MODULE 2 PARTS 1 and 2

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MODULE 2

COURSE IN MACRO-ECONOMIC DESIGN AND MANAGEMENT

INTRODUCTION TO MODULE 2

In Part 1 of Module 2 we will be looking at how money is valued, and why we cannot provide an exact measure of how fast money is falling in value. We will see why one measure which may be used to offset the falling value of money, National Average Earnings, NAE, (or even National Average wages / incomes),  may be more useful than some of the other candidates.

Along the way readers will be reminded of the instabilities in pricing; and that it is these failures of prices to adjust properly to the falling value of money, which as already explained, is the source of much chaos in the world's economies. We will be looking at how, by making a succession of changes to the financial framework, we can hope to achieve an orderly rate for the devaluation of money so that a reasonably good index can be created, or chosen, to represent this figure.

It is only when these problems have been addressed and largely eliminated, only when there is an orderly set of price adjustments throughout the economy, that we can see the way to selecting a reasonably good and practical index for use in offsetting (compensating) for the falling value of money in contracts. This is because by then, all prices will all harmonise to a greater extent than before, in making those adjustments.

In the meantime, having that index, or indeed any reasonable index, fulfilling that role is a step forward.

In Module 2 Part 2 We will see why the total stock of money needed to be in circulation cannot be defined. We will see why this means that money tends to be always falling in value.

In Module 2 Part 3 we will look into the new financial products resulting from applying the economic free market price to everything, including the value of bonds, and the cost of housing housing, and commercial finance.

Module 2 does not deal with currency pricing nor the pricing of credit (interest rates).

It is pointed out that when people seek a guaranteed return of value plus interest, costs are increased due to the matching problems left with the lenders. These costs arise because such a guarantee requires indexation of the value saved and no perfect index exists which will give the same answer every year as it gave when the account was first indexed.

For example, the index may say that a real 'real' market rate of interest is currently 2.1% for this kind of financial product. But as time passes both the index may stray off course or the real 'real' rate of interest demanded in the market may change. The provider may have some problem with that if the contract gets cancelled mid-way through the term.

The exact same problem explains why lenders offer fixed term mortgages at a fixed rate which has a higher cost than the variable rate - the market rate.

In Module 2 Parts 4 onward until finished we will look at the General Equations for Lending, which leads to a range of Ingram Lending and Savings (ILS) Models which can revolutionize the lending sector for housing and commerce.

This is by far the most technical part of the entire course. It is ideal for convincing lenders, regulators, and policy-makers that there is something here which makes sense, has been properly tested and is a practical solution to many problems. 

COURSE PRACTICALS
Students of this course will be given a basic test spreadsheet to play with and to enable them to draw their own conclusions. The conclusions drawn in this way will be of great interest to everyone doing the course, and especially those which are drawn from lenders, regulators and policy makers.























MODULE 2 PART 1
How can money be valued?
How fast does money fall in value?
Is there an index which can be used to offset the falling value of money?
Why would we need one?


HOW CAN MONEY BE VALUED?

Basic law: The value of anything is what you can exchange it for. Each item, for example a banana, is valued in terms of the other item, for example a carrot, a cabbage, or 50 cents for which it gets exchanged.

If one person has a bunch of carrots but would rather have a cabbage, then an exchange of the carrots for a cabbage may be negotiated. If successful, then both parties to the transaction will have agreed how many carrots are worth a cabbage.

We can imagine a world where all transactions were done in such a way. Everyone's idea of what their cabbage was worth would depend upon how much they wanted the carrots or other goods or services on offer in exchange for the cabbage. The same applies to money. There is no fixed value.

What a person is prepared to pay for an ice cream probably depends upon the weather at the time. On a really hot day they may be willing to pay a lot more than on a cold day. On a cold day they may not even want an ice cream.

To an extent the same applies to what people will pay for a vehicle, a house, or a hairdo - it depends upon the money available and upon the need /wish/desire of the buyer.

A good advertisement can change all that.

So there is no fixed amount of money which people are willing to pay for anything. But when a transaction is done then the item, or the service, or the asset, which was exchanged for money had that amount of money as its value. It was worth the amount of money which the buyer agreed to pay at that moment.

THE ADVANTAGE OF MONEY
The great advantage of a money-based economy is that money can be exchanged for almost anything. Money is so easy to use that it eclipses all alternatives. Transactions which use money are done very quickly. There is no need to spend time finding some other party willing to exchange something else for what is wanted. Money is easy to store, easy to access from a bank or a savings account, it can be used as a unit of account for book-keeping, and it is an easy unit with which to tax and to pay taxes. There is nothing as easy to use as money.

Shops learn what prices will clear the shelves of their goods or occupy their staff in providing services. Real estate agents have a pretty good idea of what price will sell a property. These prices have become known as market clearing prices. They are the prices at which the supply of goods, assets, and services, is equal to the demand for them. Failing that the shop clears its shelves early or has stock going rotten or out of date, tying up capital and losing value.

It usually pays to know the market clearing price.

The same applies to stocks and shares. The price of a bond or a share is the market clearing price of those bonds or shares.

THE PRACTICAL VALUE OF THIS KNOWLEDGE
We can use this market clearing price as a way to value money based on what people are buying. But what if the supply of money, or the number of people buying things, is also changing? This will affect the level of demand and therefore the price, of everything. If the quantity of money which people have and are willing to spend, for a given population of buyers, doubles, then we would expect all prices to double  in order to re-balance the supply with the increased demand and exactly clear the supplies. Over time the age profile of the population changes, maybe getting older on average or younger. Their cultural mix can change. All of these demographic changes can affect the demand for anything and the price of anything.

Here is a list of things which people can pay for and which are consequently a part of valuing money.

Any money spent on one of these leaves less to be spent on others on the list. For prices and the value of money to be changing steadily the demand for each, as well as the prices of everything have to be changing steadily. But as we all know, this is not how it works - and that is the problem. That is why we get knock-on effects and a great deal of complexity and damage and slower growth of output, plus social and political costs.

#1. All goods and services
#2. The cost of hiring people (wages and related costs)
#3. Taxes  - something to think about because they are adjusted in steps in annual budgets.
#4. Bonds - but their maturity price is fixed in advance. The price is unable to adjust  - their value and the demand for them varies all the time.
#6. Monthly or periodic loan-servicing payments - in the case of bank loans these prices can jump around. Ot of they are fixed in money terms and the value of money rises as incomes around the nation are falling, the repayments can become unaffordable. Here's a question - what then are the knock-on effects? Check a few nations in Europe, France for example.
#7. Real 'real' nterest p.a. payable on government and company bonds and on home loan bonds, is an annual or periodic, say monthly, fee payable in return for having the use of the loan. If it is fixed in money terms, its value varies. It is not a market price and its value is uncertain. [1]
#8. Rentals - these have a somewhat greater link to the falling value of money. The greater average earnings are, the more remtal people can afford to offer in competition for a desirable property. Market forces move the cost of remtals
# 9. Equities - The more people earn the more they can spend. This increases turnover, profits, the level of dividends, and the share price. The increased profits which all businesses are making can increase competition for skills and labour, so raising the cost of hiring people. 
#10. Derivatives - a dark area as far as this course is concerned. Anyone want to write something about that - please send it in. Let's all share it.
#11. Currencies - The price of a currency is influenced by things other than the balance of trade. In terms of harmony among all of the units of an economy - it is just a mess.
#12. Loan books - these have a value and can be sold, but the value can vary a lot depending upon borrower stress levels and collateral levels. This varies so much that the value can vary quite a lot both upwards and downwards.
#13. Insurance policies (which may be included as a service). These are backed by reserves. Variable value reserves can destroy the changes of insurers providing an optimum contract with minimal price and maximum benefits.
#14. Pension contributions  and pension pay-outs - For the same reason there is no way to provide a final value for a given value of payments.



[1] We need a new definition of real interest in this context. We will come to that.

There are a lot of things which money can pay for.

HAVE ANOTHER READ OF THE ABOVE LIST.
Think about the complexity theorem. Choose any item on the list and make a note of how its price can be knocked off course by the other price instabilities.

Then think through how its unstable price can affect other prices on the list.

Now the benefits of having the market price for all prices, rising nicely to offset the falling value of money, becomes easier to recognise.

Now the full extent of how these faults in the economic framework which exists today can add to the complexity of the dynamics of whole economy looks like a fast but distant train coming straight at you. The more you think out it the closer it gets - until it is about to overwhelm you.

So why do economists dream up simple models of the economy in order to try to make forecasts? Why do they write clever papers and draw conclusions from past data? What is past date really worth? What are their conclusions worth? A little bit but not much. Research progress is slow and findings are controversial. Would you like to comment on this. Send it in as a paper for us all to discuss.

NOW THERE IS ANOTHER PROBLEM
Remember, the purpose of this school of thought is not to point to problems but to solve them.

We have the idea that it may e helpful to know how fast money is falling in value, at least to an approximation

Any index which pretends to be able to define the value of money or failing that, the rate at which it is changing in value, must include the prices of everything on this list.

The real problem is that the rate at which most of these adjust to the falling value of money is not harmonious. Some things can be rising in cost or price whilst others like the maturity value of a bond or a deposit, are static. Some prices like the value of property may be falling when interest rates are rising to offset the faster rate of devaluation of money. Some costs, like the cost of servicing a loan may fall or rise much faster than the rate of change of most other prices. Such distorted pricing responses have little or nothing to do with the changing levels of supply and demand. They can more easily be described as being chaotic price changes, not related to supply and demand and not adjusting in a suitable way, or rate, to the falling value of money at the same time. In this sense, the contracts and market mechanisms which govern their cost / price adjustments are mostly designed to be chaotic or unrelated. to the rate at which money is falling in value. Market forces are denied their right to function in that way.

The effects upon the wealth of, and the budgets of, people using these assets, these contracts / finances, them and therefore the effect upon the behaviour of the economy as a whole, is also chaotic. For every distorted price which is not adjusting properly there are many knock-on effects on other prices. Many complex problems are caused. We know that now. All readers of the course have already been thinking about it.

Confusion is raised and confidence falls. The social and economic damage can be considerable. One of the consequences / knock-on effects is  the idea that interest rates need to be managed so as to avoid too much havoc resulting from these incompetently designed savings and lending contracts. That has resulted in wrong interest rates at almost all times, for only the market can decide what rate is best. We will come to how this problem may be solved in Modules 3 and 5.

The price of a bond in the bond market, for one example, varies minute by minute. The price responds fast when expectations, or rates of interest and inflation, change. This is partly because a bond's maturity price is usually fixed but the maturity value in unfixed.

Check this out. The 'true' value of the bond shown in this illustration is the value adjusted for average incomes using American National statistics:

This data is for the USA Bond Market, sourced from a Student's paper using national statistics. The market value v National Average Incomes changed by up to 27% in a single year. The trend was falling as interest rates and inflation rates were falling generally.

The same applies to currency prices. They are a mixture of supply and demand for international trade in goods and services and for finance and investments. Look at this:

Did the balance of trade change this fast and by this much? Let's have your opinions of what forces were at play. Send them in. We need to share.

ILLUSTRATIVE CHART NEEDED

The cost of housing payments finance does not change smoothly in the way we would like. There are contractual forces at play which have a much greater effect on these prices than market forces can ever have. Here is a tabulation showing by how much the cost of the monthly repayments changes when the nominal rate of interest changes by 1%. Nominal interest should increase by 1% when the rate of devaluation of money increases by 1% p.a., all else being equal. The data is for 25 year home loans and is sourced from Edward C D Ingram Spreadsheets based upon a single payment per annum divided by twelve.


Here is an illustration of the kind of effect such changes can have on the value of properties.
The higher rates of interest in the USA in the 1980s depressed property prices. The sustained low nominal rate of the 2000s inflated them.

All of these things, costs, prices, and assets,  are paid for with the limited amount of money at people's disposal. So it can be said that the rate of change in the value of money as measured by what money can be exchanged for, and what people can afford to pay for, and are paying for, changes in a chaotic way. There is nothing like what Keynes wrote about people being unaffected by the changing value of money. Neither is there anything straightforward about the rate at which money is changing in value if we take account of all of the items on the above list which can be exchanged for money and the chaotic way in which those prices change.

This is why we need to take a close look at how every price on that list changes. We need to decide whether each price would double compared to what it would otherwise have been if money had halved in value. If not, then why not.

THIS IS WHAT WE NEED TO DO
If we find some man-made obstruction to the price adjustments, as indeed we do in the case of bonds, or some amplification of price adjustments, as we do in the case of the cost of monthly repayments for home loans, or if we find some confused price adjustments as we do when looking at the price of currencies and the balance of trade, and if we find that the basic rate of interest is not based upon market forces, as indeed we do because it is a managed rate, then we should consider what is best to do to fix the problem. Can we change the way the contract, the regulations, or the market forces, are operating? Can we improve things to reduce the chaos?

There are well known laws of economics which are being over-ruled here. One of them is the pricing law which basically says that the maximum use of national resources follows from having the price move to balance the supply with the demand. That is what a free market price can do. Is that desirable? Most people would think that wasting national resources is a bad idea. Most of us would want to optimise their use if not doing so led to chaotic uncertainty and waste.

THE NEED FOR AN INDEX
When this corrective exercise has been completed and all prices are able to adjust harmoniously as money changes in value, would there then be some index which can be used in a savings contract for example, to preserve the value of the savings? Or will the rate of interest, net of tax, automatically do that? Do we need to artificially raise (index up) the value of a savings or a loan account at a rate which offsets the falling value of money when the free market rate of interest would already be doing that?

NOTE: when we get to Module 3 on interest rates we will conclude that free market rates of interest will adjust in that kind of way. Here is the basic argument:

Normally, it can be concluded that if interest rates are free to adjust to the falling value of money as well as performing its other role of ensuring that people who borrow are those most able, or most willing, to afford the payments, then the rate of interest ought to adjust to balance the supply of credit with the demand for it.

It is human nature to want things sooner rather than later or to want capital with which to buy a home or create a business. This leads to an excess of demand over the supply of credit unless the price of credit and the unavailability of unlimited credit, curbs that demand.

For this reason, after examining the contracts proposed in PART 3 and onwards, readers will see that there will always be a tendency for interest costs to exceed the rate needed to preserve the value of loans and, net of costs, of savings.

This assumes that the total credit available is constant or that it will vary above and below that ideal rate, sometimes thought to be 'the sustainable rate',  in which there is enough money in circulation to avoid a liquidity crisis and yet not so much as to create a lot of inflation.

But people and businesses also like to have greater certainty than that. They are prepared to pay extra in order to have some kind of guarantee about the value of their savings over time and the cost of their repayments and the total value to be repaid. We will look at the contracts which can be designed to do those things in PART 3 and onwards, of this module.

What this means is that there is a place for some index in which people can believe; an index which if applied to savings and loans will preserve those values despite money changing in value. If that public preference is to be satisfied, we need to define and to choose an index which can be used in administratively practical ways, and also in marketable ways, for fulfilling that need. Again, readers are referred to later parts of this module to see if they think that those suggested new contracts will achieve their various objectives.

A SUGGESTED INDEX
Suppose then that the National Average Earnings, the NAE, of that population were to double. Suppose that there was enough money created to allow every spender to spend twice as much as before. And suppose that all prices were free to make the relevant adjustment. Would that not halve the value of money?

To be more precise, suppose that all of the price adjustments for everything listed above were to be able to, and in practice did, adjust at the rate needed to offset the falling value of money.

The more obstacles to that which we can remove to such pricing adjustments, the more orderly will be the rate at which money falls in value. And the more harmonious the economy will become. The closer will the rate of change of every price get to the rate of change of every other price. This is not forgetting that price adjustments have two parts, the money-value adjustment part and the supply and demand part. We are looking at the former.

Any price which remains too high takes spendable earnings away from everything else or it reduces the demand for something until the price adjusts downwards. Every price which is too low attracts more spending until that price adjusts upwards like every other price may already have done or be in the process of doing.

Does that mean that inflation of prices has no cost? No wealth re-distribution effects or other disadvantages? No. It takes time for prices to adjust and some prices adjust before others. The effects are not uniform and the benefits and costs are not the same for everyone or every entity.

Does it mean that we are giving permission to inflation rates to become hyper-inflation rates? No. we do not have to create a lot more money than is needed. But we do need an algorithm, a convention. or a guideline on how fast to create new money.

HOW DOES NAE FIT INTO THIS?
NAE is just one price on the list. If all prices are rising at a similar offset rate, offsetting the falling value of money, then any price should do. But that is certainly not the case right now and people would not trust just any price anyway. What are the merits of using NAE?

Consider where spending comes from. It comes from earnings. Without earnings there will be no spending. There will be no economy - no money-based economy.

Spending goes to savings as well as to purchases, taxes, donations and gifts. Spending rises within the nation when:

·         People have more earnings to spend and they spend them
·         There is more borrowing and
·         Savings levels are falling and
·         Fewer goods and services are being imported.

The level of spending can be rising, but it also undulates. Sometimes it is rising faster and sometimes it is rising less quickly or it may be falling. It is the people's right to choose how much to spend.

We can think of the National Average Earnings, or earnings per person.

We can think of National Average Spending, or spending per person. One person or entity's spending is another person or entity's income.

If the population rises across all age ranges, there will be more earners and more spenders. This may balance out. It may not, but largely we might say, or hope, that it will balance out. Not so for an aging population, so that must be noted.

But for now let us say that it balances out. We are thinking that what people earn and what they earn in aggregate is, at the end of the day, or in the long run, for a fairly stable population, what they spend.

Sometimes they spend more, sometimes they spend less, but overall, after all of the undulations have worked their way through, what they earn is what they spend. What they do not spend till later will, hopefully, not lose its value by the time it gets spent. It will buy the same quantity of things as it would have bought earlier. Not exactly. Nothing is perfect. But we are not seeking perfection. We are seeking to reduce the chaos and to find ways in which to do that.

An index, NAE may be a useful index to use in contracts to do with savings and lending / borrowing and in pension funds and managed funds; wherever value needs to be preserved or could be preserved to please the end users it may be a useful index. Here are some more reasons:

THERE ARE MARKET FORCES LINKED TO NAE
When people can spend more because their earnings have increased, they can spend more on rentals. This means that prospective renters, (on average), seeking to rent 'that desirable property' have more purchasing power and so in the competition which ensues, rentals will rise proportionately to the earnings of that set of people and entities; foreign capital excepted. As rentals increase property values rise proportionately - all else being equal.

With higher earnings and higher property values people can borrow proportionately more. This means they can spend more and buy more expensive assets like property.

When people can spend more and when they do, company turnover increases effortlessly without the need to increase production. Profits rise proportionately, the cost of hiring people and all other costs rise proportionately. Dividends rise proportionately so as to avoid a take-over bid, for example. At least, raising the dividends is an option. As profits rise it is easier and necessary to raise rewards for employees to avoid losing them.  NAE rises proportionately. Full circle - as long as there is enough new money being created, spending and prices will all rise.

Then the entire economy 'floats on inflation'.

When all prices are able to adjust to the falling value of money and there is greater harmony that we have now, NAE is not such a bad choice of index to use. With a sustained high level of employment the supply-demand function should not interfere too much. There are cycles though but the cycles are cycles they are not trends. Over a cycle, NAE will probably average out as a price which has a durable and practical use as an index which preserves the value of what people have earned and saved and borrowed.

Its disadvantages are fairly few, and they are mostly related to undulations in the level of spending, or long term demographic changes. These vary the value which the index represents a little bit. And over a very long terms with changing demographics and with almost everything you can think of changing, it may prove to be less representative of value or the stake in the economy which some person or entity had earned. If there is a better idea or a better index, then readers should let us know. There is homework (written essays to hand in) for that kind of thing.

HERE ARE SOME OTHER CONSIDERATIONS:
The NAE concept is simple for people to grasp and the index is easy to calculate.

a.       The share of national earnings which you earned and saved will be returned to you - approximately.

b.       People can save 5 NAE and have it index-linked to NAE. After any number of years or decades they still have  5 NAE in that fund, plus any accumulated interest.

c.        If the nominal interest rate adjusts to the falling value of money this will. along with future expectations will be reflected in the market rate of fixed interest for fixed interest AEG-linked bonds whenever they are issued.

d.       A pension fund valued at 10 NAE can provide an income of 1 NAE for ten years, or 0.5 NAE for 20 years. The concept is simple. The maths is easy. People can easily see that most pension funds are too small when this calculation is done. Making plans and finding solutions starts with understanding the problem. Using NAE as a measure of wealth is most helpful in this way. It is easy to grasp and it can breed confidence in any contract or calculation in which it is used.

ALTERNATIVE INDICES
In relation to the choice of an index compared to other choices:

A.      People repay their loans out of NAE, not out of prices. Economists have repeatedly tried to create home loans linked to a prices index. All attempts have been abandoned. One reason was that they did not allow the cost of the repayments to fall relative to the index over time. Another reason is that repayments are made out of earnings, not prices. The two can diverge. Prices as measured by the National Statistics can rise much faster than earnings - at least in those times, because the index was comprised of just a few items on the list. Another reason was that these contracts were used mostly in high inflation environments which were very unstable. And finally the index definition keeps on being changed. Any prices index is likely to omit something significant or be very difficult to calculate.

B.      National Average Incomes may also be thought of as option. This index excludes some spending power but it may have uses in some contexts that we will be exploring later.

C.      It has been suggested by Robert Shiller and others that Bonds should be issued in units of one trillionth of a GDP so that GDP is used as the index. It might be more sensible to suggest GDP per person, since populations change. This is a possible alternative but not quite as well related to the mathematical studies done and the figure needs to be more divisible when used for personal savings, pensions, and loans. GDP figures are notoriously considered to be manipulated. With that in mind it may be better to have representatives of savers and borrowers to be put in charge of the NAE statistic for indexation purposes.

D.      Some members of the Austrian School say that the rate of money devaluation is the same as the rate at which new money is added to the total quantity in circulation. This assumes that the level of demand for money will not vary. That is not true. There is the idea included in some of these writings that when there is a liquidity shortage, money will rise in value but that because the total quantity of money has not increased or decreased, the intrinsic, or average value of money will not change. This is justified as an acceptable cost to the national economy because 'How else can the value of money be fixed?' The objection to this is that the total quantity of money needed by a working economy increases with a number of factors. That includes the overall level of population, the amount which they save and place into reserves, and the amount which they spend on imports which diverts spending from the domestic economy with other effects which may need to be taken into account. Then there is the variable rate of borrowing which also affects the aggregate level of spending and the price of many things on the list.

The main objection seems to be that there is no clear advantage in having a slowdown just because the value of money and its scarcity is rising. Furthermore, there is some degree of risk of creating a downwards spiral into a recession. In that case, what defence is there? What better defence can there be than to inject more money into the economy in a way which both relieves the liquidity shortage and at the same time forces more spending to take place? This is dealt with in  more detail in Module 3.

FOOTNOTE: The writer once suggested that Nation States in the European Union could have different NAE indices based upon each of their own NAE statistics. This would reduce the cost of borrowing for the weaker economies. This idea has not been fully explored and might require that cross-border borrowing with indices linked to other nation states within the Union should be discouraged. It was first put forward as a way of assisting the Greek Bailout making servicing Greek National debt cheaper for its own government and reducing the cash outflows needed, so cutting Austerity.  The outflow needed would be reduced by the indexation of a part of the interest. At the same time it was pointed out that Austerity would cause damage. The suggestions were sent to a member of the ECB in a private capacity. The response was a request for a more comprehensive study of the issues and a reasoned explanation for the choice of NAE as the index. This has taken until now to write. 

CONCLUSIONS
        I.            The total quantity of money needed by an economy in order to avoid a liquidity shortfall is not known and it cannot be known.

      II.            It is better to have some surplus and avoid that scenario.

   III.            Much as we would like there to be a reliable index which would rise at a rate which exactly offsets the falling value of money, this is not possible. The best we can do is to try to create more order in the way in which prices adjust to the falling value of money and then to select an index which is based upon that more orderly list.

    IV.            Why would we want to have that index?

      V.            People like certainty and it helps with budgeting if the savings and loan costs and pension pay-outs (annuities for example), are more orderly and more stable in value.

    VI.            If, in such an orderly economy, everything on the above list were to be rising at the same rate compared to the rate at which it would otherwise have been changing,  it is easier to select an appropriate index.

 VII.            To be a rate which was not affected by changing supply and demand for human capital (essentially people and their skills and outputs), and thus to be the rate of offset which we are attempting to define and to measure, a steady state of employment must be envisioned.

VIII.            In practice, this does not happen. There are times when there is a surplus of human capital, which we see as a rising level of unemployment, and there are times when there is a shortage of it.

    IX.            No matter which index we look at, supply and demand are always a factor.

      X.            That said, it can be postulated that over the course of a decade or two the cost of NAE (this price), may average out at something similar to the rate  needed to offset the rate of devolution of money

    XI.            Perhaps this is about the best index we can find as one to use to offset the falling value of money, at least over an economic cycle or two, but over longer periods, demographic changes and other unforeseen changes may distort the figures.

ALTERNATIVE INDICES OF CHOICE REVISITED
Now there is the question of what else people could relate to if asked how fast they would want their savings and loan costs to be rising simply to keep their value.

Examples of other similar indices which have been suggested and which may be looked into are
1.       National Average Incomes.
2.       Wages,
3.       GDP per person,
4.       GDP per working person.

Features which are important to the selection of the index are:
1.       The uses to which it is to be put - in particular if it is to be used for the preservation of the value of a bond,
2.       The simplicity and the marketability of the concept - is it straightforward and easily related to?
3.       Its ease of measurement, and
4.       Who is assigned to make the measurement.

THE ROLE OF TAXATION
So far the above is a summary of what has already been written.

TAXATION
We also have to understand that taxation needs to exempt capital gains and interest rate gains up to this selected indexation level. Only one index can be selected for that.

If we want any of these indices to be representative we need to assist the value of money to start falling in a more orderly way. We must first put an end to the kind of disorder which affects the value of bonds, the cost of monthly payments, the cost of credit (interest rates which add money to savings and loan accounts) and the value of currencies used for international trade.

The value of equities and derivatives has been omitted from the list because these are mostly driven by sentiment and perceptions which can change in an instant. Mostly supply and demand.

TWO RATES OF DEVALUATION OF MONEY
If we manage to iron out those problems, then almost any basket of those things listed above will have a rate of price change which has two parts:

1.       The supply and demand part which will change anyway even if money is not falling in value. This varies for everything on sale.

2.       The offsetting change which adjusts for the falling value of money so that any price does not move out of line and become too much cheaper or too much more expensive as a result of the price not having adjusted fully by being distorted or slow or too fast to adjust.

If we take all prices into account then both parts of the price change must play a part in calculating the value of money and its rate of change in value. But when we come to Keynes' definition of how fast money may be falling in value, that only looks at the second part and excluded the changing levels of supply and demand. If we used the quantity of money as the measure that would also exclude the supply and demand function. But as explained above it has its faults. Herein we are interested in having prices adjust in both ways and being free to do so. In that context we are not looking at how money changes in value overall, but how fast it would change in value if all supplies and demands were fixed.

We want that rate of offset to be about the same for everything because we want the supply and demand side to be separate and to set the real prices of everything so that optimum use is made of every resource.

To achieve this we will be looking at how that may be allowed to happen, or to be  made to happen, as we go through the above list. That is what the course in Macro-economic Design is all about. 

  When we have done that and thus created a financially stable framework for the economy, the 'Management' side can then be looked at. A more stable economy which breeds trust and confidence, one which does not ruin financial plans or re-distribute wealth is easier to manage. An economy in which wealth re-distribution is not automated and disturbing to people's financial affairs, like the economies we have today all around the world, does not need interventions to offset the damage being done.  That kind of damage will cease. Prices will be adjusting and wealth will not be scattered around. There will be that many fewer political and economic policy targets to aim at and fewer instruments of policy will be needed.

INTEREST RATES HAVE TWO PARTS
When we come to look at interest rates, like all other prices, we will be seeing that there are two parts:

a.       The part which offsets the falling value of money
b.       The part which balances the supply of credit with the demand for it
       There are other ways to add up all of the parts if we include lending costs and profits. That will be examined in Module 3.

When we look at taxation of interest we will be seeking the first part of the interest rate, part 'a', to be tax free. It should also be free of any tax relief because it is a capital adjustment. It is not a cost or an income.

In this rest of this Module we will be seeking ways to write contracts in which that part of the interest is not defined as being a cost.

Traditionally all of the interest, (a+b),  has always been treated in accounts and taxation as income or expense and all of it is thought to be payable as a part of the monthly repayments cost. This is wrong and it has dire consequences for the savings and lending industries. This has knock-on effects on just about everything which can be affected by the cost of finance - and that is about everything. The problems caused hit  everything and so they multiply many times over.





MODULE 2 - PART 2
COURSE IN MACRO-ECONOMIC DESIGN AND MANAGEMENT

We need to see:
·         Why the total stock of money needed to be in circulation cannot be defined.
·         Why this means that money tends to be always falling in value.

IN SUMMARY
Money is usually falling in value because no one knows how much is needed to avoid a shortage of money it is best to have too much rather than too little. Without money people and entities cannot pay each other. A shortage of money slows the whole economic process - which is an unnecessary obstruction to the output of any economy.

For these reasons economies generally find themselves with an excess of money to spend and this leads to excess spending and the resulting devaluation of money as prices push higher.

Should policy makers opt to let the economy slow in order to restore the value of money they have the following problems:

·         Prices which include wages as well as the prices in the shops and the prices upon which profits depend are not easily or quickly reduced. A major slowdown can result. There is a possible threat of a downwards spiral into recession.

·         The overall level of prosperity falls as output falls for no good reason. A shortage of money is not a good reason.

One reason why people might support this hardship process could be because the resulting inflation re-distributes wealth. But now that problem is to be solved by the various modules in this course, the objection falls away.

THE MONEY ISLAND STORY
This is a thought experiment. It is not a history of anything.

Money Island got its name because at first there was no money. People knew what money was but they had never had any.

Everything to do with purchasing and selling was done by barter of one kind or another. The process was slow and theft of exchangeable goods (money substitutes) was too easy.

One day, a helicopter flew over and dropped a ton of money. Everyone got some. Months later, after a painful period of guessing how much money to exchange for everything, prices settled down and the economy boomed.

In fact output tripled. Or it was going to...but unfortunately there was a shortage of money. Its value, the demand for it, had risen so much that people were waiting to be paid all the time.

The amount of money needed had grown because it was being used more and spent faster and because the population was rising.

The problem was solved when the Islanders decided to print some of their own money and the knowledge needed to do that had been acquired.

Everyone got some - it was given away in the form of a cut in sales taxes so that whatever people bought it cost less than before. The new money created was seen in their accounts and as cash left over under their mattresses at the end of the month. That was because everything had been cheaper. Except that they spent more, but the effect was a boost to the economy and enough money was created to restore the economy to full output once more.

But then people started to save money, so it was not circulating. Another shortage developed.

After a while more money was 'printed' and the economy boomed again and savers were tempted to start spending. The result was inflation as prices rose. Money was falling in value.

Some people wanted prices to fall but mostly they said wages would have to be cut and that led to a lot of opposition. The providers of goods and services were reluctant to reduce prices because they had overheads to pay and they felt threatened by the reluctance of people to reduce wages.

The result was that more money was created and that solved the problem. But again, this meant acceptance that money had fallen in value.

One day the banks started to lend a lot of the deposit money they had taken in as savings and deposits. This increased spending and led to higher prices. The higher prices required more new money in order to sustain them. Again, more money was created.

Then people started to save more and to borrow less. The demand in the economy reduced and threatened to become a downwards spiral as people started to lose jobs. That reduced confidence, more jobs were lost, people saved more, and spending fell again. More job losses occurred.

It was decided that either more money should be created in the form of tax cuts and subsidies on spending which was not taxed, or that the government should spend more money and be given it to spend rather than borrowing it. Borrowing it would cost tax payers more and lead to raised taxes later unless by that time the grown economy was paying more taxes. The balancing act was too difficult to get right and so it was decided to create more money.

The way in which all of the financial contracts were written (Module 2 PART 3 onwards) and the way in which the currency market was operating (see Module 3), meant that all prices were adjusting to the falling value of money. That included the rate of interest (See Module 4). Little or no harm would be done by boosting spending even though it added a little to the level of inflation.

What everyone seemed to have learnt by then was that there is no way to know how much money is needed. In any case, however much money there was, there was always some good reason to create more.

They were unable to prevent inflation of prices when people started to spend faster and they then has to sustain the higher prices with more new money.
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The question of whether new money should be created by lending it into circulation or by printing it made little difference except to the balance of spending in the economy. The credit dependent sectors needed more debt-based money and the remainder needed more debt-free money.  The amount of control which policy-makers had over the rate of creation of money determined how the new money was created and in what ways. That is discussed in Modules 3 and 5.

However money was created, and however it was distributed, the fact remained that more money always seemed necessary to prevent a needless slowdown due to a shortage of money (liquidity).

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The information to be given in the rest of Module 2 is not yet complete on the model testing side although the tests done were excellent proof of the new ILS models.

However much can be learned in the meantime by reading the related parts of the Main Research Website such as the page on 

New Financial Products Resulting, 
The LOW INFLATION TRAP, and 
The studies on interest rates and rates of return on adjacent pages.

The two adjacent main maths pages are on this site:








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