The Wealth Effect

Why has our economy needed so much stimulus  since the crash of 1987? Why are we having one financial crisis after another, each requiring massive stimulus to "jump start" the economy again?


The short answer is the real wealth of the USA is decreasing, and we are fighting that trend for all we are worth. The primary way we fight that trend is increasing the money base. Money is easy to increase (just "print"), but wealth is a mix of resources, innovation, and infrastructure, so increasing (or decreasing) wealth is a long term process. Money is just slips of paper that represent wealth, the medium of exchange a complex economy needs to function efficiently.


First things first - why is the real wealth of the USA decreasing? The basic reason is resources, and the end of "cheap" domestic sources of oil. Oil, more than any other natural resource in or on the earth, is a potent creator of wealth. It runs everything in modern civilization. We (USA) hit peak production of it in the 1970's, which caused depressions at the time in the local economies of Texas and Oklahoma. We used to export the stuff, which created vast revenue for the USA, but now we import 70% of the oil we use domestically from other countries.


The goose that laid the golden egg died of natural causes.


So we have been replacing real wealth creation with "the wealth effect", which is simply the idea that stimulus of the economy creates economic activity, which creates wealth. The problem is that while it does create activity, instead of real wealth stimulus creates debt. And of course debt is a claim on real wealth.


It works like this: an entity with falling revenue cannot keep pace with expenses. If it borrows money, it will spend it, stimulating the broader economy. But the entities debt has gone up, and unless it comes up with a way to increase revenue the best it can hope to do is service that debt. If it's revenue does not rise it will also have to borrow more eventually. It can play this game as long as it can beg, borrow or steal additional money.


If the entity is a country that prints it's own money, it can in effect "steal" the money. Just print more and pay off the debt with new money, hot off the press. The problem is this creates inflation for the citizens, which is a tax on citizen revenue, and a real decrease in citizen real wealth.


All this comes down to one thing: excessive debt creates instability and potentially conflict (somebody wants to get paid!), and the so called wealth effect we have been running our economy on for decades really only replaces lost revenues with increasing debt.