Where does wealth really come from?

Some Americans falsely conflate wealth with money. Some seem to think that money, as wealth, is created by the Federal Reserve (the Fed). Even some politicians may be confused, encouraging the Fed to push programs like QED1, QED2, and QED3. We are not talking about the source of money, over which, in a mechanical sense, the Fed exerts a large influence. Instead, the real source of wealth creation occurs while growing the capital stock.

Another surprise to many people may be for them to realize that wealth does not actually come from Government spending. Mostly, what federal spending does is “prime the pump.” But money, real money, or wealth, that is, the stuff that makes the economy hum, actually comes from an increase in the capital stock. Let me explain.

Gross Domestic Product

While reading a basic economic textbook, one is almost immediately confronted with the notion of Gross Domestic Product (GDP). GDP is a measurement of economic activity. Economists have agreed that both the income approach and the expenditure approach lead to the same GDP number. The basic calculation is GDP = Consumption + Government Purchases + Investment + Net Exports. But the majority of people end up confused when hearing the factoid “nearly 70% of GDP is Consumer Spending.”

So what? Yes, Consumer Spending, or Consumption IS a component of GDP and a convenient way to measure the short-term direction of our economy. But, consumer spending IS NOT the primary cause of a growing GDP. Instead, Consumption is actually a secondary effect of a growing GDP.

Soft Data

Forget the hard data, look instead at the soft data. One of the best soft data measures of whether the GDP will grow is the Consumer Confidence Index (CCI), measured monthly by the Conference Board. The reason the CCI is important is that potential entrepreneurs often note the “temperature” of the average consumer, (and the CCI is one good attempt to measure that temperature) to determine whether risk-taking can and will be amply rewarded in the current and dynamic investment environment.

One of the senior writers at Fortune magazine, Geoff Colvin, spent years and thousands of words pointing out that the uncertain investment environment was the chief culprit for the eight years of puny recovery that followed the Great Recession. Today, however, Colvin is singing a different tune. The most recent Fortune magazine cover screamed, “The End is Near” – So we ask, the end of what? And the answer is: the end of a incredible stock market rise of almost 10,000 points (as measured by the DJI) or more than 35% in the last two years, since it became obvious that a President was coming into office who would stabilize the investment environment.

Wealth Creation

Here is the bottom line. If entrepreneurs (not regular folks like us) feel comfortable taking risks, then the 1) capital stock (or Investment, which is the PRIMARY cause of GDP growth) will soon grow. When the capital stock grows, then both 2) consumer income and 3) consumer spending will grow. If consumer spending grows, then the GDP will grow and wealth is created. There is NO OTHER WAY!