How to preserve wealth

Dec 11 2013 06:30
*Edward Ingram
MOST people think that if you preserve the purchasing power of what you have earned, you are preserving the wealth that you have earned.

I strongly disagree.

I would prefer wealth to be measured in units of national average earnings/income, NAE: how much money an average person earns in a year, a month, or an hour - not units of purchasing power, and not money.

If you want to save for a pension, then for every NAE that you invest you will want an NAE to remain in your pension fund or your savings account. You will want to keep pace with average incomes/earnings. You do not want to preserve the purchasing power that you had 40 years ago, when you made your first contribution. That standard of living has long gone.

Furthermore, as explained last week, the way that market forces normally behave when left alone and when not distorted by excessive interest rate interventions, excessive taxation and housing finance models that break down and cause a financial crisis, is such as to preserve that spendable income (NAE), taking any increase in purchasing power up along with it.

You should not lose out on your share of the increased purchasing power. Everything that is not distorted or interfered with tends to grow at the same rate that average earnings/incomes (AEG% p a) are growing, plus or minus some market-related rate of additional interest.

One NAE, say 50 000 in any currency, will remain 1NAE if average incomes double, making it 100 000 if the interest added is at the same rate as average earnings are growing (AEG% p a) or if, as with an investment, market forces take its value up at that AEG rate.

Last week I wrote about AEG% p a being a good benchmark for comparing the performance of investments with the natural ‘push’ that comes from the aggregate level of demand in the economy, which is the total level of spending. I suggested AEG as a proxy for the rate of increase in aggregate demand.

Rising aggregate demand (rising average incomes) is likely to push up the price of almost everything, including property, business profits, share prices, and so forth at the same percentage rate (AEG% p a), plus or minus any special factors that may affect a particular investment.

Furthermore, I showed that the median rate of interest in an economy would need to be higher than AEG% p a in order to curb any excess borrowing. There is a relationship between long-term interest rates and AEG% p a. Past data suggested that the median rate of interest for housing finance might be as much as 3% above AEG% p a, say about 7% interest if incomes are growing at 4% p a.

In short, everything relates to what is happening to NAE (AEG). To preserve saved income/wealth (NAE), assets have to increase in money value at AEG% p a and everything has a natural tendency to do that. This is the benchmark.

Those things that cannot follow this benchmark need to be investigated to find out why that is so, and whether the situation should be allowed to continue.

The purpose of my subject macro-economic design is to identify all of the distortions which get in the way of an orderly economy. AEG% p a and NAE are my benchmarks by which to judge which financial services are acceptable, and which are creating distortions and  financial instability.

I have found that it is largely the way that we design savings and borrowing contracts around repayment of money plus interest which makes everything unstable. I have also found that by making some simple changes, like using wealth bonds that are index-linked to AEG% p a, people will become financially safer.

As a result of that, whole economies will perform better without the usual level of financial confusion and crises.

I do not expect people to count the cost of everything in NAE. People will always carry money and spend money. But when it comes to understanding how a particular contract moves wealth around - in effect stealing our wealth or failing to preserve our wealth - then checking out what happens to the wealth (the NAE) is very helpful.

There are other factors as well, such as the pricing of currencies and the management of the money supply, a favourite topic of what is known as the Austrian School, which I may write about later.

 - Fin24

*This is a guest post from Edward Ingram, a leading specialist in mortgage finance and macro-economic design for sustainable growth who is involved in studies in macro-economic reforms.

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