Adam Smith wrote The Wealth of Nations, and the title itself reflects the concept, at the macro level, that wealth is profit, too. Different word, different meaning, but essentially describing the same thing with a different framework; macro rather than micro. If the title were The Profit of Nations, we would understand it the same way. Profit is the 'excess' we gain; the 'fruit' of labor. It's something real and the mathematical difference compared to expenses. The compounding effect of profit is wealth. If we build a building yesterday, today and tomorrow, our 'wealth' is three buildings. A business makes profits and builds a building; the mathematical becomes the physical (money traded for objects). Thus, profit is more than just transactional wealth, or mathematical profit, it is infrastructure and a standard of living of consumption, too. It is a word with different nuances to it. As you shall see, I am using it mathematically. In fact, strictly mathematically.
Government taxes the transactional value of profit (business income tax), the infrastructure value (property tax), and even the expense side of the equation (employee income tax) necessary to create profit. While goods for resale are not taxed, there is a tax when the final consumer purchases them (sales tax or tariffs). Lots of taxes chasing and effecting profits/wealth, which is why tax policy is always so rancorous. People want the biggest gap possible between revenue and expense. A definition of good or bad policy, or of business choices sees the largest gap possible as healthy; The more profit the better.
On the surface, what I just said seems to have no connection to the original statement: Is the deficit the inverse of profit? But, the profit for buildings (infrastructure wealth) and the profit for transactions (taxes) are both profit at the micro level from a mathematical point of view. Profit first requires VALUATION(s). For example, when I pick an apple, it is free for the taking. When I sell the apple, the apple has valuation (whatever I sold it for). The land's value (if it were to be sold) would be based loosely on its potential to yield apples that can be sold for x amount. So profit and wealth are ultimately based on valuation, BUT valuation occurs at the micro level. Valuation makes the micro transaction possible between the buyer and the seller. Every transaction includes the exchange of something (good or service) for money. This is an exchange of the abstract for the physical. Valuation, both psychologically and mathematically, are a necessary part of the transaction, as well as the intellectual agreement to accept the medium of exchange (dollars, euros, etc.) A Continental as payment was okay in 1780, but nobody will accept it today. The Federal Reserve and the Treasury exist to provide a framework for an agreeable valuation standard. The Federal Reserve and government then try to implement policy to effect valuations that they see as desirable. Generally, the goal is to encourage trade and the build up of wealth, as described by Adam Smith. The government lives by taxing profit, so profit is the goal.
Every transaction at the micro-level has at least three participants: buyer, seller, government. But, government has multiple roles, so it is really six or more involved in every transaction (local tax, state tax, income tax, federal tax, currency creation, mandatory insurance, liability insurance, consumer protection, employee contracts, banking for credit card processing or business or consumer credit, etc). So while there is a single good moving from one hand to another, behind each hand is a huge mathematical shadow. Everyone's livelihood depends upon up this shadow. These 'other' expenses (taxes, insurance) are a part of every transaction. If the consumer does not consume, everyone involved collapses MATHEMATICALLY. If they consume, everyone gains mathematically. Not surprisingly, people are always complaining about insurance and taxes, and regulations generically, etc. Any increase in expense cuts profits which limits both the ability to consume for oneself and the ease to sell, since higher prices will reduce the number of products that any buyer can consume. But without profit, it seems as if no one can consume, either. The nut, of course, is that my profit is your expense. That is where the mathematical showdown exists. I want to buy low and sell high to you, you want to buy low from me, and sell high back to me. This is an irreconcilable problem, without a third party entering into the transaction as a buffer, which is the role of government and money. This is both necessary and possible because of the growth of players in the economy. Two farmers have no need for money. They can trade milk for eggs forever. But once they want a frying-pan, or a piece of clothing, everything gets more complicated; durable vs non-durable, overhead, infrastructure, shipping and set-up costs, etc.
Within the active economy, wages and inflation for different commodities move at different rates for individuals as well as for the aggregate. Money masks this phenomenon so transactions can take place with regularity despite the volatility. Obviously, it is in the individual transactions that boom and bust cycles originate, that government attempts to regulate. However, the government is also part of the process, too, by being the largest employer, the largest spender and the largest debtor in the economy. A good theory should accommodate that fact, and be true even if government did not exist at all. I think we can agree that the micro is the macro. The math involved is obviously related to consumption, since that is all we do, and that is what economics is (allegedly) the study of. Animals do not count anything. They just consume, and therefore have no need of economics. They are free of boom and bust cycles, which Adam Smith echoed in the claim of a natural 'invisible hand.' Clearly the opposite is logically true of what Smith claimed. Cycles are created by the works of visible hands, our own, just as the wealth is. Therefore, there must be a relationship between wealth and the cycles. The deficit equals private profit also explains the boom-bust phenomenon.
Perpetually increasing and encouraging consumption is currently the only way for the system to sustain itself mathematically, especially when combined with population growth. As a practical matter, however, the system can't collapse, since we must consume to survive. We should not need to drive production for the sake of the numbers; we must produce more to survive anyway. There will always be a consumptive demand. The challenge for government is one of distribution, both to sustain itself and to sustain its purpose. However, economics will never be anything more than moving food from the farm to the market, what animals take for granted. Food is the basis of all life. Technology is surplus labor dedicated to something other than food production. I believe the proper role of economics is distribution as a scientific study. It is no different than engineering a factory assembly-line. If the parts are not distributed properly on the assembly-line, then the workers work too hard, waste time, spoil raw materials, finished goods are of secondary quality, output is low, etc. The Industrial Revolution solved the physical distribution (assembly-line) problem really well. There was a twelvefold increase in population and a hundredfold increase in production between 1700 and 2000. However, we still have the same mathematical and social problems as prior to the Industrial Revolution and prior to democracy. Environmental abuse, not surprisingly, is off the charts. We make, consume and waste faster, too. Nevertheless, for all these technological and political-social changes, the way we are counting and VALUING items has not changed at all. What we have in modern times is a speeded up mathematical laboratory. You can make or lose a billion dollars between sun up and sun down.
The computers can only count what we program them to count, so more information is not the solution. What we need are better formulas based on better theories. We could say that 'consumption = profit,' since we can only consume for ourselves from the profit of our transactions. However, that is nonsensical, since consumption also equals expense. (This is the issue of definitions again). If consumption is both expense and profit simultaneously, well that certainly would shed some more light on the boom and bust cycle, right? The factory 'consumes' raw materials, and it's 'expense' is someone else's 'profit.' I doubt that is a controversial observation, the point is that there needs to be a macro-accounting at some point, which is what the debt = profit formula explains.
In my inflation chart where I display the difference between a business behavior (marking up goods based on a percentage of cost) and an economists observation (totaling all the transaction values in the economy) we see the micro versus macro dichotomy. But more importantly, these charts are inappropriately mixed to explain an economic situation. Remember, both charts are exactly the same, the only difference is that I appended zeroes to the cents, making it millions of dollars rather than a few cents. In other words, the math at the macro level must be EXACTLY the same as the match at the micro level. Hence, the profit is the deficit!
The chart does not say anything about the deficit or profit. It is primarily an analysis of what causes inflation (mark-ups) and the failure of economists (and businesspeople) to grasp a very important sequence of events. All science is supposed to explain a sequence of events. The fact that Bernanke and others can not explain what is wrong is a good sign, as long as they are intellectually honest enough and courageous enough to advance the alternative, which in this case is that hundreds of years of economic theory is completely bogus.
The deficit is not a short-term phenomenon. It started from the first Continental. Slowing the rate of the deficit, or running a surplus for a few budget years is meaningless. That is the same as a business selling below cost or losing money for a period of years by borrowing to stay in business. The long term trends are what macro economics are supposed to be explaining. Policy, which is short-term, can only be based on long-term theories. If the long-term theories are wrong, then the short-term policies will inevitably be wrong. A random guess will be just as effective 50% of the time as a mistaken analysis. Businesses are operating within the same mathematically flawed universe as the economists. There is a cause and effect theory that is widely regarded and accepted and applied, that has no mathematical counterpart in reality. The political process gives everyone the right to be wrong. Fortunately, it also gives everyone the possibility to change their mind.
Debt as the inverse of inflation by Steve Consilvio
But to the theory: everyone can run black or red. The theory is saying that the red of the deficit is the black of the private economy. (This is an all macro formula).
Government, businesses, individuals, non-profits, etc., can all run black or red. While the inflation chart shows a linear progression (2,4,6,8) in regard to inflation, in fact everything is much more volatile. People are losing and gaining simultaneously, but at the tip top, the formula encompasses everything happening below it. The numbers are always in motion, but at any moment in time, it is a finite amount; a closed universe and a zero sum game. Just like a business balance sheet, the world has to balance mathematically, too. This theory is the balance sheet of the economy as a whole. Every nation has its own currency, its own deficit, and its own inflation/profit valuation (which creates another whole set of problems when attempting to trade across borders).
The states have to balance their budget, but they can borrow, get free money from the Feds, cut overhead, increase taxes, etc. Just as in every simple transaction, every number is connected to many other numbers. Running in the red or black is only possible because of the existence of credit! Without credit, there would be no red. This is very important, too. We created a red and black system 200 years ago. Politically this is important because Osama bin Laden quotes Ben Franklin, 'neither a borrower nor a lender be.' To understand 9/11, it is like understanding that Ho Chi Min was a fan of George Washington. The battle between the powerless and the powerful generally revolves around wealth, credit, opportunity and the reward for work. In other words, TRADE! We need trade to survive and thrive. Trade for profit, however, creates inflation. Inflation creates debtors and creditors, which then creates conflict. The government must 'create' enough money for the private sector to operate. This is the basis of the 'prime the pump' theory. The pumped up is inflation. Our houses that cost $16,000 fifty years ago are worth $500,000 today. The government must supply the numerical increase for the transaction to occur. Government is both the first and the final source of all value.
Assuming people are of goodwill, inflation and boom-bust are mechanical problems created by a mathematical habit. It is easily fixed. But, it is important to know how the machine is engineered before trying to fix it or improve upon its design. People do not understand my solutions because they do not understand the problem. The deficit = profit/inflation is about as good as I have ever described the problem. It is a simple and clear-cut mathematical model.
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