings but for the wrong reason: instead of borrowing to spend on consumption or productive investment, they lavish on speculative investment.

Obama is now emaciated along with the tapering of his fiscal deficits. But the speculative investment is still holding up with stocks and oil being the last refuges though not for long. The forces of destruction will wear them down. In due time, the world will see that all the efforts put in by Obama and Bernanke, soon Yellen, are all for naught.

We can't depend on nature to unleash destruction. Whether it's tsunami, hurricane or typhoon, the destructive impact is always localised. Only plague has the potential to claim victims without regard to class or race but the likelihood of another pandemic is slim unless mankind misuses the power of biotechnology to concoct new microbes. Similarly, inflation which has the effect of depreciating financial wealth loses its effect in a situation of surplus capacity unless Mugabe is at the helm since he's also adept at destroying capacity.

As overcoming the present poor economic growth is beyond our powers, we must resort to one of the following five forms of wealth destruction to enable wealth circulation:
  1. Annihilative destruction
  2. Authoritative destruction
  3. Creative destruction
  4. Donative destruction
  5. Exhibitive destruction
In all these cases, the aim is to transfer wealth from the rich to the poor. There's no point sucking wealth from the poor as they don't have wealth to begin with.

 Annihilative destruction usually arises from war, the worse the destruction the better will the recovery be provided massive financial assistance is extended by the US, the only country with enough financial wherewithal, to the war protagonists. Given the horrors of war, it's something to be avoided but when it had occurred, postwar economic growth tended to be remarkable. The current fourth Kondratieff Wave (1960-2020) however lacks a major war though in its early phase, the global economy benefited from the rebuilding efforts of the WW2. The economic impact of subsequent wars was more localised. The Korean war financed the rise of Japan while the Vietnam did the same to Korea, all at the US expense.

The Iraq and Afghan wars have cost almost US$2 trillion with the eventual bill covering both direct and indirect costs to reach US$4 to US$6 trillion. However relative to the size of the US economy which currently stands at US$16 trillion and the fact that the wars have stretched over 10 years, the total annual spend is small change to the US economy. As for the future, given the size of the US government borrowings now, the US can no longer afford to fund a large scale war, closing up this option of wealth destruction. For other countries to wage wars including internal civil wars, that would be a foolish venture since they don't have the wealth to finance the rebuilding without the US assistance.

The authoritative wealth destruction occurs when financial wealth is destroyed at the whim of the state ruler. It can only work in an autocracy. Given the compounding nature of interest, debt will always grow exponentially but we know that an economy grows in a Kondratieff wave manner. So over time, debt will outpace economic growth. If this is allowed unimpeded, the financial wealth holder will own all the wealth. Their rise would also challenge the authority of the state. In fact, it can be observed now in most democracies that the wealthy have been able to influence the state with their political contributions and powerful lobbies.

The enlightened rulers of ancient Mesopotamia, Egypt, Assyria and Jerusalem at various periods, especially on the ascension of a new ruler, resorted to debt cancellation and general amnesty. The debts covered those owed to creditors as well as the state. Failure to do so would disrupt social cohesion, resulting in violent social struggles. An autocracy can also produce an unenlightened ruler, and it was the rise of such a ruler that condemned the state to chaos as land expropriation and debt enslavement took hold. A democracy however thrives if wealth creation keeps being renewed. In short, there's no best form of government. But as voters now are of the opinion that democracy is the ideal form of government even when wealth creation is subsiding, they have unwittingly trapped themselves into a situation of mass impoverishment.

The rise of democracy actually has coincided with the rise of technology in powering economic growth. Technology needs continual renewal to destroy the old and replace with the new in a process, known as creative wealth destruction. The wealth tied up in old production and communication facilities will be rendered obsolete by the new. Each renewal cycle comes in the form of a S-curve, known as the Kondratieff wave. Each wave lasts 60 years and there can be only a maximum of 5 waves. Why stop at 5? Because in terms of speed, we have reached the limits: the virtual is now instantaneous and with 3D printing, the physical will soon be. As for size, with the help of nanotechnology and biotechnology, we will soon be manipulating molecules and cells; you can scale down no further. As regards energy, we will enjoy virtually free energy, again thanks to nanotechnology and biotechnology. The nation-state will disappear to be replaced by small tribes, all in conflict with one another.

The creative wealth distribution cannot be hastened. It takes 60 years. Now, we are in the ending phase of the fourth wave. Even when this wave ends, the fifth wave will also takes its own time to mature. If you think the fourth wave is disruptive, the fifth will be multiple fold the fourth in terms of disruption to society. In short, we will be in the economic doldrums for quite a long while.

The donative or beneficial wealth destruction is a transfer of wealth from the wealth holders for beneficial purposes. The modern example is the Bill & Melinda Gates Foundation in which Bill Gates channels most of his wealth for philanthropic activities in health, agriculture, education and relief works. One problem with private charity is that it reflects only the donor's view of what is best for the community which may not necessarily be what the community really needs.

But the iconic example of donative as well as creative wealth destruction remains Andrew Carnegie whose father was devastated by creative wealth destruction when his handloom weaving had been made obsolete by mechanised steam weaving in Scotland. The family migrated to the US where Andrew Carnegie benefited from the same process that broke his father, this time on the back of steel to build his fortune. He was relentless in his business pursuit, being ruthless with both his competitors and workers. His incessant drive for efficiency meant that the latest equipment was installed to replace outdated one, in the process more than recouping the investments through savings in manpower and greater efficiency. After selling his steel corporation to JP Morgan in 1901, he made sure all his wealth was used for philanthropy. This is one man who understood that life was a game: you play hard to win and when you finish playing, you give back the winnings so that others can continue playing.

The last wealth destruction, the exhibitive wealth destruction is no longer practised. It used to be carried out by the Indian tribes living the Pacific Northwest Coast of Canada and the US. The most famous is the potlatch held by the Kwakiutl tribe. The Kwakiutl were wealthier than the neighbouring tribes. The potlatch ceremony involved rival chieftains distributing and destroying their  most valued possessions, which included burning blankets and canoes, and throwing copper into the sea. Each would outdo one another, the one with the most wealth remaining would be declared the winner. It was a status competition which gave great prestige to the winner. The Canadian government in its lack of wisdom made illegal this practice in 1884. After the 1920s, this practice began to dwindle but the unintended effect was worse; without the potlatch, the urge to accumulate wealth declined and so did the Kwakiutl economy. The secret to the Kwakiutl's successful wealth accumulation had in fact been its wealth destruction. If only the rich in our present society had destroyed or distributed their wealth in an annual competition instead of flaunting it, they would have have been extolled instead of inciting resentment in the rest of us.

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