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Monday, June 2, 2008

Creating long term wealth.

"Rebate" checks from the tax man began landing in American bank accounts last month. The alleged purpose of these funds is to stimulate the economy.

To the extent that the checks are used to pay down consumer debt, the funds will do little to stimulate the economy although, by strengthening consumer balance sheets, it will be improved just a little bit. To the extent that the money is spent on flat panel TVs, toys for the kids, clothes and other "stuff", the economy most likely to be stimulated is China's.

The reality is that we have been on a debt fuelled consumption binge since 1985. That provides jobs and wealth in the short term but does not do much for the future. Investment has been sorely neglected.

One of the reasons that we are so rich today is because of past investment in public infrastructure: roads, bridges, airports, subways, dams, reservoirs and sewage systems. Too much of this public infrastructure is decaying for lack of maintenance; too little new infrastructure is being created to serve the needs of a still rapidly growing population.

Had the President and Congress been serious about stimulating the economy, in both the short and the long term, they would have voted to spend the necessary funds for maintenance of our existing infrastructure (short term stimulus) and the creation of new large infrastructure projects (long term investment).

Gordon Brown, now Prime Minister of the United Kingdom, established a principle, when he was Chancellor of the Exchequer, that it was OK for the government to borrow if the funds were used for investment but not OK if they were to be used for current spending and consumption.

Investing is one of the paths to wealth. Except in really ugly and unusual circumstances, like the Great Depression, giving citizens money borrowed by the government so that they may buy more "stuff" is not a road to wealth. Nor is giving citizens money, to reduce their debt load, anything more than a wash if the money must first be borrowed by the government.

Jean-Claude Juncker - Prime Minister of Luxembourg - put it well when describing the biggest problem faced by politicians:

"We all know what to do. We just don’t know how to be re-elected once we’ve done it."

The Economic Stimulus Act of 2008 was simply a bad idea to make it appear that the politicians are doing something useful. The unintended consequences are likely to include little stimulus with increased government borrowing and inflation while giving the Chinese economy a modest boost.

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