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Sunday, February 27, 2005

Zero-Sum Versus Wealth Creation

I keep thinking about Wilkinson's article on Capitalism and Human Nature. I spent some time on his blog site, The Fly Bottle, and I noticed a trackback to a blog (Mixing Memory) that is, you might say, less than impressed with his work, and with evolutionary psychology (EP) in general. The writer, known only as Chris, asserts that Wilkinson's reliance upon EP is unfounded at best, and illogical at worst. This is no surprise to me - there are lots of folks, many of them reputable academics, who think EP is a farce, mainly because they think you can't prove any of it. I'll put aside my response to the naysayers at large for now and deal directly with one of Chris' statements against Mr. Wilkinson.

A central point in the Capitalism and Human Nature piece is that humans in the ancestral environment lived in relatively small groups, which led them to be coalitional (proned to in-group prejudice), hierarchical (aware of and in pursuit of status), and envious zero-sum thinkers (that is, they conceived of a finite pie and felt enmity toward individuals who amassed too much of it). This is standard fare for EP. Wilkinson's point, however, which is a very good one, is that this kind of nature does not bode well for the invisible-hand type of economy. Chris, of Mixing Memory fame, however, sees this aspect of Wilkinson's article as bordering on the nonsensical.

He writes, "In fact, it is the coalitional and hierarchical nature of human groups that makes economic and power hierarchies so natural, and readily accepted by most individuals." Really? In my view, the only thing natural and readily accepted by humans is the tendency toward reciprocity. Getting from small-group trade to a free-market economy, complete with free-market financial systems, is not just a series of baby steps, all easily navigated by our default DNA. Chris' statement, in my mind, betrays his misunderstanding of the depth of Wilkinson's insight here. I'm not at all shocked that one who understands science, or appears to, would be less erudite in matters economic. Indeed, I'd say most people don't understand the difference between having a zero-sum economy and an economy that creates wealth. Allow me to oversimplify it. It all comes down to where the money is kept.

The concept of wealth creation is sometimes difficult to grasp, but at its most basic level, it has to do with the relationship between the aggregate amount of money the country would have if each person kept his or her portion at home under the mattress (we’ll call this real money) and the aggregate amount of money the country has when most money is kept in banks (call this funny money). To understand this, we need only understand the fractional reserve system, which is the system used by all banks in the US. The idea is that banks only keep a fraction of their deposits on hand. When you deposit a dollar into your bank, it may only add 15 cents to its cash. The rest is loaned out to other customers. The borrowers may then deposit the money in that bank or another bank, and the process is repeated again and again. The effect is the creation of a huge difference between real money and funny money. This was made possible the moment the US went off the gold standard, but we need not digress.

The point is that when money is kept in banks, the economy as a whole has considerably more money than it would have if everyone kept their money at home under their mattress. Wealth is created. In a zero-sum economy, there is a finite pie that can only be divided so many times. In a wealth-creating economy, there is what is normally a finite pie, and then laid over it is this artificial pie that miraculously expands the pie below as it grows. Don't worry if it's hard to visualize - your genes have no frame of reference for this, because it occurs nowhere else in nature. The wealth-building economy (also known as the free-market economy and the capitalist economy) is the brain-child of men who were so far outside the box, they couldn't even see it. How about a more practical example?

(I think I've heard Neal Boortz use this example.) Suppose two people win the lottery, five million cash for each of them. One guy buys himself a big, nice house. He buys lavish gifts for his friends and family, and generally lives it up till the money runs out. The other guy uses his money to buy a Waffle House. He ends up hiring 20 people, taking out a loan for a piece of property, and staying in business for years to come. The question that is usually asked is, who is better? Both guys are rich, so if you hate the rich, should you hate them both equally? I'll sidestep that and use this example to point out the difference between zero-sum and wealth creation. The first guy lives in a zero-sum world. He takes his money and spends it till it's gone. The second lives in a wealth creation world. He takes advantage of the fractional reserve system that underlies our economy and he creates a money machine that ends up bringing in far more revenue than his original five million. It costed no one anything for him to do this. No exploitation involved. No cheating involved (we may assume). In fact, he created jobs in the process. He expanded the pie for everyone.

So, to get back to Mr. Mixing Memory, Wilkinson's point is that our nature is not inherently equipped to grasp a wealth-creating economy - an economy that is not finite, an economy that is not zero-sum, and economy that is not heirarchical (at least relatively speaking), and an economy that is not coalitional (our Waffle House lottery winner did not know about, nor did he care about, whomever might benefit from his choices). But...as the invisible hand concept evokes, man has no need to grasp the mechanics of this kind of economy. It does its job - it satisfies individual small-scale demands; the rest takes care of itself. Indeed, Wilkinson is saying that capitalism works well with human nature, even if humans are not wired to understand it. Am I the only one who sees the irony in guys like Chris at Mixed Memory not understanding it either?

23 Comments:

Blogger alice said...

Wow, no comments on your last two posts. What's going on. I haven't read this one in it's entirety but I just had to tell you the following:

I got Hoffer's The True Believer. I thought it would be in philosophy but it was in sociology (at Barnes and Noble) I went home and looked him up in my college sociology book and he was nowhere to be found.

I'm halfway through, which is no great feat because it's a "slim volume". First impression...I don't like it. It drones on and on. He makes statements and doesn't back anything up. He doesn't define his terms. It's all just his opinion, which I must admit he makes clear in the introduction. Some how I can see him on his lunch break at the docks with a grubby notebook, jotting down his "impressions".

I would say it's much ado about nothing but I guess mass movements were pretty relevant in the 50's because of Nazism and communsinsm.
(he never includes the American Revolution in his list of mass movements).

I will go til the bitter end and then reflect.

I also bought the "Selfish Gene" I love the blurb on the cover "the sort of popular science writing that makes the reader feel like a genius".

That's for me!!!

2/28/2005 10:58:00 AM

 
Blogger alice said...

PS:
Lest you chide me for my lack of insight I do know there is a mass movement afoot today, Islamic fundamentalism. In view of Hoffer's commentary I wonder if the Neo-cons are handling it effectively. Hoffer seems to advise that to upset the coalitional structure of a society will only bring about more "frustrated" people.

2/28/2005 11:41:00 AM

 
Blogger alice said...

PS:
Lest you chide me for my lack of insight I do know there is a mass movement afoot today, Islamic fundamentalism. In view of Hoffer's commentary I wonder if the Neo-cons are handling it effectively. Hoffer seems to advise that to upset the coalitional structure of a society will only bring about more "frustrated" people.

2/28/2005 11:43:00 AM

 
Anonymous Gareth said...

Caveman,

I agree with your basic point (that our minds are not evolved to understand financial markets), but I think you need to distinguish between creating money and creating wealth. As you point out, the existence of a fractional reserve system allows banks to create a lot more money than currency (this was true before the US left the gold standard, BTW).

But the creation of wealth is something else. If there is not enough money (or liquidity) about, it can cause a capitalist economy to seize up and deflate, but if there is too much, it causes inflation.

Wealth, on the other hand, is created by the use of factors of production in increasingly productive ways.

2/28/2005 12:00:00 PM

 
Blogger enlightenedcaveman said...

You've identified a classic problem in the social sciences - how do you prove your assertions? This is actually a major problem for evolutionary psychology, as well. You can make statements all day long about human nature and what drives humans to engage in certain behaviors, but proving that a certain stimulus always, or even almost always, produces a certain response is all but impossible.

With human behavior, the field of confounding factors seems limitless. The moment you say this or that is human nature, someone can come along and point out another consistent common denominator that could explain what we see. So what to do?

If we choose to be as rational as David Hume in his last days, we'll decide that none of this is even worth discussing. If it can't be proven, it's a waste of time. However, this, to me, seems absurd. We just have to be careful about what we do with knowledge (or ideas) that isn't supported adequately with falsifiable experimentation.

This is where critical rationalism comes in. It gets us out from under relying upon reason so much that we can't conclude anything. We can take the field of explanations for a given phenomenon (say mass movements) and put them side by side. Then, we choose the one with the least evidence against it. We're not saying it's true; we're only saying that, if pressed, this would be our preferred explanation.

So, yes, Hoffer is pretty much bullshitting about the mindset of the true believer. And yes, he hasn't proven (or even attempted to prove) anything he's saying. But that doesn't mean it isn't valuable. That doesn't mean we shouldn't keep it in the backs of our minds and notice how right he is time after time. And when opportunities come up for us to test his ideas in our own lives, it doesn't mean we shouldn't. I think we should.

The only line to be drawn is in making public policy using these kinds of ideas as the basis. You can't make a law outlawing being newly poor (absurd, I know) because it makes people frustrated and susceptible to mass movements.

At the same time, you can't put forth an economic system based upon someone's hunch about human nature, although that is *exactly* what happened with socialism and communism, thanks to Marx's notions of human perfectibility. Capitalism exists and is spreading not because it takes advantage of human nature, but because it works. That's the best reason to do anything.

It just so happens to be an interesting intellectual exercise to ponder how our genes have effectively been tricked into participating in an economic system that is well beyond the grasp of the average person.

2/28/2005 12:28:00 PM

 
Blogger enlightenedcaveman said...

Yes, Gareth, you're right about that. I'll use my, "I told you I'd oversimplify this" get out of jail free card now. Anyway, you're correct that there is a distinct difference between the creation of money and wealth. However, I think they are very much connected.

In fact, I'd say that the heights that we've reached here in America would not have been possible without a fractional reserve system. This availability of more money than actually exists allows for the division of labor to hit levels of innovation that are simply unttainable with *real* money.

That's why I say it all comes down to where the money resides. If it's in banks, there's more of it than actually exists, which means more is available for investment in productivity. And yes, this quasi-ponzi scheme has its downfalls, which is why the Federal Reserve is supposed to exist.

They *should have* slowly tightened the money supply (that is, raised interest rates) in the late 1920's in response to overspeculation on the part of investors. Instead, they raised interest rates dramatically, signaling a problem that resulted in runs on banks, plummeting prices, and ultimately, the great depression. Like I also said, capitalism is the best *but not perfect* system out there.

2/28/2005 12:37:00 PM

 
Blogger Michael Gersh said...

You can analyze markets and systems, but they hide the real essence of what is going on. The key thing is that humans have the capacity to be productive. We can produce more than what we can hunt and gather. That is why Malthus was wrong, and also why we have more of every single resource than we used to. Humans can take a rock and make a tool. We can take a seed and find ways to make a stronger plant.

Concentrating on how wealth creation is handled, or where the cash is kept, can confuse. After all, governments can, and often do, merely print more money. The key point is that when this created money is loaned or given to those who are productive, and will create something with it, rather than consume it. Some of those of the left might believe that humanity is a vermin species, that all the bad in our environment is the result of human activity. The other side of this argument is that all that is good, beyond unfeeling plants, animals, and trees, has been created by humans, the only species that can leave more on this planet than what we can find here, the only species that can produce, rather than consume. However wealth creation is systematized, humans have always produced, and that is what is important.

2/28/2005 12:59:00 PM

 
Blogger enlightenedcaveman said...

"Concentrating on how wealth creation is handled, or where the cash is kept, can confuse."

Yes. Adam Smith and Will Wilkinson (not trying to say they're on the same level) are saying exactly that. No need to dwell in the details because one need only focus on meeting his or her demands with whatever he or she has to trade. They both, however, note how amazing it is that this little manipulation of human nature could have such far reaching consequences.

2/28/2005 02:51:00 PM

 
Blogger analogee said...

alice, just a comment on The True Believer. It's interesting to hear your impressions as you read it. I read it about 3 or 4 years ago. My impression was that it had some profound insight, but that Hoffer was less than a master writer, and that perhaps the whole thing could have been done as an essay.

But to say it's much ado about nothing is incorrect, I think. Having been associated with what probably is a mass movement, I saw the attitudes and behaviors described in the book, and it is very likely that this book will have had a major impact on my life. Yes, mass movements still exist, and are being started, and I think the insight is needed, and lacking, by and large, in the world.

As I recall, Hoffer kind of witholds judgment on whether all mass movements are bad. I think the American Revolution probably qualifies as one. I'm sure there is disagreement on whether it was a good or bad thing, but probably most would at least agree that it was more benign than Nazism.

One question that remains in my mind (perhaps I missed the answer, or forgot it: let me know if you come across it) is this: What is the motivation of the leader(s) of the Mass Movement? I can follow which characteristics of the followers are exploited, but I have difficulty understanding why anyone would want to start such a thing.

2/28/2005 04:02:00 PM

 
Blogger analogee said...

EC, I'm not convinced that EP can be pursued scientifically. I'm not convinced that just P can be pursued scientifically, although it seems there is more of a chance for it.

Reasoning from analogy is dangerous, but hey, it's part of my username, so here's my take on it: In my work as a circuit designer, I've come across many circuits for which I had a certain impression about how they work. But every so often, one of the little buggers is sitting right in front of me, fooling me, until hours or days of testing and analysis reveal the real nature of its behavior. The thing is, the circuits are relatively simple. The theory (which inevitably is vindicated in the end, as I learn how to apply it properly to the case at hand) is also elegant and simple. In other words, there are some rock solid fundamentals on which we've learned we can rely, without question. But even so, it's EASY to fool oneself. Only the reality, sitting on the bench in front of me, is able to correct me.

I see none of the simplifying factors with EP. The subject is NOT simple; it's probably one of the most complex ones we deal with. And the objects of our potential experiments are not in front of us; instead they have been dead for thousands of years. The remains reveal little of what was in their minds. Even the date of their death is somewhat uncertain, as we can't go back, duplicate the conditions with a test corpse, and see whether our methods are accurate. See what I'm saying?

I confess I have not read any of the books on this yet. I'll work on that. But, my state of mind right at the moment is extreme skepticism. Can you give an example of how a particular theory of EP is falsifiable?


On the other hand, you redeem yourself, EC, when you point out that you realize there is no absolute proof, and you're just trying to eliminate the candidate explanations that have the most evidence against them. I'm just having trouble reconciling that with your assertions that EP is a real science. Not that it isn't worth pursuing, but I think there is a fundamental difference between, say, physics, and EP. Just like there is a difference between a physics book, and The True Believer.

2/28/2005 04:38:00 PM

 
Blogger alice said...

Thanks so much EC for this forum. I'm learning a lot. Today I read the posts and have been thinking about things all day, especially as I am sanding. I try to keep more focus when I'm measuring and cutting.

A couple of things...as I was reading The True Believer I was thinking that Hoffer's writing style reminded me of someone else's. I think I have figured out who's... Karl Marx. It seems to have the same cadence I noticed in "Das Kapital". Of course I read a translation, but it was the same type of writing. One observation piled up against another, no real proof of their veracity, but stated as fact. Interesting that both Marx and Hoffer are considered to be sociologists.

Second, when I visited Barnes and Noble I had to find out where these books were located. I expected Dawkins to be in Science, but no, an entire section was dedicated to evolutionary psychology. Is this a mass movement?

And Analogee, I'm dying to find out about your mass movement. I must admit when I was just out of high school I spent some time in the grips of Scientology (I'm so embarassed!) and then of course I tried my very best to be a hippie. I just couldn't ever conform enough, however, and I always ended up not wanting to be told by anyone what was really going on. I wanted to find out for myself. Hoffer says that adolescents are ripe for mass movements. I agree with this. For a young person, life is just too fucking confusing.

At this point I come down on the side that any "psychology" is more art than science. But you brought up physics. Now there is something which is not intuitively understood by the human brain (least of all mine) because we cannot see with our eyes the things it deals with.
I have been trying to plow through a book on quantum physics for the last year and it's a mind bender.
It definitely does not make me feel like a genius.

And then one more thing before I make dinner. I never went to college after high school, but have been in the process of educating myself ever since. I took to reading philosophy a while back. One of the things I noticed was that the writers always seemed to be debating someone who wasn't identified. I didn't understand what that was about until someone told me that philosophers were almost always trying to disprove some other philospher's argument.

Seems to be what's happening here, too. Cool.

2/28/2005 10:02:00 PM

 
Blogger analogee said...

just to respond, alice, on my 'mass movement'; I'm not ignoring you. It's not something I'm ready to air out in such a public forum.

"I just couldn't ever conform enough, however, and I always ended up not wanting to be told by anyone what was really going on."

- yeah, I've had similar feelings all my life. In general it has driven me towards libertarian thought, even before I knew what that meant. It might be comforting to think that someone else is responsible (for what you should do, for what you should think/believe, etc.), but it really isn't so, no matter what you think. Accepting what others say without convincing yourself is no route to happiness, at least in my experience.

3/03/2005 12:24:00 AM

 
Anonymous Rahul said...

EC

Very interested in, and fundamentally agree with, your basic thesis, but your explanation for wealth creation is off, way off, unless I am missing something big.

Highly recommend reading up on comparative advantage, Ricardo etc. Any Econ 101 textbook should do, I recommend one by Alan Stockman, very solid stuff.

I am not posting this as a matter of subjective opinion, but as a mathematical fact that is critical to your thesis and that you should be familiar with.

Your conclusions seem to be valid, but via a very questionable, if not blatantly incorrect proof. Wealth is not created because banks exist, or because fractional banking exists. In fact, a large number of free market economists might argue that fractional banking *decreases* wealth in an economy through inflationary an inefficient redistribution.

Wealth is created because of voluntary trade that results due to comparative advantage. For a brief (but admittedly not very good) overview, check out:
http://en.wikipedia.org/wiki/Comparative_advantage

Free market economics is nothing but game theory, which contains the origins (and supplies the tools) for EP. Approaching EP without economics or game theory is like playing basketball without baskets, kinda works, but not really. Be careful, and good luck!

3/04/2005 06:19:00 PM

 
Blogger enlightenedcaveman said...

OK, I'll concede that wealth creation is not strictly a function of the fractional reserve system. However, the existence of more *usable* money than actually exists seems to me to be an obvious boon to productivity. More money to invest means more wealth can be created.

While the fractional reserve system has its share of flaws, I think the benefits far outweigh them - especially if the Federal Reserve does its job right, which it patently *did not* in 1928.

3/12/2005 12:04:00 AM

 
Anonymous Anonymous said...

I do think you confuse matters with your "Ponzi Scheme" description of the fractional reserve system. Actually, putting money in a bank that is lent out ad infinitum does not create wealth. My asset (my money in the bank) is offset exactly by the bank's liability to me, the bank's asset of a loan to another party is offset by that party's liability to the bank, etc.

As others have pointed out, real wealth creation involves putting capital (financial, human, intellectual, etc.) to productive use so that one increases the value of that capital.

Just taking out a bank loan of $100 and sticking it in my mattress is zero sum. Taking out a bank loan of $100 and using it to build a widget factory that can be valued rationally at $200 entails wealth creation.

3/16/2005 04:17:00 PM

 
Anonymous Anonymous said...

I do think you confuse matters with your "Ponzi Scheme" description of the fractional reserve system. Actually, putting money in a bank that is lent out ad infinitum does not create wealth. My asset (my money in the bank) is offset exactly by the bank's liability to me, the bank's asset of a loan to another party is offset by that party's liability to the bank, etc.

As others have pointed out, real wealth creation involves putting capital (financial, human, intellectual, etc.) to productive use so that one increases the value of that capital.

Just taking out a bank loan of $100 and sticking it in my mattress is zero sum. Taking out a bank loan of $100 and using it to build a widget factory that can be valued rationally at $200 entails wealth creation.

3/16/2005 04:17:00 PM

 
Anonymous Anonymous said...

I do think you confuse matters with your "Ponzi Scheme" description of the fractional reserve system. Actually, putting money in a bank that is lent out ad infinitum does not create wealth. My asset (my money in the bank) is offset exactly by the bank's liability to me, the bank's asset of a loan to another party is offset by that party's liability to the bank, etc.

As others have pointed out, real wealth creation involves putting capital (financial, human, intellectual, etc.) to productive use so that one increases the value of that capital.

Just taking out a bank loan of $100 and sticking it in my mattress is zero sum. Taking out a bank loan of $100 and using it to build a widget factory that can be valued rationally at $200 entails wealth creation.

3/16/2005 04:18:00 PM

 
Anonymous Anonymous said...

I do think you confuse matters with your "Ponzi Scheme" description of the fractional reserve system. Actually, putting money in a bank that is lent out ad infinitum does not create wealth. My asset (my money in the bank) is offset exactly by the bank's liability to me, the bank's asset of a loan to another party is offset by that party's liability to the bank, etc.

As others have pointed out, real wealth creation involves putting capital (financial, human, intellectual, etc.) to productive use so that one increases the value of that capital.

Just taking out a bank loan of $100 and sticking it in my mattress is zero sum. Taking out a bank loan of $100 and using it to build a widget factory that can be valued rationally at $200 entails wealth creation.

3/16/2005 04:24:00 PM

 
Blogger enlightenedcaveman said...

One of the most productive uses of capital is borrowing it and loaning it. An enormous amount of wealth is created just by moving money from one place to another. Indeed, the fractional reserve system, combined with the bank's tradition of paying less interest that it demands, is a major driver of the remainder of the wealth creation in our economy.

Look at it this way - a simplistic example. It costs money to borrow money, right? When we deposit money into a bank, we are effectively loaning it to them. That's because they can use our money however they like. The only provision is that the bank be ready to pay back the loan at any time. As soon as the bank has enough customers, the money starts flowing in.

If we (the bank's customers) are smart, we get *some* amount of interest for the money we loan them. Most people don't. Anyhow, let's say we deposit $100 in a savings account that pays 1% interest every month. The bank has calculated that the proper percentage of on-hand cash (in case somebody wants their money back) is 20%. That means they have 80 dollars to loan out, at a minimum of 5%. Now let's say they have 1000 customers who have all deposited $100. They have $20,000 in cash on hand that is decreasing by $200 every month. However, they are earning $1000 a month in interest on the $80,000 they have loaned out. Therefore, every month, the bank's on-hand balance grows by $800. That wealth is *created*, because it would not exist if everyone kept their money under a mattress. Instead, it becomes a salable product, a mandatory cost of doing business for individuals looking to buy more than they can afford. And *this* is where the more tangible side of wealth creation comes in. So long as the factors of production can be manipulated to produce wealth that delivers a profit, *even after the costs of borrowing the money are paid*, the whole system works fine.

Bottom line, the fractional reserve system turns every bank customer into a benefactor for business - small and large. The more bank customers, the more wealth is available for business. Thus, the fractional reserve system is every bit as responsible for America's success as is anything else. We would never have been able to afford to build a 747 or a supercomputer, or to produce a drug like lipitor (which has single-handedly knocked the wind out of heart disease).

Am I still confusing matters?

3/17/2005 12:41:00 AM

 
Anonymous Anonymous said...

Unfortunately, yes, you are still confusing things quite a bit.

From what I understand, you are trying to prove that most things in life are not zero sum, especially when it comes to wealth creation.

This is a true fact, and there is a much more fundamental reason for it than fractional banking.

Whenever any two human beings trade with each other, they are creating wealth, and participating in a non-zero sum game.

There is a solid explanation for why this process of trade is not redistribution, but an actual INCREASE in wealth.

This explanation is best explained as comparative advantage (which is not what it sounds like - it has a specific meaning). It refers to different RATES at which people perform different tasks.

Even if I build both windows and doors faster than you do, we can STILL create wealth (measured most easily in time) by trading, as long as my rate of building windows Vs doors is different from your rate of windows Vs doors.

It is a counter intuitive concept, but ironically fundamental to human existence, and such few people understand it, which is a pity.

For example,
Lets say Peter builds 4 windows an hour and 6 doors an hour.
Paul builds 3 windows an hour and 2 doors an hour.

i.e. Peter is better at both tasks than Paul... but they work at different RATES.

Lets say each needs to build 2 windows and 2 doors.

If Peter did this by himself, he would take a total of:
30 minutes (windows) + 20 minutes (doors) = 50 minutes

Paul, working alone, would take a total of:
40 minutes (windows) + 60 minutes (doors) = 100 minutes


BUT, Peter builds doors at a faster RATE (6/hour) than he builds windows (4/hour).
Paul builds windows faster (3/hour) than he builds doors (2/hour)

Even though Peter is faster than Paul at both windows and doors, they can gain from trade by focussing on their specialties. If Peter focusses on building doors, and Paul focusses on building windows, and both trade with each other, they spend:

Peter = 4 doors = 40 minutes (savings of 10 minutes)
Paul = 4 windows = 75 minutes (savings of 25 minutes)

By trading, they've managed to create an extra 35 minutes! THIS is the basic principle of wealth creation, and it has nothing to do with fractional banking.

Please read up on your Economics!!!!!!! And good luck.

- Rahul

3/30/2005 05:39:00 PM

 
Blogger enlightenedcaveman said...

OK, I get what you're saying Rahul, and I thought I had already conceded the point. There's no question that there are ways to arrange the factors of production so as to create wealth. Got it.

But, using your example, what happens if no one wants the windows and doors that Peter and Paul are building? That's right - their little arrangement doesn't mean shit. All I am saying is that the fractional reserve system frees up (dare I say, creates) capital, which generates demand for goods and services. It's all connected.

To say that wealth creation is all about comparative advantage is reasonable, I suppose. However, financial systems like the fractional reserve system are the catalysts that kick the whole thing into motion - at least that's what accounts for *a great deal* of the success of the US.

That's just my view. I've read what I would consider to be a pretty decent amount of economics - everything from Friedman and Hayek to Sowell and Landsburg. If you think there are gaps in my understanding, do offer up some books to fill them.

3/30/2005 06:44:00 PM

 
Anonymous Anonymous said...

EC,

I hope I did not offend you, I certainly didn't mean to; as I mentioned earlier, I agree with your basic thesis and think you are on the right track.

But I do think there are some significant gaps, for example this issue of wealth creation. Of course fractional banking is important, but it is not what you are after. For example, maybe one could say comparative advantage is to economics what calculus is to applied mathematics. Fractional banking may be an exmaple of an application of economics, but it is not the fundamental concept behind wealth generation, its just an application.

The importance in distinguishing between an application and its foundations in basic theory is that basic theory applies to many different things, wheras an application of it is more specific.

Comparative advantage can increase 'wealth' in many different contexts that have nothing to do with banking... for example, in a marriage, or other human relationships. It is also the concept from which 'division of labor' is derived, among other things. I hope this is beginning to make sense.

Its interesting that you mention Landsburg, because he was one of my professors, and I know him personally. He, indeed, is the person responsible for my understanding of the issues above, since he makes these very same points very rigorously in person, and during study.

I think the problem is that some of these fundamental concepts are not 'exciting' enough or intuitive enough to make it through to pop-econ textbooks in a rigorous manner.

Thats why I am recommending serious study of some econ texts, Price Theory and Applications by Landsburg is especially good, but might be difficult, and is a good "2nd step". Alan Stockman (btw, one of Landsburg's closest friends) has an excellent introductory "1st step" textbook that is very accessible (Introduction to Microeconomics).

I genuinely think you will miss the forest for the trees without this kind of serious study, because otherwise your quest is something like trying to write a medical guide without spending a few years studing biology/anatomy/physiology etc.

You certainly know a lot more than the layman, but possibly not enough to grasp all the truths you are after.

- Rahul

4/01/2005 01:43:00 PM

 
Blogger enlightenedcaveman said...

Of course, no offense taken. As one who routinely ventures to theorize beyond my knowledge, I am often told that I don't know what I'm talking about, or that I've missed a critical component of the situation.

Now I think I know where we are colliding on this. I am not trying to say that the fractional reserve system is *as significant* a fundamental economic concept as is the notion of comparative advantage. I am only saying that it has been an essential factor in the success of this country.

As you've adeptly pointed out, comparative advantage is sort of a fundamental force in free market economics. It is responsible for the success of any economy that embraces it. But when you tack the fractional reserve onto its back, gross national product embarks on a growth that is more exponential than arithmetic. It serves as a catalyst to drive the underlying system.

"I genuinely think you will miss the forest for the trees without this kind of serious study, because otherwise your quest is something like trying to write a medical guide without spending a few years studing biology/anatomy/physiology etc."

Ay, there's the rub for one with eclectic intellectual tastes. I have to shoot for the fundamentals in most things and let the details find me. I was hoping you could recommend a 5-page pamphlet with all I need to know:-)

4/02/2005 02:42:00 AM

 

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