How to Blow $9 Billion

The life cycle of capital follows a wide-ranging succession. It is imagined, produced, consumed, and destroyed. How exactly this all takes place involves varying and infinite undulations.

 

The Stroh Brewery in Detroit. The company provided an example of how wealth that has been accumulated over generations can be completely destroyed due to just a handful of really bad decisions. [PT]

 

One generation may produce wealth, while the next generation burns through it.  Various facets of a person’s capabilities, understanding, industry, and character can determine if they are producers or consumers. The most determinant facet of this, however, is how one approaches their unique circumstances.

The July 21, 2014, edition of Forbes Magazine documented the Stroh family’s methodical rise and swift disappearance from the beer brewing business. The print edition of the article titled, How to Blow $9 Billion, began with the following summary:

 

“It took the Stroh family over a century to build the largest private beer fortune in America.  And it took just a few bad decisions to lose the entire thing.”

 

What worked for the Stroh family was taking a long time horizon. Wealth was built by incrementally acquiring and growing a loyal and devoted regional customer base. What didn’t work for the Stroh family was its debt financed acquisitions of Schaefer and Schlitz, and the costly bid to become a national brand.

 

The Shaefer brewery in Brooklyn, built in 1849. The Shaefer brothers established the business in 1842 after immigrating to the US from Germany. They brought with them the recipe for Lager beer, which was unknown in the US at the time. Not surprisingly it was a big hit. [PT]

 

By the 1980s, Stroh had gotten too big for his britches.  One early morning, with little marketing budget left over after servicing debt and operating costs, a valuable insight came to CEO Peter Stroh: Acquiring national customers is expensive.  What’s more, unlike regional customers, national customers are fickle.

Within a decade the 150 year old Stroh family beer business was sold off at fire sale prices.  We mention the capital life-cycle of Stroh, as an example.  Our interest today is not the experience of Stroh, per se.  Rather, we’re interested in wealth.

Where does it comes from?  How is it accumulated? And how it is destroyed?  Here at the Economic Prism we like to keep things real simple.  Thus, what follows, is an attempt to simplify things for our own elementary edification…

 

How Wealth is Produced, Accumulated, and Destroyed

As we understand it, when a depositor makes a deposit he is, in essence, lending money to the bank.  But what does the money represent? If the deposit is earned money, it represents something of equal value produced by the depositor’s labors. The deposit also represents something the depositor would rather save than consume.

For example, the deposit could represent a coffee table. In this regard, there are only a few things to do with a surplus coffee table. You could store it for your own future use.  You could trade it with a neighbor for something of equal value.

In each of these instances, there is no increase in capital. The coffee table remains a coffee table.  Nothing more.  Nothing less.  Alternatively, you could sell the coffee table for money.  If you then stuff the money in your mattress, you have the equivalent of one coffee table.  Again, there’s been no increase in capital.

But suppose you deposit the money at your bank and leave it there at interest.  You would’ve loaned the bank your surplus labor in the value of a coffee table.  And the interest paid represents the beginning of an increase in capital.

Now consider that after your deposit, an enterprising carpenter, who is without tools and materials, borrows your deposits from the bank to buy a table saw, doweling jigs, and red oak lumber. These tools and materials represent your coffee table.

But with these tools and materials, the carpenter gets to work and makes three coffee tables. One he keeps for himself.  The other two he sells. With the earnings of one of the coffee tables he repays the bank the money he borrowed to buy the tools and materials.  After that, he still has the proceeds of the third coffee table, which is profit.

 

Coffee tables to die for… and there’s a case of Stroh’s beer too! [PT]

 

Then, instead of spending this profit, he saves it.  He deposits it in the bank at interest. Now the bank has the capital of two coffee tables.  In addition, the carpenter still owns the tools.  All from one surplus coffee table to begin with.

Through this process wealth has been produced and accumulated.  And more wealth can be produced and accumulated in this manner, provided the labor is not lost.  Yet just as wealth has been produced and accumulated, it can also be consumed and destroyed…

Now suppose a third man comes and borrows all of the money that the carpenter had deposited.  But instead of investing it in his own labor and ingenuity, he uses it to make an ill-advised speculation on shares of General Electric.  The borrowed money, for both the lender and borrower, represents a loss.

Specifically, in this instance, the loss is equivalent to the amount of labor necessary to produce two coffee tables. Still, in this example, the loss is limited.  The borrower learns a valuable lesson from the school of hard knocks.  The lender can likely write it off without much effect.

Real wealth destruction, however, the sort that most inhabitants of the globe – including you – are subject to, is a whole different ballgame…

 

The Zealous Pursuit of State Sponsored Wealth Destruction

Remember, the value in money is in what it represents.  Every dollar of actual money should be derived from a dollar’s worth of wealth that has been produced.  Every dollar of credit multiplied upon that money should imply a dollar’s worth of wealth that’s in the process of being created.

This is how wealth creation should work in a world where money is sound, budgets are balanced, and bankers stand behind their loans. The present world, however, rarely works as expected. Through policies of state sponsored wealth destruction, wealth is extracted from those who created it and then set on fire with systematic efficiency.

This is accomplished through fake money, deficit spending, and central bank manipulation of credit markets.  The results are an unending assortment of gross distortions, misallocation, debt pileups and losses.  Moreover, the average wage earner – those who work hard, save money, and pay their way in life – don’t stand an honest man’s chance.

You see, within the system of fake money, big deficits, and central bank intervention, money is continually debased,  That is, the relationship to the wealth that money represents is degraded.  The money’s buying power is impaired.  The labor that earned the money is diminished.  The time it took to accumulate it is stolen.

 

Money from thin air – an ever faster growing pile. This is not a reflection of how much richer society has become; it merely shows how fast existing monetary units have been diluted by additions of ever more new money ex nihilo. This is what inflation actually is according to the classical definition (i.e., prior to the adoption of Orwellian new-speak). [PT]

 

When a government pursues large-scale, state sponsored counterfeiting operations… when it issues bogus money – money that has no definite relation to any form of wealth that’s been produced – what comes next is well known.  There’s progressive inflation of consumer and/or asset prices, which can only be halted by a central bank engineered financial disaster.

 

Effective federal funds rate, monthly. The shaded areas indicate recessions – every recession was preceded by a rate hike cycle. Greenspan’s initial bout of rate hikes from 1986 to 1987 did not trigger a recession, but the true money supply went from a rapid growth rate to a period of mild contraction and the stock market eventually crashed. The recession struck in 1990 after the next rate hike cycle of 1988-1989. The 1994 rate hikes caused a sharp bear market in bonds and a mild bear market in equities, but the money supply started to expand rapidly in 1995. The 1998 rate cuts and the Y2K bugaboo-caused liquidity additions of late 1999 then drove the stock market bubble into the stratosphere, but the next handful of rate hikes sufficed to stop both the asset bubble and the economy in its track. The ZIRP regime after the 2008 GFC has been the longest period of extremely suppressed interest rates in the entire post-WW2 era. It has provided plenty of opportunity for capital malinvestment. [PT]

 

Federal Reserve increases to the federal funds rate in 1980 snuffed out the rampant consumer price inflation of the 1970s.  Fed rate increases also pricked the asset bubbles of 1987, 2000, and 2008.  Fed rate increases are also in the process of pricking today’s asset bubbles.

Yet this week Fed Chair Jerome Powell dithered. If you recall, President Trump wants lower interest rates and higher asset prices.  The S&P 500 index is how he measures his success as President.  He has publicly hammered Powell over his position.

 

Top half: a close-up of the daily effective Federal Funds rate and assets held by the Fed; bottom half: 5-year breakeven inflation rate (this rate is derived from the spread between 5-year TIPS and nominal treasury notes of the same maturity. i.e., it reflects current market expectations w.r.t. future CPI). This suggests that the jury is still out on whether or not the “real” FF rate will move into positive territory. Although inflation breakevens are supposed to be forward-looking, they are in fact primarily driven by short term perceptions, which are notoriously fickle and often quite wrong. There is of course no way a central planner can find out what he should do based on these or any other data for that matter. Since his ministrations cannot possibly improve on market-derived outcomes, ultimately all he can do is resign. [PT]

 

On Wednesday, Powell demonstrated his spine is made of silly putty, and that he will bend under Trump’s repeated hammer swings.  While giving a speech at the Economic Club of New York he mentioned that the federal funds rate was “just below” the neutral level. In other words, the Fed may be nearing the conclusion of its rate hike cycle. Following Powell’s remarks, the S&P 500 jumped up nearly 2 percent.

 

More importantly, should Powell continue the zealous pursuit of monetary policy where the federal funds rate is below the rate of consumer price inflation, he may birth an attack of state sponsored wealth destruction that Americans haven’t experienced in nearly 40 years.  In the end, the savings of a lifetime’s worth of labors, reconverted to money, may not be enough to buy a gumball.

 

Charts & data by: acting-man.com, St. Louis Fed

 

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 

 

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