[From Bill Powers (970221.1840 MST)]
Mike Acree (970221.1608 PST)--
A subtle but possibly important clarification: I had characterized
inflation as an increase in the supply of money relative to the supply
of goods, not as "too much" money chasing "too few" goods. There's
nothing sacrosanct about any particular overall price level. The evils
of inflation, so far as I can tell, have to do with the unevenness of
its effects through the economy.
According to TCP, there are two added effects of the part of inflation that
is due to leakage: it is inevitably accompanied by increases in unemployment
and by slowing of the rate of economic growth. You have to understand his
equations to see how this works, but it's quite straightforward. All of the
calculations in the book, by the way, are done in constant dollars,
corrected for inflation.
The effect of leakage that TCP calls autoinflation is almost self-evident.
If only 93% of the costs of production (wages and capital income) are
returned to the composite producer in the form of income from sales of goods
and services, then there must be, in addition to the markup required to
sustain capital expenditures, and additional markup of 1/0.93 or 7.5% per
year to maintain production. The markup for capital expenditures is returned
to the economy (the money is spent on goods and services), but that required
to make up for leakage is not. This "autoinflation" may not show up as
actual inflation because the basic economy may be growing fast enough to
offset part of it. But the basic effect is to reduce employment and growth
rate as computed in constant dollars. It's almost like a feedback effect;
instead of seeing the true inflation, what we see are the compensations that
the producer makes to avoid going broke, in the form of lowering production
costs (wages and capital income) and curtailing production to fit the
resulting reduced demand. The composite producer cannot pay more to produce
goods and services than it receives for them, and it cannot pay less,
either, because that pay is the means by which the composite consumer buys
the product.
Those close to political power centers
will know that an increase in the money supply is coming and can take
advantage of existing prices, raise the interest rates they charge,
etc.; those who are hurt are those on fixed incomes, living off passbook
savings, etc.--another case of enriching the rich (which is one
explanation of why inflation is so popular among those governing). But
I think we must be talking about rather different concepts of inflation,
because I don't understand at all your comment that inflation has been
extremely rare in the macroeconomy. If inflation means a rise in the
overall price level, then we've had nothing but inflation for decades,
sometimes more, sometimes less.
The scenario you describe, in which one segment of the population profits at
the expense of others (how else?) is not a macroeconomic phenomenon: it
cannot alter the _overall_ balance or the basic laws of macroeconomics.
The classical explanation for inflation is that demand (operationally
defined in economics as money spent on goods at a given price) exceeds
supply (defined as sales of goods at a given price). That is what almost
never occurs in the macroeconomy, although it can occur in isolated segments
of the microeconomy and in a few other rare circumstances. In fact, demand
is chronically less than supply, because of leakage. There has never been a
time when money spent exceeded the sales of goods (on what would it be
spent?), and indeed there CANNOT BE such a time. All the money that is spent
by the composite consumer is first paid to it as wages or capital income
(which includes distributed profits, interest, dividends, and so on) by the
composite producer, and all the money received by the composite producer
comes from sales of goods and services (remembering that borrowing is simply
a means of obtaining the wherewithal to pay the costs of production, and is
paid for as all services are paid for).
It should be said that in deriving these conclusions, TCP assumes that on
the average, managers will adjust their production levels so that
inventories are neither increasing nor decreasing. Obviously there can be
temporary conditions under which this doesn't apply, but with millions of
businesses being involved, the chances of remarkable fluctations at the
macroeconomic level are small.
But national
boundaries enclose quite arbitrary aggregates. As far as I can tell,
TCP doesn't give any indication why his theory should not apply to the
economies of California or San Francisco.
I think it probably does, if you just include balance of trade as a factor
in leakage (irreversible -- alpha -- or reversible -- rho). In fact I see no
reason that this analysis couldn't be applied even to a town, except that
the sample would be getting so small that the assumptions of statistical
averaging might be violated significantly. The bookkeeping at the
macroeconomic level is far simpler than at the micro level; it's easier to
see the big relationships because most of the details are averaged out.
The only relevant
distinctions I can think of are legal rather than economic. At the
national level there are tariffs and numerous regulations prohibiting
various capitalist acts between consenting adults, but the most
important difference is that the fiat money system is defined and
controlled at the federal level. But if the national economy is
essentially a legally defined entity, it is not clear to me why for that
particular aggregate spending and income should add up to 0 at any
particular moment, any more than they should for any other arbitrary
aggregate.
It's hard to say that the money supply is controlled at the federal level
when the Fed is run by the member banks, in the private sector.
The summation to zero wasn't clear to me, either, until I began to learn how
to think in terms of composite entities. When you ask where the composite
consumer gets the money it spends on goods and services, you find that ALL
of it comes from the composite producer. And when you ask where the
composite producer gets the money it uses to pay the costs of production,
you find that ALL of this income comes from the composite consumer -- except
what is borrowed, essentially, from outside the circular flow through
official banking sources empowered to create money. But borrowing and
repayment go on all the time, simultaneously, so the supply of money changes
only slowly, and generally fits with the overall rate of growth of the
economy. When money is freely available, its supply is an effect, not a
cause, of economic activity. Businesses spend 20% of their income on capital
investment, period, whatever the supply of money may be.
This is basically Say's Law, about which I remember mainly the name, which
Keynes rejected and TCP proved valid.
The complexity introduced by our fiat money system is why I have tried
to understand what was going on without that complication. Perhaps TCP
would say that leakage cannot occur by definition in a barter economy if
it means a loss of currency from circulation; but it still seems to me
the consequences he claims for leakage wouldn't result from hoarding
under a 100% gold standard, either.
If gold is not valuable in itself, and if it's freely available, then the
situation would be unchanged. but if gold is scarce, that would be
equivalent to imposing monetary constraints that prevent the composite
producer from obtaining as much money as needed to pay for as much
production as it could sell. A true gold standard, I would guess, would
suppress the economy. However, people have never had a true gold standard;
there's always been a lot of paper floating around that stands for promises
to pay in gold, usually more gold that actually existed at a given time in
usable form. That's how banking got started.
If so, then they have to do
specifically with government manipulation of the money supply. But let
me try a concrete example. Mary mentions (Mary Powers 970220.1743)
Ralph Nader's report that GM is "sitting on" $17 billion. Like Bruce
Gregory (970220.1743), I can't believe it's not earning interest.
Oh, it probably is earning interest, for GM. However, the principal has not
been invested in the economy: it hasn't been borrowed by someone and then
spent on goods and services. It's a liquid asset against which GM could
write a check at any time. That money isn't circulating, so it's not part of
the macroeconomic circular flow. When large producers start stashing part of
their income instead of paying it out as wages and capital income, they are
removing buying power from the hands of their own (or each others')
customers and thus reducing their own potential income. This is apparently
too subtle a concept for the managers of the composite producer to grasp.
But
suppose they did just have it stored in a paper bag, which caught fire
and burned. Then (apart from the paper bag and some kitty litter or
landfill) the national economy would still not have lost any goods or
services.
Not so. This money could have been paid out as wages and capital income
(which includes distributing profits to owners or shareholders), and that
money would then have been available to purchase a higher output of goods
and services. As long as the stored money is there and might some day be
returned to circulation, it is only rho leakage, which is reversible. But if
it is destroyed, it is alpha leakage and the loss to the economy, in terms
of irrecoverably lost production, is permanent. The best the economy can
then do is recover its former growth rate, but it can never catch up to
where it would have been without the loss. The rosy future is postponed.
GM, it is true, would be $17 billion poorer, and might go out
of business, with considerable resultant dislocations throughout the
economy. But after these are all sorted out, the net result is that we
have the same goods and services as before, with 17 billion fewer
dollars in circulation, and a consequent lowering of prices.
This is not all that happens. If prices are lowered, then the producer has
less income to pay for production, and wages and capital income must go down
as well. The general choice, made by unions and management alike, is to
lower wage costs by eliminating workers rather than lowering hourly wages,
although both are done wherever possible. Productivity is increased not by
increasing production but by paying less for the same or less production.
Production, in terms of actual goods and services, declines. And because of
fierce battles between labor and management, the relative share of wage
income versus capital income tends to change only slightly and very slowly,
so _all_ buying power is reduced.
The
process of dislocation may have some overall costs (it certainly has
human costs, in terms of stress), but not necessarily: any firm that
would leave $17 billion in a paper bag was due to give way to more
intelligent management. But I don't see any other way that such
"leakage" impoverishes us on a macro level.
You have to work through the equations in the model. Leakage simply
subtracts from the exponent in the growth rate, directly. It can even result
in a negative growth rate, a recession. It can have large effects on the
product of number of people employed times average wage. These
"dislocations" have a staggering human cost, not the least of which is to
find your Big Mac being served to you by a person with a PhD in engineering.
You say, "When money is borrowed, it is basically created." I would
say: "It depends." If I borrow $100 (or $100 billion) from you, no
money is created; it's simply in different hands. If member banks
borrow from the Federal Reserve, however, then money typically is
created, just by fiat. That's what I would see as the source of the
loss of purchasing power that TCP calls rho.
Yes, I agree. Private borrowing doesn't change the circular flow; it just
moves money from one person's hands to another's. It's only borrowing
through banks, which are legally allowed to create new money up to the
limits set by reserve requirements, that increases the money available for
circulation in the macroeconomic sense. And restricting this money
inevitably slows the rate of growth and increases unemployment.
"TCP says that economic growth is powered by the combination of just two
factors: increases in productivity stemming from human ingenuity, and
increase in population. Nothing else." I think such an astonishing
view could only have resulted from looking at a single country (which is
what he did). I would think of human ingenuity as having been rather
constant over time and place, and my sense is that the explosion of
economic growth in this country in the 19th century is all out of
proportion to the increase in population.
Human ingenuity tends to build on itself exponentially; new developments
make even more new developments possible. But this is not a result of
monetary investment -- it is a result of the growth of knowledge. The _lack_
of money can slow this growth, but providing unlimited money could not
increase it indefinitely. Of course we can factor in the effects (and costs)
of education, but that is part of making human ingenuity more effective, not
of making factories more efficient. The efficiency of factories follows from
the growth of knowledge.
TCP estimates, just from the historical record, that the maximum achievable
growth rate would be around 13% per year in the USA. This would reflect,
among other things, the maximum usable investment in the growth of
knowledge. This would surely be considered an "explosive" rate of growth,
but generally (or at least during the past 100 years) it has seldom been
approached because of chronic leakage and restrictions on the money supply.
You're right that TCP has not studied the economies of other countries. It
would be interesting to see what they reveal.
Douglass North contends that
a lot of technology was available centuries ago (e.g., Hero's steam
engine), but didn't have an impact beyond the inventor's household just
because of lack of property rights.
That's certainly a political axe being ground. I would attribute the failure
of these technologies to spread to lack of understanding of the underlying
principles, which would permit rational designs rather than cut-and-try
experimentation. The first known control system was built around 2200 years
ago. It persisted in essentially unchanged form for the next two millenia,
primarily because nobody even started trying to work out the general
principles of control until the 19th century. I don't think it was a lack of
economic incentives that kept Hero from working out the principles of
thermodynamics.
The countries that instituted these
saw an explosion of economic growth because of the strong incentives
they provided specifically for applying that human ingenuity to
satisfying other people's wants. The relevance to TCP's analysis of the
U.S. economy is that I think he misses effects of the changing political
climate for business just within this country. Some think tank or other
estimated, for example, the current annual cost of economic regulation
at $600 billion. That seems to me a kind of "leakage" which has been
increasing over time.
Well, I guess I have to ask you whether you do or do not believe in the
basic explanation of behavior offered by PCT. Are "incentives" what make
people do things?
The costs of economic regulation, in the macroeconomy, are zero. All the
money that these regulations may cost is spent on goods and services. What
gripes people is that the money is being spent in one way while they would
prefer to spend it in a different way, mostly to increase their own wealth.
In terms of the macroeconomy, government is the least wasteful of all
institutions, because it puts every penny of income back into the economy,
with only a minor amount (perhaps 1 or 2 percent) of leakage, in the form of
foreign aid and similar global projects that return nothing to us.
Social organization has always seemed to me one of the most interesting
applications of PCT, so naturally I'd love to see you (or someone) put
the "battery" in the economy by interpreting it in terms of reference
levels.
Someone will, some day. But it will have to be someone who starts from no
political or ideological base, so we may have to wait a while.
Best,
Bill P.