The entrepreneur is under fire in America today.  Amidst a severely weakened economy, high jobless rate, and declining standard of living for most Americans, it's no wonder that successful entrepreneurs, particularly those that have amassed significant wealth, are not looked upon favorably these days.

I'm here to do the unpopular and defend them.

A successful free market, free enterprise system that yields the kind of prosperity this country once knew requires that all of the parts of the whole be allowed to exist in equilibrium with each other, such that they can interact naturally.  The entrepreneur is as important a cog in this mechanism as any other, and the importance of his role is being overlooked at best, marginalized and vilified at worst.

"Entrepreneurs create jobs."  I'm sure you've heard this cliché by now.  It's true, but it's a bit oversimplified.  Look at it this way: entrepreneurs take ideas into the marketplace and risk their capital (and sometimes other people's capital too) to make that idea come to fruition.  When they risk capital, that capital is injected into the marketplace, where it stirs the engine of commerce.  By this I mean that the entrepreneur’s application of capital creates demand where there was none (or less) to begin with.  Let's look at an example of what I mean by this:

Let’s say an entrepreneur decides she wants to start a website that promotes her freelance writing skills.  She has amassed a small amount of capital through her earnings in her previous job.  She then applies this capital to various vendors who she relies upon to get her business up and running: the company that sells her the domain name for her website; the company that hosts her domain on a secure server; the web design consultant who gains her as a client and helps her create a suitable web page.  Through the pursuit of her idea to create this freelance business, she has in turn created demand for other companies' services and products, thus raising their bottom line, and in an aggregate sense, potentially impacting their decision to eventually hire more people.

Now let's say she grows her business over the course of a couple of years, and adds two writers to her staff.  This constitutes the job creation aspect of her entrepreneurial effort.  Two jobs exist now that would not have existed had she kept the freelance idea to herself.

Let's say ten years later, she operates a multi-million dollar writing service firm, and takes home over a $1 million a year in pay.  Through extremely hard work, quite a bit of lost sleep, her own personal funds, and the intangible cost of bearing the weight of risking everything she previously knew (her job) to pursue an unknown (her business), she has managed to create a comfortable lifestyle for herself.

While much of her incentive to do all of this was derived from her desire for autonomy and freedom from an employer, the financial rewards played a part in her decision as well.  She knew that as she amassed wealth, there would be mechanisms in place to protect that wealth and help her to grow it and allow her to use it as she sees fit: to pass on to future generations in her family, expand the writing business, or perhaps start new and different kinds of businesses.  In many respects, the growth and protection of her wealth could potentially translate into even greater benefits for society as a whole.

Unfortunately, in today's society, there is a sense that individuals like those in the example above simply "owe more" than they currently pay.  Since their lifestyle is perceived as "comfortable" or even “luxurious,” it's become a given that they can afford to pay more than they already do.  The individual's fundamental right to his or her property -- a core tenet in a free society -- is overlooked and never even introduced into the debate these days.

If you've been following the Republican Presidential primary race, you've probably heard by now that Mitt Romney has released his tax returns, revealing income of over $20 million per year the last couple of years, and an effective tax rate of 14%.  Many are outraged that he pays such a low tax rate.

I'm thrilled, because it means if he can reach that point, then the same reward awaits me if I can duplicate a measure of his success.

Here's another way to look at it: for every Mitt Romney who creates wealth through hard work and dedication, there are numerous others who have tried and failed.  They risked everything, and lost everything.  But they did so because a significant reward lay ahead for them if they succeeded.  Yes, there were lots of incentives that drove them to try, but certainly we cannot discount the financial reward as one of those driving forces.

Here some will argue that these individuals would still take these risks even if they didn’t pay the 14% tax rate, but instead paid some higher amount, such as the current top tax rate (35%).  I counter that by saying, how do we know that for certain?  How do we know some of the individuals, who may have possessed great ideas for a business or product, didn't like the fact that their hard work and risk-taking would be met by higher taxes, and passed at the idea of starting that business?  How many disliked the notion that if they amassed an especially large fortune, their ability to pass it on to their family or into new businesses would be significantly impacted?  How many were discouraged by the general sentiment surrounding successful entrepreneurs, who are often made to be the scapegoat or villain, especially in hard economic times like today?

Or look at it pragmatically.  If I’m taxed at a much higher rate, that leaves less capital with which I can risk for more business development and job creation. I’d simply have less resources on hand to try and grow my wealth any further than I already had.  Why would we want to hamstring business development and initiative?  Don’t we want to encourage it as much as possible?

Ayn Rand wrote brilliantly about these questions in her book "Atlas Shrugged," which depicts a society where, after made the scapegoat for America’s economic distress, all of the competent businesspeople and entrepreneurs simply disappeared in protest, leaving the society's economy to stagnate and collapse.  Fed up with being seen as the cause of the problem rather than the remedy, they simply dropped out of society.  While it's an extreme rendering of what's possible, the general theme is what's important, and we can see the same conditions for this developing here in America today.

There is one caveat that's worth mentioning.  What I've written above does not apply when the access a given individual has to the basic requirements for starting a business is prohibitive, or does not equally apply to all people.  In other words, the barrier to entry for starting a business should be as nonexistent as possible to encourage as many people as we can to try it.  Thus, things like the administrative filings required for a business should be streamlined and inexpensive, widening the access to as many people as possible.  (With the advent of the Internet and a slew of low-cost and even free resources, starting a business has probably never been easier, from a pragmatic standpoint.  Unfortunately, from a regulatory standpoint, the opposite is probably true, but that's a discussion for another blog post.)

I submit that if we truly desire a return to prosperity, a return to better economic times and viability within the world, we must once again embrace the entrepreneur as an equally important role within the free market system.  Encouraging such individuals to pursue their ideas and grow those ideas here within our borders would be the best stimulus we could generate for the economy.  Let's hope we give this a try as soon as possible, before it's too late.

We’ve all heard the countless cries by our leaders and government officials about “ending poverty,” “waging the war on poverty,” and “eliminating poverty for future generations.”  They claim that if we just give them more of our wealth, more of our earnings, then we can finally, once and for all, put an end to poverty.

Meanwhile, the very system we live under, and which our government preserves and protects at every turn, continues to create poverty for millions of Americans – a system which in turn, supports and funds those leaders telling us to sacrifice more for the good of all.  That system is called the “monetary system.”  

You’re probably not familiar with this term, not only because it’s never mentioned in the mainstream media or in your school textbooks, but also because when you think of our economy you think of capitalism.  This is not surprising since we’ve been conditioned to think we live in a capitalist society.  And to some extent, we do.  But the problem is, by thinking of it that way and describing it by that one word alone, we omit an important aspect of the overall system that governs our economic livelihood.

Now, the term monetary system is quite broad, and so we need to look closer at what that really entails.  In general, a monetary system is any economic system that assigns goods and services a value that is exchangeable through a medium such as paper (fiat) money, gold/silver, or other means.  Capitalism per se does not imply the use of money – rather, it traditionally refers to things like the free market exchange of goods and services and private property rights.  Thus, it is important that we separate capitalism and the monetary system in our minds in order to understand the true nature of the overall system we live under.

The use of money to govern transactions within a capitalist system is not a bad thing in and of itself.  In fact, if the money has intrinsic value (such as gold or silver), this can improve the integrity of the overall economy by ensuring that the monetary value remains stable and intact, versus fluctuating significantly over time.  An example of such fluctuation would be the US dollar (a fiat currency not backed by anything of value), which has lost over 90% of its purchasing power in the last century.  (Indeed, most of this erosion in value occurred after 1971, when the dollar was unhinged from the gold standard.)

The US monetary system, of course, is based on the use of fiat money, which can be created arbitrarily through policy decisions originating from the Federal Reserve System.  In conjunction with this capability, the employment of “fractional reserve banking” provides further flexibility to the monetary system, and encourages the creation of money from, essentially, nothing.  Simply put, fractional reserve banking is when banks only maintain a portion or fraction of customer deposits in reserve, while using the remainder to originate loans and thus create higher amounts of interest income.  The amount of money the bank must retain in reserve is called the “reserve ratio.”  Traditionally, US banks have maintained a reserve ratio of 9 to 1, meaning for every dollar kept on deposit, $9 can be lent out.

The practice of fractional reserve banking is actually detailed in a booklet issued by the Chicago Federal Reserve Bank (one of the 12 regional banks under the purview of the Fed), called Modern Money Mechanics.  While I think it’s worth reading the entire 40 pages of this document, this quote should suffice as a summary:

“The purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system. The approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System - the central bank of the United States….The illustrations in the following two sections describe two processes: first, how bank deposits expand or contract in response to changes in the amount of reserves supplied by the central bank; and second, how those reserves are affected by both Federal Reserve actions and  other factors.”

We can translate this summary to mean one thing: banks create money out of nothing.  By illustration, we can see how fractional reserve banking accomplishes this:

Bank A receives a deposit of $10 million from a customer.  It places $1M in reserve (according to its 10% reserve ratio requirement), and then lends out the other $9M to Bank B, collecting interest payments from Bank B.

Bank B puts $900,000 in reserve (again, 10%), and lends out the other $8.1M to Bank C, collecting interest from Bank C in the process.

Bank C puts $810,000 in reserve, and lends out the remaining $7.2M to Bank D, while collecting interest from Bank D.

…And so on, until approximately $90M (nine times the original $10M) has been created, loaned, and monetized into interest payments for all banks involved in the transaction.  Thus, you can see how $1 of actual “wealth” (I use quotes because even the original fiat money deposit has no intrinsic value) becomes $9 of artificial money.

There are two things that are very pernicious about this.  First is the simple fact that money that never existed in the first place is used to make even more money, through the payment of interest.  Second, and more insidious since it is unseen and intangible, is what I would call the “debt-to-wealth gap” that is created by the monetary system and fractional reserve banking.  Here’s what I mean by this:

There are only so many goods and services that can be produced or performed, and subsequently sold in the marketplace.  In other words, there is a physical, tangible limit to it (however large and unquantifiable it may be to us).  At the same time, the creation of money from nothing is dislocated from this reality, since the money is created artificially and arbitrarily, when compared to the actual value of all the goods and services available in the marketplace.

In other words, there is simply more available debt than available wealth.  The ease with which new and virtually endless amounts of debt/fiat money are created is the reason why there is so much more available debt than wealth.

Again, the catalyst for this is relatively simple to understand -- through our monetary system and the use of fractional reserve banking, debt is generated rapidly and artificially.  Conversely, wealth (for the vast majority of us) can only be generated through the exertion of labor over time.

Think of it this way: in one day’s time, assuming I placed no limits on you from a credit perspective, how much debt could you get into in that one day?  Probably a whole lot.  A house purchase, a trip to the Ferrari dealership, maybe a new yacht – you could easily be millions of dollars in debt in the span of 24 hours.  Now in that same one day’s time, how much wealth could you create?  If I gave you one whole 24 hour span to generate wealth from scratch, how far do you think you’d get?  Probably nowhere, and it would have nothing to do with your aptitude.  Simply put, the creation of wealth would take time, energy, and effort that would far exceed one day’s time.

This surplus of debt compared to available wealth comprises the debt-to-wealth gap.  So what, you might be thinking…what does this have to do with you, or the poverty problem I referred to in the beginning of this article?

Here’s why it is directly relevant to you: you cannot function in our economic system without getting into debt.  It’s virtually impossible.  If you are able to pull it off, it probably means you’re living something unlike the “American dream.”  You certainly don’t have a house, and you probably don’t have a car.  You most likely never went to college.  In other words, all of the trappings of the American lifestyle are unavailable to you – until you take on that debt load.

Once you’ve taken it on, you must generate enough cash flow to service that debt.  In other words, you need a job.  Now of course, we all need cash flow for the necessities of life, but the kind of job, frequency of how often we must perform that job, and length of time we must keep that job changes considerably when we have a mortgage, car loan, student loan and other debt payments to service.  It’s one thing to truly work to pay for the basics (food, rent for shelter, medical care when needed), but another thing entirely to work to cover the trappings of the American lifestyle we’ve been conditioned to believe are “necessary” (nice house, two cars, vacations, yearly wardrobe changes, sundry electronic gadgets, other luxury items, etc.).

In other words, the availability – and more accurately, the necessity – of debt, turns us into indentured servants, who must hold jobs whether we like them or not in order to function economically.  Furthermore, when that imperative is combined with the illusion that we must continue to spend/consume in order to achieve the “American dream,” the average person’s debt load rises considerably.

And what about the poverty issue I mentioned at the beginning of this post?  How does the system create poverty purposefully?  Now that you understand the monetary system and fractional reserve banking, it’s easy to see how.  Let’s look at it through a rudimentary example:  

Say a bank has a home loan portfolio totaling $100 million.  It created these loans off of just 10% of that figure, or $10 million (so there is only $10 million of actual deposits at stake here).  The other $90 million is artificial debt created through fractional reserve banking.  Now let’s say of the $100 million, $15 million worth of loans is spoiled by foreclosures and bankruptcies.  Let’s see where that leaves the bank:

$10 million of initial capital, turns into…
$100 million of loans, with an average of 7% interest a year yielding…
$7 million a year in interest income…
With only $15 million of the total loan portfolio gone bad.

Since the $15 million of bad loans is fake money anyway, the bank doesn’t care, since it never had that money to begin with.  Its loan portfolio is generating $7 million a year, which across a 30 year standard mortgage period yields the bank revenues of over $200 million.  Ultimately, the bank turned $10 million of seed capital into over $200 million…do you think it cares one bit about the $15 million in bad loans (which really translates to foreclosed homeowners, homeless people, etc.) it perpetrated along the way?  Of course not – it’s just the cost of doing business.

The bottom line is, the bank doesn’t care who goes bankrupt or forecloses – the bank simply cares that enough debt is created to generate enough interest income for it to be profitable.  If it overshoots the mark on debt creation, and individuals go bankrupt/lose their home, it matters not – it simply performs a write-down of the loan on its books and moves on.  It was fake money anyway – it never existed in the first place.

The key for the banking/monetary system is to continue creating enough debt to generate enough interest to continue to be profitable and aggregate more wealth.  The collateral damage along the way, in the form of impoverished/bankrupt/homeless individuals, is simply the byproduct – the remainder off of the proverbial mathematical equation – that is tolerated in the overall process.

Using this premise as a backdrop, I would go on to assert that the entire 2007-09 housing collapse was nothing more than the rabid creation of debt in order to fuel more interest payments into the system, with zero regard for how many loans went bad or homeowners were devastated along the way.  Why would this matter, when the banking system knew the government would step in, bail them out and cover the losses?

But put the recent housing market crash aside for a moment.  The real problem is this: the monetary system is on its last legs.  Eventually, there is too much debt created, and no one left to service it.  And when not enough entities can afford to take on debt, then the debt creation begins to grind to a halt.  And when debt creation grinds to a halt, interest payments decrease and profits begin to shrink.  The outstanding debts remain, but there’s less profit to offset it and make the process worthwhile for lenders.

We are seeing this breakdown in the monetary system in the news every day, when we read about bank failures, rising foreclosures and shrinking home sales, states going under financially (i.e., California), entire countries going bankrupt in the EU due to systemic financial failure (i.e., Greece, Ireland, etc.), and the rising ranks of unemployed who’ve been victimized by the system and will never return to the same standard of living they once had.

Once you understand that the system you’re living within places you into servitude, creates poverty knowingly and purposefully, and is impossible to get ahead within, as an individual you begin to realize that your financial and investing priorities must adapt to such realities.  Ultimately, the monetary system needs to change, as it simply does not serve the interest of the vast majority of the people.  When we make such a claim, and it’s a significant one, we need to do so with the full and accurate knowledge of what the system actually is and how it operates, and only then can the proper reforms be put in place.

I don't understand why Germany (the most vocal), or any other EU members for that matter, are upset about the impending second bailout of Greece.

They asked for it.

They should be celebrating this collective spirit, this rush to the aid of their neighbor.  This is what socialism is fundamentally based upon.  This is a defining moment for socialism, one which we should expect an economic collective like the EU to embrace.  This is the system at work, doing what it was always designed to do.

So why aren't they celebrating this defining moment?

The answer is simple: everyone likes socialism, until it's their money that's taken away and redistributed.

Don't the EU countries trumpet their healthcare systems as some of the best around?  Free access for everyone, no strings attached.  Early retirements, big pensions, shorter workdays...it's a veritable paradise.

Until you have to loan a few billion euros to your struggling neighbor.  I don't understand the 180 degree switch in attitude.

To clarify a little, the EU is not a socialist collective per se.  But in relative terms, it’s embraced certain aspects of socialism to a greater extent than the US, for example.  EU nations have banded together for purposes of economic solidarity, and in the process forfeited a degree of national sovereignty.  Individual nations no longer have the right to decide on economic matters, according to the interests of their citizens alone.  It is this collective, we’re-in-this-together approach to economics that I’m focusing on in this article.

I'll always be the first to tell anyone in a debate about economic systems that capitalism is not a good one either -- it's just the best one we're going to get.  I believe the basic reason behind that is as follows:

Economic freedom begets personal freedom.  Socialism does not beget economic freedom, therefore socialism does not beget personal freedom.  Socialism and personal freedom are not compatible.  That incompatibility runs contrary to the principles our country was founded upon.

If we value personal liberty above all else, then the economic system that best supports that liberty is capitalism.  At the same time, we're dealing with human beings, so we have to deal with human nature, and the desire to enrich ourselves at the expense of others can sometimes be overwhelming.  Since we can never remove that impulse from people, we can never perfect capitalism.

The fact that we've never perfected it doesn't mean we should do away with it, or embrace a system like the EU.  We shouldn't do away with it, that is, unless we no longer value personal freedom.  When I say things like "personal freedom" and "economic freedom" I'm referring to the fact that in a capitalist system, the opportunity to work, prosper, thrive, take risks as an entrepreneur and benefit accordingly if success is achieved, is accessible and available to all.  In turn, these economic freedoms go hand-in-hand with personal freedoms.  Think of it in the inverse: if someone told you how much of your money you’d earned you could actually keep, and how that money should be spent, and what kinds of private property (if any) you could call your own, how free would you describe yourself?

Of course, when capitalism is distorted by the intrusion of top-down, human-based decisions and influences (such as from government officials), the opportunities normally commensurate with capitalism also become distorted.  I believe this has happened in our country, but I also believe the system is salvageable.  It’s salvageable because we’ve yet to implement it to the best extent possible.  Shrinking our government’s role in the economy, eliminating our central bank, lowering taxes, and encouraging entrepreneurship and innovation by fostering a business-friendly environment would be a good start towards doing so.

The Greece situation provides America with a window to the down side of a socialist approach to economics.  We are witnessing the sacrifices that ordinary citizens, in EU countries besides Greece, are being forced to make by their governments, bound to the notion that their economic fate is directly intertwined with Greece’s fate, mandating that the painful burden must be shared by all.  Is this the kind of philosophy we want dictating our economic future?

A few weeks ago, it came to light that General Electric, one of the corporate giants in the US, paid no taxes for the year 2010, and in fact received a $3.2 billion tax benefit.

Congratulations GE.  I couldn’t be happier for you.

I really mean that.  I’m not saying it for effect.  The furor that arose over this issue -- though seems to have died down already, a mere three weeks later -- has at least briefly shone another unflattering light on the labyrinthine, nonsensical, so-damn-confusing-it’s-almost-criminal tax code that strikes fear in the hearts of individual taxpayers and keeps droves of corporate tax lawyers employed forever.

GE followed the law.  They worked within the confines of the law and found a way to eliminate any tax obligation while benefitting the company and its shareholders.

The problem is the anger over this issue is channeled in the exact wrong direction.  The Congress is responsible for the law.  The Congress wrote the tax laws.  The Congress is responsible for our tax code.

The Congress is responsible for GE not paying any taxes.  It’s the Congress’ fault.

All of the other storylines here are basically immaterial.  Much was made of the fact that GE’s CEO, Jeffrey Immelt, is an advisor to the President on jobs issues.  So what?  He doesn’t advise him on tax issues.  

I also read that the fact that Immelt advises the President on jobs issues, while GE laid off over 20,000 American workers, was called into question.  Another red herring.  Nothing to do with the broken tax code.  

These issues and others: mere distractions from the core issue of a vampiric tax code that needs to be simplified.

Quite frankly, I think the fact that GE didn’t have to pay any taxes and instead got money back might actually incentivize them to reinvest in the company, expand, and possibly hire more Americans into new jobs.  Is that guaranteed to occur?  No, but that’s the nature of private enterprise -- GE can decide the best way to grow its business and create value for its shareholders.  We should be glad when companies get the opportunity to create more wealth and employment, rather than forking their profits over to an ever-expanding government that will simply squander the money. 

The bottom line is, if the problem is that we want our corporations to pay more taxes and avoid the kinds of loopholes that result in $0 corporate tax bills, then we need to implore the Congress to rewrite the tax code and make it simple, straightforward, and evenly applied across the board.  Until the Congress does that, it’s not serious about collecting taxes from the likes of GE.

This week the TV network NBC has been running a special event called "Education Nation," a summit of sorts to figure out what's going wrong in our nation's schools (we're currently 25th in the world in quality of education).  During a news segment on this summit, a clip was shown of NYC Mayor Michael Bloomberg giving a speech on education.  At one point, he talked about an experimental program whereby children would attend a 6-year high school/associates degree program in lieu of the traditional 4 years of high school followed by two years of associates degree work.  Bloomberg mentioned that the program would be sponsored by City University of New York and IBM, which would then consider the graduates as "first in line" for a job within IBM.  He went on to say that this program would essentially guarantee its entrants a "ticket to the middle class." 

Putting aside the emotional dimension to the highly charged education issue, I see numerous absurdities in this proposal.  Maybe the most obvious one is how IBM could know in six years if jobs would be available for these students as they finished the program.  What if 100 students graduate and IBM only has 10 job openings?  Do the other 90 students simply move on, regretting their decision to attend this school?  Admittedly, I assume the program will not function in such a literal manner, and the job assignments will be handed out more dynamically.  But I think it's worth highlighting that the virtual guarantee of a job opportunity does not seem like a sound premise, especially when one considers the economic environment we're in now. 

Furthermore, how can we "guarantee" a ticket to the middle class when we have direct evidence of it shrinking before our eyes?  I’ve referenced before on this blog the data showing median household incomes actually declining a few thousand dollars from 1988 to 2006, and I suspect the decline continued well after that given the recent economic crisis.  We’ve also witnessed paper wealth (stocks, home equity) plunge dramatically since 2008, and the climb back to even in individual portfolios is going to be an uphill battle.  Given these conditions today, how can we be talking about a guaranteed ticket to the middle class for students who won’t graduate this specialized school for years to come? 

But there’s another thing I think we need to be mindful of with this concept of guaranteeing a middle class existence.  I would loosely call it “the too good to be true factor.”  It sounds great to be able to tell high school entrants what they’ll get if they complete the program.  But haven’t we learned our lesson with this kind of decree?  Let’s take a look at some other “guarantees” we’ve received over the decades: 

In the wake of the Great Depression, Social Security was pitched as a large part of the solution to ensuring Americans had a secure financial future.  Now the program is insolvent as it begins to pay out more than it takes in, and revenues continue to decline as the tax base shrinks. 

Medicare and Medicaid were designed to guarantee us medical care.  Both programs are now headed for bankruptcy.  I just saw a headline today trumpeting the ballooning cost of Medicaid for the states, and the likelihood at least some of them will be bankrupted by that. 

The new health care law passed last year was supposed to expand coverage for Americans while reducing overall costs.  Instead, just a few months after passage, the Congressional Budget Office revised its projections and says the plan will indeed be more expensive than forecasted. 

My point here is, when it sounds great, and it even slightly appears to defy economic realities, we need to take a closer look and scrutinize the claim, program, expense or whatever it might be.  In this case, I think it’s irresponsible to state that any program could possibly guarantee a pathway into the middle class.  A vibrant middle class exists on a foundation of economic freedom, low taxes, an entrepreneur-friendly environment, and many other similar factors.  We cannot force or decree a middle class to exist.  We have to be willing to create the conditions within which it will thrive.