by James Smith
I feel that there is a gross misconception among the public about some basics concepts of economics.
Basically this is what we are going to do in this work:
· Discuss the problem of the monetary profit, and how it creates the demand for new money.
· Add to the current perception of money circulation between firms and households.
· Define Government’s role as the supplier of new money, and what challenges it has to face.
· Refute the notion that banks create new money, and reevaluate their role in the economy and the effect of loan bubbles.
· Prove that calculated government budget deficit is vital for economy.
· Discuss about possible methods to inject new money in an effective way.
So let’s do this.
Monetary Profit- I define monetary profit (or shortly “m-profit”) as a portion of earned money that is not supposed to be used for spending. The moment it is used for spending, it is no longer considered as profit and is converted into “expenditure”.
Injection- I know that in economics they already use the term “injection”. Here we use it differently. Here when I say “injection” I mean a process when the government introduces new money into circulation. This money has to be new money, and not money that was taken out previously from circulation and now is being returned, like taxes for example.
Injection will be usually made in form of direct purchases of goods and services, or paying salaries to government employees.
Usually I will say “injection of new money”, that may look redundant, because “new money” is part of definition of “injection” (kind of like saying “eat food”), but it’s ok.
Public- all the employees.
Participants- employees and firms. An individual can be both an employee and a firm owner, like a manager that receives a salary who also owns the firm.
*(M-profit can be made by all the participants, it can be part of employee’s salary or part of firm’s revenue from sales)*
Cycle- theoretical time period, when a firm spends money on labor, produces a certain amount of goods, and sells all of that amount. In the end of the cycle the firm is supposed to return to staring position, hopefully with added m-profit to its balance.
Excessive products- this means that there is a demand for those products, but they can only be purchased by injected new money (I will explain shortly).
Redundant products- products that the public have no demand for them.
*(Maybe “excessive” is not the best word for it, since it means similar as “redundant”. Maybe we should think on another word instead of “excessive”… but let’s keep it for now, maybe I replace it in the future with a more suitable word.)*
Irrational behavior- behavior that maybe rational from individual point of few, like firms’ tendency to raise prices, or people’s tendency to spend money when they have it, and not plan for the future. But from long term perspective, this may be bad for circulation.
Purchase pattern- personal preferences of the public to make purchases in a certain way.
Intermediate expenditures and m-profit
Debt or “suspended m-profit”
Contraction and expansion of the economy
Natural bankruptcy and redundant products
Let’s say we have a scenario of a single person living on an isolated island, let’s say his name is John. This person decides to open a firm that will plant coconut trees and collect the harvest. John is the owner of the firm, but he also registers himself as the only employee. He decides to pay himself a monthly salary of 120 dollars.
Now each month John manages to grow and collect 120 coconuts.
Now John’s firm has a monthly expenditure of 120 dollars.
So the firm must set the price at least 1 dollar per coconut in order to break even. With this price John will be able to purchase 120 coconuts. Now let’s say the firm decides to make a m-profit, and decides to sell coconuts for 2 dollars. Now John can only purchase 60 coconuts… So each month the firm pays John 120 dollars, produces 120 coconuts, sells 60 coconuts to John for same 120 dollars and it still has the remaining 60 coconuts.
So each cycle the firm makes profit in form of 60 coconuts, but it doesn’t make any monetary profit. In fact, no matter what price the firm sets, it can never make a profit in form of money, only in form of excessive coconuts that John wasn’t able to purchase.
And if John to make a monetary profit from his salary, by not spending all of it on coconuts, that will cause the firm to lose money each cycle. The firm won’t be able to earn back what it spent on labor, and each cycle it will have to reduce John’s salary.
Why? Because John’s only source of monetary income is the firm, and firm’s only source of monetary income is John. Therefore, the firm can never earn more money that it spends. No regular monetary profit is sustainable in an economy with a fixed amount of money. You have to have a constant external source of money, that will be periodically introduced into circulation.
That’s it. Here we proved that the “Money Circulation” that they teach in textbooks can’t be right. The image where money goes from firms to households, and from households back to firms, can’t be the full picture. Because we all know that firms and households make m-profit, but that’s not sustainable without a periodical external injection of new money. And in our reality the source of injection is the government of course.
It doesn’t matter how much employees and firms you add, it’s a zero sum equation.
Let’s say we add another person to the island, Jack. Now John doesn’t work anymore, and only collects the profit. Once again no matter how much John pays Jack, he can only profit in form of coconuts, but never in form of money. John will never earn more money than he paid to Jack.
Let’s use another example.
Let’s say we have a closed economy of 6 firms that produce different products. Each firm employs 10 people, 9 workers and a manager. Managers are also firms’ owners. Each manager decides to pay himself 120 dollars each month, and each worker will receive 90 dollars each month. So each firm will have a monthly labor expenditure worth of 930 dollars.
The cycle of all the firms is a period of one month, and it’s synchronized (meaning they all start and finish their cycle at same time).
Let’s say that labor is the only expenditure that each firm has. Also each firm decides to make 7% of m-profit from sales. So the total monthly price of products that each firm produces, will be worth 1000 dollars.
Let’s also say that the public will always try to purchase all the available goods that are available each cycle.
Also let’s say that firms begin with a capital of 930 dollars.
a.p.p.a. — aggregate public purchase ability
f.a.p.p. — firm’s aggregate products prices (GDP)
So in this table each row represents a cycle. In a single cell we can see each firm total expenditure, that is eventually equal to public’s aggregate purchasing ability of 5580 dollars. Also we see that the aggregate firms’ products prices is equal to 6000.
As we see, by adding more firms and employees we don’t solve the origin of the m-profit problem. Each cycle the firms are left with total amount of 420 dollars’ worth of goods that the public was unable to purchase.
As we see in a closed cycle economy with fixed amount of money, no m-profit is possible for the firms or public.
The firms may make profit in form of excessive goods, meaning that they will be able to make a revenue that is exactly equal to their expenditure each cycle, and still have some products left in the storage. But they will never be able to make any monetary profit from this excessive goods, nobody has money to buy it.
The only way to firms to make a monetary profit, is only if some other firms will start to lose money each cycle. If let’s say Firm F will be able to sell only 800 dollars’ worth of goods, meaning that the public would spend 130 dollars on other firms’ products.
But that can’t last for long. Firm F will lose money each cycle, so it will have to reduce its labor expenditures and the amount of products being produced. Basically in 10 cycles Firm F will disappear and we will go back to the state were no m-profit is possible, with the same amount of money going back and forth between the firms and the public.
So each cycle we have to have an external source of new money that will be injected into circulation each cycle, so that a m-profit may be possible. So we need the government to print new 420 dollars and use it to purchase the excessive goods.
It can do it by direct purchase, or by employing state servants (like a fireman, policeman, teacher) and paying their salaries with new money, that these servants will eventually use for purchasing the excessive goods.
So we have next equations, for each cycle:
f.a.e. = a.p.p.a
f.a.p.p — f.a.e. = P
P > a.p.p.a.
P = I
f.a.e. = firms’ aggregate expenditure
a.p.p.a. = aggregate public purchase ability
f.a.p.p.= firms’ aggregate product prices
P = monetary profit
I = injection
Now you may claim that in the real world firms have additional expenditures than just labor, but how will it change the main picture? Public aggregate purchasing ability will be always equal to firms’ aggregate expenditure, and in order for m-profit be possible the firms’ aggregate products prices will have to always be above aggregate expenditure.
For example you add government taxes. So now the equation is like this:
(g.p.a = government purchase ability)
f.a.e. = labour expenditures +taxes= a.p.p.a +g.p.a.
f.a.p.p. — f.a.e. = P
P > a.p.p.a. +g.p.a.
P = I
Once you increased firms’ expenditure by adding taxes, you forced the firms to raise their prices in order to make m-profit. You added the government and its taxes revenue to the aggregate purchasing ability, but equally you increased the firms’ aggregate prices. So you are back where you started.
So government collecting taxes and using it for spending is in no way can replace the need of injection of new money.
Now if you add the ability of public to make m-profits, meaning that people won’t spend their whole salary each cycle, then you decrease the aggregate public purchasing ability, and you will have to increase the injection amount in order to compensate it, so that firms will be able to sell all the goods and finish the cycle.
How about adding raw materials to the expenditures list? Ok let’s go to the next chapter.
Intermediate expenditures and m-profit
Let’s say we have a closed economy of three firms, a tomato farm, a canning factory and a store.
The tomato farm has 10 employees, and it sells its product to the canning factory for 4% m-profit.
The canning factory has 5 employees, and it sells its product to the store for 7% m-profit.
The store has 3 employees and it sells its product to the public for 10% m-profit.
All the firms’ employees consist of workers and one manager. Workers’ monthly salary is 90 dollars each, and manager salary is 120 dollars.
So the tomato farm spends 930 dollars on labor, the factory spends 480 dollars, and the store spends 300 dollars.
The cycle of all the firms is one month and it’s synchronized.
The public also will try to purchase all the available goods each cycle.
tom farm = tomatoes farm
can fac = canning factory
The farm grows tomatoes, and spends 930 dollars on labor. Now it sells the final product to the canning factory for 968,74 dollars in order to make 4% m-profit.
The canning factory processes the tomatoes and spends 480 on labor. Now its total expenditure is 1448,75 dollars, and it sells it to the store for 1557,79 dollars in order to make 7% m-profit.
The store spends 300 dollars on labor, and it sells the product back to the public for 2064,22 dollars in order to make 10% m-profit.
So the aggregate prices are 2064,22 dollars, while public purchasing ability is only 1710 dollars. So we need an injection of 354,21 dollars.
So even though technically the average firms’ m-profit is 7% (4%, 7%,10%), but really in total it’s 17,16% due to intermediate stages.
But even though, the rule of I=P still applies.
We sum up all the m-profits:
Farm= 38,75 dollars (4%).
Factory = 109,0457 dollars (7%).
Store = 206,422 dollars (10%).
Total= 354,218 dollars.
Now even though that firms’ aggregate expenditure is no longer equal to public aggregate purchasing ability, due to some of firms’ expenditure being used to cover other firms’ m-profits, we still maintain I = P.
So the government can use two methods:
-Simply to sum up all the firms’ m-profits and inject equal amount of new money.
-Find the difference between the store aggregate prices and aggregate public purchasing ability, and cover it with injected new money.
Either way the rule of P = I is maintained.
Now how about the banking system? How would the ability of loaning the m-profit money to the public will affect the situation?
Also we know firms have to invest in themselves in order to maintain equipment or purchase new machines… but that’s no different from purchasing raw materials like in the example with the tomato farm, canning factory and the store. That’s intermediate expenditures and m-profits. The final price of the goods will be always above all those maintenance and upgrade expenditures, so the aggregate prices will be above the public purchasing ability as usual.
Debt or “suspended m-profit”
Pub inc = public income
Loan rep= loan repayments
Pub dep = public deposits
loan tot = aggregate amount of loaned money
real mon= money that are physically deposited
Virtual fir, pub, tot = virtual “firm”, “public taxes” and “total” money that appears as deposited
Now let’s say we have a closed economy with 10 firms, that have 10 employees each, let’s say to make it easier every employee makes same salary of 93 dollars, including the managers (who are also the owners).
Now let’s say that the government decides to tax 7% of people’s salary and deposit it in a bank. Also the government allows to public to borrow this money without any interest rates, on the condition of having to make monthly payments of 10% of the loaned sum.
The firms also are ready to work for 7% m-profit in each cycle, and it will be deposited in the government bank. All firms’ cycle is equal to one month and synchronized.
The public will try to purchase every product available with money it holds, and by taking loans. If an employee has to make a loan payment, it will be reduced automatically by the government from his salary, and the employee will pay 7% tax of the remaining money in that month, and not from the original amount (for example if he made a monthly loan payment of 10 dollars, he will now pay 7% tax from the remaining 83 dollars of the salary, and not from original 93 dollars).
Also in this simulation all the loans will be made collectively. So if the public loaned 1000 dollars, that means every person have loaned 1 dollar individually, and has to make a monthly payment of 10 cents.
The public receives a salary of 9300 dollars, and immediately pays 651 dollars of taxes. Now the public is left with 8649 dollars, so people purchase goods with this money.
So the firms are left with 1351 dollars’ worth of goods, and the public wants to borrow money to buy it. Now in the bank there is 651 dollars available to loan, so the government decide to directly purchase additional 700 dollars’ worth of goods.
So the public borrows 651 dollars and buys all the remaining goods.
So in the end of the cycle we are left with 700 dollars of real money being present in the bank account. This the amount that was injected, and it went to the firms in form of m-profit.
The public immediately makes loan payment of 65,1 dollars and another 646,443 dollars is reduced by taxes. Now the public is left with only 8588,457 dollars as purchase ability, missing 1411,54 dollars in order to buy all the products.
Now in the bank we have 700 dollars from the previous cycle, and additional 65,1 dollars of loan payments and 646,443 of taxes that were deposited in this current cycle. Meaning a total of 1411,54 dollars available for loan, exactly same amount that is needed for purchasing the remaining goods. So the public borrows this money and purchases the remaining goods, and we end the cycle again with same 700 dollars deposited in the bank that is firms’ aggregate m-profit. This time no new injection was needed.
Now we can look at the C table and see that we can go on like this forever, with public making loan payments, tax payments, and firms able to make 7% m-profit with no need of new money injection each cycle.
So we no longer need injection? The public may borrow same money over and over again. But that comes at a price, we have created a very unstable bubble that can burst the moment that firms or government try to withdraw some of the money.
If you look at “virtual” columns, in the 25th cycle (appearing last) both government and firms see a total of 29719,3 dollars appearing on their accounts, while there is actually only 700 dollars present.
Now without the loaning option and taxes, the government would have to inject money every cycle, 25*700= 17500 dollars in total to cover the Firms’ m-profits. And if you add public taxes, that is additional 12219,3 dollars needed to be injected to cover for the aggregate purchasing ability decrease.
Back to our example, the debt will only continue to grow, and the public will never be able to repay it. Of course the public can decrease its spending and use part of its salary to start repaying the loans, but then we will need the government to inject new money to compensate the public spending decrease.
So as you see, the phenomena of banks loaning money doesn’t create the need for additional money injection. On the contrary, it creates a bubble that allows the government not to inject money, at least for a while.
Ok this example was weird, let’s use more realistic example (I added a simplier example for infinite bubble in the end of the article).
pub inc = public income ; loan rep= loan repayment
smart firm = smartphone firm ; 9 firms = “regular” firms
injection l= injection by loan ; inj dir = injection by direct purchase
bank inc = bank income
dep = deposit (1 firm = smartphone firm, pub = public)
end m= real money in bank at the end of the cycle
Again we have 10 firms, with 10 employees each, with each employee earning 93 dollars. We have 9 firms that produce “regular” products and one firm that produces smartphones. Now all firms have a synchronized cycle of one month.
The smartphone company produces only 10 units each cycle, so only 10 people can buy it each cycle. Let’s divide our population in groups of 10, and every cycle a different group will purchase the smartphones.
Now let’s define our public purchasing pattern. The public after receiving the salary, first will always make loan payments. Then public will purchase regular products that are available.
Then a different group of 10 people will borrow money from the bank in order to purchase smartphones.
The loan conditions are that a person has to make monthly 10% payments, plus 1% of interest rate (if you borrowed 100 dollars, then you have to pay 11 dollars for 10 months).
Also smartphones are only good for 10 months, after that they break and people have to buy new ones. Meaning that a person purchases a phone in the end of first cycle, his first payment will be in the second cycle and the last payment in 11th cycle. In the 11th cycle the smartphone will break, so the person immediately buys a new one in same cycle, and starts making loan payments again in the 12th cycle… ok?
Also there is no option for down payment for the smartphone, you have to loan the whole sum. And also the government in order to avoid an unstable bubble, passes a law that no person can have more than one loan at any moment.
Public receives 9300 dollars’ salary and purchases 9000 dollars’ worth of regular goods, and the remaining 300 dollars are deposited in the bank. Now in the bank we have 300 dollars plus additional 630 dollars that the regular firms just deposited as m-profit, so 930 dollars are available for loan. We are still missing 70 dollars, so the government simply deposits this amount in the bank. Now a group of 10 people borrows this money (1000 dollars) and purchases smartphones, and the smartphone firm deposits 70 dollars’ m-profit in the bank, and that’s the amount of real money that we finish the cycle with.
The first group of 10 people makes a loan payment of 110 dollars, the public then purchases 9000 dollars’ worth of goods and deposits the remaining 190 in the bank.
Now the second group of 10 people wants to purchase smartphones. We have in the bank 70 dollars from previous cycle, 630 dollars of regular firms’ m-profit, 190 dollars deposited by the public, 110 dollars of loan repayments, so in total 1000 dollars. The second group now will borrow this 1000 dollars and buy 10 smartphones, no need for government injection, the smartphone firm will make 70 dollars’ m-profit and deposit it in the bank, so we finish the cycle with same amount of real money in the bank that we started with.
Now as you see we can go on like this till the fourth cycles, then the loan repayments will reduce the public aggregate purchasing ability to lower than 9000 dollars. That will force the government to make direct purchase of the regular products.
We see that in the 11th cycle all public will be in debt, making regular 1100 loan repayments, and the government having to inject 800 dollars each cycle.
Now let’s see what is going on in the 20th cycle.
Now in 20th cycle we have a total amount of 10590 of real money, and that is the same amount the government had to inject overall.
Now in a bankless version, we would have to inject 700 dollars each cycle, making it total of 14000 dollars after 20 cycles.
So we have a difference of 3410 dollars between the two versions, so where did this money go? I think it’s in a bubble.
In our C1 example you can see that the firms have deposited 700 dollars each cycle, so they supposed to see a total of 14000 dollars on their accounts. Also the bank sees 1450 dollars of income from interest rates, also employees see 570 dollars on their account. Don’t forget that the government deposited 70 dollars in first cycle, so in total the virtual money is 16090 dollars, and real money is 10590 dollars. That means that the public supposed to have 5500 dollars of loaned money on its hands. And that makes sense, since all the public in debt and every group of 10 people is in different stage of repayments (100+200+300+400+500+600+700+800+900+1000= 5500 dollars of aggregate debt).
So basically we have 10590 of real money, we remove 1450 of bank m-profits and add 5500 dollars that are in the bubble, we get 14640 dollars, that is very close to 14000 dollars in the bankless version. There is a distortion that causes this inaccuracy of 640 dollars, it’s because in our example the public wasn’t able to spend its 570 dollars in first three cycles and had to loan it (300+190+80), and also the goverment had to deposit 70 dollars in the first month.
But don’t let it bother you, let’s continue our simulation. Let’s say that after the 20th cycle the smartphones don’t break anymore, so no one borrows money anymore, and the smartphone firm is immediately converted into regular firm (the “9 firm” column actually becomes “10 firm” column after 20th cycle, and so does the “9 firm dep”).
As you see the 21st cycle is when the first group of 10 people make its last loan payment, and nobody borrows money anymore.
Now let’s see what happens in 30th cycle.
Total real money = Injected Money = 23640 dollars
Bank m-profit = 2000 dollars
In bankless version we would have 700*30= 21000 dollars.
In our bank example, if we remove the 2000 dollars of bank m-profit, we will have 21640 dollars.
So we have a difference of 640 dollars. I think that is because in first 3 cycles the public didn’t spend its 570 dollars (300+190+80), and had to borrow it from itself through the bank. Also the government had to deposit 70 dollars in first cycle, it appears as injection, but that’s a little bit misleading. The government didn’t actually purchase any goods, but loaned money to the public that later was repaid.
In a bankless version if we assume that we have 10 regular firms from the beginning, then the public would be able to spend its 570 dollars, and the government would inject money by direct purchase, and not deposit 70 dollars to be used as a loan. So the 640 dollars’ distortion makes sense.
Either way as you see, the bank loaning money overall didn’t create the need to inject new money significantly more than in a bankless scenario. Only 2640 dollars more, which is slightly bigger than 10% of all injected new money amount. And if we ignore the 640 dollars, then it is even less than 10%.
We can program it without the 640 dollars’ distortion. The government may simply retract it’s 70 dollars in later cycles, and the public may spend the saved 570 dollars on regular products also in later cycles, decreasing the amount of needed injection by same amount. So the only difference would be 2000 dollars between bank and bankless versions.
So I don’t know why they teach in schools that banks create new money by loaning. They are not. The bank interest rates that made the government to inject additional 2000 dollars, is no different from the effect of m-profit of any firm. Banks interest rates are no different from regular m-profit that any other firm makes, and require injection of new money same way.
I never understood why people say that banks create new money by loaning. We don’t say that landlords “create new apartments” when they rent out their apartments for m-profit, so what’s the difference?
Of course what is very important is the bubble effect that the loan creates. The bubble in C2 has an upside down U shape, so the government needs to monitor the dynamic and inject new money accordingly.
If the government ignores it and just inject 700 (or 800) dollars as usually each cycle, then initially in cycles 0–11 it will cause an inflation, and in cycles 21–30 a deflation.
Also the government needs to see the effective way it injects money, whether by direct purchases or increasing bank’s deposits so there will be more money available for loaning.
But the banks do not create new money, and on the contrary they are more like shock absorbers. By allowing people who ran out of money to borrow, it lets the government some time to monitor the situation and think how to respond.
The charged interest rates do create the demand for new money, but no differently from any other m-profit in the economy.
So we may add an equation, for each cycle:
I= P — (loaned money) + (loan repayments)
At each cycle the injection equals the m-profit minus all the purchases that were made by loaned money plus all the loan repayments.
- Notice that this formula doesn’t work for the first cycle in C1 example. I think it depends on if we use the 70 dollars’ injection as a loan or as a direct purchase. If we use it as a loan, then our formula will be I = 1000–1000+0. If we use it as direct purchase of the regular products, then our formula will be
I = 1070–1000+0=70 (because public m-profit increased by 70 dollars, due to regular products reduced to 830 dollars after government direct purchase).
It doesn’t work when injection is a loan, because the formula considers the final state of the m-profit being 1000 dollars. But when we apply it during the cycle, there is actually only 930 dollars’ m-profit (public + regular firms deposits).
I guess maybe we can apply this formula only when the sum of needed loan is lower than the available deposits, otherwise the formula may be misleading, especially if the needed injection is in form of loan.
I noticed this problem with the formula only occurs in the first cycle, so keep an eye on it.
- Also keep in mind that by “loaned money” in the formula I mean purchases that are being made with loaned money in a specific cycle, if you just borrow money and don’t use it, then it won’t appear in the formula. It will still be part of “m-profit” (P).
- Also keep in mind not to use the bank m-profit twice. The interest rate can be part of “P” or part of “loan repayments”, whatever you want, but not both of them.
- Also we defined injection as “introducing new money”, and not returning old money to the circulation. But what about that 70 dollars that the government deposited in the first cycle and later I offered to retract it. If we retract it, and then return it, would it be considered as returning old money or injection of new money? Technically that will be an injection. We needed that 70 dollars only to allow to the public to borrow it, and once it was repaid, it has no role in circulation. So there may be exceptions where a government may retract unused money, and later inject it as new money.
Now you may ask, does it mean that my initial formula I=P no longer works? Not exactly, if you consider a loan as a “suspended m-profit” that is currently is being used by someone else as expenditure, then it’s temporarily not m-profit, and I=P still applies (loan repayment is a restoration of the suspended m-profit).
Now let’s say that instead of smartphones, people would buy some software program. Let’s say some guy wrote a genius program, and everybody wants it, let’s call it “Pacman 2020”. The guy wrote it in his spare time, so he has zero expenses, and he sells it for 100 dollars. So it’s all profit for him.
Now we go back to our table, we have 10 regular firms with 100 employees, in first month they spend their 9300 dollars’ salary and the government inject additional 700 dollars. Firms deposit these 700 dollars in the bank as m-profit.
Now the public borrows these 700 dollars over and over again in first month, until all the employees purchase the “Pacman 2020” program, 100 copies, 10000 dollars total. Now the public is in debt, and it has to pay monthly payment of 10% of the loan plus 1% interest rate to the bank.
So we “created” 10000 dollars out of 700 dollars in first month, but now for the next 10 months the public purchasing ability will be reduced due to loan payments by 1100 dollars, and that is the additional amount that the government will have to inject in order to prevent recession.
So because of the loans, the government will have to inject additional 11000 dollars in the next 10 months (adding to the 7000 for regular firms’ profit).
So let’s use the equation I= P — (purchases with loaned money) + (loan repayments).
First month : I=(700+10000)-(10000)+(0)= 700 dollars.
Next 10 months : I = (700)-(0)+(1100)= 1800 dollars.
And after that, back to I=700 dollars.
Timeframes, unsynchronized cycles and “suspended expenditure”
Tot w dep = total workers deposit ; tot fir dep = total firms deposit
Total work = total money on workers accounts
tot w dep = total workers money deposited in the current cycle
Let’s say we have a firm A with 20 workers, all earning same salary (manager defined as a worker and earns the same).
Each worker earns 93 dollars, and he will never spend more than 86,49 dollars on firm A’s products, and deposit the remaining 6,51 dollars in the bank. Also each worker starts with 200 dollars in his account.
Each worker has a car, and once in 10 month it has to undergo a repairment in a garage.
We have a garage with only one mechanic who is also the owner, the mechanic can repair two cars each month. The mechanic charges 65,10 dollars for each car. The mechanic also has a car, but he repairs it for free so it doesn’t appears in the table.
The mechanics spends all his earnings on firms A’s products and doesn’t make any m-profit.
All firms have a synchronized cycle of one month (firm A and the garage).
Now by looking at the D table we see that the total m-profit each cycle is 270,2 dollars but the injection is only 140 dollars.
Each cycle a different pair of workers take their car to the garage, and they pay only with saved money from the bank account. We see that the column “pair a” follows the first pair total saved money, and that it restores to its initial state of 200 dollars right before the next garage visit.
Also the “total work” column shows that the total amount of all the 20 workers’ money doesn’t change each cycle.
So how can we explain it from the I=P perspective?
Each cycle 20 workers collectively deposit 130,2 dollars, while two individual workers withdraw 130,2 dollars. And of course we have firm A 140 dollars of m-profit.
Well the thing is that workers deposited money is not exactly a m-profit, but a “suspended expenditure”. Previously we discovered that a purchase made with a loan is an expenditure that is also a suspended m-profit, now we discover that it can be the other way, a m-profit can be a suspended expenditure.
So how the government can know? How can we know what earned money is m-profit, and what is a suspended expenditure? Well I guess we can’t know. Even the people who put money aside aren’t sure how they are going to use it in the future.
Now we can think about a method that a government can use in order to know what amount of money to inject. For example the equation:
(aggregate prices) — (aggregate salaries)= I
In our case it’s (2130,2) — (1990,2) = 140 dollars. Which is the exact amount the government needs to inject. Keep in mind that the mechanic appears twice, both in “agg prices” and “agg salaries”. In fact the mechanic doesn’t influence at all on the numbers, so you can remove him all together and nothing changes. (Nothing changes in the numbers world, but in the real world people’s cars will break and not ride anymore).
Of course if the mechanic would decide to make m-profit from his earnings, then the government would have to inject an additional equal amount of money.
But will this equation (“agg prices — agg salaries”) always work? Let’s see another example.
-Accumulated profit expenditure-
Let’s go back to table D and “suspended expenditure” example. Let’s say we don’t like this definition of some of m-profit being a “suspended expenditure”.
Ok, let’s get rid of that definition, and try to look at it differently. Let’s modify our equation like this:
I = P — (spending of accumulated m-profit from past cycles)
Yes, I think it’s better. It allows us to get rid of “suspended expenditure” definition, and also address the conversion of accumulated m-profit into expenditure. But keep in mind that this equation works only for a synchronized cycle and with no “delayed revenue” products. We can add also:
I = P + (loan repayments) — (purchases with loaned money and purchases with accumulated m-profit)
We keep working on the equation, and it gets better.
pub inc = public income ; inj = injection
pub dep = public deposit ; real m = real money
Now we have two firms, firm A has 10 employees with a total salary of 930 dollars and a cycle of one month.
Firm B has only two employees, a manager and a worker, with a total salary of 210 dollars a month. Also firm B cycle is 5 months long, meaning it takes it 5 months to get its product to market and then it is immediately purchased by the public. But the firm still has to pay employees a salary each month.
Both firms make 7% m-profit from sales. Also the public will try to purchase all the available goods on the market, there is no loans but public can withdraw its savings.
Now in first 4 months, both the public and firm A making 210 dollars’ m-profit, but still we don’t need injection.
In the fifth month when firm B tries to sell its products, the public doesn’t have enough money to purchase all of them and the government has to inject 429,03 dollars.
So how do we explain it in terms of I = P?
The first four months the P was 210 and still the injection was 0. P = 210 ; I=0.
In the fifth month the m-profit was 149,0321 dollars, but the injection was 429,03 dollars.
So for the first four months: P = 210 dollars, I = 0 dollars.
Fifth month: P = 149,0321 dollars, I = 429,03 dollars.
So once again some of our m-profit is really a suspended expenditure.
Let’s use (agg prices) — (agg salaries):
first four months 1000–1140= -140 dollars (for each month).
fifth month: 2129,03–1140 = 989,03 dollars.
So we see that the equation I=P=(agg prices) — (agg salaries) doesn’t work in this example.
Why? Because our cycles are not synchronized. Each month we have one firm A cycle, and a fifth of firm B cycle.
Now if we had a synchronized cycle like this:
…then we wouldn’t have any problem. The government would simply inject 85,806 dollars each month.
Back to D1… so how we solve this problem?
How the government should know how much money to inject? It doesn’t know what saved money is m-profit and what is suspended expenditure, the previous equation of “agg prices”- “agg salaries” doesn’t work anymore, it was only good for synchronized cycles.
How about another equation:
(aggregate prices) — (aggregate public spending) =?
For first four months: 1000–1000=0 dollars (each month)
Fifth month: 2129,03–1700= 429,03 dollars.
So looks good enough, this is what the government had to inject.
So does it mean I = P is no longer working? Not exactly. I = P only works in a synchronized cycle, when we also can distinguish between true m-profit and a suspended m-profit (loan) or a suspended expenditure.
Overall if you look at 5 months, the formula I=P works, it’s I=P= 429,03 dollars.
And if the firm B would sell their products every month we would have no problem, just like D2 shows.
But we know that in real world it doesn’t work like in D2, it works more like in D1. Meaning that firms don’t work in a single synchronized cycle. Sometimes it’s even hard to measure when one cycle starts and ends. Some products have short purchase period, like milk or vegetables, another products have a very long purchase period, like nails or canned food.
Some firms getting paid frequently, like a taxi cab or a barber, other firms may wait long period before they get paid, like construction companies, it may take few years to build an apartments building and sell it to costumers.
So in real world there is no such thing as a “synchronized cycle”, and therefore the I=P formula is not easily applicable, even though still being true. The problem of (aggregate prices) > (aggregate public purchasing ability) is still remains.
Also it’s a big problem for government to know what part of saved money is m-profit, and what part is only a “suspended expenditure” (and also suspended m-profit, aka loan).
We may use additional tools to help us to know how much money to inject, tools like equations (“agg prices” — “agg salaries”), or (“agg prices” — “agg public spending”).
Also there is a problem of “irrational behavior” by the participants, both the firms and the public. Take for example D1 scenario. Now technically if the government to directly purchase 85,806 dollars’ worth of firm’s A products each month, there will be less of it for the public to buy, so the public will save additional 85,806 dollars each month. That way in fifth cycle the government will have to inject only same 85, 806 dollars, instead of the 429,03 dollars. So you may claim that we don’t need all this stuff of “suspended m-profit” and “unsynchronized cycles”.
But the thing is that in the real world participants may behave irrationally, since each month people will have money left, they will try to purchase additional firm A’s products, so firm A may respond by raising prices. So you have an inflation, and if the government to inject additional 85,806 dollars by direct purchasing, it will only add to inflation. And now in fifth cycle the government will have to inject even more than 429,03 dollars.
Of course we may have an inflation even without the monthly injection of 85,806 dollars, if the public simply tries to spend the additional 140 dollars that he is left with. Then the government should perhaps try to regulate the irrational behavior by limiting the prices for firm A’s products (1000 dollars only each month), or by taxing the participants and then use these taxes in fifth cycle for direct purchase (as I said before, spending tax money doesn’t replace the need for injection of new money).
But also there is another important issue of choosing a time frame, since in real economy with thousands of operating firms, there is no such thing as “one cycle time period”. The government has to choose a specific time period that it would work with. We already established how it is important to inject the right amount of money in the right time and by the right method (loan or purchase). Let’s look on the next example.
-time frames, and negative time frame-
pub t dep = public total deposits f dep = firms deposits each cycle
Let’s say we have four firms. All firms pay the same to all employees, 93 dollars each.
Firm A has 10 employees and a cycle of one month.
Firm B has 5 employees and a cycle of two months.
Firm C has 3 employees and a cycle of 3 months.
Firm D has 2 employees and a cycle of 5 months.
All the firms pay salaries every month, but sell their products only in the last month of their cycle (firm A sells its products every month). All firms work for 7% m-profit from sales.
No loans available, the employees will try to purchase all the available goods that are on the market, including with saved money from the bank account.
So without going into much details, you can clearly see that even the circulation is usually sustainable most of the time, occasionally it has what I call “negative time frame”. In our table it’s the 6th and the 10th month, it’s when we need the government to inject new money.
Remember in the beginning I said that without injections, the firms will always be in a state of earning same amount that they spend on labor, with their balance being a zero? Now this table shows that even breaking even may be impossible, because of “irrational” behavior by the participants. Many customers are used to spend money when they have it, people usually don’t think “I should save now, so I could purchase some product from 2 months from now”. It depends of course on the product and on each specific person, some people may behave like that, but some don’t. No one will think “I will buy only one chocolate bar right now instead of two, so in 3 month I can buy some chewing gum”.
Anyway I think the D3 table clearly shows that it is very unlikely to firms even to break even due to irrational behavior, without government injections.
Now the government has to define a time frame that it will be working with. For example if it decides to use 2 month frame, then it won’t be effective. If the government reacts in the 6th month to what have happened in the 5th month, then it may be too late, the damage already done.
Especially look at the firm D, it has 0 savings since it hasn’t made any sales yet in previous months, so if it won’t be able to earn back its labor expenditure (maximum loss of 640 dollars), it will reduce its ability to restart the next cycle due to inability to pay salaries. And it’s important to notice that this failure in our example may not be firm D’s fault, but it is government’s fault if it didn’t inject the new money on time.
The government’s duty of injection of new money is not a privilege or act of good will, but an economic necessity and even government’s obligation towards the citizens.
So it looks like the best time frame here is one month, and we use the equation:
I= (aggregate prices) — (aggregate public spending)
6th month: 2900–2260 = 640 dollars.
10th month: 3000–2540 = 460 dollars.
So it makes sense.
Notice that in real world the equation (“agg prices” — “ agg public spending”) is good after the fact, and may be not that effective. Meaning if the government use it in the end of a time frame, then it may not have enough time to make an effective injection.
That’s why the banks are so important, and that’s why I called them shock absorbers. Banks would allow the public to borrow money in the negative time frames and make purchases, preventing or reducing the damage. But that also depends on type of products, some products people simply won’t buy if they don’t have money, not even with a loan being available (like luxury products, or hotel vacation).
Now in my mind I=P is a golden rule, that cannot be avoided. But let’s talk about additional scenarios:
-Contraction and expansion of the economy-
Let’s talk about contraction first, let’s bring back the A table.
Contraction doesn’t necessarily mean a bad thing. Let’s say Firm A made a scientific discovery that allowed it to produce same amount of goods with only half of the workers.
So in the next cycle our a.p.p.a. will be 5115 dollars (let’s assume all employees have same salary), and f.a.p.p will be 5500 dollars. Now the injection needed is only 385 dollars.
Let’s say Firm A after a certain amount of cycles will use its accumulated m-profit to invest and build a new firm. Let’s call the new firm “Firm G”, with also 10 employees with same salary, same m-profit and same cycle. Now the initial one-time investment is of course a conversion of accumulated m-profit into an expenditure.
And after that we simply added another firm, so our a.p.p.a. is increased by 930, f.a.p.p. is increased by 1000, and injection now needs to be 490 dollars.
Now those two examples are simple ones, and the I=P golden rule still holds.
But we should later also check more complicated scenarios, contractions/expansions that happen in the middle of a loan bubble or an expected negative time frame. It may have some nuances, but overall it looks like I=P rule is still valid.
Well of course international trade will affect the I=P rule, but not cancel it. I don’t think it’s that important so I don’t want to waste too much time on it. It doesn’t matter if you divide the world economy into several sub economies.
But ok let’s bring it, why not:
Here we again with A table.
Let’s say all Firm F products go to export, and this economy doesn’t import anything else in return (positive balance).
So now our f.a.p.p. equals to 5000, and the public saves 580 dollars each month and we don’t need to inject new money anymore.
Now let’s say we have identical economy that imports all those products, it also has 6 firms and a.p.p.a. of 5580 and f.a.p.p. of 6000 +1000 dollars (let’s say it was originally euros, but we convert it into dollars’ worth).
Well it’s pretty obvious that the importing government now has to inject 1000 dollars more, making it 1420 dollars in total each month.
Either way it doesn’t change the I=P golden rule. Of course maybe the importing economy has a lot of saved m-profit, and its public purchases the import goods with it… ok, but it is a matter of time before they run out of the accumulated m-profit and the government will have to inject 1420 dollars’ worth of new money each month.
P.S. Someone told me once that Rosa Luxemburg had thought of this problem. She claimed that because capitalists add value to products, the only way to satisfy it is by invading another countries and forcing them to purchase those products. Let’s just say her thinking about this problem was correct, but not the solution she provided. All that the government needs to do, is to periodically inject new money into circulation.
I already mentioned it. Irrational doesn’t mean necessarily irrational per se, it may be perfectly rational from the individual point of view, but it will be harmful in terms of the big picture and the effectiveness of circulation in long term.
Firms may have tendencies to increase prices, public may spend too much money in one month, and for some reason spend too little in another month.
The government may use tools to regulate this behavior, like taxes, price caps, and using tax money for purchases and loans (I can’t stress this enough, spending previously collected tax money is not injection of new money!!!).
Also banks may create unstable loan bubble. So the government may have to bail them, or make them keep reserves, or make borrowers deposit a down payment.
The irrational behavior makes it more difficult for the government, but it doesn’t change the validity of the I=P golden rule.
Now this is something that may cause us some trouble. In all my simulations, all the goods from each firm were sold in on month. Meaning that a firm has always a beginning and an end of a cycle. But what about firms that don’t have exact cycles. A canning factory may produce 1000 units in a month, and then this product may sit on stores shelves for years. This messes up our equation:
I = (aggregate prices) — (public aggregate spending)
Why? Because can food is not supposed to be consumed in same month it was produced. So when the government uses this equation during a defined time frame, it may define the can food as excessive product and purchase it with injected new money, when in reality it’s a “delayed revenue” product, that is supposed to have long purchase time.
So purchasing it with injected new money may have a few negative effects.
It will send a wrong signal to the canning factory, the owner will think there is a high demand for his product and he may increase production. Of course eventually the government will understand that it’s making a mistake by purchasing all this can food.
Also it may cause a needless increase of money in circulation and cause irrational behavior, like inflation.
So how does the government tell apart excessive products, redundant products and delayed revenue products? I guess there is no accurate way to do this. I can’t think of any mathematical way to differentiate between those 3.
There is a possibility of calculated guess of course. The government may use statistics from the past, and divide products into different groups. Also maybe the government should better study the public and its preferences, in order to be able to predict its purchasing patterns. It’s the public purchasing patterns that define whether a product is excessive, redundant or “delayed”.
Maybe also divide products by their expected purchase time durations? For example bread is supposed to be purchased in a week, but canned food may be purchased during a whole year and even longer.
I guess this is where economics meets marketing. In our simulation we programmed the behavior of all the participants, when in real life it may be not so easy to know what people will do, and additional tools needed to be used to help make predictions and calculated guesses.
But still the golden rule I=P is always valid, even though the “delayed revenue” makes it harder to evaluate since we lose the accuracy of the (“agg prices”-”agg public spending”) equation.
-Natural bankruptcy and redundant products-
And of course some firms supposed to go bankrupt and lose money, and their products are redundant and are not supposed to be purchased.
But how to differentiate a firm that is simply experiencing a negative time frame, and its products are not purchased because of government’s incompetence and inability to perform a correct injection, from a firm that is naturally dying?
And also naturally dying firms release money to the circulation due to losses, reducing the amount needed to be injected by the government.
Of course there is no simple answer. I suppose the government should make a calculated guess.
I=P is our golden rule. Whenever a product or service is being made, it also creates a price and a purchasing ability, and those two have to match in order for the product to be purchased.
If we want this process to produce monetary profit for the producer or for the employee, then the price has to be above the purchasing ability, therefore they could never match.
If we establish that it is the greater good and even necessity for monetary profit to be made, then the government has to step in and regularly inject new money into circulation.
And it’s not like the government hands out free cash when it injects new money, no, it allows to monetize the excessive goods, according to their current market price.
The injection is not handing out free money, injection is a solution to a problem of the circulation mechanism… or whatever you want to call it.
If the injection performed correctly, it supposed to allow an effective circulation and exchange of money for goods and services.
And it’s not only a matter of the “greater good”… if the government is the only institution allowed to print money, and it is its duty to provide money to be used as a tool of exchange… then by definition it is government’s obligation to inject new money so that the excessive products could be monetized.
No “monetary profit based” economy is possible without regular new money injection:
all m-profit possible = new money injection
There are slight temporally exceptions and deviations, but in the long run the P=I rule is valid.
Therefore we arrive to conclusions:
-The yearly GDP will most likely always be above the yearly public aggregate purchasing ability, excluding positive trade balance.
-Banks do not create new money, the loaning creates a bubble that temporally distorts the amount of new money that needs to be injected, but in the long term it has no effect. Banks do create a demand for new money by charging interest rates, but that is no different from any other firm that makes monetary profit from its product.
I didn’t mention the stock market, but I guess it is no different from the bank activity. People loaning each other money for an obligation to be paid back in the future, hopefully with additional m-profit.
-It’s the government obligation to effectively inject new money into circulation in order to ensure an effective purchase of the produced goods.
Now is it possible to use the I=P rule effectively in the real world?
It’s hard to tell, due to a number of reasons. There is no doubt that this problem of I=P exists, and demands from the government to inject new money, but there are many challenges that make it hard to do effectively:
- A large amount of data and difficulty to collect it. In real world there are thousands and thousands of firms, and millions of employees. That poses a problem for the government to collect all the data about the activity of all the participants.
- Defining an effective time frame to work with. A week, a month, a quarter?
- Differentiating between m-profit, suspended m-profit (loan) and suspended expenditure. In real world the term “m-profit” may be meaningless, we may replace it with “saved money” or “unused money”, that at any time can be converted by its holder into expenditure.
Also we need to differentiate between active loan and inactive loan (was there a purchase made with the loaned money or not).
Because of this, the biggest problem is that no matter what time frame length we choose, it will not contain all the information that will allow to calculate the exact amount of new money that is needed to be injected. Each time frame is connected and affected by past and future time frames.
- Differentiating between a firm that is experiencing negative time frame, and a firm that is naturally dying.
- Differentiating between excessive goods, redundant goods and delayed goods.
- Predicting and regulating irrational behavior and purchasing patterns. Now the government has the power to decide who will make m-profit and in what amount. Government’s injection policy may be also affected by ideological or political considerations, instead of strictly economical… and that’s not good.
- Predicting contractions and expansions of the economy.
- Predicting export/import balance.
- Monitoring the loan bubble dynamic, and adjusting the injection amount accordingly.
- Choosing the right injection method. Direct or indirect purchases.
Now in our simulations we programed the behavior of all the participants, in real world we would have to predict all this behavior. In the real world the government may not allow itself to wait and react, but it will have to predict and take preventive actions. Meaning if the government expects a specific time frame to be negative for certain firms, it may have start to inject new money some time before this specific time frame actually begins.
Now I want to talk about another challenge for the government, of choosing the correct injection method. It can use two methods:
- Direct purchase with new money. Simply buying goods and services from the market with new money.
- Indirect purchase, like:
Hiring state employees and paying some of their salaries with new money. Teachers, doctors, policemen, firemen, elected officials etc.
Paying some of the social welfare with new money. Unemployment, pensions, assistance to people with disabilities etc.
The government may also fund projects that will involve both direct and indirect purchases. Like building new roads. Purchasing building materials for the project will be direct purchase, paying subcontractors for their work will be indirect purchase… of course we can go into debate whether there is a difference between direct or indirect purchase and maybe it’s same thing, in a long term maybe it’s the same.
But if the government wants to reach immediately a specific firm that may experience a negative time frame, it’s better to purchase its products directly, than pay state employees and wait until they decide to purchase these same products with their salaries’ money.
So that means that some of the government budget should be covered with new money. Yes, deficit budget is an essential and necessary thing, if calculated accurately. As I already said, injection is not a matter of choice for the government, but it’s government’s obligation towards the citizens.
So we should always expect the government budget to be slightly bigger than its revenues, and that difference should be covered by new money, but of course that difference should be properly calculated (I=P).
But that begs a question. Due to a significant complexity of the economy, vast amount of data, unpredictable purchasing patterns and irrational behavior, is it really possible for the government to implement the I=P rule effectively? I don’t know. Maybe not.
Maybe the government should just make rough estimates and once in a while just inject some amount of new money and that’s it. Yes, we may have some inflation, and some firms maybe go unnaturally bankrupt (negative time frames).
But maybe that’s just how it is. Maybe there is no real way to analyze all the data and make accurate predictions, so why bother?
What the government should do, is hire some people to work on this problem. Make a good 3d software simulation program that will be easy to work with. So they would insert all the data into this program, and it will produce graphic simulation of different firms and the public, and the exchange of goods and money between them. And this program should be used to monitor and study the I=P problem, and help to develop tools and methods how to accurately predict and solve new money injection problems and ensure effective circulation.
Because my work is only a simplified presentation of the problem, it’s just some basic concepts.
And eventually this software problem should be used to try to simulate real world economy. The data from previous years should be inserted into it, and simulated. And the economists (or whoever will be working on it) will study past events and try to see whether there were incidents of damage and firms going unnaturally bankrupt or products not purchased, due to government inability to make an accurate injection.
And based on that analysis maybe we could make predictions for the future, and the government may learn how to inject new money in more accurate way, and increase the effectiveness of the circulation.
But the thing is that it looks like the governments know about this problem and they do occasionally inject new money into the circulation… but if they know, then why it’s not in the textbooks? I don’t know what is going on in here…
So to sum up:
- The aggregate prices will always be above aggregate purchasing ability.
- A m-profit based economy can’t be sustained without periodic artificial increase of money in the circulation from outside source, even if this economy doesn’t change in size. All the m-profit in economy equals to injection from outside source.
- Banks do not create new money. They do create a temporary distortion due to loan bubble, but in the long term banks are no different than any other m-profit producing firm.
- Regular injection of new money by the government is not an anomaly, it’s not a bad practice and it’s not up to government’s will. On the contrary, periodic injection of new money is an economic necessity and government’s obligation towards its citizens. Of course it’s a very complicated challenge to perform an accurate injection, but nevertheless the government should try its best.
- Budget deficit is not a bad thing, if calculated properly. Some part of the budget has to be consisted of new money, so the spending should always be slightly above income. Covering budget deficit with new money is same as “injection”.
That’s it. Enough, no? My head hurts because of all the numbers.
Some additional material:
*During this work I claimed few times that no m-profit is possible without injection, and that injection equals m-profit. It would be more correct to say “no regular monetary profit is sustainable in an economy with fixed amount of money.”
So there can be m-profit to be made, but that’s “not normal” m-profit. Meaning that this “not normal” m-profit will hurt the circulation. If the public makes m-profit on salaries (without loaning out this m-profit), then firms can’t earn back what they spent on labor and have to reduce their production.
Firms can make m-profit only due to cycles not being synchronized and due to irrational behavior (table D3), but it is also only for short period. Also firms can make m-profit if other firms are dying and losing money, but that is also “not normal” or sustainable situation.
So as you see technically m-profit is possible without injection, but it is always for short period of time, and it is usually “not normal” m-profit that will have to be compensated by injection in the future. The only “normal” m-profit that can be made without injection that comes to my mind, is m-profit from a naturally dying firms that lose money to circulation. But that also is not entirely “normal”, and of course we don’t have enough naturally dying firms in the economy in order to cover for all the monetary profit that is being made.
And of course m-profit can be made due to loan bubble, but it is also for short period of time. It’s only a matter of time before the bubble becomes unstable, and in order to maintain or exit the loan bubble, you have to inject new money.
*I keep thinking about it, and always come back to add more. In the end this article will become a 300 pages book.
As for the equation (“agg prices” — “agg public purchasing ability”), we have to keep in mind the intermediate production stages (like in the table B example). It’s not relevant to transactions between firms, but only between firms and public.
*I keep adding material…
Here you have a table for “delayed” products:
So the above table is an extended version of D3 table. Let’s call the buttom table D4.
So in D4 we turn the firm’s D product into “delayed” product. It will still take 5 month to produce it, but it will also take 3 month for the public to purchase it, while each month a third of total amount is being purchased.
So as you see the numbers for injection and firms’ monthly deposits are different in both tables, but in the long run they are the same. After 12 months the total amount of injection is same 1280 dollars for both tables, and the total amount of firms’ deposits is same 1652 dollars. Public total deposits are also 0 for both tables after 12 months.
But notice how dramatically the amount of injection changes in shirt term between the two tables, even though in the long run it evens out.
*28.11.2019 I keep adding material.
I have thought about another possibility for “normal” m-profit without a need for injection, expenditure of m-profit from the past.
Let’s go back to table A. Now let’s also add that workers make 7% m-profit on their salaries and put it away. The owners still make 120 dollars a month and spend it all. 7% of 90 dollars of workers’ salary is 6,3 dollars, multiply by 54 is 340,2 dollars of total workers’ m-profit. Also the public purchasing ability decreases by same amount, to 5239,8 dollars. Therefore the injection amount increases to 760,2 dollars each month (Firms still make 7% m-profit from sales).
After 10 months the workers have accumulated in total 3402 dollars. Now let’s say for some reason their purchasing pattern changes, and they will try to purchase all the available products each month, including by spending money that was saved from previous months.
So now the workers no longer make m-profit and the a.p.p.a. is back to 5580 dollars. But also the workers will withdraw from their previous m-profits, so the public will be able to purchase all the 6000 dollars’ worth of products available each month. And as you see in the table, after 18 months the public runs out of savings (accumulated m-profit) and the government has to renew money injection.
Does it mean I=P no longer work? Well if you look after 20 months, the workers have 0 m-profit. The firms have 8400 dollars m-profit. And the total amount of injection is also 8400 dollars. So it works.
Of course applying I=P rule to 20 month time frame is not very effective. We should choose a one month time frame, and monitor the behavior of the participants. If at first the public saves money (makes m-profit), then we should compensate with increased amount of new money injection.
If after 10 months we see public increase spending, even including spending accumulated m-profit, then we should reduce the injection accordingly.
Notice how overall we had more m-profit then injection though. We had 3402 dollars of public m-profit, and 8400 dollars m-profit, making it total of 11802 dollars of m-profit.
But the public m-profit was later converted into expenditure. Basically public’s m-profit was relocated to firms’ m-profit.
Theoretically it’s possible after X period of time to have 0 amount of accumulated m-profit. But it doesn’t mean that there was no m-profit created during this X period, that required injection of new money, only later this m-profit was converted into expenditure.
*Simplified example of infinite bubble.
Remember when I told you about John and a coconut firm, how John earns 120 dollars and the firms sells coconuts for 2 dollars. So now the firm produces 120 coconuts a month, it can sell 60 coconuts for 120 dollars, and remain with 60 coconuts.
But let’s say we add a bank, and allow John to borrow money. So in first month John get paid 120 dollars, and he buys 60 coconuts, and the firm deposits the 120 dollars’ revenue in the bank. Now John decides to borrow these 120 dollars and purchase the remaining 60 coconuts, now the firm sold 120 coconuts and made a monetary profit of 120 dollars. The firm sees 240 dollars deposited in the bank.
Let’s say John has to pay 10% on his loan each month, without interest rates, so he has to pay 12 dollars… so next month he is left with 108 from his salary, but he can borrow this 12 dollars again and purchase 60 coconuts… so once again there is 120 in the bank, John can borrow them too and purchase the remaining 60 coconuts, so the firm once again made m-profit and sees 360 dollars on its bank account. So you can go on like this forever, John borrowing the 120 dollars over and over again while his debt is constantly growing, and the firm making a m-profit of 120 dollars each month.
So after10 months the firm sees 1200 dollars on its bank account, and John owes 1200 dollars… but there is really only 120 dollars in the circulation, it never changed. What happened is that John was allowed to purchase 1200 worth of coconuts in exchange of a promise to pay for it later… but there is still only 120 dollars in circulation, no new money was created.
Now what happens if John want to pay back his loan? Let’s say he decides to spend only 60 dollars on coconuts, and use the remaining 60 dollars to pay out the loan… now we have a problem, the firm pays 120 dollars in salary, but now is only able to sell 60 dollars’ worth of coconuts, and it remains with 90 coconuts each month. Let’s say the firm decides to operate with monetary loss, so even though the firm loses money, it still remains with 90 coconuts each month.
So it will take John 20 month to repay his debt, and the firm will lose 1200 dollars, but gain 1800 coconuts. So the firm ends up with 120 dollars and 1800 coconuts… which is the same scenario if we hadn’t bank in the first place (30*60 coconuts).
No new money was created by bank at any point, it was always 120 dollars going back and forth. But what was created is a very unstable bubble, and if the firm was to try to withdraw some of the money, the bank would default.
This is the loan table. Left column represents John’s loan payments, right column represents the amount that John borrowed that month. When the amount becomes larger than 120 dollars, John simply pays and borrows few times in same month. For example in second month John pays 12 dollars for his loan, borrows that 12 dollars back, purchases 60 coconuts for 120 dollars, borrows again that 120 dollars and purchases 60 coconuts again.
After 10 months John have borrowed 1912,491 dollars, of which he has repaid 712,491 dollars. So he is still in debt of 1200 dollars, which is exactly the amount that the firm sees on its bank account as accumulated m-profit.
And what if the firm refuses to operate with monetary lose, and cuts John’s salary to 60 dollars a month? Well assuming John is getting paid by hour, that will mean that John’s total employment will be reduced by half. Anyway now John will be once again earning same amount that he spends, and he won’t be able to make his loan payments… so his remaining debt of 1140 dollars will remain indefinitly… and once the firm will try to withdraw some of that money, the bank will default.
ehh… I keep adding material… what about the firms that provide services and not physical goods? Their excessive “goods” are not visible.
- Additional difficulty for the government to implement the I=P equation, is the occasional m-profit transformation, especially accumulated m-profit. M-profit can change hands, or can be converted into expenditure. But why wouldn’t we inject new money when profit changes hands?… need to think about that one.
- I know that I didn’t mention in the firms’ necessity to invest in themselves in order to maintain equipment or purchasing new machines… but that’s no different from purchasing raw materials like in the example with the tomato farm, canning factory and the store (table B). That’s intermediate expenditures and profit. The final price of the goods will be always above all those maintenance and upgrade expenditures, so the aggregate prices will be above the public purchasing ability as usual.
- Need to think about how m-profit problem effects the service sector. The mathematical problem is still the same though, every price for any service provided, in order to be profitable has to be above the production cost, just like physical goods.
wait, wait… I see that Karl Marx did talk about this problem, he called it “surplus value” problem… yes his approach to the subject is pretty similar to mine, but there are few differences:
1. I do not differentiate between any profit, be it “capitalist” profit or “proletariat” profit. Profit is profit, doesn’t matter how it is made. If a worker doesn’t spend all of his salary and is able to save some portion of it each month, then I call it “monetary profit”. It’s no different from firms making monetary profit when their revenue exceeds their expenditure.
2. I treat this problem not as an ideological issue, but as arithmetical problem. The money is a tool that is used for exchange, and it has limitations. The main limitation is that fixed amount of money doesn’t allow an effective monetization of all the products.
In our isolated island example, maybe the firm didn’t mind that it couldn’t monetize the remaining coconuts. It paid John 120 dollars each cycle, and got 120 dollars back plus 60 coconuts (when the price is set 2 dollars for single coconut).
But in real world, firms want to monetize all their production… they don’t want to make profit in form of remaining products.
3.Unlike Marx, I offer a simple solution… it might be very simple and has nothing special about it, but still a solution. The government simply has to calculate the amount of profit that is expected to be made during certain period of time, and cover it with newly made money… simply purchase those remaining goods with new money (I call it “excessive goods” in my work). But keep in mind that also service producing firms have this m-profit problem, their “excessive services” may be harder to measure.
I said that injecting is not handing out free cash… well it’s not free cash for the firms that sell their excessive goods. But it’s free cash for the society overall.
Let’s say in table A example where the government has to inject 420 dollars, let’s say it decides to do that by hiring 4 public service employees. Let’s say a fireman, a policeman, a street sweeper (100 dollars a month each) and a mayor (120 dollars a month). All their salaries will be paid by new money, and they will use it to purchase the firms’ goods.
Now technically the participants enjoy a free public service, that is covered by new money… but I don’t see any other way how can you allow firms to monetize their excessive products. And if employees decide also to make profit on their salaries, that will require the government to increase injection even more.
Of course that will lead to increase in accumulated profit, and if in the future the public decides to suddenly spend it, that may cause an inflation.
People keep telling me that banks create new money by loaning money… no, a loan is same as saving, but in reverse. Let’s say you save money for a period of X time, and then make a purchase. Now a loan is when they tell you: you can have it for free now, but pay us back each month for a period of X time. It’s the same, but in reverse. So just as how no new money was created when you saved (accumulated profit), same no new money was created when you borrowed money and repaid it later.
(We will need an injection that is equal to a monthly profit, or monthly loan repayment though).
For example there is 100 dollars in a bank. One person borrows it and buys a product, a store now earned 100 dollars and deposited it back in the bank. Now another person borrows it, purchase a product, and the 100 dollars is back in the bank. So you can go on like this forever, this is an infinite loan bubble.
Let’s say we have 10 people who borrowed this 100 dollars and made purchases. So you may claim that we created 1000 dollars… but no, we haven’t. If stores try to withdraw more than 100 dollars, the bank will default. There is only 100 dollars on the deposits, you haven’t created any new money by loaning out the same100 dollars over and over again.
What just happened is that 10 people got free products in exchange for obligation to pay back the money in the future. So it’s the same as savings but in reverse. According to equation , it’s almost the same thing:
I=P-(purchases with loaned money)+(loan repayments)
When public make profits (savings) or make loan repayments, it requires same injection of new money (excluding banks intrest rates).
The only difference is that with a loan the purchase happens in the beginning, and with savings the purchase happens in the end.
In fact you don’t even have to have money deposited in the bank, for infinite loan bubble. The bank simply says to the store “give those people whatever they want, they will repay you later. We just write in our books that the money is already on your account… even though it’s not yet. Don’t worry about it.”
And of course people will repay it later. If the repayments will be done from previously accumulated profit, then no new injection will be needed. But if the repayments will be made from salaries, then we will need to inject new money.
To sum up (again)…
So let’s say the government chooses a certain time frame, and it wants to decide how much of new money should it inject during this period.
So we have an equation:
I = P + (loan payments) — (purchases with loaned money + purchases with accumulated profit)
Let’s make it shorter:
Lp = loan payments
pB = purchases with borrowed money
pAP = purchases with accumulated profit
I = P + Lp — (pB + pAP)
— — — — — -
*Keep in mind that if loan payments are made with accumulated profit, then they shouldn’t be in the equation (you may consider it both as part of Lp and identical part of pAP, so it cancels itself out).
— — — — — -
Now this equation is good, except 2 main problems:
1. Unsynchronized cycles.
2. “Delayed revenue” products and redundant products.
(Of course there are problems of irrational behavior and unpredictable purchasing patterns, but let’s leave it for now).
Now in programmed simulation it is very easy to solve this problems, because we decide what is what… so it’s not even a problem. But in real world we will have to make calculated guesses.
Let’s try to think about solutions.
1.Uncynchronized cycles. Ok, so we can evaluate aggregate amount of goods produced, and aggregate amount of salaries. Now if agg salaries exceed agg prices, then it’s clear that we are in a “positive” time frame, and most likely no injection is needed. Now it looks like enormous profit is being made, due to salaries being deposited in the bank, but we don’t need no injection.
So we have to have (agg prices)> (agg salaries) in a certain time frame, then it’s likely to be a “negative” time frame, and then we may have to inject new money according to our equation:
I = P + Lp — (pB + pAP)
2. Delayed revenue and redundant products.
I have no easy method to suggest, how to differentiate delayed revenue products and redundant products.
Also delayed revenue products can become redundant products. If Apple made new smartphone model and produce 100000 units of it, expecting them to be purchased in a course of a year, then we may consider it as delayed revenue product.
But if in mid-year, Samsung or Huawei will introduce a newer and better model to the market, then nobody will buy the Apple current model… so from being delayed revenue product, it will become a redundant product.
We can talk in length how to make calculated guesses and try to estimate which products are “delayed revenue” and redundant. There is no short answer.
3. And what about the service sector? Same problem, different ways to calculate.
Some additional thoughts on loans, loan bubbles, and quantative easing.
Ok. Let’s talk some more about loans. It’s pretty clear that you don’t really have to have real money, in order to loan it out. As I already said a purchase with a loaned money is the same as a purchase with a saved money, only in first case the purchase is in the beginning, and in the second case the purchase is in the end.
So in terms of injection it doesn’t matter. In order to save money, you have to accumulate profit. So the government has to inject new money to cover your profit. When you repay a loan then you decrease your purchasing ability, so the government has to inject new money in order to cover that (as long as you pay from your salary, and not from accumulated profit)… so it’s not different.
The biggest difference I guess is when you loan out money that doesn’t exist, you create a very unstable loan bubble, that may burst if someone tries to withdraw too much money. But it’s not necessarily a bad thing, and the government should support banks during those periods by providing them money. It doesn’t mean that unstable bubble is a bad thing, people still can repay their loans in the future, banks only need some support during the initial stage. Later banks can return the money that the government provided previously, after people make some repayments and banks will restore some of the money on theirs deposits.
I know that I didn’t talk about “fractional reserve theory of money creation”, but it’s just another type of loan bubble. It’s like you deposit 100 dollars in the bank, someone borrows it and make a purchase, then the 100 dollars are back in the bank. Now someone else borrows it, makes a purchase and it’s back in the bank again. And you can continue like that forever, or limit it by passing a law that will make banks to save some fraction of the deposited amount.
So let’s say we set the required reserve ratio at 10 percent, and deposit 100 dollars. Technically by loaning out this money multiple times, people can purchase with it an amount of goods worth of 1000 dollars.
But it doesn’t mean that we have now 1000 dollars in circulation. We still have only 100 dollars in circulation. It’s simply an unstable loan bubble. Multiple people simply got free stuff by promising to pay for it later.
And when people start making payments from their salaries, that means they will buy less from the usual products that they purchase. So now the government has to inject new money in order to cover that loss of purchasing ability.
And if the government fails to do that, then firms will fail to complete their cycles, and have to decrease their next cycles, by firing people. People that will be fired won’t be able to make loan payments… and we have a problem. That’s maybe how the 2008 crisis happened in USA real estate market (maybe, I don’t know… I don’t have all the data).
I’m not sure what that is, but for my understanding it’s when the government simply introduce new money into circulation not by spending it, but by allowing to borrow it. Basically it says to public and firms “borrow how much you want, interest rates are zero or almost zero”.
Of course this is not a creation of new money, but allowing the borrowers to increase spending now (regular spending + spending with borrowed money) in exchange for reduced spending in the future (regular spending- loan repayments).
That future decrease in spending will have to be compensated by government injections, in order to prevent a financial crisis.
But, there might be some effect… quantitative easing may encourage people to spend their accumulated profit.
Why? Because people sometimes feel uncomfortable to use their savings, or don’t have enough savings to make a purchase. But they feel more comfortable to make a purchase with borrowed money, and later make loan repayments with accumulated profit money.
This is true both for firms, and the public. Let’s say a person wants to buy a new car, that costs 10k dollars, but he has only 5k in savings (accumulated profit is same as savings), so he won’t make a purchase. But then the banks tell him “borrow money now, interest rates almost 0”, so the person may even borrow the whole 10k, and he will gradually repay it, 5k from his savings and 5k from his salaries.
Now as I already said, loan repayments covered by accumulated profit don’t require new money injection, unlike loan repayments that are covered by salary.
So quantitative easing is not injection of new money (maybe in a short term it is, but not in a long term), but it may encourage people to spend accumulated profit, that will reduce the amount of new money that is needed to be injected (at least for the period of the loan being repaid).
1.In previous time the government had to inject 5k so that the person could make a profit of 5k from his salary (this injection was spent on firm goods that couldn’t be purchased due to person’s profit/saving).
2. The government had loaned 10k to the person (quantitative easing).
3. Later the government has to inject additional 5k due to person’s loan repayments (this injection will be used to purchase firm’s goods again).
4. Eventually the person has repaid his debt to the government.
So quantitative easing is not exactly an injection of new money, but it may affect participants’ purchasing patterns, and encourage them to spend accumulated profits. In order for a person to borrow 10k and repay it, the government has to inject 10k into circulation (to prevent damage).
We will talk about scenarios when firms borrow money in order to create new jobs later.
- Taking into account the national trade balance… here it’s a bit tricky. You may think that we should simply add to our injection equation another variable that represents the trade balance, and in case of positive balance you may think that we should inject less, and with negative balance we should inject more, right?
Something like this: I = P — (Trade Balance)?
Well, it doesn’t exactly work right that. Let’s say we have two countries, Exportia and Importia. Let’s say that Exportia economy is identical to table A, 6 firms with total salaries 9300 dollars and aggregate prices 1000 dollars. Also Exportia uses dollars as its currency, and Importia uses euros.
Now Importia government says to Exportia “hey, we are ready to import 700 dollars’ worth of your products each month… but we don’t have your currency”… well theoretically Exportia firms may agree to take euros, but let’s say they don’t.
Now let’s say Exportia government decides to exchange dollars for euros, let’s say at rate 1 to 1. So Exportia government each month will print new 700 dollars, and exchange it for 700 euros. Now Importia takes these 700 dollars, and purchases Exportia’s goods.
Now as you see, even though Exportia has a positive trade balance of 700 dollars, and its firms’ m-profit is also 700 dollars, it still doesn’t mean that injection is 0.
This equation I = P — (Trade Balance) = 700–700= 0, doesn’t work in our scenario for Exportia.
Now each month Exportia government will accumulate 700 euros, and maybe in future it will start importing goods from Importia, and have a neutral or even negative trade balance, but even then it will still have to inject 700 dollars each month, even if Importia stop importing goods at all. If Importia stops importing, then Exportia will still have to inject by direct purchases in order to allow firms’ profits.
So calculating how national trade balance effects the required injection amount is tricky.
- in our equation I = P + Lp — (pB + pAP), if “I” is negative, that may cause an inflation. But it also may be a signal that there is an increase in demand for a certain product.
- in negative time frames, the firms that likely to take the hit, are firms that have highly elastic demand.
- effectiveness of injections in positive timeframes. now even though we need to inject in negative timeframes, also injecting in positive timeframes may not be totally useless. It will allow participants to accumulate profit, and perhaps use it wisely in negative time frame. But of course it will be much more effective to inject in negative time frames, and not to rely on participants to work it out.
Inaccurate injections, regulating irrationality with taxes, and trying to solve unsynchronized cycles.
Ok, so let’s say that the government decides that the rational m-profit for products is 7%.
Now the government has a difficulty to guess how much to inject each month, but it does know that total salaries are 1860 dollars each month, so with 7 percent profit prices have to be 2000 dollars on average each month, but as we already know due to unsynchronized cycles each month is different in terms of products being produced and consumed.
Let’s say the government knows that during the course of a year it has to inject 140*12= 1680 dollars, but how to do that?
Let’s say the government decides to do the easiest thing, and simply injects 140 dollars each month.
Let’s also say that the public doesn’t save, and tries to spend all available money on products.
Also let’s add irrational behavior, the firms will be ready to raise and lower prices depending on public purchasing patterns. But firms will never lower the price beneath 7% profit rate.
Now the government suspects that in positive timeframes due to a.p.p.a. exceeding f.a.p.p., that may lead to irrational behavior and inflation. So the government decides to use taxes to correct it.
Each price has to be equal to its labor cost multiplied (1,075). If a price is above this rate, it will be taxed.
So for each month:
If (firms aggregate products prices)>(labor costs)*1.075, then taxation equals to the difference between the two (f.a.p.p. minus labor costs multiplied by 1,075).
Let’s make it shorter:
lC = labor costs;
T = taxation;
So: T=f.a.p.p. — lC*(1,075)
*Keep in mind that this equation is not only for products produced in the current time frame, but for all the existing products that are being purchased in the current time frame, regardless their production period.
Ok, so let’s say in first month we have a.p.p.a. worth of 1860 dollars, plus injection of 140 dollars, all this money goes to firm A, and it raises the price from 1000 to 2000 dollars.
T = 2000–930*1,075= 1000 dollars. (you have to multiply by 1,075269)
Now the government has 1000 of tax income received.
We see that next month a.p.p.a.+injection is 2000 dollars. Firm A wants to sell its products for 1860 dollars, and we have 1000 of firm b products.
Now we said that the government decides that the rational m-profits should be 7%.
So when it decides to intervene?
· When aggregate purchases exceed rational f.a.p.p. and cause inflation.
· When rational f.a.p.p. exceed a.p.p.a, and injection is needed.
Now we see that f.a.p.p. can be rational with 7% profit, and irrational when the rate of profit is bigger.
So let’s say in 2nd month the government decides not to intervene due to f.a.p.p. being irrational, and firm A decides to lower its prices in order to be able to sell its stock.
Month 3 we will have additional inflation and taxation equal to 100 dollars.
Month 5 we will have inflation/taxation equal to 666,66 dollars.
Now in month 6 we experience a negative time frame. The rational f.a.p.p. is 3233,33 dollars, while a.p.p.a+injection is only 2000 dollars.
By now the government has collected 17666,66 dollars in taxes, so it can cover the remaining 1233,33 dollars of firms’ revenue.
So in the example with only rational behavior, after 6 months, the only government intervention was injection of 306,66 dollars.
In irrational version with inflation and prices volatility, after 6 months, we had injection equal to 840 dollars, 1766,66 dollars of taxes collected, and 1233,33 of taxes spent.
So in total: 840+1233,33–1766,66= 306,66 dollars.
So we see, as I previously said, the government can use taxes in order to regulate irrational behavior.
Of course our example was very oversimplified.
So let’s sum up:
At each time frame (in this example a month), the government should see what is the aggregate purchasing ability (including accumulated profit and loans), and what is the aggregate prices (f.a.p.p.) of all available products.
Now a.p.p.a. is not a good enough definition, since a.p.p.a. doesn’t necessary means that public will use it’s all ability for purchases. So let’s use “aP”, actual “aggregate purchases”.
Also let’s define r.f.a.p.p. and i.f.a.p.p., rational and irrational aggregate prices.
*if aP> r.f.a.p.p., then it may cause an inflation.
*if f.a.p.p.> lC*1,075, then f.a.p.p. is irrational.
*In case of rational f.a.p.p. and fixed injection:
If r.f.a.p.p.> aP +injection, then we need to spend tax money.
Tax spending= r.f.a.p.p.-( aP + injection).
*In case of irrational f.a.p.p. and fixed injection:
If i.f.a.p.p = aP + injection, then we need to collect taxes from firms.
Tax collection = i.fa.p.p. — (lC)*(1,075).
If i.f.a.p.p. > aP+ injection, then we should do nothing, and let prices to fall to rational level.
Of course this example is very oversimplified, and by the way we didn’t have to have a fixed injection. We could remove injection in time frames where aP>r.f.a.p.p. (or equal). Basically Injection equals to rational aggregate prices minus aggregate public puchases.
Remember the equation I = P + Lp — (pB+pAp)? So if “I” is negative, that means we may have an inflation. Then we may have: T (tax collection) =-I(overspending).
But for individual product, overspending and price rise doesn’t necessary mean irrational behavior. That also can be a result of demand shift, and a signal for the firm to increase production, so it can use the increased profit for investment.
I guess if we have firm A and firm B, and firm A prices are inflated irrationally, then it supposed to balance itself out eventually. But if it doesn’t, and firm A raises prices and increase profits, while firm B loses money, then it may be rational behavior, and result of demand shift. So in this case, firm B is a naturally dying firm, that sells redundant products.
But that’s only true, if both firms have identical demand elasticity.
I guess that’s why in real world, the government taxes more when firms use m-profits for paying dividends, than when m-profits are used for investment.
Some additional thoughts about my work
Let’s bring back table A.
Now I claimed that if firms to start with only 930 dollars, in the end of each cycle they will be left with 70 dollars’ worth of goods that they weren’t able to sell.
Ok… but what if firms to start with 1000 dollars each? Then at the end of a cycle firms in aggregate will remain with 420 dollars’ worth of goods, and 420 dollars available for spending. So firms will be able to purchase each other’s goods and finish the cycle with no goods remained and with 1000 dollars available for next cycle.
So you may say that one of my main claims is incorrect, that circulations with fixed amount of money won’t allow the consumption of all the goods being produced… ok, but wait a second, that still doesn’t solve the origin of the monetary profit problem.
Now according to one of Kalecki equations, in closed economy with workers that don’t save, capitalists’ profit equal to capitalists’ consumption and investment (P = Cp + I, in Kalecki’s words).
In our example, capitalists’ consumption is 720 dollars, that is 6 owners that had set their salaries to 120 dollars each.
Now if we consider firms purchasing each other’s goods as “investment”, then Kalecki’s equation holds.
So for our example, Kalecki’s equation will be 1140 = 720 + 420.
Ok… but the thing is that Kalecki’s profit is not monetary profit…
In John and coconuts example, we said that the firm can generate profits only in form of excessive coconuts, and Kalecki’s equation doesn’t change that.
Now in this type of economy, we see that in order to work properly, every product has to be immediately purchased, and every income has to be immediately spent, and if not immediately, then at least incomes and products have to be exchanged in a constant rate.
But wait a second… let’s define first some conditions. What is monetary profit? Well regardless of what you think of it, monetary profit does exist.
One of the main motivations of participants (economic agents) is to accumulate monetary profits. Many participants engage in economic activity not only for consumption, but also for accumulating monetary profits.
Also there is no way to prevent participants from generating m-profits. You may claim that in our table A example firms can’t make monetary profits, but what about employees? Employees are the masters of their salaries, and they can decide how much they going to save from it. The moment employees make m-profits from their salaries (savings), the circulation will be damaged, you can’t prevent it without injecting new money.
Now the thing is, this is not how we perceive economics… we perceive that every participant has the ability to generate and accumulate m-profits, at least at some kind of rate.
But now we say that in order for one to make a m-profit, it’s only by damaging the circulation effectiveness, by withdrawing money from it, and refusing to spend it.
Imagine that each time any firm makes monetary profits, its owner first thought will be “I better spend all this money quick, in order to prevent recession”.
That doesn’t make any sense. But that what we will have if the government refuses to inject new money. The government then will have to pass a law that every participant has to have a zero cash flow balance, and in case of a surplus, that money have to be immidiately loaned out or taxed. Does that make sense to you? Can you imagine a big corporation with thousands of employees, having a main goal of achieving a zero cash flow balance?
Now you may claim that accumulated profits are being used as credit, so they don’t leave the circulation. But I don’t think it’s true, the rate of accumulating profits most likely will exceed the borrowing rate, regardless the interest rates. And we already talked about it, borrowing money is increasing purchasing ability now, in exchange of reducing it in the near future.
Now you could claim that the circulation has the ability to preserve itself by adjusting after money leakage due to m-profits… but in order to adjust to reduction of money, you most likely will have to reduce wages… and we all know about “sticky wages” problem.
You can’t argue the fact that monetary profit is a real phenomenon, and accumulation of monetary profits is the goal of the majority of population. Meaning that increasing accumulated profits doesn’t necessary lead to increasing in consumption, and people who accumulate m-profit, doesn’t necessarily do it for future consumption, but for the sake of accumulation itself.
But I think it’s clear that economy with fixed amount of money, will have a very fragile balance… it’s some kind of utopia, with everybody being worried to spend or loan out all their money, in order to prevent a recession.
Ok, let’s make some corrections.
Previously I claimed that we will have excessive goods remained in the end of a cycle, due to monetary profit problem. I claimed that it’s the government obligation to purchase these excessive goods, under the condition that their profit is rational (7%).
Now of course the excessive goods is not a universal problem. For example what about the case with intellectual products? Songs, software programs, etc? Some of them may have almost zero production cost, but they may earn millions in revenues. But let’s leave it for now…
Back to excessive goods… now that we say that it is possible for all the goods to be purchased (table A), as long as there is no monetary profit, then why is it government’s obligation to allow firms to make m-profit?
Well first as I said, we will have m-profit whether we want it or not, since employees will occasionally save some of their salaries…
Also the firms can’t be managed with zero cash flow balance… they have to have some cushion, they have to make a little bit more than they spend… I mean do you expect the economy be so finely tuned, that all the firms will run with zero cash flow balance?
And any m-profit that is not being spent, has to be loaned out… Well that fits our equation (for synchronized cycle):
I = P — (purchases with loaned money) + (loan repayments and purchases with accumulated profits).
Let’s go back to John and coconut firm. Let’s also add Jack. John will be the firm owner, and Jack the employee.
Let’s assume Jack receives an hourly wage, a dollar each hour, and he works 180 hours a month. Let’s say he produces 1 coconut each hour.
Let’s say the firm manages to produce 180 coconuts each month, and it sets the price at 2 dollars for a single coconut. Let’s also add that the firm starts with only 180 dollars.
So in the end of the month, the total production will be 180 coconuts, 90 of which will be consumed by Jack after he will purchase it with 180 dollars, and the remaining 90 will be consumed by John (he won’t need any money to purchase the remaining 90 coconuts, since it is his property).
Now it is clear if Jack’s goal is to consume coconuts, then we should have no problem. After receiving the salary, Jack will spend it all on coconuts. In this scenario we have no problem, the firm earns exactly what it spends, and each cycle is identical.
But once Jack decides that his goal is not only to consume coconuts, but also to accumulate money and save some portion of his salary, then we have a problem. Let’s say Jack decides to save 30 dollars for 3 months, so he only spends 150 dollars. For some reason he plans to reduce his consumption for 3 months by 3o dollars (150), and then for 3 month increase it by 60 dollars (210). Well his goal is still to consume coconuts, but not at a steady rate.
Now the next month the firm is no longer capable to pay for 180 hours of work, but only for 150 hours. So the total production is reduced to 150 coconuts. Now let’s say once again Jack saves 30 dollars, next month his salary will be 120 dollars and the firms output will be 120 coconuts. He saves 30 dollars again, the next moth (4th month) his salary will be 90 dollars, and coconut production will be 90 units. Now Jack bring out his saved 30 dollars, and he wants to purchase 60 coconuts. Of course what will happen now depends on John’s actions. If he decides to sell 60 coconuts for the usual 2 dollars, then we have no problem. But if John decides to consume some of them, then Jack may experience a shortage or an inflation (if John decides to raise the price). But let’s say John reacts to Jack’s actions, so he has no problem to consume whatever is left after Jack performs his purchase.
So now for 3 months John will earn 30 dollars more than he spends on labor, Jack working hours will increase by 30 hours each month, so after 6 months we restore the initial situation.
Here is the table:
firm out = firm output ;
purch, cons, sav = purchases, consumption, savings;
tot cons = total consumption ;
firm m.e., m.i. = firms monetary expenditure, monetary income
m supply= money supply ; in circul = money in circulation;
(all values in the table are in dollars)
Now as you see, all Jack wanted to do is to decrease his consumption by 30 dollars for 3 months, and later increase it by 60 dollars for 3 months, and then return to his regular 180 dollars. But his temporary accumulation of profit has caused a damage to the circulation and total production output was reduced.
The total loss equals to 540 dollars, this is the total drop in production between months 8 and 12.
Now if our annual GDP is 4320 dollars (360*12), then 540 dollars is 12,5%. So we have lost 12.5% of our annual GDP, just because Jack decided to save 16,66% from his salary for 3 months. Jack losses are 270 dollars, and John’s losses are also 270 dollars.
I mean overall Jack planned to consume same amount of products, but by trying to temporarily decrease and later increase consumption, he damaged the GDP by 12,5%. That’s pretty dramatic.
This is the perfect example how fragile economy is with fixed amount money, and how disrupting the problem of monetary profit can be.
Solutions without injection:
Now let’s say after a while, John noticed that each year Jack usually spends 180 dollars the first 6 months, but in months 7–9 he saves 30 dollars from his salary, and in months 10–12 he overspends 30 dollars more than his salary.
So the easiest solution is to communicate. Jack may simply tell John that he wants to consume less food for 3 months, and later consume more food for 3 months. So John may ask Jack to pay whole 180 dollars in months 7–9, but then John simply put aside 30 dollars’ worth of food, and in months 10–12 will gradually give to Jack. So even if Jack will pay only 180 dollars in months 10–12, he will receive 210 worth of food.
So in this scenario everything is good, no losses to the GDP and to John’s and Jack’s consumption.
But what if John and Jack can’t communicate? Let’s assume John became aware of Jack’s purchasing pattern, but they can’t communicate. So how can John solve the problem, and avoid losing 270 dollars on his part?
Well if John only has 180 dollars, he can’t solve this problem even if he is aware of it. When Jack will save 30 dollars in 7th month, John’s firm will earn only 150 dollars in revenue, and will have to cut Jack’s working hours the next month. There is nothing that John can do about it… unless…
Unless if John has accumulated profit that he can spend (90 dollars’ reserves), then he can still employ Jack the full 180 hours, even if losing 30 dollars between months 7–9. But that’s ok, because John knows that he is going to earn this money back in months 10–12 when Jack is going to spend his savings.
Also of course John has to put aside 30 coconuts in months 7–9 (90 coconuts overall), so that Jack will be able to purchase it in months 10–12.
Another solution is credit. Let’s say we add a bank, and in month 7 Jack will deposit 30 dollars of savings on his bank account. Now John can borrow these 30 dollars, and pay it to Jack the next month (adding to the 150 dollars). So John can also do it in month 8 and 9. So in month 10 we will have a loan bubble equal to 90 dollars. And in months 10–12 when Jack to spend 210 dollars each month, John can repay his debt.
(Of course Jack won’t be able to withdraw 210 dollars, because only 180 dollars really exist. But Jack can spend 180 dollars of his salary, and John can take 30 dollars from the received revenue and pay it to the bank for his loan. Now bank has 30 dollars, Jack can withdraw it and spend it again on coconuts. So Jack’s total spending will be 210 dollars, and John’s loan payment will be 30 dollars).
*Another solution is for Jack to save in form of coconuts, and not in form of money. Jack simply can purchase the coconuts at steady rate of 180 dollars a month, but consume them whenever he wishes.
Solution with injection.
Now the perfect scenario, is if the government to purchase 30 dollars’ worth of products in months 7–9, but not to consume it and put it aside. So after accumulating 90 dollars’ worth of goods between months 7–9, the government can sell it to Jack in months 10–12. This is the perfect solution.
The less perfect solution is if the government to consume the products it purchased in months 7–9. I mean it used the I = P + Lp — (pB+pAp) equation, it recognized that Jack makes 30 dollars of m-profit, so it injected 30 dollars by direct purchase, but didn’t keep the product.
Now in months 10–12 when Jack wants to spend his savings, John will have to consume 15 less coconuts each month (according to how I programed his behavior), but on other hand he will make 90 dollars of m-profit. The money supply will increase from 180 to 270 dollars.
Now even if you claim that overall John has no use for this new 90 dollars, and that really he has lost 45 coconuts, that is still less than he would lose in case of no injection at all, which was 270 dollars’ worth of coconuts (135 coconuts).
Let’s make some conclusions.
First we saw that even temporarily accumulated profit may be very disruptive, and damage the circulation and cause significant losses to the GDP.
Now we talked about possible solutions without government injection. Well there are possible solutions, that require participants to communicate, or at least some participants have to have knowledge on other participants’ future actions.
I very doubt that we can expect in real world economy with all its numerous participants, to effectively communicate and have enough knowledge on each other future actions.
And also keep in mind that we talked about temporary accumulation of m-profit, for short period of time. If Jack to make savings every month, I don’t think we could solve this problem without injection.
Now let’s talk about injections. Here I talked about of new way to inject money, to purchase goods and later sell them back to the public. Of course for this kind of injection to be effective, once again we have to have knowledge on participants’ future behavior.
But that made me think… previously I claimed that when government loans out new money (quantitative easing), it’s not exactly an injection, since this money has to be repaid. But we see in our example with temporary accumulated m-profit, government loan could do the trick. John could borrow 90 dollars from the government in 7–9 months, and repay it later after Jack overspending in months 10–12.
So injection by loan, and by purchasing and later selling products, is most effective and doesn’t have negative side effect of increasing the money supply. But it’s only good for temporary profit accumulation, and also it requires knowledge on future participants’ behavior (ability to accurately predict future purchasing patterns).
It looks like the regular injection by direct/indirect purchases (without selling products back to the public in the future) is the easiest and safest way to go. The government doesn’t have to predict future participants’ purchasing patterns, and the negative side effect of increase in money supply may be tolerable, and may be constrained by taxes.