February 5, 2011 – Freeread

This entry is part 30 of 50 in the series 2011A

Einstein’s Greatest Error

“But,” says the gold standard advocate, “you can’t have indefinite expansion. After any period of inflation, expansion and prosperity we have to pay the piper and a period of contraction must take hold. This is the big advantage of the gold standard. Even though, it is painful it causes necessary cycles of contraction.”

But why should a period of contraction even be necessary? Does such an idea correspond to nature? Well, let us look at our universe. It has not only been constantly expanding since its creation over 14 billion years ago, but at the present time the rate of expansion is increasing! Some scientists predicted an expanding universe, but not one expected to find that it is increasing its speed of expansion.

Einstein’s original calculations predicted an expanding universe but this idea went against his belief system so he altered his equations to get the answer he wanted. Later when Edwin Hubble’s observations proved the universe was indeed expanding Einstein admitted that his rejection of an expanding universe was the biggest mistake of his life.

And what caused Einstein’s greatest error?

It was not his logic for his original math and reason told him the universe would be expanding. The cause of his error was his belief system got in the way and prevented him from looking at the math without filters.

Are economists making the same mistake? Many of them are telling us that we can only expand for so long and then we must have a depression or recession. Is their belief that all good things must end interfering with the wonderful truth that we can increase and economically expand indefinitely just as the universe itself is doing?

“But how can the economy expand indefinitely? If we overspend then a correction has to come,” says the skeptic.

The problem is that solid economic expansion does not involve wild overspending as many seem to think. What is overlooked is there are two types of economic expansion. Let us illustrate.

Example One: The Smith Family has been working hard and has been struggling to make ends meet. They’ve wanted to get a new car as well as vacation in Europe but the money to do so never seems to show up. Finally, they decided they deserved some of the better things in life and took out a substantial loan against the equity in their house. This loan was like a windfall and they began spending liberally.

In the eyes of their friends it appeared that the Smiths were experiencing an economic boom.

Then the time came the money ran out and the Smith’s expenditures were more than their income. Instead of taking belt-tightening measures they decided they didn’t want to give up their new lifestyle and borrowed to the max on every credit card they had.

For the next two years their friends thought the Smiths were having a continuing economic boom.

Finally the day of reckoning came and the Smith’s couldn’t borrow enough to pay their bills. At that time their economic world collapsed and they lost everything.

Yes, the Smith’s had to pay the piper for their apparent economic boom, but do all expansions have to end this way?

No.

Example Two:

The Jones family started out in the same situation. They also wanted some of the nicer things in life. They realized they could take out an extra mortgage on their home but decided against it because if this was all they did they would have difficulty in paying it back. They also didn’t like the idea of their hard earned money going into interest payments that merely financed luxuries.

Mr. Jones tells the family, “If we want some luxuries and do not want to suffer the burden of loans we cannot pay back then the only solution is to increase our income. Any suggestions?”

Mrs. Jones spoke up. “I have one. I will go back to work and this will give us the money we need to pay back the loan we are going to take out.”

“But we didn’t want to take out a loan for luxuries,” he said.

“I’m not talking about a loan for luxuries, but for seed money to start that internet business you’ve been thinking of for years. The money from my job can pay back the loan so even if your business fails miserably we will be no worse off financially than we are now. On the other hand, if you succeed then we can not only pay back the loan but we can buy a lot of things we have dreamed of for years.”

The family thought this was a good idea and moved forward with the plan. After two years the business proved a success, they paid back the loan and both Mr. and Mrs. Jones quit their day jobs to work their new business full time.

“Shall we buy some of those luxuries now?” asked Mrs. Smith.

“We could,” said her husband but I have some new ideas for the business that could pay off big time. If we take our extra money and invest in expansion there is a good chance that in a couple more years that we can buy any luxury we want.”

Mrs. Jones was reluctant but agreed and the family continued focusing on expanding and two years later the business and money supply grew just as anticipated.

At that time the Jones took some of their extra money and bought a few things they had wanted over the years. But most important they learned the rules of true expansion and only put money at risk that they could afford to lose.

They continued to apply these lessons and expanded their business, income and savings until they retired. Then they turned their business over to their kids who continued to apply the same common sense approach and the business continued to expand.

Now some may wonder why I am giving simplistic stories illustrating the obvious.

First, I might note that the truth behind these stories must be far from obvious.

Why?

Because our best and brightest that we hire (elect) and send to Congress seem oblivious to the common sense of the Jones family and, instead, act like the inept Smiths.

Secondly, many who are considered the best and brightest in the economic world believe we are eternally doomed to the fate of the Smith family. They tell us that any continued expansion of the money supply is like borrowing money on a credit card and must be followed by either collapse or deflation.

They overlook the fact that there are two ways to increase the money supply.

The first is to copy the Smiths and borrow the money with no sensible way to pay it back. Unfortunately this insane path is supported by the most intelligent people we can manage to vote into office.

Overlooked is the fact that there is a second way. If we increase our money supply using common sense principles, as did the Jones, then the economy never needs to contract but the money supply and economic growth can continue indefinitely just as happened in the story of the Jones and illustrated in the expansion of the universe itself.

Read This entire series. Here are the links.