Keep Calm, Don’t panic.. it’s only a game.

 

Keep Calm, Don’t panic.. it’s only a game.

 

I think in these times we are having it needs to be stated, and stated clearly and simply that this financial crisis we are having is only a financial crisis – it’s not a real crisis. The crops have not failed, we have not run out of food or the ability to grow food. It might be objected  that we are fast running out of the money to buy food and this is true but it is quite different altogether from actually running out of food.

 

I want you to think long and hard about the next statement I’m going to make : “The

 

Financial system is an artificial system”. I want you to think about this statement when you see hungry people in Africa and the coming food queues in the Euro zone, when you are stuck on a squashed tube train or in a traffic jam on the way to a job you don’t care for but you need to do to pay the rent, I want you to think about it when you see 600 women a day in the UK abort their precious unborn babies, when

 

you see women in your office with computer mouse mats with faded pictures of their

 

children, I want you to think about it when you wake up in the middle of the night because you can’t sleep because you can’t pay the mortgage – it’s an artificial system – it’s made up !

 

The “laws of economics” – on the odd time when they are not just plain wrong – are merely the effects of the rules of the game. In a game like football there are two types or law : the law of physics : if you kick the ball hard it will go far, and the artificial laws – the rules of the game – “if you kick the ball before the whistle is blown the goal does not count etc…. The rules of the game can be changed, whereas the laws of physics can’t. Most of the “Laws of Economics” are just the result of the artificial rules of the financial system – and these can also be changed.

 

Now that you hopefully have started to think about this concept it might be better for you to stop reading and do you own thinking and come up with a better system or improved rules.

 

Maybe ask your friendly neighbourhood financial system designer to come up with

 

something, demand your MP set up a committee to investigate this problem and get the best brains in the country and from abroad to address this technical issue.

 

I’ve been thinking about this for a while now and I’ve set up a little WordPress blog that attempts, to show, in four or five articles, some of the major shortfalls in “economic laws” as we now know them along with a halfway adaptation of the present financial system in order to fix it that I’ve called NEFS – Net Export Financial Simulation.

 

I think it’s a really good start but if you read it, you may then think about it using NEFS as your starting point and it might be better if you think about this important issue using your own starting point.

 

 

 

Calling all Game Theorists

 

NEFS is a half-way house between the present financial system and a new one all together.

 

What I’m going to do now is show you what I think could be a “new one altogether” :

 

I’ve called it “Points”.

 

In a Points system you have

 

a) People

 

b) The Points Office

 

c) Business

 

In a Points system you don’t use money – you use Points – like in a child’s game.

 

The first thing to note is, unlike a modern bank, a Points Office is not a business, it has no  shares, no dividends – it’s best thought of as ticket kiosk issuing points instead of tickets.

 

What happens is that the “Policy manager” of the Points office is elected – like a politician by the people. In the election hustings, various potential Policy managers put forward various policies themes : Richer people, more holidays, better schools, better roads, shops, better food…  better stuff.

 

Then, upon election, Business comes to the policy manager to request points for various projects and the Points Policy manager issues Points with reference to the election manifesto. The business then pays the people Points to work to build what the people have had some major say in in terms of general theme and emphasis.

 

At the next election of the “Policy manager” the policies are reviewed by the electorate. If these policy offices are regionalised then different areas will have different characters depending on the profile of work done in the area.

 

What price ? – how many points. As part of the terms and conditions of the points issued to business it’s a good idea to compare quotes from different business as to a) how many points they need to get the job done and b) what percentage on top of cost they will charge the customers. So if the business wanted to make T-Shirts then, at a cost of 5 Points per T-Shirt they could charge 10 % profit and sell the T-shirts for 5.5 Points. As the Points issuing office could be aware of this it could issue to all the people 0.5 points X the number of T-Shirts sold so that the people would have the points to buy the goods – as you will see in the WordPress blog I show that there is a major mathematical problem with Profit in the present system : Under the Current system the business could only sell all the T-Shirts it makes if someone somewhere goes in to debt for 0.5 per T-Shirt so, as you can see from what I call the Sisyphus Equation using numbers from the National Accounts : Net Retained Profit of Companies = Net debt of everyone else – Individuals + Government + Foreigners – to

 

the penny.

 

A suggested feature of the system is that the Points office be allowed to issue Points to the people for free – this addresses another huge difficulty of our present financial system. We live a computerised production age – we don’t need full employment of old fashioned inefficient human labour lugging things up ramps here and there to produce all the goods and services we need and want – that’s the facts of the real production potential we have and this clashes somewhat tragically with the artificial rules of the Financial system that says if you don’t have one of the few jobs left you will be poor.

 

Such a system is not a monopoly – it’s a very good idea to have several different business’s producing similar goods, also if people want to save their points and use it for a project that is off-manifesto then they can do that with their own saved points and then they can charge as much as they want for the produce, but if they are going to be using public points then their reward is say 10 percent of profits should they sell their stock. It maybe an idea for them to sell their goods for less than the cost of them and the points office could then write-off the rest so goods produced via the points office, which is via the will of the people in rough terms, could be a lot cheaper and easier to sell. This would encourage other business to use the points office and in this way the will of the people will be brought to bear on the what they spend their time working on and what is in the shops for them to buy.

 

The Points office and the electorate won’t get it all right all the time – especially at first –  there will doubtlessly be a learning curve.

 

This thing about the business going to the points office to get points to pay the people to set’em a working is not novel. It’s what happens at the moment with business going to the bank to loan money except there is no election of the man who chooses which of the businesses to loan the money to.

 

By using the word “Points” instead of “Credits” or “Script” or “New Money” or something like that I hope to make it easier for people to “get it” – that it’s only a game and then natural human ingenuity and professional Game theorists can then hopefully come up with something better than the “NEFS” and “Points” Systems I’ve come up with and/or make useful additions and critiques of it. – What do you think ?

 

 

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Why Ricardo was wrong Comparative advantage – the historical fallacy

Here is a quick summary of ‘Comparative Advantage’ – the base theory of “Why international trade is a good thing”. Say Country A makes cars at : 1 car every 20 labour hours and 1 Bicycle every 3 labour hours – i.e. it’s pretty good at making both. Say Country B makes cars at : 1 car every 200 labour hours and 1 Bicycle every 200 labour hours – i.e. it’s pretty bad at making both. Then, according to Ricardo, it’s actually a good idea for these two countries to trade. To work out which country will end up making what, you look at the relative ratios of production within each country :So Country A has a 1/20 car per hour to a 1/3 bike every hour ratio =  (1/20) / (1/3) = 3/20 = 0.15 –  i.e. 0.15 cars per bikeand Country B has a 1/200 car per hour to a 1/200 bike every hour ratio =  (1/200) / (1/200) = 1/1 = 1 – i.e. 1 car per bike.  So, Country B is, internally, relatively better at making cars compared to how it makes bikes, than Country A. The theory – neigh ‘Law’ – of Comparative Advantage says : Country A should make just bikes and trade it’s ‘excess bikes’ for Country B’s ‘excess cars’ – that way everyone will be better off.  

The legal process of removing the trade barriers between these two countries will change this ‘Should’ into a ‘Will’ – via “Market Forces’ – i.e. Price, as the ratios shown above, play themselves out into prices, so the car manufacturers in Country A will go out of business due to cheap imports and bike manufactures in Country B will go out of business for the same reason.  That’s essentially it – that’s the intellectual driver behind International Trade Theory.

 Let me show you where the problems with this really are : First of all ‘Comparative Advantage’ and the funny maths above is just a pseudo-sophisticated way of saying ‘Let’s specialise’. Seen from this angle we can ask the question – ‘Is specialisation always such a good idea ?’

 – If you go to work in a cartoon style fat cat ‘greed is good’ city firm and you see their portfolio and they have two Investments A and B. Say Investment A earns £23.50 per £100 a year and Investment B earns £19.87 per £100 a year. If you go to the boss and say “Hey I’ve got a great idea – let’s sell the Investments we have in B and put the money in A. This way instead of earning £23.50 + £19.87 = £43.37 per £200 per year we could earn £23.50 + £23.50 = £47.00 per £200 per year ! If you say this your Fat Cat greedy ‘All I want is money, money, money” boss, he will sack you. Why ? – Well, all you are doing is a School Boy’s ‘Maths’ question, you’re not doing a Grown-up’s ‘Real-World’ question. In reality you don’t know that A earns £23.50 – it might have done so last year, it might have done so on average over the past few years – but in terms of the future, of what happens next, of what you get paid for – £23.50 is at best a rough number that might change a little or a lot. The way to look at it, is it’s like you are going to the horse races. In the real World, you can’t phone up and read yesterday’s racing results to the bookies and say I want a back dated bet on yesterdays winning horses – or even just one result – and put all your money on the horse with largest odds after doing your school boy (MBA) maths to get the ‘correct’ answer as to what the maximum is that you ‘should’ win. If the bookie is quite sharp he’ll be more than happy to recommend that you put all your money on the same long shot horse the next time it runs in a couple of days. The whole point is you don’t have tomorrow’s numbers to bung into your calculator to see what you should bet on… or invest in… or produce. To win in business or the horses you have to use common sense and think ahead using human intelligence and use sound ‘old fashioned’, time-honoured principles – one of which is the idea of diversity – which is usually mentioned slightly negatively as “spreading the risk” as though it’s sort of only a risk reduction fee – an “insurance cost” of sorts that reduces the maximum returns possible as the price of increased survivability in the long term, but it could equally be seen as very much a positive – engineers transferring skills and techniques from one industry to the next to make both far better than they would have been had there been only one Mono-Industry. Ok, so yesterday’s numbers and overgrown school boys with calculators – getting the ‘right answer’ – just like yesterday’s horse racing results have a use – but if you use yesterday’s results ‘automatically’ and let calculator boy run the show then you’ll be fairly certain to end up in debtor’s jail in short time. By lowering trade barriers and tariffs to encourage international trade based on the ‘Law’ of comparative advantage (or in other words : I’ve got a great idea why don’t we specialise and de-skill in industries we have quite a high level of expertise in – that we might even be the best in the World in because some foreign country is so bad at doing almost everything it’s actually internally relatively better at doing this that we are), what happens is ‘yesterday’s numbers’ unconsciously and automatically, via the hidden hand of ‘the market’, get used to arrange tomorrow’s production. Comparative advantage leads to specialisation and, according to academic calculator boy, specialisation leads to higher returns, but according to ‘make real money in the real world and continue to make money in the real world’ Big Fat Cat Greedy city traders it means idiotic instability. As said above, not only does specialisation lead to the loss of highly skilled industries as is, but when Mr highly skilled car maker has a fight with his boss and gets a job as a bike maker he can cross-fertilise some of the ideas he learnt in his former industry. Specialisation in one industry leads to increased ossification. Just because the ossification index is too complicated to for calculator boy to work out and so you won’t see it the indexes in the national accounts or the WTO’s publications does not mean that a) it does not exist and b) is not hugely important. Common sense – human thinking – says it is.

Secondly there is an assumption that ‘labour’ is actually important in modern Industry so that if it takes 1 person to make 10 things then it takes 2 people to make 20 things. The comparative advantage bods have the Car workers in country A moving to the Bike industry and producing bikes at the previous rate of knots, so that with double the workforce now the output would be doubled. The reality is that if you have a secretary and asked her to sent out emails to 10 people and then later she needed to send out an email to 20 people – you don’t (unless you work for local government) need 2 secretaries to produce twice the output – one click – from one labourer – will send a million emails with the same labour as to 1 person. What works for emails works for adding accounts numbers up on a spreadsheet – thousands of numbers can be added up in a second – the same second it’ll take to add up only 2 numbers. Computerised production lines share quite a large element of this huge scalability factor and if the factories hadn’t closed down in the West because of the ‘Law’ of comparative advantage, then they might be an awful lot higher again. Ask an accountant : “Why didn’t you add up a 1,000 numbers today ? and he can easily answer “Only because you didn’t ask me to – it’s not because of lack of ‘labour’ ”. It’s not quite the same as with say making cars : “Why didn’t you build 1,000 cars today ? It would take a little more than… “Because you didn’t ask me to” but it’s not far off – there are millions upon millions more cars the Japanese factories could have produced with minimal increase in labour force over the last 2 decades but they were limited from producing them because they were limited from selling them by the American and European import controls. For many things less complex than cars the scale is easily this high – I could type ‘1000’ then ‘Return’ into my computer and a 1000 books, or a 1000 leaflets could be printed for virtually the same labour as one book or leaflet. As a ‘factor of production’ labour could almost be defined now-a-days as a type of machine with the following properties: “Expensive, troublesome, highly inefficient at repetitive tasks but useful for tasks for which the repetitive output is so small that it’s cheaper to use than the cost of setting up an automated process”. That’s why American shoe makers, made unemployed by Chinese imports, were never going to go to the Ford Factory to help “Double the production of cars” – Ford could double its car production if customers doubled their orders with little or no increase in ‘Labour’ – indeed if the orders doubled and stayed doubled – it might be worth Ford’s while to increase the automation of some of the tasks they used ‘human machines’ to do and it’s not inconceivable that a doubling of the car orders would – say after 5 years or so would actually result in a lower work force – Ford doesn’t double its car production not because of labour limitations but because the Sales order aren’t there. All “Labour productivity” is is the ratio of Output/Labour. You could do a ratio of Output to CCTV cameras in the car park but it wouldn’t prove that if I doubled the amount of cameras it would double the output.

With tariffs you have ‘average American Joe’ paying say 20 % more for an American made car than he could have paid for a foreign car. But he gets to live in a country with a thriving advanced manufacturing base with all the social and industrial positive spin offs from that. Without tariffs ‘average American Joe’ gets a slightly cheaper car at first but then lives in a country full of unemployed and unemployable drug addicts and former specialised tool makers and fathers who are now divorced and flip burgers for their male-divorcee-ghetto rent money – while their fatherless feral kids now roam the streets with murderous rap lyrics in their head and weapons in their pocket – which means in half the country is not safe to drive his 20% cheaper foreign car in as he’ll get attacked at the traffic lights. And oh look the government now has to increase the sales tax and his income tax to pay for all the unemployed people and the war on Drugs… and Crime fighting… and… So after 30 years of the ‘Law’ of Comparative Advantage,  he’s driving a smaller foreign made car than his Dad’s American made car from 30 years ago and wondering if there really very much practical Advantage to be had after all from the theory of Comparative Advantage… all for 20 % off – the ultimate quick buck.

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What’s wrong with Keynes ? What’s wrong with Monetarism ? What’s wrong with the GDP formula? Solution to the Credit Crunch : NEFS – Net Export Financial Simulation

Solution to the Credit Crunch : NEFS – Net Export Financial Simulation.

There are 5 Main Financial Flow Patterns :

1) Fixed Assets

2) Consumer Debt

3) Mortgage Debt

4) Net Imports

5) Net Exports

In this article I’m going to look at the first one – Fixed Assets.

So what do I mean by the phrase a “Financial Flow Pattern” ? – Sounds  little bit intellectually ponsy “Financial Flow Pattern” I know but it’s quite simple : It’s the flow of a) Where money comes from b) What it does after it has been created and c) How it gets destroyed

Imagine there is a Desert Island with :

1 Banker,

1 Business man and

10 Workers

The economy is starting from scratch with nothing.

So the Business man goes to the Banker and says “Please lend me $110 (the $ is the Island currency they just made up) so I can pay some workers to make some stuff and get on with business”. The banker says “Yes” and makes the following accountancy entry in his books :

Dr $110 – Loan owed by Business to Bank – Asset of Bank

Cr $110 – Current Account of Business      – Liability of Bank

Already, just understanding just this one accountancy entry, makes you more of an expert on how the banking system really works than a bar full of finance ministers at a G8 Summit.

The three things to note are :

a) What ‘Money’ actually is, is the Credit entry – the : “Cr $110 – Current Account of Business” part. This ‘money’ was created at the same time the Loan – the Debit entry – was created. Some people – Finance Ministers and Professors of Economics included – have the idea that the numbers you see in your current account represent something else – some real thing called ‘money’ that is somewhere else… “but it’s actually all very complicated to understand. It’s a good job those banking fellows are jolly clever; they sort out all those complicated, behind the scenes, things out for us”. Whereas in fact it’s quite simple – all money is is Current Accounts at the bank – its bank debt that you own. In long-hand, the definition of money is merely : “Universally Transferable Bank Debt”. Many people have the idea that if you look at the balance sheet of a bank you will see it’s assets are things like buildings and ATM machines and it’s liabilities will be things like taxes due and shareholdings. “Money” is frequently thought of as being some real thing that banks look after for people in some sort of complicated “money accounts”. A quick Goolge for ‘Financial statements Lloyds bank’ or some other bank (try : Lloyds_2006) will show that money sits in the liabilities section of a bank’s balance sheet under the heading “Customer accounts”, loans sit in the assets section under the heading “Loans and advances to customers”. These form an integral part – indeed the largest part – of a bank’s balance sheet. To Create a loan, a bank does not go to some “money account” to see if there is any spare money to loan out, instead it makes the accountancy entry:
Debit £100 “Loans and advances to customers”
Credit £100 “Customer accounts”
This credit of £100 shows up on your bank statement in your favour – it’s money. When you repay the loan, the entries are reversed and the money is destroyed – the money does not go back into a “money pot” or a “money account” in the bank.

b) “Oh Look at the situation !  There is $110 of Savings in the economy (The $110 current account of the business) and $110 of Borrowings (The $110 loan of the business).  Aren’t economists clever ! They say that S=I (Savings = Investment) and once again S($110)= I($110) and once again economists are proved right and further this proves the other thing that economists say : That ‘Borrowers borrow from Savers – with the Bankers merely acting as a middle-man – a broker’ ” – Wrong – As you have just seen yourself from the accountancy entry above, bankers do not need Savers to ‘Loan their Savings to Borrowers’, in the example given, the Bank started with nothing – there was nothing in the whole economy. What bankers do when they ‘Issue a Loan’  is they create both a Loan Account and a Current Account (money) at the same time – they create both New Savings and New Investment in the same instance. So instead of “We need Savers so that Bankers can lend those savings to Borrowers” we have something more like : “When a bank issues a loan it creates money that is then saved” or perhaps “When a bank issues a loan it creates both New Investment and New Savings that are the same amount”  – no wonder S=I !

c) The banker is not a market middleman, a broker forced by Adam Smith’s “Invisible Hand” to find the crossing point of the combined will, abilities and resources of all the participants in the economy and follow the orders he finds left there in a sealed envelope written by this “Invisible Hand” on pain of loss of occupation. He is the de-facto King : if he issues the Loan to Businessman A then the workers will obey Businessman A or starve, if he issues the Loan to Businessman B then the workers will obey Businessman B or starve. This sounds like a lot of power to Businessman A or Businessman B. But given it is the banker who chooses who is to receive this power it is the banker who is King.

There are two ways this power is exercised : One is visible and the other, the really powerful one, is invisible and can only be seen by the imagination.

The visible way : If you run your business on an overdraft, the bank is legally entitled to treat your overdraft in the same way that you treat your current account – At a moments notice you can withdraw your money from the bank – At a moments notice – though practically a short notice period of a few days is given – the bank can demand repayment of your entire overdraft. If you can’t repay then the bank will close you down. You will be bankrupt and lose everything. The banks have done this to many business’s – perfectly viable businesses – and that was before the credit crunch – (so as a practical hint re-arrange your overdraft into a loan or put some decent repayment notice period in the terms and conditions of your overdraft facility).

The invisible way :

a) The Virtual Millionaire

Where will the Island be 10 years down the line ? Imagine on the Island there was a millionaire who had brought his millions with him – due to his wealth and hence his power it would not be surprising to find that the Island in 10 years time will have the imprint of his ‘will’ all over it. If he wants pubs then there will be pubs, if he wants theatres then there shall be theatres if he wants people to live in small houses then small houses will be built… there will be a definitive imprint of his will. A different millionaire will make a different imprint. What’s the real wealth of the Island ? The real wealth is the good manners and abilities of the people, the state and potential of the industrial capacity and the natural resources of the land. You might at this stage be thinking “These guys could do with a mini-revolution to get some democratic power in charge here, why should some bloke, just because he has some money, be able to control the whole direction of the future of the Island ? ” The only defence to that question is to say “Well he has the money”. Now take the millionaire away and go back to the situation we started with : A Businessman with nothing and a Banker with nothing. The businessman goes to the Banker and asks for some money for a project in the same way that a businessman might ask the millionaire for some money. The power the millionaire has to shape the Island with his “Yes’s and No’s” to the various business proposals put before him is the same power the banker has. Then the question should be asked “Why should some bloke, who doesn’t even have any money, be able to control the whole direction of the future of the Island just because he has a job as a banker ? – The Banker is more powerful that the millionaire – the banker is not limited to 1 million – he can create as much money as he wants – and there is no “Oh he has the money” justification for allowing this situation.

b) Heaven on Earth/ Hell on Earth :

Take both the Millionaire and the Banker away for a moment and assume that the Island has some ‘X’ method of finance whereby the Islanders can effectively express their will as to how the natural resources, the industrial potential and their own time and abilities are directed – so they have the power possessed by the millionaire and the Banker to imprint their will on the future state of the Island – not by just using their hand to mouth wages but more importantly, by their conscious power to say who the loans are given to and for what purpose : Given the Island economy can produce stuff to consume – Consumables, and it can produce stuff to produce other stuff automatically – ‘Fixed Assets’ – then after 10 years the Islanders will have the choice to go in two directions : As they now have lots of Capital equipment to produce consumables – they will have the ability to have the same standard of living as when they arrived (by this I mean the same level of consumer goods) but with hardly any work – or they could continue working hard producing even more capital goods and increase their standard of living – have more consumable goods. At any point after this, say another 10 years, with machines producing other machines which produce other machines… which produce consumer goods they can say “Stop ! let’s take the standard of living we have now in terms of consumable goods, which is very high, and lets enjoy it in a Garden of Eden like situation – very little human work producing lots of consumer goods as the machines do most of the work – then spend the thing a machine cannot make – time – living instead of working. Now look at the present world – we live in a world of push button or even screen click production and yet there is not the option for society as a whole to say ‘Let’s stop making more stuff. Let’s just maintain what we have at present and spend some time living. Why ? Well it is the will of the bankers that we follow rather than our own will. The will of the Banker is “Full Employment or Poverty”. Though most people look quite well off driving their cars and reading oversized newspapers over posh coffees at a weekend – 2 months without income and they’d be in a food queue with their car having been driven off by the Repo man. Such people – that’s most of us – have no power to impose our will over very much at all. This is where the real power of the Bankers lies. They control the policy and future direction of the human race, civilisation, the planet with no legitimacy to do so.

 OK back to the ‘Fixed Assets’ Financial Flow Pattern :

The businessman asks the Banker for a loan of $110. Of this, $100 is to be paid to the workers to produce goods for consumption, $10 is to be paid to the workers to produce a machine – a Fixed Asset. At the end of the cycle, the business has a debt to the bank of $110, $100 of Stock and $10 of Fixed assets – Investment $110. The Workers have $110 of cash so Savings (S) equals Investment (I). The Businessman wants to make a profit so he sells the Stock of consumables for $110. When he gets the $110 in sales he gives it to the bank to pay off the loan.

The funny thing about this is that nobody has a penny left ! – The workers have had all their money taken off them in prices and the businessman has used the money he received to pay off the loan. Superficially though this seems like a nice cycle and in a few cycles there will be lots of fixed assets and machines producing consumable goods automatically. Surely everybody will be better off ? – Wrong. Just look at the basic maths : Assume the Depreciation charge on a $10 Machine is $1 per cycle. Then instead of the situation being this :

End of Cycle 1: Dr $10 Accumulated Fixed Assets/Capital Goods – Cr $10 Accumulated Profit

End of Cycle 2: Dr $20 Accumulated Fixed Assets/Capital Goods – Cr $20 Accumulated Profit

End of Cycle 3: Dr $30 Accumulated Fixed Assets/Capital Goods – Cr $30 Accumulated Profit … etc

you have this :

End of Cycle 1: Dr $10 – Dep on Zero Assets $ 0 = $10 Accumulated Fixed Assets/Capital Goods – Cr $10 Accumulated Profit

End of Cycle 2: Dr $20 – Dep on One Asset $ 1 = $19 Accumulated Fixed Assets/Capital Goods Cr – $19 Accumulated Profit

End of Cycle 3: Dr $30 – Dep on Two Assets $ 2 = $28 Accumulated Fixed Assets/Capital Goods – Cr $28 Accumulated Profit

End of Cycle 4: Dr $40 – Dep on Three Assets $ 3 = $37 Accumulated Fixed Assets/Capital Goods – Cr $37 Accumulated Profit

End of Cycle 5: Dr $50 – Dep on Four Assets $ 4 = $46 Accumulated Fixed Assets/Capital Goods – Cr $46 Accumulated Profit

End of Cycle 6: Dr $60 – Dep on Five Assets $ 5 = $55 Accumulated Fixed Assets/Capital Goods – Cr $55 Accumulated Profit

End of Cycle 7: Dr $70 – Dep on Six Assets $ 6 = $64 Accumulated Fixed Assets/Capital Goods – Cr $64 Accumulated Profit

End of Cycle 8: Dr $80 – Dep on Seven Assets $ 7 = $73 Accumulated Fixed Assets/Capital Goods – Cr $73 Accumulated Profit

End of Cycle 9: Dr $90 – Dep on Eight Assets $ 8 = $82 Accumulated Fixed Assets/Capital Goods – Cr $82 Accumulated Profit

End of Cycle 10: Dr $100 – Dep on Nine Assets $ 9 = $91 Accumulated Fixed Assets/Capital Goods – Cr $91 Accumulated Profit

End of Cycle 11: Dr $110 – Dep on Ten Assets $ 10 = $100 Accumulated Fixed Assets/Capital Goods – Cr $100 Accumulated Profit

End of Cycle 12: Dr $110 – Dep on Ten Assets $ 10 = $100 Accumulated Fixed Assets/Capital Goods – Cr $100 Accumulated Profit

End of Cycle 13: Dr $110 – Dep on Ten Assets $ 10 = $100 Accumulated Fixed Assets/Capital Goods – Cr $100 Accumulated Profit ..etc

The reason the figures ‘Flat Line’ after Cycle 11 is that once the first machine has depreciated to zero (after 10 depreciation charges of $1) there is no more depreciation to charge on this asset. Likewise, the machine built in period 2 has no more depreciation charges after period 11 etc.

 Let’s look at this again, but this time, instead of looking at the Accumulated  Profits, we look at the Profit per Period :

Cycle 1: Profit $10 – Dep on Zero Assets $ 0 = $10

Cycle 2: Profit $10 – Dep on One Asset $ 1 = $9

Cycle 3: Profit $10 – Dep on Two Assets $ 2 = $8

Cycle 4: Profit $10 – Dep on Three Assets $ 3 = $7

Cycle 5: Profit $10 – Dep on Four Assets $ 4 = $6 

Cycle 6: Profit $10 – Dep on Five Assets $ 5 = $5

Cycle 7: Profit $10 – Dep on Six Assets $ 6 = $4

Cycle 8: Profit $10 – Dep on Seven Assets $ 7 = $3

Cycle 9: Profit $10 – Dep on Eight Assets $ 8 = $2

Cycle 10: Profit $10 – Dep on Nine Assets $ 9 = $1

Cycle 11: Profit $10 – Dep on Ten Assets $ 10 = $0

Cycle 12: Profit $10 – Dep on Ten Assets $ 10 = $0

Cycle 13: Profit $10 – Dep on Ten Assets $ 10= $0

 Again the reason the profit figure ‘Flat Lines’ at zero after Cycle 11 is that once the first machine has depreciated to zero (after 10 depreciation charges of $1) there is no more depreciation to charge. Likewise, the machine built in period 2 has no more depreciation charges after period 11 etc.

The above usually hits people (including economists and finance ministers) a little like the “Grain of wheat doubled on every square of a chessboard” puzzle – It doesn’t seem like much of a problem at the beginning. But later… So what will be the financial flow pattern in cycle 27 or 127 :

Well the Businessman goes to the Banker and says “Please lend me $110 so I can pay some workers to make some stuff and get on with business”. The banker says “Yes” and makes the following accountancy entry in his books :

Dr $110 – Loan owed by Business to Bank – Asset of Bank

Cr $110 – Current Account of Business      – Liability of Bank

The Businessman who, despite the best workforce the World has ever seen, and customers willing to buy the produce, pays $100 to workers to make some consumables, $10 to make a new machine and sells the produce for $110. The businessman then pays off the loan of $110 and makes $10 profit before depreciation – but has no money (he never had any money) but now he has a $10 depreciation charge ($1 from the 10 machines built in the last 10 cycles) and so has zero money and zero profit. 

Let’s have a look again at the first line :

Cycle 1: Profit $10 – Depreciation on Zero Assets $ 0 = $10

To repeat this pattern for the next cycles, what is it that we really need to repeat ? Businesses work on percentages of this and that. To take a fundamental one : Profit /Sales – the Profit is $10 and the Sales is $110 so on this example the Profit / Sales is 10/110 % = 9.09%. This is the same as a Costs/Sales Ration of 100/110 = 90.91 %

To maintain this ratio in the next period we have :

Costs : Salary to make consumable goods $100 + Depreciation of $1 = $101 so Sales must be 101/90.91% = $111.10. As a check : 101/111.10 = 9.09%. As the workers who make the consumables get paid £100, then the people who make the fixed assets must get paid, not $10 like last time, but $111.10 – $100 = $11.10 in order for there to be $111.10 in the community to buy the goods. Ok Big deal – So What ? Well the “Ok Big deal – So What ?” turns out, once again, to be a similar “Ok Big deal – So What ?” of the Persian King who promised to pay the inventor of chess one grain of wheat on one square of a chess board, double that for the second square … double that for the 3rd square…, things start off not to bad but the 64th square leaves the King in debt to the inventor for 9, with eighteen zeros after it, grains of wheat.

Something similar, but not quite so exponential happens here :

In Cycle 6, using these numbers, Business must make $16.85 worth of assets to cover the increasing depreciation charges and have enough money in the community to buy all the gods on sale – now at a total prices of $116.85 so that it continues to make a profit % of 9.09%. $116.85 Sales – $100 wages paid to produce consumables – depreciation charge on assets built in last five periods $6.23 = Profit $10.63. And so Profit /Sales = 10.62/16.85 = 9.09% – See fixed_percentage_profit_schedule.xls for Full Schedule and calculations… In cycle 88 we need $394.30 of assets to be built. While an economy is growing and all these fixed assets are needed then things look fine. But should the day of happiness arrive where people have enough machines producing enough stuff and no more expansion is required – By expansion I am not even go so far as to say lets stop building $10 of new assets per cycle, I am just saying when we get to the point of saying lets stop increasing the number of new Fixed assets built per cycle – then what should finally be Heaven on Earth (cheap machine slaves producing what we need and want) suddenly turns to Hell. Stock will not be sold as there will not be enough wages paid out to cover and maintain the profit margins, Businesses will close – factories will be shut, people will lose their homes … for no other reason that when we reached industrial point where we could go home and live, the Financial system said “Oh no you don’t – If you don’t work (and continually increase) then we will ruin you. This seems to me to be a rather dumb situation. This has nothing to do with any “allocation of scarce real resources”, it’s about the artificial allocation of scarce numbers in a bank’s ledgers while there is an abundance of real goods and production ability.

So What’s wrong with Keynesianism, What’s wrong with Monetarism ?

Loads of books on Economics have some blurb about using simple theoretical models to model the economy and how this is legitimate. They then present a model of the economy that is so simple it’s just plain wrong. This model is the basis for both Monetarism and Keynesianism. In this model there is no Retained Profit so none of the complications explained above occur. Monetarism and Keyensism are then later explained as different solutions to the same problem in this wrong model. Let me explain :

In both the Monetarist and Keynesian model, Business pays $100 to workers to produce $100 of Goods. These $100 of goods are sold for $100 and the Business then uses the $100 to pay workers to make another $100 of goods and so it goes on for ever : Income = Expenditure (I = E) is what they say without understanding what they are really talking about “Sometimes though, there is a shock – a terrorist act or something and consumers loose confidence then a recession can occur” (this really is the sort of thing they say). What they say is that $100 is paid to workers to produce some stock but the workers don’t spend it all, they save too much – “their marginal propensity to save increases” is the pseudo-scientific talk they use. Business is then left with unsold stock and is short of money to pay the next cycle’s wages and so there is a recession. At this point the Keynesian bods and Monetarist bods divide.  Keynes says the government should issue bonds at this point, then the savers will buy these bonds with the money they are not using to buy goods with, and the government can use the money it has received from the sale of these bonds (government debt) to buy the stock itself and so Business can keep going and can keep paying wages. When the shock is over and ‘confidence’ is restored then business can return to normal – people will get paid $100 as usual, the taxman will take some of this from everyone in taxes and use it to repay the bond holders so there is : $100 in the community being spent when a) Things were normal, b) When there was a crisis (“Crisis ! What Crisis ?” – Jim Callahagn – you see, according to people trained by economists, it’s all about keeping ‘Confidence’ high as “The cure to a recession is ‘Confidence’ ” – Lucy Kellaway from the FT on the BBC World Service 31 March 2009. You see ‘Confidence’ gets all those shy, frightened, irrational over-savers to go to the shops and get the ‘economy back in balance’) – and c) Afterwards as well – they call it smoothing. Monetarists on the other hand take the view that if people get paid $100 to make say 100 things and then people start saving too much and only spend $70 in the shops then business should say “well if you only want to spend $70 then this will be the new price of the 100 things that you made that are in the shops but – but we will now drop the wages to $70 to make the same 100 things”. So that’s the “genius” of both Keynes and Friedman in a few lines – they offer a solution to a theoretical problem that has nothing to do with reality.

Let’s quickly crash an economy using the Fixed Assets financial flow pattern and then apply Keynenists and Monetarist solutions to it.  

Assume Business wants to make a 9.09 % return each period and it has been expanding its fixed asset based to finance this for 5 years so we have :

 

 Cycle  Wages  Wages  Depreciation  Total Sales  Net Profit
   To Create  To Create      %
   Consumables  Fixed Assets      
 1  100  10  0  110  9.09%
 2  100  11.1  1  111.1  9.09%
 3  100  12.32  2.11  112.32  9.09%
 4  100  13.67  3.34  113.67  9.09%
 5  100  15.18  4.70  115.18  9.09%

After 5 cycles Business has no need to continue the increase in the fixed asset building programme as all production as we know it now has been automated. So in period 6 business lays off the fixed asset building people and we would have the following situation :

 Cycle  Wages  Wages  Depreciation  Total Sales  Net Profit
   To Create  To Create      %
   Consumables  Fixed Assets      
 6  100  0  6.23  116.85  9.09%

But these numbers do not add up – there is $116.85 on sale in the shops but only $100 in wages paid out. Clever Economists, both Keynesians and Monetarists, as well as G8 finance ministers who sleep with their economic text books tucked under their pillows at night, ‘know’ that this recession in cycle 6 was caused by “too much savings” (consumers are spending only $100, and, as there is $116.85 of prices in the shops, somebody secretly somewhere must be saving $16.85 !) Of course it has nothing to do with a medieval finance system that has not yet learnt to cope with fixed assets and the machine age, never mind the computer age. The Keynesians will solve this problem by issuing government bonds. These bonds will actually get bought by the banks rather than by ‘savers’ as you can see from the figures there are in fact no “Secret Savers” holding onto $16.85. Banks can buy the bonds because they can make up money at will. So with a quick accountancy entry of :

Debit Government issued Bonds $16.85

Cr Current Account of Government $16.85

The bonds are ‘sold’ and the bank earns an income stream of whatever interest these bonds pay for free – paid for by future taxes. Nice work if you can get it ! (No you haven’t been drinking and neither have I – this is how banks do things – mind you they have been getting a free income stream from the loans they made up to business as well). So as the $16.85 of fixed assets that should have been built weren’t, then there is only $100 of salary in the community and despite the current production capacity being able to meet everyone’s needs, the Keynesian government needs to go into debt and borrow $16.85 to buy the stock itself – or more usually to pay the unemployed fixed asset workers $16.85 to build bridges, roads, hospitals, sewers – large public Keynesian works – then the workers can buy the unsold goods in the shops. If they do this the business gets a debt holiday – they get to receive $116.85 in sales but only borrow $100 and not only were they able to pay off their loan of $100, they get to keep $16.85 in cash. This might give them the impression that they are doing something right and might deserve a bonus “Oh Keynes how clever you are !” The economy has been “Stimulated” and back in business !”. Meanwhile back at the ranch… well in the next cycle anyway…

a) If the government decides to pay off the bonds in the next cycle and the Business fixed asset building programme has not restarted, then the workers making consumables will be paid $100 and then will be taxed $16.85 to leave them with $83.15 in their pockets, With a depreciation charge of $6.23, wages of $100 and a profit margin of 9.09% to maintain in period 7, Business will need to sell its goods at $116.85 but with only $83.15 in people’s pockets, just after people thought the government had fixed the problem by throwing money at the problem there will be an almighty depression – You might want to make note of that last sentence given the current ‘solution’ to the Credit Crunch. 

b) If the fixed asset programme does not resume, then the government will have to borrow another $16.85 and get some more Keynsian holes in the road dug. 

c) If the Business fixed asset programme resumes, and Business picks up where it left off at making $16.85 worth of assets, then, if the government tax workers $16.85 to pay off the bond then all the stock will not be sold and all the government did was delay the day of doom by one cycle. What generally happens is the Government never pays off the loan to stop this sort of thing happening – they just role it over and over for years. Assuming this does happen, and the interest rate is zero to make things simpler, business will still be in the same situation – they will have to increase the amount they spend on fixed assets cycle after cycle. After the Keynesian emergency help, we are not back at normal equilibrium “Business pays $100 to workers who buy $100 of goods” as this never happens in the first place anyway.

(If you tax the whole nation say $100 to get the money to pay back a bond that was bought from a few savers, then all that happens is that $100 is transferred from one set of people to another. If it was a bank that ‘bought’ the bond, then, when you repay it, the money is destroyed; the accountancy entries are : 

Cr Government Issued Bonds $100

Dr Government Current Account $100

… and as ‘money’ is Cr’s in the current account of a bank, having this Dr’d by $100 reduces it – $100 is destroyed)

Monetarists Solution:

Wages should drop from $116.85 to $100 and then prices can drop to $100 and everyone will be happy. As total wages have already dropped to $100, this just doesn’t make any sense at all, but assuming we get past the first bit, if Business drops it’s prices to $100, as it has a depreciation charge of $6.23 it’ll make a loss of $6.23 which is a little shy of it’s profit target of 9.09% ! Add to that practical things like some of the workers will have mortgages and fixed rents and consumer debts they took out when they earned an average of $X; if the average wage dropped without all other business and private debts being magically reduced by the same proportion then paying off those debts would be that much more difficult and a wave of bankruptcies along with the wave of suicides that usually accompanies it would be expected to ensue.

What, you might ask does the National Accounts – the Blue Book have to say about this ? – Well, despite every company being required to file it’s annual figures they say : “However, because of the difficulties in obtaining reliable estimates of the consumption of fixed capital (depreciation)”… we don’t use it : “Gross domestic product: the concept of net and gross The term gross refers to the fact that when measuring domestic production we have not allowed for an important phenomenon: capital consumption or depreciation. Capital goods are different from the materials and fuels used up in the production process because they are not used up in the period of account but are instrumental in allowing that process to take place. However over time, capital goods wear out or become obsolete and in this sense gross domestic product does not give a true picture of value added in the economy. In otherwords, in calculating value added as the difference between output and costs we should include as a current cost that part of the capital goods used up in the production process; that is, the depreciation of the capital assets. Net concepts are net of this capital depreciation, for example: Gross domestic product minus consumption of fixed capital equals Net domestic product However, because of the difficulties in obtaining reliable estimates of the consumption of fixed capital (depreciation), gross domestic product remains the most widely used measure of economic activity.”  – Blue Book 2010 Pg 9.

This leaves the National Accounts looking like we live in a “World According to Keynes” or a “World According to Monetarists” but as the National Accounts say themselves : this “does not give a true picture”.

What’s wrong with GDP (Gross Domestic Product) ?

An Important aside on “Economist’s Formulae”:

Economists, both Keynesians, Monetarists and sundry others will attempt to dignify their field with mathematical sounding pseudo-equations. Most of theses are merely linguistic tricks. Let’s look at some of them within the context of the Fixed Asset Financial Flow pattern I’ve been discussing :

Business borrows $110 to make $100 worth of consumables and $10 of fixed assets, sells the $100 worth of stock for $110, makes a profit of $10 and pays the $110 loan off with the $110 receipts.

 Equation 1) GDP = Y= C + I  (Gross Domestic Product = National Income Y = Consumption C + Investment I)

In this case GDP = Y = $110 + $10 = $120 which doesn’t make much sense as the workers were paid $110 in total, the business owners earned a profit of $10 from this $110 when the goods were sold but at no time did anyone have $120 of income. So if a foreign country had made something that was priced at $120 they might look at the GDP equation and say “you had an ‘income’ of $120 last cycle so you could afford to buy this” but they could not look at everyone’s bank accounts and ever see the total money in them adding up to $120, the most it got to was $110. As well as the other well known problems GDP has – it also “double counts”.

Economists have there own language : they use archaic words like “Demand” instead of money and “GDP” instead of – well what ? – if you had a “One Island, One Business” situation, in normal human terms you could ask the business what the sales are ?, what the profit is ? – but you ever ask what is your GDP ? – what, in normal language is GDP ? – at this point trained economists start trotting out their catechistic definitions they memorised for their exams which are of little use and essentially are merely the different ways of calculating GDP. At base, essentially GDP is just Sales – Final Consumption Sales. There are some extra bits but pretty much, ball park figure it’s sales. In 2009 in the UK sales for Final Consumption was £1.2 Trillion and GDP was £1.4 Trillion the rest was Fixed asset Building £0.2 Trillion less Net Imports £0.03 Trillion. So now we’ve got that, we can now look at the value of the supposed solution to our economic woes – Increased GDP – “Growth”- which now equates to increases Sales. If you go to the “One Island, One Business” place for a moment, if they had economic problems would your solution be “You need more Sales” ? – To make a profit business needs to sell stuff for more money than it paid out. So more sales – at a profit – means more debt for the consumers or more debt for the Government (a fixed asset building programme would mean more debt for companies and an export drive would mean more debt for foreigners). Saying you “need more sales” makes you look a bit silly, but if you say the same thing using Economists jargon “You need more GDP”, then despite it being equally as silly, it has so much more gravitas and makes you sound like you know what you are talking about.

 Equation 2) Income (Y) = Expenditure (E) : Someone’s Expenditure =  Someone else’s Income.

Economists look at the retained profit made of $10 of a company say this is “Income” of the Owners. Because they use the word ‘Income’ and are, institutionally speaking, a bit dim –  (Clever kids go to study Engineering, Maths Physics and Medicine. Economics is for C students who can’t do maths) they forget that there is Real Income – $Dosh in the bank available to spend and Definitional Income. Retained Profits is Definitional Income. If you own shares in a company that makes $10 Profit and they give you $2 in a dividend then you can’t go to the shops and buy food with the other $8 of profit still held in the company. I know you can sell the shares for $8 but look at it from the perspective of the whole economy : If there is $100 of goods in the shops and people have only say $50 in cash and the other $50 in shares then people can swap the $50 of shares for the $50 of cash amongst themselves; but in total they will still be short in total of the $100 needed to keep the economy going round. Economists don’t get the idea of there being a shortage of money because they trot out Income = Expenditure. An Economists “Income” is no income Average Joe would recognise – it’s not even Income the Taxman would recognise – it’s definitional.

Equation 3) What’s wrong with MV = PT  ?- see MV = PT That is the Question ?

The Solution to the Credit Crunch.

There are two ways to solve the Credit Crunch and bring World Peace etc one is to stop reading this article at the end of this paragraph and to take what you now know at this point, see the real wealth we still have, that is about to be destroyed on bankers orders – which are a lot more destructive than the orders of most military commanders – no Military force could close down the USA but a handful of bailiffs could turn the USA into an industrial desert in months – destroying real wealth in order to make it match with the numbers in a set of dodgy books. You could take what you know now and work out a better way of counting the numbers – especially that bit about what happens when machines can do everything – will we all be rich because everything is free or will we all be poor because no one has a job.

The second way is to read the link below – which is my idea on how to fix it – but it may not be the best one and reading it might stifle your imagination or it may stimulate it to a better idea. It’s only a bunch of numbers – how difficult can it be ?

A Solution to the Credit Crunch :

NEFS – Net Export Financial Simulation

 

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NEFS Net Export Financial Simulation

This is a ‘Dynamic’ Article and to follow it download the spreadsheet on the link below and run the Scenarios and create new ones yourself. There are macros in the file but they are not protected so you can check yourself to see that the code is clean and safe to run.

Follow this link to find the spreadsheet: financial_scenarios.xls  What does the Spreadsheet show ? It shows we are in a lot of ‘financial’ trouble – a lot bigger than is presently thought. It shows that we are not necessarily in any sort of trouble at all in terms of production and of ‘real stuff’ but because we have financial system that is out of date we are heading for a really big mess.

How to Use the Financial Scenarios.xls Spreadsheet : How to use a Scenario that already exists (you can add your own) : In the Drop down in cell A10 choose a Named Scenario. Click the Load Scenario button to load it into the Green area : Row 12 and below. To run the whole Scenario through once Click the ‘Run Full Storyline’ Button and observe the results. The whole point of the programme is to enable you to see various different Scenarios and how they work from year to year. The trick is to continue to click the Run Full Storyline Button so that you can see what looks like a good idea for an economy for one year will, from year to year, if repeated, cause huge problems. To understand what happens at a particular ‘story line’ in a scenario, click the Run storyline step on active row button. The Sheet “Quadruple_Entry” shows what rows will be effected by a particular transaction – all companies  use “Double Entry” bookkeeping – and because there are two parties to every transaction – and this programme looks at the financial effect on the whole economy – it uses Quadruple entry. (Note – Individuals don’t produce their own profit and loss accounts, but I’ve done the Double Entry accounting here as if they did so that if an individual has a house for £10 – they will have a credit in their Long Term Credits/Wealth of -£10) Profit and Depreciation : Profit is mark up on Cost of Stock – I’ve got 10% in cell F13 for starters – if you lower it, it will not ‘fix’ your problem but it will delay the day of Doom. In the model Stock is sold at Cost of Stock – in Column E – the mark up is added on automatically for you. Depreciation is calculated on a declining balance basis – for simplicity – rate is in G13. It is calculated if Business has any Fixed assets at the start of a full Run through. I’ve got 2 Banks Bank A and Bank B just to show that ‘inter bank’ trading does not affect the result and the interest rate is Zero! Just to show it’s not the ‘Evils of Usury’ that cause the problems. I’ve Got One Business – Business’ to represent the net sum of All Business and One Worker/Consumer – being the recipient of wages and dividends that are then spent or saved. The Problem : Proposition : There is a fundamental problem with the financial system we are using – there are not enough numbers. It is a bit like the child’s game Musical Chairs – As there are more children than chairs on anyone go, no matter how hard the children run and concentrate someone will always lose – they can all run as fast Olympic athletes – they can concentrate on the music as much as a concert conductor – and from the perspective of the individual player the better the running and the better the concentration the more likely he is to win – but from an overall perspective doom is inevitable for someone. As you’ll see from below the economy – thanks to the financial system – works the same.

One point that does need emphasising at this point is what money is and how it is created and destroyed. Many people have the idea that if you look at the balance sheet of a bank you will see it’s assets are things like buildings and ATM machines and it’s liabilities will be things like taxes due and shareholdings. “Money” is frequently thought of as being some real thing that banks look after for people in some sort of complicated “money accounts”. A quick goolge for ‘Financial statements Lloyds bank’ or some other bank (try : Lloyds_2006) will show that money sits in the liabilities section of a bank’s balance sheet under the heading “Customer accounts”, loans sit in the assets section under the heading “Loans and advances to customers”. These form an integral part – indeed the largest part – of a bank’s balance sheet. To Create a loan a bank does not go to some “money account” to see if there is any spare money to loan out, instead it makes the accountancy entry:
Debit £100 “Loans and advances to customers”
Credit £100 “Customer accounts”
This credit of £100 shows up on your bank statement in your favour – it’s money. When you repay the loan, the entries are reversed and the money is destroyed – the money does not go back into a “money pot” or a “money account” in the bank. These correct Debit and Credit entries are incorporated into the spreadsheet model.

Pre-Loaded Scenarios and their problems :

Primative_Culture – “Make Stock – Sell Stock” – Select the Primative_Culture  Scenario from Cell A10 and Click the Load Scenario button. As you can see after one iteration – as Business has paid out 100 to make the stock – and wants more back than it paid out so the workers can only afford to buy £90.91 of stock at cost (90.91 + 10% = 100) – which leaves Business with Stock nobody can afford to buy Cost Price £9.09 (+10% = £10). “OK says the Business manger – I’ll try again” – Click the Run full StoryLine button a few times to see where he is headed – no matter how hard he tries – He can’t sell all his stock – In a very primitive culture this won’t matter if he can consume or barter the last of his stock away and hence consume it himself.

Industrial_Revolution – Arrival of Machines… Fixed Assets. Select the Industrial_Revolution Scenario from Cell A10 and Click the Load Scenario button. This Scenario uses loans from two banks for no particular reason at all apart from to show that the number of banks used is irrelevant to the problem at a hand. 330 is loaned out and 300 is spent to make stock. The other 30 is paid out to make Fixed assets – Machines, Buildings etc… This puts 330 in the pockets of the consumers which enables them to buy the stock for 300 + 10% Profit = 330. After one run through the situation is Economic Heaven – The Workers have been well paid and have been able to clear the shops of goods, Business has, for the first time in History, has been able to make a profit and sell all the goods it made. The Banks have been paid their loans and no one is in debt!  – Instead of having £30 of rotting unsold stock the business now has £30 of fixed assets with which to make more and better goods in the future. The only dark cloud is that “I’m in business to make money”… yet the business has no money! Not to worry, what a good start to the Industrial revolution! You can hear the cheers “Progress ! Science ! Finance, Industry and the Workers in Harmony !” Now Click the Run Full StoryLine Button again… Problems begin to occur at once : Because the Business will suffer a Depreciation charge of say 5% on the Fixed assets built in the previous period (= £1.50), it’s costs are then £300+£1.50 and to make a Profit of 10% they will have to make sales of (300+1.50)x1.1 = £331.65. To have £331.65 in the pockets of the consumers Business will have to build £1.65 more of fixed assets than the previous period. The Period after that there are two fixed assets depreciating at 5% and business,  in order to make it’s 10% profit on costs, will have to further increase the amount it spends on Fixed Assets. During the industrial revolution such increase in fixed asset building was the norm. More and more wages were being spent on building fixed assets and more and more of the costs of a final good were being made up of depreciation charges and stock charges (stock charge: If I pay you £5 to make me something I can sell at the end of the week then you are able to buy it yourself with the money you have – forget the profit for a moment, but if what I want made is quite complex that needs several companies to put several things into it over several periods of time, then the cost of the thing will contain wages paid out to the shopkeeper who sold it this period plus wages to various people who helped create the product over several previous periods (and who have spent that money already – well do you save your wages for 8 months before spending it if you work in a factory that makes parts for things that get sold 8 months later in the shops ?) as well as depreciation on machines and fixed assets used to help make it – the wages of people who added to the product directly during it’s creation is what I mean by stock charges). Nothing here has been said of the actual output – it might reasonably be presumed to have increased in volume dramatically with the price per unit lower than ever. Though consumers live well on price per unit being low, the financial system works on Total Prices and Total Wages and is independent of output levels of actual produce so the moment that the increase in the building of fixed assets slows down – maybe because of product satiation- i.e. people have enough stuff and there is no need to build another few factories, then the economy goes into depression : wages are paid to make things in factories but no wages are paid to make new factories and the total prices of the goods in the shops, which is equal to the wages paid to make them + depreciation charges on old factories and machines (old = previous periods of production) is now less than the total money available to buy them all. The price per unit of the goods on sale might still be quite low but as their is not enough money in Total to cover the Business costs in Total you end up with bankruptcy. Both Keynesianists and Moneterists see rising levels of unsold stock as caused by too much savings i.e. they claim that people have the money to buy the goods but they are ‘saving’ too much of it instead of spending it. Yet the same situation – rising levels on unsold stock, can be modelled, as you have just seen in this model, as happening at the end of a period of expansion of a fixed asset building programme – Just at the point that civilisation is free finally relieved of the burden of ‘hard work all life’ thanks to technical progress,  the financial system (Invented in 15th Century pre-machine age Venice, and possibly adequate at that time), now says “we will not give you the money to buy what machines can make for you in order for you to enjoy that progress”. While economists accused people of ‘too much saving’ during the Great Depression – they knew this was the case because their models told them so – the real life theme tune was Buddy, Can You Spare a Dime? – i.e. the people were saying that there was no money to save. With the Great Depression coming after a rapid expansion of Fixed Assets – cities, railways, etc… into the 1920’s – the model shown here better matches what happened than Keynesian and the Monetarist models with their ‘secret savers’ who needed to be ‘re-assured’ and be given ‘confidence’ to come out of hiding and spend it. What I’m showing here is major financial problems can arise that are independent of the quality of production, the desirability of the produce, bank interest, morality, lazy workers, evil capitalists, the wrath of God, the weather, wars floods, plague, pestilence, Sun spots, business cycles… the point is ‘the numbers’ just do not add up in a way that that would allow for a settled existence. The Medieval Financial system we are using is no longer Fit for Purpose.

Export_Economy Scenario : Days of Empire. Select the Export_Economy Scenario from the drop down in Cell A10 and Click the Load Scenario button. In this Scenario Loans of £330 are taken out and £300 is paid to workers to make some stock. The workers spend their £300 of wages buying the stock in the shops after profit has been added to it; so their £300 runs out quicker than the stock which is priced at £330. Business then has £27.27 – cost price (£30 inc margin) of that pesky darn un-sellable stock. Just as the old nightmares are about to repeat themselves The ‘Homeland’ acquires an Empire and now it can be a net exporter to the captured markets. So it ‘sells’ the last of its stock to Johnny Foreigner for £27.27 +10 % = £30. Where does Johnny Foreigner get the £30 from ? – in shorthand : a ‘Homeland’ bank (Bank B in this case) creates a loan for Johnny Foreigner of £30, with this he can pay the businessman £30 for his remaining stock – this is shown in the model (This loan usually is a securitised loan – i.e. it’s called a foreign government bond, a foreign mortgage, foreign commercial paper – a loan with default/foreclosure rights of some sort or another). In longhand : something more like this happens – Assuming a 1:1 exchange rate a Foreign Bank will create a Foreign loan for a Foreign Business of $10, it will ‘buy’ a Foreign Government Bond for $10 (by doing : Dr Government Securities $10 Cr Current Account of Government $10) and it will issue a mortgage to a foreign individual (by doing : Dr Mortgage Securities $10 Cr Current account of individual $10). By doing this the foreign bank will have assets of Business Loans, Government Bonds and Mortgages of $30 and the Foreign Government, Business and Individuals will have total money in their current accounts of the Foreign bank of $30. The Homeland bank can then buy the assets of the Foreign Bank (By doing Dr: Foreign Securities $30 valued and £30, Cr Current Account of Foreign Bank with Homeland Bank £30). The Foreign Bank then has a balance sheet that looks like :

Assets = Current Account at Foreign Bank £30 valued at $30

Liabilities =  Current Accounts of Foreign Government, Business and Individuals = $(30).

 When the Foreign Government, Business and Individuals want to buy the Homeland goods they first need to buy the Homeland currency – (current accounts) so (forget the middle men), they buy the Homeland Bank current accounts that the Foreign bank holds as assets from the Foreign bank using the current accounts they hold at the Foreign bank (this leaves the foreign bank with no assets and no liabilities a zero balance sheet). They then use their £30 of Homeland Bank current accounts to “pay” the Homeland Businessman for the Homeland goods. I have surrounded the word pay with 1980’s sociology student style inverted commas because the Homeland bank is left holding Johnny Foreigner’s Government bonds, his Mortgages and his Business loans – his IOU’ s  – his debt – so a) he hasn’t really paid for the Homeland goods and b) the shorthand used above and on the spreadsheet : The Homeland bank lends Jonney Foreigner the money to by the Homeland goods is accurate. 

Click the button and keep clicking the button – it’s Economic Heaven every day of the year every year of the millennium for the Homeland Business. The stock is all ‘sold’ there are no debts to the bank (from the Englishman anyway) – Johnny F is deeper in hock year after year  but who cares and for year after year the Homeland get richer and richer… But then something spoilt the party – the Germans ! Well, as they were using the same number counting thing – financial system as the British, and were getting quite industrialised – which means heavy depreciation charges – they needed some poor loser to dump their ‘Excess’ production on – to keep things ticking over on the home front (but note the goods were not necessarily ‘Excess’ at the start of the industrial revolution scenario on the first click – they only became ‘Excess’ when people could not afford to buy them at home- several clicks later the ‘numbers’ in peoples’ pockets was deficient – not necessarily the real demand for the produce). So we then had 2 World Wars which had more than is commonly stated to do with ‘fighting for foreign markets’, the proposed Berlin-Baghdad railroad would have set at nought the Commercial power derived from British Navel Supremacy. And then someone thought of a new idea to generate some more ‘numbers’ … the only thing, apart from common sense, we were really lacking in :”Why don’t we buy and sell our houses to each other at ever increasing prices ?…”

House_Price Scenario : Select the House_Price Scenario from the drop down in Cell A10 and Click the Load Scenario button. The two things needed to use House prices to ‘get the economy ticking’ – i.e. ‘make some numbers’ were a) “Allowing women into the workplace” b) The Empire Wind Rush and mass immigration. The thinking went like this a) “If we can pretty much double the ‘earning workforce’ (a workforce that, with the aid of modern machines, while Hitler’s bombs were dropping on it every night, and with ‘the men’ – the skilled experienced workers – in foreign parts being shot at, produced enough for everyone plus enough to fight a war as well – i.e. in real production requirement terms – less workers are needed in peace time rather than more now the war was over) then there will be two wages chasing each house – which should double the price of the houses which should help for a few years with the ‘numbers problem’. b) if we can get a whole new bunch of people to come to this over-crowded Island then they will need somewhere to live and they can push up the house prices and then the total mortgages will go up which will produce some more numbers to solve our ‘number problem’ for a little longer. Keep Clicking the Run Full StoryLine button – Everyone is a winner except for the newcomer in the housing market as the total salary / total private debt ratio gets lower and lower. If the ‘housing market collapses’  i.e. if we are all packed into little boxes that cost a fortune and we can’t buy a new one at a higher price which means that the housing debt can’t increase at the same rate every year then ‘the economy will go into down turn’ i.e. we’ll run out of numbers.

Consumer_Debt Scenario : This follows the same pattern – as long as the banks are prepared to hand out debt on a continual basis everyone will be happy – as long as the ‘never never’ is never ever, things will be OK.

American_Economy Scenario : This caricature of the American Economy has it that it – all they do now is borrow Domestic Currency from the Banks who then buy Foreign currency with it which enables the foreign suppliers to be paid – While the Line of Credit is open things are OK for the Americans. Meanwhile the Foreigners doing the Exports are happy as they live in a continual Export Economy. But when the line of Credit runs out… The thing about Net Exports or Net Imports is that despite the individual consumer thinking that he has paid for the goods – taken as a whole – the goods have only been borrowed from the net exporter.

A Solution – NEFS (Net Export Financial Simulation) : The Spanish in days of yore did funny things to fix the problem – they went to South America, did a genocide against the locals in order gain control over digging a rock out of the ground to bring it home – gold. Having the gold or not did nothing to increase their productive capacity yet because of the funny system of counting they had they felt richer for having this rock. We might laugh at them but the daft things we do in the modern age to ‘get some numbers’ is as bad or worse. To pay for the same house our parents lived in that was built over a hundred years ago and which a single wage as a postman could pay for 50 years ago both parents now work all the hours that God sends in top management jobs to keep their head below the water line. If an accidental pregnancy turns up… well there are 600 abortions a day in the UK and the vast majority of the mothers killing their kids are not school girls – the National Statistics Office shows that the 24-28 year olds are by far the largest group i.e. not being able to pay a mortgage/save for a mortgage… a shortage of numbers is a big factor- this numbers pressure is not just a factor in the genocide of South American Indians 300 years ago it’s a huge factor in an even larger genocide against the unborn today. There may be problems with Evil capitalists, God’s Wrath, lazy workers and/or Sun spots that will affect life on Earth. These will require other solutions but as far as the ‘missing numbers’ – which is our main problem – is concerned I hereby suggest a solution : I’ve called it “NEFS” – Net Export Financial Simulation – you call it Bob if you like. The idea is that if the UK can produce a big pile of stuff and send it to foreign ports to rot – just so we in England get some numbers to live with… ditto Germany, China, Japan… Continual net exporting countries that do quite well and never wish to be net importers – i.e. they’ll never spend all the foreign currency they’d earned – then why can’t we create the same sort of numbers without all the trouble of producing and exporting a pile of STLs (Straight To Landfill) or Weapons or other Stuff ? This way we’ll produce when we want to consume and export when we want to Import. Businesses will go bust when they are no good not because ‘the music has stopped and there just aren’t enough chairs’. That’s it – that’s my suggested solution. If you think I’m wrong about the problem then don’t throw a Thesaurus of verbal abuse at me – model it and show where I’m wrong. If you think you have a better solution – don’t talk – model it with quadruple entry bookkeeping – demo it with numbers. I’ve left the spreadsheet unprotected so you can adapt it and further develop it if your demo requires something else. (There a few notes on how to develop the Spreadsheet yourself below). Now select the Industrial_Revolution_With_NEFS from the drop down in Cell A10 and Click the Load Scenario button. In this Scenario – Business does business, workers do work and a ‘National Bank’ produces some numbers to make up for the missing numbers inherent in the traditional system. They give the excess numbers – I’m open to ways of working out just how much – to all individuals in the country. QED – as simple as that. Year after year the ‘balancing number in the bank’s books will get bigger and bigger – but so what – it’s better than another World War to ‘get the economy moving’ it’s better that the Chinese Communist Government holding pretty much the same number as a liability to be paid by the West with interest for the next how many years. The answer to the obvious question “Won’t this just cause inflation ?” is in two parts – The empirical part (what happens in the real world) – is that there are plenty of continually net exporting countries that don’t suffer inflation – so why should a country that uses NEFS necessarily suffer inflation ? The second a priori (theoretical) part needs to prove that either the famous equation : MV=PT is either incorrect or meaningless – and find an alternative to it. This is done in the other article on this Page : “MV=PT” Create your own Scenarios : If you think you know better… then you can create your own scenarios to test things for yourself. Click the drop downs in the green area Row 13 and down on the Main_Page Sheet to select a ‘who’ ‘does what’ ‘to whom’ and click the run storyline button to see the resultant balance sheets to test it. To save a Scenario enter a name (that has no spaces or ‘funny characters’) in cell D11 then click the Save Current Scenario. Should you need to you can add more actions on the Quadruple_entry Sheet – just fill in another row. Should you need to, you can add more ‘who’ and ‘whoms’ if you’ll think it’ll make any real difference – Government, ‘The Rich’, the Army, The Health Service, OPEC… copy a column from row 1 to row 7 – say G1 to G7 on the Main page and paste it in the first free column to the right – Say H1 to H7. Click Run Full StoryLine to reset the ranges so the new ‘Whom’ appears in the drop downs in the green area row 13 and downwards. Don’t insert any rows in the model. Remember we live in a quadruple entry world – Don’t just ‘talk’ about Investments = Savings and ‘desired investments’ and ‘desired savings’ and only ‘talk’ about 3 out of the 4 entries and pass your missing entry off with hand waving or quotes from a dead economist – put you numbers where you mouth is – all 4 numbers – Quadruple Entry – and then click the button to see what happens next year and the next in your world and watch it go to pot ! (the formula “S = I” (Savings = Investments) is merely a tautology, as you’ll see from doing the quadruple entry, – Savings are the bottom half of a balance sheet and Investments are the top half and so as “balance sheets balance” then Savings = Investments. All S = I then means is that “balance sheets balance”. You can’t follow that definitional tautology with a ‘so the way you increase Investments is to increase Savings’ because if you increase Investments you will increase Savings as well – £10 of unsold stock is a £10 of investment on a business balance sheet and it’s also £10 of ‘Savings’ – inadvertent savings maybe – but savings – the ‘S’ – in the tautological formula – nevertheless of the shareholders.

Now that the ‘Credit Crunch’ has started to bite, the ‘blame game’ in the financial press and various recent books – by experts – has it that it’s the fault of ‘irresponsible lenders’, Alan Greenspan, Ronald Reagan, Gordon Brown… for letting the Asset price bubble in house prices and shares since the 1980’s grow too much. None of these experts has pointed out that without these bubbles the money to fund them would not have been created (outside of a NEFS system) and instead of spending the last 25 years having some fun with that money – we’d have been flat broke and miserable. We are now flat broke and now also 25 years worth of high spending in debt and our credit card has reached its maximum spending limit, our mines are flooded and our universities are full of near useless psychology and media students – we are in a mess. My thinking is – and the Quadruple Entry bookkeeping shows it – that we should have been using NEFS for over a hundred years, failing that we should have been using it in the last 25 years, failing that we should be using it now

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New Economics Theory – The Sisyphus Formula : Retained Profit = Fixed Assets + Debt

NEFS_4
New Economics Theory – The Sisyphus Formula : Retained Profit = Fixed Assets + Debt. 

The Sisyphus Formula – Simple Version :

Net Retained Profit = Fixed Assets + Consumer Debt

Let’s start with some a priori bookkeeping and then we’ll see later how well it holds up using numbers from the National Accounts : a) Business Borrows £100 from a bank : We have :

Business                                                            Bank

Dr Cash £100                                              Dr Loan £100

Cr Loan £100                                              Cr Current Account £100

And the Sisyphus Formula : “Net Retained Profit = Fixed Assets + Consumer Debt” holds true as all items in the equation are Zero at this point. The business then pays Workers the £100 to build a Fixed Asset so we then have :

Business                                       Workers

Dr Fixed Assets £100            Dr Cash £100

Cr Loan £100                            Cr Wealth £100

Again the Sisyphus Formula : “Net Retained Profit = Fixed Assets + Consumer Debt” still holds true as we have : Retained Profit (£0) = Fixed Assets (£100) + Consumer Debt (- £100).

If we call our Fixed Asset “Stock” (I use the term ‘Fixed Asset’ as a shorthand for non-Financial Assets of all types including Stock) and we sell £20 of it to the consumers for no profit at all – for starters – we’ll have :

Business                           Workers

Dr Stock £80                  Dr Cash £80

Dr Cash £20                    Cr Wealth £80

Cr Loan £100

Again the Sisyphus Formula : “Net Retained Profit = Fixed Assets + Consumer Debt” still holds true as we have Retained Profit (£0) = Stock (£80) + Consumer Debt (- £80).

If instead Business had sold £20 of Stock and made £10 Profit on it we’d have :

Business                                Workers

Dr Stock £80                      Dr Cash £70

DR Cash £30                       Cr Wealth £70

Cr Retained Profit £10   Cr Loan £100

Here we have Retained Profit (£10) = Stock (£80) + Consumer Debt (- £70) Once again the formula holds.

If now Business pays out £5 of this profit in dividends then we’ll have this : Business                                  Workers

Dr Stock £80                          Dr Cash £75

DR Cash £25                           Cr Wealth £75

Cr Retained Profit £5          Cr Loan £100

And now we have Retained Profit (£5) = Stock (£80) + Consumer Debt (- £75).

Starting again from scratch to test other transactions : If a business found a piece rock that had a funny shape and had it ‘valued’ or ‘re-valued’ from Zero (cost price) to £150 Market price then we’d have this :

Business Dr Stock £150

Cr Re-Valuation reserve £150

In the National accounts Re-valuation Reserves are, to the best of my understanding ultimately included in Net Profit so we actually have this : Business Dr Stock £150

Cr Retained Profit £150

and once again the formula balances as we have :

Retained Profit (£150) = Stock (£150) + Consumer Debt (£0).

If some consumer with Zero wages wants to buy this Rock then they’ll have to go into debt to do so so then we’d have :

Business                                                 Consumer

Dr Cash £150                                       Dr Goods £150

Cr Retained Profit £150                  Cr Debt £150

Again Retained Profit (£150) = Consumer Debt (£150) and the Formula holds.

If some of this retained profit is released in dividends – say £30, then the total net debt of the consumers, which equals the amount they owe to the Banks to Business less the amount of cash, company bonds and company shares they own will now be reduced by £30 so once again we’d have Business                                                 Consumer

Dr Cash £120                                       Dr Goods £150

Cr Retained Profit £120                 Dr Cash £30

                                                                 Cr Debt £150

… Retained Profit (£120) = Consumer Debt (£120) and the equation still works. If this company then issued £20 of bonds which were bought by the consumers for £20, then we’d have this :

Business                                                Consumer

Dr Cash £140                                      Dr Goods £150

CR Bonds Issued £20                      Dr Company Bonds Held £20

Cr Retained Profit £120                Dr Cash £10

                                                                 Cr Debt £150

and the Sisyphus Formula would look like this: Retained Profit (£120) = Consumer Debt to bank (£150) + Cash (£-10) + Bonds Owned by Individuals (£-20) and the equation still works. Had the Company issued Company “Shares” instead of “Bonds” the situation would have been exactly the same, when all the talk is done a Share is essentially a Bond with a different risk profile attached – it’s a Financial Liability owed to the holder. So far I’ve only looked at Business and Individuals, Where does Government get involved in all this ? Well as Government isn’t a profit retaining entity – i.e. it’s not requesting more money back than it pays out – you can think of Government as being a consumer – on the outside of the Business World. So in the Formula, Government Debt is included in ‘Consumer Debt’. Foreigners – What about Imports and Exports ? – These do not fit into the equation at the moment : If a consumer borrows £150 to buy a French Rock – as in the above example – then the Retained Profits of the UK Companies is Zero but the Consumer Debt is £150. So if foreign transactions are to be included in the Formula then it needs to be amended to read : “UK Business Retained Profits = UK Business Fixed Assets + UK Consumer Debt + (Exports – Imports)”. So in this example we have : UK Business Retained Profits (£0) = UK Consumer Debt (£150) – Imports (£150). Income from Abroad – say dividends received from a foreign company for £150 – these can be counted as part of Exports for then we have : UK Business Retained Profits (£0) = UK Consumer Debt (-£150) + Exports (£100), for dividend income received by an individual and UK Business Retained Profits (£100) = Exports (£100) for dividend income received by a UK Company. As it stands, using the conventional financial system developed in pre-machine age Venice, “Retained Profits of Business” are another way of saying Business Fixed Asset Building Programmes and/or Consumer/Government Debt. In a country that has little Retained Business Profits and lots of Net Imports, the formula could be re-arranged to say Net Imports means Business Fixed Asset Building Programmes and/or Consumer/Government Debt increases. Solution : – Use NEFS – so then we have : Retained Profit = Fixed Assets + Debt + NEFS So what’s this extra NEFS – ‘Net Export Financial Simulation’ term that’s going to ‘save us’ ? Imagine we were a Net Exporting Nation – say like Germany or Japan, what happens there is workers get paid to £1,000 to build 3 cars and two of the cars are ‘Exported’ so there is only one left in the shop and it costs £333 to make so it can be sold for say £400 so the businessman makes a profit and, after buying all the cars in the shops, the Consumers still have £600 left in their bank accounts. So NEFS is about saying ‘After making 3 cars, whay can’t we own 3 cars – why give two away to some foreigner in order to balance some number in a dusty ledger somewhere ? Imagine having 3 cars sold for the £400 in total rather than just the one. This way they will own 3 cars and have £600 left in their savings. But wait ! If the businesman borrows £1,000 to pay to make 3 cars and only gets £400 back he’ll go broke – Well the only thing missing is some numbers that say £600 to balance it up – This £600 of numbers is NEFS – NET Export Financial Simulation. In the first situation the Businesman in the real Net Exporting Country had £600 in some bond from some foreign person he’ll never see and these £600’s in foreign bonds will just build up year after year in some dusty ledger somewhere never being used to buy foreign goods with – remember it’s continual year on year Net Exporting I’m talking about – not balanced trade – Exporting cars to pay for imported bananas etc. Net Exporting Countries do not suffer inflation as an automatic situation despite their ‘too much money chasing too few goods’ – £1000 wages and £300 worth of 1 car situation. If real Net Exporting Countries don’t suffer this why should NEFS countries who will have more goods – three cars to buy in the shops because they didn’t ‘Net Export’ two of them. Lack of competition is a far bigger driver of inflation than ‘too much money’. No the real big worry about people having ‘too much money’ is that once they are out of debt and have enough money they might start to live independent lives, develop their personality etc. NEFS – ‘Net Export Financial Simulation’ is the mechanism whereby the dividend of the ‘White Heat of Technology’ can be finally realised. Let’s now test this formula against the numbers from the National Accounts (or Click Here for a Spreadsheet Version) : 2001 2002 2003 2004 2005 2006 2007 2008 2001-2008 Business Retained Profits 173,200 444,300 (59,400) (48,100) (342,700) (105,100) 90,100 812,600 964,900 Increase in Business Fixed Assets 13,400 48,800 47,700 88,700 19,200 111,500 31,100 (71,100) 289,300 Household Financial Debt Increase 224,800 361,300 (127,600) (73,400) (358,000) (143,700) (46,400) 431,800 268,800 Government Financial Debt Increase (24,500) 17,600 17,600 40,300 27,800 27,300 35,200 76,400 217,700 Foreigners Financial Debt Increase (39,700) 16,500 2,700 (103,500) (32,500) (100,300) 69,100 373,500 185,800 174,000 444,200 (59,600) (47,900) (343,500) (105,200) 89,000 810,600 961,600 Difference 800 (100) (200) 200 (800) (100) (1,100) (2,000) (3,300) These numbers are in Millions and the differences are of the order of the statistical discrepancies in the Blue Book – So the Formula works in real life ! QED ! A quick look at the numbers : It shows that in 2001 all the Business profits were funded by the increase in consumer debt (Mortgage Increases/Credit card Increases/Selling of Bonds and Shares) – which also funded the decrease in Government debt as well. In 2002 the Profits of Commercial Companies and banks were almost totally accounted for/funded by an increase in consumer debt. Between 2003 and 2006 companies in total made year on year losses totally half a Trillion largely caused (matched) by Consumer Debt decreasing by three quarters of a Million over the same period. In 2007, despite Consumer debt decreasing again, Business made a Profit funded by an Increase in Government Debt, Foreign Debt and a Companies Fixed Assets. In 2008 Consumer Debt jumped sharply by just £400 Billion and Foreign Debt jumped by just under £400 Billion, helping to fund a fund a Business Profit of £800 Billion. The question arises as to why foreigners should increase their debt to the UK – given our miserable Export situation – If a foreigner borrows money – say £100 – from a UK bank then the Foreigner’s Financial Assets will go up £100 (their new Current Account) and their Financial Liabilities will also go up £100 – the new loan they owe. If the Foreigner buys UK Shares or Bonds with the money then their Financial Assets will remain the same at £100 for the financial assets to go down and for them to be only left with a Financial Liability then the shares they bought need to drop in value, in which case the £800 Billion Profits of 2008 were half funded by poor Johnney foreigner losing £400 Billion in the stock exchange, or they bought our goods (I didn’t see and Export surge in that year) or they used the money to buy things like UK Land and Buildings – The National accounts do not have any data for Non-Financial Assets of Foreigners. So what a pile of ‘funny money’ this is ! – we do pretty much the same thing each year and yet we lurch from a third of Trillion loss to nearly a Trillion Profit because some adjustments are made in a dusty ledger – or a computer screen somewhere. This ‘finance’ has no bearing on the ‘battle for scarce resources’ – what economics pretends to be – our resources don’t change so erratically. Modern finance is a miserable excuse of Proxi for reality – for real economics. This is hardly surprising as it was invented in pre-machine age Venice. Look no further than this out-of-date system for the reason that despite us living in the computer age they tell us we need to work till 70+ because we a ‘too poor’. We are not ‘too poor’ in reality – there is loads of food – it’s just the meter we use to measure our wealth – our financial system – is broke. The financial baromater shows “dull, cloudy… work hard and die poor” while actually it’s perfectly sunny outside. For Q3 2009 – So up to September 2009 – though the Government gallantly increased it’s Debt by £88,300 Million – which should provide a nice profit for Business you’d think, because Households reduced their debt by £435,300 Million and Foreigners Reduced their Debt by £209,100 Million, there was an overall reduction in Debt outside the Corporate World of £556,100 Million. The figures for Corporate Fixed Assets are not known to me yet but if Business didn’t have much of Fixed Asset Building party this year – which seems reasonable given all the ‘For Let’ signs outside empty office blocks all over the place – then Business is looking at a staggering half a Trillion loss this year. They only had £122,200 Net Retained Profit coming into the year at the start of 2009, so after all those millions of Business people have done all that work – OK in some cases “work” – for all those years, overall Business will be at a loss. To which I say “Stop playing musical chairs and start using NEFS !” Let’s now look at some of the other basic numbers picked from the UK National Accounts 2009 Blue Book and a couple of other places. Year 2000 2001 2002 2003 2004 2005 2006 2007 £ Million £ Million £ Million £ Million £ Million £ Million £ Million £ Million GDP 976,533 1,021,828 1,075,564 1,139,746 1,202,956 1,254,058 1,325,795 1,398,882 Wages 462,355 490,978 508,614 527,630 549,995 570,471 593,815 629,834 Interest/ Dividends 132,429 135,233 122,655 127,615 136,243 154,867 160,864 175,856 Small Business 56,931 61,282 64,967 68,324 74,282 79,061 80,023 82,398 Operating Profits 259,001 265,797 288,091 313,300 333,619 346,260 378,185 401,832 Less Dividends 43,755 49,894 43,787 45,248 46,705 50,397 51,249 50,087 Retained Profit 215,246 215,903 244,304 268,052 286,914 295,863 326,936 351,745 Market Cap LSE 1,868,092 1,641,945 1,358,603 1,214,293 1,386,720 1,597,609 1,869,448 2,041,056 Export Goods 187,936 189,093 186,524 188,320 190,874 211,608 243,633 220,858 Export Services 81,883 87,773 94,012 102,357 112,922 119,186 134,246 150,645 Foreign Income Received 132,934 138,534 121,664 123,185 138,311 186,740 237,622 291,302 International Transfers In 10,483 13,917 12,234 12,047 13,767 17,400 18,473 14,046 Import Goods 220,912 230,305 234,229 236,927 251,774 280,197 319,945 310,612 Import Services 66,881 70,573 74,380 79,745 84,508 93,444 99,464 105,838 Foreign Income Paid 130,972 129,109 103,378 105,662 120,466 164,885 228,049 270,527 International Transfers Out 20,258 20,432 21,104 21,882 24,043 29,249 30,358 27,584 Current Account Annual (25,787) (21,102) (18,657) (18,307) (24,917) (32,841) (43,842) (37,710) Current Account Cumulative (78,954) (100,056) (118,713) (137,020) (161,937) (194,778) (238,620) (301,398) The huge difference between the Profit shown here and the Profit (and half the time the Loss) shown above is that the Profit shown here is “Top Line Profit” – i.e. Sales less Cost of Sales and few other costs. The Real Profit – the one shown at the top of this article is derived from the movement between the balance sheet, this then is Sales less all costs and includes re-valuations of assets, pension liabilties… and ‘other’… the whole works. Notes : 1) These figures are at ‘current prices’ which means people didn’t actually get paid wages of £462,355 Million in the Year 2000 they were actually paid a bit less, say wages of something like £400,000. All the figures shown for previous years are ‘inflation adjusted’ so they look higher than they actually were – it’s trying to show the wages in ‘today’s’ money. 2) There are lot’s of problems with ‘GDP’ – the preface in the National Accounts Blue Book mentions some of them, other issues are mentioned in What’s wrong with Keynes ? What’s wrong with Monetarism ?, I have shown it here so you can have it as a ball park figure in your head to compare to the other numbers. 3) Wages, which is the Gross Wages figure, is not really income – it’s just a cost to a business, Real, cash-in-your-pocket Income is Gross Wages minus PAYE and National Insurance taxes, so take off a few quid in your mind for the PAYE and NI from these figures. 4) Interest/Dividends – This is the Interest and Dividends paid to Individuals. It’s not obvious from the Blue Book if this is Interest Before Tax or After Tax so bear in mind there might be a tax adjustment to get to the actual money received. 5) Small Business – this is the Income of small family businesses under the line Mixed Income – It does not say in the Blue Book if it is Gross, Net of Expenses, Net of Tax or actual Drawings Net of Tax – the cash-in-your-pocket Income. 6) Profits – Operating Surplus. This is the Profits of Financial and non-Financial Companies and this is where NEFS Economists differ from old fashioned Economists. According to old fashioned Economists this is all counted as Household Income i.e. £259 Billion in the Year 2000. Whereas all that you actually see as a householder and shareholder of the £259 Billion, is the Dividends paid to Households figure – a mere £45.258 Billion in the Year 2000 – (This then gets taxed so you are down to seeing something like £30 Billion in cash – but say the tax gets given to people on the state pension and nurses etc, so the we are back to £42.258 being in the hands of Consumers) . NEFS economists are not alone in this view, even the Taxman does not see the £259 Billion as your income – Shhh ! If he did – he’d tax the living day lights out of you. The Taxman, like NEFS Economists only see the Dividends you receive as your income. There is a legal fiction that the shareholders of a large PLC ‘own’ the company. In reality a modern PLC is a ‘retained profit accumulating machine’ and the dividends it pays to it’s shareholders are little different to the Interest it pays on it’s bonds – shares are just an alternative and more flexible way to structure company debt, dividends are just like variable interest payments on that debt. In the NEFS World, Business pays £10 to a worker to make stock of £10 and then tries to sell it for a profit back to the workers at the weekend in the shops – who are now consumers – for £12, but can’t because the consumers only have £10 in their pockets. An old fashioned economist does not see a problem here as, if the stock will be sold for £12 (it’s considered bad manners to ask how) then the shareholders will have made £2 profit and hence they will have £2 of what they call ‘Income’ so the Workers have £10 Income and the Shareholders £2 Income so there is £12 Income to buy they £12 retail sale price of the stock – Q E fiddle-i-D ! – In The NEFS World, for all the stock to be sold, the extra £2 is originally created by several means : Consumer debt, Government debt… see the main NEFS article. So say a consumer goes into Debt and borrows £2 from a bank (and note, some Old Fashioned economists think this is silly because if Consumer A borrows £2 from a bank then the bank is lending out some savers £2 so if the workers get paid £10 and one worker decides to save £2 and not spend it then we are down to £8 ready to spend, if the bank then lends out this £2, we are only back up to £10 ready to spend – we are still £2 short to make the £12 needed; other Old fashioned economists start wittering on about it being possible for the banks to create this extra £2 but only through ‘Fractional Reserve Banking’ – which has a few problems of it’s own see The Myth of Fractional Reserve Banking. In the real world (and the NEFS World), when a bank makes a loan of £2 it does not take the money from a savers current or savings account (has your bank balance and the NEFS world ever gone done because your bank loaned some money out to another customer ?), what is does is it adds £2 to a loan account and adds £2 to a current account – a balancing Debit and Credit, this creates £2 of new money (the current account balance), this can be then added to the £10 in wages and the stock can be sold for £12, with £2 profit for the company. (It is at this point that old Fashioned Economists fallaciously jump in and point at the New £2 in the Current account and the New £2 in the loan account and fallaciously claim “The £2 ‘savings’ in the current account is being loaned out in the Loan account – you see we need Saving to make Investments” they incorrectly cry). The company can then pay out a typical to generous 25% dividend = 50p, this 50p can be used to pay off £50p of the consumer debt but it still leaves £1.50 consumer debt that matches £1.50 retained profit of the company. So in the old fashioned Economists World we have Income (£12), which equals Consumption (£12) – and “what’s the problem ?”. In the NEFS world (and check your bank account, the real World as well), we have “I work hard, long and well and I end the week in more debt than I started with” – you might be a lucky individual who does not have this problem but over the whole economy this is inevitably going to be the case – the closest I can explain it with is its like musical chairs – no matter how fast you run and how well you listen someone is going to lose every round – there are more chairs than players – in a similar manner, in NEFS Economics – and the Real Economy – there are more prices than wages and dividends – so no matter how hard you work, someone somewhere will go into more debt. The Debt can be Consumer Debt, Mortgage Debt, Government Debt and/or Debt owed by Foreigners. It is this equation : Profit (Retained Profit of companies) = Fixed Assets (the money paid to individuals in wages and dividends during the creation of Company fixed assets and stock increases) + Increase in debt outside of the corporate world (i.e. the debt of Individuals, Mortgages, credit cards, loans, student debt… The debt of Governments, the debt of foreigners). This is the equation that we toil under, I call it the Sisyphus equation (the Greek guy with the boulder), as this is the equation that leads civilisation to destroy itself with debt burden just as it’s technology frees it from the toil of it’s ancestors. The other thing to bear in mind is a lot of ‘wealth’ in the UK is caused by the revaluation upwards of Assets. The problem with this from real and NEFS perspective is that If I build an office block for £10 million then there is £10 million paid out in wages, so when this cost of £10 Million (+ say £2 Million mark up profit = £12 Million total) gets charged to the tenants, and hence to the final customers of the tenants, though the customers cannot afford the full £12 million they will at least have the first £10 million and only need to go into debt for the last £2 Million. But, if the £10 Million is merely a ‘revaluation’, when the Company charges £12 Million to customers, the customers will have to go into debt for the full £12 Million as no-one was ever paid the ‘revaluation amount’. That said there is also a ‘middle ground’ problem here : even if £10 million is paid out to workers to build an office block, if it takes say 5 years to build it, how much of that £10 Million will be sitting in savings accounts waiting to to be spent on the prices generated to the consumer ? – Zero to very little. Most of that £10 Million will have been used to fund the profits of other companies (by ‘fund the profits’ I mean provide the extra £2 cash to consumers allow £12 to be received in sales when only £10 was paid out in costs) . These other business’s will then be sitting there with £10 million in retained earnings, requiring say a £2 million a year ROI – Return on Investment – at this point, the builders are laid off now the office is finished so there is not only not the £2 Million per year in builders pockets there is an extra demand on consumers – the prices from the office block costs will appear in consumer prices. So, even without a revaluation, this middle ground case – where it takes a long time to make something – has a similar effect to a revaluation – there is a huge gap between the prices in the shops and the money the consumers have to spend. At this point we have a recession, which has nothing to do with the battle for scarce resources or over-population… all the usual suspects – it’s just that the numbers all got in a twist. In a recent article in the Economist magazine “The danger of the bounce” 09 Jan 2010, an old fashioned economist explains that, in reference ot the big building in Dubai, the Buri Khalifa just being opened, the finishing of the Petronas Towers in Malaysia, as well as the completion of the Empire State building : “Sky scrapers have long be associated with the ends of financial booms… such towers are commissioned when money is cheap, they are often finished when the champagne has gone flat”. Here the word ‘money’ is used, as it often fallaciously is, in the singular, as if it is a one entity thing – a coin you can point at and have in your pocket, whereas, as you now know, money is more like a quantum binary particle and it comes in pairs : Debits and Credits. With real money being used in transactions which involve two parties, ‘money’ is actually a four way bookkeeping transaction – quadruple entry. It involves things like wages, which are income to the recipient yet costs to the payer, as well as prices, which need to be higher than costs for business to continue, and are income to the business and a drain on savings to the consumer. Looked at it from this way, these Sky scrapers and the general building boom that usually accompanies them, add income to the workers/consumers and are a large part of the cause of the ‘Financial boom’, rather than an effect. When the buildings have been finished, they become a drain on income through prices and are part of the cause of the ensuing depression, they are not just a white elephant effect of previous years of cheap credit and ‘bubble madness’. Given that Economics is meant to be about the battle for scare resources (whereas in reality it’s more about balancing the Sisyphus Equation), the author of the magazine article makes no attempt to explain the paradoxical depression that follows – just at the point at which the ability to produce goods and services in this new shinny office – or factory – or other major work is at an all time high and resources are plentiful and not scarce – business stops – Sisyphus’ boulder of Real Wealth rolls back down the hill due to the weight of debt – he merely finishes his sentence with the old hackneyed metaphor “the Champagne went flat”. In the £10 costs, £12 Sales example above, the Retained Profit matched the Consumer Debt. Is this always the case ? – No, the ‘full equation’, the Sisyphus equation has two major items on the right side – Fixed Assets and Non-Corporate Debt : If the company borrows £12, spends £10 to makes some goods and £2 to make a fixed asset then workers/consumers will have £12 cash from their wages, so goods can be sold for £12 and the company will make a profit of £2 and no one will end up in debt – The £2 retained profit this time is represented by the increase in fixed assets. As a 3rd alternative, the company can pay £12 to make some goods, then export £2’s worth abroad. Then the workers can use the £12 they were paid to buy the remaining £10 of goods (£10 at cost price). The company then makes £2 profit in Sterling and has say 20 Yen left spare received from the foreigners. The company can then sell the 20 Yen to a bank for say £2, the Profit of £2 is then represented by £2 cash in the company’s bank account. The Bank can then go and buy Japanese bonds, shares….’Invest in Japan’ so in the bigger picture the £2 profit is represented by owning £2 of Japan – so the Japanese owe us the £2 – the debt of foreigners. Strangely enough, this ‘trick’ also works in reverse : not only can you Net Export your way to having enough money you can also Net Import your way to having enough money as well – If workers/consumers Net Import £2 worth of Japanese goods, a Japanese bank will end up with £2 of sterling which it can then ‘Invest’ in the UK – it can buy bonds, shares, property, race horses…. The British people who are in receipt of this £2 then have the extra £2 to make the £12 needed to buy the £10 of goods at £2 profit for the company. In this case the £2 profit is represented by the £2 ownership of UK shares/bonds/property now in the hands of the Japanese. If the UK Government issues bonds of £2 and the banks buy them, then which ever worker gets paid that £2 – say a nurse – then that means that there is once again the extra £2 to enable the company to make it’s £2 profit – a profit represented by government debt (our future tax liabilities) owed to the Japanese. Another way or writing the Sisyphus formula is : Retained Profits for the year = Increase in Net Consumer Debt + Increase in Net Government Debt + Increase in Company Fixed Assets + Increase in Net Exports (An increase in Net Imports would mean that the Japanese say are able to buy our Bonds – but this is sort of already counted in the increase in net debt of the bond issuer). As you can see, doing things this way round – using a financial system invented in pre-machine age 15th Century Venice leaves us with the equation : The better we do – more profits – the more debt (or fixed assets) is need – i.e. “The better we do, the worse we do” – it’s almost Dickensian – “It was the best of times it was the worst of times” – no wonder we never got that 3 day week thanks to the ‘White Heat of Technology’ we were promised by Harold Wilson back in 1963. We got the technology bit right but we are using a daft-as-a-bat out-of-date finance system, so we are stuck in the office all day, all life, looking forward to an old age of penury. 7) Market Cap – I derived these figures from the 1) All share index on the Yahoo finance page and a base line figure I found that said that at the end of Dec 08 the Market cap of the all share was £1.28 Trillion, then I did some averages on the numbers. As this number is not from the Blue Book there is no inflation adjustments done to get to ‘current prices’ like the rest of the data shown. Also worth noting is If Company A has a Market Cap of say £1 Million and Company B, an Investment Company, issues shares and buys Company A for £1 million then the Investment company’s Market Cap might be about £1 Million as well. I suspect the All Share index might double count the one £1 Million Market Cap and show £2 Million in the situation especially where these investments are done on a ‘Portfolio basis’ – i.e. B owns less than 10% of all the shares- so bear in mind the figures might have some doubling up in them. Can we look at theses figures from the past 10 odd years and see the Credit Crunch Coming ? Looking at the Gross Wages to Household Debt Ratio (By ‘Household Debt’ I mean Currency and Deposits less Mortgages and Loans, so if you have a loan of £100 and cash in the bank of £20 then your Household Debt figure is £80) we have : 2000 2001 2002 2003 2004 2005 2006 2007 Household Debt 731,000 807,200 920,300 1,046,700 1,181,100 1,253,100 1,410,900 1,517,400 Gross wages 462,355 490,978 508,614 527,630 549,995 570,471 593,815 629,834 Debt/Wages Ratio 1.58 1.64 1.81 1.98 2.15 2.2 2.38 2.41 What this shows is that the ratio of our debt burden to our wages is getting higher. When someone takes out a mortgage for a house the essential deal is – “As an average worker I have spare income of say £100 per month, how much can I afford to pay ? – at 10% interest rate I can afford to pay £100/per Month, which is £1,200 per year, which is £12,000 over say a 10 year mortgage (this is just looking at interest only) – so the average house will cost £12,000. At an interest rate of half of that at 5% I can afford, and hence the house prices get bid up to, double £12,000 = £24,000. You might have noticed that house prices have been soaring over the past couple of decades, interest rates have been low and falling – this is old news, what is not so old news is that if you bought the house at £24,000 – not because it was ‘worth’ £24,000 but because £24,000 is essentially the answer to the equation “What I can afford per month/divided by the Interest rate when I bought it, then if the interest rate went from 5% back to 10% 1) I will be paying so much to the bank that I won’t be able to afford to buy anything else from productive industry 2) I will default on my mortgage and get repossessed and my bank, which proudly displays the mortgage I owe it as £24,000 on it’s balance sheet, will have to sell it for £12,000 and show a write down of £12,000. This, over the whole economy – I’m talking about average Joe here, might crash the bank so those people who think they have wealth in their bank shares on the stock exchange will have nothing and those people who have invested in pension companies/Investment Trusts etc who have invested in banks will have nothing. What is quite new news is that the standard answer to this “Oh this is because money was too cheap in the last two decades” have missed the point : When Mr A sold his house to Mr B for £24,000 when the interest rate was low, Mr B took out a mortgage for £24,000 and in doing so asked a bank to create a new £24,000 for him. Mr A obtained possession of this £24,000 and this and all the other extra £24,000’s provided the extra £2’s to fund the profit of the companies selling goods and services for the past two decades. And this is the rub – economics is meant to be about the “Allocation of scarce resources” but we were only able to provide goods and services for the past 20 years by messing round with some numbers on a piece of paper relating to swapping ownership rights to a couple of hundred thousand cold, draughty, leaky Edwardian hovels. If we were able to do this on the back of house price rises then we should be able to find a way for industry to provide goods and services to us independent of these house prices based on the ability to produce. Think about it in real terms rather than financial terms and you might begin to see how ridiculous the game is. Interest rates are low – why might they rise ? – Well start at the basics, the reason banks charge more in loans than they pay on current accounts is to make money. (Old fashioned economists think that borrowers lend from savers and banks are just the middle men, the broker, who takes 5% from the borrowers and pays 2% to savers and keeps 3% as a fee – Whereas NEFS Economists see that when a bank makes a loan of £100 to customer A it does not take £100 from saver B, what happens is that to create the Loan of £100 it Debits Customer A with £100 in a Loan account and Credits the same Customer A with £100 in his Current account – Customer A is both a brand new Saver and a brand new Loaner ! – ‘He saves his newly created loan’. At that point he then pays 5% on his new Loan and earns 2% on his new savings. Usually he uses his new current account balance, his new savings, to buy something, say a new car. The Current account then becomes the property of the car seller – who is now the new saver. If the car seller banks elsewhere, then the first bank, instead of owing £100 to a customer at 2% (nice and cheap), it has an inter-bank loan it owes to the second bank and pays LIBOR rates (ouch) on the £100 – this is why banks want to attract savers – not because they need the savers money to loan out, but because it’s cheaper than owing another bank. The first bank is then worried that if customer A defaults on his loan then the bank will have Zero assets but owe £100 to the second bank at LIBOR. The higher the risk of default, the higher the first bank has to charge for the loan to cover this risk. So can you think of a reason in this sunny financial climate why banks might feel the need to raise interest rates ? What else do we owe ? – Well, we’ve been Net Importing for Donkey years now, but starting with Year 1994 as zero, we had built up a cumulative Current account deficit of £53,167 Million by the year 2000, and then between 2000 and 2007 we imported 1/4 of a £Trillion more than we exported, leaving us 1/3 of a £Trillion in hock to the rest of the World. One of the sort of paradoxes of Finance is “If you only £pay for your imported goods you still owe”, So We, as a nation, owe something like £1/3 £Trillion to the rest of the World despite all these Imports having been ‘£paid for’ by the consumers who bought them. Paradoxes of Finance ? – Time for some new general theories : Well number 1 must be the one where a bank makes a loan but does not loan saver’s money out – it creates both a new Debtor and a New saver at the same time. Number 2 I suppose will have to be ‘The more profits a company makes, the more debt somebody somewhere has to go into’ (Ignoring fixed assets for a mo). Let’s call number 3 the “If you only £pay for your imported goods you still owe” paradox. I’ll Finish for now with Paradox Number 4 : If country A “Invests” in Country B then, by the same act, Country B “Invests” in Country A. Paradoxes 1 and 2 are explained above, I’ll explain 3 and 4 now : Paradox 3 -This ‘paradox’ only works in a Net Importing situation, to make things easy to explain, instead of saying We sell £100 to the Japanese and they sell £110 to us on an ongoing basis, I’ll just net it off and say that they sell us £10’s worth of goods and we sell them nothing – it’s the same effect. If I borrow money from my bank for £10 and use it to buy/pay for say a Japanese gizmo with it, then the Japanese businessman has £10. This is of no use to him as is, so he sells it to a Japanese bank for say 20 Yen and goes away happy. The Japanese bank then has a liability to the Businessman of 20 Yen and an asset of £10 owed to it from the English bank. The Japanese bank can keep the situation like this and earn LIBOR level rates from the British bank (this is quite common – in 2008 the Rest of the World had Investments in the UK that were £549,800 Million in UK Shares, £1,138,700 Million in UK Bonds and £3,582,200 in Bank Accounts), or sell it and buy shares and bonds in the UK. Whatever happens we still “owe” and we pay either in Bank interest, Bond Interest (Tax if it’s a government bond) or dividends. We only really pay for the goods properly and cease to owe when we sell something to the Japanese – i.e. have balanced trade, that way he give us back the £10 and we pay no more interest on it. Paradox 4 – If country A “Invests” in Country B then, by the same act, Country B “Invests” in Country A, is best explained by asking you to think “When you do something ‘financial’ i.e. “I Invest in Africa or China” – what are the banks doing behind the scenes ? – So if I borrow £100 from my UK Bank – Bank A then my bank does Dr Loan £100, Cr Current Account £100. To start my ‘investment’ in Africa say, I open an account in an African Bank B and pay in the £100 in (Assume the African country uses Sterling so we don’t confuse matters with Foreign Exchange). “Paying the £100″ in means I write a Bank A cheque for £100 payable to myself and deposit it in Bank B. Bank B then owes me £100 and it presents the cheque to Bank A. The UK Bank A then owes the African Bank B an Inter-Bank Balance of £100. “Investing in a country”, according to the National Accounts means that that country owes me something. I live in the UK and Bank B in Africa owes me £100 – this will show as UK investment in foreign lands. But, the UK based Bank A owes £100 inter-bank balance to the African Bank B and this will also show up in the National accounts as ‘Foreign Countries Investing in the UK’ £100. To get a Net Investment other than Zero we need to trade un-evenly so either A) I then use the £100 current account in Bank B to pay locals to make me some goods and then sell those goods to the locals for £110 and Bank the £110 back in Bank B, then the National accounts will show that Africa owes the UK a net figure of £10 – it will show that UK has Invested Net £10 in the Africa ! or B) If I just trade with Africa from the UK but sell more to them than I buy by £10 then this will show the same as A in the National Accounts that the UK has Invested in the Africa – this is what lots of ‘International Investment’ essentially amounts to it’s just the results of imbalanced trade. Looking at the National Accounts you can see some ‘strange at first glance’ numbers : In 2007, despite having a not untypical £2,175 Million Trade and Income surplus with Switzerland, they had a “The UK owes us £75,417 Million more than they owe us balance”. This sort of thing is caused by using 3rd countries to ‘do the banking’ in. So if the Chinese Net Export say £80,000 Million to us, then we will in reality owe them £80,000 Million. But if they bank £70,000 Million of this in Switzerland then the National Accounts will show that we are in debt to the Chinese for only £10,000 Million and the Swiss if £70,000 Million – so most of the real £80,000 Million debt to China will show up in ‘the don’t worry it’s only European Debt” section. It’s a similar story with Net Imports, if the Chinese sell goods to say America and they get adapted a little and sold to us, then it shows in our books as Imports from America. We are told that China is busy now-a-days trading with it’s Asian neighbours – but it’s Asian neighbours trade with us a lot as well – how much of our imports from say Singapore are front imports from China ? “Made in Hong Kong” was written on most of my toys when I was a child yet Hong Kong makes little or nothing of anything and never did. It was mainly repackaged ‘made in China’ goods. I suggest a mixture of common sense and paranoia are probably better guides to the international trade situation than the neatly arranged Geographical breakdown figures at the back of the National Accounts. Have a look – the cars on the street are German, the quality electronic goods are Japanese, if you wrote most of the rest of the stuff off as being Chinese, I don’t think you’d be too far wrong. While the value of the housing stock virtually doubled between 2000 and 2008 providing a solid jelly like base for the nation’s wealth : 2000 2001 2002 2003 2004 2005 2006 2007 2008 House Value 2,430,800 2,607,400 3,135,100 3,491,100 3,902,100 4,047,100 4,473,100 4,921,300 4,460,700 (Actually the line I am using is ‘non-Financial assets’ so New houses are included in this as well as cars etc so bear that in mind), the other source of a Englishman’s wealth was his pension: While he was being paid £10 to make something he would have to buy at £12 at the weekend, he ignored the £2 shortfall and started the week by ‘investing’ £3 in a ‘pension’ (i.e. Gave it back to companies to pay people to make more goods with more prices thus increasing the debt required to buy the goods – sterling idea ! and/or ii) Gave the money to pension fund managers to buy shares from other pension fund managers in companies that were 10 years on and Lord knows how many points higher than the point of irrational exuberance in 1986) So from what I can see from the National Accounts he made net regular Contributions of : 2000 2001 2002 2003 2004 2005 2006 2007 2008 Net Pension Contributions 29,836 34,692 47,195 36,309 44,201 51,219 61,928 67,168 16,942 a total of £389,490 Million during the period. In the meantime the value of the pensions lurched up and down : 2000 2001 2002 2003 2004 2005 2006 2007 2008 Net Pension Value 1,633,700 1,564,900 1,419,000 1,544,300 1,641,000 1,931,300 2,111,300 2,210,300 1,888,300 Movement (68,800) (145,900) 125,300 96,700 290,300 180,000 99,000 (322,000) Ending a staggering £254,600 Million higher in 2008 than in 2000 – and this after ‘contributing’ £389,490 Million – that’s £134,890 Million worse off than sticking it under the mattress – “Psst wanna buy the Brooklyn Bridge” So the rub is this : It was not the ‘greedy bankers’ that got us into this mess – actually they saved us ! – The ‘easy credit bubble’ has provided us with the extra £2’s to buy the goods in the shops for the past 10-20 years. Had we not had easy credit then we would have been flat broke 20 yers ago – we would not have had the extra £2’s to buy the goods in the shops. The challenge is this : To Mr Brown, Mr Cameron and co. as well as leaders round the World : Given the figures we have so far and given the Sisyphus equation you are working within, don’t just talk and use English words, which are wholly inadequate in discussing matters of finance – the English language uses the word ‘money’ and was based on old coins and hence was appropriately singular in many ways back in history. Modern ‘Money’ however is bookkeeping – it’s double entry for each party concerned and so it’s essentially Quadruple Entry. We will give money to X” implies 4 bookkeeping entries – 3 of which most politicians and financial journalists have no awareness off. Don’t say ‘We will work for Recovery’ – fill in the schedules – in broad terms – and show all the entries to see if your sentences even make sense in the first place : Shall our recovery be based on house price rises ? – if so how high shall the mortgage/wage ratio get ? Is it to be based on ‘working harder’ – where is the extra money going to come from to fund the profits ? Is it to be based ‘cuts in public spending’ – If a businessman can’t sell his goods to a policeman because the policeman does not have enough money, how much worse will it be if the policeman becomes unemployed ? – Granted the businessman will have lower costs due to lower taxes, but he will always want more than he paid out so the essential problem is still there. Is it to be based on an Export Drive – Shhh don’t tell all the other countries in the World or they will try it as well – how can we all Net Export to each other ? Do you want more money in pensions – if people save and ‘invest’ more how business sell the goods already in the shops that are already priced higher than the wages that have been paid out ? NEFS Manifesto : 1) The slogan “It’s Reality Dummy !” 2) The Aim – “Real Wealth” 3) Policies to get more Real Wealth for Individuals Main Policy : Adapt the Sisyphus Equation to add a NEFS element on it see : NEFS – Net Export Financial Simulation – it’s a bookkeeping trick to tidy up the numbers so we aren’t financially poor when we are in reality rich. Other stuff : Real Wealth – What do I mean by this ? “Wealth”, in many sections of society, is a rude word, it means ‘greed’ and ‘not getting to Heaven except through the eye of a needle’. My understanding of wealth : I look at women at 40 who have only just now got some financial stability and want to start a family. They spend a fortune and make themselves ill (all the hormones they have to take) to have a baby on IVF, and it’s not much good for the baby either : “Under developed liver, under sized kidneys, one eye not working… ahh were you an IVF baby ?” the doctor asks. I see women at 35 who have had a baby and their screen saver and mouse mats in the office have pictures of their kids, who they spend most of the day talking about. I see women in their twenties going into abortion chambers to kill their babies in order to keep going with their career so they can have a house and a deformed baby later by IVF. I see girls in the teens having babies to “get a flat on the social” – I see these things and I don’t see wealth. Reality has it that the best time for a woman to have a baby is in her twenties – we need a financial system that reflects this reality. It may be proactive – i.e. If you get married and have a baby in your twenties then you will receive NEFS money of £X amount. It may be benign – Everyone gets NEFS money and then nature can take over – I am in my twenties and I want to start a family now and I can afford to start a family now so I will. You can hear the word ‘wealth’ and picture a grotesque fat bloke with a cigar in his mouth or you can picture a well dressed, well fed (nutrition wise – shinny coat, bright eyes and all that) family playing in a park – this is very expensive – to feed and clothe a family properly costs a lot more than it does to buy an expensive cigar. We have the productive ability to be able to produce good food, clothes and lots of other things – we need a financial system that can match this reality. Lost potential – remember I was showing above how putting your money under your mattress was a better call than investing in pensions between 2000 to 2008 ? well think how many PHD bods were working day and night with all those computers analysing all those figures to end up with less than nothing. Imagine they had been working on designing and building massive wave power machines or solar energy factories in Africa – imagine if they had been doing something useful for us – adding real wealth ? ‘We cannot afford’ – we need a financial system so that if we look at something and say it cannot be physically done then, only then will we say ‘We cannot afford it’. If we have the brains etc to do something but don’t because of some numbers on a piece of paper then we are fools and the future will laugh at us (if we have one) and aliens will laugh at us (if they exist then they seem to be highly automated and must be using some NEFS type system otherwise, they will have had a major i.e. 100% un-employment problem) I see a teenage girl dressed like a cheap tart, “This is how they dress on the pop videos”. Pop videos use a hypnotic trick called Flicker TV – the camera angle is changed frequently – less the 3 seconds, The human eye is designed to take note of changes – it’s very useful to see a small change or movement in a big field or forest when you are hunting or being hunted. Indicators on cars use the same trick. Flicker TV needs to be banned. An eight to ten second delay in camera angle changes needs to be the legal minimum. This would destroy most of the pop video industry – which might sound like a decrease in wealth, but it will mean de-hypnotised kids who cover their underwear up when the are out, which is an addition to real wealth. I see a woman in her forties looking utterly depressed; “I’ve just been watching East Enders” – Soap operas like East Enders which specialise in ‘misery porn’ use the same Flicker TV hypnotic trick that pop videos use – watch it with the sound down and try to count to 3 before the camera angle changes. A ban on Flicker TV will destroy East Enders, again this might sound like a reduction in real wealth but if this means that millions of East Enders viewers are de-hypnotised, then think of the real wealth that will be caused by the lack of pointless made up misery they suffer. Think of the increased attendance in mid-week dance, language and evening art classes there will be, think of the extra time parents can spend playing snakes and ladders with their kids… I think I’d also like to ban things like trans-fatty acids, artificial foods dyes, sun beds – things that take money from vulnerable people and add nothing to them and actually destroy their health – which is their wealth and ours. China – This is getting silly. There is no Economic Theory on Uni-Trade – They sell to us, we don’t sell to them. China is a communist state and using Uni-Trade it has destroyed industrial production capacity all round the World. We need some import duties/WTO fine in China for a few Trillion pounds in compensation for the decimation its unfair trading practices have wrecked. Ugly News. We need to see ugly things on the News Farming – some premium meat in the shops says “Out-Door Reared”, I asked a butcher what this was about – he said that most beef in the UK is ‘grown’ indoors much like factory chickens. What sort of wealth is this ? – we see cows in fields – we need the TV cameras to show us the ugly news of cows locked in sheds all life. Fish – We need, something like a ten year ban or near ban on fishing. Lots of fish just get used as farm fertiliser and food for pigs. We need the time to allow the fish stocks to re-fill. Abortion – The TV is a wash with the fun bits of sex. TV has lots of ‘Radical, Exciting, Daring’ Producers. All ‘Radical, Exciting, Daring’ means is they want to put more bare boobs on the screen earlier and earlier in the evening. We have 600 abortions every day in the UK – pretty dire – here we are in the post Holocaust, post slavery, post hanging, post “never again…” World, in the 5th richest country in the World and we have 600 women each day, every day being so desperate/poor/cruel/whatever that they they kill their own kids. We need ugly News to show these abortions. The films are available and sickening. The “Fun side of Sex only” TV bans these films. We are out in Afghanistan fighting the World’s most evil foe so they say – Al queda and the Taliban couldn’t dream of killing 600 British people a day every day. This is huge, it’s ugly and it’s virtually completely hidden. We need to remove the log from our own eye, before going after the amateurs in Afghanistan. NEFS will go a long way to taking the financial pressure off women in the abortion line and so should reduce the number of abortions dramatically – but if we are going to butcher babies to death every then it needs to be on the news every day in full colour. Basic Maths : As is stands now the formula that is the basis of the annual economy is : Retained Profit for the Year = Increase in Fixed Assets of Companies + Increase in Debt of Individuals, Government + Foreigners. This is proved above. This is the ‘musical chairs’ equation that means the better our companies do, the more in debt someone somewhere becomes – if we are Net Exporters then its foreigners who go into debt, if we don’t then its us. But this is a wholly artificial formula imposed upon us by the rules of the artificial pre-machine age, financial system we use. We can change this formula to be Retained Profit for the Year = Increase in Fixed Assets of Companies + Increase in Debt of Individuals, Government + Foreigners + NEFS, this way, by using NEFS, we can reduce the values of the other terms in the equation hence we won’t need to build tall empty buildings to have 5 years of an Increase in Fixed Assets, we can build what we think we need in reality, not what we need ‘financially’ and hence increase our ‘real’ wealth – much of which will be our increased time away from ‘work’ – finally we’ll receive the payoff from the white heat of Technology.

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This is not a Recession it’s the beginning of the decline of the West into 3rd World Poverty.

This is not a Recession it’s the beginning of the decline of the West into 3rd World Poverty.

The WTO – The World Trade Organisation a few years ago came up with the silliest idea ever in the history of economics “Freedom of movement of Capital”.

What this means is disaster for the West, it means that we’ll end up living as tenants to our Landlord – the Chinese Communist Party : Let me explain :

When the UK had North Sea Oil and exported it, the value of the Pound Sterling was high – because foreigners wanted to buy our sterling so they could buy our oil.

But because it was too high, the UK could not sell its manufactured products abroad, and as the other countries’ currencies were weaker, UK companies could not sell their goods at home as they could not compete against cheap imports – so the industrial heartland of the UK became a wasteland and the country became de-skilled.

Now that the oil has gone, the currency should drop and we should be able to re-build or industrial base – but no ! Because we have “freedom of movement of Capital” foreigners can now, instead of buying our oil, they can now buy our land, our government bonds, our shares, our companies … And still we can’t sell our produce abroad because the value of sterling is too high.

All the theories of international trade – Ricardo and all that – were based on the idea of “we buy your goods and services and you buy our goods and services”. There is no theory of international trade to support “we buy your goods (making profits your companies and government) and we sell you bits and pieces of our country till its all gone” – what happens then ? – Well we’ll live as tenants, paying whatever rent the Chinese Communist party set for us. If this does not leave us with enough money left to eat then that’s just too bad.

“Globalisation” promised us that the Chinese can get richer without us getting poorer – we will be as rich or poor depending on how hard and well we work. More or less this might have been the case if Globalisation meant more trade in goods and services. But as we have the so called ‘Freedom of movement of Capital’ we intead have our top politicians always yakking on about attracting “inward investment” – which means at base “UK for Sale”.

Every day the West drops more and more into debt to China – by £Billions – so every time we pay £100 in tax more and more of that £100 goes to pay ‘interest’ to the Chinese so they can buy more of our government bonds so we then pay them more of our £100 next month. As they buy more and more of our shares, every £100 of dividend paid by our companies goes to the Chinese so they can buy more shares in our companies – we pay the Chinese money so they can buy more and more of us. Ball park we can’t be far off paying more in Government bond interest to the Chinese than we spend on our defence bill – add that that the ‘private money’ : the dividends we pay them and the rent we pay them for the land and buildings they own and it must be more.

… and every day it gets more and more – we’ve never had this situation before. We are running out of money, not because we are in a little recession and “things will get better like they always do” we have run out of money because we have given it to the Chinese.

We need to stop ‘Freedom of movement of Capital’

We need to sue the Chinese in the WTO courts for say £20 Trillion for manipulating their currency and causing industrial devastation in the West

We then need to start using NEFS – Net Export Financial Simulation so we don’t get back into this mess in the future

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The Myth of Fractional Reserve Banking and the Monetary Multiplier

“There is a yawning chasm of mutual misunderstanding, which has persisted for decades, between economists and those working in Central Banks. Virtually every monetary economist believes that the central bank can control the monetary base (M0), and, subject to errors in predicting the monetary multiplier, the broader monetary aggregates as well. Almost all who have worked in a Central Bank believe this view is totally mistaken” – Professor Charles Goodhart 1994

Cause or Effect : If you are a Martian and walk into one pub and see 10 beer mats on the bar and 20 customers, then go to another pub and see only 5 beer mats on the bar and only 10 customers you might report back to the Mother-Ship that the more beer mats a pub has, the more customers it gets, so if you double the beer mats you’ll double the customers. His ‘a priori’ academic maths is perfect and he could even go back to Mars and issue degrees to his University Students in how to run a pub on Earth and have questions with ‘right answers’ and graphs on the relationship between beer mats and customers – but unfortunately the Martian is ‘totally mistaken’ as to how things really work and if he tried to run a pub on Earth based on his theories he’d go out of business pretty quick.

Now try this : If you are one of those economists referred to by Professor Goodhart, or have been taught by one, and you look at the balance sheets below and try to explain how the Commercial banks managed to increase the size of their balance sheets by £11,000 while the Central Bank only increased it’s Balance Sheet by £1,000 between 2005 and 2006, then you might come up with one of the following ‘totally mistaken’ pieces of reasoning, or something essentially the same.

Balance Sheets :

  2005 2005   2006 2006
  Central Bank Commercial Banks   Central Bank Commercial Banks
Government Bonds 10,000     11,000  
Loans to Customers   100,000     110,000
Balance at Central Bank   10,000     11,000
Current Accounts   (110,000)     (121,000)
Inter Bank Deposits (10,000)     (11,000)  
Check 0 0   0 0

 Economist’s ‘totally mistaken’ explanation a) the ‘Monetary Multiplier’ 

The Central Bank ‘Increases the money supply’ by £1,000 by say buying £1,000 of Government Bonds. The Government uses this £1,000 to pay public workers who now have £1,000 extra in their Current Accounts with the Commercial Banks. This gets us to Stage 1 – 

  Central Bank Commercial Bank 1
Government Bonds 11,000  
Loans to Customers   100,000
Balance at Central Bank   11,000
Current Accounts   (111,000)
Inter Bank Deposits (11,000)  
Check 0 0

 As you can see at Stage 1, the Commercial Banks now have a balance at the Central Bank of £11,000 – i.e. the Bank of England owes them £11,000 – this is ‘Real’ Money, proper ‘Bank of England’ Money – ‘Sound Money’… so they say. The Commercial Banks are happy to lend out 10 times (10 being an arbitrary value for the ‘Monetary Multiplier’ I’ve chosen for this example) ‘more than they have’ – i.e. more than the ‘real money’ they have – ‘real money’ being what the Bank of England owes them. So then the Commercial Banks are happy to issue new loans to customers to the value of £1,000 x 10 = £10,000. The Bookkeeping being : Dr 10,000 Loan Accounts Cr 10,000 Current Accounts and in this way we arrive at the final balance sheet, when the new ratio of “Customers to Beer Mats” – oh sorry “Loans to Balances at the Bank of England” is once again at 10 (11,000/1,100 = 10) QED ! Usually however this story is embellished with several Commercial Banks, each one keeping an amount equal to the ‘Required Reserve’ ratio and ‘loaning out the rest. Starting from scratch it looks like this – Economist’s ‘totally mistaken’ explanation b) ‘Fractional Reserve’. Stage 1 The Central Bank buys a Government bond for £1,000 and the Government pays the £1,000 to say public workers who deposit their pay cheques in the Commercial Banks so we then have this : 

  Central Bank Commercial Bank 1
Government Bonds 1,000 0
Loans to Customers 0 0
Balance at Central Bank 0 1,000
Current Accounts 0 (1,000)
Inter Bank Deposits (1,000) 0
Check 0 0

 Stage 2 Bank 1 keeps the ‘Required Reserve’ (10% in this example so £1,000×10%=£100) and ‘loans out the rest’ – which ends up being deposited in another Bank – Bank 2. So we now have : 

  Central Bank Bank 1 Bank 2
Government Bonds 1,000 0 0
Loans to Customers 0 900 0
Balance at Central Bank 0 100 900
Current Accounts 0 (1,000) (900)
Inter Bank Deposits (1,000) 0 0
Check 0 0 0

 This new loan of £900 has also created a new Current account of £900 and a new current account of £900 is new money. So we started off with £1,000 of New Money and we now have £1,900 of New Money – This is called ‘Fractional Reserve’ Banking. But it does not stop there, the process continues :

Stage 3 Bank 2 keeps 10% (£900×10%)=£90 – and ‘loans out the rest’

  Central Bank Bank 1 Bank 2 Bank 3
Government Bonds 1,000 0 0 0
Loans to Customers 0 900 810 0
Balance at Central Bank 0 100 90 810
Current Accounts 0 (1,000) (900) (810)
Inter Bank Deposits (1,000) 0 0 0
Check 0 0 0 0

 This new loan of £810 has created yet another new Current Account of £810 – more new money ! So we started off with £1,000 of New Money and we now have £1,000 + £900+ £810 = £2,710 of new money. This process goes on and on so that the new money created ends up as £1,000 + £900 + £810 + £729 + …. + 1 = £10,000 (in O Level Maths speak this is the sum of a Geometric progression, the answer being given by the formula a/(1-r). With a=1,000 and r=0.9 we have :1,000/(1-0.9) = £1,000/(0.1) = £10,000 Again by a bit of O Level maths, the grandly named ‘Monetary Multiplier’ turns out to be just 1/(‘Required Reserve’ Percentage). So with a ‘Required Reserve’ percentage of 10%, the ‘Monetary Multiplier’ is 1/0.1 = 10. So with the original New Money being £1,000 we have Original New Money X ‘Monetary Multiplier’ = Total New money Created : £1,000 X 10 = £10,000 Had the ‘Required Reserve’ Percentage been 20%, the ‘Monetary Multiplier’ would have been 1/0.2 = 5 and so only £5,000 of new money would have been created from the original £1,000 : £1,000 x 5 = £5,000. These two explanations, which very impressively come to the same answer (impressive to those whose maths is a bit weak – which includes most economists), do not actually show how banks really work – they just show how a Geometric Progressions works. It’s little more that having a question like “If two apples and three oranges cost £1.50 and five apples and two oranges cost £2.30 how much does one apple cost ?”, getting the right answer then going to the shop expecting the price of an apple to be the same as the answer in the back of the text book. All the apples problem tells us is how to solve equations, all the fractional reserve routine above tells us is that you can add up a Geometric Progression the long way round £1,000 + £900 + £810 + £729 + …. or the short way round : £1,000 X ‘Monetary Multiplier’ – it’s just a maths exercise it’s not what actually happens in reality (Wikipedia has a similar explanation : Fractional Reserve Banking , as does this You Tube Video recommended to me by an Austrian School Economist, a similar misunderstanding is found in Money Masters Video Video)

Real Banking : Starting with this, as before :

 

  Central Bank Commercial Banks
Government Bonds 10,000  
Loans to Customers   100,000
Balance at Central Bank   10,000
Current Accounts   (110,000)
Inter Bank Deposits (10,000)  
Check 0 0

 Stage One : The driver is not the Central Bank buying bonds it’s the customers of the Commercial banks requesting loans for various purposes. So the real life stage one is actually this : 

  Central Bank Commercial Banks
Government Bonds 10,000  
Loans to Customers   110,000
Balance at Central Banks   10,000
Current Accounts   (120,000)
Inter Bank Deposits (10,000)  
Check 0 0

 Here the first thing that happened was the Commercial Bank issued new loans to its customers for £10,000

Stage Two : The Commercial Bank buys a government bond for £1,000 and sells it to the Bank of England for £1,000 to get the ‘Required Reserve’ ratio back in line again – that’s it ! That’s all there is to it ! – “In addition, standing deposit and (secured) facilities are available on demand, in unlimited amounts, to a wide range of banks and building societies.” http://www.bankofengland.co.uk/publications/news/2006/055.htm – The Bank of England will buy Unlimited quantities of, it used to be Government bonds and/or  Government bond backed repos but now it’ll take a range of securities… at the official interest rate – which isn’t very high so it’s in the interest of the commercial banks to only sell the bare minimum to the Central bank to get enough ‘cash’ from the Central Bank to cover their reserve requirements – a loose change “tidy up” after doing as much “real business” i.e. issuing as many loans as their reliable customers ask them for – a Central Bank Reserve is a tail and it does not wag the business dog .

And of course a bank, being a bank and different from me or you, does not need ‘cash’ to buy such a bond ! – Well when a normal individual buys something they have to hand over cash or go in to debt. A bank just goes into debt and… Bank debt is cash : Debit : Government Bonds £1,000, Credit Current Account of person who sold the bond to them on the open market £1,000 – it’s a funny world in the banking sector !

Rather than the ‘Reserve’ at the Central Bank being the ‘Base and Driver of the Economy’ or some such other grand and solid sounding expression like that – its just an after-the-fact, loose change, slightly nusiancy balance that very simple to adjust.

Whoever sells the bank the £1,000 Government bond to the bank then has a Current Account with the bank of an extra £1,000. So we once again arrive at :

 

Central Bank Commercial Banks
Government Bonds 11,000  
Loans to Customers   110,000
Balance at Central Banks   11,000
Current Accounts   (121,000)
Inter Bank Deposits (11,000)  
Check 0 0

There are reasons why customers request loans and reasons why Banks agree to issue them or not – see The World through the Bank Manger’s eyes below. Ranking very low on the reason list is anything to do with the Central Bank. The balances at the Central Banks are just loose change, they earn zero or little interest and if banks have any concern with them it is to keep them as low as possible. What this shows is that, in the same way that the amount of beer mats in a bar is an effect of both the demand by customers for beer and of the beer mat policy of the pub Landlord, the amount of money held in reserve in the Bank of England is an effect of the demand for loans by customers of Commercial Banks and the policy of the Commercial Bank managers in meeting those demands. In other words, the ‘Cash and Balances at Central Banks’ accounts are just loose change from the transactions between Commercial Customers and Commercial Banks – they are not the driver – the base – of commercial activity – it’s just a tail and attempts to use it to wag the dog will leave you with an bar full of beer mats and no customers or in the present situation – lots of government debt being bought without ‘lots of Bank of England Balances’ X ‘The Multiplier’ increase in private commercial activity. The Story in the Martian Times “Beer Mat Surge isn’t Working ! The expected increase in customer numbers following the Beer mat Surge has failed to materialise puzzled experts warned today” is analogous to the Earth bound headline Quantitative Easing isn’t Working ! .

As a de-facto, below are a few lines from Barclays PLC balance sheet at the end of 2005. Prior to QE, this was a fairly is a fairly standard bank balance sheet. The cash at the central bank is nowhere near the 10% of the size of the Balance Sheet figure used above and in text books – it’s more like 0.5 % ! If you study hard and go to University, and work hard and spend little to pay off your student debt and work even harder and end up with £10,000 in your bank account before you are 30 or 40 and go for night out with friends and have £50 in your pocket, then that £50 is 0.5% of your financial wealth – 0.5% is a little bit more that loose change, nothing more.

 

  2005
Barclays Bank PLC £m
Cash and balances at central banks 3,506
Trading portfolio assets 155,730
Derivative financial instruments 136,823
Loans and advances to banks 31,105
Loans and advances to customers 268,896
Repos etc 160,398
Other assets 4,620
Goodwill 6,022

 Reductio ad adsurdum – Proof by Contradiction. Ok I’m going to get a little a priori myself here, to prove that fractional reserve banking is an academic myth : Lets look again at the detailed multi-Bank story of Fractional Reserve Banking in slow motion to see if we can spot the elephant in the room :

Stage 1 The Central Bank buys a Government bond for £1,000 and the Government pays the £1,000 to say public workers who deposit their pay cheques in the Commercial Banks so we again have this : 

  Central Bank Commercial Bank 1
Government Bonds 1,000  
Loans to Customers    
Balance at Central Bank   1,000
Current Accounts   (1,000)
Inter Bank Deposits (1,000)  
Check 0 0

Stage 2 (a) Bank 1 keeps the ‘Required Reserve’ (10% in this example so £1,000×10%=£100) and ‘loans out the rest’. So we now actually have :

  Central Bank Bank 1 Bank 2
Government Bonds 1,000    
Loans to Customers   900  
Balance at Central Bank   1,000  
Current Accounts   (1,900)  
Inter Bank Deposits (1,000)    
Check 0 0 0

 Stage 2 (b) The person who received the loan pays the £900 to someone else who banks at bank B – so we then have …:

 

  Central Bank Bank 1 Bank 2
Government Bonds 1,000    
Loans to Customers   900  
Balance at Central Bank   1,000  
Inter Bank Amounts Owed     900
Current Accounts   (1,900) (900)
Inter Bank Deposits (1,000)    
Check 0 0 0

 and the ‘Fractional Reserve’ story comes to a dead end ! Bank 2 has no Central Bank Reserves to lend out ! – it’s ‘money’ is the balance due to it from Bank 1, not the Central Bank QED ! – It’s more like ‘Fictional Reserve Banking’ than ‘Fractional Reserve Banking’. – This is what actually happens – if someone deposits a Bank 1 cheque in Bank 2 : Inter-Bank (Only between Bank 1 and Bank 2) owing and owed accounts are set up and Bank 2 has no idea what balances Bank 1 has with the Central Bank and does not particularly care – his £ 900 Asset is purely what Bank 1 owes him. Bank 1 still has the original £1,000 as a balance owing to it from the Central Bank. It might be objected that if it’s cash we are talking about then as cash has “The Bank of England owes this money” written all over every note, that it’s still ‘game on’ as far as the ‘Fractional Reserve story is concerned. Well no ! – Have a look at the Issue Department of the Bank of England . It shows that in Oct 2005 there was £36 Billion in Notes in issue, by Christmas 2005 it had risen to £39 Billion, it was back at £36 Billion in Feb 2006. Cash is a seasonally varying convenience for shoppers – it’s not the base of the economic system. Commercial banks ‘Order more cash’ at Christmas from the Bank of England because people like to walk in to pubs a Christmas with a few twenties on them to get in the rounds. Commercial Banks ‘Order more Cash’ simply by selling government bonds to the Bank of England and instead of using their Inter-Bank reserve accounts to pay for them. If, at a reserve ratio of 0.5% (or even worse for just paper cash, commercial banks issued loans when they had more cash and withdrew overdrafts and called in loans when they had less cash, then every day would be economic turmoil : “Quick someone has just withdrawn £100 from the ATM, we’d better call in £100/0.005 = £20,000 in loans to maintain our reserve ratio !” Also, when have you ever been into a bank to pay in your wages by cheque and had the bank clerk moan “Oh what a pity you are not paying this in cash – then we could loan it out and make a fortune – Cash is proper money, it’s so it’s much better for us to have cash in the bank than these silly cheque things, as we can loan out 10 times this cash but we can’t loan out 10 times this cheque.” Neither do they seek with special offers to attract teachers and other government workers to be account holders. Where have you seen : “Deposit your Bank of England pay cheques with us” – we want your ‘real’ Bank of England Money to loan out so we can make a fortune – such things do not happen – and this is because ‘Fractional Reserve Banking’ does not happen.

The World through the Bank Manger’s eyes

There are 4 major lines on a real Bank’s balance sheet : In the Assets section there is 1) Loans issued to Customers 2) Amounts owed by other Banks. In the liabilities section there is 3) Current Accounts (and other savings accounts) owed to customers 4) Amounts owed to other Banks. Its quite reasonable for a bank to never issue any loans as a policy, to only have current accounts and still make a nice profit – How ? Say Bank B had this policy. If Business X went to Bank A and got a Loan of £100, the entries in Bank A would be Dr Loan £100, Cr Current Account £100. The loan might make 10% interest and the Current account say 2%. So we start off with Bank A earning a Net of 8% and Bank B has nothing. If Business X pays a Worker W the £100 and the Worker W banks at bank B then the Worker W will deposit the salary cheque in Bank B. What happens then, in the behind the scenes Inter-Bank World, is that Bank B presents the cheque to Bank A and says ‘Here is an order signed by Business X requiring you to transfer the liability you owe to Business X to Worker W. But Worker W has told us to accept this liability so transfer the Liability you owe to Business B to us and we will make a note in our balance sheet that you owe us £100 and we in turn owe Worker W the £100′. The balance sheet of Bank B will then show Assets of only Inter-Bank Balances due to it from other banks, and its liabilities will be current accounts owed to customers. Bank B will then pay say 2% on its current accounts but will earn LIBOR (London Inter-Bank Offer Rate), which is usually higher than current account rates, on its Inter-Bank amounts owed balances – say 5%. So Bank A will earn 10% on the loan but will now pay 5% on Inter-bank Interest while Bank B will earn that 5% in Inter-Bank Interest from Bank A and have a 2% Interest charge on the Current account. (LIBOR is not an ‘official rate’ that will be charged, it’s just an average of Inter-Bank Rates, so a dodgy bank will have higher interest charges to pay on it’s inter-Bank balances than a ‘safe’ bank). In schedule form we have :

 

  Balance Interest % Rate Interest Balance Interest % Rate Interest
  Bank A Bank A Bank A Bank B Bank B Bank B
Loans to Customers – Assets 100 10 10      
Inter-Bank Balances – Assets       100 5 5
             
Inter-Bank Balances – Liabilities (100) 5 (5)      
Customer’s Current Accounts – Liabilities       (100) 2 (2)
Interest Profit     5     3

 In a similar manner a bank can have no current accounts and issue only loans – it’s liabilities will then be essentially inter-bank liabilities. Customers need nice high street branches (expensive rent) and lots of clerks and call centre workers (expensive) for them to sign up.

Bank Thinking – To loan or not to loan :

In the first instance, the bank manager will say ‘Yes’ to a loan very largely on the answer to the question – can you pay it back with interest. Other questions include : “Are you going to put any of my other paying customers out of business ? – i.e. will my loan of £500 for you to market your Free Energy machine mean my £ Multi-million loans to my oil customers might not get re-paid ? “What’s my policy ? – Am I an Agricultural Bank that specilses in loans to farmers and so maybe I have some expertise in better assessing a farm’s prospects. One thing is for certain, the “What ‘Real’ Central Bank Money do I have ?”, while being the big question Economists think is asked, is a total non-issue and just does not figure.

To foreclose or not to foreclose : When a customer is falling behind on loan repayments, banks foreclose and sell the security that backed the loan. What usually happens in such a situation is the house or business stock is sold quickly and hence cheaply as banks do not want the administrative expense of suddenly becoming a large landlord, which would happen if repossessed houses went on the market for 2 years to get their full price – not to mention the administrative expense of owning warehouses full of frozen chickens, ply wood, … whatever the security was. The bank usually makes a loss in such situations as it frequently does not receive enough from this fireside sale to repay the loan. Foreclosure for the bank is usually a cut-the-losses situation rather than a get the money all back. It also serves as a deterrent to other potential non-payers. This said I have heard of situations (see SAFE) where quite reasonable businesses were closed down by the bank calling in overdrafts suddenly and selling the business to friends and relatives of the bank manager for next to nothing, after which normal credit lines were resumed to the business under it’s new ownership – so abuses can happen, a bank manager can have lot of power and bank managers, despite forever being tagged ‘respectable’, are not exempt from Lords Acton’s ‘Power tends to corrupt and absolute tends to corrupt absolutely’ truism. Competition is the one of the best vanguards against such abuses and it’s worrying to see the re-monopolisation of high street banking since the Credit Crunch. Big Banks in the USA have been blamed for similar abuses on a huge scale in kicking off the Great Depression by hiking Inter-Bank rates to small banks which then either went bust or past these rates on to their customer’s who went bust. The big banks then were left holding a lot higher percentage of American Business afterwards.

What happens when a Bank’s customer goes bust : Stage 1) Bank issues loan of £1,000 to a Business A and Business A pays Workers £1,000 to make stock so we have :

 

  Bank 1 Business A Worker
Loans to Customers 1,000 0 0
Stock 0 1,000 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 (1,000) 0
Inter Bank Deposits 0 0 0
Wealth 0 0 (1,000)
Check 0 0 0

 

If say the Stock rots and drops to zero value, then the balance sheets look like this : 

  Bank 1 Business A Worker
Loans to Customers 1,000 0 0
Stock 0 0 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 (1,000) 0
Inter Bank Deposits 0 0 0
Wealth 0 1,000 (1,000)
Check 0 0 0

 So the Businessman, with a £1,000 Debit in his Wealth Account goes bankrupt and the bank gets nothing from the sales of the rotton stock and will get nothing back from the loan, so it writes it down to Zero and we have this :

 

  Bank 1 Business A Worker
Loans to Customers 0 0 0
Stock 0 0 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 0 0
Inter Bank Deposits 0 0 0
Wealth 1,000 0 (1,000)
Check 0 0 0

 And so the Bank 1 now has a Debit in it’s Wealth Account of £1,000 and is insolvent and needs, by law to close down. Had the worker deposited the money in a Bank 2 then after Bank 1 closed down then Bank 2 would have to write off it’s Asset “inter-Bank Balance due from Bank 1″ down to Zero we would have had this situation :

 

  Bank 1 Bank 2 Business A Worker
Loans to Customers 0 0 0 0
Stock 0 0 0 0
Inter Bank Owed 0 0 0 0
Current Accounts Owned 0 0 0 1,000
Current Accounts Owed 0 (1,000) 0 0
Loan Owed 0 0 0 0
Inter Bank Deposits 0 0 0 0
Wealth 0 1,000 0 (1,000)
Check 0 0 0 0

 and now Bank 2 has the £1,000 Debit in it’s Wealth account and now it’s insolvent – this happens in a chain. So banks need to be careful in who they loan to – not just to Business and Individuals but to other banks as well. They don’t worry about how much Bank of England money they have, they worry if their customers will pay; and if not, what the security is worth – again no Fractional Reserve.

“We Don’t Create Money !” – If you asked a building society manager in recent years “Do you create money when you issue a new Mortgage ? – Dr Loan/Mortgage £200,000, Cr Current Account £200,000″ they’ll say “No – we don’t do that. The reason why we don’t do this is, if we have the mortgage at a nice small 5%, then those current accounts we necessarily create at the same time will be used to give to the people our customers are buying the house from and they won’t sit around as a 2% current account liability in our accounts, they will turn up in the current accounts of other banks and we will be LIBORed with Inter-Bank balances at near and maybe even over 5%. So what we do is we go out and we ‘get cheap money from the ‘wholesale markets’ by selling short term Mortgage bonds, it’s this money we lend out as mortgages – so we don’t create money, we are just agents lending out other peoples’ money – the money of the bond buyers. Our double entry to ‘get the money’ is i) Dr Inter-Bank amounts Owed £200,000 (That’s what a banker calls ‘having money’), Cr Money owed to Wholesale markets (Mortgage Bonds) £200,000. When we issue a mortgage to a house buyer, we do ii) Dr Mortgage Account Asset £200,000, Cr Current Accounts £200,000 but the moment that the ‘money’ – the Current Account – passes to the house seller and appears the next day as an inter-bank liability, then we net-off these Inter-Bank Liabilities with the Inter-Bank amounts Owed Assets from i) “

To “get cheap money from the ‘wholesale markets’ by selling short term Mortgage bonds” in more detail – The building societies type on a piece of paper “I will pay £200,000 plus interest of 3% per annum in three months to the bearer. This is a type of Commercial Paper called a Mortgage Backed Security. These are then sold to the Wholesale market for hopefully £200,000 + interest. (by ‘sold’, I mean the Building Society receives Inter-Bank balances owed as payment). 

Who bought this Commercial Paper ?, If money was not created at the point of issuing the mortgage to the house buyer, was money created at the point of selling the Commercial Paper ? If a pension company, an insurance company or rich individuals bought the Commercial Paper, then no new money was created, If a bank bought it then this does create new money (when bank buys anything it buys it with new money ! – it can’t help it ! – If a bank buys a building the entries are Dr Fixed Assets £1,000,000, Cr Current Account of building seller £1,000,000 – this is new money !) Also, if a bank made a loan to a some sort of Investment Company which then bought the Commercial Paper then new money is created at the moment the loan is made, though this money does not ‘hit the streets’ till the house seller receives the payment. So though the building society manager was right when he said “We don’t create money”, given that we now know that lots of banks lost lots of money in the housing sub-prime crash, that banks were involved, either buying this Commercial Paper directly or else making loans to companies that did, so this means that a lot of new money was created in the fuller picture of the issuing of the mortgages. 

The ‘fuller picture’ in detail : a) A Bank creates loan for an Investment Company : Dr Loan to Investment Company £200,000, Cr Current Account of Investment Company £200,000 (New money created here)

 b) The Investment Company buys Commercial Mortgage paper : Dr Commercial Paper assets £200,000 Cr Building Society £200,000

c) The Building Society issues a New Mortgage : Dr Mortgate Account £200,000 Cr Current Account of Mortgagee £200,000. The Mortgagee then ‘pays money’ to the house seller/builder and this party deposits the building society cheque in their bank account so we have essentially this can be shown in one step :

c’) Dr Mortgage £200,000, Cr Inter-Bank Liabilities £200,000 – Building society entries and Dr Inter-Bank Assets £200,000, Cr Sellers current account £200,000 – Entries for the bank account of seller – this is the point that New money created by the bank issuing the loan to the Investment Company fund in a) ‘hit’s the streets’ and is new money in Joe Bloggs bank account – (ready so spend on Chinese imports).

As a tidy-up, the Building Society that has assets of £200,000 inter-bank money owed and £200,000 Inter-Bank money owing nets them off.

I don’t fully know who bought what Commercial Paper and I’m not sure if anyone does, there was lots of off-balance sheet, off-shore stuff involved. A major purchaser of this Commercial Paper seems to have been the Chinese. China has a Net-Export policy – it sells to us but does not buy from us, this is a deliberate policy that has devastated our industrial base – far better than their air force could have. When it sells to us, say a pair of shoes, we give China £20. As China does not use this £20 to buy our goods, it instead buys our Commercial Paper – effectively our mortgages so we give China £20 for some shoes and the £20 re-appears the next day as loan to us so we can buy our houses at ever higher prices. So as well as wrecking our industrial base it has also helped create a huge mortgage bubble which has now burst and brought the West to its financial knees… and there is more to come – many American mortgages are still on their initial period ‘teaser rates'; there are quite a few mortgages that will switch to the ‘normal rate’ in the shortness of time… tick tick tick).

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