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What is wrong with this argument?

The Argument

Consider a closed capitalist society, say Earth. There are four kinds of entities:

  • business men
  • workers of capitalists
  • workers of government
  • people who can't work

Both government workers and those who can't work receive money from the government (salary and social programs). Government, in turn, receives money from taxes which businesses pay.

Note that to business men taxes are necessary expenses in order to create a certain product. We may group worker salaries, taxes and other business expenses as BE (business expenses).

Lets call the total spending ability of all the people except businessmen as Spend(customers). Whatever money those people have must have come from expenses of the businessmen, so we have an equality:

Spend(customers) = BE

However, in practice, people tend to save money, so the formula is:

Spend(customers) = BE - Savings(customers)

In order for businessmen to create a profit, they have to sell their products at a price higher than their expense, which is BE. However, the above formula shows that this is impossible since the spending ability of workers is at most BE. So how can business men create profit?

Perhaps business men can buy from other business men, thus creating profit for each other. To quantify this we can write a formula for profit:

Profit(businesses) = Spend(businesses) + Spend(customers) - BE

Combining the preceding two formulas by substituting for Spend(customers) and simplifying we have:

Profit(businesses) = Spend(businesses) - Savings(customers)

There are three special cases in above formula:

  • Ideal businessmen (don't spend their money); customers don't save and spend everything on products. Then, Spend(businesses) = 0 and Savings(customers) = 0 and hence the profit is also zero.
  • Ideal businessmen (don't spend their money); customers are not ideal: they have savings. Then, Spend(businesses)=0 and Savings(customers) > 0. In this case businesses have a loss!
  • Non-ideal businessmen but ideal customers. Then Spend(businesses) > 0 and Savings(customers)=0. In this case the net profit of businesses is exactly equal to the net spending of businesses. Profit(businesses) = Spend(businesses).

It follows that businessmen can't grow their business since the only profit they make is what they spend.

Conclusion: in a closed global economy business men can not grow their companies since the spending ability of people is equal to the business expenses.

How companies grow, then? Two methods:

  • Horizontal: Expand into new population areas where people have some savings (new customers). This is no longer going to be possible in a global economy were Earth is the country.
  • Vertical: convince customers to buy products on credit. This has two flavors:
    • Case A: People take loans themselves (credit cards)
    • Case B: government takes loans from the financial systems and injects into the market through various programs, allowing people to buy more.

Case A: profit to businesses based on credit to customers

Suppose all customers together got a credit of $1 billion. Now customers can spend $1 billion more money than business expenses BE, so when the buy products the businesses will make a profit of $1 billion.

The businessmen put that money into their bank accounts. The next year, the same $1 billion was given out again to the customers in form of more credit, and again returned to the businessmen. Now the businessmen have a capital of $2 billion, and the customers have a debt of $2 billion.

If the original $1 billion will cycle around like this 20 times, then the capital of the businessmen will be $20 billion, and the debt of the customers will be $20 billion.

However, the capital of $19 billion ($20 billion minus the original $1 billion) exists based on the trust that the customers will eventually pay of their $20 billion debt. However, this is impossible since the system works only in one direction -- in the direction of increase of the debt towards the bank by the customers. This is because that is the only way that business men can have profits.

How long can the credit cycle last ? The credit can grow while customers can pay the interest on the credit.

For example, suppose that a family spends $1000 per month to pay the interest on all of their credit cards. If today it is possible to take a credit at smaller interest than last year, than the family can take a bigger credit while keeping net monthly expense at $1000, pay off the previous debt, and on the left-over difference buy a new laptop.

This creates a cycle where old loans are covered by new bigger loans. How long can this cycle last? It can until the interest rate will decrease all the way to zero. At this point the debt of customers towards banks stops growing, since they are not taking new loans. But this means also that the profit of business men also reduces to zero. Attempt to sell products at profit will mean that not all the products will be sold. In turn, business men begin to reduce their expenses (BE) by firing workers. But by reducing BE, so is reduced the spending ability of customers Spend(customers). Furthermore, fired workers can no longer pay off their debt and the bank balance secured by those debts starts to loose its value. The virtual $19 billion begins to evaporate like it was never there.

This leads to a financial crisis.

Case B: financing businessmen through government programs

In this case government itself takes a loan from the bank and redistributes it in form of government sponsored projects. This leads to favoritism and corruption -- which business gets the money? No longer the market decides which business survives, but government officials. All this while the debt of the government increases indefinitely.

This is no longer capitalism but a totalitarian regime which will eventually crash because of its financial debt. At that point, a reboot is made -- all is cleared (new currency) and the whole process

starts from the beginning.

Edited by Boris Rarden
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What is wrong with this argument?

Lets call the total spending ability of all the people except businessmen as Spend(customers). Whatever money those people have must have come from expenses of the businessmen, so we have an equality:

Spend(customers) = BE

However, in practice, people tend to save money, so the formula is:

Spend(customers) = BE - Savings(customers)

In order for businessmen to create a profit, they have to sell their products at a price higher than their expense, which is BE. However, the above formula shows that this is impossible since the spending ability of workers is at most BE. So how can business men create profit?

More generally, in order for a businessman to create a profit, he has to sell his product at a price the the customer can afford, which simultaneously must be higher than the material/labor cost of producing it.

The value of the product can exceed the cost of material/labor to produce it.

While there may be other issues with your premises, this one, in particular, stands out to me.

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- this is not a homework.

- the article shows by a formula that it is impossible to sell at a higher price than business expense, statistically speaking. Meaning, we are not talking about a particular business, but we are lumping the whole business sector together, and the whole customer sector together. The math shows that there's no net profit.

Edited by Boris Rarden
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Consider a closed capitalist society, say Earth.

[...]

Both government workers and those who can't work receive money from the government (salary and social programs).

Contradiction, no? If not, what do you define as a capitalist society?

There are four kinds of entities:

  • business men
  • workers of capitalists
  • workers of government
  • people who can't work

How do you define "business men," and how are they separate from "workers of capitalists?" Are "business men" people who own companies, and "workers of capitalists" those who engage in productive work but don't own companies? See below.

Lets call the total spending ability of all the people except businessmen as Spend(customers). Whatever money those people have must have come from expenses of the businessmen

By money, do you mean anything of value? The relationship between employer and employee is similar to the relationship between any two traders: each is trading something of value (which he either produced or got in an earlier trade) for something of value from the other guy.

So how does it follow that all of a non-businessman's (a group of which "workers of capitalists" are a part) stuff of value comes from businessmen?"

However, in practice, people tend to save money, so the formula is:

Spend(customers) = BE - Savings(customers)

In order for businessmen to create a profit, they have to sell their products at a price higher than their expense, which is BE. However, the above formula shows that this is impossible since the spending ability of workers is at most BE.

This seems to be your attempt to address what I mentioned above, but shouldn't the minus sign be a plus sign? If customers have a set amount of money to spend, and this money is made up of what they got from businessmen and what they have apart from that, then the formula is:

"customer" money = money from businessmen plus money from elsewhere

I didn't read the rest of your argument because the terms are not clearly enough defined. As far as I can tell, though, you sneak in the idea that value can't be generated by assuming that a person's things of value can only have come from someone else, and use this to demonstrate that value can't be generated.

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- the article shows by a formula that it is impossible to sell at a higher price than business expense, statistically speaking. Meaning, we are not talking about a particular business, but we are lumping the whole business sector together, and the whole customer sector together. The math shows that there's no net profit.

At one time, the formulas used to determine the possibility of flight were applied to the knowledge derived from the observation of bumblebees. It was concluded that bumblebee's 'theoretically' cannot fly.

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Spend(customers) = BE

This equation already assumes that profits are zero. In reality, Spending = BE + Profits, because profits are spent too.

Spend(customers) = BE - Savings(customers)

This equation assumes that savings are "hoarded". In reality, Savings are invested. In other words, they're spent -- often on capital goods rather than on consumer goods. Some economists will argue that Savings will always become Investment, even if only indirectly. One can get into a lot of detail here, but in any case, a better equation would be: Spending for consumption + Investment= BE - Savings
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Boris, your equations seem to assume that the economy is a zero-sum game; that somehow you can put a ceiling on value. This assumption contradicts two facts of reality. The first is that humans are capable of adding value to existing resources (rearanging them, cutting out waste, finding new uses, etc.). The second is the law of comparative advantage. Some goods are actually worth more to some people. That's why people trade. Your equations might be true in an economy where the values of all goods were fixed for all people (edit: and the goods were fixed). That's not the world in which we live.

Edited by FeatherFall
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People trade to mutual benefit. I give you X in exchange for Y, because I value Y higher than X, and you value X higher than Y. They are not of "equal value" because values are agent-relative. We are both better off as a result of the trade. Thus the free market is not a zero-sum game.

Regarding your equations, my signature seems fitting.

Edited by brian0918
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Purchasing power. Your money is worth more as more or improved capital goods enter the economy, either through people being creative or through accessing new natural resources. Then you can pay all your existing expenses with less % of your money and have some left to spend on new things.

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Tyco: you are talking about deflation. Deflation has its own disatvantages (read wikipedia article).

This argument is originally written in russian on this forum: http://worldcrisis.ru/crisis/620469

I took the time to translate it, and thought about it for a while, to come up with my own argument against it.

I agree that capitalism is a zero sum game, that there is no net profit, in terms of money. However, there is a net "profit" of goods. While the economy is working, goods are being created and are accumulated by people, raising their standard of living. Money is only a means to make people work to create those goods, but it is impossible to accumulate it.

All business expenses (B.E.) eventually get back to the business owners. The business owners don't care that net profit is zero, they care about their own profit. This extra money that they temporarily hold keeps the production going, and the money flow out to the next people. So money, are really tokens that are passed around.

In modern world money is constantly inflated, which forces people to buy goods rather than accumulate money in bank accounts. What is going to stop business owners from accumulating money, when that is not prone to inflation ?

I would also like to refer you the other post of mine, about MMM: http://forum.ObjectivismOnline.com/index.php?showtopic=22724&hl=&fromsearch=1

Therefore, the understanding that in a capitalist society money flow is a zero-sum game, forces us to rethink what money should be all about. Money should help to create a chain of contracts based on which people are willing to work. Any accumulated money that sits in some account must come out sooner or later, or it damages the economy.

There seems to be a problem with money altogether. Its true purpose should be a token than can be passed around to make people work (as I have just outlined). However, this enables a pyramid like MMM to exist, where people just pull all the money together and can live off money of joining newcomers -- so the pyramid will grow to occupy the Earth as long as there is enough advertising. There is as strong case to believe that MMM will take over the world. In 9 months it gained 5 million people.

Any kind of anonymous currency, even gold, will be prone to the same kind of pyramid. Do you have any ideas on a better definition of money, that will serve its purpose of being a token that makes people work, however, not allowing systems like MMM exist.

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I agree that capitalism is a zero sum game, that there is no net profit, in terms of money.
What!! This is totally false, and you state it as if you don't need to prove it. Capitalism is not a zero sum game, either in money terms or non-money terms.

The business owners don't care that net profit is zero, they care about their own profit.
Net profits are not zero. You're equivocating on the term "profit". The term has a specific meaning, and aggregate profits across all businesses are not zero.

There seems to be a problem with money altogether. Its true purpose should be a token ...
Money does not need to be a token, but a token can act as money.

There is as strong case to believe that MMM will take over the world. In 9 months it gained 5 million people
There is no semi-seriously case. There is absolutely zero chance that the world will follow what (supposedly, though improbably) a few million nut cases have done.

Any kind of anonymous currency, even gold, will be prone to the same kind of pyramid.
Completely false, and unproven.
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Not necessarily deflation - i said as capital goods increase/improve, people spend a lesser percentage of their income on necessary expenses (or conversely only need a smaller % to spend on luxuries, because they're cheaper). Thus why although LPs cost in dollar amounts much more than they did 40 years ago (due to inflation), people nowadays can afford to buy much more of them. Or why people nowadays carry more computing power in their pocket than what NASA had to control the Apollo moon missions...

All wealth ultimately comes from the mind - people having the intelligence to create, refine or seek out things to improve their life. Money is just a way to facilitate exchange of goods. The true wealth of a society has got nothing to do with how many dollars are accumulating in various accounts - just how much you can buy with those dollars.

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Proud father: I have not received any reasonable argument against the formulas and discussion in my original post.
Your first formula was:

Spend(customers) = BE

This formula assumes that profits are zero.

You then took this and did a few steps to show that profits are zero.

This was completely unnecessary, because it was assumed in your very first formula.

You ended up proving your premise. Well, your conclusion proves your premise, but what is the point of it when your premise is false.

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Boris: what you really need to do is get ahold of George Reisman's "Capitalism" and read chapters 12 to 18, because this covers in extensive detail precisely what you are struggling to understand (for a snapshot, see figure 16-2 on page 732). The clincher is chapter 16 (from whence that snapshot is taken), which discusses his Net Consumption Net Investment theory.

The short answer is that you missed also the consumer spending that comes from dividends distributed to equity investors. They are NOT an expense, but the profits from prior years' efforts that sNerd is trying to tell you to consider. The initial source of these is the built-up savings that equity investors already have, out of which some personal expenditure is made (this, btw, is mistaken by Richard Salsman as making Dr Reisman's argument a type of consumptionism, which it is not). If those savings and expenditures are treated as though they did not exist then, as sNerd points out, you are working on a false premise and so can only "prove" an error.

If you want it, I have an Excel spreadsheet I created (and have Dr Reisman's permission to distribute along with due recognition of his efforts) that shows his NCNI system in action. Money in matches money out, and there are consistent profits year after year. You can fiddle with it as much as you like, expanding it as you see fit to investigate. I'll have to go find it (it is buried deep in my archives somewhere) and then I will upload it to my Google Sites cabinet.

Everyone else: you are missing Boris's point about monetary zero-sum - probably because that poorly-chosen term raises our hackles due to it being emotionally and ideologically loaded. He is not talking about non-monetary values, but the flow of units of media of exchange and trying to figure out where on earth the physical money for profits comes from in the absence of monetary expansion. The change in the real-world value of a unit of that money is a related but still distinct phenomenon. His point on this score is correct, even if he expressed it badly: in the absence of new money, money in must match money out, less that which is added to and plus that which is withdrawn from stores of cash. His problem is in failing to identify where a particular stream of monetary units comes from, and hence why he cannot properly identify the source for an outflow. The consideration of what happens when the money supply grows or shrinks is a later development.

JJM

Edited by John McVey
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Thanks, John. The premise I seemed to have missed is the assumption of fixed monies. While this is itself a fantasy (see mining, bitcoins, choco-pies), I suppose I can accept the premise on an academic level so long as it is used to gain some important knowledge about real economies. You seem to understand the nature of the question better than I do (I'm absolutely no expert). What is that real knowledge we are supposed to discover?

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No Boris, you are not wrong, loosely speaking. Rand advocated fixing monetary units to an external value (such as gold). Capitalist systems would surely use some form of precious-metals trading. But Capitalism as a political system doesn't dictate whether or not new coins will be minted, or even that there will be only one medium of exchange. There could be Capitalist economies that function with competing monetary systems that contract and expand at different rates.

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The point of Dr Reisman's model was to use it as a base from which to develop an understanding of elements, allowing one to expand it from there, one element at a time. Even as it is, without expanding it, one of the things it shows is that capitalism has (in Dr R's words) 'natural springs to profitability,' because when people are free the mathematics of the situation necessarily generates accounting profits in the aggregate, which when tied with the material world upon which accounting figures are based this has to mean physical profits as well. There are only two ways aggregate accounting profits could be zero for a given period - destruction of money and an increase in demand for money - but both of these events only have effects once for each instance, where prices then adjust and the aggregate accounting profits appear again in the next period - unless there is further destruction or demand. (The demand for money is not the desire to have a spendable income but the desire to hold cash unspent, resulting a net build-up of cash stores to higher equilibrium levels).

As to Boris's posts, it is an old variant on an even older claim. The very old claim is that economic liberty necessily leads to crises and depressions - it is a view that goes back many centuries, predating Marx by a long shot (Adam Smith's WoN was intended to refute the mercantlists' claims on this score, and they were not the first either). The variant raised by Boris's article is the claim that accounting profits cannot be generated except by the creation of new money, and in particular through the use of debt as money via the financial sector. Thus this variant is that accounting profits can only be had by continual credit creation, of debt multiplied upon debt. (This should ring bells - with sledge-hammers for knockers, no less - for many with readers with sufficiently long memories.) Eventually there is debt overload, which causes the economy to crash. The crash wipes out the debt and hence allows the process to begin anew.

Allegedly, this is the explanation for what is happening now, made inevitable by capitalism, and that we are approaching the crash phase. Naturally, the argument about the causes of what is happening today is bollocks. There is no need for an expansion of the money supply to create accounting profits, as Dr Reisman points out. Now, it is true that we are nearing a crash set up by a massive set of debts but capitalism is not to blame for this. Just in the private sector alone (ie leaving aside the sovereign debt crises caused by welfare-state profligacy and other things) the present-day multiplication of debt upon debt is the result of central banking, fiat currency, rafts of financial regulations, and various policies (eg various government guarantee mechanisms, such as FDIC & equivalents and the too-big-to-fail idea, plus artificially cheapened debt making yield income harder to get, and so on) that encouraged a degree of risk-taking that would never have been countenanced under laissez-faire capitalism. Governments caused this, not capitalism.

JJM

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Any accumulated money that sits in some account must come out sooner or later, or it damages the economy.

What rights of the economy are you establishing above individual rights?

Accumulated money would be money owned as property of an individual. "Must come out"" Under who's claim upon another?

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