Beware the limits of monetary, fiscal and regulatory policies

PRIVATE sector venture entrepreneurship, central bank monetary policy, and government tax and regulatory policy can all create - and destroy - wealth. It is good to understand the differences between the three, for the sake of our own financial well-being.

In the past seven years, major central banks injected liquidity and reduced policy interest rates, now to even below zero, to support global economic recovery. At first, the massive provision of cheap financing calmed the markets and restored confidence among the financial institutions and their clients. Global wealth in equities and housing rebounded, collateral values were restored, and bank balance sheets were repaired. Some of the wealth was redistributed from savers to borrowers. Central bank policy interventions seemed to work like magic. However, soon we found out that the wealth created by the easy money has been more ephemeral than real. Yes, there is a material difference between wealth created by venture capitalists and the transient wealth engineered by central banks and their government backers.

A venture capitalist creates wealth by building a "going concern". The process starts with creating an economic activity that brings sustainable, preferably growing net-after-depreciation-and-taxes income stream. The process ends with a sale of the rights to the future net income stream. The value of the venture at its initial public offering (IPO) or private sale is typically approximated by the present value of the venture's expected future net income, making appropriate, often heuristic, assumptions about future income growth and risk, and adjusting to contemporaneous market valuations for similar entities.