Wealth creation takes energy, time, skill, understanding and leadership
and raises complex moral, ethical and social issues and dilemmas
There is something blindingly evident about wealth creation. Wealth creates its own wealth.
Do you remember a school physics experiment that used bubbles to demonstrate pressure?
You created a large and a small soap bubble at each end of a tube sealed by closed valves. You opened the valves allowing air to move freely between them. Contrary to what you might expect, the small bubble gets smaller, and the large bubble grows bigger. Or, as my physics teacher put it, the rich get richer, and the poor get poorer.
The maths and methods of wealth creation
Research shows that ten per cent of humanity owns 85 per cent of global assets. Conversely, almost 65 per cent of the world population owns just two per cent of total global wealth.
It was not without reason that British Prime Minister Benjamin Disraeli wrote in 1845 of “Two nations between whom there is no intercourse and no sympathy; who are as ignorant of each other’s habits, thoughts, and feelings as if they were dwellers in different zones or inhabitants of different planets. The rich and the poor.”
Of course, there is no magic money tree as politician love telling us. Wealth creation takes energy, time, skill, understanding and leadership. More importantly, wealth creation is about far more than financial wealth. Happiness, health, meaning, compassion and wisdom, as well as money, are the source of real wealth.
Time to make money?
Economists recognise a concept called ‘the time value of money’. This simply states that it is better to receive a sum of money now than the same amount later.
However, if wealth creation is your objective, there is an alternative. You could forsake your right to the money today in return for some sort of payment as compensation. This compensation payment, of course, is what we usually term interest. The interest is the time value of money.
And in day-to-day financial life, borrowing or lending money with interest is common.
The ethics of lending
In early cultures, it was considered immoral, unethical and anti-social to create wealth by lending money in return for interest. There was also a view that lending money should be a philanthropic activity. The wealthy should give money to support those less well off in the community. Charging interest upset the natural laws of community survival and the obligation to care for one’s neighbour.
Debt causes damage to individuals and society as a whole. A person’s freedom is constrained by being bound to another person through financial obligation. Deterring lenders from charging interest would dissuade people from borrowing purely for consumption, it was hoped.
The alternative view is that interest, especially compound interest, is the route to financial freedom. Einstein, talking in purely mathematical terms, stated that ‘compound interest is the most powerful force in the universe.’ Indeed, financial planners and commentators argue that savings and compound returns are the most potent ways out of poverty. They are indeed excellent examples of how money creates its own wealth.
Investing for wealth creation
You can also create wealth by investing money in a business. The business uses your money to purchase equipment, raw materials, labour, training, skills and property. These assets to produce goods or services. The new product or service is sold at a price that exceeds its cost of production to create wealth.
A good investment will produce sufficient financial return to repay the capital invested. It should also exceed the opportunity cost of the money tied up in the business.
Investment requires planning, forecasting and the application of an Internal Rate of Return (IRR). The IRR is the discount rate that equalises the positive and negative cash flows of the project. Investors use the IRR to compare the return on the project with alternatives, including cash. The discount rate also facilitates a comparison between the project and the cost of borrowing money to fund the project.
Business investment is key to economic growth and is one of the metrics most analysed by governments and economists. Growing business investment will lead to economic growth and rising employment. There is another side to this coin, however. Many commentators see the perpetual drive to increase Gross Domestic Product (GDP)as a race to hell. It causes untold damage to the environment and traps people in mindless jobs.
Wealth creation 2.0
Technology and communications have advanced beyond recognition. Cash can now be used in far more insidious and imaginative ways for wealth creation. For instance, money is traded at a profit or loss in its own right In the currency markets.
The futures and options markets enable businesses to buy materials at a defined price and time with certainty. However, the trade in futures and options is now many times larger than in the underlying commodities themselves. Traders use the market to make money rather than for managing the smooth running of a business.
Bring in the financial engineers with their skills in developing exotic financial instruments, crypto-currencies and trading processes. Now you don’t have to sell your skills or expertise, rent out your room or get your hands dirty. You can use money merely to make more money.
All three methods of wealth creation require some knowledge of financial arithmetic. This will range from the basics of interest payments to highly sophisticated mathematical modelling and computer programming. It is, therefore, dangerous to enter the field without prior knowledge of what you are doing.
Moreover, the concept of making money out of money raises complex moral, ethical and social issues and dilemmas. In modern, regulated economies there is, in theory, a limited supply of currency. If you increase your share of the available stock, someone else loses it or forfeits their right to it.
It is no surprise that humanity has been wrestling with these issues since the invention of money. The potential for money to create more wealth is compelling and attractive. It can also damage your personal integrity and those with whom you come in contact if not handled correctly. It requires skills and a sense of purpose way beyond what one might consider necessary at first sight. Your relationship with money is a form of marriage. Like marriage, it should not be undertaken unadvisedly or lightly, but discretely, soberly and advisedly.
This is the third in a series of articles on the roles that money plays in our lives.
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