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Posted on February 23, 2011 -
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By John Reizner |

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What can we learn from Joseph Schumpeter's idea of "creative destruction" in capitalist economies as it applies to the U.S. current economic situation? How has the Obama administration and the Federal Reserve attempted to stop the economic process of creative destruction from taking place in our economy today? How has the Great Bailout harmed our country's economic future and the worth of our currency?

Creative destruction as Joseph Schumpeter wrote concerned the transforming power of innovation in creating the ups and downs of economic cycles in free economies. For example, after the economic recession caused by a severe banking and real estate crisis in the early 1990's, the economy and the stock market started to lift off in 1995 as a technological leap forward reached the masses: the internet revolution began. Employment increased as new companies such as Google, Amazon, and Microsoft hired tens of thousands of new workers, helping to create economic prosperity and transforming the way a whole nation lived and worked. That's the benefit of new technology created by entrepreneurs, not by those in government, in being the engine of growth for a whole business expansion. This process has been repeated many times throughout U.S. history : through the development of the railroad, the mass distribution of electricity to homes and businesses, and through the mass production of goods such as Henry Ford implemented with the invention of the Model-T.
As new technologies and industries sprout up demanding new skills from their workers, obsolete technology and outmoded production, creative destruction happens. Work itself is transformed, as workers must find ways to adapt to an ever dynamically changing economic system. That's been the economic history of America. Another example more salient to the modern era is how the discovery of new ways to tap huge untapped oil reserves resting deeper than previously thought attainable in the early 1900's led to the widespread development of fossil fuels as an energy source in the 20th century fueling new technologies and our modern way of life.

Just as Al Gore may not have invented the internet, Barack Obama may not handpick or legislate the next energy technology that will transform our economy to enable us to stop importing oil from the Middle East. Barack Obama with his top-down approach toward economic management may be the source of some level of destruction of jobs, but I do not think that he represents the transforming power of creative destruction in our country.
When Barack Obama was running for President with his promises of directing federal funds toward the laudable and very worthy goal of developing clean energy, did he anticipate that the energy industry in certain areas of the United States has been transformed by a process called hydraulic fracturing, a process that can recover untapped oil reserves in great volumes. One estimate is that the process could lower our foreign oil imports by 60% in the next nine years. The EPA is now investigating the environmental risks of hydraulic fracturing - a process that has not developed without growing pains and the appearance of unscrupulous developers causing environmental damage. Reference this article about hydraulic fracturing.
Barack Obama probably is not be the person who has the expertise to make us completely independent of foreign oil imports. A technology may be developed by scientists that we cannot conceive of yet.
We must as a people tell our legislators to address duplicative and unnecessary spending and to genuinely foster new business creation. A healthy stock market may play a role in this as new companies go public and raise funds to grow, further develop and hire additional employees. Economies and entrepreneurs operate in a dynamically always changing environment. The next transformative process or technologies may lie in the hands of researchers only a handful of people ever recognized or who may even be totally unknown in the present day. Even President Obama recognizes the importance of research and development in creating new jobs in the long run. The only problem is that the government cannot force technological change (they may encourage it through research tax credits, etc.), but the creation of life changing new technology for the masses comes from individuals, teams of people, and entrepreneurs.
How does this discussion bring us to the Bailout of the economy and its relationship to the power of creative destruction? When the stock market and the world economy almost came to a standstill in 2008, U.S. policymakers were given two choices: bailout both the market and failing important U.S. banks and brokerages by increasing federal indebtedness or no bailout. We all know what the consequences have been so far in the greatest bailout in American history orchestrated by the monetary ease of the Federal Reserve and the fiscal stimulus of the Obama administration: the stock market has doubled from its Crash low of 666 on the S&P 500, economic deflation has been avoided in my view, it is not likely in my view that there will be a double dip recession unless the economic numbers change in the coming months, the economy should accelerate in the coming months, and as job holders with financial assets may be feeling better about the state of the economy - consumer spending may improve. This in turn may inspire businesses to invest a bit more in their businesses, potentially hiring some new workers. It sounds great, doesn't it? Just what the doctor ordered? Good or bad?
But this may not represent creative destruction in my opinion: new ways of thinking and technologies supplanting the old. The Bailout may be keeping the old ways on life support. May we have had a mass run of corporate and individual bankruptcies greater than today had Wall Street been allowed to fail? I am sure that we may have. Wall Street misbehaved, but they may have been saved. Why? Well, I suppose that one good result from the bailout maneuver was that companies may still offer stock to the public in IPO's, raising money to hire new workers and expand. There are currently winners and losers from the Bailout. Perhaps the next generation may even see Wall Street as a good place to place their retirement nest eggs. Perhaps the mistrust of the Street may eventually wear away. We and our policymakers may have stewarded economic evolution rather than creative destruction at this time: financial reforms have been legislated and our policymakers have chosen to move forward.

As most people recognize, one problem with the bailout is the cost. The Congressional Budget Office in a report issued in August, stated that the national debt could grow larger than 100% of GDP in just 10 years. Citizens Against Government Waste stated in a letter to certain of its members that "under that scenario, half of all income taxes will go toward paying interest on a $23 trillion national debt... The national debt per household, which was $52,000 before the recession, would approach $150,000 by 2020." The financial markets and the bond vigilantes may eventually stop tolerating this position, or our foreign trading partners and competitors may.
However, once the drug of quantitative easing by the Federal Reserve stops in June 2011, assuming there will not be a QE3, the stock market's fate will rest on the economy's laurels.

The keys here may be U.S. monetary policy and the debt that we are all mired in. We do not want the United States to hit an inflection point where the there is a QE3 and QE4, which inflation sensitive equities may love, but which may cause interest rates to move further upward. There may be also a potential risk that China stops buying Treasury bonds in retaliation to the cheapening of our currency (and their U.S. dollar holdings) through our Federal Reserve's extreme "monetary ease." This may be two gambles our policymakers are taking.
A third potential gamble by our policymakers whose outcome may be delayed by several years down the road is be that the U.S. debt balloon is not deflated in time before either the international currency markets or our own financial markets anticipate and/or react to potentially extremely high levels of inflation not seen before in the U.S. in the modern period: the stock market could cascade down from elevated levels, the bond market bubble may have already deflated quite a bit by then, the dollar could waterfall downward as gold and silver potentially polish off their decade plus bull market with a flair.

The American citizenry really may hold the power here, just as they always have. We must support those in government who want to bring government costs down to size. Freezing spending at elevated levels is not good enough. The government needs to pare down its spending just like the citizenry of America have.
The Dow Jones Industrial Average rests at 12,105.78 and the S&P 500 closed at $1,307.40 as of this writing. The mini gold contract is at $1,412.40 and the mini silver contract is at $33.494. The dollar index rests at 77.297.
Since my last blog post here, I have done little to change my investment positions. I took off a small portion of one of my silver miners as the price of silver surged and sold two smaller Chinese equity positions. Please reference the foot of that blog post for some of my other current positions.
Please see comment box below.
Related posts:
U.S. Economic Future: May We Lose Complete Control over our Destiny?
posted July 10, 2009
How to Invest in Barack Obama's "Workers Paradise"
posted March 13, 2009
The Obama Factor: Why His "Change" May Make You Economically Worse Off
posted July 28, 2008




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I have friends involved in energy sector technology at different levels. One is doing pretty fundamental work on converting agricultural waste into energy, and they are getting closer -- it's too early for corporations to be very involved, and it's a field that was making progress way back in the 70's but had its funding cut and lost a decade or two and also expertise. If it's funding hadn't been cut we might have an entire other source of low-impact fuel today, instead of in the 2020 or 30's. Meanwhile I see a lot of research happening now by startups hoping to get rich with a patent and a process -- research that it's hard to imagine the government doing well.

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