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MODULE 2
COURSE IN MACRO-ECONOMIC DESIGN AND MANAGEMENT
INTRODUCTION TO MODULE 2
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.
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.
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 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.
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.
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.
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.
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.
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.
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
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.
------------------------------
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).
===============================
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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