Post-Newtonian economics

In spite of the fact that recent US economic data has shown new home sales increasing strongly (latest report showed a 9.6% increase in January new single-family homes), strong numbers on business investment in equipment (growing at a 10.5% annualized rate according to today's US GDP revision data), and strong corporate profits (recently making a new all-time high), investors and the general public at large continue to demonstrate angst over the economic outlook and to express concern that somehow any recovery since the 2008-2009 crisis has been entirely engineered by the Fed and could collapse again at any moment.

As an example, after Fed Chair Janet Yellen addressed a Senate panel yesterday (article here) and said that it is difficult to determine whether recent "softness" in economic data was related to exceptionally cold weather over the past few months or whether it could indicate that growth was slipping for another reason, many observers took it as evidence that the Fed might soon consider putting a temporary hold on the "tapering" of quantitative easing -- and financial markets rallied at the prospect!

We have said many times in the past that we do not believe that good investing is based upon an ability to predict the next move in the economy, and we have also said that we have never held ourselves out as being able to predict the next move in the economy, either (see for example here).  We also do not have much confidence in anyone else's ability to do so. 

However, we can say for certain that we do not believe that the economic recovery that has taken place since the 2008-2009 recession -- as weak as that recovery has been, for a variety of reasons -- has been due to the easy-money policies of the Fed or its quantitative easing.  Neither do we think the economy will suddenly collapse again if the Fed keeps on tapering, or even if the Fed raises interest rates.  In fact, we would argue that the Fed's extreme policies have actually been part of the reason that the recovery has been less robust than it should have been.

This is because we believe that economies are actually driven by something very different than what most people mistakenly believe drives economic growth.  We do not believe that economies tend to fall apart without government care or central bank micro-management.  We do not believe that various forms of "stimulus" are necessary to prod and poke people into spending money or starting businesses or trying to improve their own situation -- or even trying to improve the situation for other people around them.  In fact, we believe that these things tend to happen by themselves, as men and women use their talents and creativity to come up with new ideas and to experiment with solutions to problems.  It is government tinkering that tends to be the problem, not the solution, although a big economy composed of enough men and women trying to solve problems can resist an awful lot of government tinkering without breaking down (as evidenced by the economic growth over the past five years).

In light of this view, we would like to introduce into the discussion some extremely important statements made by George Gilder in a recent talk (video here), in which he expounded upon the revolutionary economic views he published in his new book, Knowledge and Power. In that talk, he explains that the economics of Adam Smith -- as positive as Adam Smith's contribution has been to economic thought -- were really a reflection of Newtonian physics, and the view of the human being as a kind of atom in a world of other atoms, responding to the incentives and pressures and scarcities and resources that he or she encountered (see the portion of the video between 3:00 and 4:00).

This view, Gilder explains, in many ways reduces men and women (in the eyes of economic theorists) to the equivalent of a chicken in a "Skinner box," reacting to this or that stimulus.  Such a view invites governments to try to create the perfect set of conditions, adding or withdrawing stimulus here or there, trying to prod the poor homo economicus this way or that, in order to steer the economy into growth.  George admits that even supply-side economics (of which he has been a champion in the past) falls into this fallacious view of mankind (see the portion of the video between 4:00 and 5:00).

Instead, George offers a radical new view of economic theory -- one that may perhaps be called "post-Newtonian economics"!  He argues that an economic system is "a knowledge system, not an incentive system."  In a knowledge system, knowledge is gained by performing a series of falsifiable experiments, in order to gain information and ultimately form conclusions.  This, George argues, is what entrepreneurs do at all levels (from the largest businesses to the smallest): they try different solutions to see what works.  It is the entrepreneur or innovator who comes up with a new solution, who introduces the key element of surprise into the world, who actually creates economic growth. 

This is a very different model than the "incentives-driven" view of economic growth.  We have touched on this important insight of George's previously here as well.  If he is correct, and we believe that he is, then that means that investors should spend a lot less time worrying about the level of Fed stimulus, and a lot more time analyzing which companies are creating "successful experiments," so to speak.  Which companies are offering some new solution, a solution which may have been a surprise when they first brought it out, and which solutions are gaining traction as people or businesses like that solution and find value in that solution. 

Businesses which we believe are doing that can be found all over the economy, even in the economic conditions we are facing today.  They may be creating new solutions in surgery, by using robots; they may be creating new solutions in transportation, by matching up carriers with shippers in more efficient ways; they may be creating new solutions in data networking, by using software to do tasks that previously required dedicated hardware; they may be creating new solutions in ways that we haven't even noticed yet, but which you have noticed in your own business activities or daily life!

We believe George Gilder's new, post-Newtonian way of looking at economic and entrepreneurial activity is truly world-changing.  And we believe that adopting that mindset can be very beneficial for investors and economy-watchers alike.

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