Sunday, June 03, 2007


One of the most popular justifications for erecting trade barriers against foreign competitors and increasing the minimum wage by the force of law is the popular misconception that keeping dollars circulated in the local economy benefits our people. At the surface level, we correctly observe that a dollar can go from the canneries to the cannery worker to the bus driver to the grocery store and then maybe back to cannery (thus completing the theoretical circulation). Below the surface, which is often ignored, is why the dollar goes from cannery to the worker to bus driver and then to grocery store in the first place.

For example, you can consider my workplace as its own tiny country with the CEO as the president, the board of director/stockholders as the legislators, and the employees as the people. A tuna sandwich at our marketplace is about $7 and that’s with a small bag of chips. Down the street at the “foreign country” of Seven Elevens are a tuna sandwich and a medium size bag of chips for less than $4.

Now if the dollar circulation theory works for a country, then it makes sense that it should also work for a company. Well, according to dollar circulation theorists, it benefits me for my company to restrict my lunch money to their more expensive tuna sandwich of $7 instead of Seven Elevens’ $4 combo. That’s supposed to be because the $3 difference goes back to company to pay other employees, stockholders, the CEO and then benefit me in some way that I’m expected to understand but don’t.

With minimum wage increases, workers getting paid more through the force of law will create the much-alluded-to multiplier effect, where a 50 cent increase in wages leads to 50 cent increases in spending elsewhere in the local economy. But that only works as long as the employer stays in town. When and if the employer determines that leaving is more beneficial, much like I would in choosing the Seven Elevens’ tuna sandwich over my own company’s, then what we would have is the multiplier effect of destruction as previous spending disappears.

Dollar circulation theorists simply look at the paper trail without paying any attention to the reasons behind it. A dollar goes from the cannery to the worker to the bus driver to the grocery store because every single participant believes they’re getting a better deal by passing it along then by holding on to it.

Whether it’s restricting trade or forcing up wages, we’re all worse off in the pursuit of the mighty dollar circulation as some logical goal.


At 11:21 AM , Blogger Stuart K. Hayashi said...

Tali Go Lightly,

I hope you might further clarify in a future letter that money is itself something that is sold and purchased in every transaction where money changes hands.

A single one-hundred dollar bill is just a piece of paper. If you're hungry, you might try to eat it, though I don't think it would make the best nourishment. If you're thirsty, I don't think you could drink it. And if it's snowing, I don't think you could seek shelter in it.

Unless you enjoy making origami out of it, or use it as decoration, a dollar bill is only as valuable to you as what you can trade for it.

As Francisco d'Anconia explains in Atlas Shrugged:

"Money is a tool of exchange, which can't exist unless there are goods produced and men able to produce them. . . . When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others."

Suppose that, due to the gold standard, the money supply did not significantly fluctuate in history. And, in the year 1800, for every dollar you spent, you could make your life an additional second longer than the average lifespan, which was 32.

And supppose, in the year 3000, for every additional dollar you spend, you could prolong your life by one year, and the average lifespan is 100. And 100-year-olds are healthy and active by then.

Even though changes in the money supply are not causing any inflation or deflation in this scenario, don't the goods and services available in the economy make a marginal dollar much more life-extending in one of those scenarios than the other?

Of course, the attempt by politicians to tell you that it's good for you to trade with "insiders" (people from American Samoa, Hawaii, or the continental United States) and bad for you to trade with outsiders (foreigners, like businessmen in Japan or Norway), is silly. The geographic location where somebody was born -- or where he currently lives -- isn't the primary determinant of his moral worth or the amount of money he deserves. Merit is what matters.

So what if you want to buy a personal high-tech super-computer? You could spend $5,000 to buy it from a domestic vendor. Or you could spend $800 on that same computer from a foreign vendor (and that $800 price tag includes shipping and handling).

If you send $800 to that foreigner to get the same computer, are you doing something wrong? Absolutely not. The computer is of the same quality regardless of vendor, since it's the same product; it's just that one vendor is willing to give you a better deal.

And when you spend that $800 on that foreigner, what happens to that money?

The $800 you spent on that foreign vendor will allow that foreign vendor to make investments. He could re-invest it back into his own business, so that he can sell more goods and services to American Samoa, maybe even lowering prices if economies of scale permit him to.

Or he could just spend that $800 on consumption in his foreign country. But that will encourage more businesses in that foreign country to open and invest in themselves, and this will make even more goods and services available to American Samoa, again at lower prices if there is sufficient competition.

Or that foreigner could take that $800 and spend it back in American Samoa because he can get a better deal from an American Samoan vendor,than from anybody else, for a particular product or service that he wants.

To be continued...

At 11:41 AM , Blogger Stuart K. Hayashi said...


For money to circulate -- and be invested -- in the local economy is meaningful only insofar as it allows the local economy even greater opportunities to purchase goods and services from both the local economy and from foreigners.

And the more "bang for your buck" that you get from dealing with foreigners, the more money you have to (a) finance the local economy or (b) finance the foreign economy. And the more you choose (b) and finance the foreign economy, again, the more low-price goods and services become available from that foreign economy that makes more money available to you so you have more opportunities to choose (a) or (b).

It's unlikely that every single purchase from the foreign economy will only lead to (b) and never (a); every consumer chooses both (a) and (b) in his lifetime.

The politicians make the false assumption that (D) an increase in the circulation of money in the local economy will spur (C) an increase in the overall wealth of goods and services available to people in that local economy.

The truth is exactly the opposite. Money will only circulate in a local economy to the extent that that local economy is already producing goods and services of high enough a quality and low enough a price as to motivate both local consumers and foreigners to solicit that local economy's businesses.

If politicians want both (1) American Samoa to get richer and (2) more money to circulate within American Samoa, American Samoa must first start producing goods and services that are attractive enough for both American Samoans and outsiders to purchase.

And this task will be much easier for American Samoan entrepreneurs and workers to accomplish when the government allows American Samoa to further liberalize and deregulate.

Many poor countries initially have nothing to offer except low-priced labor to foreign businesses. The more direct investments those foreign businesses make in that poor country, however, the more money the low-priced laborers save up and invest in education for their children and in improvements in the poor country's domestic infrastructure.

That's how Hong Kong went from being a poor economy with nothing to offer but low-priced, unskilled labor, to eventually becoming an economic powerhouse full of banking services and more purchasing-power-parity millionaires per-capita than most nations.

It wasn't an increase in the circulation of money that led to Hong Kong's increase in wealth-creating production. It was Hong Kong producing wealth in the first place (initially low-priced, unskilled labor, now financial services) that led to an increase in money being circulated there.

As Howard Roark put it in The Fountainhead: "Creation comes before distribution -- or there will be nothing to distribute."

Which kind of economy do you think that has a higher living standard: an Ancient Stone Age Aztec economy, where money (gold even!) is in heavy circulation, but there is still not enough industrial technology to put the average lifespan above 27? Or a highly industrialized economy with a significantly lower rate of money circulation, but with enough industrial technology to have pushed the average lifespan above 65?

And, which economy has more potential for exponential growth in the next ten years? The Aztec economy has already reached the highest point it has reached in 10 years, and it might take another 200 years to reach industrial status. A liberalized industrial economy in recession can much more easily spur growth and pick up where it once left off.

The fact being missed here is that the amount of wealth you have -- the quality of life you have -- is not primarily determined by how many paper dollars or how much bullion is spent on you. It is primarily determined by the life-enriching value you derive from what you consume -- forms of consumption that are manifest in purchases you wisely make for yourself, and/or intelligent purchases that are wisely made on your behalf (everything else being equal, Tali probably knows more about what goods and services Tali needs than the government does about what good and services Tali needs).

So the more high-quality, low-priced goods and services that foreigners make available to American Samoans is directly commensurate to the wealth of American Samoans per se.

At 12:26 PM , Blogger Stuart K. Hayashi said...

It occurred to me just now that my comments on this post -- just like the majority of comments I post on your blog -- amount to a reiteration of Say's Law of Markets.

Have you noticed that the events of Atlas Shrugged provide a dramatic demonstration of precisely why Say's Law is correct?


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