Wednesday, September 7, 2016
(Updated May 10, 2017)

Basic Economics…Or How I Loved To Appreciate The Real Science Of Economics And See Through The Absurd Illogical Fallacies That Marxists Pretend Is The Science Of Economics

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Money and Its Purchasing Power

One can perform three economic functions with money:

1. Spend…called consumption;

2. Save…called investment; or

3. Hold…withholding employment for either consumption or investment.

Let us assume holding is zero, leaving 100% of money going towards consumption and savings. If I decide to consume less and place those monies towards savings instead, the prices of the factors of consumption goods decreases, while the prices for the factors of investment goods rises by the same degree. One category of spending has been offset by the other, leaving unchanged the general price level, meaning the currency’s purchasing power is left unchanged. That is inflation is non-existent. Now let’s introduce a central bank into the picture. The central bank increases the money supply, adding money substitutes to the economy. The result is inflation,* or a diminution of the currency’s purchasing power, since now an excess of currency is chasing the same amount of the factors of production for consumption and investment categories.

Abstaining Today For Greater Rewards Tomorrow

Investment can only come from abstained consumption, where the monies that would have gone towards immediate purchases - consumption - instead goes towards investments that in the future will result in greater productivity--lower general prices. A dollar not used for consumption but used instead for investment can't cause inflation since it's the same dollar; there's been no increase in the money supply that does cause inflation. Then that dollar that goes towards investment instead of consumption decreases general costs, thereby increasing the purchasing power of the currency. In a free market not sabotaged by central banks (or other government agencies that mimic central banks), we witness a continuous, never ending, appreciation of the currency unit’s purchasing power.

When we save for investment we’re performing an act for greater future consumption, that is saving today for greater monetary purchasing power in the future. Savings goes towards investments that go into new (or old) business ventures that result in either cheaper commodities or new technologies that lower overall costs. When a central bank intervenes in this process it disconnects consumer savings from the equation, thereby allocating economic resources (labor, capital, raw resources; time) towards less needed, less productive, commodities, resulting in malinvestments.

The following will illustrate how net (new) investment (productivity increases) took place before medium of exchange - during the hunter-gatherer period - while also illustrating how such net (new) investments spurred trade between separated communities. We will then insert into the hunter-gatherer period a central bank, examining the central bank's deleterious effects on productivity.

In order to build a new fishing implement...a fishing net for capturing greater amounts of fish per attempt...a community would need to spend less time foraging for food while the fishing net was being built. Less time spent foraging for food = less consumption of food = savings; and time spent on the production of the new fishing net = investment for the future; present consumption has been saved (diminished) for investment, investment being the same thing as greater future consumption.

Result when the fishing net is completed: Thanks to a sacrifice in present consumption in order to build the fishing net, Tribe A now can increase its consumption of fish, resulting in a net increase of food intake, even when one factors in the time now spent in repairing the fishing net, called depreciation costs in the modern economy.

In modern economies where money is the entity saved (not 'saved time' searching for food, as in the example above), the lure for such savings is interest. In the example above, the lure was the fish, that is catching more fish per attempt.

Tribe A saved more by looking for food less, placing that 'saved time' into creating a net that would increase the catch of fish. We can say that Tribe A has a greater productive edge than does Tribe B, whose members are still using sharpened sticks to catch fish--very laborious and relatively unproductive.

Now Tribe A decides, due to its higher productivity/wealth, it can afford to save more time, adding this 'saved time' to the 'saved time' it used for making fishing nets, and build a boat that will allow their nets to catch even more fish. Being busy building boats, Tribe A teaches Tribe B to build the nets--a less productive venture than the new boat-building venture is. Tribe A's greater productivity thanks to fishing boats (and greater wealth thanks to fishing boats) allows for more children, increasing the tribe's population, allowing for a larger labor supply in the near future that will be available for procuring other innovative, labor-saving inventions.**

Now imagine that a central bank enters the picture and instructs Tribe A to construct less productive (less needed) tables and chairs instead of the critically needed and more productive fishing net. Well, not only has Tribe A wasted precious time, it now consumes less food. A table and chairs are consumption-based wasteful goods, while a fishing net is a new and critical capital good investment in the future greater abundance in food. The central bank has shifted production to wasteful consumption - tables and chairs - thereby making our hunter-gatherer community poorer by consuming capital (capital decumulation as opposed to capital accumulation) in the process. In the modern society central banks shift production away from long-term business ventures  – that require large capital outlays that have higher costs (higher interest charged) - towards short-term consumption-based production by lowering interest rates.

Interest Determines Savings (Investment)

Interest is the key for determining the precise magnitude consumers are willing to forego in current consumption for the promise of greater future consumption by using monies for investment (savings), and the rate must be the market rate otherwise we have – by definition – malinvestments as the fishing net analogy illustrated.

When a central bank purchases government bonds, thereby increasing the supply of money substitutes in the economic pipeline, the cost of money – interest – is artificially lowered, per the Law of Supply & Demand. This leads to ‘investments’ that consumers never demanded, resulting in malinvestments and the inevitable periodic economic downturn associated with the malinvestments. We therefore comprehend the blatant lie behind the economic doctrine that states the employment of capital is based on cost, but not only is this doctrine a lie, it's also a tautology...

                                                       “Capital has a cost; therefore
                                                       the employment of capital is
                                                       based on cost.”

Economic growth can only occur by an increase in savings (less consumption) for future greater consumption brought about by those savings. The savings that go into production, and not used for consumption, decrease the general price level via cheaper commodities and lower costs of business. Increasing consumption does nothing to enhance productivity since no new commodities/technologies are created by consumption. Consumption is merely consuming what already exists.

Only consumer savings can procure productive enterprise (increased output at the same cost) because consumer savings is consumer demand for productive enterprise, productive enterprise being ensured by profit, profit ensuring that the factors of production are indeed going towards their most urgently needed avenues for eventual consumption. Government programs don't concern themselves with profit, and can't even if government so wished, since only free market entry entrepreneurial profit/loss can identify the most urgently needed consumption goods/services that are the end product of consumer savings.

As consumers increase their savings rate, financial institutions notice the increase and begin to compete with each other for such savings by increasing interest rates. The higher interest rate allows for the advance of loans for business ventures that require relatively large capital outlays; the more capital intensive a new business venture is, the higher the cost for the loaned capital.

When a central bank induces money substitutes into the savings pipeline, the result is a decline in the cost of money - interest - per supply and demand where the supply of ‘money’ exceeds money’s demand, leading to (1) economic activity that is not demanded by consumers; and (2) the redirection of the scarce factors of production into avenues of production that are less urgently needed.

Maximum Price Controls on Capital

The cost of capital isn't based on cost - a tautology - it's based on (1) the quantity of capital loaned; and (2) the time it takes to pay back the capital loaned. The cost of capital - interest - depends on the magnitude borrowed (and time needed to pay back the loan). If one borrows a capital outlay of X, the cost of X will be less than a capital outlay of 6X, but if a central bank maintains interest rates at the artificially low X level, there can be no loans for capital outlays between X and 6X.  By implementing low cost interest rates, central banks have set in motion ruinous price controls on capital, thereby preventing the employment of capital.

For those who didn’t get the basic Algebra 1 example illustrating the productivity retarding affect of central bank price controls on interest rates for loaned capital,  the following simplified version should do the trick…

A  young boy is at the candy store and hands the retailer a candy bar costing $.95. The boy decides he wants to buy six candy bars instead, five candy bars more than one candy bar, so the price is $5.70. The boy tells the retailer he doesn't have $5.70, but that he will have the money in three years and then pay the retailer, with interest for the deferment of payment. The retailer agrees to the transaction. When the boy returns in three years, he pays the retailer only $.95! Why did the boy offer only $.95, when he owed $5.70 plus interest? Because the boy told the retailer that his father told him there's no difference between $.95 and $5.70 with interest!

Capital, an economic good like any other economic good, isn't an amorphous quantity that has an intrinsic cost. Capital has units - as do candy bars, cars, houses, plots of land, etc. - hence the cost of one unit is less than the cost of >1 units.

Iceland recapitalized its weak surviving banks with interest rates that hit rates as high as 18%, slowly bringing the interest rate down to market levels…

The benchmark interest rate in Iceland was last recorded at 5.0%…

Deposit accounts in Iceland earn up to 5.25%, for a five-year CD, where a 3-month CD brings in a robust return of 4.25%…

At the height of Iceland's economic crisis in 2008, the budget deficit represented 13% of GDP, sinking to 0.80% of GDP for 2015. At the height of the economic crisis for the United States in 2009, the budget deficit represented nearly 10% of GDP, and has shrunk to 2.6% of GDP as of March 2017. In the case of Iceland its economy has recovered, sporting an impressive GDP increase of 7.2% in 2016 and an astronomical GDP increase of 11.7% for the fourth quarter of 2016, a stark contrast to the still moribund United States economy, which saw in 2016 an anemic GDP increase of 1.6%. Iceland's robust economy has prompted Reykjavík to lift capital controls on foreign assets, put in place in 2008 to stabilize Iceland's currency, the króna.
An economy only grows with relatively high, market rate, interest rates, hence the following anemic economies whose central banks maintain unusually low interest rates…

The United States where the Federal funds rate is 1%…

The United Kingdom where the bank rate is 0.25%…

The European Union where the benchmark refinancing rate is 0.0%…

Central Banking Monetary Manipulation & Decapitalization

The ruinous economic effects of central bank monetary manipulation comes into existence via two complementary avenues:

1. Central bank money substitutes lowers the cost of money – interest – thereby diverting optimum productive enterprises towards less productive enterprises; and

2. The new, and less productive, enterprises financed with central bank monetarism were never demanded by consumers, giving rise to the periodic economic downturns economies suffer through when commodities/services financed with central bank money substitutes go unsold.

When central bank financed economic projects are on the cuff of failing, to stave off the collapse of the artificial economy the central bank will buy more government bonds resulting in a further reduction of interest rates, and so on until an economy gets to where the West’s economies are today…bereft of new business ventures due to interest rates near or at zero percent. This is called decapitalization of an economy…the death card of modern economies, resulting in an economy’s productive implosion and the resulting national chaos such an implosion produces. Today, and on the supply side of the coin, business ventures that require large capitalized loans for startup are bereft from obtaining such loans because (1) interest rates – as determined by central bank government-bond purchases – are too low to cover the large capitalized loans that require higher, market rate, interest rates; and (2) relatively large capitalized loans require longer time periods to pay back the loan than do relatively small capitalized loans. On the demand side of the coin, there is no demand for new highly productive business ventures because consumers are prevented from placing savings into longer maturing accounts due to the abysmally low returns such accounts pay out.
* The True Calculation For Inflation 

Let’s say the official rate of inflation for 2015 was 5% and productivity for that same year was 3%. In fact then the true rate of inflation would be 8% for 2015, not 5%, because general prices had actually fallen 3% in 2015 but this fall in general prices was masked by the 5% inflation. Alternatively, if the official rate of inflation were 0% for 2015 and productivity 3% for the year, this would entail appreciation of the currency, not inflation [of 0%], where the purchasing power of the currency has increased by 3%.

** In the modern economy, any additional savings for investment increases the capital base of the economy relative to that of labor, thereby decreasing labor’s wages. The wage decrease labor experiences with additions of capital to the economy is in line with the Law of Supply and Demand; labor’s value diminishes relative to capital’s greater productive value. The fall in general labor wages is derived from the consumption side of the labor force. Using the United States to illustrate, because consumption related jobs account for approximately 63% of total nonagricultural wage and salary employment, a decrease in consumption will produce downward pressure on all wages (which includes the wages of labor in the capital goods industries). This downward pressure on wages then clears the labor market of the upsurge in unemployment in consumption related jobs.

In the hunter-gatherer scenario illustrated above, the capital tools created likewise diminishes the role labor plays in the hunter-gatherer economy relative to the increased role of capital. In the modern economy profit is the key that assigns labor, capital, and resources to their highest known productive values ensuring that the end result of additional capital at work in the economy, and the degree of wealth such additional capital procures, more than compensates consumers for the loss experienced in nominal wages. In other words, although wages do decline with increasing rates of capital, the increased prospective purchasing power of remaining wages more than compensates for the loss in nominal wages, just as the hunter-gatherer community must suffer an interim period of minimal deprivation of wealth (as represented by a cutback in food intake) before the reward of greater food intake is attained from such deprivation.