The Four Cylinders of Economic Growth - Part 1

By: Clif_Droke

Making economic predictions has always been a popular pastime, and never so more than today. We all fancy ourselves armchair economists, and why not, with the stakes higher than ever. Our very livelihoods are to a large extent tied up in the future direction of the economy. With so much at stake now and in the year ahead, the topic of economic growth has never been more relevant.

Yet behind all the economic rhetoric is a question that is seldom asked, namely, what exactly makes our economy tick? Why is it that some countries (notably the U.S.) seem to always have an essentially vibrant economy while others are constantly stuck in neutral...or worse! In short, what are the keys to economic growth? I think you'll agree that they can be distilled into essentially four key principles, which we'll examine here.

Before we look at what the main ingredients for economic growth are, let's first clarify what they are not. Economic growth is not dependent on money supply creation alone (in spite of contentions to the contrary from mainstream economists). If that were true then a country like Zimbabwe would have a bigger GDP than the United States could ever dream of!

Having abundant natural resources, while extremely desirable, is also something that cannot by itself generate economic growth. Nor can a temperate climate (as some have argued) bring about by itself the necessary conditions for a vigorous economy. Finally, so-called long-wave "cycles" don't create economic growth. While they may be present and exert influence within an economy, they do not ultimately control the direction of the economy.

While all of the above mentioned variables are necessary ingredients for dynamic growth, they cannot by themselves bring it about. From where, then, does the impulse for a productive economy originate? It can be boiled down to four key factors:

1. Productivity/energy
2. Innovation/creative impulse
3. Long-range optimism
4. Liquidity

Thus we see that the growth and functioning of any economy can be compared to a four-cylinder internal combustion engine. The first of these "cylinders", namely productivity, is seen in large measure only in those countries with a large and energetic population. One variable that contributes to this energy was touched on earlier, namely climate. This point was expounded at length in the seminal work by Winless and Browning, "Climate and the Affairs of Men."

Getting beyond these superficial considerations, from where does productivity arise in a great nation such as ours? It comes in large measure from a deep-seeded moral principal that can be found only in freedom-loving countries whose governments do not exert a heavy hand upon the industry of the people, but instead encourage them to produce. People in whom the incentive to create is not frustrated by heavy-handed government will respond inexorably to the call of production and the lure of profit motive. When free reign is given to creative impulses without the restrictions of cumbersome regulation, productivity will explode as the dynamo of economic growth is set into motion.

One of the problems in a production-driven economy, however, and a problem that helps create the type of regulation that stifles creativity, is the fear of over-production. This is one of the major setbacks to even greater economic growth within most major economies. To take one example, the fear of unemployment brought about through unrestrained technological development has served to hinder progress in even the most advanced countries. This is one reason why advanced technologies are often withheld from the marketplace for years at a time so that psychological preparations can be made for their acceptance. Were it not for this primal fear of technological change, our standard of living and economic prosperity would be light years ahead of where it is now (a point we'll discuss a bit later).

The scourge of modern industrial economies is the periodic appearance of business recessions. These are characterized by either a paucity of money in relation to the demands of commerce or else an abundance of non-essential goods. One of the great past masters of production - in both theory and practice - was the automobile magnate Henry Ford. In his memoirs, "My Life and Work," he addresses this problem in these words:

"Both manufacturing and employment are in-and-out affairs. Instead of steady progression we go ahead by fits and starts - now going too fast, now stopping altogether. When a great many people want to buy, there is said to be a shortage of goods. When nobody wants to buy, there is said to be an overproduction of goods. I know that we have always had a shortage of goods, but I do not believe we have ever had an overproduction. We may have, at a particular time, too much of the wrong kind of goods. That is not overproduction - that is merely heedless production. We may also have great stocks of goods at too high prices. That is not overproduction - it is either bad manufacturing or bad financing."

Ford was perhaps the most famous exponent of unrestrained production (of essential goods). He believed that in any normally functioning economy there could never be a true surplus, and to an extent he was right. The basis for his philosophy of production is the assumption that the demand for goods in a nation such as the U.S. is insatiable, and given enough incentive to produce (namely a plentiful money supply) there could be a never-ending long boom in economic prosperity with each successive generation outpacing the prior one. Modern central banking theory, on the other hand, is based on the fallacy that "too much" production, or put another way, a full employment rate, inevitably results in inflation and is therefore something to be avoided. (Unfortunately, many within the perma-bear camp subscribe to this view, albeit unwittingly).

But if the banking system responded in concert to the demands of commerce by increasing the supply of money and created as needed and kept the rate of interest in check with the demands for money, you would see a prosperity unequalled in U.S. history. The economic pessimists in our midst fail to realize that an expansion in the money supply can be highly beneficial and without resulting in the much-feared inflation. This is because modern day production, bolstered by an ever-improving technology, would chase the excess of money by producing a commensurate supply of goods and services before any adverse effects could be noticed in the general price level of consumer goods.

Today's U.S. economy is literally crying out for an increase in money and credit - at any price! The super bears seem to think such an increase in money supply would prove too heavy a burden to bear by the supposedly "fragile" financial system. The legitimacy of such a notion ranks right up there with the flat earth theory. The financial markets are forward looking, and since 2003 they have been looking forward to the day when finally the monetary regulators throw open the flood gates and allow a tidal wave of liquidity to wash over the commercial landscape. When that happens you will see an economic boom unlike any other. We have yet to even experience what some have called the "build-out phase" in the ongoing Technological Revolution. Part of this revolution is the extraordinary production potential of nanotechnology, which has yet to be fully unleashed upon our economy. This segment alone will require massive amounts of money to develop and could absorb, by itself, any amount of increase in the money supply the banks would care to make available.

Again we return to the productive genius of Henry Ford. He writes:

"Take the industrial idea; what is it? The true industrial idea is not to make money. The industrial idea is to express a serviceable idea, to duplicate a useful idea, by as many thousands as there are people who need it."

Have you any idea how many millions of "serviceable ideas" there are out there today just waiting for enough financing to make their production practicable? American is and has always been the land of serviceable ideas. This is one reason why a major economic collapse in this land is well nigh impossible: American ingenuity won't all it. The only thin that has ever brought the country to its knees in an economic sense has been a lack of liquidity, no thanks to our monetary authorities. The problem has never been with too much production, nor with a lack of demand among consumers, but with a periodic lack of money to meet the ever-growing needs of commerce. (This will lead us to a discussion of liquidity as the fourth "cylinder" of economic growth in the next installment of our commentary.) The real problem in the U.S. has never been with its productive economy, or even with the financial markets. The main problem has always been with the Fed.

In the old days, production was limited by the size and cost of capital goods, or the means of production. The logistics of transporting goods and finding ready markets for them was also sometimes prohibitive to the small producer even as recently as 20-30 years ago, and this kept many thousands of would-be producers from participating. But today, micro-production techniques have opened up myriad doors for the small producer and its potential in expanding the economy has only been broached.

A groundbreaking book on the subject of micro-fabrication was published in 2005, entitled "Fab: The Coming Revolution on Your Desktop - From Personal Computers to Personal Fabrication." The author, renowned MIT scientist Neil Gershenfeld, describes the coming revolution in personal fabrication when, for instance, it will be possible "to e-mail a bicycle" in a literal sense. He right describes this as a "paradigm shift." "Personal fabricators" as they're called, are now available which can allow for the production of even the most complex goods in one's own basement. Here for the first time, inventors have access to an affordable technology that can let them produce or small-scale manufacture their ideas and bring them to market without the traditional hindrances. These machines are currently being used in developing countries to help raise the standard of living for thousands.

Can you imagine what will happen when micro-fabrication becomes a widespread reality in the U.S. economy? I bring this isolated example up, along with an earlier discussion of nanotech, to show you why the U.S. economy is hardly in its death throes (as the eternal pessimists proclaim). Indeed, the best has not yet been seen and the boom times we experienced in the late 1990s were only a foretaste of what is to come. We"ll have more to say on this in the second installment of this article.

By Clif Droke
www.clifdroke.com

Clif Droke is editor of the daily Durban Deep/XAU Report which covers South African, U.S. and Canadian gold and silver mining equities and forecasts PM trends, short- and intermediate-term, using unique proprietary analytical methods and internal momentum analysis.  He is also the author of numerous books, including "Stock Trading with Moving Averages."  For more information visit www.clifdroke.com

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