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One way to divide the economy is into financial assets and real assets. Making this distinction allows us to make judgments about intangible ideas such as value, productivity and net worth .

Financial assets can be roughly divided into two classifications: 1. currency or deposits and 2. paper assets such as stocks and bonds. Mortgage notes are also financial assets, generally held by banks with a real asset as collateral.

Financial assets generally derive their value from a contractual claim on the liability of another. This is why, if you cancelled out all the financial assets in the world, what you would be left with is all the Real Assets.

Real assets could also be broken down into two categories: tangible assets and intangible assets. Tangible assets are anything which can be physically touched, including real estate and personal property, such as an antique chair or work of art. Intangible assets would be items like copyrights, trademarks or patents, which can be owned and transferred but have no, or minimal, physical substance.

This post isn’t about making great hires, having a badass product or service, or making smart cost-control purchases.

This is a look at business profits at the economy wide (or macro) level. It is inspired (damn near copied!) from this post by Bill Mitchell. I’m sure it sounds dreadful, but stick with me through the equation and hopefully it will be rewarding.

The profit equation was developed by economist Michal Kalecki using a simplified accounting model, and then expanded to include additional elements. Let’s jump straight to the expanded conclusion. The equation is: Pn = I + (G – T) + NX + Cp – Sw.

What this says is that Gross Profits after tax (Pn) equals Gross Investment (I) plus Government deficits (g-t), plus the export surplus (Nx) plus Capitalist consumption (Cp) minus household savings (Sw).

Gross Investment (I) is business investment plus household investment, which is mostly new residential real estate.

Investment (I) can generally be thought of as any new bank lending for the given period.

Government deficits are the amount the Government spends over the amount it taxes. So we can see that, contrary to conventional wisdom, deficits add directly to private profits and will allow for increased “capital formation” (code for investment), which is an addition to the real assets in the economy.

An export surplus is the opposite of a trade deficit. It will add foreign currency to the domestic sector as the sale of goods and services abroad outstrip the amount of dollars sent abroad through imports. If there is a trade deficit which sends dollars abroad then that deficit, if it becomes chronic, can create a domestic demand problem as those dollars are not able to be recycled domestically. This is the situation we are currently in in the US and requires one of the other elements (New investment, Government deficits, decreased household savings) to pick up the slack in demand.

Household savings, likewise, act as a drain on demand, and will require additional investment in the next period to maintain business revenues and profits.

Finally, as Bill says in the post linked to above: “when the government runs a surplus it reduces profits via its squeeze on aggregate income. That is why all the business sector should be screaming at the fiscal austerity plans that are rampant at present.”

So now we can see that the two primary drivers of the economy (as well as business profits) are new private investment and government deficits, with the trade surplus being a lesser element. We can also get why we hear such a clamor in the news media for a more export driven policy, so as to maintain the ideological bias against deficits as a critical component of economic health.

An automatic stabilizer is a non-discretionary item in a government budget which kicks in automatically when economic activity decreases.

Unemployment benefits are an example of automatic stabilizers. As economic activity decreases & workers are laid off, the automatic stabilizers kick in to provide a floor of support.

This is a critical concept when talking about Government deficits, because it means that the deficits themselves are outside of the direct control of the budget process. We could say the deficit result is endogenously determined, that is, it is determined by events in the private sector of the economy.

Targeting a desired deficit outcome (such as a balanced budget) becomes impossible because if private sector activity decreases, as people are laid off the automatic stabilizers will kick in and throw the desired deficit result off track.

When economists talk about stocks and flows of money, they are essentially adding time to the equation.

A flow is a quantity of money measured over a given time period. For example, the Government deficit is a flow, typically measured over a quarter or a year.

The Government debt is a stock, which is the cumulative total of Government deficits. In this way, the deficits accumulate to become the debt. So we say flows accumulate to stocks.

One common measure we frequently see is the Debt to GDP ratio. In my opinion, this is a difficult ratio to draw meaningful conclusions from because it compares a stock to a flow. Presumably a high debt to gdp ratio is bad because it means you are getting less productivity out of each dollar of debt. However, it could also mean that the population has a high amount of savings relative to economic activity. Not necessarily a bad thing.

The Monetary Base (also known as high-powered money, or M0) is made up of coins, currency, and bank reserves. The Monetary Base is considered the most liquid form of money for final payment in bank transactions.

In a Nation-state that has Monetary Sovereignty, the Central Bank is the monopoly issuer of the monetary base, although in the US, the Treasury is the issuer of coins and the Central Bank issues the Physical Notes and bank reserves.

As we learned in our post, What are bank reserves?, bank reserves are an IOU of the Central Bank to the commercial banking system. Bank Reserves do not circulate among the public, they are simply an electric entry in the Central Bank’s accounts which can be swapped for physical currency.

The currency in the monetary base consists of both currency is circulation and in bank vaults.

In other posts, we will learn about other measures of money, typically measured by levels of M, such as M1, M2, etc.

There’s been a lot of keyboard punches thrown recently over the concepts of Savings and Investment. To sum up, Modern Monetary Realism (MMR) has accused Modern Monetary Theory (MMT) of overlooking the importance of business investment as a driver of global savings. While I might agree with this critique to a point, I think it in turns overlooks an important MMT point which MMR would be well-served to poach.

As a quick background–because I haven’t said much about Savings (S) or Investment (I) on this site yet–the idea is that Investment (no matter what it’s original source, public or private sector) becomes Savings as a “leakage” in demand. As a simple example, when you receive your paycheck from your employer, it is immediately kept in your accounts as “savings,” until you on-spend it at the grocery store as consumption, at which point it becomes savings, or “retained earnings” of the store. Any income you don’t spend over the long term remains your savings.

Now, it is not well understood that both the private business sector and the public Government sector work, essentially, from negative equity positions to act as the source of net worth for the private household sector. This is the point that MMR is making. But likewise, the business sector needs revenues as a source of cash flow to feed their original investment. As investment becomes savings, an increase in new investment is necessary to provide those revenues.

The point that MMT makes is that the Government sector has a special position as the issuer of the Monetary Base (currency and bank reserves) in the economy. They can, essentially, create new investment whenever necessary while their needs for revenue to fund that new investment is, in a very real sense, relaxed. A business which is short of revenue will not make new investment until revenues pick up. A Government has no such restriction, and, in times of a shortage of new business investment, must step in to fill the gap. It’s failure to do so on a sufficient scale results in recession. In this way Government becomes the Investor of last resort.

According to mainstream economics, customer deposits allow banks to on-lend those deposits and make loans. Banks then hold a portion of those deposits in “reserve” for customer withdrawals. You may have heard of this referred to as the “money multiplier.”

The reality is, of course, exactly the opposite: banks don’t need deposits to make loans because the loan itself creates the deposit.(1)

Banks make their loan determinations based on the credit-worthiness of the customer, their capital requirements (2) and the cost of obtaining any reserves it would need ( if any) after creating the loan.

This is called endogenous money, because the money supply is determined by the preferences of actors in the real economy. For example, your need to spend on credit expands the money supply and didn’t come from anyone else’s pre-existing deposit. So the appropriate causation says: Loans Create Deposits. Banks create loans ex nihilo (out of nothing).

(1) Marc Lavoie, Credit And Money: Overdraft Economies, And Post-Keynesian Economics, pp 67-69, Money And Macro Policy, ed. Marc Jarsulic, 1985.

(2) SEC rule changes in 2004 make even capital requirements a suspect drag on bank lending, particularly for investment banks.

What is it about Modern Monetary Theory (MMT) that renders ordinarily brilliant economists incapable of comprehension?

Superficially, it appears that MMT is too radical for these mainstream stalwarts to address face to face. I won’t mention all points of contention between MMT’ers and the rest of the economics world. But specifically, MMT’s denial that taxation and bond sales fund government expenditure never gets ink spilled by the likes of Paul Krugman, Dean Baker or Robert Murphy. It’s simply too much for public discourse to address the state theory of money, despite the fact that its blindingly obvious now that that’s how it works.

In reality, MMT is really pretty tame as far as it goes. When you really dig down into it, MMT is hardly about the re-distribution of wealth from upper classes to lower classes which would ordinarily disqualify it from public consideration. The essence of MMT is that, if we take an honest look at how the monetary system operates, it’s easy enough to see that we can raise the floor for everyone, and it often goes out of its way to say that the rich don’t have to be worse off for it. It’s a construct.

In any event, none of this is out of the comprehension levels of the aforementioned economists or our political and media public figures. They just simply leave it out when talking about MMT, toning it down for the public into just “good old Keynesian economics,” as Dean Baker says.

All of which goes to show that the whole thing–and by that I mean anything which reaches the level of public discourse– is just a charade. In the words of Pete Townshend, it’s an “eminence front. It’s a put on.”

Researchers for the 1st time have “cloaked” a 3D object, making it appear as if it isn’t there.  Read about it at BBC.

Often times on this blog I will post things about GDP (Gross Domestic Product) which is a simplistic measure of all the transactions in the economy over a given period, which adds up to a reasonable measure of economic health.  If GDP is growing, we are making progress.  If GDP is negative, we are going backwards.

But it should be pretty clear that GDP is not the only measure of national well-being and likely not the best either.   To mention a couple of directly related items:  we could have a fast growing GDP which is largely produced by going to war with other nations.  I think I can say pretty definitely that a nation at war is worse-off than a nation at peace.  Additionally, we could have growing GDP in times of high-unemployment (such as now), when workers are working longer hours (enjoying less leisure), or unsustainable periods of GDP growth based on consumer credit expansion which will be paid for with debt defaults and foreclosures later on.

Separately, the GINI coeffecient is a measure of income equality.  The US ranks near the bottom (at .45 on a scale of 0 being perfectly equitable and .50 being perfectly unequitable) alongside such luminaries as Cameroon, Uganda and Rwanda.  The Atlantic recently published an article here.  Now, this isn’t to say that those countries have a higher standard of living than we do, but the point is telling.

Finally, we have more subjective measures such as ecological well-being, Gross National Happiness, and the Genuine Progress Indicator.    Economist Herman Daly pioneered what he called steady-state economics, which contained ideas about maintaining population growth and use of physical resources to the limits of ecological sustainability.

In any event, it should be clear that GDP is simply one metric to be used in determining a holistic economics.

From now on, this website is dedicated to finding the best mix of democracy and national well-being possible.